10-Q 1 a4698994.txt NSD BANCORP 10-Q -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) [ x ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2004 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ______________ to ______________ Commission File Number: 0-22124 ------- NSD Bancorp, Inc. -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Pennsylvania 25-1616814 -------------------------------------------------------------------------------- (State or other jurisdiction of (IRS Employer Identification No.) incorporation or organization) 5004 McKnight Road, Pittsburgh, Pennsylvania, 15237 -------------------------------------------------------------------------------- (Address of principal executive offices) (412) 231-6900 -------------------------------------------------------------------------------- (Registrant's telephone number, including area code) N/A -------------------------------------------------------------------------------- (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. X Yes No --- --- Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes X No --- -- APPLICABLE ONLY TO CORPORATE ISSUERS Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of August 1, 2004: Common Stock, $1.00 par value 3,397,204 ----------------------------- --------- (Class) (Outstanding) -------------------------------------------------------------------------------- NSD Bancorp, Inc. INDEX TO QUARTERLY REPORT ON FORM 10-Q

4 NSD Bancorp, Inc. and Subsidiary Notes to Consolidated Financial Statements 1. Business and Basis of Presentation NSD Bancorp, Inc. (the Corporation) is a Pennsylvania corporation and bank holding company that provides a wide range of retail and commercial financial products and services to customers in western Pennsylvania through its wholly owned subsidiary bank, NorthSide Bank (the Bank). The Bank is an FDIC-insured, state chartered bank based in Pittsburgh, Pennsylvania, that operates twelve branch offices serving Pittsburgh and its northern suburbs. In addition to providing traditional lending and depository products and related banking services, the Bank offers investment advisory, brokerage and insurance services. The Bank also provides title searches and other real estate settlement services through its wholly owned subsidiary, NSB Financial Services, LLC, a limited liability corporation, which operates as a licensed title insurance agency. The consolidated financial statements contained herein include the accounts of the Corporation, the Bank and the Bank's wholly owned subsidiary, which operate as one operating segment. All inter-company amounts have been eliminated. The accompanying unaudited consolidated financial statements for the interim periods include all adjustments, consisting of normal recurring accruals, which are necessary, in the opinion of management, to fairly reflect the Corporation's financial position and results of operations. Additionally, these consolidated financial statements for the interim periods have been prepared in accordance with instructions for the Securities and Exchange Commission's Form 10-Q and therefore do not include all information or footnotes necessary for a complete presentation of financial condition, results of operations and cash flows in conformity with accounting principles generally accepted in the United States of America. For further information, refer to the audited consolidated financial statements and footnotes thereto as of and for the year ended December 31, 2003, as contained in the Corporation's 2003 Annual Report to Stockholders, presented as Exhibit 13 in the Corporation's Form 10-K for the year ended December 31, 2003 filed March 30, 2004. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses and deferred tax assets. The results of operations for interim quarterly or year to date periods are not necessarily indicative of the results that may be expected for the entire year or any other period. Certain amounts previously reported may have been reclassified to conform to the current year's financial statement presentation. 2. Stock Dividend On April 28, 2004, the Corporation declared a 5% stock dividend payable on May 17, 2004 to shareholders of record as of May 3, 2004. A cash payment was made in lieu of fractional shares. 3. Earnings Per Common Share Basic earnings per share represents income available to common stockholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Corporation relate solely to outstanding stock options, and are determined using the treasury stock method. The following table sets forth the computation of basic and diluted earnings per share for the three and six months ended June 30: 5

Average outstanding options to purchase shares of common stock of 60,205, at prices from $24.72 to $25.17, for the three months ended June 30, 2004 and 40,318 shares, at prices from $24.72 to $25.13, for the three months ended June 30, 2003 were not included in the computation of diluted earnings per share for the three months ended June 30, 2004 and June 30, 2003 because, to do so, would have been anti-dilutive. Average outstanding options to purchase shares of common stock of 60,205, at prices from $24.72 to $25.17, for the six months ended June 30, 2004 and 27,816 shares, at prices from $24.79 to $25.09, for the six months ended June 30, 2003 were not included in the computation of diluted earnings per share for the six months ended June 30, 2004 and June 30, 2003 because, to do so, would have been anti-dilutive. 4. Securities The following table summarizes the Corporation's securities available-for-sale:

6 5. Loans receivable The following table summarizes the Corporation's loans receivable:

6. Deposits The following table summarizes the Corporation's deposits:

7. Borrowed funds The Corporation has borrowed funds, comprised of Federal Home Loan Bank Convertible Select Advances, totaling $94.0 million at June 30, 2004 and December 31, 2003. These advances have a weighted average interest rate of 5.65% and 5.72%, respectively. Contractual maturities of these advances are as follows: $4.0 million in 2008, $10.0 million in 2009 and $80.0 million in 2010 and thereafter. Throughout the first half of 2004, maturities totaled $5.0 million. The Corporation added $5.0 million during the second quarter of 2004 and is committed to borrow an additional $5.0 million during the third quarter of 2004 from the Federal Home Loan Bank in connection with a specific investment strategy. The additional $10 million in advances have a term of ten years and a rate of 3.95% and 3.98%, respectively. These advances are ten-year / two-year Convertible Select Advances, fixed at the stated rate for two years then floating thereafter should the three-month Libor rate exceed 8.0%. Further discussion of and disclosures associated with the Corporation's borrowed funds can be found in the 2003 Annual Report to Stockholders. 7 8. Stock based compensation The Corporation maintains two stock-based compensation plans. These plans provide for the granting of stock options to the Corporation's employees and directors. The Corporation follows Accounting Principles Board Opinion No. 25 "Accounting for Stock Issued to Employees" and related Interpretations, under which no compensation cost has been recognized for any of the periods presented. The options have exercise prices equal to the market value of the underlying common stock on the dates of grant. If grants are made during a reporting period, the pro forma effect on net income and earnings per share are disclosed via footnote disclosure as if the Corporation had applied the fair value recognition provisions of the Statement of Financial Accounting Standards No. 123, "Accounting for Stock-based Compensation," to stock-based employee and director compensation. No grants were made during the periods presented herein. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations -------------------------------------------------------------------------------- This section discusses the consolidated financial condition and results of operations of NSD Bancorp, Inc. (the Corporation) and its wholly owned subsidiary bank, NorthSide Bank (the Bank) and the Bank's subsidiary NSB Financial Services, LLC, as of and for the three and six month periods ended June 30, 2004, and should be read in conjunction with the accompanying consolidated financial statements and notes presented on pages 1 through 7. Discussions of certain matters in this Report on Form 10-Q may constitute forward-looking statements within the meaning of the Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the Exchange Act), and as such, may involve risks and uncertainties. Forward-looking statements, which are based on certain assumptions and describe future plans, strategies, and expectations, are generally identifiable by the use of words or phrases such as "believe", "plan", "expect", "intend", "anticipate", "estimate", "project", "forecast", "may increase", "may fluctuate", "may improve" and similar expressions of future or conditional verbs such as "will", "should", "would", and "could". These forward-looking statements relate to, among other things, expectations of the business environment in which the Corporation operates, projections of future performance, potential future credit experience, perceived opportunities in the market, and statements regarding the Corporation's mission and vision. The Corporation's actual results, performance, and achievements may differ materially from the results, performance, and achievements expressed or implied in such forward-looking statements due to a wide range of factors. These factors include, but are not limited to, changes in interest rates, general economic conditions, the demand for the Corporation's products and services, accounting principles or guidelines, legislative and regulatory changes, monetary and fiscal policies of the US Government, US Treasury, and Federal Reserve, real estate markets, competition in the financial services industry, attracting and retaining key personnel, performance of new employees, regulatory actions, changes in and utilization of new technologies, and other risks detailed in the Corporation's reports filed with the Securities and Exchange Commission (SEC) from time to time, including the Annual Report on Form 10-K for the year ended December 31, 2003. These factors should be considered in evaluating the forward-looking statements, and undue reliance should not be placed on such statements. The Corporation does not undertake, and specifically disclaims any obligation, to update any forward-looking statements to reflect occurrences or unanticipated events or circumstances after the date of such statements. CRITICAL ACCOUNTING POLICIES The most significant accounting policies followed by the Corporation are presented in Note 1 of the Corporation's 2003 Annual Report to Stockholders. These policies, along with the disclosures presented in the other financial statement notes provide information on how significant assets and liabilities are valued in the financial statements and how these values are determined. Management views critical accounting policies to be those which are highly dependent on subjective or complex judgments, estimates and assumptions and where changes in those estimates and assumptions could have a significant impact on the financial statements. Management has identified the allowance for loan losses and accounting for stock options as critical accounting policies. Further discussion of these policies can be found in the Management's Discussion and Analysis of Financial Condition and Results of Operations section of the Corporation's 2003 Annual Report to Stockholders. 8 CHANGES IN FINANCIAL CONDITION General. The Corporation's total assets increased $25.7 million or 5.1% to $532.3 million at June 30, 2004 from $506.6 million at December 31, 2003. This net increase was comprised of an increase in loans receivable and investment securities of $1.3 million and $23.6 million, respectively. Partially offsetting these increases was a decrease in cash and cash equivalents of $1.9 million. The increase in total assets reflects a corresponding increase in total liabilities of $27.9 million or 6.0% and a decrease in stockholders' equity of $2.2 million or 5.7%, respectively. The net increase was primarily the result of an increase in deposits of $28.1 million, partially offset by a decrease in accumulated other comprehensive income (loss) totaling $3.2 million. Cash and cash equivalents. Cash and cash equivalents decreased $1.9 million or 7.9% to $22.3 million at June 30, 2004 from $24.2 million at December 31, 2003. The net decrease between June 30, 2004 and December 31, 2003 was primarily the result of the utilization of cash to fund purchases of investment securities and the origination of loans. Securities. The Corporation's securities portfolio increased $23.6 million or 15.6% to $174.7 million at June 30, 2004 from $151.1 million at December 31, 2003. This net increase included security purchases totaling $51.0 million, partially offset by repayments, maturities and calls totaling $17.3 million. Security purchases were comprised of U.S. Government agency, mortgage-backed and tax-free municipal securities of $32.0 million, $9.1 million and $9.9 million, respectively. Security maturities and calls were comprised of U.S. Government agency, tax-free municipal, mortgage-backed and other securities of $6.3 million, $1.7 million, $68,000 and $250,000, respectively. The increase in securities was primarily due to the necessity of reinvesting cash obtained through deposit growth and loan repayments throughout the first half of 2004. Loans receivable. Net loans receivable increased $1.3 million to $306.9 million at June 30, 2004 from $305.6 million at December 31, 2003. Residential mortgage, commercial and consumer loans increased $3.7 million, $6.8 million and $4.7 million, respectively, while nonresidential mortgages decreased $11.7 million. During the second quarter of 2004, loan originations began to outpace prepayments as the Corporation's residential and home equity mortgage lending efforts improved. Nonperforming assets. Nonperforming assets include nonaccrual loans, repossessed assets and real estate acquired through foreclosure. Nonperforming assets decreased slightly by $112,000 to $8.5 million or 1.60% of total assets at June 30, 2004, from $8.6 million or 1.70% of total assets at December 31, 2003. Further discussion of the Corporation's nonperforming assets can be found in the 2003 Annual Report to Stockholders. Deposits. Total deposits increased $28.1 million or 7.7% to $394.1 million at June 30, 2004 from $366.0 million at December 31, 2003. This increase was comprised of an increase in time deposits and other interest bearing demand deposits of $25.7 million and $2.7 million, respectively, as the Bank increased its focus on generating deposits via strategically offered specials. Also contributing to the increase were deposits made by a local school district and the City of Pittsburgh in the form of interest bearing deposits. Noninterest bearing deposits remained relatively unchanged. Stockholders' equity. Stockholders' equity decreased $2.2 million or 5.7% to $36.7 million at June 30, 2004 from $38.9 million at December 31, 2003. The net decrease was principally the result of a decrease in accumulated other comprehensive income (loss) of $3.2 million. Partially offsetting this decrease, net income totaled $2.0 million, of which $1.5 million was paid to stockholders in the form of a cash dividend. 9 RESULTS OF OPERATIONS Comparison of Results for the Three-Month Periods Ended June 30, 2004 and 2003 General. The Corporation reported net income of $979,000 and a net loss of $429,000 for the three months ended June 30, 2004 and 2003, respectively. The $1.4 million increase in net income for the three months ended June 30, 2004, as compared to the three months ended June 30, 2003, was attributable to a decrease in provision for loan losses of $2.7 million. Partially offsetting this favorable variance were unfavorable variances related to net interest income, noninterest income, noninterest expense and provision for income taxes of $82,000, $177,000, $206,000 and $782,000, respectively. The second quarter 2003 net loss was primarily the result of $2.5 million in additional loan loss provision recorded as the result of the deterioration of a large commercial loan relationship in the prior year. The financial deterioration of this large commercial loan customer resulted in placing the credit relationship on nonperforming status and the provision for loan losses charge. 10 Average Balance Sheet and Yield/Rate Analysis. The following table sets forth, for periods indicated, information concerning the total dollar amounts of interest income from interest-earning assets and the resultant average yields, the total dollar amounts of interest expense on interest-bearing liabilities and the resulting average costs, net interest income, interest rate spread and the net interest margin earned on average interest-earning assets. For purposes of this table, average loan balances include nonaccrual loans and exclude the allowance for loan losses, and interest income includes accretion of net deferred loan costs. To compare the tax-exempt asset yields to taxable yields, amounts are adjusted to pretax equivalents based on the marginal corporate Federal tax rate of 34%. The tax-equivalent adjustments to net interest income for 2004 and 2003 were $157,000 and $126,000, respectively.

11 Analysis of Changes in Net Interest Income. The following table analyzes the changes in interest income and interest expense in terms of: (1) changes in volume of interest-earning assets and interest-bearing liabilities and (2) changes in yields and rates. The table reflects the extent to which changes in the Corporation's interest income and interest expense are attributable to changes in rate (change in rate multiplied by prior year volume), changes in volume (changes in volume multiplied by prior year rate) and changes attributable to the combined impact of volume/rate (change in rate multiplied by change in volume). The changes attributable to the combined impact of volume/rate are allocated on a consistent basis between the volume and rate variances. Changes in interest income on securities reflect the changes in interest income on a fully tax equivalent basis.

Net interest income. Net interest income on a tax equivalent basis decreased $51,000 or 1.3% to $3.9 million for the three months ended June 30, 2004, compared to $4.0 million for the same period in the prior year. This net decrease can be attributed to a decrease in interest income of $601,000 partially offset by a decrease in interest expense of $550,000. Interest income. Interest income on a tax equivalent basis decreased $601,000 or 8.4% to $6.6 million for the three months ended June 30, 2004, compared to $7.2 million for the same period in the prior year. The net decrease in interest income can be attributed to a decrease in interest earned on loans of $727,000, partially offset by an increase in interest earned on securities and other interest-earning assets of $112,000 and $14,000, respectively. Interest earned on loans receivable decreased $727,000 or 13.7% to $4.6 million for the three months ended June 30, 2004, compared to $5.3 million for the same period in the previous year. The loan portfolio lost $398,000 in interest income related to a 50 basis point reduction in the average interest rate earned on loans. Further impacting interest earned on loans was a decrease in average loans outstanding of $20.7 million or 6.4%, accounting for $329,000 of the decrease in interest income. The decrease in the yield on loans is reflective of the general low interest rate environment. Loan volume declined as a result of lower new loan demand and higher repayments during the second half of 2003 and 2004. Tax equivalent interest earned on securities increased $112,000 or 6.2% to $1.9 million for the three months ended June 30, 2004, compared to $1.8 million for the same period in the previous year. The securities portfolio gained $336,000 in interest income related to an increase in average securities outstanding of $33.8 million or 24.4%. Partially offsetting this favorable increase in average balance was a decrease in the average interest rate earned on securities of 57 basis points resulting in $224,000 of interest income lost. Average securities increased as funds from loan repayments and customer deposits have been deployed in marketable securities during late 2003 and 2004. 12 Interest earned on other interest-earning assets increased $14,000 or 28.0% to $64,000 for the three months ended June 30, 2004, compared to $50,000 for the same period in the previous year. This decrease was the result of a decrease in the average interest rate earned on such assets of 40 basis points, partially offset by an increase in the average balance outstanding of $8.6 million or 69.9% as a result of cash received from deposits and loan repayments not yet deployed into higher yielding assets. The overall decrease in interest income was primarily due to generally lower market interest rates and the corresponding downward re-pricing of adjustable-rate loans and securities in the current interest rate environment, as well as the lower pricing of new loans and securities added during 2004 compared to 2003. Interest expense. Interest expense decreased $550,000 or 17.3% to $2.6 million for the three months ended June 30, 2004, compared to $3.2 million for the same period in the previous year. The net decrease in interest expense can be attributed to a decrease in interest incurred on deposits of $533,000, partially offset by an increase in interest expense related to borrowed funds of $17,000. Interest-bearing deposit expense decreased $533,000 or 29.3% to $1.3 million for the three months ended June 30, 2004, compared to $1.8 million for the same period in the previous year. This decrease in interest expense can be attributed to an 82 basis point decline in the cost of interest-bearing deposits resulting in a reduction in expense due to rate of $645,000. Partially offsetting the favorable rate variance was an increase in average interest-bearing deposits of $19.4 million or 6.5%. The overall decrease in interest expense, similar to that of interest income, was primarily due to the lower interest rate environment; however, the rate on the cost of funds did not decrease as quickly and as much as the yield on interest-earning assets. Provision for loan losses. The Corporation records provisions for loan losses to bring the total allowance for loan losses to a level deemed adequate to cover probable losses inherent in the loan portfolio. In determining the appropriate level of allowance for loan losses, management considers historical loss experience, the present and prospective financial condition of borrowers, current and prospective economic conditions (particularly as they relate to markets where the Corporation originates loans), the status of nonperforming assets, the estimated underlying value of the collateral and other factors related to the collectibility of the loan portfolio. The $2.7 million decrease in the Corporation's provision for loans losses between the three-month periods ended June 30, 2004 and 2003 can be attributed to an additional loan loss provision charge of $2.5 million during the second quarter of 2003 related to the deterioration of a large commercial loan relationship. Excluding this charge, the Corporation's provision for loan losses decreased $155,000 between the three month periods ended June 30, 2004 and 2003, primarily due to the overall adequacy of the Corporation's allowance for loan losses at June 30, 2004. Noninterest income. Noninterest income decreased $177,000 or 16.6% to $890,000 during the three months ended June 30, 2004, compared to $1.1 million during the same period in the prior year. The net decrease can be attributed to decreases in correspondent premium mortgage fee income, title company revenue, gain on sale of investment securities and earnings on bank-owned life insurance of $90,000, $49,000, $30,000 and $27,000, respectively. Correspondent premium mortgage fee income and title company revenue decreased as a direct result of the decrease in mortgage loans originated for sale as the Corporation directed its focus on retaining rather than selling loans in this lending category. The decrease in earnings on bank-owned life insurance was primarily associated with a decrease in the yield on the policies related to the general decline of interest rates. 13 Noninterest expense. Noninterest expense increased $206,000 or 6.7% to $3.3 million during the three months ended June 30, 2004, compared to $3.1 million during the same period in the prior year. The increase in noninterest expense can primarily be attributed to increases in compensation and benefits expense, data processing expense and professional fees of $209,000, $54,000 and $18,000, respectively, partially offset by a decrease in title company expenses of $60,000. The increase in compensation and benefits expense can be attributed to normal salary and wage increases, incentive management plans put into place at the beginning of 2004 and the addition of several senior management members added during 2004 to further solidify the management team and to aid in the accomplishment of specific initiatives set forth to position the Corporation for continued growth and success. Also contributing to the increase in compensation and benefits expense was an increase in employee related benefits such as healthcare costs. Partially offsetting these increases was a decrease in the overall headcount of the Corporation. Data processing fees increased as a direct result of an increase in activity related to items processed. Professional fees expense increased due to increased problem credit workout costs associated with the increase of nonperforming loans during the second quarter of 2003 and regulatory compliance initiatives. Title company expenses decreased as activity associated with mortgage loans held for sale decreased. Provision for income taxes. The provision for income taxes increased $782,000 to $364,000 for the three months ended June 30, 2004, compared to a benefit from income taxes of $418,000 for the same period in the prior year. This change was directly related to the change in pre-tax income (loss). Comparison of Results for the Six-Month Periods Ended June 30, 2004 and 2003 General. The Corporation reported net income of $2.0 million and $910,000 for the six months ended June 30, 2004 and 2003, respectively. The $1.1 million increase in net income for the six months ended June 30, 2004, as compared to the six months ended June 30, 2003, was attributable to a decrease in provision for loan losses of $2.8 million. Partially offsetting this favorable variance were unfavorable variances related to net interest income, noninterest income, noninterest expense and provision for income taxes of $259,000, $289,000, $417,000 and $716,000, respectively. 14 Average Balance Sheet and Yield/Rate Analysis. Tax-equivalent adjustments to net interest income for 2004 and 2003 were $279,000 and $244,000, respectively.

15 Analysis of Changes in Net Interest Income. The following table analyzes the changes in interest income and interest expense on a fully tax equivalent basis.

Net interest income. Net interest income on a tax equivalent basis decreased $224,000 or 2.8% to $7.9 million for the six months ended June 30, 2004, compared to $8.1 million for the same period in the prior year. This net decrease can be attributed to a decrease in interest income of $1.5 million partially offset by a decrease in interest expense of $1.3 million. Interest income. Interest income on a tax equivalent basis decreased $1.5 million or 10.3% to $13.1 million for the six months ended June 30, 2004, compared to $14.6 million for the same period in the prior year. The net decrease in interest income can be attributed to a decrease in interest earned on loans and other interest-earning assets of $1.7 million and $29,000, respectively, partially offset by an increase in interest earned on securities of $233,000. Interest earned on loans receivable decreased $1.7 million or 15.5% to $9.3 million for the six months ended June 30, 2004, compared to $11.0 million for the same period in the previous year. The loan portfolio lost $997,000 in interest income related to a 67 basis point reduction in the average interest rate earned on loans. Further impacting interest earned on loans was a decrease in average loans outstanding of $21.5 million or 6.7%, accounting for $706,000 of the decrease in interest income. The decrease in the yield on loans is reflective of the general low interest rate environment prevalent throughout the end of 2003 and the first half of 2004. Tax equivalent interest earned on securities increased $233,000 or 6.7% to $3.7 million for the six months ended June 30, 2004, compared to $3.5 million for the same period in the previous year. The securities portfolio gained $493,000 in interest income related to an increase in average securities outstanding of $25.9 million or 19.3%. Partially offsetting this favorable increase in average balance was a decrease in the average interest rate earned on securities of 37 basis points resulting in $260,000 of interest income lost. Average securities increased as funds from loan repayments and customer deposits have been deployed in marketable securities during late 2003 and 2004. 16 Interest earned on other interest-earning assets decreased $29,000 or 19.9% to $117,000 for the six months ended June 30, 2004, compared to $146,000 for the same period in the previous year. This decrease was the result of a decrease in the average interest rate earned on such assets of 55 basis points, partially offset by an increase in the average balance outstanding of $3.3 million or 18.9%. The overall decrease in interest income was primarily due to generally lower market interest rates and the corresponding downward re-pricing of adjustable-rate loans and securities during 2003 and 2004. Also contributing to the decline in interest income was the necessity of redeploying funds from loan repayments in lower yielding marketable securities. Interest expense. Interest expense decreased $1.3 million or 19.6% to $5.2 million for the six months ended June 30, 2004, compared to $6.5 million for the same period in the previous year. The net decrease in interest expense can be attributed to a decrease in interest incurred on deposits of $1.3 million. Interest-bearing deposit expense, which includes demand and time deposits, decreased $1.3 million or 33.6% to $2.5 million for the six months ended June 30, 2004, compared to $3.8 million for the same period in the previous year. This decrease in interest expense can be attributed to a 90 basis point decline in the cost of interest-bearing deposits resulting in a reduction in expense due to rate of $1.3 million. Partially offsetting the favorable rate variance was an increase in average interest-bearing deposits of $5.7 million. The overall decrease in interest expense, similar to that of interest income, was primarily due to the lower interest rate environment; however, the rate on the cost of funds did not decrease as quickly and as much as the yield on interest-earning assets. Provision for loan losses. During the second quarter of 2003, $2.5 million of additional loan loss provision was recorded as the result of the deterioration of a large commercial loan relationship. The financial deterioration of this large commercial loan customer resulted in placing the credit relationship on nonperforming status and the provision for loan loss charge. Aside from the aforementioned charge, the Corporation's provision for loan losses decreased $280,000 between the six-month periods ended June 30, 2004 and 2003, primarily due to the overall adequacy of the Corporation's allowance for loan losses at June 30, 2004 and lower than anticipated loan production during the first half of 2004. The allowance for loan losses to total loans was 2.2% at June 30, 2004 and December 31, 2003. Noninterest income. Noninterest income decreased $289,000 or 14.4% to $1.7 million during the six months ended June 30, 2004, compared to $2.0 million during the same period in the prior year. This decrease can be attributed to decreases in correspondent mortgage fees, title company revenue, gain on sale of investment securities and earnings on bank-owned life insurance of $149,000, $75,000, $44,000 and $36,000, partially offset by an increase in customer service fees of $28,000. Correspondent premium mortgage fee income and title company revenue decreased due to the decrease in loan originations associated with mortgage loans held for sale. Bank owned life insurance earnings decreased as a result of a decrease in the yield associated with the policies. Customer service fee income increased primarily from an increase in overdraft fee income. Noninterest expense. Noninterest expense increased $417,000 or 7.0% to $6.4 million during the six months ended June 30, 2004, compared to $5.9 million during the same period in the prior year. The increase in noninterest expense can be attributed to increases in compensation and benefits and professional fees of $404,000 and 74,000, respectively. Partially offsetting these increases was an insurance claim settlement received in 2004 totaling $118,000 related to a fraud associated with a home equity line of credit from 2003. 17 Compensation and benefits expense increased $404,000 or 14.1% to $3.3 million during the six months ended June 30, 2004 compared to $2.9 million for the same period in the prior year. This increase can be attributed to normal salary and wage increases, the addition of incentive management plans and additional senior management personnel added during 2004. Professional fees increased as a result of increased problem credit workout costs and regulatory compliance initiatives. Provision for income taxes. The provision for income taxes increased $716,000 to $778,000 for the six months ended June 30, 2004, compared to $62,000 for the same period in the prior year. This change was directly related to the change in pre-tax income. LIQUIDITY The Corporation's primary sources of funds generally have been deposits obtained through the offices of the Bank, borrowings from the Federal Home Loan Bank (FHLB), and amortization and prepayments of outstanding loans and maturing securities. During the six months ended June 30, 2004, the Corporation used its sources of funds primarily to purchase securities and, to a lesser extent, fund loan commitments. As of such date, the Corporation had outstanding loan commitments, including undisbursed loans and amounts available under credit lines, totaling $20.0 million, and standby letters of credit, which have collateral typically in the form of Bank deposit instruments and a term generally under one year, totaling $859,000. At June 30, 2004, time deposits amounted to $155.1 million or 39.4% of the Corporation's total consolidated deposits, including approximately $99.1 million, which are scheduled to mature within the next year. Management of the Corporation believes that it has adequate resources to fund all of its commitments, that all of its commitments will be funded as required by related maturity dates and that, based upon past experience and current pricing policies, it can adjust the rates of time deposits to retain a substantial portion of maturing liabilities. Aside from liquidity available from customer deposits or through sales and maturities of securities, the Corporation has alternative sources of funds such as a line of credit and term borrowing capacity from the FHLB and, to a limited and rare extent, the sale of loans. At June 30, 2004, the Corporation's borrowing capacity with the FHLB, net of funds borrowed, was $30.9 million. Management is not aware of any conditions, including any regulatory recommendations or requirements, which would adversely impact its liquidity or its ability to meet funding needs in the ordinary course of business. CAPITAL RESOURCES Total stockholders' equity decreased $2.2 million or 5.7% to $36.7 million at June 30, 2004 from $38.9 million at December 31, 2003. Accumulated other comprehensive income (loss) decreased $3.2 million. Net income contributed $2.0 million to stockholders' equity during the first half of 2004, partially offset by dividends paid totaling $1.5 million for the first six months of 2004. The Corporation has maintained a strong capital position with a capital to assets ratio of 6.9% at June 30, 2004. While continuing to sustain this capital position, the Corporation declared a quarterly cash divided of $0.22 per share during both the first and second quarters of 2004. Capital adequacy is the Corporation's ability to support growth while protecting the interest of shareholders and deposits and to ensure that capital ratios are in compliance with regulatory minimum requirements. At June 30, 2004, the Corporation and the Bank were in compliance with all regulatory capital requirements. 18 Item 3. Quantitative and Qualitative Disclosures about Market Risk ------------------------------------------------------------------- There have been no material changes in information regarding quantitative and qualitative disclosures about market risk at June 30, 2004 from the information presented in the 2003 Annual Report to Stockholders under the caption, Management's Discussion and Analysis of Financial Condition and Results of Operations - Market Risk Management. Item 4. Controls and Procedures -------------------------------- The Corporation's management evaluated, with the participation of the Corporation's President and Chief Operating Officer and Chief Financial Officer, the effectiveness of the Corporation's disclosure controls and procedures, as of the end of the period covered by this Form 10-Q. Based on that evaluation, the Chief Operating Officer and Chief Financial Officer concluded that the Corporation's disclosure controls and procedures, as defined in rules 13(a) - 15(e) and 15(d) - 15(e) under the Securities Exchange Act of 1934, are effective to ensure that information required to be disclosed by the Corporation in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms. There were no changes in the Corporation's internal control over financial reporting that occurred during the Corporation's last fiscal quarter that have materially affected, or are reasonably likely to affect, the Corporation's internal control over financial reporting. PART II - OTHER INFORMATION --------------------------- Item 1. Legal Proceedings -------------------------- The Corporation is involved in various legal proceedings occurring in the ordinary course of business. It is the opinion of management, after consultation with legal counsel, that these matters will not materially effect the Corporation's consolidated financial position or results of operations. Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities -------------------------------------------------------------------------------- None. Item 3. Defaults Upon Senior Securities ---------------------------------------- None. Item 4. Submission of Matters to a Vote of Security Holders ------------------------------------------------------------ (a) The annual meeting of stockholders of the Corporation was held April 27, 2004. Of 3,200,590 common shares eligible to vote, 2,874,221 or 89.8% were voted in person or by proxy. (b) The following First Class directors were elected for a two-year term expiring in 2006: Name Shares For Shares Withheld ---- ---------- --------------- Nicholas C. Geanopulos 2,823,896 50,325 Gus P. Georgiadis 2,808,803 65,418 Andrew W. Hasley 2,814,659 59,562 Charles S. Lenzner 2,824,777 49,444 Kenneth L. Rall 2,826,078 48,143 In addition to the above listed individuals, the following persons continue to serve as directors: William R. Baierl, John C. Brown, Jr., Grant A. Colton, Jr., Lawrence R. Gaus, David J. Malone and Arthur J. Rooney, II. 19 (c) The recommendation of the Board of Directors to approve and adopt the NSD Bancorp, Inc. 2004 Omnibus Stock Incentive Plan, as described in the proxy statement for the annual meeting, was approved with 1,591,264 shares in favor, 149,561 shares against and 27,396 shares abstained. (d) The recommendation of the Board of Directors to ratify the appointment of S.R. Snodgrass, A.C. as the Corporation's independent auditors, as described in the proxy statement for the annual meeting, was approved with 2,857,433 shares in favor, 15,526 shares against and 1,262 shares abstained. Item 5. Other Information -------------------------- None. Item 6. Exhibits and Reports on Form 8-K ----------------------------------------- (a) Exhibits: Exhibit 3.1 Articles of Incorporation of NSD Bancorp, Inc. filed as Exhibit 3a to NSD Bancorp, Inc.'s Form S-4 filed March 9, 1993 (Registration No. 33-59242), is incorporated herein by reference. Exhibit 3.2 Bylaws of NSD Bancorp, Inc. filed as Exhibit 3b to NSD Bancorp, Inc.'s Form S-4 filed March 9, 1993 (Registration No. 33-59242), is incorporated herein by reference. Exhibit 10.1 Agreement and Mutual Release dated August 29, 2003, between NSD Bancorp, Inc., NorthSide Bank and Lloyd G. Gibson filed as Exhibit 10.1 to NSD Bancorp, Inc.'s Form 10-Q filed November 14, 2003, is incorporated herein by reference. Exhibit 10.2 NSD Bancorp, Inc. 1994 Stock Option Plan filed as Exhibit 4.1 to NSD Bancorp, Inc.'s Form S-8 filed April 27, 1994, is incorporated herein by reference. Exhibit 10.3 NSD Bancorp, Inc. 1994 Non-Employee Director Stock Option Plan filed as Exhibit 4.1 to NSD Bancorp, Inc.'s Form S-8 filed April 27, 1994, is incorporated herein by reference. Exhibit 10.4 NSD Bancorp, Inc. 2004 Omnibus Stock Incentive Plan is incorporated by reference as Exhibit C to NSD Bancorp, Inc.'s 2004 Proxy Statement for the Annual Shareholders Meeting to be held April 27, 2004. Exhibit 11.1 Statements re: computation of ratios. The information for this Exhibit is incorporated by reference to pages 5-6 of this Form 10-Q. Exhibit 31.1 Rule 15(d)-14(a) certification of the President and Chief Operating Officer. Exhibit 31.2 Rule 15(d)-14(a) certification of the Senior Vice President, Treasurer and Chief Financial Officer. Exhibit 32.1 Principal Executive Officer Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. Exhibit 32.2 Principal Financial Officer Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 20 (b) Reports on Form 8-K: Reports on Form 8-K filed during the three month period ended June 30, 2004: A Report on Form 8-K was filed on April 21, 2004 to announce earnings for the quarter ended March 31, 2004. A report on Form 8-K was filed on April 28, 2004 to declare a stock dividend. A report on Form 8-K was filed on May 20, 2004 documenting change of control agreements with Andrew W. Hasley and William C. Marsh. A report on Form 8-K was filed on May 26, 2004 to declare a cash dividend. A report on Form 8-K was filed on June 2, 2004 announcing the hiring of a new Senior Vice President and Chief Lending Officer. Signatures ---------- Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. NSD Bancorp, Inc. Date: August 10, 2004 By: /s/ Andrew W. Hasley ---------------------------------------------- Andrew W. Hasley President and Chief Operating Officer (Principal Executive Officer) Date: August 10, 2004 By: /s/ William C. Marsh ---------------------------------------------- William C. Marsh Senior Vice President, Treasurer and Chief Financial Officer (Principal Financial and Accounting Officer) 21

NSD BANCORP INC 10-Q