SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE
ACT 1934
For the fiscal year ended December 31, 1999
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 or 15 (d) OF THE SECURITIES
EXCHANGE ACT 1934
For the transition period from ______ to _______ Commission file Number 0-16667
DNB FINANCIAL CORPORATION
(Exact Name of registrant as specified in its charter)
PENNSYLVANIA 23-2222567
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
4 BRANDYWINE AVENUE, DOWNINGTOWN, PENNSYLVANIA 19335
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code
(610) 269-1040
Securities registered pursuant to Section 12 (b) of the Act
NOT APPLICABLE
Securities registered pursuant to Section 12 (g) of the Act
Common stock, par value $1.00 per share
(Title of class)
Indicate by check mark whether the Registrant: (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. [ X ] Yes [ ] No
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ X ] Yes [ ] No
As of March 23, 2000, the aggregate market value of the 1,527,404 shares of
Common Stock of the Registrant issued and outstanding on such date, excluding
218,375 shares beneficially owned by all directors and officers of the
Registrant as a group, was approximately $22.0 million. This figure is based on
the closing sales price of $14.375 per share of the Registrant's Common Stock on
March 22, 2000.
Number of shares of Common Stock outstanding as of March 23, 2000
1,611,339
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the following documents are incorporated by reference
Parts I, III and IV - Proxy Statement for the Annual Meeting of Stockholders to
be held April 25, 2000. Parts II and IV - Annual Report to Stockholders for the
Year Ended December 31, 1999.
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DNB FINANCIAL CORPORATION
Table of Contents
<TABLE>
<CAPTION>
<S> <C>
Part I Page
- ----------------------------------------------------------------------------------------------------
Item 1. Business 3
Item 2. Properties 10
Item 3. Legal Proceedings 11
Item 4. Submission of Matters to a Vote of Security Holders 11
Part II
Item 5. Market for Registrant's Common Equity and Related 11
Stockholder Matters
Item 6. Selected Financial Data 11
Item 7. Management's Discussion and Analysis of Financial 11
Condition and Results of Operations
Item 7a. Quantitative and Qualitative Disclosures About Market Risk 11
Item 8. Financial Statements Supplementary Data 11
Item 9. Changes in and Disagreements with Accountants 11
on Accounting and Financial Disclosure
Part III
Item 10. Directors and Executive Officers of the Registrant 11
Item 11. Executive Compensation 11
Item 12. Security Ownership of Certain 12
Beneficial Owners and Management
Item 13. Certain Relationships and Related Transactions 12
Part IV
Item 14. Exhibits, Financial Statement Schedules, and
Reports on Form 8-K 12
Signatures 14
</TABLE>
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DNB FINANCIAL CORPORATION
FORM 10-K
Part I
Item 1. Business
General
DNB Financial Corporation (the "Registrant"), a Pennsylvania
business corporation, is a bank holding company registered with and
supervised by the Board of Governors of the Federal Reserve System
(Federal Reserve Board). Registrant was incorporated on October 28,
1982 and commenced operations on July 1, 1983 upon consummation of the
acquisition of all of the outstanding stock of The Downingtown National
Bank (the "Bank"). Since commencing operations, Registrant's business
has consisted primarily of managing and supervising the Bank, and its
principal source of income has been dividends paid by the Bank.
Registrant has one wholly-owned subsidiary, the Bank. At December 31,
1999, Registrant had total consolidated assets, total liabilities and
stockholders' equity of $301.3 million, $280.8 million, and $20.5
million, respectively.
The Bank was organized in 1861. The Bank is a national banking
association that is a member of the Federal Reserve System, the
deposits of which are insured by the Federal Deposit Insurance
Corporation ("FDIC"). The Bank is a full service commercial bank
providing a wide range of services to individuals and small to medium
sized businesses in its southeastern Pennsylvania market area,
including accepting time, demand, and savings deposits and making
secured and unsecured commercial, real estate and consumer loans. In
addition, the Bank has one limited service branch and a full-service
Trust and Investment Services Division. The Bank's subsidiary, Downco,
Inc. was incorporated in December, 1995 for the purpose of acquiring
and holding other real estate owned acquired through foreclosure or
deed in lieu of foreclosure and now owns certain Bank-occupied real
estate.
The Bank's legal headquarters are located at 4 Brandywine
Avenue, Downingtown, Pennsylvania. As of December 31, 1999, the Bank
had total assets of $301.3 million, total deposits of $254.9 million
and total stockholders' equity of $20.5 million. The Bank's business is
not seasonal in nature. Its deposits are insured by the FDIC to the
extent provided by law. At December 31, 1999, the Bank had 97 full-time
employees and 12 part-time employees.
The Bank derives its income principally from interest charged
on loans and, to a lesser extent, interest earned on investments and
fees received in connection with the origination of loans and for other
services. The Bank's principal expenses are interest expense on
deposits and borrowings and operating expenses. Funds for activities
are provided principally by operating revenues, deposit growth and the
repayment of outstanding loans.
Competition - Bank
The Bank encounters vigorous competition from a number of
sources, including other commercial banks, thrift institutions, other
financial institutions and financial intermediaries. In addition to
commercial banks, federal and state savings and loan associations,
savings banks, credit unions and industrial savings banks actively
compete in the Bank's market area to provide a wide variety of banking
services. Mortgage banking firms, real estate investment trusts,
finance companies, insurance companies, leasing companies and brokerage
companies, financial affiliates of industrial companies and certain
government agencies
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provide additional competition for loans and for certain financial
services. The Bank also currently competes for interest-bearing funds
with a number of other financial intermediaries which offer a diverse
range of investment alternatives, including brokerage firms and mutual
funds.
Supervision and Regulation - Registrant
Federal Banking Laws
The Registrant is subject to a number of complex Federal
banking laws --- most notably the provisions of the Bank Holding
Company Act of 1956, as amended ("Bank Holding Company Act") and the
Change in Bank Control Act of 1978 ("Change in Control Act"), and to
supervision by the Federal Reserve Board.
Bank Holding Company Act
The Bank Holding Company Act requires a "company" (including
the Registrant) to secure the prior approval of the Federal Reserve
Board before it owns or controls, directly or indirectly, more than
five percent (5%) of the voting shares or substantially all of the
assets of any bank. It also prohibits acquisition by any "company"
(including the Registrant) of more than five percent (5%) of the voting
shares of, or interest in, or all or substantially all of the assets
of, any bank located outside of the state in which a current bank
subsidiary is located unless such acquisition is specifically
authorized by laws of the state in which such bank is located. A "bank
holding company" (including the Registrant) is prohibited from engaging
in or acquiring direct or indirect control of more than five percent
(5%) of the voting shares of any company engaged in non-banking
activities unless the Federal Reserve Board, by order or regulation,
has found such activities to be so closely related to banking or
managing or controlling banks as to be a proper incident thereto. In
making this determination, the Federal Reserve Board considers whether
the performance of these activities by a bank holding company would
offer benefits to the public that outweigh possible adverse effects.
Applications under the Bank Holding Company Act and the Change in
Control Act are subject to review, based upon the record of compliance
of the applicant with the Community Reinvestment Act of 1977 ("CRA").
See further discussion below.
The Registrant is required to file an annual report with the
Federal Reserve Board and any additional information that the Federal
Reserve Board may require pursuant to the Bank Holding Company Act. The
Federal Reserve Board may also make examinations of the Registrant and
any or all of its subsidiaries. Further, under Section 106 of the 1970
amendments to the Bank Holding Company Act and the Federal Reserve
Board's regulations, a bank holding company and its subsidiaries are
prohibited from engaging in certain tie-in arrangements in connection
with any extension of credit or provision of credit or provision of any
property or services. The so-called "anti-tie-in" provisions state
generally that a bank may not extend credit, lease, sell property or
furnish any service to a customer on the condition that the customer
provide additional credit or service to the bank, to its bank holding
company or to any other subsidiary of its bank holding company or on
the condition that the customer not obtain other credit or service from
a competitor of the bank, its bank holding company or any subsidiary of
its bank holding company.
Permitted Non-Banking Activities. The Federal Reserve Board
permits bank holding companies to engage in non-banking activities so
closely related to banking or managing or controlling banks as to be a
proper incident thereto. A number of activities are authorized by
Federal Reserve Board regulation, while other activities require prior
Federal Reserve Board approval. The types of permissible activities are
subject to change by the Federal Reserve Board. Recent revisions to the
Bank Holding Company Act contained in the Federal Gramm-Leach Bliley
Act of 1999 permit certain eligible bank holding companies to qualify
as
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"financial holding companies" and thereupon engage in a wider variety
of financial services such as securities and insurance activities.
Change in Bank Control Act
Under the Change in Control Act, no person, acting directly or
indirectly or through or in concert with one or more other persons, may
acquire "control" of any Federally insured depository institution
unless the appropriate Federal banking agency has been given 60 days
prior written notice of the proposed acquisition and within that period
has not issued a notice disapproving of the proposed acquisition or has
issued written notice of its intent not to disapprove the action. The
period for the agency's disapproval may be extended by the agency. Upon
receiving such notice, the Federal agency is required to provide a copy
to the appropriate state regulatory agency, if the institution of which
control is to be acquired is state chartered, and the Federal agency is
obligated to give due consideration to the views and recommendations of
the state agency. Upon receiving a notice, the Federal agency is also
required to conduct an investigation of each person involved in the
proposed acquisition. Notice of such proposal is to be published and
public comment solicited thereon. A proposal may be disapproved by the
Federal agency if the proposal would have anticompetitive effects, if
the proposal would jeopardize the financial stability of the
institution to be acquired or prejudice the interests of its
depositors, if the competence, experience or integrity of any acquiring
person or proposed management personnel indicates that it would not be
in the interest of depositors or the public to permit such person to
control the institution, if any acquiring person fails to furnish the
Federal agency with all information required by the agency, or if the
Federal agency determines that the proposed transaction would result in
an adverse effect on a deposit insurance fund. In addition, the Change
in Control Act requires that, whenever any Federally insured depository
institution makes a loan or loans secured, or to be secured, by 25% or
more of the outstanding voting stock of a Federally insured depository
institution, the president or chief executive officer of the lending
bank must promptly report such fact to the appropriate Federal banking
agency regulating the institution whose stock secures the loan or
loans.
Pennsylvania Banking Laws
Under the Pennsylvania Banking Code of 1965, as amended ("PA
Code"), the Registrant is permitted to control an unlimited number of
banks, subject to prior approval of the Federal Reserve Board as more
fully described above. The PA Code authorizes reciprocal interstate
banking without any geographic limitation. Reciprocity between states
exists when a foreign state's law authorizes Pennsylvania bank holding
companies to acquire banks or bank holding companies located in that
state on terms and conditions substantially no more restrictive than
those applicable to such an acquisition by a bank holding company
located in that state. Interstate ownership of banks in Pennsylvania
with banks in Delaware, Maryland, New Jersey, Ohio, New York and other
states, is currently authorized. A number of additional states are
considering legislation to authorize reciprocal interstate banking.
(See discussion of 1994 Interstate and PA Banking Legislation on Page
9)
Environmental Laws
The Registrant, the Bank and the Bank's customers are subject
in the course of their activities to a growing number of Federal, state
and local environmental laws and regulations. Neither the Registrant
nor the Bank anticipates that compliance with environmental laws and
regulations will have any material effect on capital expenditures,
earnings, or on its competitive positions.
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Supervision and Regulation - Bank
The operations of the Bank are subject to Federal and State
statutes applicable to banks chartered under the banking laws of the
United States, to members of the Federal Reserve System and to banks
whose deposits are insured by the FDIC. Bank operations are also
subject to regulations of the Office of the Comptroller of the Currency
("OCC"), the Federal Reserve Board and the FDIC.
The primary supervisory authority of the Bank is the OCC, who
regularly examines the Bank. The OCC has the authority to prevent a
national bank from engaging in an unsafe or unsound practice in
conducting its business.
Federal and state banking laws and regulations govern, among
other things, the scope of a bank's business, the investments a bank
may make, the reserves against deposits a bank must maintain, loans a
bank makes and collateral it takes, the activities of a bank with
respect to mergers and consolidations and the establishment of
branches. All nationally and state-chartered banks in Pennsylvania are
permitted to maintain branch offices in any county of the state.
National bank branches may be established only after approval by the
OCC. It is the general policy of the OCC to approve applications to
establish and operate domestic branches, including ATMs and other
automated devices that take deposits, provided that approval would not
violate applicable Federal or state laws regarding the establishment of
such branches. The OCC reserves the right to deny an application or
grant approval subject to conditions if (1) there are significant
supervisory concerns with respect to the applicant or affiliated
organizations, (2) in accordance with CRA, the applicant's record of
helping meet the credit needs of its entire community, including low
and moderate income neighborhoods, consistent with safe and sound
operation, is less than satisfactory, or (3) any financial or other
business arrangement, direct or indirect, involving the proposed branch
or device and bank "insiders" (directors, officers, employees and
10%-or-greater shareholders) involves terms and conditions more
favorable to the insiders than would be available in a comparable
transaction with unrelated parties.
The Bank, as a subsidiary of a bank holding company, is
subject to certain restrictions imposed by the Federal Reserve Act on
any extensions of credit to the bank holding company or its
subsidiaries, on investments in the stock or other securities of the
bank holding company or its subsidiaries and on taking such stock or
securities as collateral for loans. The Federal Reserve Act and Federal
Reserve Board regulations also place certain limitations and reporting
requirements on extensions of credit by a bank to principal
shareholders of its parent holding company, among others, and to
related interests of such principal shareholders. In addition, such
legislation and regulations may affect the terms upon which any person
becoming a principal shareholder of a holding company may obtain credit
from banks with which the subsidiary bank maintains a correspondent
relationship.
Prompt Corrective Action - Federal banking law mandates
certain "prompt corrective actions" which Federal banking agencies are
required to take, and certain actions which they have discretion to
take, based upon the capital category into which a Federally regulated
depository institution falls. Regulations have been adopted by the
Federal bank regulatory agencies setting forth detailed procedures and
criteria for implementing prompt corrective action in the case of any
institution which is not adequately capitalized. Under the rules, an
institution will be deemed to be "adequately capitalized" or better if
it exceeds the minimum Federal regulatory capital requirements.
However, it will be deemed "undercapitalized" if it fails to meet the
minimum capital requirements, "significantly undercapitalized" if it
has a total risk-based capital ratio that is less than 6.0%, a Tier 1
risk-based capital ratio that is less than 3.0%, or a leverage ratio
that is less than 3.0%, and "critically undercapitalized" if the
institution has a ratio of tangible equity to total assets that is
equal to or less than 2.0%. The rules require an undercapitalized
institution to file a written capital restoration plan, along
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with a performance guaranty by its holding company or a third party. In
addition, an undercapitalized institution becomes subject to certain
automatic restrictions including a prohibition on the payment of
dividends, a limitation on asset growth and expansion, and in certain
cases, a limitation on the payment of bonuses or raises to senior
executive officers, and a prohibition on the payment of certain
"management fees" to any "controlling person". Institutions that are
classified as undercapitalized are also subject to certain additional
supervisory actions, including increased reporting burdens and
regulatory monitoring, a limitation on the institution's ability to
make acquisitions, open new branch offices, or engage in new lines of
business, obligations to raise additional capital, restrictions on
transactions with affiliates, and restrictions on interest rates paid
by the institution on deposits. In certain cases, bank regulatory
agencies may require replacement of senior executive officers or
directors, or sale of the institution to a willing purchaser. If an
institution is deemed to be "critically undercapitalized" and continues
in that category for four quarters, the statute requires, with certain
narrowly limited exceptions, that the institution be placed in
receivership.
Under the Federal Deposit Insurance Act, the OCC possesses the
power to prohibit institutions regulated by it, such as the Bank, from
engaging in any activity that would be an unsafe and unsound banking
practice and in violation of the law. Moreover, Federal law enactments
have expanded the circumstances under which officers or directors of a
bank may be removed by the institution's Federal supervisory agency;
restricted and further regulated lending by a bank to its executive
officers, directors, principal shareholders or related interests
thereof; and restricted management personnel of a bank from serving as
directors or in other management positions with certain depository
institutions whose assets exceed a specified amount or which have an
office within a specified geographic area; and restricted management
personnel from borrowing from another institution that has a
correspondent relationship with their bank.
Capital Rules. Pursuant to The Financial Institutions Reform,
Recovery and Enforcement Act of 1989 ("FIRREA") and the laws it
amended, the Federal banking agencies have issued certain "risk-based
capital" guidelines, which supplemented existing capital requirements.
In addition, the OCC imposes certain "leverage" requirements on
national banks such as the Bank. Banking regulators have authority to
require higher minimum capital ratios for an individual bank or bank
holding company in view of its circumstances.
The risk-based guidelines require all banks and bank holding
companies to maintain two "risk-weighted assets" ratios. The first is a
minimum ratio of total capital ("Tier 1" and "Tier 2" capital) to
risk-weighted assets equal to 8.00%; the second is a minimum ratio of
"Tier 1" capital to risk-weighted assets equal to 4.00%. Assets are
assigned to five risk categories, with higher levels of capital being
required for the categories perceived as representing greater risk. In
making the calculation, certain intangible assets must be deducted from
the capital base. The risk-based capital rules are designed to make
regulatory capital requirements more sensitive to differences in risk
profiles among banks and bank holding companies and to minimize
disincentives for holding liquid assets.
The risk-based capital rules also account for interest rate
risk. Institutions with interest rate risk exposure above a normal
level, would be required to hold extra capital in proportion to that
risk. A bank's exposure to declines in the economic value of its
capital due to changes in interest rates is a factor that the banking
agencies will consider in evaluating a bank's capital adequacy. The
rule does not codify an explicit minimum capital charge for interest
rate risk. The Bank currently monitors and manages its assets and
liabilities for interest rate risk, and management believes that the
interest rate risk rules which have been implemented and proposed will
not materially adversely affect the Bank's operations.
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The OCC's "leverage" ratio rules require national banks which
are rated the highest by the OCC in the composite areas of capital,
asset quality, management, earnings and liquidity to maintain a ratio
of "Tier 1" capital to "adjusted total assets" (equal to the bank's
average total assets as stated in its most recent quarterly Call Report
filed with the OCC, minus end-of-quarter intangible assets that are
deducted from Tier 1 capital) of not less than 3.00%. For banks which
are not the most highly rated, the minimum "leverage" ratio will range
from 4.00% to 5.00%, or higher at the discretion of the OCC, and is
required to be at a level commensurate with the nature of the riskiness
of the bank's condition and activities.
For purposes of the capital requirements, "Tier 1" or "core"
capital is defined to include common stockholders' equity and certain
noncumulative perpetual preferred stock and related surplus. "Tier 2"
or "qualifying supplementary" capital is defined to include a bank's
allowance for loan and lease losses up to 1.25% of risk-weighted
assets, plus certain types of preferred stock and related surplus,
certain "hybrid capital instruments" and certain term subordinated debt
instruments.
The Bank is in compliance with each of these capital rules,
and as of December 31, 1999 the required ratios and the Bank's actual
ratios are as follows:
<TABLE>
<CAPTION>
Capital Rule Required Ratio Bank's Ratio Excess
<S> <C> <C> <C>
Tier 1 Risk-Based Capital 4.00% 10.47% 6.47%
Total (Tiers 1 and 2)
Risk-Based Capital 8.00 11.74 3.74
Leverage Ratio 4.00 7.26 3.26
</TABLE>
On the basis of an analysis of the rules and the projected
composition of the Registrant's consolidated assets and the risks
presented by the Bank's activities, it is not expected that the
foregoing capital rules will have a material effect on the Registrant's
business and capital plans.
Deposit Insurance Assessments. All Federally insured
depository institutions pay special assessments toward the funding of
interest payments on FICO bonds which were issued in 1989 to fund the
savings and loan bailout. The special assessments, which were effective
for periods commencing January 1, 1997, are calculated on a
deposit-by-deposit basis and differs depending upon whether a deposit
is insured by SAIF or BIF. Currently, the special assessment rates are
6.1 basis points on all SAIF-assessable deposits, and 20% of that rate,
or approximately 1.2 basis points, on all BIF-assessable deposits,
regardless of whether an institution is a "bank", a "savings
association". After December 31, 1999, all assessable deposits at all
institutions will be assessed at the same rates in order to pay FICO
bond interest.
The FDIC sets deposit insurance assessment rates on a
semiannual basis. The FDIC has authority to reduce the assessment rates
whenever the ratio of its reserves to insured deposits is equal to or
greater than 1.25%, and to increase deposit insurance assessments
whenever that ratio is less than 1.25%.
An institution's semiannual deposit insurance assessment is
computed primarily by multiplying its "average assessment base"
(generally, total insurable domestic deposits) for the prior semiannual
period by one-half the annual assessment rate applicable to that
institution depending upon its risk category, which is based
principally on two measures of risk. These measures involve capital and
supervisory factors.
For the capital measure, institutions are assigned
semiannually to one of three capital groups according to their levels
of supervisory capital as reported on their Call Reports: "well
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capitalized" (group 1), "adequately capitalized" (group 2) and
"undercapitalized" (group 3). The capital ratio standards for
classifying an institution in one of these three groups are total
risk-based capital ratio (10 percent or greater for group 1, and
between 8 and 10 percent for group 2), the Tier 1 risk-based capital
ratio (6 percent or greater for group 1, and between 4 and 6 percent
for group 2), and the leverage capital ratio (5 percent or greater for
group 1, between 4 and 5 percent for group 2). Management believes that
the Bank has met the definition of "well capitalized" for regulatory
purposes on December 31, 1999 and thereafter.
Within each capital group, institutions are assigned to one of
three supervisory risk subgroups --subgroup A, B, or C, depending upon
an assessment of the institution's perceived risk based upon the
results of its most recent examination and other information available
to regulators. Subgroup A will consist of financially sound
institutions with only a few minor weaknesses. Subgroup B will consist
of institutions that demonstrate weaknesses which, if not corrected,
could result in significant deterioration of the institution and
increased risk of loss to the BIF. Subgroup C will consist of
institutions that pose a substantial probability of loss to the deposit
insurance fund unless effective corrective action is taken. Thus, there
are nine possible classifications to which varying assessment rates are
applicable. The regulation generally prohibits institutions from
disclosing their subgroup assignments or assessment risk
classifications without FDIC authorization.
The following table sets forth the current BIF assessment
rates by capital group and supervisory risk subgroup (with no minimum
assessment amount):
Supervisory subgroup
Capital Group A B C
------------- ---------------------------
1 0 3 17
2 3 10 24
3 10 24 27
Interstate Banking - Federal law permits interstate bank
mergers and acquisitions. Limited branch purchases are still subject to
state laws. Pennsylvania law permits out-of-state banking institutions
to establish branches in Pennsylvania with the approval of the
Pennsylvania Banking Department, provided the law of the state where
the banking institution is located would permit a Pennsylvania banking
institution to establish and maintain a branch in that state on
substantially similar terms and conditions. It also permits
Pennsylvania banking institutions to maintain branches in other states.
Bank management anticipates that interstate banking will continue to
increase competitive pressures in the Bank's market by permitting entry
of additional competitors, but management is of the opinion that this
will not have a material impact upon the anticipated results of
operations of the Bank.
Under the Bank Secrecy Act ("BSA"), the Bank is required to
report to the Internal Revenue Service, currency transactions of more
than $10,000 or multiple transactions of which the Bank is aware in any
one day that aggregate in excess of $10,000. Civil and criminal
penalties are provided under the BSA for failure to file a required
report, for failure to supply information required by the BSA or for
filing a false or fraudulent report.
Under the Community Reinvestment Act of 1977 ("CRA"), the
record of a bank holding company and its subsidiary banks must be
considered by the appropriate Federal banking agencies, including the
Federal Reserve and the OCC, in reviewing and approving or disapproving
a variety of regulatory applications including approval of a branch or
other deposit facility, office relocation, a merger and certain
acquisitions of bank shares. Federal banking agencies have recently
demonstrated an increased readiness to deny applications based on
unsatisfactory CRA performance. The OCC is required to assess the
record of the Bank to determine if it is meeting the credit needs of
the community (including low and moderate neighborhoods) which it
serves. FIRREA amended the CRA to require, among other
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things, that the OCC make publicly available an evaluation of the
Bank's record of meeting the credit needs of its entire community
including low- and moderate-income neighborhoods. This evaluation
includes a descriptive rating (outstanding, satisfactory, needs to
improve, or substantial noncompliance) and a statement describing the
basis for the rating.
The Bank is subject to a variety of consumer protection laws,
including the Truth in Lending Act, the Truth in Savings Act adopted as
part of the Federal Deposit Insurance Corporation Improvement Act of
1991 ("FDICIA"), the Equal Credit Opportunity Act, the Home Mortgage
Disclosure Act, the Electronic Funds Transfer Act, the Real Estate
Settlement Procedures Act and the regulations adopted thereunder. In
the aggregate, compliance with these consumer protection laws and
regulations involves substantial expense and administrative time on the
part of the Bank and the Registrant.
Legislation and Regulatory Changes - From time to time,
legislation is enacted which has the effect of increasing the cost of
doing business, limiting or expanding permissible activities and/or
affecting the competitive balance between banks and other financial
institutions. Proposals to change the laws and regulations governing
the operations and taxation of banks, bank holding companies and other
financial institutions are frequently made in Congress, and before
various bank regulatory agencies. No prediction can be made as to the
likelihood of any major changes or the impact such changes might have
on the Registrant and its subsidiary Bank.
Effect of Government Monetary Policies - The earnings of the
Registrant are and will be affected by domestic economic conditions and
the monetary and fiscal policies of the United States Government and
its agencies (particularly the Federal Reserve Board). The monetary
policies of the Federal Reserve Board have had and will likely continue
to have, an important impact on the operating results of commercial
banks through its power to implement national monetary policy in order,
among other things, to curb inflation or combat a recession. The
Federal Reserve Board has a major effect upon the levels of bank loans,
investments and deposits through its open market operations in United
States Government securities and through its regulation of, among other
things, the discount rate on borrowing of member banks and the reserve
requirements against member bank deposits. It is not possible to
predict the nature and impact of future changes in monetary and fiscal
policies.
Item 2. Properties
The main office of the Bank is located at 4 Brandywine Avenue,
Downingtown, Pennsylvania 19335. The Registrant's registered office is
also at this location. The Registrant pays no rent or other form of
consideration for the use of the Bank's main office as its principal
executive office. The Bank also has an operations center located at 104
Brandywine Avenue, Downingtown. With the exception of the West Goshen
office and a limited service office at Tel Hai, both of which are
leased, the Bank owns all of its existing branches as described below
which had a net book value of $3.7 million including leasehold
improvements at December 31, 1999.
The bank has eight full service offices located in Chester
County, Pennsylvania. In addition to the Main Office discussed above,
they are: Little Washington Office (Intersection of Route 322 and
Little Washington Road, Downingtown), East End Office (701 East
Lancaster Avenue, Downingtown), Lionville Office (Intersection of Route
100 and Welsh Pool Road, Exton), Ludwig's Corner Office (Intersection
of Routes 100 and 401, Uwchland), Caln Office (1835 East Lincoln
Highway, Coatesville), West Goshen Office (1115 West Chester Pike, West
Chester), Kennett Square Office (215 E. Cypress St., Kennett Square).
The Bank also has a limited service office at Tel Hai Retirement
Community (Beaver Dam Road, Honey Brook. The Bank has also received OCC
approval for a de novo full service office at 111 East Lincoln Highway,
Exton, PA. The Bank anticipates a third quarter 2000 opening of this
facility.
10
<PAGE>
Item 3. Legal Proceedings
DNB is a party to a number of lawsuits arising in the ordinary
course of business. While any litigation causes an element of
uncertainty, management is of the opinion that the liability, if any,
resulting from the actions, will not have a material effect on the
accompanying financial statements.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable.
Part II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters
The information required herein is incorporated by reference
in the Registrant's Annual Report to Stockholders ("Annual Report") for
the fiscal year ended December 31, 1999 at page 19 filed as Exhibit 13.
Item 6. Selected Financial Data
The information required herein is incorporated by reference
in the Registrant's Annual Report for the year ended December 31, 1999
at page 1 filed as Exhibit 13.
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations
The information required herein is incorporated by reference
in the Registrant's Annual Report for the year ended December 31, 1999
from pages 4 to 20 filed as Exhibit 13.
Item 7a. Quantitative and Qualitative Disclosures About Market Risk
The information required by this item is incorporated herein
by reference to pages 16 and 17 of Registrant's 1999 Annual Report to
Shareholders attached to this filing as Exhibit 13.
Item 8. Financial Statements and Supplementary Data
The information required herein is incorporated by reference
in the Registrant's Annual Report for the year ended December 31, 1999
from pages 21 to 41 filed as Exhibit 13.
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure
None
Part III
Item 10. Directors and Executive Officers of the Registrant
The information required herein is incorporated by reference
in the Registrant's Proxy Statement from pages 4 to 6 filed as Exhibit
22.
Item 11. Executive Compensation
The information required herein is incorporated by reference
in the Registrant's Proxy Statement from pages 6 to 9 filed as Exhibit
22.
11
<PAGE>
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information required herein is incorporated by reference
in the Registrant's Proxy Statement at page 2 filed as Exhibit 22.
Item 13. Certain Relationships and Related Transactions
The information required herein is incorporated by reference
in the Registrant's Proxy Statement at page 9 filed as Exhibit 22.
Part IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(A) Documents filed as part of this report
(1.) The Annual Report to Stockholders of the Registrant
for the year ended December 31, 1999.
(2.) All schedules are omitted because they are not
applicable or the required information is shown in
the financial statements or notes thereto.
(3.) Exhibits, pursuant to Item 601 of Regulation S-K.
Exhibit Number
Referred to
Item 601 of
Regulation S-K Description of Exhibit
---------------- ----------------------
3.1 Articles of Incorporation filed on March 31, 1989, at
Exhibit 3.1 to Form 10-K for the fiscal year ended
December 31, 1988 (No. 0-16667) and hereby
incorporated by reference
3.2 Amended By-laws of the Registrant filed on January 8,
1990, at Item 7C to Form 8-K, date of report,
January 3, 1990 (No. 0-16667) and hereby
incorporated by reference
3.3 Amended Articles of Incorporation filed on May 2, 1990,
at Item 7C to Form 8-K, date of report, April 26, 1990
(No. 0-16667) and hereby incorporated by reference.
3.4 Amended by-laws of the Registrant filed on July 20,
1990, at Item 7C to Form 8-K, date of report July 18,
1990 (No. 0-16667) and hereby incorporated by
reference.
3.5 Amended Articles of Incorporation of the Registrant
effective May 18, 1998, filed on March 26, 1999 at Item
3.5 to Form 10-K for the fiscal year ended December 31,
1999, and hereby incorporated by reference.
10.1 Employment agreement between Downingtown National Bank
and Henry F. Thorne dated December 31, 1996, filed on
March 26, 1999 at Item 10.1 to Form 10-K for the fiscal
year ended December 31, 1999, and hereby incorporated by
reference.
12
<PAGE>
10.2 Form of Change of Control Agreements dated May 5, 1998
between DNB Financial Corporation and Downingtown
National Bank and the following executive officers:
Richard L. Bergey; Ronald K. Dankanich; J. William Erb;
Eileen M. Knott; Bruce E. Moroney and Joseph M.
Stauffer, filed on March 26, 1999 at Item 10.2 to Form
10-K for the fiscal year ended December 31, 1999, and
hereby incorporated by reference.
10.3 One branch purchase and assumption agreement between
Keystone Financial Bank, NA as Seller and Downingtown
National Bank as Purchaser as of January 6, 1998 - 215
East Cypress Street, Kennett Square, Chester County, PA,
filed on March 26, 1999 at Item 10.3 to Form 10-K for
the fiscal year ended December 31, 1999, and hereby
incorporated by reference.
11 Statement of Computation of earnings per share, see
footnote #11 in Annual Report of the Registrant for the
year ended December 31, 1999, attached hereto as Exhibit
13 and incorporated herein by reference.
13 Annual Report to Stockholders for the year ended
December 31, 1999 (This document shall be deemed to have
been "Filed" only to the extent of the material
incorporated herein by reference)
21 List of Subsidiaries.
22 Proxy Statement for the Annual Meeting of Stockholders
to be held April 25, 2000 and hereby incorporated by
reference
23 Consent of KPMG LLP, Independent Certified Public
Accountants dated March 21, 2000 to S-8 Registration
Statement
27 Financial Data Schedule
(B) Reports on Form 8-K
Not applicable
(C) The exhibits required to be filed pursuant to this item are
listed above under Item 14(a)(3).
(D) Not Applicable
13
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the Registrant has duly caused this
report to be signed on its behalf by the undersigned, thereunto duly
authorized.
DNB FINANCIAL CORPORATION
March 23, 2000
BY: /s/ Henry F. Thorne
Henry F. Thorne,
President and
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of
1934, this Form 10-K has been signed below by the following persons and
on behalf of the Registrant and in the capacities and on the dates
indicated.
/s/ Henry F. Thorne March 23, 2000
---------------------------------------
Henry F. Thorne, President,
Chief Executive Officer and Director
/s/ Bruce E. Moroney March 23, 2000
---------------------------------------
Bruce E. Moroney
Chief Financial Officer
(Principal Accounting Officer)
/s/ Robert J. Charles March 23, 2000
---------------------------------------
Robert J. Charles
Chairman of the Board
/s/ Vernon J. Jameson March 23, 2000
---------------------------------------
Vernon J. Jameson
Vice-Chairman of the Board
/s/ Thomas R. Greenleaf March 23, 2000
---------------------------------------
Thomas R. Greenleaf
Director
/s/ William S. Latoff March 23, 2000
---------------------------------------
William S. Latoff
Director
/s/ Joseph G. Riper March 23, 2000
---------------------------------------
Joseph G. Riper
Director
/s/Louis N. Teti March 23, 2000
---------------------------------------
Louis N. Teti
Director
/s/James H. Thornton March 23, 2000
---------------------------------------
James H. Thornton
Director
14
DNB Financial Corporation and Subsidiary
Corporate Profile
Downingtown National Bank is Chester County's oldest, locally-owned,
independent commercial bank. We have been an important part of our community in
the heart of Chester County since our founding on May 16, 1861.
We remain committed to building solid banking relationships, to providing
excellent customer service and to achieving above average returns for our
stockholders.
As involved citizens, we donate our services, volunteer our skills, and
commit charitable resources toward improving the community in which we live and
work.
Table of Contents
1 Selected Financial Data
2 Letter to Shareholders
4 Management's Discussion and Analysis of
Financial Condition and Results of
Operations
19 Market for Common Stock
21 Consolidated Financial Statements and
Notes
42 Corporate Information
<PAGE>
DNB FINANCIAL CORPORATION AND SUBSIDIARY
Selected Financial Data (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
At or For the Year Ended December 31
1999 1998 1997 1996 1995
====================================================================================================================
<S> <C> <C> <C> <C> <C>
RESULTS OF OPERATIONS
Interest income $ 20,500 $ 17,903 $ 16,364 $ 15,162 $ 13,996
Interest expense 9,825 8,266 6,984 6,459 5,788
- --------------------------------------------------------------------------------------------------------------------
Net interest income 10,675 9,637 9,380 8,703 8,208
Provision for loan losses -- -- -- -- --
Non-interest income 1,634 1,506 1,283 1,004 814
Non-interest expense 8,231 6,969 7,083 6,731 6,983
- --------------------------------------------------------------------------------------------------------------------
Income before income taxes 4,078 4,174 3,580 2,976 2,039
- --------------------------------------------------------------------------------------------------------------------
Income tax expense 1,246 1,252 865 658 169
- --------------------------------------------------------------------------------------------------------------------
Net income $ 2,832 $ 2,922 $ 2,715 $ 2,318 $ 1,870
- --------------------------------------------------------------------------------------------------------------------
PER SHARE DATA*
Basic earnings $ 1.77 $ 1.83 $ 1.70 $ 1.45 $ 1.17
Diluted earnings 1.72 1.77 1.66 1.44 1.17
Cash dividends 0.50 0.44 0.38 0.23 0.08
Book value 12.76 12.87 11.47 10.13 8.97
Weighted average
Common shares outstanding 1,603,566 1,600,521 1,600,243 1,600,243 1,600,243
FINANCIAL CONDITION
Total assets $301,349 $265,418 $219,451 $207,128 $188,781
Loans, less unearned income 171,456 148,726 129,954 121,573 117,886
Allowance for loan losses 5,085 5,205 5,281 5,112 5,515
Deposits 254,881 225,373 199,237 178,424 165,009
Stockholders' equity 20,538 20,606 18,356 16,216 14,355
SELECTED RATIOS
Return on average stockholders' equity 13.66% 15.13% 15.77% 15.35% 14.01%
Return on average assets 0.99 1.22 1.29 1.18 1.04
Average equity to average assets 7.28 8.07 8.21 7.65 7.40
Loans to deposits 67.27 65.99 65.22 68.14 71.44
Dividend payout ratio 28.07 23.85 22.41 15.63 6.71
====================================================================================================================
* Per share data and shares outstanding have been adjusted for the 2 for 1 stock
split in September 1997 and for the 5% stock dividends in December of 1999,
1998, 1997, 1996 and 1995.
====================================================================================================================
</TABLE>
1
<PAGE>
DNB FINANCIAL CORPORATION AND SUBSIDIARY
Letter to Shareholders
March 24, 2000
Dear Fellow Shareholder:
I am pleased to report that 1999 was another very good year for the Bank.
While we did not exceed the record earnings we achieved in 1998, we did do
better than our original budget projections -- and 1999 still represented the
second best year of earnings in our 138-year history.
In my letter to you last year, I indicated that 1999 would represent a
challenge to the Bank's earnings momentum because of continuing strong
competitive pressures, an interest rate environment that would limit our
investment opportunities, and our planned investments in branch expansion and
new technology. Despite these tough circumstances, we did do better than
expected, and we achieved several milestones in the process. Our total assets
exceeded $300 million for the first time, which represented an increase of 14%
from the prior year. Total deposits and borrowings were $278 million, including
$9 million of deposits acquired in the purchase of our Kennett Square branch,
resulting in an increase of 15% from December 31, 1998. Loan demand also
remained strong throughout the year enabling us to grow the loan portfolio by
15% to $172 million. This growth was achieved despite the sale of $2 million in
fixed rate loans to another local bank at year-end, which we participated in an
effort to better manage our interest rate risk and to develop future business
development opportunities.
We were especially pleased with the successful openings of our Kennett
Square branch in March and our West Goshen branch in May. We were fortunate to
have acquired an experienced, sales-oriented staff who have helped to make the
opening of our seventh and eighth offices a great success. We are very pleased
with the initial performance of both offices, and we have been well received by
customers - old and new - in both communities. Plans for our ninth office at the
site of the former Guernsey Cow on the Exton Square Mall property have been
completed. We expect to begin work on the adaptive reuse of this landmark
building shortly, and we hope to be open for business in the third quarter. In
addition to a full-service branch with four drive-up windows, the building will
also be home to our Investment Services and Trust Division.
During the year, the Bank continued with the implementation of its
Technology Plan, which proved to be a more significant challenge than originally
expected. A great deal of effort was expended to ensure that the
state-of-the-art system works reliably and provides the enhanced customer
service delivery platform that we expected. We are very pleased with the results
of our efforts and in our decision to upgrade hardware and software capabilities
further as we went along. We still have work to do, but we expect everything to
be completed during the second quarter. The system has already enabled us to
improve our workflow, and we believe that the decisions we made will position us
very well to take advantage of the changes that are occurring in the delivery of
traditional banking services. We are in the process now of evaluating the local
demand for Internet banking services and of developing a "best of class"
e-banking service - something that would not have been possible without our
recent efforts to upgrade technology. The challenge for us will be to meet our
customers' needs for alternative delivery channels while earning the required
return on our investment.
We are also looking at several approaches to broaden our offering of
non-traditional banking services to include the sale of mutual funds, annuities,
insurance and discount brokerage
[GRAPHIC OMITTED]
2
<PAGE>
Letter to Shareholders
- --------------------------------------------------------------------------------
services. Again the challenge will be to develop an approach that will enable us
to offer real value to our customers and to earn an appropriate return on our
investment of time and money as well. The recent passage of the financial
modernization bill, known as the Gramm-Leach-Bliley Act, will redefine the way
financial services are provided in the future. The barriers that separated
banking, insurance and securities in the past have now been eliminated. The new
challenge for all bankers will be to develop ways to improve efficiency,
customer service and innovation in the delivery of financial services. We
believe this new legislation will provide expanded opportunities for the Bank to
broaden its offering of financial services to customers.
I am pleased to report that our efforts to prepare for problems related to
the date change on January 1, 2000 were successful, and we entered the new
millennium with confidence that service to our customers would continue
uninterrupted. Our endeavor to be fully prepared, however, took considerable
time and effort during the past year, so I am especially pleased that the
challenge is behind us and that we can now spend our energies more profitably.
One of the outcomes of the focus on Y2K is an enhanced awareness on the part of
all banks for the potential of new technology to meet customer needs. We expect
that this awareness will result in new competitive pressures as our peers also
attempt to leverage their knowledge of, and investment in, these technologies to
develop new products and services for customers - including an increased
emphasis on Internet banking.
During 1999, the Bank earned $2,831,800, or $1.72 per share, compared to a
profit of $2,922,300, or $1.77 per share, for 1998. Although earnings were down
from the prior record year as expected, they continue to reflect the benefits of
strong loan demand as well as good growth in non-interest income, which
increased by 8.5% to $1,634,000 from $1,506,000 in the prior year. Net interest
income increased 10.8% during the same period while non-interest expense
increased 18.1% as a result of the investments in new branches and technology I
mentioned earlier.
Return on average equity compared favorably to peers at 13.7%, although it
was down from the prior year reflecting the decline in earnings as well as the
growth in our average capital base. Return on average assets was just under
0.99% for the period compared to 1.22% for 1998. The quarterly cash dividend was
increased in the first quarter to $0.13 per share, demonstrating our continued
confidence in the Bank's future along with a desire to manage our capital
resources to provide a good return for our shareholders and to support future
growth. On December 23rd, we also paid our sixth consecutive 5% stock dividend,
which we believe enhances shareholder value over the long term.
Last year was a challenging time for the Bank as we made significant
investments in our future. The first year in the new millennium will present its
own set of challenges. Banks will continue to see pressure on their net interest
margins as competition for loans and deposits remains intense, and the effort to
diversify revenues by developing more fee-based product offerings will become
even more important. Fortunately, our location in Chester County and our loyal
customer base provides us with an excellent opportunity to continue our success.
We are excited about our prospects and we remain committed to our belief that a
well-regarded community bank, with its ability to meet changing customer needs
and wants in a flexible and responsive manner, can survive and prosper.
At the Chester County Chamber of Business and Industry's Small Business
Dinner held on November 4, 1999, I was honored to receive the Small Business
Leader of the Year award. I accepted this prestigious award on behalf of our
Bank family - directors, officers, employees and loyal customers - who have been
responsible for the success the Bank has enjoyed.
Again, I want to express my appreciation to our directors, officers and
employees who remain dedicated to the goal of helping us become the best
community bank serving Chester County.
Sincerely,
/s/ Henry F. Thorne
Henry F. Thorne
President and Chief Executive Officer
3
<PAGE>
Management's Discussion and Analysis
of Financial Condition and Results of Operations
The following discussion provides an overview of the financial condition
and results of operations of DNB Financial Corporation (the "Corporation" or
"DNB") and its wholly owned subsidiary, Downingtown National Bank (the "Bank")
which is managed as a single operating segment. This discussion should be read
in conjunction with the Corporation's consolidated financial statements
presented elsewhere in this annual report.
Results of Operations
Summary of Performance
For the year ended December 31, 1999, DNB reported net income of $2.8
million or $1.72 per share on a diluted basis. This represents a $90,000 or 3%
decrease from $2.9 million or $1.77 per share in 1998. Earnings before taxes
decreased $96,000 or 2% to $4.1 million from $4.2 million in 1998. For the year
ended December 31, 1997, net income was $2.7 million or $1.66 per share, and
income before taxes was $3.6 million.
Interest income grew $2.6 million or 15% to $20.5 million for the year
ended December 31, 1999. Significant growth in loans and investments contributed
to the increase in interest income over the prior year. Interest expense
increased $1.6 million or 19% to $9.8 million for the year ended December 31,
1999. Interest bearing liabilities increased in all categories. Net interest
income increased by $1.1 million or 11% to $10.7 million in 1999. Net interest
income was $9.6 million and $9.4 million in 1998 and 1997, respectively.
Non-interest income was $1.6 million for the year ended December 31, 1999.
Non-interest income for 1998 and 1997 was $1.5 million and $1.3 million,
respectively. The $128,000 or 8% increase in 1999 was primarily the result of
increased service charge and other fee income.
Non-interest expense was $8.2 million for the year ended December 31,
1999. This represented a $1.3 million or 18% increase from $7.0 million in 1998.
Non-interest expense in 1997 was $7.1 million. The significant increase in
operating expenses in 1999 reflects DNB's branch expansion into two new market
areas during the year. Increased levels of salaries & employee benefits,
occupancy, furniture & equipment, advertising & marketing, printing & supplies
and other less significant expenses are a direct result of the new branches. In
addition, DNB made a significant investment in new technology in preparation for
future online and e-banking products.
Net Interest Income
DNB's earnings performance is primarily dependent upon its level of net
interest income, which is the excess of interest revenue over interest expense.
Interest revenue includes interest earned on loans (net of interest reversals on
non-performing loans), investments, Federal funds sold and interest-earning
cash, as well as net loan fee amortization and dividend income. Interest expense
includes the interest cost for deposits, repurchase agreements, Federal funds
purchased and other borrowings.
During 1999, net interest income increased, on a tax equivalent basis,
$1.2 million or 12% to $10.9 million, from $9.7 million in 1998. As shown in the
Rate/Volume Analysis below, the increase in net interest income during 1999 was
due to the positive effects of changes in volume, which was partially offset by
the negative effects of rate changes. The increased volume resulted from
significant loan and investment growth, which exceeded interest-bearing
liability growth by $3.0 million, aided in part by an increase in non-interest
bearing demand balances of $4.8 million. Average loan balances for 1999 rose
$24.9 million, average investment securities rose $25.9 million and Federal
funds sold were down $8.2 million. The impact from higher volumes of earning
assets amounted to an increase of $3.4 million in interest income. Average NOW,
money market and savings accounts increased a total of $21.8 million. Average
time deposits increased $7.5 million ($3 million from public deposits over
$100,000) and borrowings (FHLB advances and lease obligations) increased on
average $10.3 million. The net impact on earnings of higher volumes of
interest-bearing liabilities amounted to $1.5 million, partially offsetting the
impact from the increased volume of interest-earning assets. The overall im-
4
<PAGE>
Management's Discussion and Analysis
- --------------------------------------------------------------------------------
pact of rate changes amounted to a negative $624,000 reflecting strong
competition for loans as well as deposits. Rising interest rates have also
negatively impacted earnings as DNB's deposits repriced earlier while loans and
investments lagged. As a result of these rate pressures, DNB has experienced
declines in both its net interest spread and net interest margin.
During 1998, net interest income increased, on a tax-equivalent basis
$285,000 or 3% to $9.7 million, from $9.4 million in 1997. As shown in the
Rate/Volume Analysis below, the increase in net interest income during 1998 was
due to the positive effects of changes in volume, which was largely offset by
the negative effects of rate changes. The increased volume resulted from overall
earning asset growth, which exceeded interest-bearing liability growth by $5.2
million, aided in part by an increase in non-interest bearing demand balances of
$2.9 million. Average loan balances for 1998 rose $10.2 million, average
investment securities rose $12.2 million and Federal fund sold were up $7.2
million. The impact from higher volumes of earning assets amounted to an
increase of $2.1 million in interest income. Average NOW, money market and
savings accounts increased a total of $10.8 million. Average time deposits
increased $8.7 million (largely in public deposits over $100,000) and borrowings
(repurchase agreements, FHLB advances and Federal funds purchased) increased on
average $5.0 million. The net impact of higher volumes of interest-bearing
liabilities amounted to $1.1 million, significantly offsetting the impact from
the increased volume of interest-earning assets. The overall impact of rate
changes amounted to a negative $716,000 which was precipitated by a flat yield
curve, lower interest rates and strong competition for loans as well as
deposits.
The following tables set forth, among other things, the extent to which
changes in interest rates and changes in the average balances of
interest-earning assets and interest-bearing liabilities have affected interest
income and expense during 1999 and 1998 (tax-exempt yields have been adjusted to
a tax equivalent basis using a 34% tax rate). For each category of
interest-earning assets and interest-bearing liabilities, information is
provided with respect to changes attributable to: (i) changes in rate (change in
rate multiplied by old volume) and (ii) changes in volume (change in volume
multiplied by old rate). The net change attributable to the combined impact of
rate and volume has been allocated proportionately to the change due to rate and
the change due to volume.
<TABLE>
<CAPTION>
Rate / Volume Analysis
(Dollars in thousands)
1999 Versus 1998 1998 Versus 1997
------------------------------------------------------------------------------------
Change Due To Change Due To
Rate Volume Total Rate Volume Total
================================================================================================================================
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans $ (394) $ 2,097 $ 1,703 $ (308) $ 881 $ 573
Investment securities--taxable (156) 1,103 947 (166) 706 540
Investment securities--tax-exempt 3 588 591 -- 83 83
Federal funds sold (52) (420) (472) (21) 392 371
- --------------------------------------------------------------------------------------------------------------------------------
Total $ (599) $ 3,368 $ 2,769 $ (495) $ 2,062 $ 1,567
- --------------------------------------------------------------------------------------------------------------------------------
Interest-bearing liabilities:
Time deposits $ (239) $ 341 $ 102 $ 51 $ 486 $ 537
NOW, money market and savings deposits 183 655 838 179 298 477
FHLB advances 5 539 544 (9) 385 376
Other borrowings 76 -- 76 -- (108) (108)
- --------------------------------------------------------------------------------------------------------------------------------
Total 25 1,535 1,560 221 1,061 1,282
- --------------------------------------------------------------------------------------------------------------------------------
Net interest income $ (624) $ 1,833 $ 1,209 $ (716) $ 1,001 $ 285
- --------------------------------------------------------------------------------------------------------------------------------
</TABLE>
5
<PAGE>
Management's Discussion and Analysis
- --------------------------------------------------------------------------------
The following table provides, for the periods indicated, information
regarding: (i) DNB's average balance sheet; (ii) the total dollar amounts of
interest income from interest-earning assets and the resulting average yields
(tax-exempt yields have been adjusted to a tax equivalent basis using a 34% tax
rate); (iii) the total dollar amounts of interest expense on interest-bearing
liabilities and the resulting average costs; (iv) net interest income; (v) net
interest rate spread; and (vi) net interest margin. Average balances were
calculated based on daily balances. Nonaccrual loan balances are included in
total loans. Loan fees are included in interest on total loans.
Provision for Loan Losses
To provide for potential losses in the loan portfolio, DNB maintains an
allowance for loan losses. To maintain an adequate allowance, man-
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Average Balances, Rates, and Interest Income and Expense
(Dollars in thousands)
Year Ended December 31
1999 1998 1997
Average Yield/ Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate Balance Interest Rate
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
ASSETS
Interest-earning assets:
Investment securities:
Taxable $ 93,441 $ 5,846 6.26% $ 75,714 $ 4,899 6.47% $ 64,676 $ 4,359 6.74%
Tax-exempt 9,423 674 7.16 1,201 83 6.91 -- -- --
- -------------------------------------------------------------------------------------------------------------------------
Total securities 102,864 6,520 6.34 76,915 4,982 6.48 64,676 4,359 6.74
Federal funds sold 7,572 385 5.08 15,766 857 5.44 8,543 486 5.69
Total loans 163,053 13,856 8.50 138,171 12,154 8.80 127,950 11,581 9.05
- -------------------------------------------------------------------------------------------------------------------------
Total interest-earning
assets 273,489 20,761 7.59 230,852 17,993 7.79 201,169 16,426 8.17
Non-interest-earning assets 11,376 8,398 8,553
- -------------------------------------------------------------------------------------------------------------------------
Total assets $284,865 $239,250 $209,722
- -------------------------------------------------------------------------------------------------------------------------
LIABILITIES AND
STOCKHOLDERS' EQUITY
Interest-bearing liabilities:
NOW, money market
and savings deposits $110,180 $ 3,357 3.05% $ 88,384 $ 2,519 2.85% $ 77,609 $ 2,042 2.63%
Time deposits 101,741 5,378 5.29 94,247 5,276 5.60 85,566 4,740 5.54
- -------------------------------------------------------------------------------------------------------------------------
Total interest-bearing
deposits 211,921 8,735 4.12 182,631 7,795 4.27 163,175 6,782 4.16
Federal funds purchased -- -- -- -- -- -- 92 5 5.43
Other borrowings 19,470 1,090 5.60 9,127 471 5.16 4,021 197 4.90
- -------------------------------------------------------------------------------------------------------------------------
Total interest-bearing
liabilities 231,391 9,825 4.25 191,758 8,266 4.31 167,288 6,984 4.17
Demand deposits 31,379 26,588 23,668
Other liabilities 1,362 1,592 1,553
Stockholders' equity 20,733 19,312 17,213
- -------------------------------------------------------------------------------------------------------------------------
Total liabilities and
stockholders' equity $284,865 $239,250 $209,722
=========================================================================================================================
Net interest income $10,936 $ 9,727 $ 9,442
=========================================================================================================================
Interest rate spread 3.34% 3.48% 4.00%
=========================================================================================================================
Net interest margin 4.00% 4.21% 4.69%
=========================================================================================================================
</TABLE>
6
<PAGE>
agement charges the provision for loan losses against income. There were no
provisions made during the three years ended December 31, 1999, since management
determined the allowance for loan losses was adequate based on its analysis and
the level of net charge-offs/recoveries compared to the total allowance. Net
loan charge-offs were $120,000 in 1999, compared to $76,000 in 1998 and net loan
recoveries of $169,000 in 1997. The percentage of net (charge-offs)/recoveries
to total average loans was (0.07)%, (0.06)% and .13% during 1999, 1998 and 1997,
respectively. Another measure of the adequacy of the allowance is the coverage
ratio of the allowance to non-performing loans, which has been in excess of 175%
during this three year period. In addition, the ratio of non-performing loans to
total loans has steadily declined during the period.
Non-Interest Income
Total non-interest income includes service charges on deposit products;
fees received by DNB's Investment Services and Trust Division; and other sources
of income such as net gains on sales of investment securities and other real
estate owned ("OREO") properties, fees for cash management, safe deposit box
rentals, issuing travelers' checks and money orders, check cashing, lock box
services and similar activities.
Non-interest income was $1.6 million in 1999, compared to $1.5 million in
1998 and $1.3 million in 1997. Service charges on deposit accounts increased
$112,000 or 22% to $627,000 in 1999 from $515,000 in 1998 and $469,000 in 1997.
Much of the increase in this category came from non-sufficient funds ("NSF")
fees, which rose $46,000, due to an increase in the volume of accounts as well
as a concerted effort by management to reduce the waived fee percentage on
deposit account overdrafts. In addition, business analysis charges and cycle
charges rose $29,000 and $17,000, respectively, also due to volume.
Trust income was $399,000 in 1999, compared to $430,000 in 1998 and
$416,000 in 1997. The $31,000 or 7% decrease in 1999 was due to a higher volume
of commissions earned on estate settlements in 1998.
Other non-interest income grew $52,000 or 9% to $608,000 for the year
ended December 31, 1999, from $556,000 in 1998. Other non-interest income was
$391,000 in 1997. The increases in this category during 1999 and 1998 were
caused by net gains recognized on the sales of several OREO properties, as well
as increased commissions from DNB's Visa/debit card.
Non-Interest Expense
Non-interest expense includes salaries & employee benefits, furniture &
equipment, occupancy, professional & consulting fees as well as advertising &
marketing, printing & supplies and other less significant expense items.
Non-interest expenses were $8.2 million in 1999, compared to $7.0 million
and $7.1 million in 1998 and 1997, respectively. The increase of $1.2 million or
18% was due primarily to higher levels of expenses in all categories as
discussed below.
Salaries & employee benefits expense totaled $4.3 million in 1999,
compared to $3.9 million in 1998 and $4.0 million in 1997. Salary & employee
benefits expense for 1999 increased as a result of staffing for our two new
branches and back-office processing as well as normal merit increases. The
decrease in salary & employee benefits expense during 1998 over 1997 resulted
from fewer full-time equivalent employees than 1997. In addition, DNB incurred
higher costs for hospitalization and other employee benefits during 1997.
Furniture & equipment expense includes depreciation, rent, maintenance and
miscellaneous purchases of office equipment and furniture. Furniture & equipment
expense increased $216,000 or 30% to $927,000 during 1999, compared to $711,000
in 1998 and $672,000 in 1997. The significant rise in this category during 1999
is attributable to new computer hardware and software that was purchased at the
end of 1998 and depreciated for a full year in 1999. Depreciation on this
equipment totaled $195,000 and accounted for 91% of the increase. The remaining
$20,000 relates to small office equipment which was purchased for the two new
branches. The increase
7
<PAGE>
Management's Discussion and Analysis
- --------------------------------------------------------------------------------
in 1998 over 1997 resulted primarily from write-offs of obsolete equipment as
DNB began purchasing new equipment at the end of the year to upgrade its
customer service and back-office processing.
Occupancy expense includes office building depreciation, rent, taxes,
maintenance and utilities. Occupancy expense totaled $519,000 in 1999, compared
to $438,000 in 1998 and $458,000 in 1997. Depreciation and repairs, largely for
the new offices, account for much of the increase. The decrease in this category
in 1998 over 1997 related to higher levels of repairs and maintenance of our
community offices during 1997.
Professional & consulting expense includes fees for legal services, audit
and accounting services, asset/liability management services as well as
consulting fees for technology, human resources and other special projects.
Professional and consulting expense for 1999 was $492,000, compared to $347,000
in 1998 and $445,000 in 1997. The significant increase in 1999 over 1998 related
to costs incurred for legal and other professional services associated with
opening new branches during the year, as well as services provided by technology
consultants in connection with DNB's equipment upgrade. The amount for 1997
included additional costs incurred in relation to a project undertaken with an
outside consultant to help identify and implement improved operating procedures.
DNB did not incur such expenditures in 1998.
Advertising & marketing expense increased $144,000 to $422,000 for the
year ended December 31, 1999, compared to $278,000 and $216,000 in 1998 and
1997. Advertising & marketing increased, generally, due to the addition of the
Kennett Square and West Goshen branches. Grand opening celebrations, direct
mailings, brochures and general advertising accounted for approximately $74,000,
while new employee recruitment amounted to $70,000. The advertising budget for
1998 included added expenditures related to DNB's new logo, marketing research
and television advertisements.
Printing & supplies expense increased $115,000 or 68% to $283,000 in 1999.
This compares to $168,000 and $229,000 in 1998 and 1997, respectively. The
significant increase in 1999 was due to expenditures for flyers, posters,
mailers and supplies relating to the Kennett Square Branch purchase in March
1999 and the opening of the West Goshen Office in May. In addition, mailings and
new brochures relating to the re-alignment of all of DNB's checking products
during the second quarter of 1999 contributed to the increase. Expenses were
higher in 1997 compared to 1998 because of stationery purchased when DNB adopted
a new corporate logo in 1997.
Other expenses include such items as postage, insurance, director fees,
satisfaction fees, appraisal fees, telephone and other miscellaneous expenses.
Other expenses increased $218,000 or 20% to $1.3 million in 1999. This compares
to $1.1 million in both 1998 and 1997. The increase in expense in 1999 relates
to the aforementioned technology upgrade and branch expansion. The largest
single increase in this category was telephone and fax expense which increased
$74,000 over 1998 due to the increased number and higher quality of
communication lines required to support the new technology.
Income Taxes
Income tax expense was $1.2 million in 1999, $1.3 million in 1998 and
$865,000 in 1997. DNB's effective tax rate was 31%, 30%, and 24% for the years
ended December 31, 1999, 1998 and 1997, respectively. The 1999 and 1998
effective tax rates were less than the statutory rate due to the effect of tax
exempt income. The lower 1997 effective tax rate was due to tax exempt interest
income and the elimination of the valuation allowance on deferred taxes arising
from DNB's improved profitability.
Financial Condition Analysis
Investment Securities
DNB's investment portfolio consists of US agency securities,
mortgage-backed securities issued by US Government agencies, corporate bonds,
collateralized mortgage obligations, asset-
8
<PAGE>
Management's Discussion and Analysis
- --------------------------------------------------------------------------------
backed securities, state and municipal securities, bank stocks, commercial paper
and other bonds and notes. In addition to generating revenue, DNB maintains the
investment portfolio to manage interest rate risk, provide liquidity, provide
collateral for borrowings and to diversify the credit risk of earning assets.
The portfolio is structured to maximize DNB's net interest income given changes
in the economic environment, liquidity position and balance sheet mix.
Given the nature of the portfolio, and its generally high credit quality,
management expects to realize all of its investment upon the maturity of such
instruments, and believes that any market value decline is temporary in nature.
Man-
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Investment Maturity Schedule, Including Weighted Average Yield
(Dollars in thousands)
December 31, 1999
Less than Over No Stated
Held to Maturity 1 Year 1-5 Years 5-10 Years 10 Years Maturity Total Yield
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
US Government agency and
corporations $-- $ 2,000 $5,013 $ 7,190 $-- $14,203 6.83%
Collateralized mortgage obligations -- -- -- 19,608 -- 19,608 6.31
US agency mortgage-backed securities -- 538 281 2,089 -- 2,908 6.05
Equity securities -- -- -- -- 2,965 2,965 6.49
Other securities -- -- -- 999 -- 999 6.05
- ----------------------------------------------------------------------------------------------------------------------
Total $-- $ 2,538 $5,294 $29,886 $2,965 $40,683
- ----------------------------------------------------------------------------------------------------------------------
Percent of portfolio --% 6% 13% 74% 7% 100%
- ----------------------------------------------------------------------------------------------------------------------
Weighted average yield --% 6.3% 7.1% 6.4% 6.5% 6.5%
- ----------------------------------------------------------------------------------------------------------------------
Less than Over No Stated
Available for Sale 1 Year 1-5 Years 5-10 Years 10 Years Maturity Total Yield
- ----------------------------------------------------------------------------------------------------------------------
US Government agency and
corporations $-- $ 8,295 $1,189 $ 9,179 $-- $18,663 6.52%
Corporate bonds -- -- 2,754 17,739 -- 20,493 7.29
State and municipal tax-exempt -- -- -- 8,250 -- 8,250 7.16
US agency mortgage-backed securities -- 2,180 -- 8,630 -- 10,810 5.95
Other securities -- 1,422 1,589 1,761 -- 4,772 6.92
- ----------------------------------------------------------------------------------------------------------------------
Total $-- $11,897 $5,532 $45,559 $-- $62,988
- ----------------------------------------------------------------------------------------------------------------------
Percent of portfolio --% 19% 9% 72% --% 100%
- ----------------------------------------------------------------------------------------------------------------------
Weighted average yield --% 5.9% 6.3% 7.0% --% 6.8%
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
Composition of Investment Securities
(Dollars in thousands) December 31
1999 1998
Held to Available Held to Available
Maturity for Sale Maturity for Sale
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
US Government agency and
corporations $14,203 $18,663 $23,467 $ 8,215
Corporate bonds -- 20,493 -- 18,826
Collateralized mortgage obligations 19,608 -- 17,462 --
State and municipal tax-exempt -- 8,250 -- 6,905
US agency mortgage-backed securities 2,908 10,810 4,055 6,625
Other securities 3,964 4,772 2,396 4,948
- -------------------------------------------------------------------------------------------------------------------
Total $40,683 $62,988 $47,380 $45,519
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
9
<PAGE>
Management's Discussion and Analysis
- --------------------------------------------------------------------------------
agement determines the appropriate classification of securities at the time of
purchase. Investment securities are classified as: (a) securities held to
maturity ("HTM") based on management's intent and ability to hold them to
maturity; (b) trading account ("TA") securities that are bought and held
principally for the purpose of selling them in the near term; and (c) securities
available for sale ("AFS"). DNB does not currently maintain a trading account
portfolio.
Securities classified as AFS include securities that may be sold in
response to changes in interest rates, changes in prepayment assumptions, the
need to increase regulatory capital or other similar requirements. DNB does not
necessarily intend to sell such securities, but has classified them as AFS to
provide flexibility to respond to liquidity needs.
DNB's investment portfolio (HTM and AFS securities) totaled $103.7 million
at December 31, 1999, up 12% from $92.9 million at December 31, 1998. The growth
in the investment portfolio was funded by increased deposits and borrowings
during the year.
The tables on the previous page set forth information regarding the
composition, stated maturity and average yield of DNB's investment security
portfolio as of the dates indicated. The first two tables do not include
amortization or anticipated prepayments on mortgage-backed securities. Callable
securities are included at their stated maturity dates.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Total Loans Outstanding, Net of Allowance for Loan Losses
(Dollars in thousands) December 31
1999 1998 1997 1996 1995
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Residential mortgage $ 39,873 $ 29,656 $ 20,392 $ 17,658 $ 19,009
Commercial mortgage 57,656 51,434 46,130 45,907 42,945
Commercial 38,734 35,549 34,966 29,970 28,803
Consumer 35,193 32,087 28,466 28,037 27,129
- ---------------------------------------------------------------------------------------------------------------------
Total loans 171,456 148,726 129,954 121,572 117,886
Less allowance for loan losses (5,085) (5,205) (5,281) (5,112) (5,515)
- ---------------------------------------------------------------------------------------------------------------------
Net loans $166,371 $143,521 $124,673 $116,460 $112,371
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
The following table sets forth information concerning the contractual
maturities of the loan portfolio, net of unearned income and fees. For
amortizing loans, scheduled repayments for the maturity category in which the
payment is due are not reflected below, because such information is not readily
available.
<TABLE>
<CAPTION>
Loan Maturities December 31, 1999
(Dollars in thousands) Less than 1 Year 1-5 Years Over 5 Years Total
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Real estate $13,087 $31,388 $53,054 $ 97,529
Commercial 38,018 581 135 38,734
Consumer 3,794 9,938 21,461 35,193
- -------------------------------------------------------------------------------------------------------------------
Total loans 54,899 41,907 74,650 171,456
- -------------------------------------------------------------------------------------------------------------------
Loans with predetermined interest rates 15,427 20,473 72,099 107,999
Loans with variable interest rates 39,472 21,434 2,551 63,457
- -------------------------------------------------------------------------------------------------------------------
Total loans $54,899 $41,907 $74,650 $171,456
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
10
<PAGE>
Management's Discussion and Analysis
- --------------------------------------------------------------------------------
Loans
The loan portfolio consists primarily of commercial and residential real
estate loans, commercial loans and lines of credit (including commercial
construction), and consumer loans. The loan portfolio provides a stable source
of interest income, monthly amortization of principal and, in the case of
adjustable rate loans, repricing opportunities.
Net loans were $166.4 million at December 31, 1999, up $22.9 million or
16% from 1998. Residential loans increased $10.2 million or 34% to $39.9
million, commercial mortgage loans increased $6.2 million or 12% to $57.7
million, and consumer loans increased $3.1 million or 10% to $35.2 million. The
increase in these portfolios continues to reflect DNB's commitment to commercial
and residential development in Chester County and the northern part of Delaware
state.
The table on the previous page sets forth information concerning the
composition of total loans outstanding, net of the allowance for loan losses, as
of the dates indicated.
Non-Performing Assets
Total non-performing assets decreased significantly during 1999, and at
December 31, 1999 were $2.1 million compared to $3.3 million at December 31,
1998 and $3.2 million at December 31, 1997. Nonaccrual loans decreased $1.1
million while loans 90 days past due and still accruing remained relatively the
same and included two loans to a single borrower that are well secured and have
demonstrated a sustained period of repayment performance. DNB, which has a
significant level of commercial, real estate and consumer loans, has worked
diligently to improve asset quality and position itself for possible economic
downturns in the future by tightening underwriting standards and improving
lending policies and procedures. Non-performing assets have, and will continue
to have, an impact on earnings, therefore management intends to con-
<TABLE>
<CAPTION>
Non-Performing Assets
(Dollars in thousands)
December 31
1999 1998 1997 1996 1995
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Nonaccrual loans:
Residential mortgage $-- $ 250 $ 676 $ 743 $1,355
Commercial mortgage 361 1,063 1,301 1,315 1,832
Commercial 674 990 821 650 722
Consumer 292 114 107 187 237
- ---------------------------------------------------------------------------------------------------------------------
Total nonaccrual loans 1,327 2,417 2,905 2,895 4,146
Loans 90 days past due and still accruing 694 699 70 194 129
Troubled debt restructurings -- -- -- 184 --
- ---------------------------------------------------------------------------------------------------------------------
Total non-performing loans 2,021 3,116 2,975 3,273 4,275
Other real estate owned 83 139 231 1,010 810
- ---------------------------------------------------------------------------------------------------------------------
Total non-performing assets $2,104 $3,255 $3,206 $4,283 $5,085
- ---------------------------------------------------------------------------------------------------------------------
Asset quality ratios:
Non-performing loans to total loans 1.17% 2.10% 2.29% 2.69% 3.63%
Non-performing assets to total assets 0.69 1.23 1.46 2.07 2.69
Allowance for loan losses to:
Total loans 2.96 3.50 4.06 4.20 4.68
Non-performing loans 251.61 167.04 177.51 156.17 129.02
Non-performing assets 241.68 159.91 164.72 119.36 108.46
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
11
<PAGE>
Management's Discussion and Analysis
- --------------------------------------------------------------------------------
tinue working aggressively to reduce the level of such assets.
Non-performing assets are comprised of nonaccrual loans, loans delinquent
over ninety days and still accruing, troubled debt restructurings ("TDRs") and
other real estate owned ("OREO"). Nonaccrual loans are loans on which the
accrual of interest ceases when the collection of principal or interest payments
is determined to be doubtful by management. It is the policy of DNB to
discontinue the accrual of interest when principal or interest payments are
delinquent 90 days or more (unless the loan principal and interest are
determined by management to be fully secured and in the process of collection),
or earlier, if considered prudent. Interest received on such loans is applied to
the principal balance, or may in some instances be recognized as income on a
cash basis. OREO includes both real estate obtained as a result of, or in lieu
of, foreclosure. Any significant change in the level of non-performing assets is
dependent, to a large extent, on the economic climate within DNB's market area.
The table on the previous page sets forth those assets that are: (i)
placed on nonaccrual status, (ii) contractually delinquent by 90 days or more
and still accruing, (iii) troubled debt restructurings other than those included
in items (i) and (ii), and (iv) OREO as a result of foreclosure or voluntary
transfer to DNB.
DNB's Special Assets Committee monitors the performance of the loan
portfolio to identify potential problem assets on a timely basis. Committee
members meet to design, implement and review asset recovery strategies which
serve to maximize the recovery of each troubled asset. DNB had $7.9 million of
loans which, although performing at December 31, 1999, are believed to require
increased supervision and review; and may, depending on the economic environment
and other factors, become non-performing assets in future periods. The amount of
such loans at December 31, 1998 was $6.5 million. The majority of the loans are
secured by commercial real estate, with lesser amounts being secured by
residential real estate, inventory and receivables.
Allowance for Loan Losses
The allowance for loan losses is increased by the provision for loan
losses which is charged to operations. Loan losses are charged directly against
the allowance and recoveries on previously charged-off loans are added to the
allowance.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Analysis of Allowance for Loan Losses
(Dollars in thousands) Year Ended December 31
1999 1998 1997 1996 1995
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Beginning balance $5,205 $5,281 $5,112 $5,515 $5,645
Provisions -- -- -- -- --
Loans charged off:
Real estate (171) (59) -- (454) (25)
Commercial (35) (233) (32) (50) (124)
Consumer (10) (11) (16) (30) (164)
- ---------------------------------------------------------------------------------------------------------------------
Total charged off (216) (303) (48) (534) (313)
- ---------------------------------------------------------------------------------------------------------------------
Recoveries:
Real estate 21 144 1 38 86
Commercial 68 71 167 48 24
Consumer 7 12 49 45 73
- ---------------------------------------------------------------------------------------------------------------------
Total recoveries 96 227 217 131 183
- ---------------------------------------------------------------------------------------------------------------------
Ending balance $5,085 $5,205 $5,281 $5,112 $5,515
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
12
<PAGE>
Management's Discussion and Analysis
- --------------------------------------------------------------------------------
In establishing its allowance for loan losses, management considers the
size and risk exposure of each segment of the loan portfolio, past loss
experience, present indicators of risk such as delinquency rates, levels of
nonaccruals, the potential for losses in future periods, and other relevant
factors. Management's evaluation of the loan portfolio generally includes
reviews, on a sample basis, of individual borrowers of $350,000 or greater and
reviews of problem borrowers of $100,000 or greater. Consideration is also given
to examinations performed by regulatory agencies, primarily the Office of the
Comptroller of the Currency ("OCC"). The provisions are based on management's
review of the economy, interest rates, general market conditions, estimates of
the fair value of collateral, financial strength and ability of the borrowers
and guarantors to pay, and considerations regarding the current and anticipated
operating or sales environment. These estimates are particularly susceptible to
change and may result in a material adjustment to the allowance. While
management uses the latest information available to make its evaluation of the
adequacy of the allowance, future adjustments may be necessary if conditions
differ substantially from the assumptions used in making the evaluations.
The table on the previous page sets forth the changes in DNB's allowance
for loan losses for the years indicated. Real estate includes both residential
and commercial real estate.
In determining the adequacy of the allowance, DNB utilizes a methodology
which includes an analysis of historical loss experience for the commercial real
estate, commercial, residential real estate, home equity and consumer
installment loan pools to determine a historical loss factor. The historical
loss factors are then applied to the current portfolio balances to determine the
required reserve percentage for each loan pool based on risk rating. In
addition, specific allocations are established for loans where loss is probable
and reasonably identifiable, based on management's judgment and an evaluation of
the individual credit, which includes various factors mentioned above. The
allocated portion of the reserve is then determined as a result of an analysis
of the loan pools and specific allocations.
The following table sets forth the composition of DNB's allowance for loan
losses at the dates indicated. The portion allocated to each category is
generally not the total amount available for future losses that might occur
within such categories. The allocation of the allowance should also not be
interpreted as an indication that charge-offs will occur in these amounts or
proportions. The specific allocations in any particular category may prove
excessive or inadequate and consequently may be reallocated in the future to
reflect current conditions. Accordingly, management considers the entire
allowance to be available to absorb losses in any category.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Composition of Allowance for Loan Losses
(Dollars in thousands)
December 31
1999 1998 1997 1996 1995
Percent of Percent of Percent of Percent of Percent of
Loan Type to Loan Type to Loan Type to Loan Type to Loan Type to
Amount Total Loans Amount Total Loans Amount Total Loans Amount Total Loans Amount Total Loans
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Real estate $1,272 57% $1,537 54% $1,104 51% $1,405 52% $1,504 53%
Commercial* 1,275 23 1,192 24 1,220 27 830 25 730 24
Consumer 199 20 185 22 164 22 231 23 289 23
Unallocated 2,339 -- 2,291 -- 2,793 -- 2,646 -- 2,992 --
- ------------------------------------------------------------------------------------------------------------------------
Total $5,085 100% $5,205 100% $5,281 100% $5,112 100% $5,515 100%
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
*includes commercial construction
13
<PAGE>
Management's Discussion and Analysis
- --------------------------------------------------------------------------------
During 1998, management enhanced its evaluation of the loan portfolio to
include, as a separate component, the risks associated with its growing
commercial construction loan portfolio (which includes residential housing
developments as well as commercial real estate construction). Prior to 1998,
because of its relative size and lack of specific loss experience, these risks
were provided for as part of the total loan portfolio, and not associated with
any particular loan segment. As a result of this change, a portion of the
unallocated reserve was reallocated to the commercial construction portfolio,
and included in the commercial allocation. For comparative purposes, all prior
year data has been restated to reflect this change.
Liquidity and Capital Resources
Management maintains liquidity to meet depositors' needs for funds, to
satisfy or fund loan commitments, and for other operating purposes. DNB's
foundation for liquidity is a stable and loyal customer deposit base and a
marketable investment portfolio that provides periodic cash flow through regular
maturities and amortization, or that can be used as collateral to secure
funding. DNB's primary source of liquidity is dependent upon its ability to
maintain and expand its customer deposit base. During 1999, deposits increased
$29.5 million or 13%, with $9.1 million of the increase coming from the Kennett
Square Branch purchase at the end of the first quarter. The remaining $20.4
million increase in deposits was the result of the successful promotion of DNB's
Premier Money Market account, as well as general growth in demand deposits, NOW
accounts and time deposits.
As of December 31, 1999, deposits totaled $254.9 million, up from $225.4
million at December 31, 1998. Money market accounts increased $14.9 million to
$47.5 million and certificates of deposit increased $7.3 million to $89.7
million. In addition, non-interest bearing deposits and NOW accounts increased a
combined $7.1 million.
DNB maintains borrowing arrangements with a correspondent bank and the
Federal Home Loan Bank of Pittsburgh, as well as access to the discount window
at the Federal Reserve Bank of Philadelphia, to meet short-term liquidity needs.
Through these relationships, DNB has additional available short-term credit of
approximately $86.4 million.
At December 31, 1999, DNB has $13.4 million in commitments to fund
commercial real estate, construction and land development loans. In addition,
there are $3.2 million in unfunded home equity lines of credit and $10.0 million
in other unused loan commitments. Management anticipates the majority of these
commitments will be funded by means of normal cash flows.
- --------------------------------------------------------------------------------
The following table sets forth the composition of DNB's deposits at the
dates indicated.
<TABLE>
<CAPTION>
Deposits By Major Classification
(Dollars in thousands) December 31
1999 1998 1997 1996 1995
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Non-interest-bearing deposits $ 31,864 $ 30,001 $ 27,150 $ 26,429 $ 22,936
Interest-bearing deposits:
NOW 39,501 37,075 33,387 31,140 27,485
Money market 47,517 32,582 19,289 15,550 16,333
Savings 30,199 28,321 27,714 28,559 29,224
Certificates 89,691 82,424 78,509 63,783 56,533
IRA 16,109 14,970 13,188 12,963 12,498
- ----------------------------------------------------------------------------------------------------------------------
Total deposits $254,881 $225,373 $199,237 $178,424 $165,009
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
14
<PAGE>
Management's Discussion and Analysis
- --------------------------------------------------------------------------------
There are approximately $75.0 million in certificates of deposit scheduled to
mature during the twelve months ending December 31, 2000. To meet its funding
needs, DNB maintains assets which comprise its primary liquidity totaling $78.0
million on December 31, 1999. Primary liquidity includes Federal funds sold,
investments and interest-bearing cash balances, less pledged securities. DNB
also anticipates scheduled payments and prepayments on its loan and
mortgage-backed securities portfolios.
Interest Rate Sensitivity Analysis
The largest component of DNB's total income is net interest income, and
the majority of DNB's financial instruments are composed of interest
rate-sensitive assets and liabilities with various terms and maturities. The
primary objective of management is to maximize net interest income while
minimizing interest rate risk. Interest rate risk is derived from timing
differences in the repricing of assets and liabilities, loan prepayments,
deposit withdrawals, and differences in lending and funding rates. The
Asset-Liability Committee ("ALCO") actively seeks to monitor and control the mix
of interest rate-sensitive assets and interest rate-sensitive liabilities.
One measure of interest rate risk is the gap ratio, which is defined as
the difference between the dollar volume of interest-earning assets and
interest-bearing liabilities maturing or repricing within a specified period of
time as a percentage of total assets. A positive gap results when the volume of
interest rate-sensitive assets exceeds that of interest rate-sensitive
liabilities within comparable time periods. A negative gap results when the
volume of interest rate-sensitive liabilities exceeds that of interest
rate-sensitive assets within comparable time periods.
As indicated in the table below, the one year gap position at December 31,
1999 was a negative 14.3%. Generally, a financial institution with a negative
gap position will most likely experience decreases in net interest income during
periods of rising rates and increases in net interest income during periods of
falling interest rates.
The negative gap was due largely to customer preferences for short-term
and floating rate deposit products and fixed rate loans which caused
interest-rate sensitive liabilities to exceed interest- rate sensitive assets
during the earlier time periods presented. While gap analysis represents a
useful asset/liability management tool, it does not necessarily indicate the
effect of general interest rate movements on DNB's net interest income, due to
discretionary repricing of assets and liabilities, and other competitive
pressures.
DNB reports its callable agency, callable corporate notes and callable
municipal investments ($42.6 million at December 31, 1999) at their Option
Adjusted Spread ("OAS") modified duration date, as opposed to the call or
maturity date. In management's opinion, using modified duration dates on
callable securities provides a better estimate of the option exercise date under
any interest rate environment. The OAS methodology is an approach whereby the
likelihood of option exercise takes into account the coupon on the security, the
distance to the call date, the maturity date and current interest rate
volatility. In addition, prepayment assumptions derived from historical data
have been applied to mortgage-related securities, which are included in
investments.
Included in the analysis of the gap position are certain savings deposit
and demand accounts which are less sensitive to fluctuations in interest rates
than other interest-bearing sources of funds. In determining the sensitivity of
such deposits, management reviews the movement of its deposit rates for the past
five years relative to market rates. Using regression analysis, the ALCO has
estimated that these deposits are approximately 25-30% sensitive to interest
rate changes (i.e., if short term rates were to increase 100 basis points, the
interest rate on such deposits would increase 25-30 basis points).
The following table sets forth certain information relating to DNB's
financial instruments that are sensitive to changes in interest rates,
categorized by expected maturity or repricing at December 31, 1999.
15
<PAGE>
Management's Discussion and Analysis
- --------------------------------------------------------------------------------
The Bank continually evaluates interest rate risk management
opportunities, including the use of derivative financial instruments. Management
believes that hedging instruments currently available are not cost-effective,
and therefore, has focused its efforts on increasing the Bank's spread by
attracting lower-costing retail deposits.
In addition to utilizing the gap ratio for interest rate risk management,
the ALCO utilizes simulation analysis whereby the model estimates the variance
in net interest income with a change in interest rates of plus or minus 300
basis points over a twelve and twenty-four month period. Given recent
simulations, net interest income would be within policy guidelines regardless of
the direction of market rates.
Market Risk Analysis
To measure the impacts of longer-term asset and liability mismatches
beyond two years, DNB utilizes Modified Duration of Equity and Economic Value of
Portfolio Equity ("EVPE") models.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Interest Rate Sensitivity Analysis
(Dollars in thousands)
December 31, 1999
More Than More Than More Than More Than More Than
One Year Two Years Three Years Four Years Five Years
Under One Through Through Through Through and
Year Two Years Three Years Four Years Five Years Non-repricing Total
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
ASSETS
Cash and due from banks
and Federal funds sold $ 7,499 $-- $-- $-- $-- $ 10,031 $ 17,530
Investments 40,261 12,614 14,583 6,810 5,293 24,110 103,671
Commercial loans 27,808 2,551 1,999 2,251 1,785 2,340 38,734
Mortgage loans 18,725 10,452 8,710 12,232 7,416 39,995 97,530
Consumer loans 8,925 4,276 3,943 3,594 2,730 11,724 35,192
Other assets (net) -- -- -- -- -- 8,692 8,692
- ------------------------------------------------------------------------------------------------------------------------------------
Total assets $ 103,218 $ 29,893 $ 29,235 $ 24,887 $ 17,224 $ 96,892 $ 301,349
- ------------------------------------------------------------------------------------------------------------------------------------
LIABILITIES AND EQUITY
Non-interest-bearing demand $-- $-- $-- $ 5,311 $ 5,311 $ 21,242 $ 31,864
NOW 11,850 3,950 7,900 3,950 3,950 7,901 39,501
Money market 41,378 3,069 3,070 -- -- -- 47,517
Savings 8,758 3,322 6,040 3,020 3,020 6,039 30,199
Certificates and IRAs less
than $100,000 49,161 18,653 3,578 6,665 364 -- 78,421
Certificates and IRAs at or more
than $100,000 24,038 1,814 28 1,277 104 118 27,379
- ------------------------------------------------------------------------------------------------------------------------------------
Total deposits 135,185 30,808 20,616 20,223 12,749 35,300 254,881
Borrowings 11,000 3,000 -- 2,000 7,000 746 23,746
Other liabilities, net -- -- -- -- -- 2,184 2,184
Stockholders' equity -- -- -- -- -- 20,538 20,538
- ------------------------------------------------------------------------------------------------------------------------------------
Total liabilities and equity $ 146,185 $ 33,808 $ 20,616 $ 22,223 $ 19,749 $ 58,768 $ 301,349
- ------------------------------------------------------------------------------------------------------------------------------------
Gap $ (42,967) $ (3,915) $ 8,619 $ 2,664 $ (2,525) $ 38,124
- ------------------------------------------------------------------------------------------------------------------------------------
Cumulative gap $ (42,967) $ (46,882) $ (38,263) $ (35,599) $ (38,124) $--
- ------------------------------------------------------------------------------------------------------------------------------------
Cumulative gap to total assets (14.3%) (15.6%) (12.7%) (11.8%) (12.7%)
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
16
<PAGE>
Management's Discussion and Analysis
- --------------------------------------------------------------------------------
The modified duration of equity measures the potential price risk of equity to
changes in interest rates. A longer modified duration of equity indicates a
greater degree of risk to rising interest rates. Because of balance sheet
optionality, an EVPE analysis is also used to dynamically model the present
value of asset and liability cash flows, with rates ranging up or down 200 basis
points. The economic value of equity is likely to be different as interest rates
change. Results falling outside prescribed ranges require action by the ALCO. At
December 31, 1999 and 1998, DNB's variance in the economic value of equity as a
percentage of assets with an instantaneous and sustained parallel shift of 200
basis points is within the Bank's negative 3% policy guideline, as shown in the
tables below.
The market capitalization of DNB should not be equated to the EVPE, which
only deals with the valuation of balance sheet cash flows using conservative
assumptions. Calculated core deposit premiums may be less than what is available
in an outright sale. The model does not consider potential premiums on floating
rate loan sales, the impact of overhead expense, non-interest income, taxes,
industry market price multiples and other factors reflected in the market
capitalization of a company.
Market Risk Analysis
(Dollars in thousands)
December 31, 1999
Change in Rates Flat -200 bp +200 bp
- ---------------------------------------------------------------
Economic Value of
Portfolio Equity $28,232 $33,060 $20,351
Change 4,828 (7,881)
Change as a % of assets 1.60% (2.62%)
- ---------------------------------------------------------------
December 31, 1998
Change in Rates Flat -200 bp +200 bp
- ---------------------------------------------------------------
Economic Value of
Portfolio Equity $28,307 $26,244 $20,505
Change (2,063) (7,802)
Change as a % of assets (0.78%) (2.94%)
- ---------------------------------------------------------------
Capital Resources
Stockholders' equity decreased modestly to $20.5 million at December 31,
1999. The net income of $2.8 million reported for the year was offset by the net
unrealized loss in the available-for-sale investment portfolio ($2.1 million)
and by dividends paid ($801,000). Management believes that the Corporation and
the Bank have each met the definition of "well capitalized" for regulatory
purposes on December 31, 1999 and thereafter. The Bank's capital category is
determined for the purposes of applying the bank regulators' "prompt corrective
action" regulations and for determining levels of deposit insurance assessments
and may not constitute an accurate representation of the Corporation's or the
Bank's overall financial condition or prospects. The Corporation's capital
exceeds the FRB's minimum leverage ratio requirements for bank holding companies
(see additional discussion in Regulatory Matters -- Footnote 16).
Regulatory Matters
Dividends payable to the Corporation by the Bank are subject to certain
regulatory limitations. Under normal circumstances, the payment of dividends in
any year without regulatory permission is limited to the net profits (as defined
for regulatory purposes) for that year, plus the retained net profits for the
preceding two calendar years, which amounted to $6.5 million for the year ended
December 31, 1999.
Year 2000 Issues
As of the filing date of this report, DNB has not encountered any
significant problems or irregularities as a result of the century date change.
If Year 2000 issues arise at a later date, DNB will react according to its
contingency plan established in 1999. The contingency plan outlines DNB's
courses of action in the event of a Year 2000-related systems failure. The plan
was developed to help DNB resume operations in an orderly fashion and to
continue providing essential services in the event of the most reasonably likely
worst case scenarios.
17
<PAGE>
Management's Discussion and Analysis
- --------------------------------------------------------------------------------
The costs of Year 2000 compliance totaled $104,000 through December 31,
1999. All of these expenses were funded from normal operating cash flow. DNB
does not expect to incur any additional material Year 2000 compliance related
expenditures. The Year 2000 statements contained herein, and in other securities
filings of DNB, are Year 2000 readiness disclosures subject to the Year 2000
Readiness and Disclosure Act of 1998, and may not be relied upon as
representations or warranties for any purpose other than disclosure for Federal
securities law compliance purposes.
Forward-Looking Statements
Certain statements in this report, including any which are not statements
of historical fact, may constitute "forward-looking statements" within the
meaning of Section 27A of the Securities Act and Section 21E of the Exchange
Act. Without limiting the foregoing, the words "expect", "anticipate", "plan",
"believe", "seek", "estimate", "predict", "internal" and similar words are
intended to identify expressions that may be forward-looking statements.
Forward-looking statements involve certain risks and uncertainties, and actual
results may differ materially from those contemplated by such statements. For
example, actual results may be adversely affected by the following
possibilities: (1) competitive pressures among depository institutions may
increase; (2) changes in interest rates may reduce banking interest margins; (3)
general economic conditions and real estate values may be less favorable than
contemplated; (4) adverse legislation or regulatory requirements may be adopted;
(5) the impact of the Year 2000 issue may be more significant than currently
anticipated; (6) unexpected contingencies relating to Year 2000 compliance; and
(7) other unexpected contingencies may arise. Many of these factors are beyond
DNB's ability to control or predict. Readers of this report are accordingly
cautioned not to place undue reliance on forward-looking statements. DNB
disclaims any intent or obligation to update publicly any of the forward-looking
statements herein, whether in response to new information, future events or
otherwise.
Recent Legislative Developments
Federal Financial Modernization Legislation. In November 1999, Congress
enacted the "Gramm-Leach-Bliley Act" (also known as "HR10") to implement
financial services modernization. The new law repeals certain restrictions on
bank and securities firm affiliations, and allows bank holding companies to
elect to be treated as a "financial holding company" that can engage in approved
"financial activities," including insurance, securities underwriting and
merchant banking. Banks without holding companies can engage in many of these
new financial activities through a subsidiary. The new law also mandates
functional regulation of bank securities activities. Banks' exemption from
broker-dealer regulation would be limited to, for example, trust, safekeeping,
custodian, shareholder and employee benefit plans, sweep accounts, private
placements (under certain conditions), self-directed IRAs, third party
networking arrangements to offer brokerage services to bank customers, and the
like. It also requires banks that advise mutual funds to register as investment
advisers. The legislation provides for state regulation of insurance, subject to
certain specified state preemption standards. It establishes which insurance
products banks and bank subsidiaries may provide as principal or underwriter,
and prohibits bank underwriting of title insurance, but also preempts state laws
interfering with affiliations. Gramm-Leach-Bliley prohibits approval of new de
novo thrift charter applications by commercial entities and limits sales of
existing so-called "unitary" thrifts to commercial entities. The new federal law
bars banks, savings and loans, credit unions, securities firms and insurance
companies, as well as other "financial institutions," from disclosing customer
account numbers or access codes to unaffiliated third parties for telemarketing
or other direct marketing purposes, and enables customers of financial
institutions to "opt out" of having their personal financial information shared
with unaffiliated third parties, subject to exceptions related to the processing
of customer transactions and joint financial services marketing arrangements
with third parties, as long as the institution dis-
18
<PAGE>
Management's Discussion and Analysis
- --------------------------------------------------------------------------------
closes the activity to its customers and requires the third party to keep the
information confidential. It requires policies on privacy and disclosure of
information to be disclosed annually, and requires federal regulators to adopt
comprehensive regulations for ensuring the security and confidentiality of
consumers' personal information. Nevertheless, the federal law also allows state
laws to give consumers greater privacy protections. The new law requires ATM
notices of surcharge fees and makes changes to Community Reinvestment Act
("CRA") regulations. Depository institutions with an "unsatisfactory" CRA rating
could not acquire additional banks, securities firms, or insurance companies
until their grades improved. Banks and thrifts with assets below $250 million
and with "outstanding" CRA scores would be examined for CRA compliance every
five years; if "satisfactory", every four years; if "unsatisfactory," more
frequently. Community groups engaging in CRA protests would have to publicly
report any related grants or loans they received from financial institutions.
Those receiving grants above approximately $10,000 or loans above $50,000 would
have to report annually what they did with the funds. Regulations under the
Gramm-Leach-Bliley Act have not been finally adopted.
The Gramm-Leach-Bliley Act is likely to affect DNB in at least two ways.
First, the new legislation has focused attention on customer privacy issues and,
together with state-level privacy initiatives, is likely to result in increased
compliance expense for financial institutions such as DNB. Second, the new
legislation is likely to accelerate the integration of the banking, securities
and insurance sectors, which have historically been separated. One impact of
accelerated integration is that the markets for financial services in which DNB
competes are likely to get more competitive. However, the new legislation also
gives DNB an opportunity to provide its customers with products and services
that DNB might not otherwise have been authorized to offer. A second possible
impact of accelerated integration of the financial services sectors may be an
increase in the number of insurance and securities firms proposing to acquire
existing banking institutions. However, the new legislation may also provide DNB
new opportunities to acquire firms providing compatible financial services.
Management does not believe that the new legislation or its possible impacts
will materially adversely affect DNB or its financial performance.
Recent Accounting Pronouncements
In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities, which was subsequently amended ("SFAS No.
133"). This statement standardizes the accounting for derivative instruments,
including certain derivative instruments embedded in other contracts, and those
used for hedging activities, by requiring that an entity recognize those items
as assets or liabilities in the statement of financial position and measure them
at fair value. SFAS No. 133 generally provides for matching of gain or loss
recognition on the hedging instrument with the recognition of the changes in the
fair value of the hedged asset or liability that are attributable to the hedged
risk, so long as the hedge is effective. Prospective application of SFAS No. 133
is required for all fiscal years beginning after June 15, 2000, however earlier
application is permitted. DNB has not yet determined the impact, if any, of this
statement, including its provisions for the potential reclassifications of
investment securities, on operations, financial condition and equity and
comprehensive income. However, DNB currently has no derivatives covered by this
statement and currently conducts no hedging activities.
Market for Common Stock
DNB Financial Corporation's common stock is listed under the symbol "DNBF"
on the Over The Counter Electronic Bulletin Board, an automated quotation
service, made available through and governed by the NASDAQ system. Current price
information is available from account executives at most brokerage firms as well
as the firms listed at the back of this annual report who are market makers of
DNB's common stock. There were approximately 900 stockholders who owned
19
<PAGE>
Management's Discussion and Analysis
- --------------------------------------------------------------------------------
1,609,463 shares of common stock outstanding at December 31, 1999.
The following table sets forth the quarterly high and low prices for a
share of DNB's common stock during the periods indicated. Prices for the sale of
stock are based upon transactions reported by the brokerage firms of Tucker
Anthony Cleary Gull, Inc. and Ryan, Beck & Company. The quoted high and low bids
prices are limited only to those transactions known by management to have
occurred and there may, in fact, have been additional transactions of which
management is unaware. Prices have been adjusted for stock dividends.
1999 1998
High Low High Low
- ---------------------------------------------------------
First Quarter $30.00 $27.62 $30.84 $27.21
Second Quarter 28.33 25.71 33.10 30.84
Third Quarter 26.67 23.21 32.76 29.70
Fourth Quarter 23.33 16.75 30.95 28.10
- ---------------------------------------------------------
- --------------------------------------------------------------------------------
The following table sets forth selected quarterly financial data and
earnings per share for the periods indicated. Per share data have been adjusted
for the five percent (5%) stock dividends declared in 1999 and 1998.
<TABLE>
<CAPTION>
Quarterly Financial Data
(Dollars in thousands, except per share data)
1999 1998
Fourth Third Second First Fourth Third Second First
Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Interest income $5,441 $5,232 $5,130 $4,697 $4,835 $4,594 $4,311 $4,164
Interest expense 2,740 2,516 2,350 2,219 2,276 2,195 1,949 1,847
- -----------------------------------------------------------------------------------------------------------------------
Net interest income 2,701 2,716 2,780 2,478 2,559 2,399 2,362 2,317
Provision for loan losses -- -- -- -- -- -- -- --
Non-interest income 382 495 391 366 352 419 396 338
Non-interest expense 2,035 2,198 2,072 1,926 1,800 1,686 1,728 1,754
- -----------------------------------------------------------------------------------------------------------------------
Income before income taxes 1,048 1,013 1,099 918 1,111 1,132 1,030 901
Income tax expense 280 323 352 291 333 384 285 250
- -----------------------------------------------------------------------------------------------------------------------
Net income $ 768 $ 690 $ 747 $ 627 $ 778 $ 748 $ 745 $ 651
- -----------------------------------------------------------------------------------------------------------------------
Basic earnings per share $0.48 $0.43 $0.47 $0.39 $0.49 $0.47 $0.47 $0.41
Diluted earnings per share 0.47 0.42 0.45 0.38 0.47 0.45 0.44 0.39
- -----------------------------------------------------------------------------------------------------------------------
Cash dividends per share $0.125 $0.125 $0.125 $0.125 $0.11 $0.11 $0.11 $0.11
- -----------------------------------------------------------------------------------------------------------------------
</TABLE>
20
<PAGE>
DNB FINANCIAL CORPORATION AND SUBSIDIARY
Consolidated Statements of Financial Condition
<TABLE>
<CAPTION>
December 31
1999 1998
- --------------------------------------------------------------------------------------------------------------------
Assets
<S> <C> <C>
Cash and due from banks $ 11,226 $ 13,660
Federal funds sold 6,304 6,171
- --------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents 17,530 19,831
- --------------------------------------------------------------------------------------------------------------------
Investment securities available for sale, at market value 62,988 45,519
Investment securities (market value $39,869 in 1999
and $47,528 in 1998) 40,683 47,380
Loans, net of unearned income 171,456 148,726
Allowance for loan losses (5,085) (5,205)
- --------------------------------------------------------------------------------------------------------------------
Net loans 166,371 143,521
- --------------------------------------------------------------------------------------------------------------------
Office property and equipment 5,776 4,559
Accrued interest receivable 1,804 1,670
Other real estate owned 83 139
Deferred income taxes 2,002 1,037
Other assets 4,112 1,762
- --------------------------------------------------------------------------------------------------------------------
Total assets $301,349 $265,418
====================================================================================================================
Liabilities and Stockholders' Equity
Liabilities
Non-interest-bearing deposits $ 31,864 $ 30,001
Interest-bearing deposits:
NOW 39,501 37,075
Money market 47,517 32,582
Savings 30,199 28,321
Time 105,800 97,394
- --------------------------------------------------------------------------------------------------------------------
Total deposits 254,881 225,373
- --------------------------------------------------------------------------------------------------------------------
FHLB advances and other borrowings 23,746 18,000
Accrued interest payable 1,078 902
Other liabilities 1,106 537
- --------------------------------------------------------------------------------------------------------------------
Total liabilities 280,811 244,812
====================================================================================================================
Commitments and contingencies
Stockholders' Equity
Preferred stock, $10.00 par value;
1,000,000 shares authorized; none issued -- --
Common stock, $1.00 par value;
10,000,000 shares authorized; 1,609,463 and
1,524,229 issued and outstanding, respectively 1,609 1,524
Surplus 18,555 17,105
Retained earnings 2,429 1,924
Accumulated other comprehensive (loss) income (2,055) 53
- --------------------------------------------------------------------------------------------------------------------
Total stockholders' equity 20,538 20,606
- --------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $301,349 $265,418
====================================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
21
<PAGE>
DNB FINANCIAL CORPORATION AND SUBSIDIARY
Consolidated Statements of Operations
<TABLE>
<CAPTION>
Year Ended December 31
1999 1998 1997
Interest Income:
====================================================================================================================
<S> <C> <C> <C>
Interest and fees on loans $13,825 $12,092 $11,519
Interest and dividends on investment securities:
Taxable 5,846 4,898 4,359
Exempt from Federal taxes 445 56 --
Interest on Federal funds sold 384 857 486
- --------------------------------------------------------------------------------------------------------------------
Total interest income 20,500 17,903 16,364
- --------------------------------------------------------------------------------------------------------------------
Interest Expense:
Interest on NOW, money market and savings 3,357 2,519 2,042
Interest on time deposits 5,378 5,276 4,740
Interest on FHLB advances 1,014 470 89
Interest on other borrowings 76 1 113
- --------------------------------------------------------------------------------------------------------------------
Total interest expense 9,825 8,266 6,984
- --------------------------------------------------------------------------------------------------------------------
Net interest income 10,675 9,637 9,380
Provision for loan losses -- -- --
- --------------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 10,675 9,637 9,380
- --------------------------------------------------------------------------------------------------------------------
Non-interest Income:
Service charges 627 515 469
Trust income 399 430 416
Gains on sales of investment securities -- 5 7
Other 608 556 391
- --------------------------------------------------------------------------------------------------------------------
Total non-interest income 1,634 1,506 1,283
- --------------------------------------------------------------------------------------------------------------------
Non-interest Expense:
Salaries and employee benefits 4,254 3,911 3,952
Furniture and equipment 927 711 672
Occupancy 519 438 458
Professional and consulting 492 347 445
Advertising and marketing 422 278 216
Printing and supplies 283 168 229
Other 1,334 1,116 1,111
- --------------------------------------------------------------------------------------------------------------------
Total non-interest expense 8,231 6,969 7,083
- --------------------------------------------------------------------------------------------------------------------
Income before income taxes 4,078 4,174 3,580
Income tax expense 1,246 1,252 865
- --------------------------------------------------------------------------------------------------------------------
Net Income $ 2,832 $ 2,922 $ 2,715
====================================================================================================================
Earnings per share:
Basic $1.77 $1.83 $1.70
Diluted 1.72 1.77 1.66
Cash dividends per share $0.50 $0.44 $0.38
Weighted average common shares outstanding:
Basic 1,603,566 1,600,521 1,600,243
Diluted 1,645,198 1,655,540 1,634,839
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes to consolidated financial statements.
22
<PAGE>
DNB FINANCIAL CORPORATION AND SUBSIDIARY
Consolidated Statements of Stockholders' Equity and Comprehensive Income
<TABLE>
<CAPTION>
Accumulated
Other
Comprehensive Common Retained Comprehensive
Income Stock Surplus Earnings Income (Loss) Total
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Balance at January 1, 1997 $ 6,914 $ 5,196 $ 4,128 $ (22) $16,216
Comprehensive Income:
Net income $ 2,715 -- -- 2,715 -- 2,715
Other comprehensive income,
net of tax, relating to net
unrealized gains on investments 43 -- -- -- 43 43
-------
Total comprehensive income 2,758
Cash dividends -- -- (608) -- (608)
Issuance of stock dividends 689 1,411 (2,100) -- --
Cash payment for fractional shares -- -- (10) -- (10)
Stock split 6,914 (5,550) (1,364) -- --
Transfer to surplus -- 485 (485) -- --
- ----------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1997 14,517 1,542 2,276 21 18,356
Change in par value (13,068) 13,068 -- -- --
- ----------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1997
as adjusted 1,449 14,610 2,276 21 18,356
Comprehensive Income:
Net income 2,922 -- -- 2,922 -- 2,922
Other comprehensive income,
net of tax, relating to net
unrealized gains on investments 32 -- -- -- 32 32
-------
Total comprehensive income 2,954
Cash dividends -- -- (697) -- (697)
Issuance of stock dividends 72 2,222 (2,294) -- --
Cash payment for fractional shares -- -- (10) -- (10)
Exercise of stock options 3 7 (7) -- 3
Transfer to surplus -- 266 (266) -- --
- ----------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1998 1,524 17,105 1,924 53 20,606
Comprehensive Income:
Net income 2,832 -- -- 2,832 -- 2,832
Other comprehensive income,
net of tax, relating to net
unrealized losses on investments (2,108) -- -- -- (2,108) (2,108)
-------
Total comprehensive income 724
Cash dividends -- -- (795) -- (795)
Issuance of stock dividends 76 1,450 (1,526) -- --
Cash payment for fractional shares -- -- (6) -- (6)
Exercise of stock options 9 -- -- -- 9
- ----------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1999 $ 1,609 $18,555 $ 2,429 $(2,055) $20,538
======================================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
23
<PAGE>
DNB FINANCIAL CORPORATION AND SUBSIDIARY
Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
Year Ended December 31
(Dollars in thousands) 1999 1998 1997
====================================================================================================================
Cash Flows From Operating Activities:
<S> <C> <C> <C>
Net income $ 2,832 $ 2,922 $ 2,715
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation, amortization and accretion 821 750 420
Gains on sale of OREO (159) (162) (108)
Net gain on sale of securities -- (5) (7)
Increase in interest receivable (134) (86) (21)
Increase in other assets (2,350) (396) (142)
Increase in interest payable 176 71 376
Decrease (increase) in current taxes payable (137) (89) 64
Decrease (increase) in deferred income taxes 26 (75) (124)
Increase (decrease) in other liabilities 706 (401) 155
- --------------------------------------------------------------------------------------------------------------------
Net Cash Provided By Operating Activities 1,781 2,529 3,328
- --------------------------------------------------------------------------------------------------------------------
Cash Flows From Investing Activities:
Proceeds from maturities and paydowns - AFS securities 1,554 6,353 11,601
Proceeds from maturities and paydowns - HTM securities 13,180 38,450 17,957
Proceeds from maturities and paydowns - MBS-AFS 2,550 2,248 625
Proceeds from maturities and paydowns - MBS-HTM 1,965 1,727 1,521
Purchase of AFS securities (17,887) (42,388) (2,251)
Purchase of HTM securities (5,567) (20,514) (20,350)
Purchase of MBS-AFS (6,838) -- (3,084)
Purchase of MBS-HTM (3,011) (17,475) --
Proceeds from sale of securities -- 1,996 1,004
Proceeds from sale of OREO 683 542 978
Net increase in loans (23,319) (19,135) (8,304)
Purchase of bank property and equipment (1,854) (1,326) (72)
- --------------------------------------------------------------------------------------------------------------------
Net Cash Used By Investing Activities (38,544) (49,522) (375)
- --------------------------------------------------------------------------------------------------------------------
Cash Flows From Financing Activities:
Net increase in deposits 29,508 26,136 20,813
Increase in FHLB advances greater than ninety days 5,000 18,000 --
Increase in lease obligations 746 -- --
Decrease in repurchase agreements -- -- (11,225)
Dividends paid (801) (707) (618)
Proceeds from issuance of stock under stock option plan 9 3 --
- --------------------------------------------------------------------------------------------------------------------
Net Cash Provided By Financing Activities 34,462 43,432 8,970
- --------------------------------------------------------------------------------------------------------------------
Net Change in Cash and Cash Equivalents (2,301) (3,561) 11,923
Cash and Cash Equivalents at Beginning of Period 19,831 23,392 11,469
- --------------------------------------------------------------------------------------------------------------------
Cash and Cash Equivalents at End of Period $17,530 $19,831 $23,392
====================================================================================================================
Supplemental Disclosure Of Cash Flow Information:
Cash paid during the period for:
Interest $ 9,649 $ 8,195 $ 6,608
Income taxes 1,357 1,417 925
Supplemental Disclosure Of Non-cash Flow Information:
Net transfer of loans to OREO $ 469 $ 332 $ 91
Change in unrealized (losses) gains on securities - AFS (3,098) 48 55
Change in deferred taxes due to change in unrealized
gains or losses on securities - AFS 990 (16) (12)
====================================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
24
<PAGE>
Notes to Consolidated Financial Statements
- -------------------------------------------------------------------------------
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DNB Financial Corporation (the "Corporation" or "DNB") through its wholly
owned subsidiary, Downingtown National Bank (the "Bank"), has been serving
individuals and small to medium sized businesses of Chester County, Pennsylvania
since 1861. The Bank is a locally managed commercial bank providing personal and
commercial loans and deposit products, in addition to investment and trust
services from eight community offices. The Bank encounters vigorous competition
for market share from commercial banks, thrift institutions, credit unions and
other financial intermediaries.
The consolidated financial statements of DNB and its subsidiary, the Bank,
which together are managed as a single segment entity, are prepared in
accordance with generally accepted accounting principles and general practices
within the industry. In preparing the financial statements, management is
required to make estimates and assumptions that affect the reported amounts of
assets and liabilities and affect revenues and expenses for the period. Actual
results could differ significantly from those estimates.
The material estimates that are particularly susceptible to significant
changes in the near term relate to the determination of the adequacy of the
allowance for loan losses, the valuation of other real estate owned and the
valuation of deferred tax assets. In connection with the determination of the
allowance for losses on loans and other real estate owned, independent
appraisals for significant properties are obtained when practical.
The more significant accounting policies are summarized below. Prior
period amounts not affecting net income are reclassified when necessary to
conform with current year classifications.
Principles of Consolidation -- The accompanying consolidated financial
statements include the accounts of the Corporation and its wholly owned
subsidiary, the Bank. All significant intercompany transactions have been
eliminated.
Cash and Due From Banks -- DNB is required to maintain certain daily
reserve balances in accordance with Federal Reserve Board requirements. The
average reserve balance maintained in accordance with such requirements for the
years ended December 31, 1999 and 1998 was approximately $1.2 million and
$700,000, respectively.
Investment Securities -- Investment securities are classified and
accounted for as follows:
Held-To-Maturity ("HTM") -- includes debt and non-readily marketable
equity securities that DNB has the positive intent and ability to hold to
maturity. Debt securities are reported at cost, adjusted for amortization of
premiums and accretion of discounts. Non-readily marketable equity securities
are carried at cost, which approximates liquidation value.
Trading Account ("TA") -- includes securities which are generally held
for a short term in anticipation of market gains. Such securities would be
carried at fair value with realized and unrealized gains and losses on
trading account securities included in the statement of operations. DNB did
not have any securities classified as TA during 1999, 1998, or 1997.
Available-For-Sale ("AFS") -- includes debt and equity securities not
classified as HTM or TA securities. Securities classified as AFS are
securities that DNB intends to hold for an indefinite period of time, but not
necessarily to maturity. Such securities are reported at fair value, with
unrealized holding gains and losses excluded from earnings and reported, net
of tax (if applicable), as a separate component of stockholders' equity.
Realized gains and losses on the sale of AFS securities are computed on the
basis of specific identification of the adjusted cost of each security.
Amortization of premiums and accretion of discounts for all types of
securities are computed using a method approximating a level-yield basis.
Loans -- Loans are stated net of unearned discounts, unamortized net loan
origination fees and the allowance for loan losses. Interest income is
recognized on the accrual basis. The accrual of interest on loans is generally
discontinued when loans become 90 days past due or earlier when, in management's
judgment, it is determined that a reasonable doubt exists as to its
collectibility.
25
<PAGE>
Notes to Consolidated Financial Statements
- -------------------------------------------------------------------------------
When a loan is placed on nonaccrual, interest accruals cease and uncollected
accrued interest is reversed and charged against current income. Additional
interest payments on such loans are applied to principal or recognized in income
on a cash basis. A nonaccrual loan may be restored to accrual status when
management expects to collect all contractual principal and interest due and the
borrower has demonstrated a sustained period of repayment performance in
accordance with the contractual terms.
Deferred Loan Fees -- Loan origination and commitment fees and related
direct-loan origination costs of completed loans are deferred and accreted to
income as a yield adjustment over the life of the loan using the level-yield
method. The accretion to income is discontinued when a loan is placed on
nonaccrual status. When a loan is paid off, any unamortized net deferred-fee
balance is credited to income. When a loan is sold, any unamortized net
deferred-fee balance is considered in the calculation of gain or loss.
Allowance for Loan Losses -- The allowance for loan losses ("allowance")
is based on a periodic evaluation of the portfolio and is maintained at a level
that management considers adequate to absorb losses known and inherent in the
portfolio. Management considers a variety of factors when establishing the
allowance, recognizing that an inherent risk of loss always exists in the
lending process. Consideration is given to the impact of current economic
conditions, diversification of the loan portfolio, historical loss experience,
delinquency statistics, results of detailed loan reviews, borrowers' financial
and managerial strengths, the adequacy of underlying collateral, and other
relevant factors. While management utilizes the latest available information to
determine the potential for losses on loans, future additions to the allowance
may be necessary based on changes in economic conditions as well as adverse
changes in the financial condition of borrowers. In addition, various regulatory
agencies, as an integral part of their examination process, periodically review
the allowance. Such agencies may require DNB to recognize additions to the
allowance based on their judgments of information available to them at the time
of their examination. The allowance is increased by the provision for loan
losses, which is charged to operations. Loan losses are charged directly against
the allowance and recoveries on previously charged-off loans are added to the
allowance.
For purposes of applying the measurement criteria for impaired loans, DNB
excludes large groups of smaller-balance homogeneous loans, primarily consisting
of residential real estate loans and consumer loans, as well as commercial loans
with balances less than $100,000. For applicable loans, management evaluates the
need for impairment recognition when a loan becomes nonaccrual, or earlier, if
based on an assessment of the relevant facts and circumstances, it is probable
that DNB will be unable to collect all proceeds due according to the contractual
terms of the loan agreement. DNB's policy for the recognition of interest income
on impaired loans is the same as for nonaccrual loans. Impairment is charged to
the allowance when management determines that foreclosure is probable or the
fair value of the collateral is less than the recorded investment of the
impaired loan.
Other Real Estate Owned -- Other real estate owned ("OREO") consists of
properties acquired as a result of, or in-lieu-of, foreclosure. Properties
classified as OREO are reported at the lower of carrying value or fair value,
less estimated costs to sell. Costs relating to the development or improvement
of the properties are capitalized and costs relating to holding the properties
are charged to expense.
Office Properties and Equipment -- Office properties and equipment are
recorded at cost. Depreciation is computed using the straight-line method over
the expected useful lives of the assets. The costs of maintenance and repairs
are expensed as they are incurred; renewals and betterments are capitalized. All
long-lived assets are reviewed for impairment, based on the fair value of the
asset. In addition, long-lived assets to be disposed of are generally reported
at the lower of carrying amount or fair value, less costs to sell. Gains or
losses on disposition of premises and equipment are reflected in operations.
Federal Income Taxes -- DNB accounts for income taxes in accordance with
the asset and liability method of accounting for income taxes.
26
<PAGE>
Notes to Consolidated Financial Statements
- -------------------------------------------------------------------------------
Under this method, deferred tax assets and liabilities are recognized for the
future tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases. Deferred tax assets and liabilities are measured using
enacted tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or settled. The effect
on deferred tax assets and liabilities of a change in tax rates is recognized in
income in the period that includes the enactment date. The Corporation files a
consolidated Federal income tax return with the Bank.
Pension Plan -- The Bank maintains a noncontributory defined benefit
pension plan covering substantially all employees over the age of 21 with one
year of service. Plan benefits are based on years of service and the employee's
monthly average compensation for the highest five consecutive years of their
last ten years of service.
Stock Option Plan -- SFAS No. 123, Accounting for Stock-Based Compensation
("SFAS No. 123"), permits entities to recognize as expense over the vesting
period, the fair value of all stock-based awards on the date of grant.
Alternatively, SFAS No. 123 also allows entities to continue to apply the
provisions of APB Opinion No. 25, Accounting for Stock Issued to Employees, and
related interpretations and provide pro forma net income and pro forma earnings
per share disclosures for employee stock option grants made in 1995 and future
years as if the fair-value-based method defined in SFAS No. 123 had been
applied. DNB has elected to continue to apply the provisions of APB Opinion No.
25 and provide the pro forma disclosure provisions of SFAS No. 123. As such,
compensation expense is recorded on the date of grant only if the current market
price of the underlying stock exceeds the exercise price.
Earnings Per Share -- Basic earnings per share is computed based on the
weighted average number of common shares outstanding during the year. Diluted
earnings per share reflects the potential dilution that could occur from the
conversion of common stock equivalents and is computed using the treasury stock
method. Earnings per share, dividends per share and weighted average shares
outstanding have been adjusted to reflect the effects of the 5% stock dividends
paid in December 1999, 1998 and 1997 and the September 1997 two-for-one stock
split, effected in the form of a 100% dividend.
Common Stock -- In May 1998, the Corporation's amended Articles of
Incorporation were filed with the State. The amendment to Article 5 was approved
by the Board of Directors and ratified by the shareholders at the Annual Meeting
held in April 1998. The amendment (a) increased the number of authorized shares
of the Corporation's Common Stock from 5,000,000 to 10,000,000 shares and (b)
changed the par value of the Common Stock from $10.00 to $1.00. The Common Stock
and Surplus accounts were adjusted in 1998 for this change by decreasing Common
Stock and increasing Surplus by $13,067,649. All prior periods presented have
been restated.
Trust Assets -- Assets held by DNB in fiduciary or agency capacities are
not included in the consolidated financial statements since such items are not
assets of DNB. Operating income and expenses of the Investment Services and
Trust Division are included in the consolidated statements of operations and are
recorded on an accrual basis.
Statements of Cash Flows -- For purposes of the statements of cash flows,
DNB considers cash in banks, amounts due from banks, and Federal funds sold to
be cash equivalents. Generally, Federal funds are sold for one-day periods.
Recent Accounting Pronouncements -- In June 1998, the FASB issued SFAS No.
133, Accounting for Derivative Instruments and Hedging Activities, which was
subsequently amended ("SFAS No. 133"). This statement standardizes the
accounting for derivative instruments, including certain derivative instruments
embedded in other contracts, and those used for hedging activities, by requiring
that an entity recognize those items as assets or liabilities in the statement
of financial position and measure them at fair value. SFAS No. 133 generally
provides for matching of gain or loss recognition on the hedging instrument with
the recognition of the changes in the fair value of the hedged asset or
liability that are
27
<PAGE>
Notes to Consolidated Financial Statements
- -------------------------------------------------------------------------------
attributable to the hedged risk, so long as the hedge is effective. Prospective
application of SFAS No. 133 is required for all fiscal years beginning after
June 15, 2000, however earlier application is permitted. DNB has not yet
determined the impact, if any, of this statement, including its provisions for
the potential reclassifications of investment securities, on operations,
financial condition and equity and comprehensive income. However, DNB currently
has no derivatives covered by this statement and currently conducts no hedging
activities.
(2) INVESTMENT SECURITIES
Amortized cost and estimated fair values of investment securities, as of
the dates indicated, are summarized as follows:
<TABLE>
<CAPTION>
(Dollars in thousands) December 31, 1999
Amortized Unrealized Unrealized Estimated
Held to Maturity Cost Gains Losses Fair Value
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
US Government agency and corporations $14,203 $ 10 $ (375) $13,838
Collateralized mortgage obligations 19,608 -- (368) 19,240
US agency mortgage-backed securities 2,908 2 (54) 2,856
Equity securities 2,965 -- -- 2,965
Other securities 999 -- (29) 970
- ----------------------------------------------------------------------------------------------------------------------
Total investment securities $40,683 $ 12 $ (826) $39,869
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
Amortized Unrealized Unrealized Estimated
Available for Sale Cost Gains Losses Fair Value
- ----------------------------------------------------------------------------------------------------------------------
US Government agency and corporations $18,920 $ -- $ (257) $18,663
US agency mortgage-backed securities 10,903 16 (109) 10,810
State and municipal tax exempt 9,629 -- (1,379) 8,250
Corporate bonds 21,548 206 (1,261) 20,493
Other securities 5,011 -- (239) 4,772
- ----------------------------------------------------------------------------------------------------------------------
Total investment securities $66,011 $222 $(3,245) $62,988
- ----------------------------------------------------------------------------------------------------------------------
December 31, 1998
Amortized Unrealized Unrealized Estimated
Held to Maturity Cost Gains Losses Fair Value
- ----------------------------------------------------------------------------------------------------------------------
US Government and agency corporations $23,467 $181 $ (3) $23,645
US agency mortgage-backed securities 4,055 21 (19) 4,057
Collateralized mortgage obligations 17,462 23 (55) 17,430
Equity securities 2,396 -- -- 2,396
- ----------------------------------------------------------------------------------------------------------------------
Total investment securities $47,380 $225 $ (77) $47,528
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
Amortized Unrealized Unrealized Estimated
Available for Sale Cost Gains Losses Fair Value
- ----------------------------------------------------------------------------------------------------------------------
US Government and agency corporations $ 8,202 $ 27 $ (14) $ 8,215
US agency mortgage-backed securities 6,647 12 (34) 6,625
State and municipal tax-exempt 7,034 2 (131) 6,905
Corporate bonds 18,616 231 (21) 18,826
Other securities 4,945 80 (77) 4,948
- ----------------------------------------------------------------------------------------------------------------------
Total investment securities $45,444 $352 $ (277) $45,519
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
28
<PAGE>
Notes to Consolidated Financial Statements
- -------------------------------------------------------------------------------
The amortized cost and estimated fair value of investment securities as of
December 31, 1999, by contractual maturity, are shown below. Actual maturities
may differ from contractual maturities because certain securities may be called
or prepaid without penalties.
<TABLE>
<CAPTION>
Investment Securities Investment Securities
Held to Maturity Available for Sale
Amortized Estimated Amortized Estimated
(Dollars in thousands) Cost Fair Value Cost Fair Value
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Due in one year or less $-- $-- $-- $--
Due after one year through five years 2,538 2,482 12,045 11,897
Due after five years through ten years 5,294 5,182 5,750 5,532
Due after ten years 29,886 29,240 48,216 45,559
No stated maturity 2,965 2,965 -- --
- -----------------------------------------------------------------------------------------------------------------------
Total investment securities $40,683 $39,869 $66,011 $62,988
- -----------------------------------------------------------------------------------------------------------------------
</TABLE>
DNB sold $2.0 million and $1.0 million of securities from the AFS
portfolio during 1998 and 1997, respectively. No securities were sold during
1999. Gains and losses from sales of investment securities were as follows:
Year Ended December 31
(Dollars in thousands) 1999 1998 1997
- --------------------------------------------------------
Gross realized gains $ -- $ 5 $ 7
Gross realized losses -- -- --
- --------------------------------------------------------
Net realized gain $ -- $ 5 $ 7
- --------------------------------------------------------
At December 31, 1999 and 1998, investment securities with a carrying value
of approximately $32.6 million and $31.6 million, respectively, were pledged to
secure public funds and for other purposes as required by law. In addition, at
December 31, 1999 DNB had three investment securities which represented a
significant concentration (greater than 10% of stockholders' equity). Two
securities are private label collateralized mortgage obligations ("CMO") with
carrying and fair values of $5.5 million and $5.5 million, respectively. The
third security is a corporate bond carried at $2.9 million with a fair value of
$2.8 million.
At December 31, 1998, DNB had two investment securities which represented
a significant concentration. The first security was a private label CMO with a
carrying value and fair value of $2.5 million and $2.5 million, respectively.
The second security was a corporate bond with a carrying value and fair value of
$3.0 million and $3.0 million, respectively.
Interest and dividends on all investment securities for the years ended
December 31, 1999, 1998 and 1997 consisted of:
Year Ended December 31
(Dollars in thousands) 1999 1998 1997
- -------------------------------------------------------------------------
US Treasury $ 42 $ 27 $ 11
US Government agency
and corporations 2,057 2,796 3,277
US agency mortgage-
backed securities 623 805 860
Collateralized mortgage
obligations 1,199 466 --
Corporate bonds 1,415 305 --
State and municipal
tax-exempt 445 56 --
Equity securities 168 100 67
Other 342 399 144
- -------------------------------------------------------------------------
Total $6,291 $4,954 $4,359
- -------------------------------------------------------------------------
29
<PAGE>
Notes to Consolidated Financial Statements
- -------------------------------------------------------------------------------
(3) LOANS
December 31
(Dollars in thousands) 1999 1998
- ---------------------------------------------------------
Residential mortgage $ 39,873 $ 29,656
Commercial mortgage 57,656 51,434
Commercial 38,734 35,549
Consumer 35,193 32,087
- ---------------------------------------------------------
Total loans 171,456 148,726
- ---------------------------------------------------------
Less allowance for
loan losses (5,085) (5,205)
- ---------------------------------------------------------
Net loans $166,371 $143,521
- ---------------------------------------------------------
Included in the loan portfolio are loans for which DNB has ceased the
accrual of interest. Loans of approximately $1.3 million, $2.4 million and $2.9
million as of December 31, 1999, 1998 and 1997, respectively, were on a
nonaccrual basis. DNB also had loans of approximately $694,000, $700,000 and
$70,000 that were more than 90 days delinquent, but still accruing as of
December 31, 1999, 1998 and 1997, respectively. If contractual interest income
had been recorded on nonaccrual loans, interest would have been increased as
shown in the following table:
Year Ended December 31
(Dollars in thousands) 1999 1998 1997
- ---------------------------------------------------------
Interest income which
would have been
recorded under
original terms $105 $194 $243
Interest income recorded
during the year (21) (92) (71)
- ---------------------------------------------------------
Net impact on
interest income $ 84 $102 $172
- ---------------------------------------------------------
At December 31, 1999, DNB had $7.9 million of loans which, although
performing at December 31, 1999, are believed to require increased supervision
and review, and may, depending on the economic environment and other factors,
become non-performing assets in future periods. The majority of the loans are
secured by commercial real estate with lesser amounts being secured by
residential real estate, inventory and receivables.
Although DNB has a significant concentration of residential and commercial
mortgage loans collateralized by first mortgage liens located in Chester County,
DNB has no concentration of loans to borrowers engaged in similar activities
which exceed 10% of total loans at December 31, 1999, except for loans of
approximately $17.4 million relating to local multi-unit office buildings. DNB
also had loans of approximately $13.5 million to local residential real estate
developers at December 31, 1999.
(4) ALLOWANCE FOR LOAN LOSSES
Changes in the allowance for loan losses, for the years indicated, are as
follows:
Year Ended December 31
(Dollars in thousands) 1999 1998 1997
- ---------------------------------------------------------
Beginning balance $5,205 $5,281 $5,112
Provisions -- -- --
Loans charged off (216) (303) (48)
Recoveries 96 227 217
- ---------------------------------------------------------
Net (charge-offs)
recoveries (120) (76) 169
- ---------------------------------------------------------
Ending balance $5,085 $5,205 $5,281
- ---------------------------------------------------------
At December 31, 1999, 1998 and 1997, DNB had impaired loans with total
recorded investments of $715,000, $1.7 million and $1.8 million, and average
recorded investments for the year ended December 31, 1999, of $1.0 million and
$1.6 million for the years ended December 31, 1998 and 1997. The aggregate
amount of impaired loans are measured under the fair value measurement method.
Total cash collected on impaired loans was credited to the outstanding principal
balance in the amounts of $113,000, $68,000 and $241,000 during the years ended
December 31, 1999, 1998 and 1997. No interest income was recorded on such loans
during the three years ended December 31, 1999.
30
<PAGE>
Notes to Consolidated Financial Statements
- -------------------------------------------------------------------------------
(5) OFFICE PROPERTY AND EQUIPMENT
December 31
Estimated
(Dollars in thousands) Useful Lives 1999 1998
- -------------------------------------------------------------------
Land $ 935 $ 855
Buildings 25-33 years 4,853 3,841
Furniture, fixtures
and equipment 5-20 years 6,157 5,395
- -------------------------------------------------------------------
Total cost 11,945 10,091
Less accumulated
depreciation (6,169) (5,532)
- -------------------------------------------------------------------
Office property and
equipment, net $ 5,776 $ 4,559
- -------------------------------------------------------------------
Amounts charged to operating expense for depreciation for the years ended
December 31, 1999, 1998 and 1997 amounted to $637,000, $412,000 and $414,000,
respectively.
(6) DEPOSITS
Included in interest-bearing time deposits are certificates of deposit
issued in amounts of $100,000 or more. These certificates and their remaining
maturities were as follows:
December 31
(Dollars in thousands) 1999 1998
- -------------------------------------------------------------------
Three months or less $ 8,985 $ 11,458
Over three through
six months 12,671 4,920
Over six through
twelve months 2,585 3,318
Over one year through
two years 1,814 2,135
Over two years 1,324 869
- -------------------------------------------------------------------
Total $ 27,379 $ 22,700
- -------------------------------------------------------------------
(7) FHLB ADVANCES AND SHORT TERM BORROWED FUNDS
DNB's short-term borrowed funds consist of Federal funds purchased and
repurchase agreements. Federal funds purchased generally represent one-day
borrowings. Securities sold under repurchase agreements represent overnight
borrowings that are secured by U.S. Agency securities. DNB had no outstanding
short-term borrowed funds during 1999 or 1998.
In addition to Federal funds purchased, DNB maintains borrowing
arrangements with a correspondent bank and the Federal Home Loan Bank (FHLB) of
Pittsburgh. As of December 31, 1999 DNB has a maximum borrowing capacity at the
FHLB of approximately $78.9 million. At December 31, 1999, advances from the
FHLB amounted to $23.0 million. All advances were convertible term advances,
which mature at various dates through the year ended December 31, 2008, as shown
in the table below. Advances are callable, at the FHLB's option, at various
dates starting on January 13, 2000 and ending on October 11, 2003. If an advance
is called by the FHLB, DNB has the option of repaying the borrowing, or it may
continue to borrow at three month Libor plus 10-14 basis points. The weighted
average interest rate for these advances at December 31, 1999 was 5.26%. FHLB
advances are collateralized by a pledge of the Bank's entire portfolio of
unencumbered investment securities, certain mortgage loans and a lien on the
Bank's FHLB stock.
(Dollars in thousands) December 31, 1999
- -------------------------------------------------------------------
Due by Weighted
December 31st Average Rate Amount
- -------------------------------------------------------------------
2004 5.78% $ 3,000
Thereafter 5.18 20,000
- -------------------------------------------------------------------
Total 5.26% $23,000
- -------------------------------------------------------------------
(8) CAPITAL LEASE OBLIGATIONS
Included in other borrowings is a long-term capital lease agreement, which
relates to DNB's West Goshen branch. As of December 31, 1999 the branch has a
carrying amount of $726,000, net of accumulated depreciation of $24,000, and is
included in the balance of office properties and equipment in the accompanying
statements of financial condition. The following is a schedule of the future
minimum lease payments, together with the present value of the net minimum lease
payments, as of December 31, 1999.
31
<PAGE>
Notes to Consolidated Financial Statements
- -------------------------------------------------------------------------------
(Dollars in thousands)
Year ending December 31 Amount
- -------------------------------------------------------
2000 $77
2001 79
2002 81
2003 84
2004 86
Thereafter 2,005
- -------------------------------------------------------
Total minimum lease payments 2,412
Less amount representing interest (1,666)
- -------------------------------------------------------
Present value of net minimum lease payments $ 746
- -------------------------------------------------------
(9) FAIR VALUE OF FINANCIAL INSTRUMENTS
Fair value assumptions, methods, and estimates are set forth below for
DNB's financial instruments.
Limitations
Fair value estimates are made at a specific point in time, based on
relevant market information about the financial instrument. These estimates do
not reflect any premium or discount that could result from offering for sale at
one time DNB's entire holdings of a particular financial instrument. Because no
market exists for a significant portion of DNB's financial instruments, fair
value estimates are based on judgments regarding future expected loss
experience, current economic conditions, risk characteristics of various
financial instruments, and other factors. These estimates are subjective in
nature and involve uncertainties and matters of significant judgment and
therefore cannot be determined with precision. Changes in assumptions could
significantly affect the estimates.
The following methods and assumptions were used to estimate the fair value
of each class of financial instruments.
Cash, Federal Funds Sold and Investment Securities
The carrying amounts for short-term investments (cash and Federal funds
sold) approximate fair value. The fair value of investment securities is
estimated based on bid prices published in financial newspapers or bid
quotations received from securities dealers. The carrying amount of non-readily
marketable equity securities approximates liquidation value.
Loans
Fair values are estimated for portfolios of loans with similar financial
characteristics. Loans are segregated by type such as commercial, commercial
mortgages, residential mortgages, consumer and student loans, and nonaccrual
loans.
The fair value of performing loans is calculated by discounting expected
cash flows using an estimated market discount rate. Expected cash flows include
both contractual cash flows and prepayments of loan balances. Prepayments on
consumer loans were determined using the median of estimates of securities
dealers for mortgage-backed investment pools.
The estimated discount rate considers credit and interest rate risk
inherent in the loan portfolios and other factors such as liquidity premiums and
incremental servicing costs to an investor. Management has made estimates of
fair value discount rates that it believes to be reasonable. However, because
there is no market for many of these financial instruments, management has no
basis to determine whether the fair value presented below would be indicative of
the value negotiated in an actual sale.
The fair value for nonaccrual loans was derived through a discounted cash
flow analysis, which includes the opportunity costs of carrying a non-performing
asset. An estimated discount rate was used for all nonaccrual loans, based on
the probability of loss and the expected time to recovery.
Deposits and Borrowings
The fair value of deposits with no stated maturity, such as
non-interest-bearing deposits, savings, NOW and money market accounts, is equal
to the amount payable on demand as of December 31, 1999 and 1998. The fair
values of certificates of deposit and borrowings are based on the
32
<PAGE>
Notes to Consolidated Financial Statements
- -------------------------------------------------------------------------------
present value of contractual cash flows. The discount rates used to compute
present values are estimated using the rates currently offered for deposits of
similar maturities in DNB's marketplace and rates currently being offered for
borrowings of similar maturities.
Off-balance-sheet Instruments
Off-balance-sheet instruments are primarily comprised of loan commitments
which are generally priced at market at the time of funding. Fees on commitments
to extend credit and standby letters of credit are deemed to be immaterial and
these instruments are expected to be settled at face value or expire unused. It
is impractical to assign any fair value to these instruments. At December 31,
1999 and 1998, loan commitments were $26.6 million and $22.6 million,
respectively. Stand-by letters of credit were $2.6 million and $2.2 million at
December 31, 1999 and 1998, respectively.
The following tables summarize information for all on-balance-sheet
financial instruments.
<TABLE>
<CAPTION>
December 31
1999 1998
- ---------------------------------------------------------------------------------
Estimated Estimated
Carrying Fair Carrying Fair
(Dollars in thousands) Amount Value Amount Value
- ---------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Financial assets
Cash and Federal
funds sold $ 17,530 $ 17,530 $ 19,831 $ 19,831
Investment
securities, AFS 62,988 62,988 45,519 45,519
Investment
securities, HTM 40,683 39,869 47,380 47,528
Loans, net of
unearned income 171,456 168,795 148,726 149,028
Accrued interest
receivable 1,804 1,804 1,670 1,670
Financial liabilities
Deposits 254,881 254,862 225,373 226,130
Borrowings 23,746 23,461 18,000 18,472
Accrued interest
payable 1,078 1,078 902 902
- ---------------------------------------------------------------------------------
</TABLE>
(10) FEDERAL INCOME TAXES
Income tax expense was comprised of the following:
Year Ended December 31
(Dollars in thousands) 1999 1998 1997
- ------------------------------------------------------------------
Current tax expense $ 1,220 $ 1,327 $ 989
Deferred income tax
expense (benefit) 26 (75) (124)
- ------------------------------------------------------------------
Income tax expense $ 1,246 $ 1,252 $ 865
- ------------------------------------------------------------------
The effective income tax rates of 31% for 1999, 30% for 1998 and 24% for
1997 were less than the applicable statutory Federal income tax rate. The reason
for these differences follows:
Year Ended December 31
(Dollars in thousands) 1999 1998 1997
- ------------------------------------------------------------------
Federal income taxes
at statutory rate $1,386 $1,419 $1,217
Decrease resulting from:
Tax-exempt
interest income (147) (58) (73)
Valuation allowance-
deferred taxes -- -- (318)
Other, net 7 (109) 39
- ------------------------------------------------------------------
Income tax expense $1,246 $1,252 $ 865
- ------------------------------------------------------------------
The significant components of deferred income tax expense (benefit)
attributable to income are as follows:
Year Ended December 31
(Dollars in thousands) 1999 1998 1997
- ------------------------------------------------------------------
Deferred tax expense
(benefit) (exclusive
of the effects of
the component
listed below) $ 26 $ (75) $ 194
Decrease in
beginning-of-the-year
balance of the
valuation allowance
for deferred tax assets -- -- (318)
- ------------------------------------------------------------------
Deferred income tax
expense (benefit) $ 26 $ (75) $(124)
- ------------------------------------------------------------------
33
<PAGE>
Notes to Consolidated Financial Statements
- -------------------------------------------------------------------------------
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities are presented
below:
December 31
(Dollars in thousands) 1999 1998
- ----------------------------------------------------------------
Deferred tax assets:
Allowance for loan losses $ 1,430 $ 1,577
Valuation adjustment for
debt securities 990 --
Other 200 108
- ----------------------------------------------------------------
Total gross deferred tax assets 2,620 1,685
Deferred tax liabilities:
Depreciation (120) (120)
Pension expense (407) (407)
Valuation adjustment for
debt securities -- (16)
Other (91) (105)
- ----------------------------------------------------------------
Total gross deferred
tax liabilities (618) (648)
- ----------------------------------------------------------------
Net deferred tax asset $ 2,002 $ 1,037
- ----------------------------------------------------------------
Based upon DNB's current and historical tax history and the anticipated
level of future taxable income, management believes the existing net deferred
tax asset will, more likely than not, be realized based on future taxable
income. The reduction in the valuation allowance for deferred taxes during 1997
was attributable to improved earnings and expected continued improvement through
the subsequent one year period permitted under applicable regulations.
(11) EARNINGS PER SHARE
Options to purchase 32,235 shares of common stock at $31.97 per share have
been outstanding since June 30, 1998, but were not included in the computation
of diluted EPS for 1999 or 1998 because these options were anti-dilutive during
such periods. The options, which expire on June 30, 2008 were still outstanding
at December 31, 1999.
Also, options to purchase 26,980 shares of common stock at $25.71 per
share have been outstanding since June 30, 1999, but were not included in the
computation of diluted EPS for the second, third and fourth quarters of 1999
because these options were anti-dilutive during such periods. These options
which expire on June 30, 2009 were still outstanding at December 31, 1999.
- --------------------------------------------------------------------------------
(11) EARNINGS PER SHARE
The following is a reconcilement of net income and the weighted average
number of shares out- standing for basic and diluted EPS:
<TABLE>
<CAPTION>
Year Ended December 31
1999 1998 1997
- -------------------------------------------------------------------------------------------------------------------------------
Income Shares Amount Income Shares Amount Income Shares Amount
- -------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Basic EPS
Income available to
common stockholders $2,832 1,604 $ 1.77 $2,922 1,601 $ 1.83 $2,715 1,600 $ 1.70
Effect of dilutive common
stock equivalents -
stock options -- 41 0.05 -- 55 0.06 -- 35 0.04
- -------------------------------------------------------------------------------------------------------------------------------
Diluted EPS
Income available to
common stockholders
after assumed
conversions $2,832 1,645 $ 1.72 $2,922 1,656 $ 1.77 $2,715 1,635 $ 1.66
- -------------------------------------------------------------------------------------------------------------------------------
</TABLE>
34
<PAGE>
Notes to Consolidated Financial Statements
- -------------------------------------------------------------------------------
(12) OTHER COMPREHENSIVE INCOME
The tax effects allocated to each component of "Other Comprehensive
Income" are as follows:
Tax
Before-Tax (Expense) Net-of-Tax
(Dollars in thousands) Amount Benefit Amount
- --------------------------------------------------------------------------
Year Ended
December 31, 1999:
Unrealized losses on securities:
Unrealized holding losses
arising during the period $(3,098) $ 990 $(2,108)
Less reclassified adjustment
for losses included
in net income -- -- --
- --------------------------------------------------------------------------
Other Comprehensive Income $(3,098) $ 990 $(2,108)
- --------------------------------------------------------------------------
Year Ended
December 31, 1998:
Unrealized gains on securities:
Unrealized holding gains
arising during the period $ 48 $ (16) $ 32
Less reclassified adjustment
for gains included
in net income -- -- --
- --------------------------------------------------------------------------
Other Comprehensive Income $ 48 $ (16) $ 32
- --------------------------------------------------------------------------
Year Ended
December 31, 1997:
Unrealized gains on securities:
Unrealized holding gains
arising during the period $ 55 $ (12) $ 43
Less reclassified adjustment
for gains included
in net income -- -- --
- --------------------------------------------------------------------------
Other Comprehensive Income $ 55 $ (12) $ 43
- --------------------------------------------------------------------------
(13) BENEFIT PLANS
Pension Plan
Qualified - The Bank maintains a pension plan (the "Plan") covering all
employees, including officers, who have been employed for one year and have
attained 21 years of age. Prior to May 1, 1985, an individual must have attained
the age of 25 and accrued one year of service. The Plan provides pension
benefits to eligible retired employees at 65 years of age equal to 1.5% of their
average monthly pay multiplied by their years of accredited service (maximum 40
years). The accrued benefit is based on the monthly average of their highest
five consecutive years of their last ten years of service.
The following table sets forth the Plan's funded status, as of the
measurement dates of December 31, 1999 and 1998 and amounts recognized in DNB's
consolidated financial statements at December 31, 1999 and 1998:
December 31
(Dollars in thousands) 1999 1998
- --------------------------------------------------------------------------
Actuarial present value of
benefit obligation:
Vested benefit obligation $(3,896) $(3,575)
- --------------------------------------------------------------------------
Accumulated benefit obligation (3,956) (3,637)
- --------------------------------------------------------------------------
Projected benefit obligation (4,408) (4,239)
Plan assets at fair value 5,849 5,619
- --------------------------------------------------------------------------
Projected benefit obligation
over plan assets 1,441 1,380
Unrecognized net asset at
January 1, 1987 being
amortized over 17 years (94) (113)
Unrecognized net (gain) loss (137) (74)
- --------------------------------------------------------------------------
Prepaid pension cost
included in other assets $ 1,210 $ 1,193
- --------------------------------------------------------------------------
Net periodic pension (benefit) costs for the years indicated include the
following components:
Year Ended December 31
(Dollars in thousands) 1999 1998 1997
- --------------------------------------------------------------------------
Service cost-benefits earned
during the period $ 183 $ 180 $ 159
Interest cost on projected
benefit obligation 297 296 292
Actual return on
plan assets (230) (103) (988)
Asset (gain) loss (247) (361) 614
Amortization of
unrecognized net asset
at transition (19) (18) (18)
Amortization of
unrecognized net loss
after transition -- -- 16
- --------------------------------------------------------------------------
Net pension (benefit) cost $ (16) $ (6) $ 75
- --------------------------------------------------------------------------
Assumptions used:
Discount rate 7.00% 7.00% 7.00%
Rate of increase in
compensation level 5.00 5.00 5.00
Expected long-term rate
of return on assets 8.50 8.50 8.50
- --------------------------------------------------------------------------
35
<PAGE>
Notes to Consolidated Financial Statements
- -------------------------------------------------------------------------------
The Pension Plan's assets are invested using an asset allocation strategy
in units of certain equity, bond, real estate and money market funds.
During 1999, DNB adopted an arrangement for supplemental compensation (the
"Supplemental Plan") for its Chief Executive Officer (the "Executive"). The
Supplemental Plan provides that the Bank and the Executive share in the rights
to the cash surrender value and death benefits of a split-dollar life insurance
policy (the "Split-dollar Policy") and provides for additional compensation to
the Executive, equal to any income tax consequences related to the Supplemental
Plan until retirement. The Split-dollar Policy is designed to provide the
Executive, upon attaining age 65, with projected annual after-tax distributions
of approximately $35,000, funded by loans against the cash surrender value of
the Split-dollar Policy. In addition, the Split-dollar Policy is intended to
provide the Executive with a projected death benefit of $750,000. Neither the
insurance company nor DNB has guaranteed any minimum cash value under the
Supplemental Plan. To fund the annual premium on the Split-dollar Policy and
mitigate the obligations under this Plan, the Bank has purchased an additional
life insurance policy on the Executive's life (the "BOLI Policy") with an
initial deposit of $1.5 million. The amount of the BOLI Policy has been
calculated so that the projected increases in its cash surrender value will
substantially offset the Bank's expense related to the Split-dollar Policy.
401(k) Retirement Savings Plan
The Bank's retirement savings plan enables employees to become eligible to
participate after six months of service, and will thereafter participate in the
401(k) plan for any year in which they have been employed for at least 501
hours. In general, amounts held in a participant's account are not distributable
until the participant terminates employment, reaches age 59 1/2, dies or becomes
permanently disabled.
Participants are permitted to authorize pre-tax savings contributions to a
separate trust established under the 401(k) plan, subject to limitations on
deductibility of contributions imposed by the Internal Revenue Code. The Bank
makes matching contributions of $.25 for every dollar of deferred salary up to
6% of each participant's annual compensation. Each participant is 100% vested at
all times in employee and employer contributions. The matching contributions to
the 401(k) plan were $35,000, $33,000 and $29,000 in 1999, 1998 and 1997,
respectively.
Stock Option Plan
DNB has a Stock Option Plan for employees and directors. Under the plan,
options (both qualified and non-qualified) to purchase a maximum of 270,916
shares of DNB's common stock could be issued to employees and directors. On
February 24, 1999, the Board of Directors of the Corporation amended and
restated DNB Financial Corporation's 1995 Stock Option Plan (the "Plan"), to
increase by 100,000 the number of shares for which options may be issued under
the Plan. This amendment was approved by shareholders at the April 27, 1999
Annual Meeting.
Under the plan, option exercise prices must equal the fair market value of
the shares on the date of option grant and the option exercise period may not
exceed ten years. Vesting of options under the plan is determined by the Plan
Committee. There were 121,437 and 27,601 shares available for grant at December
31, 1999 and 1998, respectively. At December 31, 1999 and 1998, the number of
options exercisable was 149,479 and 136,936, respectively, and the weighted
average exercise price of those options was $19.61 and $18.18, respectively.
36
<PAGE>
Notes to Consolidated Financial Statements
- -------------------------------------------------------------------------------
The per share weighted-average fair value of stock options granted during
1999, 1998 and 1997 was $8.41, $9.04 and $6.49 on the date of grant using the
Black Scholes option-pricing model with the following weighted-average
assumptions: for 1999-expected dividend yield of 1.88%, risk-free interest rate
of 6.44%, expected life of 9.5 years and an expected volatility of stock over
the expected life of the options was 16%; for 1998-expected dividend yield of
1.39%, risk-free interest rate of 4.82%, expected life of 9.5 years and an
expected volatility of stock over the expected life of the options of 14%; for
1997-expected dividend yield of 1.85%, risk-free interest rate of 5.77%,
expected life of 9.5 years and an expected volatility of stock over the expected
life of the options of 26%.
DNB applies APB Opinion No. 25 in accounting for its Stock Option Plan,
and accordingly, no compensation cost has been recognized for its stock options
in the financial statements. Had DNB determined compensation cost based on the
fair value at the grant date for its stock options under SFAS No. 123, DNB's net
income and earnings per share would have been reduced to the pro forma amounts
indicated below:
Year Ended December 31
1999 1998 1997
- --------------------------------------------------------
Net income
as reported $2,832 $2,922 $2,715
pro forma 2,594 2,616 2,522
Diluted net income
per share
as reported $1.72 $1.77 $1.66
pro forma 1.58 1.58 1.54
- --------------------------------------------------------
Stock option activity is indicated below. Shares have been adjusted for
the 2 for 1 stock split in September 1997 and the 5% stock dividends in December
of 1999, 1998 and 1997.
Number Weighted Average
Outstanding Exercise Price
- ------------------------------------------------------------------------
Outstanding, January 1, 1997 78,113 $10.44
Granted 29,415 17.50
- ------------------------------------------------------------------------
Outstanding, December 31, 1997 107,528 12.85
Granted 29,723 31.97
Exercised (315) 8.91
- ------------------------------------------------------------------------
Outstanding, December 31, 1998 136,936 18.18
Granted 28,329 25.71
Exercised (14,132) 8.91
Terminated (1,654) 31.97
- ------------------------------------------------------------------------
Outstanding, December 31, 1999 149,479 $19.61
- ------------------------------------------------------------------------
The weighted average price and weighted average remaining contractual life
for the outstanding options are listed below for the dates indicated. All
outstanding options are exercisable.
December 31, 1999
- ----------------------------------------------------------------
Range of Number Weighted Average
Exercise Prices Outstanding Remaining Contractual Life
- ----------------------------------------------------------------
$ 8.91 - $12.03 57,580 6.0 years
17.50 29,723 7.5 years
31.97 33,847 8.5 years
25.71 28,329 9.5 years
149,479 7.5 years
- ----------------------------------------------------------------
December 31, 1998
- ----------------------------------------------------------------
Range of Number Weighted Average
Exercise Prices Outstanding Remaining Contractual Life
- ----------------------------------------------------------------
$ 8.91 - $12.03 71,712 6.9 years
17.50 29,723 8.5 years
31.97 35,501 9.5 years
136,936 7.9 years
- ----------------------------------------------------------------
37
<PAGE>
Notes to Consolidated Financial Statements
- -------------------------------------------------------------------------------
(14) COMMITMENTS, CONTINGENT LIABILITIES AND OFF-BALANCE-SHEET RISK
In the normal course of business, various commitments and contingent
liabilities are outstanding, such as guarantees and commitments to extend
credit, borrow money or act in a fiduciary capacity, which are not reflected in
the consolidated financial statements. Management does not anticipate any
significant losses as a result of these commitments.
DNB had outstanding standby letters of credit in the amount of
approximately $2.6 million and unfunded loan and lines of credit commitments in
the amount of approximately $26.6 million at December 31, 1999. Of the $26.6
million, $23.1 million was for variable rate loans and $3.5 million was for
fixed rate loans.
These instruments involve, to varying degrees, elements of credit and
interest rate risk in excess of the amount recognized on the balance sheet. The
exposure to credit loss in the event of non-performance by the party to the
financial instrument for commitments to extend credit and standby letters of
credit is represented by the contractual amount. Management uses the same credit
policies in making commitments and conditional obligations as it does for
on-balance-sheet instruments.
Standby letters of credit are conditional commitments issued by DNB to
guarantee the performance of a customer to a third party. Those guarantees are
primarily issued to support public and private borrowing arrangements. The
credit risks involved in issuing letters of credit are essentially the same as
those involved in extending loan facilities to customers. DNB holds various
collateral to support these commitments.
Commitments to extend credit are agreements to lend to a customer as long
as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination clauses
and may require payment of a fee. DNB evaluates each customer's creditworthiness
on a case-by-case basis. The amount of collateral, if any, obtained upon the
extension of credit, usually consists of real estate, but may include
securities, property or other assets.
DNB maintains borrowing arrangements with a correspondent bank and the
FHLB of Pittsburgh, as well as access to the discount window at the Federal
Reserve Bank of Philadelphia to meet short-term liquidity needs. Through these
relationships, DNB has available short-term credit of approximately $86.4
million.
Approximately $63.0 million of assets are held by the Bank's Investment
Services and Trust Division in a fiduciary or agency capacity. These assets are
not assets of DNB, and are not included in the consolidated financial
statements.
DNB is a party to a number of lawsuits arising in the ordinary course of
business. While any litigation causes an element of uncertainty, management is
of the opinion that the liability, if any, resulting from the actions, will not
have a material effect on the accompanying financial statements.
<PAGE>
Notes to Consolidated Financial Statements
- -------------------------------------------------------------------------------
(15) PARENT COMPANY FINANCIAL INFORMATION
Condensed financial information of DNB Financial Corporation (parent
company only) follows:
Condensed Statements of Financial Condition
December 31
(Dollars in thousands) 1999 1998
- ----------------------------------------------------------
Assets
Investment in subsidiary $20,538 $20,606
- ----------------------------------------------------------
Total assets $20,538 $20,606
- ----------------------------------------------------------
Liabilities and
Stockholders' Equity
Liabilities
Dividends payable
to stockholders $-- $--
- ----------------------------------------------------------
Total liabilities -- --
- ----------------------------------------------------------
Stockholders' Equity
Total stockholders' equity 20,538 20,606
- ----------------------------------------------------------
Total liabilities and
stockholders' equity $20,538 $20,606
- ----------------------------------------------------------
Condensed Statements of Operations
Year Ended December 31
(Dollars in thousands) 1999 1998 1997
- -------------------------------------------------------------------
Income:
Dividends from subsidiary $ 801 $ 707 $ 618
Equity in undistributed
income of subsidiary 2,031 2,215 2,097
- -------------------------------------------------------------------
Net income $2,832 $2,922 $2,715
- -------------------------------------------------------------------
Condensed Statements of Cash Flows
Year Ended December 31
(Dollars in thousands) 1999 1998 1997
- ----------------------------------------------------------------------
Cash Flows From
Operating Activities:
Net income $ 2,832 $ 2,922 $ 2,715
Adjustments to reconcile
net income to
net cash provided by
operating activities:
Equity in undistributed
income of subsidiary (2,031) (2,215) (2,097)
- ----------------------------------------------------------------------
Net Cash Provided by
Operating Activities 801 707 618
- ----------------------------------------------------------------------
Cash Flows From
Investing Activities:
Purchase of
Bank subsidiary stock (9) (3) --
- ----------------------------------------------------------------------
Net Cash Used In
Investing Activities (9) (3) --
Cash Flows From
Financing Activities:
Dividends paid (801) (707) (618)
Proceeds from issuance
of stock under
Stock Option Plan 9 3 --
- ----------------------------------------------------------------------
Net Cash Used in
Financing Activities (792) (704) (618)
- ----------------------------------------------------------------------
Net Change in Cash
and Cash Equivalents $-- $-- $--
- ----------------------------------------------------------------------
39
<PAGE>
Notes to Consolidated Financial Statements
- -------------------------------------------------------------------------------
(16) REGULATORY MATTERS
Dividends payable to the Corporation by the Bank are subject to certain
regulatory limitations. Under normal circumstances, the payment of dividends in
any year without regulatory permission is limited to the net profits (as defined
for regulatory purposes) for that year, plus the retained net profits for the
preceding two calendar years, which amounted to $6.5 million for the year ended
December 31, 1999.
Federal banking agencies impose three minimum capital requirements on DNB
- -- risk-based capital ratios based on total capital and "Tier 1" capital, and a
leverage capital ratio. The risk-based capital ratios measure the adequacy of a
bank's capital against the riskiness of its assets and off-balance sheet
activities. Failure to maintain adequate capital is a basis for "prompt
corrective action" or other regulatory enforcement action. In assessing a bank's
capital adequacy, regulators also consider other factors such as interest rate
risk exposure; liquidity, funding and market risks; quality and level of
earnings; concentrations of credit, quality of loans and investments; risks of
any nontraditional activities; effectiveness of bank policies; and management's
overall ability to monitor and control risks.
Quantitative measures established by regulation to ensure capital adequacy
require DNB to maintain certain minimum amounts and ratios as set forth below.
Management believes that DNB and the Bank meet all capital adequacy requirements
to which they are subject.
The Bank is considered "Well Capitalized" under the regulatory framework
for prompt corrective action. To be categorized as Well Capitalized, the Bank
must maintain minimum ratios as set forth below. There are no conditions or
events since that notification, that management believes would have changed the
Bank's category. Actual capital amounts and ratios are presented below.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
- --------------------------------------------------------------------------------------------------------------------
(Dollars in thousands) Amount Ratio Amount Ratio Amount Ratio
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
December 31, 1999:
Total risk-based capital $24,534 11.74% $16,724 8.00% $20,905 10.00%
Tier 1 capital 21,890 10.47 8,362 4.00 12,543 6.00
Tier 1 (leverage) capital 21,890 7.26 12,085 4.00 15,107 5.00
December 31, 1998:
Total risk-based capital $22,909 12.35% $14,841 8.00% $18,552 10.00%
Tier 1 capital 20,554 11.08 7,421 4.00 11,131 6.00
Tier 1 (leverage) capital 20,554 7.92 10,383 4.00 12,979 5.00
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
40
<PAGE>
Independent Auditors' Report
[KPMG Letterhead]
The Board of Directors and Stockholders
DNB Financial Corporation:
We have audited the accompanying consolidated statements of financial
condition of DNB Financial Corporation and subsidiary as of December 31, 1999
and 1998, and the related consolidated statements of operations, stockholders'
equity and comprehensive income, and cash flows for each of the years in the
three-year period ended December 31, 1999. These consolidated financial
statements are the responsibility of the Corporation's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of DNB
Financial Corporation and subsidiary as of December 31, 1999 and 1998, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 1999 in conformity with generally accepted
accounting principles.
/s/ KPMG LLP
January 14, 2000
Philadelphia, PA
41
<PAGE>
DNB Financial Corporation and Subsidiary
Dnb Financial Corporation
Directors
Robert J. Charles
Chairman
Vernon J. Jameson
Vice Chairman
Thomas R. Greenleaf
William S. Latoff
Joseph G. Riper
Louis N. Teti
Henry F. Thorne
James H. Thornton
Directors Emeritus
Ellis Y. Brown, III
Paul F. DiMatteo
I. Newton Evans, Jr.
Ilario S. Polite
Officers
Henry F. Thorne
President and CEO
Ronald K. Dankanich
Secretary
Bruce E. Moroney
Chief Financial Officer
Downingtown National Bank
Officers
Henry F. Thorne
President and CEO
Richard L. Bergey
Senior Vice President/
Senior Loan Officer
Ronald K. Dankanich
Senior Vice President/
Operations and Secretary
J. William Erb
Senior Vice President/
Investment Services and
Trust Division
Eileen M. Knott
Senior Vice President/
Auditor and Compliance Officer
Bruce E. Moroney
Senior Vice President and CFO
Joseph M. Stauffer
Senior Vice President/
Retail Banking and Marketing
Departments
Elizabeth B. Barr
Vice President/Construction Lending
David L. Binder
Vice President/Commercial Lending
William W. Brown
Vice President/Data Processing
Elizabeth A. Cook
Asst. Vice President/
Marketing Manager
Dominick A. Frederick
Vice President/Central Operations
Charles H. Fulton
Asst. Vice President/
Consumer Lending
Michelle L. Griffith
Assistant Controller
Kenneth R. Kramer
Vice President/Retail Lending
Denise Lindsay
Vice President/Controller
Timothy J. Mahan
Asst. Vice President/
Loan Operations Manager
Debora A. Micka
Vice President/Commercial Lending
Charles S. Moore
Vice President/Commercial Lending
Tracy E. Panati
Asst. Vice President/Human Resources
M. Esther Popjoy
Vice President/Reconcilements
Barry A. Schmidt
Vice President/Commercial Lending and Cash Management
42
<PAGE>
DNB Financial Corporation and Subsidiary
[GRAPHIC OMITTED]
Officers Left to Right: Richard L. Bergey, Joseph M. Stauffer, Eileen M. Knott,
Henry F. Thorne, Ronald K. Dankanich, Bruce E. Moroney, J. William Erb
[GRAPHIC OMITTED]
Directors Left to Right: Robert J. Charles, William S. Latoff, Vernon J.
Jameson, James H. Thornton, Henry F. Thorne, Thomas R. Greenleaf, Louis N. Teti,
Joseph G. Riper
43
<PAGE>
DNB Financial Corporation and Subsidiary
Corporate Headquarters
4 Brandywine Avenue
Downingtown, PA 19335
Tel. 610-269-1040 Fax 610-873-5298
Internet http://www.dnb4you.com
Financial Information
Investors, brokers, security analysts
and others desiring financial
information should contact
Bruce Moroney at 610-873-5253.
Auditors
KPMG LLP
1600 Market Street
Philadelphia, PA 19103
Counsel
Stradley, Ronon, Stevens and Young, LLP
30 Valley Stream Parkway
Malvern, PA 19355
Registrar and Stock Transfer Agent
Registrar and Transfer Company
10 Commerce Drive
Cranford, NJ 07016
800-368-5948
Market Makers
F. J. Morrissey & Company, Inc. 800-842-8928
Herzog, Heine, Geduld, Inc. 215-972-0860
Janney Montgomery Scott, Inc. 800-526-6397
Ryan Beck & Company 800-223-8969
Tucker Anthony Cleary Gull 800-456-9234
Investment Services and Trust Division
610-269-4657
J. William Erb
Sr.Vice President/Senior Trust Officer
Cheryl T. Burkey
Vice President/Trust Officer
Community Offices
Main Office 610-269-1040
Wanda G. Mize
Vice President and Manager
Caln Office 610-383-7562
Toni M. Miller
Community Banking Officer and Manager
East End Office 610-269-3800
Christine M. Beam
Assistant Vice President and Manager
Kennett Square Office 610-444-4350
C. Ray Cornell
Assistant Vice President and Manager
Lionville Office 610-363-7590
Joseph J. Bucciaglia
Vice President and Manager
Little Washington Office 610-942-3666
John R. Rode
Vice President and Manager
Ludwig's Corner Office 610-458-5100
Anthony Rogevich
Assistant Vice President and Manager
West Goshen Office 610-429-5860
Clifford Purse
Assistant Vice President and Manager
Opening Soon:
Exton Office
(at the former Guernsey Cow Site)
111 East Lincoln Highway
Exton, PA 19341
44
Exhibit 21
List of Subsidaries:
Name Jurisdiction
--------------------------- -------------------
Downingtown National Bank National Bank, PA
Downco, Inc. PA
[KPMG LETTERHEAD]
The Board of Directors and Stockholders
DNB Financial Corporation:
We consent to incorporation by reference in the registration statement (No.
33-78913) on Form S-8 of DNB Financial Corporation of our report dated January
14, 2000, relating to the consolidated statements of financial condition of DNB
Financial Corporation and subsidiary as of December 31, 1999 and 1998, and the
related consolidated statements of operations, stockholders' equity and
comprehensive income and cash flows for each of the years in the three-year
period ended December 31, 1999, which report appears in the December 31, 1999
annual report incorporated by reference in the Form 10-K of DNB Financial
Corporation.
/s/ KPMG LLP
KPMG LLP
March 21, 2000
Philadelphia, Pennsylvania
<TABLE> <S> <C>
<ARTICLE> 9
<CIK> 0000713671
<NAME> DNB FINANCIAL CORP
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> DEC-31-1999
<CASH> 11,226
<INT-BEARING-DEPOSITS> 1,195
<FED-FUNDS-SOLD> 6,304
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 62,988
<INVESTMENTS-CARRYING> 40,683
<INVESTMENTS-MARKET> 39,869
<LOANS> 171,456
<ALLOWANCE> 5,085
<TOTAL-ASSETS> 301,349
<DEPOSITS> 254,881
<SHORT-TERM> 0
<LIABILITIES-OTHER> 2,184
<LONG-TERM> 23,746
0
0
<COMMON> 1,609
<OTHER-SE> 18,929
<TOTAL-LIABILITIES-AND-EQUITY> 301,349
<INTEREST-LOAN> 13,825
<INTEREST-INVEST> 6,291
<INTEREST-OTHER> 384
<INTEREST-TOTAL> 20,500
<INTEREST-DEPOSIT> 8,735
<INTEREST-EXPENSE> 9,825
<INTEREST-INCOME-NET> 10,675
<LOAN-LOSSES> 0
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 8,231
<INCOME-PRETAX> 4,078
<INCOME-PRE-EXTRAORDINARY> 2,832
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,832
<EPS-BASIC> 1.77
<EPS-DILUTED> 1.72
<YIELD-ACTUAL> 7.53
<LOANS-NON> 1,327
<LOANS-PAST> 694
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 7,942
<ALLOWANCE-OPEN> 5,205
<CHARGE-OFFS> 216
<RECOVERIES> 96
<ALLOWANCE-CLOSE> 5,085
<ALLOWANCE-DOMESTIC> 5,085
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
