**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, DC 20549**

 

----

 

**FORM 10-Q**

 

**(MarkOne)**

| **ý** | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES**                                                                                                                                                                                                                                             |
|------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** ** | ** ** | **EXCHANGE ACT OF 1934**                                                                                                                                                                                                                                                                                                 |
|       |       |                                                                                                                                                                                                                                                                                                                     |
|       |       | **For the quarterly period ended September 30,  2004**                                                                                                                                                                                                                                                              |
|       |       | ** **                                                                                                                                                                                                                                                                                                               |
|       |       | **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: 333-116370**                                                                                                                                                                                                                                                                                   |

 

| **Abington Community Bancorp,  Inc.**                           |
|-----------------------------------------------------------------|
| (Exact Name of Registrant as Specified in Its  Charter)         |
|                                                            |   |   |
| **Pennsylvania**                                                | ** ** | **02-0724068** |
| (State or Other Jurisdiction of Incorporation or  Organization) |   | (I.R.S. Employer Identification No.) |
|                                                            |   |   |
| **180 Old York Road  Jenkintown, Pennsylvania**                 | ** ** | **19046** |
| (Address of Principal Executive Offices)                        |   | (Zip Code) |
|                                                            |   |   |
| **(215) 886-8280**                                              |
| (Registrant’s Telephone Number, Including Area Code)       |

 

Indicateby check mark whether the registrant (1) has filed all reports required to befiled by Section  13 or 15(d) of the Securities Exchange Act of 1934during the preceding 12 months (or for such shorter period that the registrantwas required to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.     Yes   o     No   ý

 

Indicateby check mark whether the registrant is an accelerated filer (as defined inRule 12b-2 of the Exchange Act).   Yes   o  No   ý

 

Indicatethe number of shares outstanding of each of the issuer’s classes of commonstock, as of the latest practicable date: As of December 3, 2004, no shares of the Registrant’s common stock wereissued and outstanding. *

 

----

*                 The issuer became subject to the filing requirementsof Sections 13 and 15(d) when its Form S-1 was declared effective by the SEC onOctober 21, 2004.

 

 

----

 

**ABINGTONBANK AND SUBSIDIARIES**

 

**TABLEOF CONTENTS**

 
|                                   | **Page**       |
|----------------------------------------|----------------|
| PART I – FINANANCIAL  INFORMATION |           |
|                                   |           |   |   |
|                                   | ITEM 1.        | FINANCIAL  STATEMENTS |   |
|                                   |           |   |   |
|                                   |           | Unaudited  Consolidated Statements of Financial Condition as of September 30, 2004  and December 31, 2003 (Restated) | 1 |
|                                   |           |   |   |
|                                   |           | Unaudited  Consolidated Statements of Income for the Three and Nine Months Ended September 30,  2004 and 2003 | 2 |
|                                   |           |   |   |
|                                   |           | Unaudited  Consolidated Statement of Changes in Retained Earnings and Comprehensive  Income for the Nine Months Ended September 30, 2004 | 3 |
|                                   |           |   |   |
|                                   |           | Unaudited  Statements of Cash Flows for the Nine Months Ended September 30, 2004  and 2003 | 4 |
|                                   |           |   |   |
|                                   |           | Notes  to Unaudited Consolidated Financial Statements | 5 |
|                                   |           |   |   |
|                                   | ITEM  2.       | MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | 14 |
|                                   |           |   |   |
|                                   | ITEM 3.        | QUANTITATIVE AND  QUALITATIVE DISCLOSURES ABOUT MARKET RISK | 27 |
|                                   |           |   |   |
|                                   | ITEM 4.        | CONTROLS AND  PROCEDURES | 31 |
|                                   |           |   |   |
| PART II – OTHER  INFORMATION      | 32             |
|                                   |           |   |   |
|                                   | ITEM 1.        | Legal  Proceedings | 32 |
|                                   |           |   |   |
|                                   | ITEM 2.        | Unregistered  Sales of Equity Securities and Use of Proceeds | 32 |
|                                   |           |   |   |
|                                   | ITEM 3.        | Defaults upon  Senior Securities | 32 |
|                                   |           |   |   |
|                                   | ITEM 4.        | Submission of  Matters to a Vote of Security Holders | 32 |
|                                   |           |   |   |
|                                   | ITEM 5.        | Other  Information | 32 |
|                                   |           |   |   |
|                                   | ITEM 6.        | Exhibits | 32 |
|                                   |           |   |   |
|                                   | SIGNATURES     | 33 |
|                                   |           |   |   |
|                                   | CERTIFICATIONS | 34 |
|                                        |                |  |  |  |

 

----

 

**ABINGTON BANK AND SUBSIDIARIES**

 

**UNAUDITEDCONSOLIDATED STATEMENTS OF FINANCIAL CONDITION**

 
| ** **                                                                                                    | ** ** | **September 30, 2004** | ** **  | **December 31, 2003**     | ** ** |
|---------------------------------------------------------------------------------------------------------------|------------|-----------------------------|-------------|--------------------------------|------------|
| ** **                                                                                                    | ** ** | ** **                  | ** **  | **(as restated - see note 6)** | ** ** |
| **ASSETS**                                                                                                    |       |                        |        |                           |       |
|                                                                                                          |       |                        |        |                           |       |
| Cash and cash equivalents                                                                                     |       | $                           | 29,498,897  |                           | $          | 19,695,625 |   |
| Investment securities held to maturity (estimated  fair value—2004, $10,315,138)                         |       | 10,220,473                  |        |                           |       |
| Investment securities available for sale (amortized  cost—2004, $67,528,178; 2003, $79,579,757)          |       | 66,582,164                  |        | 78,984,495                     |       |
| Mortgage-backed securities held to maturity  (estimated fair value—2004, $46,981,990; 2003, $42,891,508) |       | 47,438,046                  |        | 43,009,221                     |       |
| Mortgage-backed securities available for sale  (amortized cost—2004, $84,836,167; 2003, $77,908,514)     |       | 84,951,431                  |        | 78,212,883                     |       |
| Loans receivable, net of allowance for loan loss (2004,  $1,412,469; 2003, $1,455,889)                        |       | 395,968,387                 |        | 364,619,621                    |       |
| Accrued interest receivable                                                                                   |       | 2,632,882                   |        | 2,386,841                      |       |
| Federal Home Loan Bank stock—at cost                                                                     |       | 10,968,700                  |        | 10,039,300                     |       |
| Property and equipment, net                                                                                   |       | 5,581,019                   |        | 5,800,068                      |       |
| Deferred tax asset                                                                                            |       | 1,152,765                   |        | 1,062,471                      |       |
| Prepaid expenses and other assets                                                                             |       | 2,749,322                   |        | 628,431                        |       |
|                                                                                                          |       |                        |        |                           |       |
| TOTAL ASSETS                                                                                                  |       | $                           | 657,744,086 |                           | $          | 604,438,956 |   |
|                                                                                                          |       |                        |        |                           |       |
| **LIABILITIES AND RETAINED EARNINGS**                                                                         |       |                        |        |                           |       |
| ** **                                                                                                    |       |                        |        |                           |       |
| LIABILITIES:                                                                                                  |       |                        |        |                           |       |
| Deposits:                                                                                                     |       |                        |        |                           |       |
| Noninterest-bearing                                                                                           |       | $                           | 38,247,718  |                           | $          | 37,855,415 |   |
| Interest-bearing                                                                                              |       | 350,815,514                 |        | 324,810,757                    |       |
| Total deposits                                                                                                |       | 389,063,232                 |        | 362,666,172                    |       |
| Advances from Federal Home Loan Bank                                                                          |       | 185,587,714                 |        | 173,731,623                    |       |
| Other borrowed money                                                                                          |       | 19,317,116                  |        | 8,680,916                      |       |
| Accrued interest payable                                                                                      |       | 2,637,094                   |        | 943,949                        |       |
| Advances from borrowers for taxes and insurance                                                               |       | 351,670                     |        | 2,135,301                      |       |
| Accounts payable and accrued expenses                                                                         |       | 4,762,705                   |        | 3,046,727                      |       |
|                                                                                                          |       |                        |        |                           |       |
| Total liabilities                                                                                             |       | 601,719,531                 |        | 551,204,688                    |       |
|                                                                                                          |       |                        |        |                           |       |
| RETAINED EARNINGS:                                                                                            |       |                        |        |                           |       |
| Retained earnings                                                                                             |       | 56,572,850                  |        | 53,426,380                     |       |
| Accumulated other comprehensive loss                                                                          |       | (548,295                    | )           | (192,112                       | )          |
|                                                                                                          |       |                        |        |                           |       |
| Total retained earnings                                                                                       |       | 56,024,555                  |        | 53,234,268                     |       |
|                                                                                                          |       |                        |        |                           |       |
| TOTAL LIABILITIES AND RETAINED EARNINGS                                                                       |       | $                           | 657,744,086 |                           | $          | 604,438,956 |   |

 

See notes to unaudited consolidated financialstatements.

 

1

----

 

**ABINGTON BANK AND SUBSIDIARIES**

 

**UNAUDITED CONSOLIDATED STATEMENTS OFINCOME**

 
| ** **                                                           | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|----------------------------------------------------------------------|------------|-------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                           | ** ** | **2004**                                  | ** ** | **2003**                                 | ** ** | **2004** | ** ** | **2003** | ** ** |
| INTEREST INCOME:                                                     |       |                                      |       |                                     |       |   |   |   |   |
| Interest on loans                                                    |       | $                                         | 5,743,416  |                                     | $          | 5,803,661 |   | $ | 16,708,624 |   | $ | 18,386,308 |   |
| Interest and dividends on investment and mortgage-backed  securities |       | 2,017,912                                 |       | 1,518,313                                |       | 5,713,845 |   | 4,224,997 |   |
|                                                                 |       |                                      |       |                                     |       |   |   |   |   |
| Total interest income                                                |       | 7,761,328                                 |       | 7,321,974                                |       | 22,422,469 |   | 22,611,305 |   |
|                                                                 |       |                                      |       |                                     |       |   |   |   |   |
| INTEREST EXPENSE:                                                    |       |                                      |       |                                     |       |   |   |   |   |
| Interest on deposits                                                 |       | 1,665,979                                 |       | 1,661,351                                |       | 4,779,645 |   | 5,289,392 |   |
| Interest on Federal Home Loan Bank advances                          |       | 1,918,494                                 |       | 1,788,522                                |       | 5,571,236 |   | 5,111,020 |   |
| Interest on other borrowed money                                     |       | 16,508                                    |       | 33,440                                   |       | 54,737 |   | 83,989 |   |
|                                                                 |       |                                      |       |                                     |       |   |   |   |   |
| Total interest expense                                               |       | 3,600,981                                 |       | 3,483,313                                |       | 10,405,618 |   | 10,484,401 |   |
|                                                                 |       |                                      |       |                                     |       |   |   |   |   |
| NET INTEREST INCOME                                                  |       | 4,160,347                                 |       | 3,838,661                                |       | 12,016,851 |   | 12,126,904 |   |
|                                                                 |       |                                      |       |                                     |       |   |   |   |   |
| PROVISION FOR LOAN LOSSES                                            |       |                                      |       | 125,000                                  |       | 45,000 |   | 375,000 |   |
|                                                                 |       |                                      |       |                                     |       |   |   |   |   |
| NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES                  |       | 4,160,347                                 |       | 3,713,661                                |       | 11,971,851 |   | 11,751,904 |   |
|                                                                 |       |                                      |       |                                     |       |   |   |   |   |
| NON-INTEREST INCOME                                                  |       |                                      |       |                                     |       |   |   |   |   |
| Rental income                                                        |       | 12,687                                    |       | 12,713                                   |       | 39,277 |   | 41,272 |   |
| Gain on sale of property                                             |       |                                      |       | 91,268                                   |       |   |   | 146,268 |   |
| (Loss) gain on derivative instruments, net                           |       | (105,644                                  | )          | 135,719                                  |       | (154,869 | ) | (512,527 | ) |
| Service charges                                                      |       | 432,052                                   |       | 432,701                                  |       | 1,241,378 |   | 903,581 |   |
| Other income                                                         |       | 170,270                                   |       | 201,544                                  |       | 478,195 |   | 536,824 |   |
| Gain on sale of loans                                                |       |                                      |       |                                     |       |   |   | 44,036 |   |
|                                                                 |       |                                      |       |                                     |       |   |   |   |   |
| Total non-interest income                                            |       | 509,365                                   |       | 873,945                                  |       | 1,603,981 |   | 1,159,454 |   |
|                                                                 |       |                                      |       |                                     |       |   |   |   |   |
| NON-INTEREST EXPENSES                                                |       |                                      |       |                                     |       |   |   |   |   |
| Salaries and employee benefits                                       |       | 1,647,694                                 |       | 1,613,494                                |       | 4,693,488 |   | 4,624,910 |   |
| Net occupancy                                                        |       | 268,963                                   |       | 293,029                                  |       | 856,904 |   | 884,194 |   |
| Depreciation                                                         |       | 124,309                                   |       | 139,032                                  |       | 374,397 |   | 402,966 |   |
| Data processing                                                      |       | 300,559                                   |       | 282,538                                  |       | 902,332 |   | 820,286 |   |
| ATM expense                                                          |       | 94,274                                    |       | 108,195                                  |       | 207,461 |   | 317,420 |   |
| Deposit insurance premium                                            |       | 32,721                                    |       | 20,461                                   |       | 84,898 |   | 73,489 |   |
| Advertising and promotions                                           |       | 66,047                                    |       | 73,760                                   |       | 226,563 |   | 236,190 |   |
| Other                                                                |       | 509,922                                   |       | 542,311                                  |       | 1,472,579 |   | 1,330,390 |   |
|                                                                 |       |                                      |       |                                     |       |   |   |   |   |
| Total non-interest expenses                                          |       | 3,044,489                                 |       | 3,072,820                                |       | 8,818,622 |   | 8,689,845 |   |
|                                                                 |       |                                      |       |                                     |       |   |   |   |   |
| INCOME BEFORE INCOME TAXES                                           |       | 1,625,223                                 |       | 1,514,786                                |       | 4,757,210 |   | 4,221,513 |   |
|                                                                 |       |                                      |       |                                     |       |   |   |   |   |
| PROVISION FOR INCOME TAXES                                           |       | 570,900                                   |       | 497,472                                  |       | 1,610,740 |   | 1,426,491 |   |
|                                                                 |       |                                      |       |                                     |       |   |   |   |   |
| NET INCOME                                                           |       | $                                         | 1,054,323  |                                     | $          | 1,017,314 |   | $ | 3,146,470 |   | $ | 2,795,022 |   |

 

See notes to unaudited consolidated financialstatements.

 

2

----

 

**ABINGTON BANK AND SUBSIDIARIES**

 

**UNAUDITEDCONSOLIDATED STATEMENT OF CHANGES IN RETAINED EARNINGS AND COMPREHENSIVE INCOME**

 
| ** **                                                                                                                  | ** ** | **Retained  Earnings** | ** ** | **Accumulated  Other  Comprehensive  Loss** | ** ** | **Total  Retained  Earnings** | ** ** | **Comprehensive  Income** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|---------------------------------------------|------------|-------------------------------|------------|---------------------------|------------|
|                                                                                                                        |       |                   |       |                                        |       |                          |       |                      |       |
| BALANCE—DECEMBER 31, 2003 (as restated)                                                                           |       | 53,426,380             |       | (192,112                                    | )          | 53,234,268                    |       |                      |       |
|                                                                                                                        |       |                   |       |                                        |       |                          |       |                      |       |
| Comprehensive income:                                                                                                       |       |                   |       |                                        |       |                          |       |                      |       |
| Net income                                                                                                                  |       | 3,146,470              |       |                                        |       | 3,146,470                     |       | $                         | 3,146,470  |   |
| Net unrealized holding loss on available for sale  securities arising during the period, net of tax benefit of $183,674 (1) |       |                   |       | (356,183                                    | )          | (356,183                      | )          | (356,183                  | )          |
|                                                                                                                        |       |                   |       |                                        |       |                          |       |                      |       |
| Comprehensive income                                                                                                        |       | —                 |       | —                                      |       | —                        |       | $                         | 2,790,287  |   |
|                                                                                                                        |       |                   |       |                                        |       |                          |       |                      |       |
| BALANCE—SEPTEMBER 30, 2004                                                                                        |       | $                      | 56,572,850 |                                        | $          | (548,295                      | )          | $                         | 56,024,555 |   |   |   |
|                                                                                                                             |            |                        |            |                                             |            |                               |            |                           |            |  |  |  |  |

 

(1) Disclosure ofreclassication amount, net of tax, for:

 
| Unrealized holding loss arising during the year                         |   | $      | (356,183 | )      |   |   |   |   |   |   |
|-------------------------------------------------------------------------|--------|--------|----------|--------|--------|--------|--------|--------|--------|--------|
| Less: reclassification adjustment for net gains  included in net income |   |   |     |   |   |   |   |   |   |
|                                                                    |   |   |     |   |   |   |   |   |   |
| Net unrealized loss on securities                                       |   | $      | (356,183 | )      |   |   |   |   |   |   |

 

See notes to unaudited consolidated financial statements.

 

3

----

 

**ABINGTONBANK AND SUBSIDIARIES**

 

**UNAUDITEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

 
| ** **                                                                         | ** ** | **Nine Months Ended September 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                                         | ** ** | **2004**                                 | ** ** | **2003** | ** ** |
| OPERATING ACTIVITIES:                                                              |       |                                     |       |   |   |
| Net income                                                                         |       | $                                        | 3,146,470  |   | $ | 2,795,022 |   |
| Adjustments to reconcile net income to net cash provided  by operating activities: |       |                                     |       |   |   |
| Provision for loan losses                                                          |       | 45,000                                   |       | 375,000 |   |
| Depreciation                                                                       |       | 374,397                                  |       | 402,966 |   |
| Unrealized (gain) loss on derivative instruments                                   |       | (340,500                                 | )          | 86,416 |   |
| Gain on sale of loans                                                              |       |                                     |       | (44,036 | ) |
| Gain on sale of property                                                           |       |                                     |       | (55,000 | ) |
| Deferred income tax expense                                                        |       | 93,380                                   |       | 29,381 |   |
| Deferred loan fees                                                                 |       | 1,201,574                                |       | 1,772,367 |   |
| Amortization of:                                                                   |       |                                     |       |   |   |
| Deferred loan fees                                                                 |       | (1,262,965                               | )          | (2,132,308 | ) |
| Premiums and discounts, net                                                        |       | 276,459                                  |       | 402,615 |   |
| Changes in assets and liabilities which (used)  provided cash:                     |       |                                     |       |   |   |
| Accrued interest receivable                                                        |       | (246,041                                 | )          | (248,896 | ) |
| Prepaid expenses and other assets                                                  |       | (2,120,891                               | )          | (1,803,540 | ) |
| Accrued interest payable                                                           |       | 1,693,145                                |       | 1,479,016 |   |
| Accounts payable and accrued expenses                                              |       | 2,056,478                                |       | 1,948,090 |   |
|                                                                               |       |                                     |       |   |   |
| Net cash provided by operating activities                                          |       | 4,916,506                                |       | 5,007,093 |   |
|                                                                               |       |                                     |       |   |   |
| INVESTING ACTIVITIES:                                                              |       |                                     |       |   |   |
| Principal collected on loans                                                       |       | 105,773,362                              |       | 135,093,948 |   |
| Disbursements for loans                                                            |       | (137,105,737                             | )          | (120,609,869 | ) |
| Purchases of:                                                                      |       |                                     |       |   |   |
| Mortgage-backed securities held to maturity                                        |       | (10,956,924                              | )          | (39,232,674 | ) |
| Mortgage-backed securities available for sale                                      |       | (29,305,178                              | )          | (66,730,082 | ) |
| Investments held to maturity                                                       |       | (10,220,792                              | )          |   |   |
| Investments available for sale                                                     |       | (24,244,942                              | )          | (106,061,514 | ) |
| Federal Home Loan Bank stock                                                       |       | (1,908,700                               | )          | (2,410,400 | ) |
| Property and equipment                                                             |       | (155,348                                 | )          | (342,532 | ) |
| Proceeds from:                                                                     |       |                                     |       |   |   |
| Maturities of mortgage-backed securities available  for sale                       |       | 101,504                                  |       | 5,410,664 |   |
| Maturities of investments available for sale                                       |       | 36,297,000                               |       | 65,926,503 |   |
| Principal repayments of mortgage-backed securities  held to maturity               |       | 6,396,352                                |       | 4,569,291 |   |
| Principal repayments of mortgage-backed securities  available for sale             |       | 22,131,149                               |       | 26,727,828 |   |
| Sale of real estate investment                                                     |       |                                     |       | 448,000 |   |
| Sales of Federal Home Loan Bank stock                                              |       | 979,300                                  |       |   |   |
|                                                                               |       |                                     |       |   |   |
| Net cash used in investing activities                                              |       | (42,218,954                              | )          | (97,210,837 | ) |
|                                                                               |       |                                     |       |   |   |
| FINANCING ACTIVITIES:                                                              |       |                                     |       |   |   |
| Net increase in demand deposits and savings accounts                               |       | 10,785,787                               |       | 16,548,485 |   |
| Net increase in certificate accounts                                               |       | 15,611,273                               |       | 1,800,865 |   |
| Net increase in other borrowed money                                               |       | 10,636,200                               |       | 8,026,897 |   |
| Advances from Federal Home Loan Bank                                               |       | 311,045,000                              |       | 47,447,996 |   |
| Repayments of advances from Federal Home Loan Bank                                 |       | (299,188,909                             | )          | (9,360,542 | ) |
| Net decrease in advances from borrowers for taxes  and insurance                   |       | (1,783,631                               | )          | (1,817,340 | ) |
|                                                                               |       |                                     |       |   |   |
| Net cash provided by financing activities                                          |       | 47,105,720                               |       | 62,646,361 |   |
|                                                                               |       |                                     |       |   |   |
| NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                               |       | 9,803,272                                |       | (29,557,383 | ) |
|                                                                               |       |                                     |       |   |   |
| CASH AND CASH EQUIVALENTS—Beginning of year                                   |       | 19,695,625                               |       | 51,701,706 |   |
|                                                                               |       |                                     |       |   |   |
| CASH AND CASH EQUIVALENTS—End of year                                         |       | $                                        | 29,498,897 |   | $ | 22,144,323 |   |
|                                                                               |       |                                     |       |   |   |
| SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:                                 |       |                                     |       |   |   |
| Noncash transfer of real estate investment to loans  receivable                    |       |                                     |       | $ | 1,955,322 |   |
|                                                                               |       |                                     |       |   |   |
| Cash paid during the year for:                                                     |       |                                     |       |   |   |
| Interest on deposits and other borrowings                                          |       | $                                        | 8,712,473  |   | $ | 9,005,385 |   |
|                                                                               |       |                                     |       |   |   |
| Income taxes                                                                       |       | $                                        | 1,600,000  |   | $ | 1,573,000 |   |

 

See notes to unaudited consolidated financialstatements.

 

4

----

 

**ABINGTONBANK AND SUBSIDIARIES**

 

**NOTES TO UNAUDITED CONSOLIDATEDFINANCIAL STATEMENTS**

 

**1.****                     ****FINANCIALSTATEMENT PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES**

 

***Basis of Financial Statement Presentation—***On April 21, 2004, the Board ofTrustees approved a plan of reorganization by which Abington Savings Bank,which conducts business under the name “Abington Bank” (the “Bank” or “AbingtonBank”), will reorganize from its current status as a mutual savings bank to amutual holding company structure. Upon completion of the reorganization, whichis expected to occur in December 2004, Abington Bank will be a whollyowned subsidiary of Abington Community Bancorp, Inc. (the “Company” or “registrant”).Abington Mutual Holding Company, a Pennsylvania corporation, will become themutual holding company parent of Abington Community Bancorp. Initially,Abington Mutual Holding Company will own 55% of Abington Community Bancorp’soutstanding common stock after the reorganization and must always own at leasta majority of the voting stock of Abington Community Bancorp. In addition tothe shares of Abington Community Bancorp which it will own, Abington MutualHolding Company will be capitalized with $100,000 in cash. As part of thereorganization, approximately 45% of the to-be-outstanding common stock of theCompany is being offered to certain depositors and others.

 

TheCompany filed a registration statement of Form S-1 (the “Registration Statement”)with the Securities and Exchange Commission (“SEC”) on June 10, 2004,which as amended, was declared effective by the SEC on October 21, 2004(File No. 333-116370). The registrant is in organization and has engaged in nooperations to date; accordingly, no financial statements of the Company havebeen included herein. The unaudited consolidated financial statements includedherein are the financial statements of Abington Bank and the Bank’s whollyowned subsidiaries, ASB Investment Co., Keswick Services II and its whollyowned subsidiaries, and Abington Corp. All significant intercompany balancesand transactions have been eliminated.

 

Theaccompanying unaudited consolidated financial statements were prepared inaccordance with the instructions to Form 10-Q, and therefore, do not includeall the information or footnotes necessary for a complete presentation offinancial position, results of operations, changes in equity and comprehensiveincome and cash flows in conformity with accounting principles generallyaccepted in the United States of America. However, all normal recurringadjustments that, in the opinion of management, are necessary for a fairpresentation of the consolidated financial statements have been included. Thesefinancial statements should be read in conjunction with the auditedconsolidated financial statements of the Bank and the accompanying notesthereto included in the Company’s Registration Statement on Form S-1 for theperiod ended December 31, 2003. The results for the three and nine monthsended September 30, 2004 are not necessarily indicative of the resultsthat may be expected for the fiscal year ending December 31, 2004, or anyother period.

 

***Use of Estimates in the Preparation of Financial Statements—***The preparation of financial statementsin conformity with accounting principles generally accepted in the UnitedStates of America requires management to make estimates and assumptions thataffect the reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities at the date of the financial statements andthe reported amounts of income and expenses during the reporting period. Actualresults could differ from those estimates. The Bank’s most significantestimates are the allowance for loan losses and deferred income taxes.

 

5

----

 

***Accounting for Derivative Financial Instruments—***The Bank uses interest rate cap and swapagreements to manage its exposure to fluctuations in interest rates on aportion of its fixed rate loans and variable rate deposits. The agreements donot qualify for hedge accounting.  Gainsand losses in the fair value of the hedges, as well as amounts paid or receivedunder the cap or swap agreement, are recognized in a separate line item, losson derivative instruments, net, included in non-interest income in the Bank’sconsolidated statements of income during the period in which they accrue. TheBank does not hold any derivative financial instruments for trading purposes.

 

In April 2003,the FASB issued SFAS No. 149, *Amendment ofStatement 133 on Derivative Instruments and Hedging Activities*. SFASNo. 149 amends and clarifies accounting for derivative instruments and hedgingactivities under SFAS No. 133. In addition, this statement clarifies under whatcircumstances a contract with an initial net investment meets thecharacteristic of a derivative and when a derivative contains a financingcomponent that warrants special reporting in the statement of cash flows. Thisstatement is effective for contracts entered into or modified after June 30,2003. The adoption of SFAS No. 149 did not have a significant effect on theBank’s financial position or results of operations.

 

At September 30,2004, the Bank is party to three swap agreements with terms expiring in December 2004,June 2005, and December 2005. Under the December 2004 and June 2005agreements, the Bank will either receive or pay, on a quarterly basis, the amountby which the ten-year CMT exceeds or falls below 5.92% and 5.57%, respectively,on the notional amount of $15 million per contract. These agreementseffectively changed a portion of the Bank’s fixed rate mortgage portfolio to avariable rate of interest. Under the December 2005, agreement, the Bankwill either receive or pay on a quarterly basis, the amount by which the threemonth LIBOR exceeds or falls below 2.59% on the notional amount of $15 million.This agreement effectively changed the Bank’s variable rate money marketaccounts to a fixed rate of interest.

 

Thefair value of the swap agreements was a negative $245,000 and a negative$569,000 at September 30, 2004, and December 31, 2003, respectively.During the nine months ended September 30, 2004 and 2003, the Bank paid$495,369 and $598,943, respectively, under the agreements. In addition, theunrealized gains on derivatives recognized in loss on derivative instruments,net in the Bank’s unaudited consolidated statements of income were $340,500 and$86,416 for the nine months ended September 30, 2004 and 2003,respectively.

 

***Recent Accounting Pronouncements***—In January 2003, the FASB issuedFIN No. 46, *Consolidation of VariableInterest Entities*. The Interpretation clarifies the application ofAccounting Research Bulletin No. 51, *ConsolidatedFinancial Statements*, to certain entities in which equity investorsdo not have the characteristics of a controlling financial interest or do nothave sufficient equity at risk for the entity to finance its activities withoutadditional subordinated financial support from other parties. The FASB haspublished a revision to FIN No. 46 (FIN No. 46R) to clarify some of theprovisions of FIN No. 46 and to exempt certain entities from its requirements.The Bank is not a party to any variable interest entities covered by theInterpretation.

 

In May2003, the FASB issued SFAS No. 150, *Accountingfor Certain Financial Instruments with Characteristics of both Liabilities andEquity*. This statement requires that certain financial instruments,which previously could be designated as equity, now be classified asliabilities on the balance sheet. Certain effective dates of SFAS No. 150 weredeferred by the provisions of FASB Staff Position No. 150-3, *Effective Date, Disclosures, and Transition forMandatorily Redeemable Financial Instruments of Certain Nonpublic Entities andCertain Mandatorily Redeemable Noncontrolling Interests Under FASB StatementNo. 150, Accounting for Certain Financial*

 

6

----

 

*Instruments with Characteristics of Both Liabilities andEquity*.Currently, the Bank has no financial instruments entered into or modified thatrequire application of this statement.

 

In March 2004,the SEC issued Staff Accounting Bulletin (“SAB”) No. 105, *Applicationof Accounting Principles to Loan Commitments*, which providesguidance regarding loan commitments that are accounted for as derivativeinstruments. In this SAB, the SEC determined that an interest rate lockcommitment should generally be valued at zero at inception. The rate locks willcontinue to be adjusted for changes in value resulting from changes in marketinterest rates. The adoption of this standard did not have a material effect onthe Bank’s financial position or results of operations.

 

In March 2004,the FASB Emerging Issues Task Force (“EITF”) reached a consensus regarding EITF03-1, “*The Meaning of Other-Than-Temporary Impairment andIts Application to Certain Investments*.”  The consensusprovides guidance for evaluating whether an investment isother-than-temporarily impaired and was effective for other-than-temporaryimpairment evaluations made in reporting periods beginning after June 15,2004.  However, the guidance contained inparagraphs 10-20 of this Issue has been delayed by FASB Staff Position (“FSP”)EITF Issue 03-1-1, “*Effective Date ofParagraphs 10–20 of EITF Issue No. 03-1, The Meaning of Other-Than-TemporaryImpairment and Its Application to Certain Investments*,” posted September 30,2004. The delay of the effective date for paragraphs 10–20 will be supersededconcurrent with the final issuance of proposed FSP EITF Issue 03-1-a, “*Implication Guidance for the Application of Paragraph 16 of EITF IssueNo. 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application toCertain Investments*.”  Theproposed FSP would provide implementation guidance with respect to debtsecurities that are impaired solely due to interest rates and/or sector spreadsand analyzed for other-than-temporary impairment.  The disclosures continue to be effective forthe Bank’s consolidated financial statements for fiscal years ending after December 15,2003, for investments accounted for under SFAS No. 115 and No. 124. For allother investments within the scope of this Issue, the disclosures continue tobe effective for fiscal years ending after June 15, 2004. The additionaldisclosures for cost method investments continue to be effective for fiscalyears ending after June 15, 2004.

 

7

----

 

**2.****                     ****INVESTMENT SECURITIES**

 

Theamortized cost and estimated fair value of investment securities are summarizedas follows: 

 
| ** **            | ** ** | **Held to Maturity  September 30, 2004** | ** ** |
|-----------------------|------------|-----------------------------------------------|------------|
| ** **            | ** ** | **Amortized  Cost**                           | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  Fair  Value** | ** ** |
| Debt securities:      |       |                                          |       |   |   |   |   |   |   |
| Municipal bonds       |       | $                                             | 10,220,473 |   | $ | 94,683 |   | $ | (18 | ) | $ | 10,315,138 |   |
|                  |       |                                          |       |   |   |   |   |   |   |
| Total debt securities |       | $                                             | 10,220,473 |   | $ | 94,683 |   | $ | (18 | ) | $ | 10,315,138 |   |
|                       |            |                                               |            |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                           | ** ** | **Available for Sale  September 30, 2004** | ** ** |
|--------------------------------------|------------|-------------------------------------------------|------------|
| ** **                           | ** ** | **Amortized  Cost**                             | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  Fair  Value** | ** ** |
| Debt securities:                     |       |                                            |       |   |   |   |   |   |   |
| Agency bonds                         |       | $                                               | 61,489,340 |   | $ | 101,570 |   | $ | (973,370 | ) | $ | 60,617,540 |   |
| Corporate bonds and commercial paper |       | 1,000,061                                       |       | 22,232 |   | (2,573 | ) | 1,019,720 |   |
| Municipal bonds                      |       | 180,000                                         |       | 5,825 |   |   |   | 185,825 |   |
| Certificates of deposit              |       | 1,480,000                                       |       |   |   |   |   | 1,480,000 |   |
|                                 |       |                                            |       |   |   |   |   |   |   |
| Total debt securities                |       | 64,149,401                                      |       | 129,627 |   | (975,943 | ) | 63,303,085 |   |
|                                 |       |                                            |       |   |   |   |   |   |   |
| Equity securities:                   |       |                                            |       |   |   |   |   |   |   |
| Common stock                         |       | 2,510                                           |       | 624 |   | (2,500 | ) | 634 |   |
| Mutual funds                         |       | 3,376,267                                       |       |   |   | (97,822 | ) | 3,278,445 |   |
|                                 |       |                                            |       |   |   |   |   |   |   |
| Total equity securities              |       | 3,378,777                                       |       | 624 |   | (100,322 | ) | 3,279,079 |   |
|                                 |       |                                            |       |   |   |   |   |   |   |
| Total                                |       | $                                               | 67,528,178 |   | $ | 130,251 |   | $ | (1,076,265 | ) | $ | 66,582,164 |   |
|                                      |            |                                                 |            |  |  |  |  |  |  |  |  |  |  |  |

 

8

----

 
| ** **                           | ** ** | **Available for Sale  December 31, 2003** | ** ** |
|--------------------------------------|------------|------------------------------------------------|------------|
| ** **                           | ** ** | **Amortized  Cost**                            | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  Fair  Value** | ** ** |
| Debt securities:                     |       |                                           |       |   |   |   |   |   |   |
| Agency bonds                         |       | $                                              | 72,988,418 |   | $ | 321,800 |   | $ | (881,048 | ) | $ | 72,429,170 |   |
| Corporate bonds and commercial paper |       | 1,500,506                                      |       | 36,284 |   |   |   | 1,536,790 |   |
| Municipal bonds                      |       | 180,000                                        |       | 9,340 |   |   |   | 189,340 |   |
| Certificates of deposit              |       | 1,579,000                                      |       |   |   |   |   | 1,579,000 |   |
|                                 |       |                                           |       |   |   |   |   |   |   |
| Total debt securities                |       | 76,247,924                                     |       | 367,424 |   | (881,048 | ) | 75,734,300 |   |
|                                 |       |                                           |       |   |   |   |   |   |   |
| Equity securities:                   |       |                                           |       |   |   |   |   |   |   |
| Common stock                         |       | 2,510                                          |       | 741 |   | (2,500 | ) | 751 |   |
| Mutual funds                         |       | 3,329,323                                      |       |   |   | (79,879 | ) | 3,249,444 |   |
|                                 |       |                                           |       |   |   |   |   |   |   |
| Total equity securities              |       | 3,331,833                                      |       | 741 |   | (82,379 | ) | 3,250,195 |   |
|                                 |       |                                           |       |   |   |   |   |   |   |
| Total                                |       | $                                              | 79,579,757 |   | $ | 368,165 |   | $ | (963,427 | ) | $ | 78,984,495 |   |
|                                      |            |                                                |            |  |  |  |  |  |  |  |  |  |  |  |

 

**The tablebelow sets forth investment securities which have an unrealized loss positionsas of September 30, 2004:**

 
| ** **                          | ** ** | **Less than 12 months**       | ** ** | **More than 12 months**    | ** ** |
|-------------------------------------|------------|-------------------------------|------------|----------------------------|------------|
| ** **                          | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  Fair  Value** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  Fair  Value** | ** ** |
|                                |       |                          |       |                       |       |   |   |   |   |
| Securities held to maturity:        |       |                          |       |                       |       |   |   |   |   |
| Municipal bonds                     |       | $                             | (18        | )                          | $          | 454,982 |   |   |   |   |   |
|                                |       |                          |       |                       |       |   |   |   |   |
| Total securities held to maturity   |       | (18                           | )          | 454,982                    |       |   |   |   |   |
|                                |       |                          |       |                       |       |   |   |   |   |
| Securities available for sale:      |       |                          |       |                       |       |   |   |   |   |
|                                |       |                          |       |                       |       |   |   |   |   |
| Government agency securities        |       | $                             | (378,650   | )                          | $          | 36,621,350 |   | $ | (594,720 | ) | $ | 19,394,620 |   |
| Other securities                    |       | (2,573                        | )          | 496,510                    |       | (100,322 | ) | 3,278,445 |   |
|                                |       |                          |       |                       |       |   |   |   |   |
| Total securities available for sale |       | (381,223                      | )          | 37,117,860                 |       | (695,042 | ) | 22,673,065 |   |
|                                |       |                          |       |                       |       |   |   |   |   |
| Total                               |       | $                             | (381,241   | )                          | $          | 37,572,842 |   | $ | (695,042 | ) | $ | 22,673,065 |   |
|                                     |            |                               |            |                            |            |  |  |  |  |  |  |  |  |  |

 

At September 30,2004, securities in a gross unrealized loss position for twelve months orlonger consist of 10 securities having an aggregate depreciation of 3.0% fromthe Bank’s amortized cost basis. Securities in a gross unrealized loss positionfor less than twelve months consist of 21 securities having an aggregatedepreciation of 1.0% from the Bank’s amortized cost basis. Management believesthat the estimated fair value of the securities disclosed above is primarilydependent upon the movement in

 

9

----

 

market interest rates.Although the fair value will fluctuate as the market interest rates move, themajority of the Bank’s investment portfolio consists of securities frommunicipalities and government agencies considered to be low-risk. If held tomaturity, the contractual principal and interest payments of the securities areexpected to be received in full. As such, no loss in value is expected over thelives of the securities. Although not all of the securities are classified asheld to maturity, the Bank has the ability to hold these securities until theymature and does not intend to sell the securities at a loss. Thus, theunrealized losses are not other-than-temporary. The determination of whether adecline in market value is other-than-temporary is necessarily a matter ofsubjective judgment. The timing and amount of any realized losses reported inthe Bank’s financial statements could vary if conclusions other than those madeby management were to determine whether an other-than-temporary impairmentexists.

 

**3.****                     ****MORTGAGE-BACKED SECURITIES**

 

Theamortized cost and estimated fair value of mortgage-backed securities aresummarized as follows:

 
| ** **                      | ** ** | **Held to Maturity  September 30, 2004** | ** ** |
|---------------------------------|------------|-----------------------------------------------|------------|
| ** **                      | ** ** | **Amortized  Cost**                           | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  Fair  Value** | ** ** |
|                            |       |                                          |       |   |   |   |   |   |   |
| FNMA pass-through certificates  |       | $                                             | 35,141,416 |   | $ | 167,453 |   | $ | (404,299 | ) | $ | 34,904,570 |   |
| FHLMC pass-through certificates |       | 12,296,630                                    |       |   |   | (219,210 | ) | 12,077,420 |   |
|                            |       |                                          |       |   |   |   |   |   |   |
| Total                           |       | $                                             | 47,438,046 |   | $ | 167,453 |   | $ | (623,509 | ) | $ | 46,981,990 |   |
|                                 |            |                                               |            |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                               | ** ** | **Available for sale  September 30, 2004** | ** ** |
|------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                               | ** ** | **Amortized  Cost**                             | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  Fair  Value** | ** ** |
|                                     |       |                                            |       |   |   |   |   |   |   |
| GNMA pass-through certificates           |       | $                                               | 1,025,557  |   | $ | 48,379 |   | $ | (1,164 | ) | $ | 1,072,772 |   |
| FNMA pass-through certificates           |       | 14,165,232                                      |       | 362,796 |   | (8,158 | ) | 14,519,870 |   |
| FHLMC pass-through certificates          |       | 62,270,863                                      |       | 506,785 |   | (783,058 | ) | 61,994,590 |   |
| Real estate mortgage investment conduits |       | 7,374,515                                       |       | 19,213 |   | (29,529 | ) | 7,364,199 |   |
|                                     |       |                                            |       |   |   |   |   |   |   |
| Total                                    |       | $                                               | 84,836,167 |   | $ | 937,173 |   | $ | (821,909 | ) | $ | 84,951,431 |   |
|                                          |            |                                                 |            |  |  |  |  |  |  |  |  |  |  |  |

 

10

----

 
| ** **                      | ** ** | **Held to Maturity  December 31, 2003** | ** ** |
|---------------------------------|------------|----------------------------------------------|------------|
| ** **                      | ** ** | **Amortized  Cost**                          | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  Fair  Value** | ** ** |
|                            |       |                                         |       |   |   |   |   |   |   |
| FNMA pass-through certificates  |       | $                                            | 40,275,940 |   | $ | 345,905 |   | $ | (449,890 | ) | $ | 40,171,955 |   |
| FHLMC pass-through certificates |       | 2,733,281                                    |       |   |   | (13,728 | ) | 2,719,553 |   |
|                            |       |                                         |       |   |   |   |   |   |   |
| Total                           |       | $                                            | 43,009,221 |   | $ | 345,905 |   | $ | (463,618 | ) | $ | 42,891,508 |   |
|                                 |            |                                              |            |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                               | ** ** | **Available for Sale  December 31, 2003** | ** ** |
|------------------------------------------|------------|------------------------------------------------|------------|
| ** **                               | ** ** | **Amortized  Cost**                            | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  Fair  Value** | ** ** |
|                                     |       |                                           |       |   |   |   |   |   |   |
| GNMA pass-through certificates           |       | $                                              | 1,575,087  |   | $ | 77,829 |   | $ | (8,613 | ) | $ | 1,644,303 |   |
| FNMA pass-through certificates           |       | 11,790,003                                     |       | 236,737 |   | (13,144 | ) | 12,013,596 |   |
| FHLMC pass-through certificates          |       | 58,687,031                                     |       | 442,747 |   | (412,742 | ) | 58,717,036 |   |
| Real estate mortgage investment conduits |       | 5,856,393                                      |       | 11,017 |   | (29,462 | ) | 5,837,948 |   |
|                                     |       |                                           |       |   |   |   |   |   |   |
| Total                                    |       | $                                              | 77,908,514 |   | $ | 768,330 |   | $ | (463,961 | ) | $ | 78,212,883 |   |
|                                          |            |                                                |            |  |  |  |  |  |  |  |  |  |  |  |

 

11

----

 

The table below sets forthmortgage-backed securities which have an unrealized loss positions as of September 30,2004:

 
| ** **                                                          | ** ** | **Less than 12 months**       | ** ** | **More than 12 months**    | ** ** |
|---------------------------------------------------------------------|------------|-------------------------------|------------|----------------------------|------------|
| ** **                                                          | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  Fair  Value** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  Fair  Value** | ** ** |
|                                                                |       |                          |       |                       |       |   |   |   |   |
| Securities held to maturity:                                        |       |                          |       |                       |       |   |   |   |   |
| Mortgage-backed securities                                          |       | $                             | (219,210   | )                          | $          | 12,077,420 |   | $ | (404,299 | ) | $ | 16,106,384 |   |
|                                                                |       |                          |       |                       |       |   |   |   |   |
| Total securities held to maturity                                   |       | (219,210                      | )          | 12,077,420                 |       | (404,299 | ) | 16,106,384 |   |
|                                                                |       |                          |       |                       |       |   |   |   |   |
| Securities available for sale:                                      |       |                          |       |                       |       |   |   |   |   |
| Mortgage-backed securities and collateralized  mortgage obligations |       | $                             | (185,724   | )                          | $          | 16,622,089 |   | $ | (636,185 | ) | $ | 28,881,611 |   |
|                                                                |       |                          |       |                       |       |   |   |   |   |
| Total securities available for sale                                 |       | (185,724                      | )          | 16,622,089                 |       | (636,185 | ) | 28,881,611 |   |
|                                                                |       |                          |       |                       |       |   |   |   |   |
| Total                                                               |       | $                             | (404,934   | )                          | $          | 28,699,509 |   | $ | (1,040,484 | ) | $ | 44,987,995 |   |
|                                                                     |            |                               |            |                            |            |  |  |  |  |  |  |  |  |  |  |

 

At September 30,2004, securities in a gross unrealized loss position for twelve months orlonger consist of 15 securities having an aggregate depreciation of 2.3% fromthe Bank’s amortized cost basis. Securities in a gross unrealized loss positionfor less than twelve months consist of 15 securities having an aggregatedepreciation of 1.4% from the Bank’s amortized cost basis. Management believesthat the estimated fair value of the securities disclosed above is primarilydependent upon the movement in market interest rates. Although the fair valuewill fluctuate as the market interest rates move, all of the Bank’smortgage-backed securities portfolio consists of securities from FNMA, FHLMCand GNMA considered to be low-risk. If held to maturity, the contractualprincipal and interest payments of the securities are expected to be receivedin full. As such, no loss in value is expected over the lives of thesecurities. Although not all of the securities are classified as held tomaturity, the Bank has the ability to hold these securities until they matureand does not intend to sell the securities at a loss. Thus, the unrealizedlosses are not other-than-temporary. The determination of whether a decline inmarket value is other-than-temporary is necessarily a matter of subjectivejudgment. The timing and amount of any realized losses reported in the Bank’sfinancial statements could vary if conclusions other than those made bymanagement were to determine whether an other-than-temporary impairment exists.

 

12

----

 

**4.****                     ****ALLOWANCE FOR LOAN LOSSES**

 

Followingis a summary of changes in the allowance for loan losses:

 
| ** **                      | ** ** | **Nine Months Ended September 30,** | ** ** | **Year Ended** | ** ** |
|---------------------------------|------------|------------------------------------------|------------|----------------|------------|
| ** **                      | ** ** | **2004**                                 | ** ** | **2003**       | ** ** | **December 31, 2003** | ** ** |
|                            |       |                                     |       |           |       |   |   |
| Balance—beginning of year  |       | $                                        | 1,455,889  |           | $          | 1,813,450 |   | $ | 1,813,450 |   |
| Provision for loan losses       |       | 45,000                                   |       | 375,000        |       | 375,000 |   |
| Charge-offs/recoveries—net |       | (88,420                                  | )          | (735,572       | )          | (732,561 | ) |
|                            |       |                                     |       |           |       |   |   |
| Balance—end of period      |       | $                                        | 1,412,469  |           | $          | 1,452,878 |   | $ | 1,455,889 |   |

 

Theprovision for loan losses charged to expense is based upon past loan and lossexperience and an evaluation of losses in the current loan portfolio, includingthe evaluation of impaired loans. A loan is considered to be impaired when,based upon current information and events, it is probable that the Bank will beunable to collect all amounts due according to the contractual terms of theloan. An insignificant delay or insignificant shortfall in amount of paymentsdoes not necessarily result in the loan being identified as impaired. For thispurpose, delays less than 90 days are considered to be insignificant. Duringthe periods presented, loan impairment was evaluated based on the fair value ofthe loans’ collateral. Impairment losses are included in the provision for loanlosses. Large groups of smaller balance, homogeneous loans are collectivelyevaluated for impairment, except for those loans restructured under a troubleddebt restructuring. Loans collectively evaluated for impairment include smallerbalance commercial real estate loans, residential real estate loans andconsumer loans. During the nine months ended September 30, 2004, and theyear ended December 31, 2003, the Bank had loans to one borrower totalingapproximately $0 and $99,137, respectively, that were individually evaluatedfor impairment and determined to be impaired. A reserve on these loans isincluded in the Bank’s allowance for loan losses at December 31, 2003.

 

Nonaccrualloans (which consist of smaller balance, homogeneous loans) at September 30,2004, and December 31, 2003, amounted to approximately $6,000 and$115,096, respectively. Commercial loans and commercial real estate loans areplaced on nonaccrual at the time the loan is 90 days delinquent unless thecredit is well secured and in the process of collection. Commercial loans arecharged off when the loan is deemed uncollectible. Residential real estateloans are typically placed on nonaccrual only when the loan is 90 days delinquentand not well secured and in the process of collection. Other consumer loans aretypically charged off at 90 days delinquent. In all cases, loans must be placedon nonaccrual or charged off at an earlier date if collection of principal orinterest is considered doubtful.

 

Interestpayments on impaired loans and nonaccrual loans are typically applied toprincipal unless the ability to collect the principal amount is fully assured,in which case interest is recognized on the cash basis. For the nine monthsended September 30, 2004 and the year ended December 31, 2003, nocash basis interest income has been recognized. Interest income foregone onnonaccrual loans was not material to the consolidated financial statements forthe nine months ended September 30, 2004 or the year ended December 31,2003.

 

13

----

 

**5.****                     ****DEFERRED INCOME TAXES**

 

Itemsthat gave rise to significant portions of the deferred tax accounts are asfollows:

 
| ** **                                                                   | ** ** | **September 30, 2004** | ** ** | **December 31, 2003** | ** ** |
|------------------------------------------------------------------------------|------------|-----------------------------|------------|----------------------------|------------|
|                                                                         |       |                        |       |                       |       |
| Deferred tax assets:                                                         |       |                        |       |                       |       |
| Allowance for loan losses                                                    |       | $                           | 480,239    |                       | $          | 495,000 |   |
| Deferred compensation                                                        |       | 786,668                     |       | 677,749                    |       |
| Unrealized loss on securities available-for-sale and  cap and swap contracts |       | 365,755                     |       | 297,974                    |       |
| Other                                                                        |       |                        |       | 74,891                     |       |
|                                                                         |       |                        |       |                       |       |
| Total deferred tax assets                                                    |       | 1,632,662                   |       | 1,545,614                  |       |
|                                                                         |       |                        |       |                       |       |
| Deferred tax liabilities:                                                    |       |                        |       |                       |       |
| Property and equipment                                                       |       | (151,368                    | )          | (221,392                   | )          |
| Deferred loan fees                                                           |       | (302,550                    | )          | (261,751                   | )          |
| Other                                                                        |       | (25,979                     | )          |                       |       |
|                                                                         |       |                        |       |                       |       |
| Total deferred tax liabilities                                               |       | (479,897                    | )          | (483,143                   | )          |
|                                                                         |       |                        |       |                       |       |
| Net deferred tax asset                                                       |       | $                           | 1,152,765  |                       | $          | 1,062,471 |   |

 

**6.****                     ****RESTATEMENT OF FINANCIALSTATEMENT – CORRECTION OF AN ERROR**

 

Subsequentto the issuance of the Bank’s 2003 financial statements, Bank’s managementdetermined that certain derivatives that had been accounted for as cash flowhedges under SFAS No. 133 did not qualify for hedge accounting. The unrealizedgains (losses) on the derivatives, net of related taxes, of $239,885,$(524,751), and $(101,441) for the years ended December 31, 2003, 2002,and 2001, respectively, were inappropriately included in accumulated othercomprehensive income. Accordingly, the Bank restated the consolidated financialstatements to include unrealized gains (losses) on derivatives in the incomestatement.

 

**ITEM 2.  –MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OFOPERATIONS**

 

***Overview—***The Company was formed by the Bank inconnection with the Bank’s reorganization into the mutual holding company formand has not yet commenced operations. The Company’s results of operations willbe primarily dependent on the results of the Bank, which will be a wholly ownedsubsidiary of the Company upon completion of the reorganization. The Bank’sresults of operations depend to a large extent on net interest income, which isthe difference between the income earned on its loan and investment portfoliosand the cost of funds, which is the interest paid on deposits andborrowings.  Results of operations arealso affected by our provisions for loan losses, losses on derivativeinstruments, service charges and other non-interest income and non-interestexpense. Non-interest expense principally consists of salaries and employeebenefits, office occupancy and equipment expense, data processing expense, advertisingand promotions and other expense. Our results of operations are alsosignificantly affected by general economic and competitive conditions,particularly changes in interest rates, government policies and actions ofregulatory authorities. Future changes in applicable laws, regulations orgovernment policies may materially impact our financial condition and resultsof operations. The Bank is subject to regulation by the Federal DepositInsurance Corporation (“FDIC”) and

 

14

----

 

the PennsylvaniaDepartment of Banking. The Bank’s executive offices are in Jenkintown,Pennsylvania, with seven other branches and four limited service facilitieslocated in nearby Montgomery County neighborhoods. The Bank is principallyengaged in the business of accepting customer deposits and investing thesefunds in loans, primarily residential mortgages.

 

***CriticalAccounting Policies, Judgments and Estimates—***In reviewing and understanding financialinformation for Abington Bank, you are encouraged to read and understand thesignificant accounting policies used in preparing our consolidated financialstatements. These policies are described in Note 1 of the notes to ourconsolidated financial statements. The accounting and financial reportingpolicies of Abington Bank conform to accounting principles generally acceptedin the United States of America and to general practices within the bankingindustry. The preparation of the Bank’s consolidated financial statementsrequires management to make estimates and assumptions that affect the reportedamounts of assets and liabilities and disclosure of contingent assets andliabilities at the date of the financial statements and the reported amounts ofincome and expenses during the reporting period. Management evaluates theseestimates and assumptions on an ongoing basis including those related to theallowance for loan losses and deferred income taxes. Management bases itsestimates on historical experience and various other factors and assumptionsthat are believed to be reasonable under the circumstances. These form thebases for making judgments on the carrying value of assets and liabilities thatare not readily apparent from other sources. Actual results may differ fromthese estimates under different assumptions or conditions.

 

***Allowancefor Loan Losses—***Theallowance for loan losses is established through a provision for loan lossescharged to expense. Loans are charged against the allowance for loan losseswhen management believes that the collectibility of the principal is unlikely.Subsequent recoveries are added to the allowance. The allowance is an amountthat management believes will cover known and inherent losses in the loanportfolio, based on regular evaluations of the collectibility of loans. Theevaluations take into consideration such factors as changes in the types andamount of loans in the loan portfolio, delinquency and nonperforming loan data,historical loss experience, adverse situations that may affect the borrower’s abilityto repay, estimated value of any underlying collateral, estimated lossesrelating to specifically identified loans, and current economic conditions.This evaluation is inherently subjective as it requires material estimatesincluding, among others, exposure at default, the amount and timing of expectedfuture cash flows on impacted loans, value of collateral, estimated losses onour commercial and residential loan portfolios and general amounts forhistorical loss experience. All of these estimates may be susceptible tosignificant change.

 

While management uses thebest information available to make loan loss allowance valuations, adjustmentsto the allowance may be necessary based on changes in economic and otherconditions, changes in the composition of the loan portfolio or changes inaccounting guidance. In times of economic slowdown, either regional ornational, the risk inherent in the loan portfolio could increase resulting inthe need for additional provisions to the allowance for loan losses in futureperiods. An increase could also be necessitated by an increase in the size ofthe loan portfolio or in any of its components even though the credit qualityof the overall portfolio may be improving. Historically, our estimates of theallowance for loan loss have not required significant adjustments frommanagement’s initial estimates. In addition, the Pennsylvania Department ofBanking and the FDIC, as an integral part of their examination processes,periodically review our allowance for loan losses. The Pennsylvania Departmentof Banking and the FDIC may require the recognition of adjustment to theallowance for loan losses based on their judgment of information available tothem at the time of their examinations. To the extent that actual outcomesdiffer from management’s estimates, additional provisions to the allowance forloan losses may be required that would adversely impact earnings in futureperiods.

 

15

----

 

***Income Taxes—***Management makes estimates and judgments tocalculate some of our tax liabilities and determine the recoverability of someof our deferred tax assets, which arise from temporary differences between thetax and financial statement recognition of revenues and expenses. Managementalso estimates a reserve for deferred tax assets if, based on the availableevidence, it is more likely than not that some portion or all of the recordeddeferred tax assets will not be realized in future periods. These estimates andjudgments are inherently subjective. Historically, our estimates and judgmentsto calculate our deferred tax accounts have not required significant revisionfrom management’s initial estimates.

 

In evaluating our abilityto recover deferred tax assets, management considers all available positive andnegative evidence, including our past operating results, recent cumulativelosses and our forecast of future taxable income. In determining future taxableincome, management makes assumptions for the amount of taxable income, thereversal of temporary differences and the implementation of feasible andprudent tax planning strategies. These assumptions require us to make judgmentsabout our future taxable income and are consistent with the plans and estimateswe use to manage our business. Any reduction is estimated future taxable incomemay require us to record an additional valuation allowance against our deferredtax assets. An increase in the valuation allowance would result in additionalincome tax expense in the period and could have a significant impact on ourfuture earnings.

 

**COMPARISON OF FINANCIAL CONDITION AT SEPTEMBER 30,2004 AND DECEMBER 31, 2003**

 

Ourtotal assets increased by $53.3 million, or 8.8%, to $657.7 million atSeptember 30, 2004 compared to $604.4 million at December 31, 2003.  This increase in our assets is relativelyconsistent with the growth we have experienced in recent years.  During the three-year period ended December31, 2003, our average increase in assets over the prior year was 11.8%.  During the first nine months of 2004, thelargest increases in our assets were in the categories of mortgage-backedsecurities, cash and cash equivalents and net loans receivable.  Our mortgage-backed securities, bothheld-to-maturity and available-for-sale increased by an aggregate of $11.1million, or 9.2%, to $132.4 million at September 30, 2004 compared to $121.2million at December 31, 2003.  Wecontinued to purchase mortgage-backed securities during the first nine monthsof 2004 and purchases of $40.3 million in the aggregate more than offset $28.6million in payments and repayments of our held-to-maturity andavailable-for-sale mortgage-backed securities. Given the relative efficiencies provided by mortgage-backed securitiescoupled with what we believe is good credit risk, we have continued to investin mortgage-backed securities as a part of our growth efforts.  Our net loans receivable increased by $31.3million, or 8.6%, to $396.0 million at September 30, 2004 compared to $364.6million at December 31, 2003.  During thefirst nine months of 2004 our total loan originations amounted to $137.1million and loan principal payments were $105.8 million.  Our cash and cash equivalents increased by$9.8 million to $29.5 million at September 30, 2004 compared to $19.7 millionat December 31, 2003.  This was due inpart to repayments of certain investment securities as well as the increase inour deposit base.  While we purchased$36.4 million in additional investment securities during the period, includingFederal Home Loan Bank (“FHLB”) stock, such purchases were more than offset byan aggregate of $37.3 million of maturities and calls of such securities.  As a result, our total investment securitiesand FHLB stock amounted to $87.8 million at September 30, 2004 compared to$89.0 million at December 31, 2003.

 

Ourdeposits increased by $26.4 million, or 7.3%, to $389.1 million at September30, 2004 compared to $362.7 million at December 31, 2003.  The amount of our FHLB advances increased by$11.9 million, or 6.8%, to $185.6 million at September 30, 2004 compared to$173.7 million at December 31, 2003.  Theincrease in other borrowings to $19.3 million at September 30, 2004 compared to$8.7 million at December 31, 2003 reflects an increase in the amount ofsecurities repurchase agreements entered into with certain commercial checkingaccount customers pursuant to a sweep account agreement with suchcustomers.  Our retained earningsamounted to $56.0 million at September 30, 2004 compared to $53.2 million

 

16

----

 

atDecember 31, 2003.  The primary reasonfor the increase in our retained earnings was net income of $3.1 million forthe first nine months of 2004.

 

**LIQUIDITY AND CAPITAL RESOURCES**

 

Ourprimary sources of funds are from deposits, amortization of loans, loanprepayments and the maturity of loans, mortgage-backed securities and otherinvestments, and other funds provided from operations. While scheduled paymentsfrom the amortization of loans and mortgage-backed securities and maturinginvestment securities are relatively predictable sources of funds, depositflows and loan prepayments can be greatly influenced by general interest rates,economic conditions and competition.  Wealso maintain excess funds in short-term, interest-bearing assets that provideadditional liquidity.  At September 30,2004, our cash and cash equivalents amounted to $29.5 million.  In addition, at such date we had $1.3 millionin investment securities scheduled to mature within the next 12 months.  Our available for sale investment andmortgage-backed securities amounted to an aggregate of $151.5 million atSeptember 30, 2004.

 

Weuse our liquidity to fund existing and future loan commitments, to fundmaturing certificates of deposit and demand deposit withdrawals, to invest inother interest-earning assets, and to meet operating expenses.  At September 30, 2004, we had certificates ofdeposit maturing within the next 12 months amounting to $70.0 million. Based uponhistorical experience, we anticipate that a significant portion of the maturingcertificates of deposit will be redeposited with us.  For the nine months ended September 30, 2004and year ended December 31, 2003, the average balance of our outstanding FHLBadvances was $169.6 million and $148.1 million, respectively.  At September 30, 2004, we had $185.6 millionin outstanding FHLB advances and we had $220.9 million in additional FHLBadvances available to us.

 

Inaddition to cash flow from loan and securities payments and prepayments as wellas from sales of available for sale securities, we have significant borrowingcapacity available to fund liquidity needs. We have increased our utilization of borrowings in recent years as acost efficient addition to deposits as a source of funds.  Our borrowings consist primarily of advancesfrom the Federal Home Loan Bank of Pittsburgh, of which we are a member.  Under terms of the collateral agreement withthe Federal Home Loan Bank, we pledge residential mortgage loans andmortgage-backed securities as well as our stock in the Federal Home Loan Bankas collateral for such advances.

 

Netproceeds from the sale of common stock in the Company cannot be determineduntil the reorganization is completed, however it is anticipated that the netproceeds from the sale of the common stock will be between $44.4 million at theminimum of the offering range and $60.4 million at the maximum of the offeringrange. The net proceeds received from the sale of shares of the common stockin the offering will increase the capital of both the Company and theBank.  Half of the net proceeds from theoffering will be used by the Company to buy the common stock of the Bank.  While we have not identified specific usesfor the portion of the net proceeds to be invested in the Bank, we anticipatethat the Bank will use the portion of the cash proceeds it receives for generalcorporate purposes.  On a short-termbasis, the Bank may purchase investment securities.  The net proceeds received by the Bank willfurther strengthen its capital position, which already exceeds all regulatoryrequirements (see table below).  As aresult, the Bank will continue to be a well-capitalized institution and willhave additional flexibility to grow and diversify.  The proceeds invested in the Bank, inaddition to funding new loans and being invested in equity securities, may alsobe used to finance the further expansion of our banking operations.

 

17

----

 

Thefollowing table summarizes the Bank’s capital ratios as of September 30, 2004and compares them to current regulatory guidelines and December 31, andSeptember 30, 2003 actual ratios.

 
| ** **                                                          | ** ** | **Tier I  Leverage** | ** ** | **Tier I Capital/  Risk-Weighted  Assets** | ** ** | **Total Capital/  Risk-Weighted  Assets** | ** ** |
|---------------------------------------------------------------------|------------|----------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
|                                                                |       |                 |       |                                       |       |                                      |       |
| Regulatory Minimum                                                  |       | 3.00%-4.00           | %          | 4.00                                       | %          | 8.00                                      | %          |
|                                                                |       |                 |       |                                       |       |                                      |       |
| Ratios as of:                                                       |       |                 |       |                                       |       |                                      |       |
|                                                                |       |                 |       |                                       |       |                                      |       |
| September 30, 2004                                                  |       | 8.72                 | %          | 14.42                                      | %          | 14.78                                     | %          |
| December 31, 2003                                                   |       | 8.81                 | %          | 15.12                                      | %          | 15.53                                     | %          |
| September 30, 2003                                                  |       | 8.70                 | %          | 14.73                                      | %          | 15.14                                     | %          |
|                                                                |       |                 |       |                                       |       |                                      |       |
| Regulatory Criteria for a “Well-Capitalized”  Institution |       | 5.00                 | %          | 6.00                                       | %          | 10.00                                     | %          |

 

**DERIVATIVE FINANCIAL INSTRUMENTS**

 

Aderivative financial instrument includes futures, forwards, interest rateswaps, option contracts, and other financial instruments with similarcharacteristics.  On occasion, we haveused interest rate caps and swap agreements to manage our exposure tofluctuations in interest rates on a portion of our fixed-rate loans andvariable rate deposits.  We have usedinterest rate swap agreements to hedge interest rate risk resulting from ourportfolio of interest-earning loans and interest-bearing deposit liabilities.We do not hold any derivative financial instruments for trading purposes.

 

AtSeptember 30, 2004, we are a party to three interest rate swap agreements,which we entered into in December 2001, June 2002 and December 2002,respectively, with notional amounts of $15.0 million each, and with termsexpiring in December 2004, June 2005 and December 2005, respectively.  Previously, we also were a party to oneinterest rate cap agreement, with a notional amount of $15.0 million, which weentered into in June 2001 and which expired in June 2004.  The contra party on each of our cap and swapagreements is the FHLB of Pittsburgh. We entered into these cap and swapagreements as a part of our strategy to manage our interest rate risk and weintended them to serve as a direct hedge against a specified portion of ourloans or deposits. Under the cap agreement, which was intended to hedge a portionof our fixed-rate single-family residential mortgage loan portfolio, we wereentitled to receive the amount, if any, by which the ten-year CMT exceeded7.53% on the notional amount. Given the low interest rates in recent periods,we did not receive any payments from the cap agreement. However, had weexperienced a rising interest rate environment, the cap agreement would haveprovided additional income that would have ameliorated the adverse impact ofour fixed-rate, long-term mortgage loans. The premium cost of the cap was$99,000, which was amortized over its three-year term. Two of our interest rateswap agreements at September 30, 2004 also were designed to serve as a hedgeagainst our fixed-rate, single-family mortgage loan portfolio. Under the agreementswith terms expiring in December 2004 and June 2005, we either pay or receivethe amount by which the ten-year CMT falls below or exceeds 5.92% and 5.57%,respectively. Again, given the low interest rate environment in recent periods,these swap agreements have resulted in us making payments to the contra party.The intent of these two agreements was to effectively convert a portion of ourfixed-rate loan portfolio to assets with a variable interest rate. Our thirdinterest rate swap agreement was designed to hedge a portion of our variablerate money market deposit accounts against rising interest rates. Under thisswap agreement, we either pay or receive the amount by which the three-monthLIBOR falls below or exceeds 2.59%. Again, as a result of market rates inrecent periods, we have made payments on this swap agreement to the

 

18

----

 

contra-party.Our intent with this agreement was to effectively convert a portion of ourdeposits from a variable rate liability to a fixed-rate liability.

 

The fair value of the swap agreements was a negative $245,000 and anegative $569,000 at September 30, 2004, and December 31, 2003, respectively.During the nine months ended September 30, 2004 and 2003, the Bank paid $495,369and $598,943, respectively, under the agreements. In addition, the unrealizedgains on derivatives recognized in loss on derivative instruments, net in theBank’s unaudited consolidated statements of income were $340,500 and $86,416for the nine months ended September 30, 2004 and 2003, respectively.

 

Thefollowing tables summarize our derivative financial instruments at September30, 2004.

 
| ** **                                       | ** ** | ** **                  | ** ** | **Amount of Commitment Expiration - Per Period** | ** ** |
|--------------------------------------------------|------------|-----------------------------|------------|--------------------------------------------------|------------|
| ** **                                       | ** ** | **Total Amount  Committed** | ** ** | **To  1 Year**                                   | ** ** | **1-3  Years** | ** ** | **4-5  Years** | ** ** | **After 5  Years** | ** ** |
| ** **                                       | ** ** | **(In Thousands)**          | ** ** |
| Interest rate cap agreement (notional  amount)   |       | $                           | —     |                                             | $          | — |   | $ | — |   | $ | — |   | $ | — |   |
| Interest rate swap agreements (notional  amount) |       | 45,000                      |       | 30,000                                           |       | 15,000 |   | — |   | — |   |
| Interest-rate loan lock commitments              |       | —                      |       | —                                           |       | — |   | — |   | — |   |
|                                                  |            |                             |            |                                                  |            |  |  |  |  |  |  |  |  |  |  |  |

 

**COMMITMENTS AND OFF-BALANCE SHEET ARRANGEMENTS**

 

Weare a party to financial instruments with off-balance sheet risk in the normalcourse of business to meet the financing needs of our customers.  These financial instruments includecommitments to extend credit and the unused portions of lines of credit. Theseinstruments involve, to varying degrees, elements of credit and interest raterisk in excess of the amount recognized in the consolidated statements offinancial condition.  Commitments toextend credit and lines of credit are not recorded as an asset or liability byus until the instrument is exercised.

 

Commitmentsto extend credit are agreements to lend to a customer as long as there is noviolation of any condition established in the contract. Commitments generallyhave fixed expiration dates or other termination clauses and may requirepayment of a fee. Since many of the commitments are expected to expire withoutbeing drawn upon, the total commitment amounts do not necessarily representfuture cash   requirements. The Bankevaluates each customer’s creditworthiness on a case-by-case basis. The amountof collateral obtained, if deemed necessary by the Bank upon extension ofcredit, is based on management’s credit evaluation of the customer.  The amount and type of collateral requiredvaries, but may include accounts receivable, inventory, equipment, real estateand income-producing commercial properties. At September 30, 2004 and 2003,commitments to originate loans and commitments under unused lines of credit,including undisbursed portions of construction loans in process, for which theBank is obligated amounted to approximately $95.9 million and $91.5 million,respectively.

 

Lettersof credit are conditional commitments issued by the Bank guaranteeing paymentsof drafts in accordance with the terms of the letter  of  credit agreements.  Commercial letters of credit are usedprimarily to facilitate trade or commerce and are also issued to support publicand private borrowing arrangements, bond financing and similartransactions.  Collateral may be requiredto support letters of credit based upon management’s evaluation of thecreditworthiness of each customer.  Thecredit risk

 

19

----

 

involvedin issuing letters of credit is substantially the same as that involved inextending loan facilities to customers. Most letters of credit expire within one year. At September 30, 2004 and2003, the Bank had letters of credit outstanding of approximately  $8.3 million and $9.0 million,respectively.  At September 30, 2004, theuncollateralized portion of the letters of credit extended by the Bank wasapproximately $284,000.

 

TheBank is also subject to various pending claims and contingent liabilitiesarising in the normal course of business, which are not reflected in theunaudited consolidated financial statements. Management considers that theaggregate liability, if any, resulting from such matters will not be material.

 

Amongthe Bank’s contingent liabilities, are exposures to limited recoursearrangements with respect to the Bank’s sales of whole loans and participationinterests. At September 30, 2004, the exposure, which represent a portion ofcredit risk associated with the sold interests, amounted to $185,000. Theexposure is for the life of the related loans and payable, on our proportionalshare, as losses are incurred.

 

Weanticipate that we will continue to have sufficient funds and alternativefunding sources to meet our current commitments.

 

Thefollowing tables summarize our outstanding commitments to originate loans andto advance additional amounts pursuant to outstanding letters of credit, linesof credit and under our construction loans at September 30, 2004.

 
| ** **                                            | ** ** | ** **                   | ** ** | **Amount of Commitment Expiration - Per Period** | ** ** |
|-------------------------------------------------------|------------|------------------------------|------------|--------------------------------------------------|------------|
| ** **                                            | ** ** | **Total Amounts  Committed** | ** ** | **To  1 Year**                                   | ** ** | **1-3  Years** | ** ** | **4-5  Years** | ** ** | **After 5  Years** | ** ** |
| ** **                                            | ** ** | **(In Thousands)**           | ** ** |
| Letters of credit                                     |       | $                            | 8,303      |                                             | $          | 7,109 |   | $ | 1,194 |   | $ | — |   | $ | — |   |
| Recourse obligations on loans sold                    |       | 185                          |       | —                                           |       | — |   | — |   | 185 |   |
| Commitments to originate loans                        |       | 4,464                        |       | 4,464                                            |       | — |   | — |   | — |   |
| Unused portion of home equity lines of  credit        |       | 20,966                       |       | —                                           |       | — |   | — |   | 20,966 |   |
| Unused portion of commercial lines of  credit         |       | 36,324                       |       | 36,324                                           |       | — |   | — |   | — |   |
| Undisbursed portion of construction loans  in process |       | 34,160                       |       | 26,310                                           |       | 7,850 |   | — |   | — |   |
| Total commitments                                     |       | $                            | 104,402    |                                             | $          | 74,207 |   | $ | 9,044 |   | $ | — |   | $ | 21,151 |   |

 

20

----

 

Thefollowing tables summarize our contractual cash obligations at September 30,2004.

 
| ** **                    | ** ** | ** **         | ** ** | **Payments Due By Period** | ** ** |
|-------------------------------|------------|--------------------|------------|----------------------------|------------|
| ** **                    | ** ** | **Total**          | ** ** | **To  1 Year**             | ** ** | **1-3  Years** | ** ** | **4-5  Years** | ** ** | **After 5  Years** | ** ** |
| ** **                    | ** ** | **(In Thousands)** | ** ** |
| Certificates of deposit       |       | $                  | 177,299    |                       | $          | 69,969 |   | $ | 85,472 |   | $ | 10,080 |   | $ | 11,778 |   |
| FHLB advances                 |       | 185,588            |       | 22,735                     |       | 11,628 |   | 70,852 |   | 80,373 |   |
| Repurchase agreements         |       | 19,317             |       | 19,317                     |       | — |   | — |   | — |   |
| Total debt                    |       | 204,905            |       | 42,052                     |       | 11,628 |   | 70,852 |   | 80,373 |   |
| Operating lease obligations   |       | 3,870              |       | 428                        |       | 779 |   | 623 |   | 2,040 |   |
| Total contractual obligations |       | $                  | 386,074    |                       | $          | 112,449 |   | $ | 97,879 |   | $ | 81,555 |   | $ | 94,191 |   |

 

**COMPARISON OF OPERATING RESULTS FOR THE THREE MONTHS ENDEDSEPTEMBER 30, 2004 AND 2003**

 

**General. **We had net income of $1.1 million for the three months ended September30, 2004, relatively consistent with net income of $1.0 million for the threemonths ended September 30, 2003.  Our netinterest income improved by $322,000 or 8.4% to $4.2 million for the quarterended September 30, 2004 from $3.8 million for the quarter ended September 30,2003. Our results in the 2004 period reflect, in part, increases in the amountof interest-earning assets, which have offset, in whole or in part, thenarrowing or compression of our net interest margins.  Our net interest margin decreased by onebasis point to 2.67% for the three months ended September 30, 2004 compared to2.68% for the three months ended September 30, 2003 while our net interestspread improved to 2.36% for the three months ended September 30, 2004 comparedto 2.34% for the three months ended September 30, 2003. In addition, a decreasein our non-interest income for the three months ended September 30, 2004 whencompared to the three months ended September 30, 2003, offset a nominaldecrease in non-interest expense. The decrease in non-interest income was dueprimarily to a net loss on derivative instruments in the 2004 period comparedto a net gain on derivative instruments in the 2003 period, as well as a gainon the sale of property that was recognized in 2003 with no such transactionocurring in 2004.

 

**InterestIncome.**  Our total interest income was $7.8 millionfor the three months ended September 30, 2004 compared to $7.3 million for thethree months ended September 30, 2003, a $439,000 or 6.0% increase.  The increase in interest income for the threemonths ended September 30, 2004 compared to the three months ended September30, 2003 was due primarily to an increase in the amount of our interest-earningassets, particularly loans and mortgage-backed securities. Our average loanbalance for the quarter ended September 30, 2004 increased $31.9 million or8.9% from the previous year to $391.7 million. Our average balance ofmortgage-backed securities for the quarter ended September 30, 2004 increased$35.4 million or 35.5% from the previous year to $135.0 million. This increasein interest-earning assets was somewhat offset by a decrease in the averageyield on interest-earning assets to 4.98% for the three months ended September30, 2004 compared to 5.11% for the comparable period in 2003.

 

**InterestExpense.**  Our total interest expense was $3.6 millionfor the three months ended September 30, 2004 compared to $3.5 million for thethree months ended September 30, 2003, an increase of $118,000 or 3.4%. Thelower average rates of interest we paid on both our deposits and our borrowingsin the 2004 period were offset in whole or in part by an increase in thebalances of our interest-bearing liabilities. Our average rate paid on interest-bearing liabilities was 2.62% for thethree months ended September 30, 2004 compared to 2.77% for the three monthsended September 30, 2003. Interest expense on FHLB advances

 

21

----

 

increasedby $130,000 to $1.9 million for the three months ended September 30, 2004 as aresult of a $22.3 million or 14.4% increase in the average balance of FHLBadvances.

 

**Average Balances, Net Interest Income, and Yields Earned andRates Paid.** Thefollowing table shows for the periods indicated the total dollar amount ofinterest from average interest-earning assets and the resulting yields, as wellas the interest expense on average interest-bearing liabilities, expressed bothin dollars and rates, and the net interest margin.  Tax-exempt income and yields have not beenadjusted to a tax-equivalent basis. All average balances are based on monthlybalances. Management does not believe that the monthly averages differsignificantly from what the daily averages would be.

 
| ** **                                         | ** ** | ** **                           | ** **           | **Three  Months  Ended September 30,** | ** **   |
|----------------------------------------------------|------------|--------------------------------------|----------------------|----------------------------------------|--------------|
| ** **                                         | ** ** | **Yield/RateAt September  30, 2004** | ** **           | **2004**                               | ** **   | **2003** | ** ** |
| ** **                                         | ** ** | ** **                           | **Average  Balance** | ** **                             | **Interest** | ** ** | **Average  Yield/Rate** | ** ** | **Average  Balance** | ** ** | **Interest** | ** ** | **Average  Yield/Rate** | ** ** |
| ** **                                         | ** ** | ** **                           | ** **           | **(Dollars  in Thousands)**            | ** **   |
| Interest-earning  assets:                          |       |                                 |                 |                                   |         |   |   |   |   |   |   |   |   |   |   |
| Investment  securities(1)                          |       | 3.14                                 | %                    | $                                      | 83,542       |   | $ | 604 |   | 2.89 | % | $ | 89,405 |   | 4,833 |   | 2.16 | % |
| Mortgage-backed  securities                        |       | 4.31                                 |                 | 134,997                                |         | 1,373 |   | 4.07 |   | 99,642 |   | 823 |   | 3.30 |   |
| Loans  receivable(2)                               |       | 5.71                                 |                 | 391,692                                |         | 5,743 |   | 5.86 |   | 359,745 |   | 5,804 |   | 6.45 |   |
| Other  interest-earning assets                     |       | 1.83                                 |                 | 13,192                                 |         | 41 |   | 1.24 |   | 24,209 |   | 212 |   | 3.50 |   |
| Total  interest-earning assets                     |       | 4.97                                 | %                    | 623,423                                |         | 7,761 |   | 4.98 | % | 573,001 |   | 7,322 |   | 5.11 | % |
| Cash and  non-interest bearing balances            |       |                                 |                 | 17,805                                 |         |   |   |   |   | 16,093 |   |   |   |   |   |
| Other  non-interest-earning assets                 |       |                                 |                 | 10,523                                 |         |   |   |   |   | 12,206 |   |   |   |   |   |
| Total assets                                       |       |                                 |                 | $                                      | 651,751      |   |   |   |   |   | $ | 601,300 |   |   |   |   |   |
| Interest-bearing  liabilities:                     |       |                                 |                 |                                   |         |   |   |   |   |   |   |   |   |   |   |
| Deposits:                                          |       |                                 |                 |                                   |         |   |   |   |   |   |   |   |   |   |   |
| Savings accounts                                   |       | 0.87                                 | %                    | $                                      | 101,626      |   | 226 |   | 0.89 | % | $ | 93,860 |   | 190 |   | 0.81 | % |
| Checking accounts                                  |       | 0.08                                 |                 | 52,829                                 |         | 8 |   | 0.06 |   | 46,710 |   | 13 |   | 0.11 |   |
| Money market  accounts                             |       | 1.09                                 |                 | 21,613                                 |         | 61 |   | 1.13 |   | 16,894 |   | 41 |   | 0.97 |   |
| Certificate  accounts                              |       | 3.14                                 |                 | 175,760                                |         | 1,371 |   | 3.12 |   | 169,663 |   | 1,417 |   | 3.34 |   |
| Total deposits                                     |       | 1.87                                 |                 | 351,828                                |         | 1,666 |   | 1.89 |   | 327,127 |   | 1,661 |   | 2.03 |   |
| FHLB advances                                      |       | 4.24                                 |                 | 177,167                                |         | 1,918 |   | 4.33 |   | 154,856 |   | 1,789 |   | 4.62 |   |
| Other borrowings                                   |       | 0.94                                 |                 | 19,740                                 |         | 17 |   | 0.34 |   | 20,499 |   | 33 |   | 0.64 |   |
| Total  interest-bearing liabilities                |       | 2.60                                 | %                    | 548,735                                |         | $ | 3,601 |   | 2.62 | % | 502,482 |   | $ | 3,483 |   | 2.77 | % |
| Non-interest-bearing  liabilities:                 |       |                                 |                 |                                   |         |   |   |   |   |   |   |   |   |   |   |
| Non-interest-bearing  demand accounts              |       |                                 |                 | 39,459                                 |         |   |   |   |   | 37,628 |   |   |   |   |   |
| Real estate tax  escrow accounts                   |       |                                 |                 | 1,820                                  |         |   |   |   |   | 1,364 |   |   |   |   |   |
| Other liabilities                                  |       |                                 |                 | 6,900                                  |         |   |   |   |   | 7,429 |   |   |   |   |   |
| Total liabilities                                  |       |                                 |                 | 596,914                                |         |   |   |   |   | 548,903 |   |   |   |   |   |
| Retained earnings                                  |       |                                 |                 | 54,837                                 |         |   |   |   |   | 52,397 |   |   |   |   |   |
| Total liabilities  and retained earnings           |       |                                 |                 | $                                      | 651,751      |   |   |   |   |   | $ | 601,300 |   |   |   |   |   |
| Net  interest-earning assets                       |       |                                 |                 | $                                      | 74,688       |   |   |   |   |   | $ | 70,519 |   |   |   |   |   |
| Net interest  income; average Interest rate spread |       | 2.37                                 | %                    |                                   |         | $ | 4,160 |   | 2.36 | % |   |   | $ | 3,839 |   | 2.34 | % |
| Net interest  margin(3)                            |       |                                 |                 |                                   |         |   |   | 2.67 | % |   |   |   |   | 2.68 | % |

 

----

(1)                                  Investment securities for the 2004 periodinclude 26 non-taxable municipal bonds with an aggregate average balance of$2.8 million and an average yield of 4.3%. Investment securities for the 2003period include one non-taxable municipal bond in the amount of $180,000 and ayield of 3.9%.  The tax-exempt incomefrom such securities has not been calculated on a tax equivalent basis.

(2)                                  Includes nonaccrual loans during therespective periods.  Calculated net ofdeferred fees and discounts, loans in process and allowance for loan losses.

(3)                                  Equals net interest income divided byaverage interest-earning assets.

 

22

----

 

**Provisionfor Loan Losses.**  We made no provision for loan losses in thequarter ended September 30, 2004 compared to $125,000 in the quarter endedSeptember 30, 2003.  At September 30,2004, we had only $6,000 of non-performing assets and our allowance for loanlosses amounted to $1.4 million.  Ournon-performing loans as a percentage of loans receivable amounted to 0.01% atSeptember 30, 2004 compared to 0.17% at September 30, 2003. During the thirdquarter of 2004 we had net recoveries to our allowance for loan losses of$53,000 compared to net charge-offs of $38,000 during the third quarter of2003.

 

**Non-interestIncome.**  Our total non-interest income amounted to$509,000 for the three months ended September 30, 2004 compared to $874,000 forthe three months ended September 30, 2003, a $365,000 or 41.8% decrease.  The decrease in non-interest income was dueprimarily to a net loss on derivative instruments of $106,000 for the threemonths ended September 30, 2004 compared to a net gain of $136,000 for thethree months ended September 30, 2003. In addition, we recognized a gain on thesale of property of $91,000 that was recognized in 2003 with no suchtransaction occurring in 2004.

 

**Non-interestExpense.**  Our total non-interest expense decreased by$28,000, or 0.9%, to $3.0 million for the quarter ended September 30, 2004 comparedto $3.1 million for the quarter ended September 30, 2003.  The primary reasons for the relativelynominal decrease in non-interest expense in the third quarter of 2004 comparedto the third quarter of 2003 were decreases in net occupancy and depreciationcosts of $24,000 and $15,000, respectively, as well as a decrease in othernon-interest expenses of $32,000. The decreases in net occupancy costs wasprimarily the result of lower maintenance and repairs expenses, due to adecrease in the actual need for maintenance work on facilities and equipment.The decrease in depreciation expense is the result of assets, mainly furniture,fixtures and equipment, becoming fully depreciated. The decrease in otherexpense is due in large part to the timing of expenditures as the expense forthe nine months ended September 30, 2004 had increased from the same period in2003. These decreases were somewhat offset by increases in salaries andemployee benefits expense and data processing expense of $34,000 and $18,000, respectively.The increase in salaries and employee benefits expense was the result of normalmerit increases and an increase in staffing levels. Our data processing expenseincreased as a result of increased deposits and deposit activity as the expenseis dependent in part on the number of deposit transactions that are processed.

 

**IncomeTax Expense.**  Our income tax expense was $571,000 for thethree months ended September 30, 2004 compared to $497,000 for the three monthsended September 30, 2003.  The primaryreason for the $73,000 increase in income tax expenses was the increase inpre-tax income.

 

**COMPARISON OF OPERATING RESULTS FOR THE NINE MONTHS ENDEDSEPTEMBER 30, 2004 AND 2003**

 

**General. **For the nine months ended September 30, 2004, our net income was $3.1million compared to $2.8 million for the first nine months of 2003, a 12.6%increase.  Our results in the 2004 periodreflect an increase in the amount of interest-earning assets which have offset,in whole or in part, the narrowing or compression of our net interest margin.For the first nine months of 2004, our net interest margin and net interestspread were 2.65% and 2.32%, respectively, compared to 2.92% and 2.54%,respectively, for the nine months ended September 30, 2003.  During the first nine months of 2004, thecontinuing low interest rate environment continued to reduce the average yieldearned on our interest-earning assets to a greater degree than the reduction inthe average rate we paid on our interest-bearing liabilities.  In addition, an increase in our non-interestincome of $445,000 for the first nine months of 2004 compared to the first ninemonths of 2003, is due primarily to a decrease in our net loss on derivativesof $358,000, offset a nominal 1.5% increase in non-interest expense.

 

23

----

 

**InterestIncome.**  For the nine months ended September 30, 2004,total interest income was $22.4 million compared to $22.6 million for the ninemonths ended September 30, 2003, a decrease of $189,000 or 0.8%. The primaryreason for the decrease in total interest income in the first nine months of2004 was the continuing effects of the low market rates of interest.  The average yield on our interest-earningassets was 4.94% for the nine months ended September 30, 2004 compared to 5.44%for the comparable period in 2003. The lower yields were partially offset byincreases in the average balances for investment securities, mortgage-backedsecurities and loans receivable, with the average balance of totalinterest-earning assets increasing 9.1% to $604.7 million for the nine monthsended September 30, 2004 from $554.2 million for the nine months endedSeptember 30, 2003.

 

**InterestExpense.**  Our total interest expense was $10.4 millionfor the nine months ended September 30, 2004 compared to $10.5 million for thenine months ended September 30, 2003, a $79,000 or 0.8% decline. The loweraverage rates of interest we paid on both our deposits and our borrowings inthe 2004 period were offset in part by an increase in the balances of ourinterest-bearing liabilities. For the nine months ended September 30, 2004, ouraverage rate paid on interest-bearing liabilities was 2.62% compared to 2.90%for the nine months ended September 30, 2003. Our average balance of interest-bearing liabilities was $530.4 millionfor the nine months ended September 30, 2004 compared to $481.5 million for thenine months ended September 30, 2003, an increase of 10.2%.

 

24

----

 

**Average Balances, Net Interest Income, and Yields Earned andRates Paid.** Thefollowing table shows for the periods indicated the total dollar amount ofinterest from average interest-earning assets and the resulting yields, as wellas the interest expense on average interest-bearing liabilities, expressed bothin dollars and rates, and the net interest margin.  Tax-exempt income and yields have not beenadjusted to a tax-equivalent basis. All average balances are based on monthlybalances. Management does not believe that the monthly averages differsignificantly from what the daily averages would be.

 
| ** **                                         | ** ** | ** **                           | ** **           | **Nine  Months  Ended September 30,** | ** **   |
|----------------------------------------------------|------------|--------------------------------------|----------------------|---------------------------------------|--------------|
| ** **                                         | ** ** | **Yield/RateAt September  30, 2004** | ** **           | **2004**                              | ** **   | **2003** | ** ** |
| ** **                                         | ** ** | ** **                           | **Average  Balance** | ** **                            | **Interest** | ** ** | **Average  Yield/Rate** | ** ** | **Average  Balance** | ** ** | **Interest** | ** ** | **Average  Yield/Rate** | ** ** |
| ** **                                         | ** ** | ** **                           | ** **           | **(Dollars  in Thousands)**           | ** **   |
| Interest-earning  assets:                          |       |                                 |                 |                                  |         |   |   |   |   |   |   |   |   |   |   |
| Investment  securities(1)                          |       | 3.14                                 | %                    | $                                     | 81,312       |   | $ | 1,678 |   | 2.75 | % | $ | 72,431 |   | 1,430 |   | 2.63 | % |
| Mortgage-backed  securities                        |       | 4.31                                 |                 | 131,250                               |         | 3,925 |   | 3.99 |   | 82,482 |   | 2,515 |   | 4.07 |   |
| Loans  receivable(2)                               |       | 5.71                                 |                 | 377,578                               |         | 16,709 |   | 5.90 |   | 361,573 |   | 18,386 |   | 6.77 |   |
| Other  interest-earning assets                     |       | 1.83                                 |                 | 14,579                                |         | 111 |   | 1.02 |   | 37,703 |   | 280 |   | 0.99 |   |
| Total  interest-earning assets                     |       | 4.97                                 | %                    | 604,719                               |         | 22,423 |   | 4.94 | % | 554,189 |   | 22,611 |   | 5.44 | % |
| Cash and  non-interest bearing balances            |       |                                 |                 | 15,767                                |         |   |   |   |   | 12,630 |   |   |   |   |   |
| Other  non-interest-earning assets                 |       |                                 |                 | 10,271                                |         |   |   |   |   | 11,476 |   |   |   |   |   |
| Total assets                                       |       |                                 |                 | $                                     | 630,757      |   |   |   |   |   | $ | 578,295 |   |   |   |   |   |
| Interest-bearing  liabilities:                     |       |                                 |                 |                                  |         |   |   |   |   |   |   |   |   |   |   |
| Deposits:                                          |       |                                 |                 |                                  |         |   |   |   |   |   |   |   |   |   |   |
| Savings accounts                                   |       | 0.87                                 | %                    | $                                     | 99,181       |   | 637 |   | 0.86 | % | $ | 88,860 |   | 725 |   | 1.09 | % |
| Checking accounts                                  |       | 0.08                                 |                 | 51,912                                |         | 32 |   | 0.08 |   | 46,017 |   | 38 |   | 0.11 |   |
| Money market  accounts                             |       | 1.09                                 |                 | 19,698                                |         | 131 |   | 0.89 |   | 17,029 |   | 144 |   | 1.13 |   |
| Certificate  accounts                              |       | 3.14                                 |                 | 172,497                               |         | 3,980 |   | 3.08 |   | 169,753 |   | 4,382 |   | 3.32 |   |
| Total deposits                                     |       | 1.87                                 |                 | 343,288                               |         | 4,780 |   | 1.86 |   | 321,659 |   | 5,289 |   | 2.13 |   |
| FHLB advances                                      |       | 4.24                                 |                 | 169,595                               |         | 5,571 |   | 4.38 |   | 143,266 |   | 5,111 |   | 4.90 |   |
| Other borrowings                                   |       | 0.94                                 |                 | 17,481                                |         | 55 |   | 0.42 |   | 16,548 |   | 84 |   | 0.68 |   |
|                                               |       |                                 |                 |                                  |         |   |   |   |   |   |   |   |   |   |   |
| Total  interest-bearing liabilities                |       | 2.60                                 | %                    | 530,364                               |         | $ | 10,406 |   | 2.62 | % | 481,473 |   | $ | 10,484 |   | 2.90 | % |
| Non-interest-bearing  liabilities:                 |       |                                 |                 |                                  |         |   |   |   |   |   |   |   |   |   |   |
| Non-interest-bearing  demand accounts              |       |                                 |                 | 37,501                                |         |   |   |   |   | 36,555 |   |   |   |   |   |
| Real estate tax  escrow accounts                   |       |                                 |                 | 2,513                                 |         |   |   |   |   | 2,359 |   |   |   |   |   |
| Other liabilities                                  |       |                                 |                 | 5,900                                 |         |   |   |   |   | 6,046 |   |   |   |   |   |
| Total liabilities                                  |       |                                 |                 | 576,278                               |         |   |   |   |   | 526,433 |   |   |   |   |   |
| Retained earnings                                  |       |                                 |                 | 54,479                                |         |   |   |   |   | 51,862 |   |   |   |   |   |
| Total liabilities  and retained earnings           |       |                                 |                 | $                                     | 630,757      |   |   |   |   |   | $ | 578,295 |   |   |   |   |   |
| Net  interest-earning assets                       |       |                                 |                 | $                                     | 74,355       |   |   |   |   |   | $ | 72,716 |   |   |   |   |   |
| Net interest  income; average interest rate spread |       | 2.37                                 | %                    |                                  |         | $ | 12,017 |   | 2.32 | % |   |   | $ | 12,127 |   | 2.54 | % |
| Net interest margin(3)                             |       |                                 |                 |                                  |         |   |   | 2.65 | % |   |   |   |   | 2.92 | % |

 

----

(4)                                  Investment securities for the 2004 periodinclude 26 non-taxable municipal bonds with an aggregate average balance of$1.1 million and an average yield of 4.3%. Investment securities for the 2003period include one non-taxable municipal bond in the amount of $180,000 and ayield of 3.9%.  The tax-exempt incomefrom such securities has not been calculated on a tax equivalent basis.

(5)                                  Includes nonaccrual loans during therespective periods.  Calculated net of deferredfees and discounts, loans in process and allowance for loan losses.

(6)                                  Equals net interest income divided byaverage interest-earning assets.

 

25

----

 

**Provisionfor Loan Losses.**  For the nine months ended September 30, 2004,our provision for loan losses was $45,000 compared to $375,000 for the ninemonths ended September 30, 2003. At September 30, 2004, we had only $6,000 ofnon-performing assets and our allowance for loan losses amounted to $1.4 million.Our non-performing loans as a percentage of loans receivable amounted to 0.01%at September 30, 2004 compared to 0.17% at September 30, 2003. For the ninemonths ended September 30, 2004, our net charge-offs amounted to $88,000. Netcharge-offs amounted to $736,000 for the nine months ended September 30, 2003,of which $671,000 related to one borrower.

 

**Non-interestIncome.**  For the nine months ended September 30, 2004,our non-interest income was $1.6 million compared to $1.2 million for the ninemonths ended September 30, 2003, a $444,000 or 38.3% increase.  For the first nine months of 2004, our netloss on derivative instruments was $155,000 compared to a net loss of $513,000for the first nine months of 2003. Also contributing to the increase in non-interestincome for the first nine months of 2004 compared to the first nine months of2003 was increased service charge income, particularly fees earned on ouroverdraft protection program which we began offering in May 2003. Overdraftfees increased approximately $297,000 to $961,000 for the first nine months of2004 compared to $663,000 for the first nine months of 2003.  These increases were somewhat offset as$190,000 of combined gains on sales of loans and property that were recognizedfor the nine months ending September 30, 2003 did not recur in 2004.

 

**Non-interestExpense.**  For the nine months ended September 30, 2004compared to the nine months ended September 30, 2003, non-interest expenseincreased by $129,000, or 1.5%.  Theprimary reasons for the relatively nominal increase in non-interest expense forthe first nine months of 2004 compared to the first nine months of 2003 were a$69,000 increase in salary and compensation expense, the largest component ofnon-interest expense, an $82,000 increase in data processing expense, and a$142,000 increase in other non-interest expense. The increase in salary expensewas due primarily to normal merit increases in salaries and an increase instaffing levels. Our data processing expense increased as a result of increaseddeposits and deposit activity, as the expense is dependent in part on thenumber of deposit transactions that are processed. The increase in othernon-interest expense was primarily due to increases in professional servicesand consulting expenses of $65,000 and $70,000, respectively. Our professionalservices expense increased primarily as a result of increased audit fees. Theincrease in consulting expense was primarily due to fees paid in relation toour overdraft protection program, which we began offering in May 2003. Theseincreases were somewhat offset by a combined decrease of $56,000 in netoccupancy and depreciation costs and a decrease of $110,000 in ATM expense. Thedecreases in net occupancy and depreciation costs for the nine months endedSeptember 30, 2004 compared to the nine months ended September 30, 2003 weredue to the same factors as the decreases for the quarter ended September 30,2004 compared to the quarter ended September 30, 2003. The decrease in ATMexpense was due to a $75,000 credit and reduced fees obtained during a contractrenewal in 2004.

 

**IncomeTax Expense.**  Our income tax expense was $1.6 million forthe nine months ended September 30, 2004 compared to $1.4 million for the ninemonths ended September 30, 2003.  Theprimary reason for the $184,000 increase in income tax expenses was theincrease in pre-tax income.

 

26

----

 

**FORWARD LOOKING STATEMENTS**

 

This document contains forward-looking statements, which can be identifiedby the use of words such as “estimate,” “project,” “believe,” “intend,” “anticipate,”“plan,” “seek,” “expect” and similar expressions.  These forward-looking statements include:

 

•                                          statements of goals, intentions andexpectations;

 

•                                          statements regarding prospects andbusiness strategy;

 

•                                          statements regarding asset quality andmarket risk; and

 

•                                          estimates of future costs, benefits andresults.

 

These forward-looking statements are subject to significant risks,assumptions and uncertainties, including, among other things, the following:  (1) general economic conditions,  (2) competitive pressure among financialservices companies,  (3) changes ininterest rates,  (4) deposit flows,  (5) loan demand, (6) changes in legislationor regulation,  (7) changes in accountingprinciples, policies and guidelines, (8) litigation liabilities,  including costs, expenses, settlements andjudgments,  (9) the ability of AbingtonBank to complete its mutual holding company reorganization as anticipatedand  (10) other  economic, competitive,  governmental, regulatory and technologicalfactors affecting Abington Bank’s operations, pricing, products and services.

 

Because of these and other uncertainties, our actual future results maybe materially different from the results indicated by these forward-lookingstatements.  We have no obligation toupdate or revise any forward-looking statements to reflect any changedassumptions, any unanticipated events or any changes in the future.

 

**ITEM 3****.  –QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK**

 

**Asset/Liability Management and Market Risk.**  Marketrisk is the risk of loss from adverse changes in market prices and rates.  Our market risk arises primarily from theinterest rate risk which is inherent in our lending and deposit takingactivities.  To that end, managementactively monitors and manages interest rate risk exposure.  In addition to market risk, our primary riskis credit risk on our loan portfolio.  Weattempt to manage credit risk through our loan underwriting and oversightpolicies.

 

Theprincipal objective of our interest rate risk management function is toevaluate the interest rate risk embedded in certain balance sheet accounts,determine the level of risk appropriate given our business strategy, operatingenvironment, capital and liquidity requirements and performance objectives, andmanage the risk consistent with approved guidelines. We seek to manage ourexposure to risks from changes in interest rates while at the same time tryingto improve our net interest spread.  Wemonitor interest rate risk as such risk relates to our operatingstrategies.  We have established anAsset/Liability Committee, which is comprised of our President and ChiefExecutive Officer, three Senior Vice Presidents and two Vice Presidents ofLending, and which is responsible for reviewing our asset/liability policiesand interest rate risk position.  TheAsset/Liability Committee meets on a regular basis.  The extent of the movement of interest ratesis an uncertainty that could have a negative impact on future earnings.

 

27

----

 

Inrecent years, we primarily have utilized the following strategies in ourefforts to manage interest rate risk:

 

•                                          we have increased our originations of shorterterm loans and/or loans with adjustable rates of interest, particularlyconstruction loans, commercial real estate and multi-family residentialmortgage loans and home equity lines of credit;

 

•                                          we have attempted to match fund a portion ofour securities portfolio with borrowings having similar expected lives;

 

•                                          we have reduced our reliance on certificatesof deposit as a funding source and increased the amount of our transactionaccounts;

 

•                                          we have attempted, where possible, to extendthe maturities of our deposits and borrowings;

 

•                                          we have invested in securities withrelatively short anticipated lives, generally three to five years, andincreased our holding of liquid assets; and

 

•                                          on occasion, we have utilized certainoff-balance sheet derivative products, consisting of interest rate cap and swapagreements, in our efforts to protect our net interest income from suddenshifts.

 

**Gap Analysis.**  The matching of assets andliabilities may be analyzed by examining the extent to which such assets andliabilities are “interest rate sensitive” and by monitoring a bank’s interestrate sensitivity “gap.”  An asset andliability is said to be interest rate sensitive within a specific time periodif it will mature or reprice within that time period.  The interest rate sensitivity gap is definedas the difference between the amount of interest-earning assets maturing orrepricing within a specific time period and the amount of interest-bearingliabilities maturing or repricing within that same time period.  A gap is considered positive when the amountof interest rate sensitive assets exceeds the amount of interest rate sensitiveliabilities.  A gap is considerednegative when the amount of interest rate sensitive liabilities exceeds theamount of interest rate sensitive assets. During a period of rising interest rates, a negative gap would tend toaffect adversely net interest income while a positive gap would tend to resultin an increase in net interest income. Conversely, during a period of falling interest rates, a negative gapwould tend to result in an increase in net interest income while a positive gapwould tend to affect adversely net interest income.  Our current asset/liability policy providesthat our one-year interest rate gap as a percentage of total assets should notexceed positive or negative 20%.  Thispolicy was adopted by our management and Board based upon their judgment thatit established an appropriate benchmark for the level of interest-rate risk, expressedin terms of the one-year gap, for the Bank. In the event our one-year gap position were to approach or exceed the20% policy limit, we would review the composition of our assets and liabilitiesin order to determine what steps might appropriately be taken, such as sellingcertain securities or loans or repaying certain borrowings, in order tomaintain our one-year gap in accordance with the policy.  Alternatively, depending on the then-currenteconomic scenario, we could determine to make an exception to our policy or wecould determine to revise our policy.  Inrecent periods, our one-year gap position was well within our policy. Ourone-year cumulative gap was a negative 1.39% at September 30, 2004, compared toa negative 1.78% at December 31, 2003. Part of the reason that we determinedseveral years ago to increase our originations of commercial real estate andmulti-family residential real estate loans, construction loans, home equitylines and commercial business loans, all of which generally have shorter termsto maturity than single-family residential mortgage loans and are more likelyto have floating or adjustable rates of interest, was, in part, to increase theamount of our interest rate sensitive

 

28

----

 

assetsin the one- to three-year time horizon. By increasing the amount of our interest rate sensitive assets in theone-to three-year time horizon, we felt that we better positioned ourselves tobenefit from a rising interest rate environment because the average interestrates on our loans would increase as general market rates of interest wereincreasing.

 

Thefollowing table sets forth the amounts of our interest-earning assets andinterest-bearing liabilities outstanding at September 30, 2004, which weexpect, based upon certain assumptions, to reprice or mature in each of thefuture time periods shown (the “GAP Table”). Except as stated below, the amount of assets and liabilities shown whichreprice or mature during a particular period were determined in accordance withthe earlier of term to repricing or the contractual maturity of the asset orliability.  The table sets forth anapproximation of the projected repricing of assets and liabilities at September30, 2004, on the basis of contractual maturities, anticipated prepayments, andscheduled rate adjustments within a three-month period and subsequent selectedtime intervals.  The loan amounts in thetable reflect principal balances expected to be redeployed and/or repriced as aresult of contractual amortization and anticipated prepayments ofadjustable-rate loans and fixed-rate loans, and as a result of contractual rateadjustments on adjustable-rate loans. Annual prepayment rates for adjustable-rate and fixed-rate single-familyand multi-family mortgage loans are assumed to range from 10% to 26%.  The annual prepayment rate formortgage-backed securities is assumed to range from 9% to 63%.  Money market deposit accounts, savingsaccounts and interest-bearing checking accounts are assumed to have annualrates of withdrawal, or “decay rates,” of 16%, 12.5% and 0%, respectively.

 

29

----

 
| ** **                                                                                                            | ** ** | **3 Months  or Less**       | ** ** | **More  than  3  Months  to 6  Months** | ** ** | **More  than  6 Months  to 1 Year** | ** ** | **More  than  1 Year  to 3 Years** | ** ** | **More  than  3 Years  to 5 Years** | ** ** | **More  than  5 Years** | ** ** | **Total  Amount** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|-----------------------------------------|------------|-------------------------------------|------------|------------------------------------|------------|-------------------------------------|------------|-------------------------|------------|-------------------|------------|
| ** **                                                                                                            | ** ** | **(Dollars  in Thousands)** | ** ** |
| Interest-earning  assets(1):                                                                                          |       |                        |       |                                    |       |                                |       |                               |       |                                |       |                    |       |              |       |
| Loans  receivable(2)                                                                                                  |       | $                           | 110,541    |                                    | $          | 27,246                              |       | $                                  | 26,332     |                                | $          | 89,521                  |       | $                 | 63,682     |   | $ | 78,646 |   | $ | 395,968 |   |
| Mortgage-backed  securities                                                                                           |       | 13,804                      |       | 10,539                                  |       | 18,177                              |       | 43,323                             |       | 21,300                              |       | 25,246                  |       | 132,389           |       |
| Investment  securities                                                                                                |       | 13,978                      |       | 543                                     |       | 198                                 |       | 31,377                             |       | 18,500                              |       | 23,175                  |       | 87,771            |       |
| Other  interest-earning assets                                                                                        |       | 13,718                      |       | —                                  |       | —                              |       | —                             |       | —                              |       | —                  |       | 13,718            |       |
| Total  interest-earning assets                                                                                        |       | 152,041                     |       | 38,328                                  |       | 44,707                              |       | 164,221                            |       | 103,482                             |       | 127,067                 |       | 629,846           |       |
| Interest-bearing  liabilities:                                                                                        |       |                        |       |                                    |       |                                |       |                               |       |                                |       |                    |       |              |       |
| Savings accounts                                                                                                      |       | $                           | 6,338      |                                    | $          | 6,338                               |       | $                                  | 12,676     |                                | $          | 39,609                  |       | $                 | 18,281     |   | $ | 18,168 |   | $ | 101,410 |   |
| Checking accounts                                                                                                     |       | —                      |       | —                                  |       | —                              |       | —                             |       | —                              |       | 51,130                  |       | 51,130            |       |
| Money market accounts                                                                                                 |       | 1,678                       |       | 1,678                                   |       | 3,356                               |       | 7,761                              |       | 3,566                               |       | 2,938                   |       | 20,977            |       |
| Certificate  accounts                                                                                                 |       | 24,583                      |       | 18,802                                  |       | 26,582                              |       | 85,471                             |       | 10,079                              |       | 11,782                  |       | 177,299           |       |
| FHLB advances                                                                                                         |       | 111,623                     |       | 2,385                                   |       | 8,866                               |       | 28,476                             |       | 19,514                              |       | 14,724                  |       | 185,588           |       |
| Other borrowed  money                                                                                                 |       | 19,317                      |       | —                                  |       | —                              |       | —                             |       | —                              |       | —                  |       | 19,317            |       |
| Total  interest-bearing liabilities                                                                                   |       | 163,539                     |       | 29,203                                  |       | 51,480                              |       | 161,317                            |       | 51,440                              |       | 98,742                  |       | 555,721           |       |
|                                                                                                                  |       |                        |       |                                    |       |                                |       |                               |       |                                |       |                    |       |              |       |
| Interest-earning  assets less interest-bearing liabilities                                                            |       | $                           | (11,498    | )                                       | $          | 9,125                               |       | $                                  | (6,773     | )                                   | $          | 2,904                   |       | $                 | 52,042     |   | $ | 28,325 |   | $ | 74,125 |   |
|                                                                                                                  |       |                        |       |                                    |       |                                |       |                               |       |                                |       |                    |       |              |       |
| Cumulative  interest-rate sensitivity gap(3)                                                                          |       | $                           | (11,498    | )                                       | $          | (2,373                              | )          | $                                  | (9,146     | )                                   | $          | (6,242                  | )          | $                 | 45,800     |   | $ | 74,125 |   |   |   |
|                                                                                                                  |       |                        |       |                                    |       |                                |       |                               |       |                                |       |                    |       |              |       |
| Cumulative  interest-rate gap as a percentage of total assets at September 30, 2004                                   |       | (1.75                       | )%         | (0.36                                   | )%         | (1.39                               | )%         | (0.95                              | )%         | 6.96                                | %          | 11.27                   | %          |              |       |
|                                                                                                                  |       |                        |       |                                    |       |                                |       |                               |       |                                |       |                    |       |              |       |
| Cumulative  interest-earning assets as a percentage of cumulative interest-bearing  liabilities at September 30, 2004 |       | 92.97                       | %          | 98.77                                   | %          | 96.25                               | %          | 98.46                              | %          | 110.02                              |       | 113.34                  | %          |              |       |

 

----

(1)                                  Interest-earningassets are included in the period in which the balances are expected to beredeployed and/or repriced as a result of anticipated prepayments, scheduledrate adjustments and contractual maturities.

 

(2)                                  Forpurposes of the gap analysis, loans receivable includes non-performing loansnet of the allowance for loan losses, undisbursed loan funds, unamortizeddiscounts and deferred loan fees.

 

(3)                                  Interest-ratesensitivity gap represents the difference between net interest-earning assetsand interest-bearing liabilities.

 

30

----

 

Certain shortcomings areinherent in the method of analysis presented in the foregoing table.  For example, although certain assets and liabilitiesmay have similar maturities or periods to repricing, they may react indifferent degrees to changes in market interest rates.  Also, the interest rates on certain types ofassets and liabilities may fluctuate in advance of changes in market interestrates, while interest rates on other types may lag behind changes in marketrates.  Additionally, certain assets,such as adjustable-rate loans, have features which restrict changes in interestrates both on a short-term basis and over the life of the asset.  Further, in the event of a change in interestrates, prepayment and early withdrawal levels would likely deviatesignificantly from those assumed in calculating the table.  Finally, the ability of many borrowers toservice their adjustable-rate loans may decrease in the event of an interestrate increase.

 

**ITEM 4.****  – CONTROLS ANDPROCEDURES**

 

Our management evaluated, with the participation of our Chief Executive Officer and Chief Financial Officer, the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this report. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and regulations and are operating in an effective manner.

 

No change in our internal control over financial reporting (as defined in Rule 13a-15(f) or 15d-15(f) under the Securities Exchange Act of 1934) occurred during the most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

31

----

 

**Part II****                                                                                                                                                             OTHERINFORMATION**

 
| Item 1. | Legal  Proceedings                                           |
|---------|--------------------------------------------------------------|
|    |                                                         |
|    | Not  applicable.                                             |
|    |                                                         |
| Item 2. | Unregistered  Sales of Equity Securities and Use of Proceeds |
|    |                                                         |
|    | Not  applicable.                                             |
|    |                                                         |
| Item 3. | Defaults  upon Senior Securities                             |
|    |                                                         |
|    | Not  applicable.                                             |
|    |                                                         |
|    |                                                         |
| Item 4. | Submission  of Matters to a Vote of Security Holders         |
|    |                                                         |
|    | Not applicable.                                              |
|    |                                                         |
| Item 5. | Other  Information                                           |
|    |                                                         |
|    | Not  applicable.                                             |
|    |                                                         |
| Item 6. | Exhibits                                                     |

 
| **No.** | ** ** | **Description**                                                                                                                                                               |
|---------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 31.1    |       | Certification  pursuant to Rule 13a-14 and 15d-14 of the Securities Exchange Act of 1934, as  amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of  2002. |
|    |       |                                                                                                                                                                          |
| 31.2    |       | Certification  pursuant to Rule 13a-14 and 15d-14 of the Securities Exchange Act of 1934, as  amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of  2002. |
|    |       |                                                                                                                                                                          |
| 32.1    |       | Certification  pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                                                     |
|    |       |                                                                                                                                                                          |
| 32.2    |       | Certification  pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                                                     |

 

32

----

 

**SIGNATURES**

 

Pursuant tothe requirements of the Securities Exchange Act of 1934, the Registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 

 
|                    | **ABINGTON  COMMUNITY BANCORP, INC.** |
|-------------------------|---------------------------------------|
|                    |                                  |   |   |
|                    |                                  |   |   |
| Date: December  3, 2004 | By:                                   |  /s/ Robert  W. White |   |
|                    |                                  | Robert W.  White |
|                    |                                  | Chairman,  President and |
|                    |                                  | Chief  Executive Officer |
|                    |                                  |   |
|                    |                                  |   |
| Date: December  3, 2004 | By:                                   |   /s/  Jack J. Sandoski |   |
|                    |                                  | Jack J.  Sandoski |
|                    |                                  | Senior Vice  President and |
|                    |                                  | Chief  Financial Officer |

 

33

----