SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

x                              QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the period ended September 30, 2006

- or -

o                                 TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                                     to                                    

Commission file number:  0-24168

TF FINANCIAL CORPORATION
(Exact Name of Registrant as Specified in Its Charter)

 

Registrant’s telephone number, including area code:  (215) 579-4000

Securities registered pursuant to Section 12(b) of the Act:  None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, par value $.10 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. YES x  NO o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o                    Accelerated filer o              Non-accelerated filer x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 Exchange Act). YES o  NO x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date: October 30, 2006

 

CONTENTS

PART I-CONSOLIDATED FINANCIAL INFORMATION
Item 1.		Consolidated Financial Statements		3
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations		12
Item 3.		Quantitative and Qualitative Disclosures about Market Risk		20
Item 4.		Controls and Procedures		20
PART II-OTHER INFORMATION
Item 1.		Legal Proceedings		22
Item 1A.		Risk Factors		22
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds		22
Item 3.		Defaults Upon Senior Securities		22
Item 4.		Submission of Matters to a Vote of Security Holders		22
Item 5.		Other Information		22
Item 6.		Exhibits		22
Signatures				23
Exhibits
31. Certifications pursuant to Section 302 of the Sarbanes-Oxley Act of 2002				24
32. Certification pursuant of Section 906 of the Sarbanes-Oxley Act of 2002				26

 

2

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TF Financial Corporation and Subsidiaries

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

		Unaudited September 30, 2006			Audited December 31, 2005
		(in thousands)
ASSETS
Cash and cash equivalents		$	6,492		$	3,821
Certificates of deposit in other financial institutions		40			40
Investment securities available for sale—at fair value		34,471			30,401
Investment securities held to maturity (fair value of $1,681 and $4,707 respectively)		1,676			4,690
Mortgage-backed securities available for sale—at fair value		66,614			83,511
Mortgage-backed securities held to maturity (fair value of $8,124 and $10,385, respectively)		8,038			10,177
Loans receivable, net (including loans held for sale of $660 and $68, respectively)		500,029			490,959
Federal Home Loan Bank stock—at cost		7,534			7,432
Accrued interest receivable		2,782			3,048
Premises and equipment, net		6,477			6,289
Core deposit intangible asset, net of accumulated amortization of $2,824 and $2,741, respectively		—			83
Goodwill		4,324			4,324
Other assets		16,300			16,064
TOTAL ASSETS		$	654,777		$	660,839
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities
Deposits		$	470,398		$	470,521
Advances from the Federal Home Loan Bank		111,366			121,260
Advances from borrowers for taxes and insurance		1,284			1,915
Accrued interest payable		3,761			2,052
Other liabilities		2,581			2,443
Total liabilities		589,390			598,191
Stockholders’ equity
Preferred stock, no par value; 2,000,000 shares authorized at September 30, 2006 and December 31, 2005, none issued		—			—
Common stock, $0.10 par value; 10,000,000 shares authorized, 5,290,000 shares issued, 2,700,121 and 2,714,173 shares outstanding at September 30, 2006 and December 31, 2005, respectively, net of shares in treasury 2,418,630 and 2,390,943, respectively		529			529
Retained earnings		64,131			61,610
Additional paid-in capital		52,787			53,048
Unearned restricted stock		—			(1,080		)
Unearned ESOP shares		(1,712		)	(1,849		)
Treasury stock—at cost		(48,923		)	(47,920		)
Accumulated other comprehensive loss		(1,425		)	(1,690		)
Total stockholders’ equity		65,387			62,648
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY		$	654,777		$	660,839

 

The accompanying notes are an integral part of these statements

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TF Financial Corporation and Subsidiaries

CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)

		For the three months ended September 30,						For the nine months ended September 30,
		2006			2005			2006			2005
		(in thousands, except per share data)
Interest income
Loans, including fees		$	8,243		$	7,032		$	24,081		$	20,206
Mortgage-backed securities		872			1,135			2,841			3,730
Investment securities		453			383			1,354			1,060
Interest-bearing deposits and other		43			20			65			42
TOTAL INTEREST INCOME		9,611			8,570			28,341			25,038
Interest expense
Deposits		2,949			2,052			7,757			5,419
Borrowings		1,144			935			3,880			2,832
TOTAL INTEREST EXPENSE		4,093			2,987			11,637			8,251
NET INTEREST INCOME		5,518			5,583			16,704			16,787
Provision for loan losses		—			150			150			450
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES		5,518			5,433			16,554			16,337
Non-interest income
Service fees, charges and other operating income		661			632			1,980			1,941
Gain on sale of loans		152			110			190			140
Loss on sale of mortgage-backed securities available for sale		—			—			(51		)	—
TOTAL NON-INTEREST INCOME		813			742			2,119			2,081
Non-interest expense
Employee compensation and benefits		2,693			2,322			8,015			7,016
Occupancy and equipment		772			651			2,170			1,952
Federal deposit insurance premium		15			15			45			48
Professional fees		128			211			475			648
Marketing and advertising		176			191			528			553
Other operating		559			660			1,725			1,839
Amortization of core deposit intangible asset		27			34			83			102
TOTAL NON-INTEREST EXPENSE		4,370			4,084			13,041			12,158
INCOME BEFORE INCOME TAXES		1,961			2,091			5,632			6,260
Income taxes		549			546			1,573			1,634
NET INCOME		$	1,412		$	1,545		$	4,059		$	4,626
Earnings per share—basic		$	0.52		$	0.57		$	1.50		$	1.69
Earnings per share—diluted		$	0.52		$	0.55		$	1.49		$	1.64
Dividends paid		$	0.19		$	0.18		$	0.57		$	0.54

 

The accompanying notes are an integral part of these statements

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TF Financial Corporation and Subsidiaries

CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

		For the nine months ended
		September 30,
		2006			2005
		(in thousands)
OPERATING ACTIVITIES
Net income		$	4,059		$	4,626
Adjustments to reconcile net income to net cash provided by operating activities
Amortization of
Mortgage loan servicing rights		23			3
Deferred loan origination fees		(151		)	(44		)
Premiums and discounts on investment securities, net		49			59
Premiums and discounts on mortgage-backed securities, net		201			354
Premiums and discounts on loans, net		129			85
Discount on brokered deposits		12			—
Core deposit intangibles		83			102
Provision for loan losses		150			450
Provision for decline in market value of MSR’s		5			—
Depreciation of premises and equipment		708			713
Increase in value of bank-owned life insurance		(373		)	(377		)
Stock grant expense		271			—
Stock option expense		287			—
Stock-based benefit programs: ESOP		402			376
Tax benefit arising from stock compensation		102			110
Proceeds from sale of loans originated for sale		8,380			7,388
Origination of loans held for sale		(8,911		)	(7,160		)
(Gain) loss on the sale of
Mortgage loans available for sale		(60		)	(57		)
Mortgage-backed securities available for sale		51			—
Real estate acquired through foreclosure		(29		)	—
Mortgage loans held to maturity		(130		)	(83		)
Income from mortgage loan derivatives		(1		)	—
Loss associated with forward loan sales		3			—
(Increase) decrease in
Accrued interest receivable		266			(2		)
Other assets		(731		)	(259		)
Increase in
Accrued interest payable		1,709			661
Other liabilities		138			834
NET CASH PROVIDED BY OPERATING ACTIVITIES		6,642			7,779
INVESTING ACTIVITIES
Loan originations		(101,166		)	(118,330		)
Loan principal payments		71,412			86,718
Principal repayments on mortgage-backed securities held to maturity		2,133			3,506
Principal repayments on mortgage-backed securities available for sale		11,754			23,254
Proceeds from loan sales		16,251			1,108
Proceeds from sale of loan participations		5,027			—
(Purchases) and maturities of certificates of deposit in other financial institutions, net		—			(2		)
Purchase of investment securities available for sale		(3,795		)	(10,821		)
Purchase of mortgage-backed securities available for sale		—			(8,956		)
Proceeds from maturities of investment securities held to maturity		3,018			1,280
Proceeds from the sale of mortgage-backed securities available for sale		4,971			—
Purchase of Federal Home Loan Bank stock		(102		)	(273		)

 

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		For the nine months ended
		September 30,
		2006			2005
		(in thousands)
Proceeds from the sale of real estate acquired through foreclosure		729			—
Purchase of premises and equipment		(896		)	(869		)
NET CASH PROVIDED (USED) BY INVESTING ACTIVITIES		9,336			(23,385		)
FINANCING ACTIVITIES
Net increase (decrease) in demand deposit/NOW accounts, passbook savings accounts and certificates of deposit		(135		)	4,983
Net increase (decrease) in short-term Federal Home Loan Bank advances		(11,436		)	6,499
Proceeds of long-term Federal Home Loan Bank advances		15,535			16,367
Repayment of long-term Federal Home Loan Bank advances		(13,993		)	(11,303		)
Net decrease in advances from borrowers for taxes and insurance		(631		)	(548		)
Treasury stock acquired		(1,421		)	(1,773		)
Exercise of stock options		312			602
Common stock dividends paid		(1,538		)	(1,479		)
NET CASH PROVIDED (USED) BY FINANCING ACTIVITIES		(13,307		)	13,348
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS		2,671			(2,258		)
Cash and cash equivalents at beginning of period		3,821			7,900
Cash and cash equivalents at end of period		$	6,492		$	5,642
Supplemental disclosure of cash flow information
Cash paid for
Interest on deposits and advances from Federal Home Loan Bank		$	9,928		$	7,590
Income taxes		$	1,415		$	910

 

The accompanying notes are an integral part of these statements

 

6

TF FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 - PRINCIPLES OF CONSOLIDATION

The consolidated financial statements as of September 30, 2006 (unaudited) and December 31, 2005 and for the nine-month periods ended September 30, 2006 and 2005 (unaudited) include the accounts of TF Financial Corporation (the “Company”) and its wholly owned subsidiaries Third Federal Bank (the “Bank”), TF Investments Corporation and Penns Trail Development Corporation. The Company’s business is conducted principally through the Bank. All significant intercompany accounts and transactions have been eliminated in consolidation.

NOTE 2 - BASIS OF PRESENTATION

The accompanying unaudited consolidated financial statements were prepared in accordance with instructions for Form 10-Q and, therefore, do not include all of the disclosures or footnotes required by accounting principles generally accepted in the United States of America. In the opinion of management, all adjustments, consisting of normal recurring accruals, necessary for fair presentation of the consolidated financial statements have been included. The results of operations for the period ended September 30, 2006 are not necessarily indicative of the results which may be expected for the entire fiscal year or any other period. For further information, refer to consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2005.

NOTE 3 — CONTINGENCIES

The Company, from time to time, is a party to routine litigation that arises in the normal course of business. In the opinion of management, the resolution of this litigation, if any, would not have a material adverse effect on the Company’s consolidated financial position or results of operations.

NOTE 4 - OTHER COMPREHENSIVE INCOME

The Company’s other comprehensive income consists of net unrealized losses on investment securities and mortgage-backed securities available for sale. Total comprehensive income for the three-month periods ended September 30, 2006 and 2005 was $2,603,000 and $506,000, net of applicable income tax expense of $1,163,000 and $11,000 respectively. Total comprehensive income for the nine-month periods ended September 30, 2006 and 2005 was $4,324,000 and $3,421,000, net of applicable income tax expense of $1,708,000 and $1,014,000, respectively.

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NOTE 5—EARNINGS PER SHARE

The following tables illustrate the reconciliation of the numerators and denominators of the basic and diluted earnings per share computations (dollars in thousands, except per share data):

		Three months ended September 30, 2006
		Income (numerator)			Weighted average shares (denominator)		Per share Amount
Basic earnings per share
Income available to common stockholders		$	1,412		2,698,490		$	0.52
Effect of dilutive securities
Stock options		—			21,858		—
Diluted earnings per share
Income available to common stockholders plus effect of dilutive securities		$	1,412		2,720,348		$	0.52

 

		Nine months ended September 30, 2006
		Income (numerator)			Weighted average shares (denominator)		Per share Amount
Basic earnings per share
Income available to common stockholders		$	4,059		2,697,629		$	1.50
Effect of dilutive securities
Stock options		—			18,972		(0.01		)
Diluted earnings per share
Income available to common stockholders plus effect of dilutive securities		$	4,059		2,716,601		$	1.49

 

There were options to purchase 20,768 shares of common stock at a price of $34.14 per share which were outstanding during the nine months ended September 30, 2006 that were not included in the computation of diluted earnings per share because the options’ exercise prices were greater than the average market price of the common shares.

		Three months ended September 30, 2005
		Income (numerator)			Weighted average shares (denominator)		Per share Amount
Basic earnings per share
Income available to common stockholders		$	1,545		2,732,451		$	0.57
Effect of dilutive securities
Stock options		—			63,247		(0.02		)
Diluted earnings per share
Income available to common stockholders plus effect of dilutive securities		$	1,545		2,795,698		$	0.55

 

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		Nine months ended September 30, 2005
		Income (numerator)			Weighted average shares (denominator)		Per share Amount
Basic earnings per share
Income available to common stockholders		$	4,626		2,741,848		$	1.69
Effect of dilutive securities
Stock options		—			70,671		(0.05		)
Diluted earnings per share
Income available to common stockholders plus effect of dilutive securities		$	4,626		2,812,519		$	1.64

 

There were options to purchase 41,284 shares of common stock at a weighted average price of $32.00 per share which were outstanding during the nine months ended September 30, 2005 that were not included in the computation of diluted earnings per share because the options’ exercise prices were greater than the average market price of the common shares.

NOTE 6- STOCK BASED COMPENSATION

The Company has stock benefit plans that allow the Company to grant options and stock to employees and directors. The options, which have a term of up to 10 years when issued, vest over a three to five year period. The exercise price of each option equals the market price of the Company’s stock on the date of the grant.

On January 1, 2006, the Company adopted the provisions of Statement of Financial Accounting Standards (“SFAS”) 123R, “Share-Based Payment,” using the modified prospective transition method. Under this transition method, compensation cost to be recognized beginning in the first quarter of 2006 includes: (a) compensation cost for all share-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS 123, and (b) compensation cost for all share-based payments granted subsequent to January 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of SFAS 123R. Stock-based compensation expense included in net income related to stock options was $98,000, resulting in a tax benefit of $29,000, for the three months ended September 30, 2006. Stock-based compensation expense included in net income related to stock options was $287,000, resulting in a tax benefit of $86,000, for the nine months ended September 30, 2006. Results for prior periods have not been restated. As of September 30, 2006, there was $909,000 of total unrecognized compensation cost, net of estimated forfeitures, related to non-vested options under the Plan. That cost is expected to be recognized over a weighted average period of 27.5 months

Prior to 2006, the Company disclosed pro forma compensation expense quarterly and annually by calculating the stock option grant’s fair value using the intrinsic value method under APB Opinion No. 25, “Accounting for Stock Issued to Employees”, as permitted by SFAS No. 123 “Accounting for Stock-Based Compensation,” which contains a fair value-based method for valuing stock-based compensation that entities may use, which measures compensation cost at the grant date based on the fair value of the award. Compensation is then recognized over the service period, which is usually the vesting period. No stock-based compensation expense related to stock options was reflected in net income in 2005, as all options granted under the plans had an exercise price equal to the market value of the underlying common stock on the date of the grant.

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The tables below reflect the estimated impact the fair value method would have had on the Company’s net income and net income per share if SFAS 123R had been in effect for the three and nine months ended September 30, 2005 (dollars in thousands except per share data):

Three months ended September 30, 2005		Net income			Basic earnings per share			Diluted earnings per share
As reported		$	1,545		$	0.57		$	0.55
Deduct: stock-based compensation expense determined using the fair value method, net of related tax effects		17			0.01			—
Pro forma		$	1,528		$	0.56		$	0.55
Nine months ended September 30, 2005
As reported		$	4,626		$	1.69		$	1.64
Deduct: stock-based compensation expense determined using the fair value method, net of related tax effects		51			0.02			—
Pro forma		$	4,575		$	1.67		$	1.64

 

Option activity under the Company’s stock option plan as of September 30, 2006 is as follows:

 

The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value (the difference between the Company’s closing stock price on the last trading day of the third quarter of 2006 and the exercise price, multiplied by the number of in-the money options).

Stock options outstanding were 366,622 and 255,138 at September 30, 2006 and 2005, respectively. The aggregate intrinsic value of options exercised during the nine months ended September 30, 2006 and 2005 was $311,000 and $549,000, respectively. Exercise of stock options during the nine months ended September 30, 2006 and 2005 resulted in cash receipts of $312,000 and $602,000, respectively.

Stock-based compensation expense included in net income related to stock grants was $90,000 for the three months ended September 30, 2006. Stock-based compensation expense included in net income related to the Company’s employee stock ownership plan totaled $88,000 and $91,000 for the three-month periods ended September 30, 2006 and 2005, respectively.

Stock-based compensation expense included in net income related to stock grants was $271,000 for the nine months ended September 30, 2006. Stock-based compensation expense included in net income related to the Company’s employee stock ownership plan totaled $303,000 and $295,000 for the nine-month periods ended September 30, 2006 and 2005, respectively.

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NOTE 7- EMPLOYEE BENEFIT PLANS

Net periodic defined benefit pension cost included the following (in thousands):

		Three months ended September 30
		2006			2005
Components of net periodic benefit cost
Service cost		$	77		$	78
Interest cost		53			53
Expected return on plan assets		(81		)	(56		)
Amortization of prior service cost		16			16
Recognized net actuarial (gain) loss		12			11
Net periodic benefit cost		$	77		$	102

 

		Nine months ended September 30
		2006			2005
Components of net periodic benefit cost
Service cost		$	231		$	234
Interest cost		158			159
Expected return on plan assets		(242		)	(159		)
Amortization of prior service cost		47			48
Amortization of transition obligation (asset)		—			—
Recognized net actuarial (gain) loss		38			33
Net periodic benefit cost		$	232		$	315

 

The employer contributions made for the nine months ended September 30, 2006 and 2005 were $620,000 and $1,015,000, respectively. It is the policy of the Company to fund the maximum amount allowable under the individual aggregate cost method to the extent deductible under existing federal income tax regulations. The Company expects to make a contribution of $1.3 million prior to year-end.

NOTE 8- RECLASSIFICATIONS

Certain prior period amounts have been reclassified to conform to the current period presentation.

 

11

TF FINANCIAL CORPORATION AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

GENERAL

The Company may from time to time make written or oral “forward-looking statements”, including statements contained in the Company’s filings with the Securities and Exchange Commission (including this Quarterly Report on Form 10-Q and the exhibits thereto), in its reports to stockholders and in other communications by the Company, which are made in good faith by the Company pursuant to the “Safe Harbor” Provisions of the Private Securities Litigation Reform Act of 1995.

These forward-looking statements involve risks and uncertainties, such as statements of the Company’s plans, objectives, expectations, estimates and intentions that are subject to change based on various important factors (some of which are beyond the Company’s control). The following factors, among others, could cause the Company’s financial performance to differ materially from the plans, objectives, expectations, estimates and intentions expressed in such forward-looking statements: the strength of the United States economy in general and the strength of the local economies in which the Company conducts operations; the effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System, inflation, interest rate, market and monetary fluctuations; the timely development of and acceptance of new products and services of the Company and the perceived overall value of these products and services by users, including the features, pricing and quality compared to competitors’ products and services; the willingness of users to substitute competitors’ products and services for the Company’s products and services; the success of the Company in gaining regulatory approval of its products and services, when required; the impact of changes in financial services’ laws and regulations (including laws concerning taxes, banking, securities and insurance); technological changes, acquisitions; changes in consumer spending and saving habits; and the success of the Company at managing the risks involved in the foregoing.

The Company cautions that the foregoing list of important factors is not exclusive. The Company does not undertake to update any forward-looking statement, whether written or oral, that may be made from time to time by or on behalf of the Company.

Financial Position

The Company’s total assets at September 30, 2006 and December 31, 2005 were $654.8 million and $660.8 million, respectively, a decrease of $6.0 million, or 0.9%, during the nine-month period. Cash and cash equivalents increased by $2.7 million. Investment securities available for sale increased by $4.1 million due to purchases of $3.8 million of tax free municipal bonds and a $0.3 million increase in the market value of investment securities available for sale. Investment securities held to maturity decreased by $3.0 million as a result of security maturities. Mortgage-backed securities available for sale decreased by $16.9 million due to sales of $5.0 million, principal repayments of $11.8 million, and amortization of net premiums totaling $0.2 million offset by an increase in the market value of these securities of $0.1 million. Mortgage-backed securities held to maturity decreased by $2.1 million as a result of principal repayments.

Loans receivable increased by $9.1 million during the first nine months of 2006. Consumer and single-family residential mortgage loans of $49.9 million and commercial loans of $51.3 million were originated during the first nine months of 2006. Principal repayments of loans receivable were $71.4 million and proceeds from sales of loan participations totaled $5.0 million in the first nine months of 2006. Additionally, the Company sold $16.3 million of previously purchased loans. Loans originated for sale during this period totaled $8.9 million, and there were $8.4 million in proceeds from the sale of these loans in the secondary market during this period. In June 2006, the Company sold for $0.7 million the sole parcel of foreclosed real estate owned at December 31, 2005.

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Total liabilities decreased by $8.8 million. Deposit balances decreased by $0.1 million during the first nine months of 2006. Savings, money market, interest-bearing, and non-interest bearing checking accounts decreased by a combined $43.4 million. Retail certificates of deposit increased by $31.6 million and broker originated deposits received during the second quarter of 2006 totaled $11.7 million. Advances from the Federal Home Loan Bank decreased by $9.9 million due to scheduled amortization payments of $14.0 million and repayments of $11.4 million of short term advances offset by a $15.5 million increase in long-term fixed rate advances,.

Total consolidated stockholders’ equity of the Company was $65.4 million or 10.0% of total assets at September 30, 2006. During the first nine months of 2006 the Company repurchased 48,404 shares of its common stock and issued 20,717 shares pursuant to the exercise of stock options. As of September 30, 2006, there were approximately 76,000 shares available for repurchase under the previously announced share repurchase plan.

Asset Quality

During the first nine months of 2006 and 2005, the Company’s provision for loan losses was $150,000 and $450,000, respectively. Management of the Company believes that there has not been any significant deterioration in its asset quality during the first nine months of 2006.

The following table sets forth information regarding the Company’s asset quality (dollars in thousands):

 

Management maintains an allowance for loan losses at levels that are believed to be adequate; however, there can be no assurances that further additions will not be necessary or that losses inherent in the existing loan portfolio will not exceed the allowance. The following table sets forth the activity in the allowance for loan losses during the periods indicated (in thousands):

 

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RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2006 AND 2005

Net Income. The Company recorded net income of $1,412,000, or $0.52 per diluted share, for the three months ended September 30, 2006 as compared to net income of $1,545,000, or $0.55 per diluted share, for the three months ended September 30, 2005.

Average Balance Sheet

The following table sets forth information (dollars in thousands) relating to the Company’s average balance sheet and reflects the average yield on assets and average cost of liabilities for the periods indicated. Yield and cost are computed by dividing income or expense by the average daily balance of interest-earning assets or interest-bearing liabilities, respectively, at-or for the three-month periods indicated.

		September 30,
		2006								2005
		Average balance			Interest			Average yld/cost		Average balance			Interest			Average yld/cost
ASSETS
Interest-earning assets:
Loans receivable(1)		$	501,012		$	8,243		6.53	%	$	465,712		$	7,032		5.99	%
Mortgage-backed securities		75,620			872			4.57	%	104,148			1,135			4.32	%
Investment securities(2)		41,957			555			5.25	%	39,553			466			4.67	%
Other interest-earning assets(3)		2,987			43			5.71	%	2,631			20			3.02	%
Total interest-earning assets		621,576			9,713			6.20	%	612,044			8,653			5.61	%
Non interest-earning assets		35,058								33,179
Total assets		$	656,634							$	645,223
LIABILITIES AND STOCKHOLDERS’ EQUITY
Interest-bearing liabilities:
Deposits		$	471,556		2,949			2.48	%	$	473,801		2,052			1.72	%
Advances from the FHLB		114,070			1,144			3.98	%	104,918			935			3.54	%
Total interest-bearing liabilities		585,626			4,093			2.77	%	578,719			2,987			2.05	%
Non interest-bearing liabilities		7,297								6,469
Total liabilities		592,923								585,188
Stockholders’ equity		63,711								60,035
Total liabilities and stockholders’ equity		$	656,634							$	645,223
Net interest income					$	5,620							$	5,666
Interest rate spread(4)								3.43	%							3.56	%
Net yield on interest-earning assets(5)								3.59	%							3.67	%
Ratio of average interest-earning assets to average interest- bearing liabilities								106	%							106	%

(1)             Nonaccrual loans have been included in the appropriate average loan balance category, but interest on nonaccrual loans has not been included for purposes of determining interest income.

(2)             Tax equivalent adjustments to interest on investment securities were $102,000 and $83,000 for the quarters ended September 30, 2006 and 2005, respectively. Tax equivalent interest income is based upon a marginal effective tax rate of 34%.

(3)             Includes interest-bearing deposits in other banks.

(4)             Interest rate spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities.

(5)             Net yield on interest-earning assets represents net interest income as a percentage of average interest-earning assets.

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Rate/Volume Analysis

The following table presents, for the periods indicated, the change in interest income and interest expense (in thousands) attributed to (i) changes in volume (changes in the weighted average balance of the total interest earning asset and interest bearing liability portfolios multiplied by the prior year rate), and (ii) changes in rate (changes in rate multiplied by prior year volume). Changes attributable to the combined impact of volume and rate have been allocated proportionately based on the absolute value of changes due to volume and changes due to rate.

		Three months ended September 30,
		2006 vs. 2005 Increase (decrease) due to
		Volume			Rate			Net
Interest income:
Loans receivable, net		$	555		$	656		$	1,211
Mortgage-backed securities		(649		)	386			(263		)
Investment securities (1)		29			60			89
Other interest-earning assets		3			20			23
Total interest-earning assets		(62		)	1,122			1,060
Interest expense:
Deposits		(67		)	964			897
Advances from the FHLB		86			123			209
Total interest-bearing liabilities		19			1,087			1,106
Net change in net interest income		$	(81	)	$	35		$	(46	)

(1)             Tax equivalent adjustments to interest on investment securities were $102,000 and $83,000 for the quarters ended September 30, 2006 and 2005, respectively. Tax equivalent interest income is based upon a marginal effective tax rate of 34%.

Total Interest Income. Total interest income, on a taxable equivalent basis, increased by $1.1 million or 12.3% to $9.7 million for the quarter ended September 30, 2006 compared with the third quarter of 2005 primarily because of a $35.3 million increase in average loans outstanding combined with an increase of 54 basis points on the average yield on these loans. The yield on both existing loans and new loans added to the portfolio increased during the intervening period in part due to six, 25 basis point increases in the Bank’s prime rate during the period September 30, 2005 through September 30, 2006 corresponding to identical increases in the federal funds interest rate of the Federal Reserve Bank. At September 30, 2006, the Bank had approximately $73.2 million in loans that are indexed to the prime rate primarily consisting of construction loans and commercial and consumer lines of credit. Interest income from mortgage-backed securities was lower in the third quarter of 2006 in comparison to the same period of 2005 due to the reduction of balances maintained in mortgage-backed securities.

Total Interest Expense. Total interest expense increased by $1.1 million to $4.1 million during the three-month period ended September 30, 2006 as compared with the third quarter of 2005. During 2005 and the first nine months of 2006, the Bank raised the interest rates paid on many of its deposit products due to the competitive pricing environment in the Bank’s deposit market. In addition, the Company had during the third quarter of 2006 but not during the third quarter of 2005, $24.7 million of certificates of deposit that have interest rates tied to the change in the federal funds rate. As a result, the average rate paid on deposits increased by 76 basis points. Interest on advances from the Federal Home Loan Bank increased by $0.2 million during the third quarter of 2006 versus the third quarter of 2005 as a result of a $9.2 million increase in the average balance of borrowings as well as an increase of 44 basis points in the cost of these funds due, generally, to the amortization of lower cost advances and the higher cost of new advances.

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Non-interest income. Total non-interest income was $813,000 for the three-month period ended September 30, 2006 compared with $742,000 for the same period in 2005. The Company recognized $25,000 of non-interest income related to real estate held for development during the third quarter of 2006. Net gain on the sale of previously purchased portfolio loans totaled $130,000 during the third quarter of 2006 while the gain associated with the sale of the credit card portfolio in the third quarter of 2005 was $83,000.

Non-interest expense. Total non-interest expense increased by $286,000 to $4.4 million for the three months ended September 30, 2006 compared to the same period in 2005. Stock-based compensation expense related to stock grants and the recognition of option expense associated with the new accounting standard SFAS 123R, “Share-Based Payment” amounted to $188,000 for the third quarter of 2006 while there was no such expense for the third quarter of 2005. In addition, compensation and other benefit expenses were higher by $183,000 due to staffing and annual salary increases. Office and occupancy costs increased $121,000 between the two quarters mainly as a result of costs associated with the relocation and renovations of the Feasterville branch as well as the new branch opened in Girard during 2005. In addition, costs associated with technology-related maintenance well as higher utilities costs contributed to the overall increase. Professional fees declined $83,000 in the third quarter of 2006 over the third quarter of 2005 which included employment recruitment fees as well as expenses associated with technology-related compliance work which was completed in 2005. Other operating expenses decreased by $101,000 in the third quarter of 2006 versus the third quarter of 2005 mainly due to $50,000 of deposit losses incurred in 2005.

 

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