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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2003
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
Commission file number 0-15786
[GRAPHIC OMITTED]COMMUNITYBANKS[GRAPHIC OMITTED]
COMMUNITY BANKS, INC.
(Exact name of registrant as specified in its charter)
Pennsylvania 23-2251762
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
750 East Park Drive, Harrisburg, PA 17111
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (717) 920-1698
Securities registered pursuant to Section 12 (b) of the Act: None
Securities registered pursuant to Section 12 (g) of the Act:
Common Stock, par value $5 per share
------------------------------------
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, and (2) has been subject to such filing requirements
for the past 90 days.
Yes X No
----- ----
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of the Form 10-K or any amendments to this
Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
Yes X No
----- ----
Aggregate market value of the Common Stock, $5 par value, held by non-affiliates
of the registrant, computed by reference to the closing price as of the close of
business on June 30, 2003: $258,000,000
Number of shares of the Common Stock, $5 par value, outstanding as of the close
of business on March 1, 2004: 11,700,000 shares.
Documents Incorporated by Reference:
Portions of the Proxy Statement for the 2004 Annual Meeting of Shareholders of
Community Banks, Inc., have been incorporated by reference into Part III.
COMMUNITY BANKS, INC. and SUBSIDIARIES
FORM 10-K
INDEX
PART I Page
Item 1 Business 3-4
Item 2 Properties 5
Item 3 Legal Proceedings 5
Item 4 Submission of Matters to a Vote of Security Holders 5
PART II
Item 5 Market for Registrant's Common Equity and Related Stockholder Matters 6
Item 6 Selected Financial Data 7
Item 7 Management's Discussion and Analysis of Financial Condition and Results
of Operation 8-32
Item 7A Quantitative and Qualitative Disclosures About Market Risk 33-35
Item 8 Financial Statements and Supplementary Data 36-63
Item 9 Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure 64
Item 9A Controls and Procedures 64
PART III
Item 10 Directors and Executive Officers of the Registrant 65
Item 11 Executive Compensation 65
Item 12 Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters 65
Item 13 Certain Relationships and Related Transactions 65
Item 14 Principal Accounting Fees and Services 65
PART IV
Item 15 Exhibits, Financial Statement Schedules, and Reports on Form 8-K 66-68
SIGNATURES 69
2
PART I
Item 1. Business:
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Community Banks, Inc., referred to in this report as the "Corporation" or
"Community," is a financial holding company that was formed as a Pennsylvania
corporation in 1982. Community's banking subsidiary is Community Banks, referred
to in this report as the "Bank." Community's non-banking subsidiaries are
Community Bank Investments, Inc. (CBII), Community Banks Life Insurance Company,
Inc. (CBLIC), CMTY Capital Trust I, and CMTY Capital Statutory Trust II. The
subsidiaries of the Bank are UDNB Investments, Inc.; PSB Realty Co., Inc.; The
Sentinel Agency, LLC; Community Banks Insurance Services, LLC; CB Services, LLC;
and Erie Financial Group, LLC.
On January 1, 2002, Community consolidated the charters of its banking
subsidiaries under the name Community Banks, pursuant to regulatory approvals.
Prior to that time, Community's separate banking organizations operated as
Peoples State Bank (PSB), a state chartered bank with offices throughout York
and Adams Counties; and Community Banks, N.A. (CBNA), a federally chartered bank
headquartered in Dauphin County with offices in central and northeastern
Pennsylvania. The consolidation was designed to facilitate a regional
operational focus that would ease regulatory burdens while, at the same time,
maintain a philosophy of local decision-making.
Community conducts a full service commercial banking business and provides trust
services through 46 banking offices in Pennsylvania and Maryland: 3 offices in
Adams County, 2 offices in Cumberland County, 10 offices in Dauphin County, 3
offices in Luzerne County, 2 offices in Northumberland County, 7 offices in
Schuylkill County, 1 office in Snyder County, and 16 offices in York County,
Pennsylvania and 2 offices in Carroll County, Maryland. There are nearly 700
offices of commercial banks and savings and loan associations within its market
area with which Community competes. Deposits of Community represent
approximately 5% of the total deposits in the market area.
Like other banking companies, Community has been subjected to competition from
credit unions, brokerage firms, money market funds, consumer finance and credit
card companies and other companies providing financial services and credit to
consumers.
Over the years, Community has formed special purpose subsidiaries which are
included in consolidated results. In December 2003, Community formed CMTY
Statutory Capital Trust II to execute a trust preferred issuance of $15 million.
In December 2002, Community formed CMTY Capital Trust I to execute a pooled
trust preferred issuance of $15 million. In 1986, Community formed CBLIC to
provide credit life insurance to its consumer credit borrowers. Total premiums
earned were $188,000 for the year ended December 31, 2003. In 1985, Community
formed CBII to make investments primarily in equity securities of other banks.
Total assets of CBII at December 31, 2003 were $7.9 million.
Community and its subsidiaries have approximately 630 full and part-time
employees and Community considers its employee relations to be satisfactory.
Supervision and Regulation of Community
- ---------------------------------------
The banking industry is subject to extensive state and federal regulation.
Proposals to change laws and regulations governing the banking industry are
frequently raised in Congress, in state legislatures, and in various bank
regulatory agencies. The likelihood and timing that any such changes may have on
Community are difficult to determine with any certainty. Changes in laws or
regulations, or changes in the interpretation of laws or regulations, may have a
material impact on the business, operations and earnings of Community.
Community Banks, Inc. is registered as a financial holding company with the
Federal Reserve Board in accordance with the requirements of the
Gramm-Leach-Bliley Act (the "GLB Act"). The GLB Act enables broad-scale
consolidation among banks, securities firms and insurance companies for eligible
bank holding companies that have elected and maintain "financial holding
company" status. Financial holding companies can offer virtually any type of
financial service, including banking, securities underwriting, insurance (both
agency and underwriting) and merchant banking. If a bank holding company does
not become a financial holding company, it will be limited to those activities
previously determined by the Federal Reserve Board to be permissible; i.e.,
"closely related to banking" under the standard set forth in the Bank Holding
Company Act. In order to become a financial holding company, all of a bank
holding company's bank subsidiaries must be well capitalized and well managed
and have a rating under the Community Reinvestment Act (the "CRA") of at least
"satisfactory."
3
Community is subject to regulation by the Federal Reserve Board. The Federal
Reserve Board requires regular reports from Community and is authorized to make
regular examinations of Community and its subsidiaries. The Bank is subject to
supervision and regulation, and is examined regularly, by the Federal Deposit
Insurance Corporation and the state banking departments in the states in which
it operates. To the extent that the Bank's subsidiaries are licensed to engage
in the sale of insurance or the mortgage brokerage business, the subsidiaries
are subject to examination by the respective licensing authorities. Community
and its direct non-banking subsidiaries are affiliates, within the meaning of
the GLB Act, of the Bank and its subsidiaries. As a result, the Bank and its
subsidiaries are subject to restrictions on loans or extensions of credit to,
purchase of assets from, investments in, and transactions with Community and its
direct non-banking subsidiaries and on certain other transactions with them or
involving their securities.
Capital Adequacy
- ----------------
The Federal Reserve Board and the FDIC have adopted risk-based capital adequacy
guidelines for financial holding companies and banks under their supervision.
Under these guidelines, "Tier 1 capital" and "Total capital" as a percentage of
risk-weighted assets and certain off-balance sheet instruments must be at least
4% and 8%, respectively. The regulators have also imposed a leverage standard,
which focuses on the institution's ratio of Tier 1 capital to average total
assets, adjusted for goodwill and certain other items, to supplement their
risk-based ratios. This minimum leverage ratio was set at 3% and would apply
only to those banking organizations receiving a regulatory composite 1 rating.
Most banking organizations will be required to maintain a leverage ratio ranging
from 1 to 2 percentage points above the minimum standard.
Community and the Bank are subject to various regulatory capital requirements
administered by federal and state banking agencies. Failure to meet minimum
capital requirements can initiate certain mandatory and possibly additional
discretionary actions by regulators that, if undertaken, could have a direct
material effect on Community's financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, each
subsidiary bank must meet specific capital guidelines that involve quantitative
measures of assets, liabilities, and certain off-balance-sheet items as
calculated under regulatory accounting practices. The capital amounts and
classification are also subject to qualitative judgments by the regulators about
the risk weightings of components, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require Community to maintain minimum amounts and ratios of total and Tier 1
capital to risk-weighted assets and of Tier 1 capital to average assets.
Management believes, as of December 31, 2003, that Community and the Bank have
met all capital adequacy requirements to which they are subject. For tables
presenting Community's capital ratios, see "Notes to Consolidated Financial
Statements - Regulatory Matters" included in Part II, Item 8.
Sarbanes-Oxley Act of 2002
- --------------------------
The Sarbanes-Oxley Act of 2002 (Sarbanes-Oxley), which was signed into law in
July, 2002, impacts all companies with securities registered under the
Securities Exchange Act of 1934, including Community. Sarbanes-Oxley created new
requirements in the areas of corporate governance and financial disclosure
including, among other things, (i) increased responsibility for Chief Executive
Officers and Chief Financial Officers with respect to the content of filings
with the SEC; (ii) enhanced requirements for audit committees, including
independence and disclosure of expertise; (iii) enhanced requirements for
auditor independence and the types of non-audit services that auditors can
provide; (iv) accelerated filing requirements for SEC reports; (v) increased
disclosure and reporting obligations for companies, their directors and their
executive officers; and (vi) new and increased civil and criminal penalties for
violation of securities laws.
Certifications of the Chief Executive Officer and the Chief Financial Officer as
required by Sarbanes-Oxley and the resulting SEC rules can be found in the
"Exhibits" section of this document.
Other Information
- -----------------
Community's internet address is www.communitybanks.com. Electronic copies of
Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports
on Form 8-K, and amendments to those reports filed or furnished pursuant to
Section 13(a) or 15(d) of the Exchange Act, are available through the "Investor
Relations" section of Community's website as soon as reasonably practicable
after filing such material with, or furnishing it to, the Securities and
Exchange Commission. Copies of such reports are also available at no charge.
4
Item 2. Properties:
- -------------------
The following table summarizes the Bank's branch network:
PSB Total
Bank (1) Realty(2) Leased Term (3) Branches
------- -------- ------ ------- --------
In Pennsylvania:
Adams County 2 1 - - 3
Cumberland County 1 - 1 2019 2
Dauphin County 7 - 3 2018 10
Luzerne County 1 - 2 2005 3
Northumberland County 2 - - - 2
Schuylkill County 7 - - - 7
Snyder County 1 - - - 1
York County 6 4 6 2020 16
In Maryland:
Carroll County 1 - 1 2007 2
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Total 28 5 13 46
=========================================== ===========
(1) Properties are owned by the Bank, free and clear of encumbrances.
(2) Properties are owned by PSB Realty Company and are leased to the Bank.
(3) Latest lease term expiration date, excluding renewal options.
From time to time, the Bank also acquires real estate by virtue of foreclosure
proceedings, and such real estate is disposed of in the usual and ordinary
course of business as expeditiously as is prudently possible.
The following table summarizes the Corporation's other significant properties:
Owned/ Lease
User Character of Facility Location Leased Expires(1)
---- --------------------- -------- ------ ----------
Community Banks, Inc. Executive Offices Harrisburg, PA Leased 2007
Community Banks Operations Center Halifax, PA Owned
Community Banks Operations Center Hanover, PA Owned
The Sentinel Agency LLC Admin/Sales Harrisburg, PA Leased 2004
CB Insurance Services LLC Admin Mechanicsburg, PA Leased 2004
Erie Financial Group LLC Admin/Sales York, PA Owned
(1) Latest lease term expiration date, excluding renewal options.
Item 3. Legal Proceedings:
- ---------------------------
Various actions and proceedings are presently pending to which Community or one
or more of its subsidiaries is a party. These actions and proceedings arise out
of routine operations and, in management's opinion, will not have a material
adverse effect on Community's consolidated financial position.
Item 4. Submission of Matters to a Vote of Security Holders:
- -------------------------------------------------------------
No matters were submitted to a vote of security holders during the fourth
quarter of 2003.
5
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters:
- -------------------------------------------------------------------------------
Market Information
- ------------------
The shares of Community are traded on the Nasdaq National Market under the
symbol CMTY and are transferred through local and regional brokerage houses.
Community had approximately 3,346 shareholders as of December 31, 2003. The
following table sets forth dividends declared per share and the high and low
prices of Community at which the common stock has been transferred during the
periods indicated. High and low prices are based solely upon transactions known
to management of Community and represent a portion of the actual transfers of
common stock during the periods in question.
------------------------------------------------------------------------------------------------------
2003 2002
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Price Per Share Dividends Price Per Share Dividends
Low High Declared Low High Declared
First Quarter $21.83 $23.63 .16 $19.33 $22.02 .13
Second Quarter 23.22 25.00 .16 20.28 23.57 .14
Third Quarter 24.88 27.92 .17 18.97 21.98 .14
Fourth Quarter 28.00 33.75 .17 20.62 23.02 .16
Holders of the common stock of Community are entitled to such dividends as may
be declared from time to time by the Board of Directors out of funds legally
available therefore. Community currently expects that it will continue to pay
comparable dividends in the future, subject to regulatory requirements,
Community's financial condition and requirements, future prospects, business
conditions and other factors deemed relevant by the Board of Directors. As noted
in "Capital Adequacy" in Part I, Item 1, Community is subject to various
regulatory capital requirements that limit the amount of capital available for
dividends.
The market prices listed above are based on historical market quotations and
have been restated to reflect stock dividends and splits.
Equity Compensation Plan Information
- ------------------------------------
- ---------------------------------- -------------------------------- -------------------------------- -------------------------------
(a) (b) (c)
Number of securities
remaining available for
Number of securities to be future issuance under equity
issued upon exercise of Weighted average exercise compensation plans (excluding
outstanding options, warrants price of outstanding options, securities reflected in
Plan Category and rights warrants and rights column (a))
- ---------------------------------- -------------------------------- -------------------------------- -------------------------------
Equity compensation plans 978,376 $18.80 1,049,468 (1)
approved by security holders
- ---------------------------------- -------------------------------- -------------------------------- -------------------------------
Equity compensation plans not
approved by security holders (2) None n/a n/a
- ---------------------------------- -------------------------------- -------------------------------- -------------------------------
Total 978,376 $18.80 1,049,468
- ---------------------------------- -------------------------------- -------------------------------- -------------------------------
(1) Includes 80,960 shares available for future issuance under Community's
Employee Stock Purchase Plan.
(2) Community does not maintain equity compensation plans that have not
been approved by its stockholders.
Sales of Unregistered Securities
- --------------------------------
On December 16, 2003, Community, through its subsidiary CMTY Capital Statutory
Trust II, issued and sold to STI Investment Management, Inc., 15,000 trust
preferred securities for an aggregate offering price of $15 million. The trust
securities were exempt from registration under the private offering exemption in
Section 4(2) of the Securities Act of 1933 and Section 506 of Securities and
Exchange Commission Regulation D. Community used the proceeds of the sale for
general corporate purposes.
6
Item 6. Selected Financial Data:
- --------------------------------
At or for the Year Ended December 31
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2003 2002 2001 2000 1999
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(dollars in thousands except per share data)
BALANCE SHEET DATA:
At Period End:
Investment securities $ 646,961 $ 667,801 $ 543,901 $ 389,819 $ 360,540
Total loans 1,078,611 904,568 857,278 814,874 708,016
Total assets 1,860,130 1,679,898 1,509,734 1,308,713 1,151,344
Total deposits 1,230,685 1,132,913 1,003,225 919,241 826,167
Long-term debt 441,422 335,533 322,155 239,613 213,865
Stockholders' equity 143,406 129,162 111,249 103,978 86,309
Average:
Total assets 1,780,171 1,580,046 1,398,521 1,238,870 1,093,262
Total stockholders' equity 135,773 119,352 111,381 92,255 92,274
EARNINGS DATA:
Net interest income 52,536 50,488 45,935 43,795 40,248
Provision for loan losses 2,500 3,350 5,080 2,863 1,588
Net interest income after provision
for loan losses 50,036 47,138 40,855 40,932 38,660
Other income 20,441 13,975 12,141 8,148 6,388
Other expense 45,718 39,300 36,521 30,463 27,501
Provision for income taxes 4,359 3,367 2,879 4,702 4,257
Net income 20,400 18,446 13,596 13,915 13,290
PER SHARE DATA:
Basic earnings per share 1.76 1.59 1.17 1.21 1.14
Diluted earnings per share 1.71 1.55 1.15 1.19 1.12
Cash dividends .66 .57 .51 .45 .41
Book value 12.31 11.20 9.50 9.08 7.44
Average diluted shares outstanding 11,902,259 11,896,495 11,868,567 11,649,436 11,821,835
PROFITABILITY RATIOS:
Return on average assets 1.15% 1.17% .97% 1.12% 1.22%
Return on average stockholders' equity 15.03% 15.46% 12.21% 15.08% 14.40%
Net interest margin (FTE) 3.50% 3.78% 3.83% 4.01% 4.20%
Efficiency ratio 60.47% 56.81% 59.77% 55.42% 55.54%
CAPITAL AND LIQUIDITY RATIOS:
Stockholders' equity to total assets 7.71% 7.69% 7.37% 7.95% 7.50%
Average equity to average assets 7.64% 7.55% 7.96% 7.45% 8.44%
Dividend payout ratio 37.35% 36.07% 43.25% 37.48% 36.70%
Net loans to assets 57.28% 53.11% 55.98% 61.48% 60.72%
ASSET QUALITY RATIOS:
Allowance for loan losses to total loans
outstanding 1.22% 1.36% 1.42% 1.27% 1.27%
Allowance for loan losses to non-accrual
loans 162% 131% 109% 171% 152%
Non-accrual loans to total loans
outstanding .76% 1.04% 1.29% .74% .83%
Non-performing assets to total assets .70% .63% .78% .49% .57%
Net charge-offs to average loans outstanding .17% .35% .39% .20% .18%
7
Item 7. Management's Discussion and Analysis of Financial Condition and Results
- --------------------------------------------------------------------------------
of Operation:
-------------
MANAGEMENT'S DISCUSSION OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This discussion is being presented to provide a narrative explanation of the
financial statements of Community. The purpose of this presentation is to
enhance the overall financial disclosure and to provide information about
historic financial performance as a means to assess whether past performance can
be used to evaluate the prospects for future performance. Throughout this
presentation, net income and yield on earning assets have been presented on a
tax equivalent basis and balances represent average daily balances unless
otherwise indicated. All per share amounts have been restated to give effect to
the stock split, issued in the form of a 20% stock dividend, announced in the
fourth quarter of 2003. During 2003, Community completed the acquisitions of
several businesses, including: Abstracting Company of York County (ABCO), a
title, settlement, and abstracting company (April, 2003); Erie Financial Group,
Ltd. (Erie), a company providing mortgage origination services (July, 2003); and
Your Insurance Partnership, an insurance agency group specializing in personal
insurance services (October, 2003). All dollar amounts are presented in
thousands, unless otherwise indicated.
FORWARD-LOOKING STATEMENTS
Periodically, Community has made and will continue to make statements that may
include forward-looking information. The Corporation cautions that
forward-looking information disseminated through financial presentations should
not be construed as guarantees of future performance. Furthermore, actual
results may differ from expectations contained in such forward-looking
information as a result of factors that are not predictable. Financial
performance can be affected by any number of factors that are not predictable or
are out of management's direct control. Examples include: the effect of
prevailing economic conditions; unforeseen or dramatic changes in the general
interest rate environment; actions or changes in policies of the Federal Reserve
Board and other government agencies; business risk associated with the
management of the credit extension function and fiduciary activities. Each of
these factors could affect estimates, assumptions, uncertainties and risk used
to develop forward-looking information, and could cause actual results to differ
materially from management's expectations regarding future performance.
CRITICAL ACCOUNTING POLICY: ADEQUACY OF ALLOWANCE
Management believes that the application of its accounting policies and
procedures in the determination of the adequacy of the allowance for loan
losses, and the related provision for loan losses, should be considered to be a
critical accounting policy to ensure the fair presentation of the Corporation's
financial statements. Community applies a systemic methodology in order to
estimate the allowance for loan losses. These methodologies incorporate
management's judgments about the credit quality of the loan portfolio through a
disciplined process that is consistently applied. This process requires that a
detailed analysis of the loan portfolio be performed on a quarterly basis. This
analysis includes a specific individual loan review for any and all loans that
meet specific materiality criteria. Such loans are evaluated for impairment
under the provisions of Statement of Financial Accounting Standards (SF AS) No.
114, "Accounting by Creditors for Impairment of a Loan". The portfolio is
further stratified to analyze groups of homogenous loans with similar risk
characteristics. Such loans are evaluated under the provisions of SFAS No. 5
"Accounting for Contingencies". Management considers all known relevant internal
and external factors that may affect loan collectability, as well as particular
risks indigenous to specific types of lending. The process is further designed
to consolidate the aggregate loss estimates and to ensure that the allowance for
loan losses is recorded in accordance with generally accepted accounting
principles. The final results are reviewed and approved by executive management.
Results are constantly validated by a review of trends associated with loan
volume, delinquencies, potential concentrations, or other factors that may
influence the methodology used to estimate the allowance for loan losses.
2003 PERFORMANCE OVERVIEW
Community completed another year of record performance in 2003, reporting the
highest net income and earnings per share in its history. At the same time,
Community made significant progress in its continuing effort to evolve into a
"community-focused" financial services corporation, capable of delivering a
competitive menu of services to meet the expanding needs of individuals and
businesses within its marketplace. Community is committed to achieving the
highest possible return to its shareholders, constrained by the need for both
prudent management of critical risk factors and the continuing investment in
infrastructure to ensure superior customer service and growth of the franchise.
8
Net income reached $20.4 million, an 11% increase from the net income of $18.4
million reported in 2002. Similarly, diluted earnings per share reached $1.71, a
10% improvement from the $1.55 reported in 2002. Return on average assets (ROA)
and return on average equity (ROE) provide traditional benchmarks used to
compare the relative operating performance of financial service companies. At
the end of 2003, the Corporation produced an ROA of 1.15% and an ROE of 15.03%,
which were comparable to the performances of 1.17% and 15.46%, respectively, in
the prior year. Community has established long-term performance goals that are
consistent with its emergence as a growing and vibrant competitor within its
expanding footprint. The performance during 2003 was consistent with these
operating goals and generated favorable performance comparisons to
similarly-sized financial service companies operating within the northeast
region of the United States.
Performance for 2003 included double-digit growth in loan volume and steady
deposit growth that combined to yield a 5% increase in net interest income.
Non-interest income was influenced primarily by the growth in fees associated
with acquired businesses and with increases in new or existing banking products.
Mortgage origination fees expanded due to demand from the existing bank delivery
network and from the activity generated as a result of the midyear acquisition
of Erie. Title and settlement revenues grew at record levels throughout the year
and were influenced by the flurry of origination activity and by the acquisition
of ABCO. Community also recorded a $1.1 million gain from the sale of a retail
office, which is included in other income, as part of its ongoing office
reconfiguration effort. These and other factors provided a significant boost to
non-interest revenues. Aside from increases in the non-interest revenue stream,
a reduction in the provision for loan losses also contributed to improved
performance. Community continues to monitor and manage its credit quality to
minimize losses from credit activities. Finally, profitability was also
influenced by growth in expenses that occurred as a result of the additional
costs from acquired businesses, expenses associated with the expansion of the
delivery network, and from other investments in the growth of the Corporation.
Economic Climate
The year 2003 began with the predictable uncertainty that accompanies
geopolitical discord and the escalation of armed international conflict. Since
the tragedies brought on by the World Trade Center attack in September of 2001,
Americans have had to adjust to a new global reality that has made " terror
alerts" and " al Qaeda" a normal part of our national lexicon. This new reality
has had a dampening effect on economic growth. Beyond this backdrop of global
tensions lie national, regional, and local economies within the United States
that are more directly affected by international trends and events. This
vulnerability was particularly evident in the first half of 2003, with
escalation of military involvement in Iraq and increased concern over the
potential for further terrorist attacks. The economic malaise in the first half
of 2003 was even more directly affected by the overall business climate, which
was characterized by lackluster stock market returns, increased skepticism
associated with corporate scandals, and reduced capital spending within the
commercial sector.
The impact of declining interest rates during 2003 was the most influential
trend affecting the financial services industry. For the second consecutive
year, interest rates fell to the lowest levels in the last four decades. This
trend had its most significant impact on growth in net interest income, the
largest source of revenue for most financial institutions. The low rate
environment was a catalyst for borrowing activity, particularly within the
consumer sector. Since the demise of the `bubble economy' of the 1990's, steady
consumer confidence has been an important constant in sustaining the national
economy. The retail consumer's capacity and appetite for debt to accommodate the
purchase of goods and services has helped forestall a deeper, more dramatic
recessionary downturn.
The Federal Reserve Board ("Fed") maintained an accommodative stance on interest
rates throughout most of the year in order to preempt the effect of higher rates
on economic growth. The Fed's interest rate posture was also responsive to an
absence of inflationary concerns, forestalling the need to raise rates in order
to suppress the adverse consequences of unchecked inflation. These lower rates
created unprecedented challenges to achieving growth in interest spread for most
financial institutions. The rate environment provided a stimulus for credit
services, but also produced challenges associated with expanding the deposit
base. As interest rates declined, most financial institutions were forced to
become less competitive on the pricing of deposit funding products. Late in the
year, many of these products had reached practical floors, preventing meaningful
downward repricing of deposit funding. The pressure on net interest income was
exacerbated by the inability to achieve higher loan pricing or identify
favorable reinvestment opportunities within the bond markets to enhance net
interest spread.
9
While lower interest rates constrained growth in net interest income, this trend
had a positive impact on other areas of financial services industry performance.
The highest direct correlation between lower rates and higher performance
occurred in the mortgage origination markets. Nationwide, housing starts grew to
over 1.7 million while total home sales reached a record high 5.8 million in
2003. At the same time, the lower mortgage rates spurred another record level of
mortgage refinancing. This trend provided consumers with increased disposable
income and helped sustain consumer confidence during a period of rising
unemployment and stagnant economic trends. Lower interest rates also have the
tendency to reduce the volume and severity of losses from credit activities.
Affordable credit tends to mitigate the potential for borrower default, which
can be expected to increase during sustained periods of higher interest rates.
Late in the third and fourth quarters of 2003, tentative signs of a modest
economic recovery began to emerge. Unfortunately, some industry sectors continue
to be influenced adversely by conditions largely beyond their control, thus
reducing the potential for more robust improvement in near term profitability.
Specific examples include the travel, airline, and telecommunications
industries. Most industries also continued to be hamstrung by their inability to
raise prices during a period that has been almost devoid of inflationary
pressure. Many other sectors, such as the automobile and home construction
industries, remained strong during the slowdown, but are unlikely to achieve
another layer of sizeable gains in the near term, regardless of the pace of
economic improvement. As a consequence, the recovery, although welcome, is
expected to be comparatively modest in magnitude.
Community operates within a regional economy, and smaller local economies, that
traditionally have been sheltered from major aftershocks produced by volatile
swings in specific industry sectors or other subsets of the broader national
economy. Community's diverse economic underpinnings provide a solid base that is
less predisposed to broad expansions or deep slumps caused by the ebb and flow
of global or national business cycles. While the local economies are partially
cushioned from these macro-trends, they will never be totally buffered.
Consequently, while Community and the businesses and individual customers within
its markets were affected by the overall downturn in the economy, those
constituencies experienced only modest deterioration in employment and relative
economic stability.
Strategy
Community's stated operating focus is manifested in its marketing slogan, "Local
People, Local Decisions". Its operating strategy centers around three guiding
factors: growth, diversity, and profitability. During 2003, Community made
substantial progress in each of these areas.
The growth of the Community franchise was quantified several ways. The absolute
growth in loans and deposits, combined with deepening and expanding customer
relationships provided an affirmation of the potential for franchise expansion.
Community also made significant strides fortifying its presence in existing
markets in 2003. During the year, Community added three new offices, including a
presence in northern Maryland, and announced additional plans to open at least
two new offices in 2004. At the same time, management has consistently
reevaluated the viability of the delivery system, resulting in the sale of three
offices over the last two years. This ongoing evaluation of the delivery system
has allowed for redeployment of both human and financial capital in more vibrant
markets with higher potential for economic growth. During this time, the entry
of larger, less personable financial institutions into Community's core markets
via bank acquisitions has generated opportunities to gain market share and
expand customer relationships.
Diversity has been a hallmark of Community's operating strategy. Improvements
have been realized through introductions of new products and services, additions
of acquired businesses, and execution of strategic partnerships with other
financial services companies. As an example, Community has become a leading
provider of title and settlement services inside its footprint. In April, 2003,
Community added to its presence in the York, PA market by acquiring ABCO, a key
provider of title services in this vital component of Community's core banking
market. Later in 2003, the acquisition of Erie added a leading provider of
mortgage origination services in the York and northern Maryland markets. This
transaction has doubled the previous mortgage origination capacity of the
franchise and will provide efficiencies with Community's legacy origination
operations. The Corporation also added to its ability to deliver high quality
insurance services to both commercial and retail customers. The acquisition of
Your Insurance Partner, an insurance agency group with two offices in the heart
of Community's geographic footprint, adds capacity to the Corporation's growing
menu of insurance services. Improvements to fee-based revenues were also
achieved through the introduction of new, convenience-driven banking services
such as the "OverdraftHonor" program.
10
As another testimony to the commitment to meeting customer needs, the
Corporation announced an innovative revenue-sharing arrangement with Bryn Mawr
Trust Company (Bryn Mawr) in late 2003. Bryn Mawr, which is headquartered in the
affluent "Main Line" area of suburban Philadelphia, has been in the trust and
investment management services business for over 100 years. Community, which
historically has had a limited capability for delivery of these essential
services to its existing customer base, now possesses access to the expertise
and experience of a corporation that currently manages over $1.6 billion in
assets.
The net result of these growth initiatives and increased diversity of the
revenue stream has been improved profitability. This improved profitability was
achieved while simultaneously improving credit quality and making the
appropriate investment in the future growth of the franchise. Such investments
will continue to exert pressure on the overall cost structure and will present
challenges into 2004 and beyond.
Emerging Trends
For the foreseeable future, net interest income will remain the most significant
source of revenue for banks. Recent trends have resulted in pricing compression,
creating a major challenge to future revenue expansion. This convergence of
trends, combined with increasing competition from both smaller and larger
rivals, has constrained growth in this vital driver of performance. Entering
2004, management had made substantial efforts to reposition both earning asset
and funding sources to benefit from a gradual, measured rise in overall interest
rates. The Fed's stimulative monetary policy, combined with the increasing
federal budget deficit, is beginning to intensify conditions that could give
rise to inflationary pressure and higher interest rates. Most economists agree
that interest rates will begin to rise, perhaps as early as the third quarter of
2004. Management has considered options to more aggressively extend loan or
investment maturities to achieve higher asset yields, but continues to pursue a
more moderate approach. Execution of a more aggressive approach could lead to
unacceptable levels of interest rate risk to the long-term revenue stream,
particularly given the current proximity to a perceived low point in the
interest rate cycle. Consequently, the potential for reprieve from the effects
of interest rate compression remains subdued in the near term, placing increased
emphasis on garnering market share and achieving absolute earning asset growth.
Credit quality is vital to the financial performance of community-based
financial services companies. The diversity of Community's markets and the
relative granularity of its loan portfolio make it somewhat less susceptible to
adverse credit quality conditions that are systemic in nature. During 2003,
Community recognized net charge-offs that were at their lowest level since 1999.
The allowance for loan losses, the Corporation's reserve to absorb credit risk
within the existing loan portfolio, is near a five year high in terms of its
coverage of non-accrual loans. Absolute levels of non-accrual loans saw marked
reductions since the end of 2002, providing further evidence of the bank's
improving asset quality metrics.
Continuous improvement in the level of other revenue sources has served to
offset the pressure on net interest income experienced during this extended
period of declining interest rates. Community's focus on the integration of new
products and services has fueled this growth. The strategic acquisitions and
partnerships completed during 2003 have solidified existing capabilities in
title insurance and settlement services, mortgage origination, and insurance
agency services. The recently announced plan to partner with Bryn Mawr Trust
Company is expected to add new capabilities in the arena of investment
management for higher net worth customers. Growth in these areas in 2004 could
be limited, however, depending on the magnitude and velocity of market shifts.
For example, both title and mortgage origination revenues could be adversely
influenced by a sudden and substantial spike in interest rates. Similarly, the
record level of refinancing activity during the past two years is likely to
moderate as interest rates rise. Increases in revenue from delivery of asset
management services through Bryn Mawr is expected to occur gradually over a more
extended time horizon, especially given the challenges associated with garnering
market share in this segment of the financial services market.
The final major aspect of performance that will be influenced by emerging trends
is operating expenses. Community's execution of its growth strategies has driven
steady increases in operating expenses in two major areas. First, expenses
related to the new branch expansion over the last several years continued to
influence operating expenses, especially in salaries, benefits and depreciation
expense. This ongoing investment in a measured expansion plan is critical to
positioning Community in both its core markets and in contiguous markets that
are natural extensions of the franchise. Secondly, the Corporation's efforts to
expand the mix and volume of integrated services have also had the impact of
increasing operating expenses as compared to historical levels. These efforts
have been correlated with synchronous programs designed to increase the revenue
stream from both core banking and integrated services. Increases in the cost
structure have always been
11
predicated on management's assessment of market share growth potential, higher
revenues, and improvements in both profitability and return on invested capital.
NET INTEREST INCOME
Community's major source of revenue is derived from intermediation activities
and is reported as net interest income. Net interest income is defined as the
difference between interest income on earning assets and interest expense on
deposits and borrowed funds. Net interest margin is a relative measure of a
financial institution's ability to efficiently deliver net interest income from
a given level of earning assets. Both net interest income and net interest
margin are influenced by the frequency, velocity, and extent of interest rate
changes and by the composition and absolute volumes of earning assets and
funding sources.
The following table compares net interest income and net interest margin
components between 2003 and 2002 (in thousands):
2003 2002 Change
----------------------- ---------------------- --------------------
Yield/ Yield/ Yield/
Amount Rate Amount Rate Amount Rate
Interest income $ 101,217 6.02% $ 102,488 6.89% $ (1,271) (0.87)%
Interest expense 42,329 2.89% 46,212 3.60% (3,883) (0.71)%
--------- ----- ---------- ----- --------- -------
Net interest income $ 58,888 $ 56,276 $ 2,612
Interest spread 3.13% 3.29% (0.16)%
Impact of
non-interest fund s 0.37% 0.49% (0.12)%
----- ----- -------
Net interest margin 3.50% 3.78% (0.28)%
===== ===== =======
Interest Rates
Interest rates profoundly influenced net interest income and profit performance
during 2003. Since the year 2000, key interest rate indices began a steady
pattern of decline. In each of the last two years, it was assumed that rates had
declined to levels at, or near, the trough in the interest rate cycle. By 2002,
such rates had declined to levels not seen since the 1950's. Entering 2003, most
rate forecasts reflected expectations that rates would begin to increase, though
not dramatically, sometime in 2003. Instead, buoyed by Fed policy, rates
continued on a descending path throughout most of the year, reaching yet another
level of lows in most key indices. To illustrate, the following graph provides a
comparison of U.S Treasury rates for the key maturity intervals for both 2003
and the prior year: [GRAPH OMITTED]
Average U.S. Treasury Curve
---------------------------
3 Months 6 Months 1 Year 2 Year 3 Year 5 Year 10 Year
-------- -------- ------ ------ ------ ------ -------
2002 1.64% 1.72% 2.00% 2.64% 3.10% 3.82% 4.61%
2003 1.03% 1.08% 1.24% 1.65% 2.10% 2.97% 4.01%
12
The various Treasury indices, which are important interest rate barometers,
declined across the board by virtually the same extent. This ratable decline
resulted in little change to the overall slope of the yield curve. Consequently,
both earning asset yields and funding costs declined during the year. General
interest rate trends were crucial to both interest income and the interest
expense results. The incremental pricing of maturing investments, variable rate
loans, and new loan relationships was correlated with the lower prevailing
interest rates, increasing pressure on asset yields. Despite the decline in
earning asset yields, interest income was stabilized during most of the year as
earning assets were redeployed from lower-yielding, maturing investments to
comparatively higher-yielding loans. The increasing affordability of credit
created increased demand for both business and consumer credit products,
resulting in an overall increase in earning assets. At the same time, most banks
continued to benefit from an influx of deposit funding. The paucity of
competitive returns in either the equity markets or other investment yields made
bank deposits a viable short-term alternative given consumer preferences for
liquidity in anticipation of future rate increases. Most consumers were
understandably averse to commit funds into longer maturity instruments given the
expectation of higher rates. As a consequence, many banks were able to secure
increases in deposit funding, despite that fact that many of the more liquid
deposit products were priced at record low levels. The net impact was that
interest expense declined by 8% while interest income declined by only 1%,
resulting in an increase in net interest income of nearly 5%.
Interest Income /Earning Assets
Interest income was $101.2 million in 2003, only slightly below the $102.5
million recorded in 2002, despite the fact that earning asset yields declined
from 6.89% to 6.02% over the two-year period. Earning asset growth, fueled
principally by loan growth, forged a 13.0% increase from $1.487 million to
$1.680 million and helped to offset the compression that would normally
accompany lower earning asset yields. From 2002 to 2003, earning assets grew
$193 million, including $111 million in loans and $89 million in portfolio
investment securities. Growth in loans accelerated during the year and was
funded by both runoff in the investment portfolio and by an $86 million increase
in the level of deposits, most of which occurred in Community's successful Power
NOW offering. As interest rates declined, Community also sought opportunities to
"lock in" low-cost term funding. With interest rates at historic lows,
management selectively "termed out" certain short-term borrowings to secure the
benefits of the lower, longer term rates available during the year.
Interest Expense / Funding Sources
Interest expense on deposits declined dramatically during 2003 and was a major
contributor to the nearly 5% increase in net interest income. Despite increases
in loan mix and an overall increase in the level of earning assets, Community
was not able to achieve improvement in interest income due to the impact of
lower rates. Fortunately, that same rate environment permitted most banks to
reduce interest rates on deposit funding and enabled Community to reduce its
overall funding costs from $46.2 million in 2002 to $42.3 million in 2003, a
decline of almost $3.9 million or 8%. Simultaneously, most banks continued to
enjoy an influx of deposit funding as consumers opted for the security and
short-term liquidity of bank deposits. It is likely that this trend, at least in
part, could be linked to corporate and mutual fund scandals, a lackluster stock
market, low money market rates, and other developments that reduced consumer
interest in these other alternatives. Total deposits grew by nearly $86 million,
the vast majority of which occurred in savings, Power Now and other accounts
that were responsive to customer preferences for liquidity. For the first time
in several years, Community realized no growth in its time deposit categories as
consumers were reluctant to extend maturities for relatively unattractive rate
premiums.
Community also made strategic use of other forms of funding in order to meet the
consistent demand for credit extension that occurred throughout the year.
Incremental borrowing rates on federal funds, which are set by the Federal
Reserve, influenced the pricing of all short-term sources of funds and made
these borrowings far less expensive than other funding sources. Community made
strategic use of this source of liquidity within the risk parameters set forth
in its asset / liability management (ALCO) policies and procedures. At various
times during the year, Community also increased its long-term borrowings, which
are composed principally of term funding available through the Federal Home Loan
Bank programs. The Corporation experienced a 17% increase in long-term funding,
which included the first full year of $15 million in trust preferred instruments
issued under a pooled arrangement in December of 2002. Community executed an
additional $15 million in these instruments at the end of 2003, bringing its
total issuances to $30 million. The issuances were integrated with, and
responsive to, the overall capital management policy discussed later in this
presentation.
13
Interest Spread and Net Interest Margin
A financial institution's ability to effectively blend the impact of changing
rates, shifting rate indices, customer preferences, and product development
initiatives can be measured by the performance of interest spread, which is
defined as the difference between earning asset yield and the cost of funding
sources. Net interest margin combines the impact of interest spread with both
investment of non-interest bearing funding sources and management of non-earning
assets. As a result of rate trends and other dynamics specific to Community's
balance sheet, the Corporation reported a decline in net interest spread from
3.29% in 2002 to 3.13% in 2003, and a decline in net interest margin from 3.78%
to 3.50% over the same period. The decline in margin was also linked to the
impact of reduced contribution from non-interest funding sources, which declined
from 0.49% to 0.37%. During periods of declining interest rates, the
contribution from non-interest funds to net interest margin is reduced since
funds are invested at progressively lower rates. During periods of rising rates,
these funds can be expected to contribute to improvements in net interest
margin.
Quarterly Performance
The following table provides a comparison of earning asset yields, funding
costs, and other information for each of the four quarters of 2003 and 2002.
2003
-----------------------------------------------------
Fourth Third Second First
Quarter Quarter Quarter Quarter
-----------------------------------------------------
Asset yield 5.81% 5.88% 6.05% 6.38%
Funding cost 2.76% 2.80% 2.94% 3.10%
-----------------------------------------------------
Interest spread 3.05% 3.08% 3.11% 3.28%
-----------------------------------------------------
Net interest margin 3.41% 3.45% 3.49% 3.68%
-----------------------------------------------------
Net interest margin $14,795 $14,884 $14,618 $14,591
=====================================================
2002
-----------------------------------------------------
Fourth Third Second First
Quarter Quarter Quarter Quarter
-----------------------------------------------------
Asset yield 6.54% 6.80% 7.01% 7.26%
Funding cost 3.35% 3.51% 3.74% 3.82%
-----------------------------------------------------
Interest spread 3.19% 3.29% 3.27% 3.44%
-----------------------------------------------------
Net interest margin 3.65% 3.78% 3.76% 3.96%
-----------------------------------------------------
Net interest margin $14,180 $14,394 $13,757 $13,946
=====================================================
Continuing a trend which has corresponded to the general decline in interest
rates, quarterly net interest margin exhibited a steady decline throughout both
2002 and 2003. Throughout 2003, Community experienced a steady, almost
consistent decline in earning asset yields despite the benefits of a more
concentrated mix of loans, whose yields normally exceed those of portfolio
investments with comparable maturities. The increase in the mix and volume of
higher yielding loans tended to offset the overall reduction of interest income
from lower offering rates since 2002. This improved mix had the impact of
offsetting some of the adverse consequences of a lower rate environment on
interest income. Funding costs also declined during 2003, and such declines were
more directly responsible for the improvement in net interest income for the
first nine months of the year. Community's ability to improve either net
interest income or net interest margin through further reductions in incremental
pricing of deposits or other funding sources was minimized in the fourth quarter
of 2003, as a significant portion of the funding pool reached all time lows.
Pricing of both loans and deposits is also subject to competitive pressures in
the marketplace. Consequently, the short-term potential for improving net
interest margin or net interest income through further reductions in funding
costs seems less likely in the current environment.
14
PROVISION FOR CREDIT LOSSES
For the second consecutive year, Community reported a decline in the provision
for loan losses, which reflected the steady improvement in the overall asset
quality metrics of its loan portfolio. The provision declined from $3.4 million
in 2002 to $2.5 million in 2003, while the relationship of the allowance for
loan losses to loans declined from 1.36% at December 31, 2002 to 1.22% at the
end of 2003. The provision, and the level of the allowance, were responsive to
the changing credit quality conditions of both seasoned loans and the
incremental risk inherent in a growing loan portfolio. Net charge-offs during
2003 were only $1.7 million, or 0.17% of average loans, and reflected a
significant decline from charge off levels of the past two years. Non-accrual
loans aggregated $8.2 million, the lowest absolute level since the beginning of
2001. The coverage of these loans provided by the allowance reached 162%, nearly
equal to the 171% high recorded at the end of 2000. See the section addressing
the allowance for loan losses and asset quality of this discussion for
additional information.
NON-INTEREST INCOME
This increasingly vital component of the revenue stream grew substantially
during 2003 as important steps were undertaken to solidify and expand
Community's integrated businesses and complementary banking services. Excluding
the impact from sales of investment securities, non-interest revenue grew 43%,
from $12.9 million in 2002 to over $18.5 million in 2003. The income recorded
during 2003, however, included two nonrecurring gains without which Community
would still have recorded an increase of 37%, as adjusted for these items in
both years. Amounts recorded in 2003 included a gain from the curtailment of a
legacy, defined benefit plan in the third quarter and the recognition of a gain
from the sale of an office, inclusive of both loans and deposits, in the fourth
quarter. Community had recognized a similar gain from the sale of two offices
and related deposits in 2002.
The following is a summary of the various components of non-interest income for
both 2003 and 2002, including the year over year increases related thereto:
Change
2003 2002 Amount %
--------------------------------------------------------
Investment management and trust services $ 1,326 $ 993 $ 333 34%
Service charges on deposit accounts 5,128 3,440 1,688 49%
Other service charges, commissions and fees 2,958 2,471 487 20%
Insurance premium income and commissions 2,822 2,016 806 40%
Mortgage banking activities 2,532 1,221 1,311 107%
Other income 3,748 2,800 948 34%
--------------------------------------------------------
18,514 12,941 5,573 43%
Investment security gains 1,927 1,034 893 86%
--------------------------------------------------------
Total $ 20,441 $ 13,975 $ 6,466 46%
========================================================
Investment management and trust revenues include fees derived from the sale of
various retail investment products (annuities, brokerage services, mutual funds,
etc) and other fees related to Community's limited trust department activities.
Sales of investment products are facilitated under an arrangement with a
national provider of these services. Consultative sales are conducted through
the community office network. This arrangement provides convenient access to
alternative investment vehicles through licensed employees who live and work in
the communities where customers conduct their normal banking business. This
service has facilitated a more holistic approach to meeting the expanding
financial service needs of customers who live within Community's footprint.
Customers are increasingly comfortable with using trusted, competent employees
who work within their primary financial institutions for this vital service.
While traditional trust fees showed a meaningful increase in 2003, the vast
majority of the increase in this category was derived from the sale of
additional investment products to new and existing customers. Near term
increases in this category will continue to be weighted toward sales of retail
investment products. In the future, the affiliated arrangement with Bryn Mawr
Trust Company is expected to provide more competitive services to high net worth
individuals as these product offerings are made available.
15
The most substantial increase in fees occurred in the area of service charges on
deposits. In the first quarter of 2003, Community provided a new service known
as "OverdraftHonor". Under this carefully designed program, customers who so
choose now have access to a service that facilitates payment of periodic
overdraft items while simultaneously avoiding adverse credit history events.
Fees from these services, which were not provided prior to 2003, were
responsible for virtually all of the increase in this category.
Other service charges include interchange fees from Community's vast ATM network
and debit card transactions. Community continues to boast an ATM network of
nearly 100 ATMs, including those in place under a relationship with a local
convenience store chain operating within the Corporation's geographic footprint.
Fees associated with non-customer use of these convenient locations to
facilitate cash withdrawal needs grew by more than 23% since 2002. A more robust
increase of 42% was realized in the interchange fees associated with retail
transactions conducted via the use of debit or credit cards. Nearly all of the
increases in these sources of fee income resulted from increased usage and the
consumer's growing acceptance of electronic mediums as a substitute for cash or
check-based transactions.
Insurance premiums and commissions include agency-based commissions from
commercial and personal lines, fees from credit reinsurance activities related
to consumer lending, and the revenue from title insurance and settlement
activities conducted through Community's title insurance subsidiary. These fees,
which rose by a total of $806 thousand from 2002 to 2003, included an increase
of over $530 thousand related to title-based activities alone. Such increases
were related to both the overall increase in mortgage loan originations, and to
the addition of the ABCO franchise at the beginning of the second quarter of
2003. The remainder of the increase was related to the acquisitions of the
insurance agencies during the year. Community continues to explore
opportunities, through either acquisitions or strategic alliances, which will
help develop a meaningful critical mass in this important financial service.
The single largest percentage increase in revenues occurred in income from
mortgage banking activities. The increase was related both to volume increases
in purchase mortgages and refinancings, and to new volumes generated through the
midyear acquisition of the Erie subsidiary. Community has more than doubled its
capacity to originate mortgages with the acquisition of Erie and has become a
more significant and efficient competitor in its core and extended Maryland
markets.
Other income included gains from the sales of offices in both 2003 and 2002. A
gain in excess of $1 million was recorded in the fourth quarter of 2003 and
related to the sale of the loans, deposits and physical location of a single
community office. In 2002, Community had recorded a $500 thousand gain from the
sale of two smaller offices. Both sales coincided with entry into markets with
more favorable growth demographics. Other income also included a nonrecurring
gain from the curtailment of a legacy pension plan in the third quarter. With
this action, Community has made substantial progress toward uniform retirement
benefit programs for current and prospective employees while simultaneously
forestalling increased expenses from higher-cost defined benefit plans.
Security gains increased by nearly $900 thousand from 2002 as efforts were made
to identify opportunities to improve the duration or average yield of the
portfolio at various times during the year. The total gains of $1.9 million
recorded in 2003 included nearly $1.5 million of gains related to sales of bank
equity holdings.
NON-INTEREST EXPENSES
Total non-interest expenses reached $45.7 million in 2003 and reflected a 16%
increase, or $6.4 million, from the $39.3 million recorded in 2002. The growth
was influenced by two major factors. Over 25% of the increase of $6.4 million,
or $1.7 million, was directly related to increased expenses from the integrated
businesses acquired at different points during 2003. These increases included
the expenses from ABCO, Erie, and incremental insurance agency activity.
Excluding the portion of the increase related to acquired businesses, 2003
operating expenses increased $4.7 million or 12% over 2002 expenses. This second
component of the increase was more directly related to the costs associated with
expansion of the core banking franchise.
16
The following is a summary of the various components of change in operating
expenses:
Change From Total Change
-------------------- ---------------
Integrated
2003 2002 Businesses Other Amount %
---- ---- ---------- ----- ------- -
Salaries and employee benefits $ 25,397 $ 21,636 $ 1,265 $ 2,496 $ 3,761 17%
Net occupancy expense 7,200 6,051 119 1,030 1,149 19%
Marketing expense 2,018 1,090 20 908 928 85%
Telecommunications expense 1,302 995 39 268 307 31%
Other operating expenses 9,801 9,528 237 36 273 3%
-------- -------- ------- ------- ------- ---
Total $ 45,718 $ 39,300 $ 1,680 $ 4,738 $ 6,418 16%
======== ======== ======= ======= ======= ===
Excluding that portion of the increase related to the additional expenses of
businesses acquired in 2003, Community reflected significant increases in salary
and employee benefits costs (12%), occupancy expenses (17%), and other operating
expenses, including marketing and telecommunications (10%). Since the end of
2001, Community has added a total of seven new banking facilities in new or
existing markets while selling three offices in markets with less robust growth
characteristics. This selective expansion of the Community Banks franchise has
had a significant influence on the operating expense structure. At the same
time, this expansion has also been an important catalyst for the growth in loan
and deposit balances since the end of 2001.
The single largest component of costs is salary and benefits, as these expenses
represent nearly 56% of total operating costs. Excluding the impact of salaries
added from the acquired businesses, salary and benefit expenses grew nearly $2.5
million from 2002 to 2003. Of this increase, over $1 million was attributed to
the effect of the 3% average salary increase and to a heavier reliance on
employee incentives for sales of certain financial product offerings. Payroll
taxes and employee insurance costs, which increased by nearly $600 thousand,
were influenced by personnel added in both banking and acquired businesses, and
by increases in health insurance rates. The remainder of the increase, less than
$1 million, was affected by personnel added as a result of the new community
offices, the increased cost of the customer service center, and by the addition
of new lenders for certain key growth markets.
As would be expected, occupancy expenses were also influenced by increased costs
associated with community office expansion and rose by just over $1 million. The
costs for offices added since the end of 2001 grew by almost $400 thousand.
Another $250 thousand of increased costs were related to the first full year of
operation of the southern operations center and by the expansion of the customer
service center. These initiatives had been undertaken in 2002 to improve the
level of customer service to new and existing customers.
Within the overall category of other operating expenses, marketing and
promotional increased over $900 thousand. In its 2002 annual report, Community
announced its intention to increase its 2003 spending to accommodate a more
significant level of marketing and advertising costs. These costs were
undertaken in order to increase Community's market share in new markets and to
preserve and expand share in its legacy communities. Expenses were related to
expanded awareness, image and lead product advertising, especially in the first
half of 2003. Community also reflected a $300 thousand increase in its
communications and data connection expenses during the year, which included cost
for upgrades of existing systems and the increased costs for its growing office
network. Other operating expenses increased $300 thousand and were principally
related to the acquired businesses.
INCOME TAXES
Income taxes grew from $3.4 million in 2002 to $4.4 million in 2003, an increase
of nearly 30%. The increase was commensurate with the increase in pretax income
and resulted in an effective tax rate of over 17%, only slightly higher than the
15% tax rate recorded in 2002. The relative mix of tax exempt income, which grew
during 2003, influences the level of effective income tax rates and remains the
primary reason for the difference between the effective tax rate and the
statutory federal tax rate for corporations.
17
STATEMENT OF CONDITION: OVERVIEW
At December 31, 2003, Community's total assets reached almost $1.9 billion,
reflecting a change of almost 11% from the nearly $1.7 billion of assets
recorded at the end of 2002. Average assets grew to $1.8 billion for 2003 and
grew almost 13% from 2002 average assets. Average balances of earning assets,
loans and deposits grew 13%, 13% and 8%, respectively. Community benefited from
increased demand for credit in both the consumer and commercial sectors. While
consumer demand for credit was influenced by both low rates and steady consumer
confidence, growth in the commercial sector was more directly related to
Community's ability to garner market share from larger, less nimble financial
institutions. The growth trends experienced in 2003 and in previous years
continue to demonstrate Community's commitment to staying close to its core
markets and to using its local presence and responsiveness as a competitive
advantage.
INVESTMENTS
Community has established corporate investment policies that address various
aspects of portfolio management, including quality standards, liquidity and
maturity limits, investment concentrations and regulatory guidelines. The
Corporation's objective with respect to investment management includes
maintenance of appropriate asset liquidity, facilitation of asset/liability
strategy and maximization of return. Compliance with investment policy is
regularly reported to the Board of Directors.
Community actively manages its investment portfolio and, accordingly, classifies
all investment securities as "available for sale". Under current policy, if
management has the intent and the Corporation has the ability to hold securities
until maturity, securities are classified as "held-to-maturity" investments at
the time of purchase and carried at amortized historical cost. Securities to be
held for indefinite periods of time are classified as available for sale and
carried at fair value. Such securities are intended to be used as part of
Community's asset/liability management strategy, and may be sold in response to
changes in interest rates, prepayment risk and other factors affecting overall
investment strategy.
During 2003, the average balance in the investment portfolio grew from $585
million to $674 million, a growth rate of 15% that, though substantial, was far
less than the investment portfolio growth of 29% that was experienced from 2001
to 2002. During 2002, Community had experienced robust deposit growth,
particularly early in that year. Unfortunately, loan growth did not keep pace
with deposit generation growth rates, creating additional liquidity that fueled
growth in the investment portfolio throughout 2002. As Community entered 2003,
loan demand for both commercial and consumer credits increased coincident with
the demand created by steadily declining interest rates. While deposit inflow
remained significant into 2003, it was less robust growth than experienced in
2002. The combination of investment runoff and the increasing deposit base
provided more than adequate funding to keep pace with the 2003 loan growth
rates. Consequently, Community continued to experience growth in its investment
portfolio between the two years.
The pretax unrealized net gain within the investment portfolio at December 31,
2003 was $13.3 million. As required, this fair value adjustment was reflected in
other comprehensive income (adjusted for income taxes) in the stockholders'
equity section of the statement of condition. Near the end of 2003, a new
accounting pronouncement was issued that requires additional disclosures in the
footnotes to the financial statements. Such disclosures relate to declines in
the market value of specific securities that may be considered "temporarily
impaired" pursuant to newly-established criteria for identifying such
securities. Of the total of $674 million of investments included in Community's
portfolio at year end, securities aggregating over $148 million were identified
as having met the criteria necessary for disclosure. The aggregate unrealized
loss disclosed in the footnotes to the financial statements is slightly in
excess of $3.8 million, nearly all of which was related to the extraordinary
decline in interest rates on certain securities and its impact on the valuation
of those securities. Such declines were not attributed to any perceived
deterioration in an individual issuer's ability to meet the terms and
obligations of the issuance and were more than offset by gross unrealized gains
of just over $17 million. Community has the ability and intent to hold such
investments until their original maturity and fully expects that any unrealized
losses will be recovered over the term of the investments.
18
The following tables summarize amortized cost and estimated fair values at
December 31, 2003, 2002, and 2001 and maturity distribution of securities at
December 31, 2003 (in thousands).
2003 2002 2001
-----------------------------------------------------------------------------
Amortized Fair Amortized Fair Amortized Fair
Cost Value Cost Value Cost Value
-----------------------------------------------------------------------------
Mortgage-backed U.S. government agencies $ 121,853 $ 123,395 $ 206,450 $ 210,825 $ 74,403 $ 74,370
U.S. Government corporations and agencies 173,651 173,292 130,947 134,334 144,640 142,544
Obligations of states and political sub-
divisions 177,546 184,481 172,391 177,135 172,223 169,993
Corporate securities 95,461 97,987 95,022 93,094 99,561 98,405
Equity securities 65,070 67,806 50,610 52,413 57,846 58,589
--------- --------- --------- --------- --------- ---------
Total $ 633,581 $ 646,961 $ 655,420 $ 667,801 $ 548,673 $ 543,901
========= ========= ========= ========= ========= =========
MATURITY DISTRIBUTION OF SECURITIES (Fair Value)
One Five Weighted
Within Through Through After Average Average
One Year Five Years Ten Years Ten Years Total Maturity Yield(a)
---------------------------------------------------------------------------------------
U.S. Government agencies $ 18,433 $ 20,495 $ 157,165 $ 100,594 $ 296,687 10yr. 13 mos. 4.33%
Obligations of states and political
subdivisions --- 1,589 12,382 170,510 184,481 16yr. 3 mos. 7.17%
Other 5,039 23,332 27,271 110,151 165,793 15yr. 5 mos. 4.90%
-------- -------- --------- --------- ---------
Total $ 23,472 $ 45,416 $ 196,818 $ 381,255 $ 646,961 13yr. 2 mos. 5.29%
======== ======== ========= ========= =========
Percentage of total 3.63% 7.02% 30.42% 58.93% 100.0%
==== ==== ===== ===== =====
Weighted average yield (a) 2.21% 4.99% 4.80% 5.76% 5.29%
==== ==== ==== ==== ====
(a) Weighted average yields were computed on a tax equivalent basis using
a federal tax rate of 35%.
The Corporation monitors investment performance and valuation on an ongoing
basis to evaluate investment quality. An investment which has experienced a
decline in market value considered to be other than temporary is written down to
its net realizable value and the amount of the write down is accounted for as a
realized loss.
LOANS
Average loans reached $997 million at the end of 2003, a 12% increase over the
$887 million of average loans recorded in 2002. The composition of loans between
the two years was influenced by a number of factors, including the influence of
lower interest rates. The following presentation of loans at December 31 for
each of the past two years is an indication of the relative mix of loans
included in the portfolio (in thousands):
Change
2003 2002 Amount %
---- ---- ------ -
Commercial $ 367,444 $ 295,506 $ 71,938 24 %
Commercial real estate 283,662 246,533 37,129 15 %
Residential real estate 97,178 109,497 (12,319) (11)%
Consumer 330,327 253,032 77,295 31 %
---------------------------------------------------
Total $ 1,078,611 $ 904,568 $ 174,043 19 %
===================================================
19
Following a year of less robust commercial loan activity in 2002, commercial
borrowing began to increase dramatically during the second quarter of 2003, and
growth continued well into the second half of the year. After the end of the
first quarter, the steady declines in interest rate trends caused many
borrowers, including those with prior relationships with competitors of
Community, to reevaluate their existing credit arrangements in search of
improved funding terms and more responsive credit relationships. Community has
consistently made efforts to position itself in the marketplace to ensure its
ability to compete with large and small competitors alike. As a result, the
Corporation was able to increase both its commercial and commercial real estate
portfolios by nearly $109 million on an aggregate basis. Much of the growth in
the commercial sector was attributed to Community's ability to acquire existing
market share since business lending has been constrained on both a national
level and in certain segments of Community's market. A portion of this growth
also can be attributed to the addition of certain key lending personnel made
available as a result of mergers of local financial institutions by
out-of-market acquirers.
The single most significant source of loan growth occurred in consumer lending,
particularly home equity lending, which grew by $77 million between December 31,
2002 and the end of 2003. As part of Community's effort to increase its
visibility in core markets, a concerted effort was made to become a more
effective consumer lender, including substantial increases in marketing and
advertising efforts. Historically, Community has been more widely known
throughout its market as a lender to small and medium-size businesses, with an
emphasis on commercial mortgages and commercial loans secured by real estate. In
2003, Community sought to leverage its office network as a channel for expanding
consumer lending and to fulfill the consumer's appetite for convenient,
accessible retail lending services. Consumer demand for credit was also aided by
the high levels of consumer confidence and improved credit affordability
experienced in the current interest rate environment. These efforts were also
aided by the growth achieved as a result of the expansion of the office network
and sales efforts over the last several years.
Residential real estate lending, which is composed primarily of loans to
single-family creditors, has experienced a steady decline as a result of the
increasing accessibility of secondary market liquidity through mortgage banking
activities. Community-based banks continue to provide a convenient avenue for
consumers to access funding for residential lending, but most new credits
continue to be sold in the secondary market. This strategy has reduced the
interest rate risk associated with consumer preferences for long-term, fixed
rate lending, and continues to provide valuable liquidity for other forms of
relationship lending.
ALLOWANCE FOR LOAN LOSSES AND CREDIT QUALITY
The following sets forth activity within the allowance for credit losses for the
last three years.
2003 2002 2001
---- ---- ----
Balance at January 1, $ 12,343 $ 12,132 $ 10,328
Loans charged off (2,839) (4,180) (3,776)
Recoveries 1,174 1,041 500
Provision charged to operations 2,500 3,350 5,080
----------------------------------------------
Balance at December 31, $ 13,178 $ 12,343 $ 12,132
==============================================
Allowance for credit losses to loans 1.22% 1.36% 1.42%
20
The period between January 1, 2001 and December 2002 marked a period of
adjustment in the credit quality profile of Community Banks, Inc. In the last
three quarters of 2002, emerging trends suggested that the risk profile of
Corporation's loan portfolio would experience steady improvement in 2003. The
decline in both non-accrual loans and in loans "90 days or more past due"
provided indications of an improving picture of credit quality, despite dramatic
increases in the overall loan balances. During 2003, further indications of
these favorable trends continued to emerge, resulting in dramatic reductions in
both net charge-offs and additional reductions in the level of problem credits.
Net charge-offs were reduced to $1.7 million, or 0.17% of average outstanding
loans, and compared favorably to the net charge-offs of $ 3.1 million, or 0.35%,
in the prior year. Non-accrual loans, the most severe category of problem
credits, declined 13% from $9.4 million in 2002 to $8.2 million at the end of
2003 while loans 90 days or more past due declined from $961 thousand to $90
thousand over the same period. Despite a decline in the ratio of the allowance
for credit losses to loans from 1.36% at year end 2002 to 1.22% at the end of
2003, the coverage of non-accrual loans provided by the allowance increased from
131% to 162% over the two year period. As a consequence of these and other
critical factors, management was able to reduce the provision for loan losses
from $3.4 million in 2002 to $2.5 million in 2003.
The following sets forth loan loss experience for the last five years (in
thousands):
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
Loans at year-end, net of unearned income $ 1,078,611 $ 904,568 $ 857,278 $ 814,874 $ 708,016
=========== ========= ========= ========= =========
Average loans balance $ 997,190 $ 886,808 $ 838,178 $ 768,204 $ 665,422
=========== ========= ========= ========= =========
Balance, allowance for loan losses,
January 1 $ 12,343 $ 12,132 $ 10,328 $ 8,976 $ 8,608
Loans charged off:
Commercial, financial and agricultural 253 1,878 2,275 303 489
Real estate-mortgage 1,548 1,447 484 521 190
Consumer and other 1,038 855 1,017 1,101 984
----------- --------- --------- --------- ---------
Total 2,839 4,180 3,776 1,925 1,663
----------- --------- --------- --------- ----------
Loans recovered:
Commercial, financial and agricultural 240 644 120 23 140
Real estate-mortgage 689 25 108 83 43
Consumer and other 245 372 272 308 260
----------- --------- --------- --------- ---------
Total 1,174 1,041 500 414 443
----------- --------- --------- --------- ---------
Net charge-offs (1,665) (3,139) (3,276) (1,511) (1,220)
Provision for loan losses 2,500 3,350 5,080 2,863 1,588
----------- --------- --------- --------- ---------
Balance, allowance for loan losses,
December 31 $ 13,178 $ 12,343 $ 12,132 $ 10,328 $ 8,976
=========== ========= ========= ========= =========
Net charge-offs to loans at year end .15% .35% .38% .19% .17%
Net charge-offs to average loans .17% .35% .39% .20% .18%
Balance of allowance for loan losses
to loans at year end 1.22% 1.36% 1.42% 1.27% 1.27%
21
The allowance for loan losses is based upon management's continuing evaluation
of the loan portfolio. A review as to loan quality, current macro-economic
conditions and delinquency status is performed on a quarterly basis. The
provision for loan losses is adjusted quarterly based upon current review. The
following table presents an allocation by loan categories of the allowance for
loan losses at December 31 for the last five years (in thousands).
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
Loans:
Commercial, financial and agricultural $ 7,090 $ 6,305 $ 9,285 $ 5,268 $ 3,030
Real estate-construction --- --- 10 14 9
Real estate-mortgage 2,313 1,936 965 1,593 1,509
Installment 2,184 1,767 1,030 1,748 1,575
Unallocated 1,591 2,335 842 1,705 2,853
--------- --------- --------- --------- --------
Balance $ 13,178 $ 12,343 $ 12,132 $ 10,328 $ 8,976
========= ========= ========= ========= ========
The amount of the allowance assigned to each component of the loan portfolio is
derived from a combination of factors. Estimation methods and assumptions used
in the process are reviewed periodically by both management and the Board of
Directors.
The percentage of loans in each category above is included in the "Loan Account
Composition" table in Appendix A to Management's Discussion and Analysis of
Financial Condition and Results of Operation, Part II Item 7.
The Corporation's allowance for loan losses is based upon management's quarterly
review of the loan portfolio utilizing a consistent valuation methodology. The
purpose of the review is to assess loan quality, identify impaired loans,
analyze delinquencies, ascertain loan growth, evaluate potential charge-offs and
recoveries, and assess general economic conditions in the markets its affiliates
serve. Commercial and real estate loans are individually risk rated by the
Corporation's loan officers and periodically reviewed by independent loan review
personnel. Consumer and residential real estate loans are generally analyzed in
homogeneous pools utilizing historical loan charge-off information.
To determine the allowance and corresponding loan loss provision, an amount is
allocated to specific loans. For certain commercial and construction loans, this
amount is based upon specific borrower data and supporting collateral determined
by reviewing individual non-performing, delinquent, or potentially troubled
credits. For the majority of the loans that are individually reviewed for
impairment, this analysis is based on a comparison of the loan's carrying amount
to the net realizable value of the collateral. The portion of the allowance
attributable to specific impaired loans was $546 thousand at December 31, 2003.
The remaining commercial as well as consumer, and residential real estate loans
are evaluated as part of various pools. These pool reserves, generally are based
upon historic charge-offs and delinquency history, other known trends and
expected losses over the remaining lives of these loans, as well as the
condition of local, regional and national economies and other qualitative
factors.
To ensure adequacy to a higher degree of confidence, a portion of the allowance
for loan losses is considered unallocated. The unallocated portion of the
allowance is intended to provide for probable losses that are not otherwise
identifiable, for possible imprecise estimates in assessing potential losses on
commercial loans or in the calculation of pool reserves, and for the extenuating
influence of current factors, such as economic uncertainties. This unallocated
portion is available to absorb losses sustained anywhere within the loan
portfolio. The combined allocated and unallocated portions bring the total
allowance to an amount deemed prudent and reasonable by management at that time.
Risk Elements
The following sets forth information regarding various segments of the loan
portfolio, collectively referred to as risk elements. These segments include
both nonperforming assets and those loans past due for 90 days or more.
Non-performing assets include non-accrual loans, restructurings, and other real
estate. Non-accrual loans are loans for which interest income is not accrued due
to concerns about the collection of interest and/or principal. Restructured
loans may involve renegotiated interest rates, repayment terms, or both, because
of deterioration in the financial condition of the borrower. The only credits
that would have qualified as restructured loans at the end of both years were
already classified in the more severe non-accrual category. The following table
provides a comparative summary of nonperforming assets and total risk elements
at the end of each of the last five years (in thousands).
22
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
Loans on which accrual of interest has
been discontinued:
Commercial, financial and agricultural $ 3,066 $ 2,257 $ 3,783 $ 2,042 $ 2,231
Mortgages 4,054 6,609 6,952 3,445 3,203
Other 1,031 527 355 356 222
---------- ---------- ---------- ---------- ----------
8,151 9,393 11,090 5,843 5,656
---------- ---------- ---------- ---------- ----------
Loans renegotiated with borrowers --- --- --- 205 254
---------- ---------- ---------- ---------- ----------
Total non-accrual loans 8,151 9,393 11,090 6,048 5,910
Foreclosed real estate 4,865 1,183 631 416 615
---------- ---------- ---------- ---------- ----------
Total non-performing assets 13,016 10,576 11,721 6,464 6,525
Loans past due 90 days or more:
Commercial, financial and agricultural 4 97 1,002 8 146
Mortgages 40 770 405 495 147
Consumer and other 46 94 252 109 85
---------- ---------- ---------- ---------- ----------
90 961 1,659 612 378
---------- ---------- ---------- ---------- ----------
Total risk elements $ 13,106 $ 11,537 $ 13,380 $ 7,076 $ 6,903
========== ========== ========== ========== ==========
Ending allowance for loan losses $ 13,178 $ 12,343 $ 12,132 $ 10,328 $ 8,976
========== ========== ========== ========== ==========
Ending allowance to non-accrual loans 162% 131% 109% 171% 152%
Despite improvement in most categories of problem credits, there was a
substantial increase in foreclosed real estate from 2002 to 2003. The balance in
this category grew from $1.2 million at December 31, 2002 to $4.9 million at the
end of 2003. Nearly all of the increase was related to the reclassification of
two large credits that had been made to a single borrower. Pursuant to the
provisions of the original loan agreements, Community took possession of two
collateral properties in the fourth quarter of 2003, due to borrower default. A
new, unrelated borrower purchased one of the properties in January, 2004,
resulting in the return of nearly $2.6 million of loans to accrual status.
Amounts included in foreclosed real estate are stated at the lower of cost or
market and no losses are expected from the final disposition of these
properties.
The determination to discontinue the accrual of interest on non-performing loans
is made on the individual case basis. Such factors as the character and size of
the loan, quality of the collateral and the historical creditworthiness of the
borrower and/or guarantors are considered by management in assessing the
collectibility of such amounts.
The approximate amount that would have been accrued on those loans for which
interest was discontinued in 2003 was $350,000.
Overall Assessment
Community has assessed all of the above factors in the establishment of the
allowance for loan losses. The determination as to the adequacy of the allowance
reflects management's judgment, and was based upon collateral, local market
conditions, various estimates, and other information that requires subjective
analysis. These factors, which are prone to change, are monitored by management
to evaluate their potential impact on management's assessment of the adequacy of
the allowance. Based on its evaluation of loan quality, management believes that
the allowance for loan losses at December 31, 2003 was adequate to absorb
probable losses within the loan portfolio.
23
DEPOSITS
Deposit balances remain the primary source of funding for financial institutions
and Community recognized steady growth of nearly 8% in this important
core-funding source, summarized as follows (in thousands):
Change
2003 2002 Amount %
---- ---- ------ -
Demand $ 167,315 $ 163,434 $ 3,881 2%
Savings & NOW accounts 401,805 322,632 79,173 25%
Time 498,005 498,159 (154) --%
Time $100,000 or more 110,231 107,523 2,708 3%
-------------------------------------------------------------
$ 1,177,356 $ 1,091,748 $ 85,608 8%
=============================================================
Deposit growth in 2003 occurred almost exclusively in savings deposits, more
specifically Community's Power Now account. This account, which has
characteristics of both a money market and checking account, grew steadily
throughout the year. At the same time, longer term time deposit growth was flat.
Consumer preferences were clearly weighted in favor of maintaining adequate
liquidity in anticipation of a gradual rise in rates. Despite the fact that most
interest rates declined steadily throughout the period, most depositors were
reluctant to extend time deposit maturities to obtain only marginally higher
rates. The consistent downward pressure on rates, combined with lack of
confidence in other more risky investment vehicles, increased consumer
preference for the flexibility, liquidity and guaranteed return provided by
these accounts.
The following table summarizes the maturity distribution of time deposits of
$100,000 or more as of December 31, 2003 (in thousands).
Remaining to Maturity:
Less than three months $ 24,791
Three months to six months 21,735
Six months to twelve months 33,076
More than twelve months 34,403
----------
$ 114,005
==========
BORROWED FUNDS
Community makes tactical use of Federal Home Loan Bank (FHLB) advances and other
borrowed funds to augment its funding needs. Strategic capital leverage efforts,
including share repurchase and various investment initiatives, have affected the
volume and composition of non-deposit funding. The largest component of borrowed
funds comes from FHLB advances. FHLB borrowings, which are collateralized by
residential mortgages or other qualified securities, include a variety of credit
products available to Community through its membership in the Federal Home Loan
Bank.
CAPITAL ADEQUACY
Capital strength is an important measure with which to judge the overall
stability of a financial institution. A strong capital base is a prerequisite
for sustaining franchise growth through both internal expansion and strategic
acquisition opportunities. Regulatory authorities impose constraints and
restrictions on bank capital levels that are designed to help ensure the
vitality of the nation's banking system.
Community believes that capital is a valuable, albeit limited resource whose
availability moderates with changes in the business cycle. The Corporation has
developed an extensive capital management policy designed to consider all
aspects of capital management. This policy is mindful of the responsibilities to
Community's shareholders, employees, regulators, and other constituencies to
ensure that capital is well-managed. The policy considers the impact of numerous
capital management issues, including: the maintenance of key financial ratios;
the need for an adequate return to shareholders in terms of both dividend payout
and capital appreciation; the flexibility to apply techniques that will
accommodate either equity expansion or contraction; and the restraint required
to avoid accumulation of unsustainable levels of intangible assets. Community
also continuously examines its options with regard to capital management in the
context of intrinsic factors, including its prospects for growth, the potential
for earnings disruption, and others. Maintenance of appropriate capital levels
24
may require the application of techniques designed to help Community meet or
exceed regulatory guidelines and to correlate capital levels with a given asset
growth rate. The Corporation's capital management and planning process is
reviewed and approved by its Board of Directors.
In addition to internal guidelines, regulators have established standards for
the monitoring and maintenance of appropriate levels of capital for financial
institutions. All regulatory capital guidelines are now based upon a risk-based
supervisory approach that has been designed to ensure effective management of
capital levels and associated business risk. The following table provides the
risk-based capital positions of Community and its principal banking subsidiary
at the end of 2003, along with an indication of the various regulatory capital
requirements.
December 31, "Well Regulatory
2003 Capitalized" Minimums
---- ------------ --------
Leverage ratio
Community Banks, Inc. 8.8% n/a 4%
Bank only 7.7% 5% 4%
Tier 1 capital ratio
Community Banks, Inc. 11.6% n/a 4%
Bank only 10.1% 6% 4%
Total risk-based capital ratio
Community Banks, Inc. 12.6% n/a 8%
Bank only 11.1% 10% 8%
The most fundamental source of capital is earnings and earnings retention. This
cornerstone of capital adequacy can be augmented by a number of capital
management strategies, many of which were utilized during 2003. As it has for a
number of years, the Board approved the issuance of a 5% stock dividend in the
first quarter. In the fourth quarter, the Board announced the approval of a
stock split issued in the form of a 20% stock dividend, which has been accounted
for on a pro forma basis throughout this presentation. Throughout the year, the
Corporation's strong earnings supported a return of capital to existing
shareholders in the form of an increase in the traditional cash dividend.
Community also continues to make strategic use of share repurchase as another
efficient means of returning capital to shareholders. In December of 2003,
management executed another pooled trust preferred issuance of $15 million in
order to increase the amount of qualifying regulatory capital through this
relatively inexpensive funding source. Community previously had executed a $15
million issuance at the end of 2002, bringing the total trust preferred balances
to $30 million at December 31, 2003. Such amounts are classified as long-term
debt for financial statement purposes. It is anticipated that additional
regulatory guidance is forthcoming regarding the suitability of trust preferred
issuances as "Tier 1 capital" on a going forward basis. Community places no
significant reliance on these instruments to meet regulatory capital
requirements and anticipates no material change in its accounting as a
consequence of this new guidance. In the aggregate, these various strategies and
techniques have allowed management to maintain capital at levels that
represented an efficient use of this valuable resource.
ASSET/LIABILITY MANAGEMENT AND LIQUIDITY
The process by which financial institutions manage earning assets and funding
sources under different interest rate environments is called asset/liability
management. The primary goal of asset/liability management is to increase net
interest income through the prudent control of market risk, liquidity, interest
rate risk and capital. Two important barometers of performance are net interest
margin and liquidity. Net interest margin is increased by widening interest
spread while controlling interest rate sensitivity. The adequacy of liquidity is
determined by the ability to meet the cash flow requirements of both depositors
and customers requesting bank credit. The Board of Directors (the "Board") and
the Audit Committee of the Board governs and monitors asset/liability management
processes as part of the overall risk management process and delegates the
responsibility for management of these processes to the corporate
Asset/Liability Management Committee (ALCO).
25
Liquidity is defined as the ability to meet maturing obligations and customers'
demand for funds on a continuous basis. Liquidity is sustained by stable core
deposits, a diversified mix of liabilities, strong credit perception and the
presence of sufficient assets convertible to cash without material loss or
disruption of normal operations. Community actively manages liquidity within a
defined range and has developed reasonable liquidity contingency plans, ensuring
availability of alternate funding sources to maintain adequate liquidity under a
variety of business conditions. The Corporation's investing and financing
activities are conducted within the overall constraints of its liquidity
management policy and practices.
Community utilizes a variety of techniques to assist management and the Board of
Directors in the management and monitoring of interest rate risk. In order to
quantify the impact of changes in interest rates on net interest income, the
Corporation conducts a quarterly interest rate shock simulation that projects
the impact of interest rate changes on net interest income over the next year.
These simulations are utilized to assess whether management should consider
corrective actions in order to minimize Community's exposure or vulnerability to
a particular trend in interest rates. Management has established acceptable
tolerance limits for the impact of changes in interest rates on the volatility
of net interest income, and is authorized to pursue mitigating strategies in
order to minimize unfavorable impact under a variety of scenarios. Such
simulations are conducted under a variety of assumptions that require estimates
of the velocity and extent of interest rate changes, including an assessment of
the impact of such changes on those assets and liabilities that have
indeterminate maturity or repricing characteristics. Simulation of earnings is
used primarily to measure Community's earning exposure for the ensuing year.
Current policy limits unfavorable exposure of simulated net interest income to
10% of the base case net interest income in either a rising or falling rate
"shock" scenario (immediate repricing) of 200 basis points. The following is a
summary of the rate "shock" results conducted under these various assumptions as
December 31, 2003:
Annual
Simultaneous Change
Rate in Net Interest %
"Shock" Income Change
------- ------ ------
+300bp -$1.3 million -2.30%
+200bp -$1.0 million -1.70%
+100bp -$0.4 million -0.60%
- 100bp -$2.5 million -4.20%
Management augments its simulation process with two other techniques, GAP
analysis and economic value of equity (EVE) computations. The most practical
tool for day-to-day management of interest rate risk is GAP analysis, which
provides an array of various timeframes during which earning assets and funding
sources can be expected to mature or reprice. This information is ordinarily
examined in the context of the results derived from the quarterly rate shock
simulations. Management uses such information to identify specific "cause and
effect" relationships that can be reviewed, analyzed, managed, or changed to
ensure maximization of net revenue from intermediation activities. The
combination of GAP analysis and rate shock simulations provides the most
practical measurement tools for monitoring and managing of the largest source of
revenue for community banks. As with the simulation or "shock" analysis,
Community has established a policy limit for the cumulative twelve month GAP of
"plus or minus" 15% of total assets. At December 31, 2003, the twelve month GAP
fell well within this policy limit for each of the time intervals less than one
year, as shown in the following summary:
Cumulative GAP
Interval Expressed as % of Assets)
-------- -------------------------
0 - 90 days + 2.60%
91 - 180 days + 2.97%
181 - 365 days + 1.67%
EVE computations provide a longer-term assessment of interest rate risk, but are
more practical for evaluating long-term, strategic planning alternatives. EVE
has several limitations, including: the intrinsic value of assets and
liabilities does not necessarily represent the fair value of financial
instruments since it does not include credit risk and liquidity; estimated cash
flows are required for nonmaturity financial instruments and are, by their
nature, inexact and; the future structure of
26
Community's balance sheet does not consider increased loan and deposit
activities from core business within its present value assessment. The results
derived from EVE computations, however, provide a valuable framework for
managing longer-term balance sheet exposures and interest rate volatility
trends. At the end of 2003, all measures of EVE fell within the policy limits
established via the asset/liability management policy, as approved by the Board
of Directors.
CONTRACTUAL OBLIGATIONS
Significant contractual obligations at December 31, 2003 are summarized in the
following table:
Less than 1-3 3-5 More than
Dollars in thousands Total 1 year years years 5 years
-----------------------------------------------------------------------------------------------------------
Long-term debt $ 411,422 $ 42,140 $ 69,280 $ 67,640 $ 232,362
Operating lease obligations 10,095 1,117 1,872 1,228 5,878
Trust preferred securities 30,000 --- --- --- 30,000
Time Deposits 608,823 341,538 171,427 94,542 1,316
Defined benefit pension payments 889 889 --- --- ---
-----------------------------------------------------------------------------------------------------------
Total $ 1,061,229 $ 385,684 $ 242,579 $ 163,410 $ 269,556
-----------------------------------------------------------------------------------------------------------
OFF-BALANCE-SHEET COMMITMENTS
As of December 31, 2003, the Corporation had unfunded commitments totaling
$432.7 million. For details of these off-balance-sheet commitments, see "Notes
to Consolidated Financial Statements - Commitments and Contingencies" included
in Part II, Item 8.
REGULATORY MATTERS
Community and its affiliates are subject to periodic examinations by the various
regulatory agencies. These examinations include, but are not limited to,
procedures designed to review lending practices, risk management, credit
quality, liquidity, compliance and capital adequacy. During 2003, the
Pennsylvania State Department of Banking, the Federal Deposit Insurance
Corporation, and the Federal Reserve Bank performed various examinations of
Community and its banking subsidiaries pursuant to their regular, periodic
regulatory reviews. No comments were received from these various bodies that
would have a material adverse effect on Community's liquidity, capital
resources, or operations.
INFLATION
Community's ability to cope with the impact of inflation is best measured by its
ability to respond to changing interest rates and manage non-interest income and
expense. Within its ALCO processes, the Corporation manages the mix of interest
rate-sensitive assets and liabilities in order to limit the impact of changing
interest rates on net interest income. Inflation also has a direct impact on
non-interest income and expense such as service fee income, salary and benefits
expenses, and other overhead expenses. Inflationary pressures over the last
several years have been modest but this trend is subject to change. Management
will continue to monitor the potential for inflation and its impact on the
pricing of products and services.
PERFORMANCE REVIEW: 2002 VS. 2001
Against a backdrop of an uncertain economy, increasing global tensions, a series
of unfortunate corporate scandals, and the lowest interest rate environment in
the last four decades, Community Banks, Inc. recorded substantial performance
improvement in 2002. Net income reached $18.5 million and earnings per share
grew to $1.55, reflecting an increase of 36% and 35%, respectively, over the
results achieved in 2001. Performance in 2001 had been reduced by charges
incurred in connection with the merger of Glen Rock State Bank, which was
combined into Community Banks at the end of the first quarter of 2001. Results
for 2002 translated into a ROA of 1.17% and a ROE of 15.46%, and represented a
substantial improvement over the ROA of 0.97% and ROE of 12.21 % reported in
2001. Performance in 2002 represented a realization of Community's strategic
efforts to provide its customers with expanded financial services within the
framework of a convenient and efficient "community banking" model.
27
Interest Income
Interest income was $102.5 million in 2002, virtually equal to the $102.4
million recorded in 2001, despite the fact that earning asset yields declined
from 7.81% to 6.89% over the two-year period. At the same time, earning assets
grew 13.6%, from nearly $1.310 billion to $1.487 billion, and helped to offset
the compression that would normally accompany lower earning asset yields. From
2001 to 2002, earning assets grew $178 million, including $52 million in loans
and $132 million in portfolio investment securities. This reflected growth rates
of 6.2 % in loans and 29.0% in investments. During 2002, Community experienced
11.8% growth in total deposits, which increased by nearly $115 million, and
clearly outpaced the level of demand for increased credit facilities. This
excess funding was then utilized to fund increases in the level of portfolio
investments throughout the year. Community seeks to maintain an investment
portfolio that both maximizes return and provides an additional source of
liquidity as demand for more profitable loan relationships increases.
Interest Expense
Interest expense on deposits and other funding sources declined dramatically
during 2002 and was the primary driver of the 12% improvement in net interest
income. While interest income was stable during 2002, Community achieved an
11.4% reduction in interest expense, even as total deposits increased 11.8 % and
total interest bearing liabilities grew 14.2%. Total interest expense dropped to
$46.2 million, a decline of $5.9 million, representing substantial improvement
from the interest expense of $52.1 million recorded in 2001. Deposits grew by
$115 million, which included growth of $ 44 million in core transaction and
saving accounts and $71 million in time deposits. Growth in deposit funding was
attributable to a number of factors, including the safety, soundness and
convenience of bank deposit products as contrasted with the volatility and risk
of loss that has characterized other investment and savings alternatives over
the last several years.
Community also grew its funding from long-term debt, which consists primarily of
collateralized borrowings from the Federal Home Loan Bank, by almost $30
million, or 11% to selectively augment growth in the deposit categories.
Throughout 2002, the steady decline in prevailing interest rates allowed
Community to reduce pricing on time deposits. In the fourth quarter of the year,
most banks were forced to reexamine the pricing on more core sources of funds as
rates declined to the lowest levels in decades. As a consequence of these
trends, the overall cost of funds declined 103 basis points, from 4.63% in 2001
to 3.60% in 2002.
Net Interest Income
Net interest income reached $56.3 million in 2002 compared to $50.2 million in
2001, an increase of $6.0 million or 12%. Virtually all of the improvement was
related to the decline in the cost of funding, which declined by $5.9 million.
This improvement was achieved despite a drop in net interest margin from 3.83%
in 2001 to 3.78% in 2002. As in 2003, Community benefited from increases in the
absolute volume of earning assets and from its ability to lower funding costs in
declining rate environment.
Provision for Credit Losses
The provision for credit losses declined from $5.1 million in 2001 to $3.4
million in 2002, while the ratio of the allowance for loan losses to loans also
reflected a modest decline from 1.42% at the end of 2001 to 1.36% at the end of
2002. When comparing asset quality trends from 2001 to those during 2002,
Community reported significant improvements in the metrics commonly used to
assess the overall credit quality of the loan portfolio.
Non-interest Income
Income from non-interest sources grew to $12.9 million from $10.4 in 2001, an
increase of nearly 24%. Results in 2002 included over $500 thousand in gains
from the sale of two branches, but improvement in year over year performance
still would have reached 20%, exclusive of these gains. Community experienced
growth in almost all categories of non-interest income. Income from the
commissions earned on sales of mutual funds and annuity products grew 34% as
2002 was the first full year, bank-wide rollout of these product offerings. The
increase of 14 % in deposit service charges was driven by both the increase in
the volume of personal and business accounts and by the continuous evaluation of
the fee structure to ensure that Community is fairly compensated for the cost of
providing these deposit services. Other service charges, commissions and fees
28
reflect revenues received from customers who utilize the various cash exchange
and payment systems that are accessible through Community's bank network, and
grew 39%. Insurance fees were increased by the fees from the first full year of
operation of The Sentinel Agency. On the credit insurance side, Community
actually experienced a reduction in the fees earned through its captive
insurance business, which partially offset the increase in title insurance fees.
Revenues from mortgage origination activities were strong in both 2001 and 2002
due to the favorable effect of low interest rates on both purchase mortgages and
refinancings.
Non-interest Expenses
Non-interest expenses grew 8% to $39.3 million in 2002 versus $36.5 in 2001,
resulting in an increase of $2.7 million in year-over-year expenses. Expenses in
2001 had included nearly $2.0 million in nonrecurring expenses incurred in
connection with the merger of Glen Rock State Bank at the end of the first
quarter of 2001. Excluding these charges, non-interest expenses grew nearly $4.7
million and reflected an increase in core operating expenses of 14%. The vast
majority of the increase in recurring expenses occurred in salary and benefits
expense, which grew from $18.5 million in 2001 to $21.6 million in 2002, an
increase of 17%. Of the total increase from 2001 to 2002, nearly 4% was
attributed to the average 2002 salary increase of 4%. An additional 4% was
ascribed to increases in the Corporation's discretionary variable compensation
plans, employee benefit plan contributions, sales incentives and other
performance-driven compensation plans. The impact of annual merit increase
combined with performance-driven compensation accounted for almost one half of
the 17% increase in salary and benefit costs. The remaining 8% of the total 17%
increase in salary and benefit expenses was driven by several factors, including
the following: the full year impact of staffing of offices added in 2001 along
with the partial year impact of those added in 2002; the increase in personnel
added in nontraditional banking services, most notably those added from the
merger of The Sentinel Agency; and the increased cost of providing group
insurance benefits to employees. Occupancy expenses increased $784 thousand and,
like salary and benefit expenses, were influenced by offices added in both 2001
and 2002. Other expense exhibited a more modest increase from 2001 to 2002.
During 2001, Community had incurred incremental costs associated with new branch
openings, the acquisition of Glen Rock State Bank and the convergence of bank
charters.
Income Taxes
Income tax expense grew to $3.4 million in 2002, reflecting an increase of
nearly 17% over the income tax of $2.9 million recorded in 2001. The effective
tax rate for 2002 was nearly 16% and was comparable to the 17% rate experienced
in 2001.
APPENDIX A - ADDITIONAL STATISTICAL DISCLOSURE BY BANK HOLDING COMPANIES
The following tables are provided as a supplement to Management's Discussion and
Analysis of Financial Condition and Results of Operation:
Distribution of Assets, Liabilities and Stockholders' Equity; Interest Rates and
Interest Differential
Rate/Volume Analysis - Tax Equivalent Basis
Loan Account Composition as of December 31, 2003, 2002, 2001, 2000, and 1999.
Maturities and Sensitivity to Changes in Interest Rates for Commercial,
Financial, and Agricultural Loans as of December 31, 2003.
29
Distribution of Assets, Liabilities and Stockholders' Equity; Interest rates and Interest Differential
Income and Rates on a Tax Equivalent Basis (b) for the Years Ended December 31, 2003, 2002, and 2001
(dollars in thousands)
2003 2002 2001
-----------------------------------------------------------------------------------------------------
Average Average Average
Interest Rates Interest Rates Interest Rates
Average Income/ Earned/ Average Income/ Earned/ Average Income Earned/
Balance(c) Expense(a) Paid (a) Balance(c) Expense Paid (a) Balance(c) Expense(a) Paid(a)
-----------------------------------------------------------------------------------------------------
Assets:
Cash and due from banks $ 36,451 $ 36,982 $ 36,129
----------- ----------- -----------
Earning assets:
Interest-bearing deposits
in other banks 1,160 $ 9 .78% 1,742 $ 26 1.49% 2,126 $ 103 4.84%
----------- ----------- -----------
Investment securities:
Taxable 466,316 18,607 3.99 384,097 19,602 5.10 300,040 20,075 6.69
Tax-exempt (b) 207,627 15,957 7.69 200,419 14,955 7.46 152,960 11,034 7.21
----------- ----------- -----------
Total investment
securities 673,943 584,516 453,000
----------- ----------- -----------
Federal funds sold 4,015 40 1.00 11,126 193 1.73 16,221 800 4.93
----------- ----------- -----------
Loans (b) 1,001,086 66,604 6.65 889,912 67,712 7.61 838,178 70,339 8.39
----------- -------- ----- ----------- --------- ---- ----------- -------- ----
Total earning assets 1,680,204 $101,217 6.02 1,487,296 $ 102,488 6.89 1,309,525 $102,351 7.81
----------- -------- ----- ----------- --------- ---- ----------- -------- ----
Allowance for loan losses (13,016) (12,689) (11,745)
Premises, equipment, and
other assets 76,532 68,457 64,612
----------- ----------- -----------
Total assets $ 1,780,171 $ 1,580,046 $ 1,398,521
=========== =========== ===========
Liabilities:
Demand deposits $ 167,315 $ 163,434 $ 150,218
----------- ----------- -----------
Interest-bearing liabilities:
Savings deposits 164,207 690 .42 149,066 1,864 1.25 71,346 2,816 3.95
Money market deposits 74,156 624 .84 82,793 1,289 1.56 85,126 2,582 3.03
NOW accounts 163,442 2,006 1.23 90,773 998 1.10 135,715 1,422 1.05
Time deposits
$100,000 or greater 110,231 107,523 77,321
Other 498,005 498,159 457,196
----------- ----------- -----------
Total time deposits 608,236 19,777 3.25 605,682 24,498 4.04 534,517 28,731 5.38
----------- ----------- -----------
Total interest-bearing
deposits 1,010,041 928,314 826,704
Short-term borrowings 97,837 1,243 1.27 54,178 977 1.80 12,344 240 1.94
Long-term debt 355,209 17,989 5.06 302,406 16,586 5.48 286,569 16,349 5.71
----------- -------- ----- ----------- --------- ---- ----------- -------- ----
Total interest-bearing
liabilities 1,463,087 $ 42,329 2.89 1,284,898 $ 46,212 3.60 1,125,617 $ 52,140 4.63
----------- -------- ----- ----------- --------- ---- ----------- -------- ----
Accrued interest, taxes and
other liabilities 13,996 12,362 11,305
----------- ----------- -----------
Total liabilities 1,644,398 1,460,694 1,287,140
Stockholders' equity 135,773 119,352 111,381
----------- ----------- -----------
Total liabilities and
stockholders'
equity $ 1,780,171 $ 1,580,046 $ 1,398,521
=========== =========== ===========
Interest income to earning
assets 6.02% 6.89% 7.81%
Interest expense to earning
assets 2.52 3.11 3.98
----- ---- ----
Effective interest
differential $ 58,888 3.50% $ 56,276 3.78% $ 50,211 3.83%
======== ===== ========= ==== ======== ====
(a) Loan fees are included in interest income and rate calculations.
(b) Interest income on all tax-exempt securities and loans have been adjusted
to tax equivalent basis utilizing a Federal tax rate of 35% in 2003, 2002,
and 2001. Loans includes loans held for sale.
(c) Averages are a combination of monthly and daily averages.
30
Rate/Volume Analysis-Tax Equivalent Basis (a)
For the Years Ended December 31, 2003 and 2002
(dollars in thousands)
--------------------------------------------------------------------
2003 vs 2002 2002 vs 2001
--------------------------------------------------------------------
Volume Rate Total Volume Rate Total
--------------------------------------------------------------------
Favorable (Unfavorable)
Increase (decrease) in interest income:
Loans $ 7,935 $ (9,042) $ (1,107) $ 4,169 $(6,796) $(2,627)
Investment securities:
Taxable 3,734 (4,729) (995) 4,906 (5,379) (473)
Tax exempt 545 457 1,002 3,527 394 3,921
--------- -------- -------- -------- ------- --------
Total 4,279 (4,272) 7 8,433 (4,985) 3,448
Federal funds sold (92) (61) (153) (198) (409) (607)
Interest-bearing deposits in other
banks (7) (10) (17) (16) (61) (77)
--------- -------- -------- -------- ------- --------
Total 12,115 (13,385) (1,270) 12,388 (12,251) 137
--------- -------- -------- -------- ------- --------
(Increase) decrease in interest expense:
Savings deposits ( 877) 1,708 831 (645) 3,314 2,669
Time deposits (102) 4,823 4,721 (3,516) 7,749 4,233
Short-term borrowings (615) 349 (266) (755) 18 (737)
Long-term debt (2,731) 1,328 (1,403) (899) 662 (237)
--------- -------- -------- -------- ------- --------
Total (4,325) 8,208 3,883 (5,815) 11,743 5,928
--------- -------- -------- -------- ------- --------
Increase (decrease) in effective
interest differential $ 7,790 $ (5,177) $ 2,613 $ 6,573 $ (508) $ 6,065
======== ======== ======== ======== ======= ========
(a) Table shows approximate effect on the effective interest differential of
volume and rate changes for the years 2003 and 2002. The effect of a change in
average volume has been determined by applying the average yield or rate in the
earlier period to the change in average volume during the period. The effect of
a change in rate has been determined by applying the change in rate during the
period to the average volume of the prior period. Any resulting unallocated
amount was allocated ratably between the volume and rate components. Non-accrual
loans have been included in the average volume of each period. Tax-exempt income
is shown on a tax equivalent basis assuming a federal income tax rate of 35% in
2003, 2002, and 2001.
31
LOAN ACCOUNT COMPOSITION
(dollars in thousands)
as of December 31
-----------------
2003 2002 2001 2000 1999
------------------------------------------------------------------------------------------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ ------- -------------- ------ -------
Commercial, financial and
agricultural $ 367,444 34.1% $295,506 32.7% $158,223 18.4% $135,612 16.6% $107,419 15.2%
Real estate-construction 7,338 0.7 2,615 0.3 21,225 2.5 22,403 2.7 17,003 2.4
Real estate-commercial mortgage 283,662 26.3 246,533 27.2 554,354* 64.7 540,639* 66.4 464,680* 65.6
Real estate-retail mortgage 89,840 8.3 106,882 11.8 --- 0.0 --- 0.0 --- 0.0
Consumer-home equity 38,298 3.5 28,169 3.1 --- 0.0 --- 0.0 --- 0.0
Consumer-installment and other 292,029 27.1 224,863 24.9 123,476 14.4 116,220 14.3 118,914 16.8
----------- ----- -------- ----- -------- ----- -------- ----- -------- -----
1,078,611 100.0% 904,568 100.0% 857,278 100.0% 814,874 100.0% 708,016 100.0%
===== ===== ===== ===== =====
Less:
Reserve for loan losses (13,178) (12,343) (12,132) (10,328) (8,976)
----------- -------- -------- -------- --------
$ 1,065,433 $892,225 $845,146 $804,546 $699,040
=========== ======== ======== ======== ========
* Prior breakouts of historical information could not be readily reconstructed
from predecessor banks' records. Breakouts from 1999 to 2001 are assumed to
approximate current mix trends.
The Corporation's loan activity is principally with customers located within its
local market area. The Corporation continues to maintain a diversified loan
portfolio and has no significant loan concentration in any economic sector.
Commercial, financial, and agricultural loans consist principally of commercial
lending secured by financial assets of businesses including accounts receivable,
inventories and equipment, and, in most cases, include liens on real estate.
Real estate construction and mortgage loans are primarily 1 to 4 family
residential loans secured by residential properties within the bank's market
area. Personal-installment loans consist principally of secured loans for items
such as automobiles, property improvement, household and other consumer goods.
The Corporation continues to sell fixed rate mortgages in the secondary market
to manage interest rate risk. Historically, relative credit risk of commercial,
financial and agricultural loans has generally been greater than that of other
types of loans.
MATURITIES AND SENSITIVITY TO CHANGES IN INTEREST
RATES FOR COMMERCIAL, FINANCIAL AND AGRICULTURAL
AND REAL-ESTATE CONSTRUCTION LOANS
(dollars in thousands)
as of December 31, 2003
-----------------------
Maturity Distribution
---------------------
One Year One to Over Five
Or Less Five Years Years Total
------- ---------- ----- -----
Commercial, financial and
agricultural $ 68,447 $ 125,035 $ 173,962 $ 367,444
Real estate-construction 3,454 241 3,643 7,338
Real estate-commercial mortgage 40,643 92,697 150,322 283,662
----------- ---------- ----------- -----------
$ 112,544 $ 217,973 $ 327,927 $ 658,444
=========== ========== =========== ===========
Interest Sensitivity
--------------------
Variable Fixed Total
-------- ----- -----
Due in one year or less $ 57,010 $ 55,534 $ 112,544
Due after one year 346,142 199,758 545,900
----------- ---------- -----------
$ 403,152 $ 255,292 $ 658,444
=========== ========== ===========
32
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
- --------------------------------------------------------------------
A portion of the information related to quantitative and qualitative disclosures
about market risk is included under Management's Discussion and Analysis (MD&A)
under the heading of Asset/Liability Management and Liquidity. The purpose of
this presentation is to augment the discussion contained in the MD&A.
Market risk is defined as the exposure to economic loss that arises from changes
in the values of certain financial instruments pursuant to factors arising out
of the various categories of market risk. Market risk can include a number of
categories, including interest rate risk, foreign currency risk, exchange rate
risk, commodity price risk, etc. For domestic, community-based banks, the vast
majority of market risk is related to interest rate risk. Financial institutions
use a number of techniques to attempt to measure the impact of interest rate
risk which includes GAP analysis, interest rate "shock simulation" and economic
value of equity. Each of these techniques is used to help quantify market risk
attributable to the inherent sensitivity of both interest earning assets and
interest bearing liabilities.
Interest rate sensitivity results when the maturity or repricing intervals of
interest-earning assets, interest-bearing liabilities, and off-balance sheet
financial instruments are different, creating a risk that changes in the level
of market interest rates will result in disproportionate changes in the value
of, and the net earnings generated from, the Corporation's interest-earning
assets, interest-bearing liabilities, and off-balance sheet financial
instruments. The Corporation's exposure to interest rate sensitivity is managed
primarily through the Corporation's strategy of selecting the types and terms of
interest-earning assets and interest-bearing liabilities which generate
favorable earnings, while limiting the potential negative effects of changes in
market interest rates. Since the Corporation's primary source of
interest-bearing liabilities is customer deposits, its ability to manage the
types and terms of such deposits may be somewhat limited by customer preferences
in the market areas in which it operates. Borrowings, which include Federal Home
Loan Bank (FHLB) advances and short-term loans, subordinated notes, and other
short-term and long-term borrowings, are generally structured with specific
terms which in management's judgment, when aggregated with the terms for
outstanding deposits and matched with interest-earning assets, mitigate the
Corporation's exposure to interest rate sensitivity.
The rates, terms and interest rate indices of the Corporation's interest-earning
assets result primarily from its strategy of investing in loans and securities
(a substantial portion of which have adjustable-rate terms) which permit the
Corporation to limit its exposure to interest rate sensitivity, together with
credit risk, while at the same time achieving a positive interest rate spread
compared to the cost of interest-bearing liabilities.
The following table provides a measure of interest rate sensitivity for each
category of interest earning assets and interest bearing liabilities at December
31, 2003.
Interest Rate Sensitivity
---------------------------------------------------------------------------------------------------------------------
At December 31, 2003 1-90 90-180 180-365 1 year
Dollars in thousands days days days or more Total
---------------------------------------------------------------------------------------------------------------------
Assets
Federal funds sold $ 17,097 $ --- $ --- $ --- $ 17,097
Interest-bearing deposits in
other banks 3,301 --- --- --- 3,301
Loans held for sale(1) 97 97 193 3,906 4,293
Investment securities 127,390 48,912 48,758 421,901 646,961
Loans(2) 366,158 62,793 99,823 549,837 1,078,611
---------------------------------------------------------------------------------------------------------------------
Earning assets 514,043 111,802 148,774 975,644 1,750,263
Non-earning assets 1,775 --- --- 108,092 109,867
---------------------------------------------------------------------------------------------------------------------
Total Assets $ 515,818 $ 111,802 $ 148,774 $ 1,083,736 $ 1,860,130
--------------------------------------------------------------------------------------------------------------------
33
Liabilities
Savings $ 309,026 $ --- $ --- $ 147,662 $ 456,688
Time 71,610 56,467 136,277 230,464 494,818
Time in denominations of
$100,000 or more 24,791 21,735 33,075 34,404 114,005
Short-term borrowings 27,764 --- --- --- 27,764
Long-term debt 11,785 26,785 3,570 369,282 411,422
Subordinated debentures 22,500 --- --- 7,500 30,000
----------------------------------------------------------------------------------------------------------------------
Interest bearing liabilities 467,476 104,987 172,922 789,312 1,534,697
Other liabilities and equity --- --- --- 325,433 325,433
---------------------------------------------------------------------------------------------------------------------
Total liability and equity $ 467,476 $ 104,987 $ 172,922 $ 1,114,745 $ 1,860,130
---------------------------------------------------------------------------------------------------------------------
Interest Sensitivity GAP
Periodic $ 48,342 $ 6,815 $ (24,148) $ (31,009)
Cumulative 55,157 31,009 ---
Cumulative GAP as a percentage
of total assets 2.60% 2.97% 1.67% 0%
(1) Only education loans held for sale are included in earning assets.
(2) Includes non-accrual loans.
Community seeks to maximize net interest income and minimize earnings volatility
by managing the level of interest rate sensitivity. Interest rate sensitivity is
influenced by the repricing characteristic of both assets and liabilities and
includes the volume of assets and liabilities repricing, the timing of repricing
and the relative magnitude of the repricing. While GAP measurement provides an
important tool to quantify the level of interest rate sensitivity at a specific
point in time, its utility is constrained by the inherent limitations of GAP
measurement for a number of reasons. First, changes in the level of interest
rates cannot be expected to affect all assets and liabilities equally nor will
they all be impacted at the same time. Second, assets and liabilities that are
eligible to be repriced within a specific time frame may, in fact, not reprice
or may not reprice to the same extent. Third, the measurement of GAP is
inherently limited in that it provides a representation of the repricing
characteristics of assets and liabilities at a specific point in time while
actual sensitivity of assets and liabilities are undergoing constant change.
Finally, much of the presentation of GAP is, by necessity, based upon estimates
and assumptions for certain assets and liabilities. For example, savings, NOW
accounts, and other forms of core deposits do not have defined maturities or
repricing dates and therefore require estimates to be made based upon historical
deposit decay rate analysis or other forms of approximation.
Interest rate sensitivity, and the measurement thereof, are also influenced by
the optionality of certain earning assets and interest bearing liabilities. For
example, a substantial portion of the Corporation's loans and mortgage-backed
securities and residential mortgage loans contain significant embedded options,
which permit the borrower to prepay the principal balance of the loan prior to
maturity ("prepayments") without penalty. A loan's propensity for prepayment is
dependent upon a number of factors, including the current interest rate and
interest rate index (if any) of the loan, the financial ability of the borrower
to refinance, the economic benefit to be obtained from refinancing, availability
of refinancing at attractive terms, as well as economic and other factors in
specific geographic areas which affect the sales and price levels of residential
property. In a changing interest rate environment, prepayments may increase or
decrease on fixed and adjustable-rate loans pursuant to the current relative
levels and expectations of future short and long-term interest rates.
Investment securities, other than mortgage-backed securities and those with
early call provisions generally do not have significant embedded options and
repay pursuant to specific terms until maturity. While savings and checking
deposits generally may be withdrawn upon the customer's request without prior
notice, a continuing relationship with such customers is generally predictable
resulting in a dependable and uninterrupted source of funds. Time deposits
generally have early withdrawal penalties, while term FHLB borrowings and
subordinated notes have prepayment penalties, which discourage customer
withdrawal of time deposits and prepayment by the Corporation of FHLB borrowings
and subordinated notes prior to maturity.
34
In addition to periodic GAP reports comparing the sensitivity of
interest-earning assets and interest-bearing liabilities to changes in interest
rates, management also utilizes a report which measures the exposure of the
Corporation's economic value of equity to interest rate risk. The model
calculates the present value of assets, liabilities and equity at current
interest rates, and at hypothetically higher and lower interest rates at one
percent intervals. The present value of each major category of financial
instruments is calculated by the model using estimated cash flows based on
prepayments, early withdrawals, weighted average contractual rates and terms,
and discount rates for similar financial instruments. The resulting present
value of longer term fixed-rate financial instruments are more sensitive to
change in a higher or lower interest rate scenario, while adjustable-rate
financial instruments largely reflect only a change in present value
representing the difference between the contractual and discounted rates until
the next interest rate repricing date. The information provided by these
analyses provides some indication of the potential for interest rate adjustment,
but does not necessarily mean that the rate adjustment will occur or that it
will occur in accordance with the assumptions. Despite these inherent
limitations, Community believes that the tools used to manage its level of
interest rate risk provide an appropriate measure of market risk exposure.
The following table reflects the estimated present value of assets, liabilities
and equity using the model for Community as of December 31, 2003 at current
interest rates and hypothetically, higher and lower interest rates of one and
two percent.
Base
-2% -1% Present Value +1% +2%
------------------------------------------------------------------------------------
Assets: (dollars in thousands)
Cash, interest-bearing time deposits,
and federal funds sold $ 63,188 $ 63,188 $ 63,188 $ 63,188 $ 63,188
Loans held for sale (1) 4,480 4,480 4,293 4,112 3,941
Investment securities 686,968 665,929 646,961 623,851 602,812
Loans 1,097,279 1,085,786 1,065,433 1,052,653 1,033,591
Other assets 80,255 80,255 80,255 80,255 80,255
-------------- ------------- ----------- ------------- -------------
Total assets $ 1,932,170 $ 1,899,638 $ 1,860,130 $ 1,824,059 $ 1,783,787
============== ============= ============ ============= =============
Liabilities:
Deposits $ 1,252,523 $ 1,245,181 $ 1,230,685 $ 1,229,886 $ 1,222,517
Short-term borrowings 27,764 27,764 27,764 27,764 27,764
Long-term debt 461,533 440,266 411,422 401,565 383,960
Trust preferred securities 30,000 30,000 30,000 30,000 30,000
Other liabilities 16,853 16,853 16,853 16,853 16,853
-------------- ------------- ------------ ------------- -------------
Total liabilities 1,788,673 1,760,064 1,716,724 1,706,068 1,681,094
-------------- ------------- ------------ ------------- -------------
Total stockholders' equity 143,497 139,574 143,406 117,991 102,692
-------------- ------------- ------------ ------------- -------------
Total liabilities and
stockholders' equity $ 1,932,170 $ 1,899,638 $ 1,860,130 $ 1,824,059 $ 1,783,786
============== ============= ============ ============= =============
(1) Only education loans held for sale are included in earning assets.
35
Item 8. Financial Statements and Supplementary Data:
- -----------------------------------------------------
Community Banks, Inc. and Subsidiaries
CONSOLIDATED BALANCE SHEETS
At December 31, 2003 and 2002
(Dollars in thousands except per share data)
---------------------------------
2003 2002
---------------------------------
ASSETS
Cash and due from banks $ 42,790 $ 36,137
Federal funds sold 17,097 ---
----------- -----------
Cash and cash equivalents 59,887 36,137
Interest-bearing time deposits in other banks 3,301 951
Investment securities, available for sale 646,961 667,801
Loans held for sale 6,067 11,483
Loans 1,078,611 904,568
Less: Allowance for loan losses (13,178) (12,343)
----------- -----------
Net loans 1,065,433 892,225
Premises and equipment, net 24,153 24,209
Goodwill and identifiable intangible assets 4,773 1,760
Accrued interest receivable and other assets 49,555 45,332
----------- -----------
Total assets $ 1,860,130 $ 1,679,898
=========== ===========
LIABILITIES
Deposits:
Non-interest bearing $ 165,174 $ 168,277
Interest bearing 1,065,511 964,636
----------- -----------
Total deposits 1,230,685 1,132,913
Short-term borrowings 27,764 69,125
Long-term debt 411,422 320,533
Trust preferred securities 30,000 15,000
Accrued interest payable and other liabilities 16,853 13,165
----------- -----------
Total liabilities 1,716,724 1,550,736
----------- -----------
STOCKHOLDERS' EQUITY
Preferred stock, no par value;
500,000 shares authorized;
no shares issued and outstanding --- ---
Common stock - $5.00 par value; 20,000,000 shares
authorized; 11,851,000 and 9,410,000 shares
issued at 2003 and 2002 59,256 47,053
Surplus 57,563 46,418
Retained earnings 24,297 35,344
Accumulated other comprehensive income,
net of tax 6,596 6,538
Treasury stock; 203,000 and 258,000 shares
in 2003 and 2002, at cost (4,306) (6,191)
----------- -----------
Total stockholders' equity 143,406 129,162
----------- -----------
Total liabilities and stockholders' equity $ 1,860,130 $ 1,679,898
=========== ===========
The accompanying notes are an integral part of the consolidated
financial statements.
36
Community Banks, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF INCOME
For the Years Ended December 31, 2003, 2002, and 2001
(dollars in thousands except per share data)
---------------------------------------
2003 2002 2001
---------------------------------------
INTEREST INCOME:
Loans, including fees $ 65,837 $ 67,158 $ 69,925
Investment securities:
Taxable 17,532 18,478 17,750
Tax exempt 8,957 8,457 7,172
Dividends 2,490 2,388 2,325
Other 49 219 903
--------- --------- ---------
Total interest income 94,865 96,700 98,075
--------- --------- ---------
INTEREST EXPENSE:
Deposits 23,097 28,649 35,551
Short-term borrowings 1,243 977 240
Long-term debt 17,256 16,560 16,349
Trust preferred securities 733 26 ---
--------- --------- ---------
Total interest expense 42,329 46,212 52,140
--------- --------- ---------
Net interest income 52,536 50,488 45,935
Provision for loan losses 2,500 3,350 5,080
--------- --------- ---------
Net interest income after provision for
loan losses 50,036 47,138 40,855
--------- --------- ---------
NON-INTEREST INCOME:
Investment management and trust services 1,326 993 740
Service charges on deposit accounts 5,128 3,440 3,023
Other service charges, commissions and fees 2,958 2,471 1,783
Investment security gains, net 1,927 1,034 1,704
Insurance premium income and commissions 2,822 2,016 1,483
Mortgage banking activities 2,532 1,221 1,367
Other 3,748 2,800 2,041
--------- --------- ---------
Total non-interest income 20,441 13,975 12,141
--------- --------- ---------
NON-INTEREST EXPENSES:
Salaries and employee benefits 25,397 21,636 18,528
Net occupancy and equipment 7,200 6,051 5,267
Marketing expense 2,018 1,090 707
Telecommunications expense 1,302 995 940
Merger and restructuring related --- --- 1,968
Other 9,801 9,528 9,111
--------- --------- ---------
Total non-interest expenses 45,718 39,300 36,521
--------- --------- ---------
Income before income taxes 24,759 21,813 16,475
Income taxes 4,359 3,367 2,879
--------- --------- ---------
Net income $ 20,400 $ 18,446 $ 13,596
========= ========= =========
Basic earnings per share $ 1.76 $ 1.59 $ 1.17
========= ========= =========
Diluted earnings per share $ 1.71 $ 1.55 $ 1.15
========= ========= =========
The accompanying notes are an integral part of the consolidated financial
statements.
37
Community Banks, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
For the Years Ended December 31, 2003, 2002, and 2001
(dollars in thousands except per share data)
-----------------------------------------------------------------------
Accumulated
Other Total
Common Retained Comprehensive Treasury Stockholders'
Stock Surplus Earnings Income (Loss) Stock Equity
-----------------------------------------------------------------------
Balance, December 31, 2000 $42,726 $29,155 $38,723 $ (694) $(5,932) $103,978
Comprehensive income:
Net income 13,596 13,596
Change in unrealized gain (loss) on
securities, net of reclassification
adjustment and tax effect (2,408) (2,408)
Change in unfunded pension liability,
net of tax effect (922) (922)
--------
Total comprehensive income 10,266
Cash dividends ($.51 per share) (5,880) (5,880)
5% stock dividend (426,000 shares) 2,130 6,773 (8,903)
Purchase of treasury stock (28,000 shares) (689) (689)
Issuance of additional shares (209,000 net
shares of treasury stock reissued and
3,000 shares of common stock canceled) (17) (22) (613) 4,226 3,574
-----------------------------------------------------------------------
Balance, December 31, 2001 44,839 35,906 36,923 (4,024) (2,395) 111,249
Comprehensive income:
Net income 18,446 18,446
Change in unrealized gain (loss) on
securities, net of reclassification
adjustment and tax effect 11,151 11,151
Change in unfunded pension liability,
net of tax effect (589) (589)
--------
Total comprehensive income 29,008
Cash dividends ($.57 per share) (6,654) (6,654)
5% stock dividend (440,000 shares) 2,241 10,177 (12,418)
Purchases of treasury stock (224,000 shares) (5,828) (5,828)
Issuance of additional shares (93,000 net
shares of treasury stock reissued and
5,000 shares of common stock canceled) (27) 335 (953) 2,032 1,387
-----------------------------------------------------------------------
Balance, December 31, 2002 47,053 46,418 35,344 6,538 (6,191) 129,162
Comprehensive income:
Net income 20,400 20,400
Change in unrealized gain (loss) on
securities, net of reclassification
adjustment and tax effect 626 626
Change in unfunded pension liability,
net of tax effect (568) (568)
--------
Total comprehensive income 20,458
Cash dividends ($.66 per share) (7,619) (7,619)
5% stock dividend (470,000 shares) 2,346 10,612 (12,984) (26)
Stock split payable in the form of a 20%
stock dividend (1,975,000 shares) 9,876 (9,876)
Purchases of treasury stock (125,000 shares) (3,627) (3,627)
Issuance of additional shares (224,000 net
shares of treasury stock reissued and
4,000 shares of common stock canceled) (19) 533 (968) 5,512 5,058
-----------------------------------------------------------------------
Balance, December 31, 2003 $59,256 $57,563 $24,297 $ 6,596 $ (4,306) $143,406
=======================================================================
The accompanying notes are an integral part of the consolidated financial
statements.
38
Community Banks, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended December 31, 2003, 2002, and 2001
(in thousands)
--------------------------------------------
2003 2002 2001
--------------------------------------------
Operating Activities:
Net income $ 20,400 $ 18,446 $ 13,596
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for loan losses 2,500 3,350 5,080
Deferred income taxes (152) (192) (906)
Depreciation and amortization 3,075 2,541 2,127
Amortization of security premiums and discounts, net 2,431 779 1,960
Investment security gains, net (1,927) (1,034) (1,704)
Loans originated for sale (66,976) (66,158) (94,933)
Proceeds from sales of loans 73,957 66,375 88,540
Gains on loan sales (1,565) (1,221) (1,367)
Earnings on investment in life insurance (1,455) (1,476) (1,100)
Pension curtailment gain (497) --- ---
Change in other assets, net 2,480 (5,523) 2,249
Change in accrued interest payable and other
liabilities, net 3,275 (527) 4,237
--------- --------- ---------
Net cash provided by operating activities 35,546 15,360 17,779
--------- --------- ---------
Investing Activities:
Net (increase) decrease in interest-bearing time
deposits in other banks (2,350) 421 1,196
Proceeds from sales of investment securities 165,513 147,610 124,490
Proceeds from maturities of investment securities 145,221 83,605 134,308
Purchases of investment securities (289,398) (337,706) (418,685)
Net increase in total loans (180,725) (54,094) (46,343)
Net additions to premises and equipment (2,677) (4,037) (3,532)
Other (2,717) (880) (335)
--------- --------- ---------
Net cash used in investing activities (167,133) (165,081) (208,901)
--------- -------- ---------
Financing Activities:
Net increase in deposits 97,773 129,688 83,984
Net increase (decrease) in short-term borrowings (41,361) 9,123 23,909
Proceeds from issuance of long-term debt 98,751 34,767 83,236
Proceeds from issuance of trust preferred securities 15,000 15,000 ---
Repayment of long-term debt (7,862) (36,389) (694)
Cash dividends (7,645) (6,654) (5,880)
Purchases of treasury stock (3,627) (5,828) (689)
Proceeds from issuance of common stock 4,308 1,387 3,574
--------- --------- ---------
Net cash provided by financing activities 155,337 141,094 187,440
--------- --------- ---------
Increase (decrease) in cash and cash equivalents 23,750 (8,627) (3,682)
Cash and cash equivalents at beginning of year 36,137 44,764 48,446
--------- --------- ---------
Cash and cash equivalents at end of year $ 59,887 $ 36,137 $ 44,764
========= ========= =========
Cash paid during the year for:
Interest $ 42,311 $ 46,617 $ 52,112
========= ========= =========
Income taxes $ 4,170 $ 4,304 $ 3,610
========= ========= =========
The accompanying notes are an integral part of the consolidated financial
statements.
39
Community Banks, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND BASIS OF PRESENTATION:
Community Banks, Inc. ("Community" or the "Corporation") is a financial holding
company whose wholly-owned subsidiaries include Community Banks, Community Bank
Investments, Inc. (CBII), Community Banks Life Insurance Company (CBLIC), CMTY
Capital Trust I and CMTY Capital Statutory Trust II. All significant
intercompany transactions have been eliminated in consolidation. The Corporation
operates through its executive office in Harrisburg, Pennsylvania, and through
46 branch banking offices located in Adams, Cumberland, Dauphin, Luzerne,
Northumberland, Schuylkill, Snyder, and York Counties in Pennsylvania, and
Carroll County in Maryland. Community Banks provides a wide range of services
through its network of offices. Lending services include secured and unsecured
commercial loans, residential and commercial mortgages and various forms of
consumer lending. Deposit services include a variety of checking, savings, time
and money market deposits. The Corporation also provides specialized services
through its wholly-owned subsidiaries. Community and its subsidiaries are
subject to the regulations of certain Federal and state agencies and undergo
periodic examinations by such regulatory authorities.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
USE OF ESTIMATES:
The preparation of financial statements in accordance with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those estimates. The
principal material estimate that is particularly susceptible to significant
change in the near term relates to the determination of the allowance for loan
losses.
CASH FLOWS INFORMATION:
Cash and cash equivalents include cash and due from banks and federal funds
sold. Noncash transactions included the issuance of $750,000 of common stock for
an acquisition in 2003.
SIGNFICANT GROUP CONCENTRATIONS OF CREDIT RISK:
Most of the Corporation's activities are with customers located within Northeast
/ Central Pennsylvania and Northern Maryland. Note 3 discusses the types of
securities in which the Corporation invests. Note 4 discusses the types of
lending engaged in by the Corporation. The Corporation does not have any
significant concentrations to any one industry or customer.
INVESTMENT SECURITIES:
The Corporation classifies debt and equity securities as either
"held-to-maturity," "available-for-sale," or "trading." Investments for which
management has the intent, and the Corporation has the ability, to hold to
maturity are carried at cost adjusted for amortization of premium and accretion
of discount. Amortization and accretion are calculated principally on the
interest method. Securities bought and held primarily for the purpose of selling
them in the near term are classified as trading and reported at fair value.
Changes in unrealized gains and losses on trading securities are recognized in
the Consolidated Statements of Income. At December 31, 2003 and 2002, there were
no securities identified as held-to-maturity or trading. All other securities
are classified as available-for-sale securities and reported at fair value.
Changes in unrealized gains and losses on available-for-sale securities, net of
applicable taxes, are recorded as a component of stockholders' equity. Quoted
market values, when available, are used to determine the fair value of
available-for-sale securities. If quoted market prices are not available, then
fair values are estimated using quoted prices of instruments with similar
characteristics.
Securities classified as available-for-sale include those investments management
intends to use as part of its asset/liability management strategy and may be
sold in response to changes in interest rates, resultant prepayment risk and
other factors. Declines in the fair value of available-for-sale securities below
their cost that are deemed to be other than temporary are reflected in the
Consolidated Statements of Income as realized losses. In estimating
other-than-temporary impairment losses, management considers independent price
quotations, projected target prices of investment analysts within the short term
and the financial condition of the issuer. Realized gains and losses on the sale
of securities are recognized using the specific identification method and are
included in Non-Interest Income in the Consolidated Statements of Income.
40
Equity securities include Federal Home Loan Bank (FHLB) stock at December 31,
2003 and 2002 of $21.2 million and $18.9 million, and represent equity interests
in the FHLB. Such securities, which are carried at cost, do not have a readily
determinable fair value because ownership is restricted and can be sold back
only to the FHLB or to another member institution. The FHLB requires the
Corporation to maintain certain amounts of FHLB stock based on its balance of
FHLB advances.
LOANS HELD FOR SALE:
Loans held for sale, consisting primarily of fixed rate mortgages and education
loans, are valued at the lower of cost or fair value, determined on an aggregate
basis.
LOANS AND REVENUE RECOGNITION:
Loans are stated at their principal amount outstanding adjusted for charge-offs
and certain origination fees or costs. Interest income on loans is recorded on
the interest method. Non-accrual loans are those on which the accrual of
interest has ceased and where all previously accrued and unpaid interest is
reversed. Loans, other than consumer loans, are placed on non-accrual status
when principal or interest is past due 90 days or more and the collateral may be
inadequate to recover principal and interest, or immediately, if in the opinion
of management, full collection is doubtful. Generally, the uncollateralized
portions of consumer loans past due 90 days or more are charged-off. Interest
accrued but not collected as of the date of placement on non-accrual status is
reversed and charged against current income. Subsequent cash payments received
are applied either to the outstanding principal balance or recorded as interest
income, depending upon management's assessment of the ultimate collectibility of
principal and interest. Nonaccrual loans are restored to accrual status when all
delinquent principal and interest become current or the loan is considered
secured and in the process of collection. Delinquency status is based on the
contractual terms of the loan. Loan origination fees and certain direct
origination costs are being deferred and the net amount amortized as an
adjustment of the yield on the related loan under the interest method, generally
over the contractual life.
ALLOWANCE FOR LOAN LOSSES:
The allowance for loan losses is established as losses are estimated to have
occurred through a provision for loan losses charged to earnings. Loan losses
are charged against the allowance when management believes the uncollectibility
of a loan balance is confirmed. Subsequent recoveries, if any, are credited to
the allowance.
The allowance for loan losses is evaluated on a quarterly basis by management
using a systemic methodology that incorporates management's judgments about the
credit quality of the loan portfolio through a disciplined process that is
consistently applied. Management considers all known relevant internal and
external factors that may affect loan collectibility, as well as particular
risks indigenous to specific types of lending. The final results of the process
are reviewed and approved by executive management. Results are regularly
validated by a review of trends associated with loan volume, delinquencies, and
other factors that may influence the methodology used to estimate the allowance
for loan losses. This evaluation is inherently subjective as it requires
estimates that are susceptible to significant revision as additional information
becomes available. An unallocated component is maintained in the allowance to
cover uncertainties that could affect management's estimate of probable losses.
The unallocated component of the allowance reflects the margin of imprecision
inherent in the underlying assumptions used in the methodologies for estimating
specific and general losses in the portfolio.
A loan is considered impaired when, based on current information and events, it
is probable that the Corporation will be unable to collect the scheduled
payments of principal or interest when due, according to the contractual terms
of the loan agreement. Factors considered by management in determining
impairment include payment status, collateral value, and the probability of
collecting scheduled principal and interest payments when due. Loans that
experience insignificant payment delays and payment shortfalls generally are not
classified as impaired. Management determines the significance of payment delays
and payment shortfalls on a case-by-case basis, taking into consideration all of
the circumstances surrounding the loan and the borrower, including the length of
the delay, the reasons for the delay, the borrower's prior payment record, and
the amount of the shortfall in relation to the principal and interest owed.
Impairment is measured on a loan-by-loan basis for commercial and construction
loans over $250,000 by either the present value of expected future cash flows
discounted at the loan's effective interest rate, the loan's obtainable market
price, or the fair value of the collateral if the loan is collateral dependent.
41
Community Banks, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued):
Large groups of smaller balance homogeneous loans are collectively evaluated for
impairment. Accordingly, the Corporation does not separately identify individual
consumer and residential loans for impairment disclosures.
Loans continue to be classified as impaired unless they are brought fully
current and the collection of scheduled interest and principal is considered
probable. When an impaired loan or portion of an impaired loan is determined to
be uncollectible, the portion deemed uncollectible is charged against the
related valuation allowance, and subsequent recoveries, if any, are credited to
the valuation allowance.
PREMISES AND EQUIPMENT:
Premises and equipment are stated at cost, less accumulated depreciation and
amortization. Depreciation is calculated using accelerated and straight-line
methods over the estimated useful lives of the related assets as follows:
banking premises, 20 to 40 years, furniture, fixtures, and equipment, 3 to 5
years. Leasehold improvements are amortized over the shorter of the lease term
or 20 years. Long-lived assets are reviewed for impairment whenever events or
changes in business circumstances indicate the carrying value of the assets may
not be recovered. Maintenance and repairs are expensed as incurred, while major
additions and improvements are capitalized. Gain or loss on retirement or
disposal of individual assets is recorded as income or expense in the period of
retirement or disposal.
GOODWILL AND IDENTIFIABLE INTANGIBLE ASSETS:
The costs of acquired companies in excess of the fair value of net assets at
acquisition date is recorded as goodwill. Through December 31, 2001, goodwill
was amortized on a straight-line basis over 15 years. Subsequent to December 31,
2001, goodwill is not amortized but, instead, is tested at least annually for
impairment. Identifiable intangible assets relate to acquisitions of branch
offices from other banks and customer lists and other intangibles related to
acquisitions of insurance agencies and mortgage origination entities.
Identifiable intangible assets are amortized over their estimated useful lives.
Goodwill amortization was $289,000 for 2001. Amortization for other intangibles
was $94,000, $73,000, and $73,000 for 2003, 2002, and 2001, respectively.
FORECLOSED REAL ESTATE:
Real estate acquired through foreclosure is initially carried at fair value,
typically derived from the current appraised value of the property at transfer
date less estimated selling cost. Prior to foreclosure, the recorded amount of
the loan is written down, if necessary, to the appraised value of the real
estate to be acquired by charging the allowance for loan losses. During 2003,
2002, and 2001 transfers from loans to foreclosed real estate totaled $5
million, $3.7 million, and $663,000, respectively.
Subsequent to foreclosure, gains or losses on the sale of and losses on the
periodic revaluation of foreclosed real estate are credited or charged to other
expense. Costs of maintaining and operating foreclosed property are expensed as
incurred.
RETIREMENT PLANS:
The Corporation has a noncontributory defined benefit pension plan covering
current and former employees of a predecessor bank. Pension costs are funded
currently subject to the full funding limitation imposed under federal income
tax regulations. The defined benefit pension plan was amended during 2001 to
discontinue the admittance of any future participants into the plan. During the
third quarter of 2003, the plan was amended to curtail future eligibility
services and affected participants will no longer accrue benefits in the future.
Community uses a September 30 measurement date for its plan.
The Corporation maintains a 401(k) savings plan covering substantially all
employees which allows employees to invest a percentage of their earnings,
matched to a certain amount specified by the Corporation. The expense related to
this savings plan was $1.1 million in 2003, $1.3 million in 2002, and $938,000
in 2001, and has been included in salaries and benefits expense.
42
The Corporation maintains supplemental retirement plans and life insurance for
selected executives. The supplemental life insurance plans replaced other
insurance coverage. The expense associated with these plans was approximately
$181,000 for 2003, $277,000 for 2002, and $367,000 for 2001. The accrued
liability was $1.6 million at December 31, 2003, and $1.5 million at December
31, 2002. Investment in bank owned life insurance policies was used to finance
the supplemental benefit plans, and provide a tax-exempt return to Community.
INCOME TAXES:
Deferred income taxes are accounted for by the liability method, wherein
deferred tax assets and liabilities are calculated on the differences between
the basis of assets and liabilities for financial statement purposes versus tax
purposes (temporary differences) using enacted tax rates in effect for the year
in which the differences are expected to reverse.
EARNINGS PER 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.
All share and per share amounts are restated for stock splits and stock
dividends that occur prior to the issuance of the financial statements.
STOCK-BASED COMPENSATION:
At December 31, 2003, the Corporation has a stock-based compensation plan, which
is described more fully in Note 12. The Corporation accounts for this plan under
the recognition and measurement principle of APB No. 25, "Accounting for Stock
Issued to Employees," and related Interpretations. No stock-based compensation
cost is reflected in net income, as all options granted under this plan had an
exercise price equal to the market value of the underlying common stock on the
date of grant. The following table illustrates the effect on net income and
earnings per share if the Corporation had applied the fair value recognition
provisions of FASB No. 123, "Accounting for Stock-Based Compensation," to
stock-based compensation.
Years Ended December 31,
(In Thousands, Except Per Share Data)
----------------------------------------------
2003 2002 2001
----------------------------------------------
(in thousands)
Net income, as reported $ 20,400 $ 18,446 $ 13,596
Deduct: Total stock-based
compensation expense determined under fair
value based method for all awards, net of
related tax effects (822) (644) (557)
------------ ----------- -----------
Pro forma net income $ 19,578 $ 17,802 $ 13,039
=========== =========== ===========
Earnings per share:
Basic-as reported $ 1.76 $ 1.59 $ 1.17
=========== =========== ===========
Basic-pro forma $ 1.69 $ 1.53 $ 1.12
=========== =========== ===========
Diluted-as reported $ 1.71 $ 1.55 $ 1.15
=========== =========== ===========
Diluted-pro forma $ 1.64 $ 1.50 $ 1.10
=========== =========== ===========
43
Community Banks, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (continued)
COMPREHENSIVE INCOME:
The Corporation reports comprehensive income in accordance with Statement of
Financial Accounting Standard No. 130, "Reporting Comprehensive Income." The
components of other comprehensive income and related tax effects for years ended
December 31 are as follows:
2003 2002 2001
---------------------------------------------
(in thousands)
Unrealized holding gains (losses)
on available-for-sale securities $ 2,891 $ 18,189 $ (5,409)
Reclassification adjustments for
(gains) included in net income (1,927) (1,034) (1,704)
----------- ----------- ----------
Net unrealized gains (losses) 964 17,155 (3,705)
Tax effect (338) (6,004) 1,297
----------- ----------- ----------
Net-of-tax amount 626 11,151 (2,408)
----------- ----------- ----------
Increase in unfunded pension liability (874) (906) (1,419)
Tax effect 306 317 497
----------- ----------- ----------
Net-of-tax amount (568) (589) (922)
----------- ----------- ----------
$ 58 $ 10,562 $ (3,330)
=========== =========== ==========
The components of accumulated other comprehensive income, included in
stockholders' equity, are as follows at December 31:
2003 2002
----------------------------
(in thousands)
Net unrealized gain (loss) on
available-for-sale securities $ 13,347 $ 12,381
Tax effect (4,672) (4,332)
----------- -----------
Net-of-tax amount 8,675 8,049
----------- -----------
Unfunded pension liability (3,199) (2,325)
Tax effect 1,120 814
----------- -----------
Net-of-tax amount (2,079) (1,511)
----------- -----------
Accumulated other comprehensive income $ 6,596 $ 6,538
=========== ===========
SEGMENT REPORTING:
The Corporation has determined its only reportable segment is community banking.
The Corporation's non-banking activities have been determined to be
insignificant and do not require separate disclosure.
TRANSFERS OF FINANCIAL ASSETS:
Transfers of financial assets are accounted for as sales, when control over the
assets has been surrendered. Control over transferred assets is deemed to be
surrendered when (1) the assets have been isolated from the Corporation, (2) the
transferee obtains the right (free of conditions that constrain it from taking
advantage of that right) to pledge or exchange the transferred assets, and (3)
the Corporation does not maintain effective control over the transferred assets
through an agreement to repurchase them before their maturity.
44
RECENT ACCOUNTING PRONOUNCEMENTS:
In January 2003, the Financial Accounting Standards Board issued FASB
Interpretation No. (FIN) 46, "Consolidation of Variable Interest Entities, an
Interpretation of ARB No. 51." FIN 46 was revised in December 2003. This
interpretation provides new guidance for the consolidation of variable interest
entities (VIEs) and requires such entities to be consolidated by their primary
beneficiaries if the entities do not effectively disperse risk among parties
involved. The interpretation also adds disclosure requirements for investors
that are involved with unconsolidated VIEs. The disclosure requirements apply to
all financial statements issued after December 31, 2003. The consolidation
requirements apply to companies that have interests in special-purpose entities
for periods ended after December 15, 2003. Consolidation of other types of VIEs
is required in financial statements for periods ending after March 15, 2004.
Community has evaluated the impact of FIN 46 on CMTY Capital Trust I and CMTY
Statutory Capital Trust II, VIEs currently consolidated by the Corporation.
Management has determined that the provisions of FIN 46 will require
de-consolidation of the trusts, which issued mandatorily redeemable preferred
capital securities to third-party investors. Upon adoption of FIN 46 as of March
31, 2004, the trusts will be de-consolidated and the trust preferred securities
of the Corporation will be reported in the Consolidated Balance Sheets as
"Long-Term Debt" rather than the trust preferred securities line item
representing preferred shares in the trusts. Community's equity interest in the
trusts, which is not significant, will be reported in "Other Assets." For
regulatory reporting purposes, the Federal Reserve Board has indicated that the
preferred securities will continue to qualify as Tier 1 capital subject to
previously specified limitations, until further notice. Additional information
on the trusts is summarized in Note 8. The adoption of this interpretation did
not have and is not expected to have a material impact on results of operations,
financial position, or liquidity.
SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging
Activities," was issued in April 2003. SFAS 149 amends and clarifies financial
accounting and reporting for derivatives instruments, including certain
derivative instruments embedded in other contracts (collectively referred to as
"derivatives") and for hedging activities under SFAS 133, "Accounting for
Derivative Instruments and Hedging Activities." SFAS 149 was effective for
contracts entered into or modified after June 30, 2003. The adoption of this
standard did not have a material impact on results of operations, financial
position, or liquidity.
SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics
of Both Liabilities and Equity," was issued in May 2003. SFAS 150 requires that
an issuer classify a financial instrument that is within its scope as a
liability. Many of these instruments were previously classified as equity. SFAS
150 was effective for financial instruments entered into or modified after May
31, 2003 and otherwise was effective beginning July 1, 2003. The adoption of
this standard did not have any impact on results of operations, financial
position, or liquidity.
RECLASSIFICATIONS:
Certain amounts reported in prior years have been reclassified to conform with
the 2003 presentation. These reclassifications did not impact the Corporation's
financial condition or results of operations.
45
Community Banks, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. INVESTMENT SECURITIES:
The amortized cost and fair value of investment securities at December 31, 2003
and 2002 are as follows:
2003 2002
-----------------------------------------------------------------------------------------
Gross Gross Gross Gross
Amortized Unrealized Unrealized Fair Amortized Unrealized Unrealized Fair
Cost Gains Losses Value Cost Gains Losses Value
-----------------------------------------------------------------------------------------
(in thousands)
U.S. Treasury and federal agencies $ 173,651 $ 1,923 $ (2,282) $ 173,292 $ 130,947 $ 3,391 $ (4) $ 134,334
Mortgage-backed U.S. government agencies 121,853 1,817 (275) 123,395 206,450 4,375 --- 210,825
Obligations of states and political
subdivisions 177,546 7,217 (282) 184,481 172,391 5,252 (508) 177,135
Corporate securities 95,461 3,283 (757) 97,987 95,022 2,003 (3,931) 93,094
Equity securities 65,070 2,961 (225) 67,806 50,610 1,858 (55) 52,413
--------- -------- -------- -------- --------- ------- -------- ---------
Total $ 633,581 $ 17,201 $ (3,821) $ 646,961 $ 655,420 $ 16,879 $ (4,498) $ 667,801
========= ======== ======== ========= ========= ======== ======== =========
The following table shows gross unrealized losses and fair value, aggregated by
investment category and length of time that individual securities have been in a
continuous unrealized loss position, at December 31, 2003.
Less Than 12 Months 12 Months or More Total
-------------------------------------------------------------------------------
Unrealized Unrealized Unrealized
Fair Value Losses Fair Value Losses Fair Value Losses
-------------------------------------------------------------------------------
U.S. Treasury and federal agencies $ 79,564 $ (2,282) $ --- $ --- $ 79,564 $ (2,282)
Mortgage-backed U.S. government agencies 44,710 (275) --- --- 44,710 (275)
Obligations of states and political subdivisions 15,580 (256) 1,256 (26) 16,836 (282)
Corporate securities 1,245 (5) 19,691 (752) 20,936 (757)
--------- -------- --------- -------- ---------- ---------
Subtotal of debt securities 141,099 (2,818) 20,947 (778) 162,046 (3,596)
Equity securities --- --- 1,275 (225) 1,275 (225)
--------- -------- --------- -------- ---------- ---------
Total temporarily impaired securities $141,099 $(2,818) $ 22,222 $(1,003) $ 163,321 $ (3,821)
========= ======== ========= ======== ========== =========
The above table represents 67 investment securities where the current fair value
is less than the related amortized cost. Management believes that the unrealized
losses reflect changes in interest rates subsequent to the acquisition of
specific securities and do not reflect any deterioration of the credit
worthiness of the issuing entities. Generally, securities with an unrealized
loss are debt securities of investment grade. Therefore the bonds have a
maturity date and are generally expected to pay-off at par, substantially
eliminating any market value losses at that time.
The amortized cost and fair value of all investment securities at December 31,
2003, by contractual maturity, are shown below. Expected maturities will differ
from contractual maturities because obligors may have the right to call or repay
obligations with or without call or prepayment penalties.
Amortized Fair
Cost Value
-------------------------------
(in thousands)
Due in one year or less $ 23,416 $ 23,472
Due after one year through five years 41,923 43,445
Due after five years through ten years 159,135 161,407
Due after ten years 222,184 227,436
----------- -----------
446,658 455,760
Mortgage-backed securities 121,853 123,395
Equity securities 65,070 67,806
----------- ----------
$ 633,581 $ 646,961
=========== ==========
Gross investment security gains and losses of $2.8 million and $907,000,
respectively were recognized in 2003. Gross gains and losses of $1.9 million and
$865,000, respectively, were recognized in 2002. Gross gains and losses of $2.1
million and $360,000, respectively were recognized in 2001. The tax provision
applicable to these net realized gains amounted to $674,000 in 2003, $362,000 in
2002 and $596,000 in 2001.
At December 31, 2003 and 2002, investment securities with carrying amounts of
approximately $296.3 million and $222.2 million, respectively, were pledged to
collateralize public deposits and for other purposes as provided by law.
46
4. LOANS AND ALLOWANCE FOR LOAN LOSSES:
The composition of loans outstanding by lending classification as of December 31
is as follows (in thousands):
2003 2002
----------------------------
Commercial $ 367,444 $ 295,506
Real estate - construction 7,338 2,615
Real estate - mortgage:
Residential 89,840 106,882
Commercial 283,662 246,533
Consumer 330,327 253,032
----------- ----------
$ 1,078,611 $ 904,568
=========== ==========
Changes in the allowance for loan losses for years ended December 31 are as
follows (in thousands):
2003 2002 2001
----------------------------------------
Balance, January 1 $ 12,343 $ 12,132 $ 10,328
Provision for loan losses 2,500 3,350 5,080
Loan charge-offs (2,839) (4,180) (3,776)
Recoveries 1,174 1,041 500
--------- --------- --------
Balance, December 31 $ 13,178 $ 12,343 $ 12,132
========= ========= ========
The following table summarizes risk elements as of December 31 (in thousands):
2003 2002
------------------------
Loans on which accrual of interest has
been discontinued $ 8,151 $ 9,393
Foreclosed real estate 4,865 1,183
--------- ---------
Total non-performing assets 13,016 10,576
Loans past due 90 days or more and
still accruing interest 90 961
--------- ---------
Total risk elements $ 13,106 $ 11,537
========= =========
The following is a summary of information pertaining to impaired loans as of
December 31 (in thousands):
2003 2002
--------------------------
Impaired loans without a valuation allowance $ 3,644 $ 5,894
Impaired loans with a valuation allowance 2,112 1,100
--------- ---------
Total impaired loans $ 5,756 $ 6,994
========= =========
Valuation allowance related to impaired loans $ 546 $ 326
========= =========
Impaired loans are included in nonaccrual loans. For the years
ended December 31, 2003, 2002 and 2001, the average recorded
investment in impaired loans approximated $7.8 million, $6.6
million, and $7.3 million. Interest recognized on impaired loans
on the cash basis for the years ending December 31, 2003, 2002,
and 2001 was not significant.
Certain directors and their business affiliates (defined as the beneficial
ownership of at least a 10 percent interest), executive officers and their
families are indebted to Community Banks for loans made in the ordinary course
of business. In the opinion of management, such loans are consistent with sound
banking practices and are within applicable regulatory lending limitations. The
aggregate dollar amount of these loans was $14.3 million and $13.3 million at
December 31, 2003 and 2002. During 2003, $7.4 million of new advances were made
and repayments totaled $6.4 million.
47
Community Banks, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5. PREMISES AND EQUIPMENT:
Premises and equipment are comprised of the following as of December 31:
------------------------
2003 2002
------------------------
(in thousands)
Banking premises $ 25,279 $ 23,224
Furniture, fixtures, and equipment 20,310 19,993
Leasehold improvements 1,793 1,485
Construction-in-progress 279 1,813
-------- --------
47,661 46,515
Less accumulated depreciation
and amortization (23,508) (22,306)
-------- --------
$ 24,153 $ 24,209
======== ========
Depreciation and amortization expense related to premises and equipment charged
to operations amounted to approximately $3.0 million, $2.5 million, and $2.1
million in 2003, 2002, and 2001, respectively.
Certain branch offices and equipment are leased under agreements which expire at
varying dates through 2024. Most leases contain renewal provisions at the
Corporation's option. Total rental expense was approximately $1.1 million in
2003, $853,000 in 2002 and $865,000 in 2001. Future minimum payments as of
December 31, 2003 under noncancelable operating leases are as follows (in
thousands):
2004 $ 1,117
2005 1,015
2006 857
2007 694
2008 534
Thereafter 5,878
------------
$ 10,095
============
48
6. DEPOSITS
Deposits consisted of the following as of December 31:
-------------------------------
2003 2002
-------------------------------
(in thousands)
Non-interest bearing deposits $ 165,174 $ 168,277
Savings deposits 162,908 153,679
Money market deposits 72,778 78,508
NOW accounts 221,002 113,411
Time deposits 608,823 619,038
------------ ------------
Total $ 1,230,685 $ 1,132,913
============ ============
The aggregate amount of time deposits with minimum denominations of $100,000 or
more totaled approximately $114 million and $112 million at December 31, 2003
and 2002.
At December 31, 2003 scheduled maturities of time deposits were as follows (in
thousands):
2004 $ 341,538
2005 121,998
2006 49,429
2007 67,176
2008 27,366
Thereafter 1,316
------------
$ 608,823
============
49
Community Banks, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. SHORT-TERM BORROWINGS AND LONG-TERM DEBT:
Short-term borrowings consist of the following as of December 31:
-------------------------------------------
2003 Rate 2002 Rate
-------------------------------------------
(dollars in thousands)
Securities sold under agreements to repurchase $ 23,732 0.75% $ 31,694 1.73%
Treasury tax and loan note 2,032 0.76% 1,891 1.02%
Other 2,000 2.42% --- ---
FHLB borrowings --- --- 35,540 1.31%
-------- --------
$ 27,764 $ 69,125
======== ========
The maximum short-term FHLB borrowings outstanding at any month-end during 2003
and 2002 was $139.3 million and $35.5 million; the average amounts outstanding
during the year were $73.1 million and $16.2 million; and the weighted average
interest rate during the year approximated 1.35% and 1.82%.
At December 31, 2003, additional amounts available for borrowing under these
arrangements totaled approximately $50.0 million.
Long-term debt consists of the following as of December 31:
-------------------------
2003 2002
-------------------------
(in thousands)
Outstanding advances from the FHLB of Pittsburgh are currently fixed rate
and mature from 2004 to 2016. The advances are collateralized by FHLB stock,
certain first mortgage loans and both agency and mortgage-backed securities. The
advance rates range from 1.14% to 6.66%, with a weighted average interest rate
of 4.44%. Advances totaling $289.5 million are convertible advances. Under the
terms of these arrangements, the FHLB retains the option to convert the advances
from fixed to variable rate. If the FHLB were to convert their options,
Community has the ability to prepay the advances at no penalty. At the current
time no advances have been converted, and remain at a fixed rate of interest.
Additional amounts available for borrowing at the FHLB totaled $87.7 million and
$123.2 million at December 31, 2003 and 2002, respectively. $ 411,117 $ 320,222
Other long-term debt has an interest rate of 4% and matures in 2017. 305 311
--------- ---------
$ 411,422 $ 320,533
========= =========
Maturities on long-term debt at December 31, 2003 are as follows
(in thousands):
2004 $ 42,140
2005 42,140
2006 27,140
2007 6,886
2008 60,754
Thereafter 232,362
--------------
$ 411,422
==============
50
8. TRUST PREFERRED SECURITIES:
In December 2002, the Corporation issued $15 million of floating rate junior
subordinated deferrable interest debentures to CMTY Capital Trust I (the Trust),
a Delaware Business Trust, in which the Corporation owns all of the common
equity. The debentures are the sole asset of the Trust. The Trust issued $15
million of preferred securities to a single investor. The Corporation's
obligations under the debentures and related documents, taken together,
constitute a full and unconditional guarantee by the Corporation of the Trust's
obligations under the preferred securities. The junior subordinated debt
securities pay interest quarterly at 3 month LIBOR + 3.35%. The preferred
securities are redeemable by the Corporation on or after January 7, 2008 at 100%
of principal plus accrued interest. The preferred securities must be redeemed
upon maturity of the debentures on January 7, 2033. All $15 million of the
debentures currently qualify as Tier 1 capital for regulatory purposes.
In December 2003, the Corporation issued $15 million of floating rate junior
subordinated deferrable interest debentures to CMTY Statutory Capital Trust II
(the Trust II), a Connecticut Business Trust, in which the Corporation owns all
of the common equity. The debentures are the sole asset of the Trust. The Trust
issued $15 million of preferred securities to a single accredited investor. The
Corporation's obligations under the debentures and related documents, taken
together, constitute a full and unconditional guarantee by the Corporation of
the Trust's obligations under the preferred securities. The junior subordinated
debt securities pay interest quarterly at 3 month LIBOR + 2.84%. The preferred
securities are redeemable by the Corporation on or after December 16, 2008 at
100% of principal plus accrued interest. The preferred securities must be
redeemed upon maturity of the debentures on December 16, 2033. All $15 million
of the debentures currently qualify as Tier 1 capital for regulatory purposes.
9. PENSION PLAN:
Community maintains a defined benefit pension plan for employees of a
predecessor bank. As of September 30, 2003, this plan covered less than 25% of
the aggregate employee base. Effective at the end of the third quarter of 2003,
the Board of Directors of Community approved a curtailment of this pension plan
and, in connection therewith, recorded a gain of $497,000 related to the
recognition of a previously unrecognized prior service benefit, which was
recorded as other income. In addition, the Corporation also recorded periodic
pension expense of $280,000 for 2003. The determination of pension expense for
each of the last three years is provided as follows:
----------------------------------------------------------------------------------------------------------------
(dollars in thousands) 2003 2002 2001
----------------------------------------------------------------------------------------------------------------
Components of net periodic benefit cost:
Service cost benefit earned during year $ 115 $ 107 $ 130
Interest cost on projected benefit obligation 428 401 373
Actual return on plan assets (549) (453) (477)
Net amortization and deferral:
Net transition asset --- (4) (9)
Prior service benefit (103) (103) (110)
Net loss 239 156 130
Gain deferred 150 --- ---
--------- --------- ---------
Pension cost $ 280 $ 104 $ 37
========= ========= =========
Increase in minimum liability included in other
comprehensive income $ 874 $ 906 $ 1,419
========= ========= =========
51
Community Banks, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
9. PENSION PLAN - (Continued):
The following table sets forth the pension plan's funded status at September 30,
2003 and 2002:
-----------------------------------------------------------------------------------------------
(dollars in thousands) 2003 2002
-----------------------------------------------------------------------------------------------
Obligations and funded status:
Change in benefit obligation:
Projected benefit obligation, beginning of year $ 6,238 $ 5,842
Service cost 115 107
Interest cost 428 401
Benefits paid (314) (269)
Change in assumptions 662 93
Experience loss 156 64
Curtailment (478) ---
--------- ---------
Projected benefit obligation, end of year $ 6,807 $ 6,238
========= =========
Change in plan assets:
Fair value of plan assets, beginning of year $ 4,511 $ 5,083
Actual return on plan assets 549 (454)
Employer contributions 158 151
Benefits paid (314) (269)
--------- ---------
Fair value of plan assets, end of year $ 4,904 $ 4,511
========= =========
Funded status, end of year $ (1,903) $ (1,727)
Unrecognized prior service benefit --- (600)
Unrecognized net cost 3,199 3,248
Recognition of additional minimum liability (3,199) (2,325)
--------- ---------
Accrued pension liability $ (1,903) $ (1,404)
========= =========
Amounts recognized in the consolidated balance sheet
consist of:
Prepaid benefit cost $ 1,296 $ 921
Accumulated other comprehensive income adjustment (3,199) (2,325)
--------- ---------
Net accrued pension liability $ (1,903) $ (1,404)
========= =========
The accumulated benefit obligation for the pension plan was $6.8 million and $5.9 million at December 31, 2003 and 2002.
Assumptions used in the determination of the funded status of the plan at
December 31, 2003 and 2002 and pension expense for each of the last three years
were as follows:
2003 2002 2001
--------------------------------------------
Discount rate 6.25% 7.0% 7.0%
Expected long-term return on plan assets 9.0% 9.0% 9.0%
Rate of compensation increase 4.0% 4.0% 4.0%
Community maintains a pension investment policy which addresses the assumptions
required for the various aspects of plan management and plan accounting. Such
policy has been designed to be responsive to changing conditions affecting its
pension plan, including overall investment style, targeted annual returns and
asset allocation. Plan assumptions are determined by management pursuant to the
guidance provided by the investment policy and through consultation with plan
actuaries.
52
Targeted allocations of plan assets have been developed as a component of the
investment policy and are responsive to the investment goals, risk management
practices and the relationship between plan assets and benefit obligations. The
current investment style favors an emphasis on growth given that a substantial
portion of the benefited employees are not receiving pension benefits at the
current time. During the last three years, the performance of plan assets has
given rise to an increase in the minimum liability, which is included in the
financial statements as a component of other comprehensive income. The
development of a targeted allocation of plan assets has facilitated a more
disciplined investment approach that seeks to more closely coordinate investment
goals with benefit obligations. Pursuant to that policy, the following targeted
allocations, including an acceptable range of allocations under varying
conditions, and actual asset allocations at the end of each of the last two
years are provided.
Target At December 31,
Asset -----------------
Allocation Range 2003 2002
---------- ----- -----------------
Equity 60% 50-70% 64% 41%
Fixed income 35% 25-45% 28% 38%
Cash and/or equivalents 5% 2-10% 8% 21%
----
100%
====
The expected long-term rate of return on plan assets is based upon historical
returns of specified benchmark investment categories that are weighted by
targeted allocations of plan assets. Such returns are then compared to actual
returns achieved during the most recent ten and fifteen year periods in order to
ascertain the reasonableness of the assumptions utilized for the current plan
year. The following presentation provides an indication of targeted asset
allocation, which is specified within the investment policy, and a comparison to
historical annualized returns that provide support for the assumed expected long
term rate of return on plan assets.
Targeted 10yrs (12/31/03) 15yrs (12/31/03)
Asset Annualized Annualized
Allocation Benchmarks Returns Returns
---------- ---------- ------- -------
Equities 60% S&P 500 11.06% 12.21%
Fixed income 35% Lehman Bros Aggregate 6.95% 8.37%
Cash equivalents 5% 3 mo T-Bill 4.33% 4.81%
----- ------ -----
Total pension 100% 9.29% 10.50%
===== ====== =====
The plan currently maintains no investment in the common stock of Community and
contributions to the plan during 2004 are currently estimated to be $889,000.
The Corporation anticipates no adverse funding issues associated with the plan.
The curtailment of the plan is expected to limit future increases in pension
expense as eligible employees are no longer accruing benefits associated with
future service.
53
Community Banks, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
10. EARNINGS PER SHARE:
The following table sets forth the calculation of Basic and Diluted Earnings Per
Share for the years ended below.
2003 2002 2001
-------------------------------------------------------------------------------------------
Per-Share Per-Share Per-Share
Income Shares Amount Income Shares Amount Income Shares Amount
------ ------ ------ ------ ------ ------ ------ ------ ------
(in thousands except per share data)
Basic EPS:
Income available to common
stockholders $ 20,400 11,561 $ 1.76 $18,446 11,624 $1.59 $13,596 11,634 $1.17
======== ====== ======= ===== ======= =====
Effect of Dilutive Securities:
Incentive stock options
outstanding 341 272 235
------ ------ ------
Diluted EPS:
Income available to common
stockholders and assumed
conversion $ 20,400 11,902 $ 1.71 $18,446 11,896 $1.55 $13,596 11,869 $1.15
======== ====== ====== ======= ====== ===== ======= ====== =====
Per share and share data have been adjusted to reflect a 5% stock dividend paid
to shareholders of record April 16, 2003, and a stock split to be paid in the
form of a 20% stock dividend to shareholders of record January 16, 2004.
Antidilutive options excluded from the above earnings per share calculations for
2003, 2002 and 2001 were not significant.
54
11. INCOME TAXES:
The provision for income taxes for the years ended December 31 consists of the
following:
---------------------------------------
2003 2002 2001
---------------------------------------
(in thousands)
Current $ 4,511 $ 3,559 $ 3,785
Deferred (152) (192) (906)
-------- -------- --------
$ 4,359 $ 3,367 $ 2,879
======== ======== ========
A reconciliation of income tax expense and the amounts which would have been
recorded based upon statutory rates (35%) is as follows:
---------------------------------------
2003 2002 2001
---------------------------------------
(in thousands)
Provision on pre-tax income at statutory rate $ 8,666 $ 7,635 $ 5,766
Tax-exempt interest income (3,284) (2,939) (2,379)
Earnings on investment in insurance (473) (481) (364)
Other, net (550) (848) (144)
-------- -------- --------
Total provision for income taxes $ 4,359 $ 3,367 $ 2,879
======== ======== ========
The components of the net deferred tax asset as of December 31, were as follows:
-----------------------
2003 2002
-----------------------
(in thousands)
Deferred tax assets:
Allowance for loan losses $ 4,542 $ 4,197
Non-accrual loan interest income 230 235
Unfunded pension adjustment 1,120 814
Deferred loan fees 211 240
Deferred compensation 586 539
Alternative minimum tax 250 ---
Other 35 74
-------- --------
Total deferred tax assets 6,974 6,099
-------- --------
Deferred tax liabilities:
Depreciation $ 1,053 $ 934
Unrealized gain on available for sale securities 4,672 4,332
Pension expense 647 351
Life insurance company reserves 404 410
Other 28 20
-------- --------
Total deferred tax liabilities 6,804 6,047
-------- --------
Net deferred tax asset $ 170 $ 52
======== ========
As of December 31, 2003 and 2002, the Corporation had not established any
valuation allowance against deferred tax assets since these tax benefits are
realizable either through carry-back availability against prior years' taxable
income or the reversal of existing deferred tax liabilities.
55
Community Banks, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12. STOCK-BASED COMPENSATION:
The Corporation has a Long-term Incentive Plan (the "Plan") that allows the
Corporation to grant to employees, executive officers and directors stock awards
in the form of Incentive Stock Options, Nonqualified Stock Options or Stock
Appreciation Rights. The stock options can be granted at prices not less than
the fair market value in the case of Incentive Stock Options and not less than
80% of the fair market value in the case of Nonqualified Stock Options. The
Corporation has elected to follow Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB 25"), and related
interpretations in accounting for its stock-based compensation and to provide
the disclosures required under SFAS No. 123, "Accounting for Stock Based
Compensation" ("SFAS 123"). All options to date have been issued at fair value.
Accordingly, no compensation expense has been recognized for stock options
issued under the Plan.
In electing to follow APB 25 for expense recognition purposes, the Corporation
is obliged to provide the expanded disclosures required under SFAS No. 123 for
stock-based compensation granted. The weighted average fair values at date of
grant for options granted during fiscal years 2003, 2002, and 2001 were $8.29,
$5.94, and $6.25, respectively, and were estimated using the Black-Scholes
option valuation model with the following weighted average assumptions for 2003,
2002, and 2001, respectively: dividend yield of 2.0%, 2.6%, and 2.6%; volatility
of 22%, 26%, and 26%; risk free interest rates of 3.9%, 3.8%, and 5.5%; and
expected life in years of 7.9, 8.4, and 8.7.
As of December 31, 2003, shares totaling 968,508 were authorized but not awarded
under the Plan. The stock options generally vest from one to five years from the
date of grant, and expire no later than ten years after the date of grant. The
changes in outstanding options are as follows:
Weighted
Average
Shares Under Exercise Price
Option Per Share
---------------------------------------------------------------------------------------
Balance December 31, 2000 923,363 $ 12.63
Issued 145,530 19.95
Exercised (125,296) 9.62
Forfeited (558) 14.87
---------------------------------------------------------------------------------------
Balance December 31, 2001 943,039 $ 14.17
Issued 157,500 22.11
Exercised (105,076) 11.78
Forfeited (4,603) 17.19
---------------------------------------------------------------------------------------
Balance December 31, 2002 990,860 $ 15.70
Issued 162,000 31.92
Exercised (165,081) 12.92
Forfeited (9,403) 18.76
---------------------------------------------------------------------------------------
Balance December 31, 2003 978,376 $ 18.80
---------------------------------------------------------------------------------------
The following table provides certain information about stock options outstanding
and exercisable at December 31, 2003:
Options Outstanding Options Exercisable
--------------------------------------------------------------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Remaining Exercise
Range of exercise prices Number Price Contractual Number Price
per share Outstanding Per Share Life in Years Exercisable Per Share
-----------------------------------------------------------------------------------------------------------------
Under $9.58 96,601 $ 7.83 2.2 96,601 $ 7.83
$9.59-$12.77 31,117 $ 10.28 1.9 31,117 $ 10.28
$12.78-$15.96 326,342 $ 14.81 5.1 272,529 $ 14.88
$15.97-$19.15 73,409 $ 16.55 3.7 73,409 $ 16.55
$19.16-$22.34 288,907 $ 21.10 8.4 131,147 $ 20.93
$22.35-$31.92 162,000 $ 31.92 9.9 --- $ ---
-----------------------------------------------------------------------------------------------------------------
$6.42-$31.92 978,376 $ 18.80 6.4 604,803 $ 15.03
------------------------------------------------------------------------- ---------------------------------------
56
13. CONDENSED FINANCIAL INFORMATION OF COMMUNITY BANKS, INC. (PARENT ONLY):
------------------------
2003 2002
------------------------
(in thousands)
Condensed Balance Sheets:
Cash $ 1,241 $ 658
Interest bearing time deposits in other banks 64 ---
Investment securities, available for sale 17,130 8,494
Investment in banking subsidiary 150,688 130,412
Investment in nonbank subsidiaries 6,446 4,355
Other assets 986 774
----------- ----------
Total assets $ 176,555 $ 144,693
=========== ==========
Short-term borrowings $ 2,000 $ ---
Long term debt 30,928 15,464
Other liabilities 221 67
Stockholders' equity 143,406 129,162
----------- ----------
Total liabilities and stockholders' equity $ 176,555 $ 144,693
=========== ==========
----------------------------------
2003 2002 2001
----------------------------------
(in thousands)
Condensed Statements of Income:
Dividends from:
Banking subsidiary $ --- $ 5,000 $ 4,396
Other income (expense) (830) (354) (686)
-------- -------- --------
Income (loss) before equity in undistributed earnings of subsidiaries (830) 4,646 3,710
-------- -------- --------
Equity in undistributed earnings of:
Banking subsidiary 20,118 13,416 9,205
Nonbank subsidiaries 1,112 384 681
-------- -------- --------
21,230 13,800 9,886
-------- -------- --------
Net income $ 20,400 $ 18,446 $ 13,596
======== ======== ========
Condensed Statements of Cash Flows:
Operating activities:
Net income $ 20,400 $18,446 $13,596
Adjustments to reconcile net cash provided by operating activities:
Undistributed earnings of:
Banking subsidiary (20,118) (13,416) (9,205)
Nonbank subsidiaries (1,112) (384) (681)
Other, net (181) (1,768) 1,548
-------- -------- --------
Net cash provided by (used in) operating activities (1,011) 2,878 5,258
-------- -------- --------
Investing activities:
Purchases of investment securities (17,304) (8,494) ---
Proceeds from maturities and sales of investment securities 8,862 --- ---
Investment in subsidiary (464) (464) ---
-------- -------- --------
Net cash used in investment activities (8,906) (8,958) ---
-------- -------- --------
Financing Activities:
Net increase in short-term borrowings 2,000 --- ---
Proceeds from issuance of long term debt 15,464 15,464 ---
Proceeds from issuance of common stock 4,308 1,387 3,574
Purchases of treasury stock (3,627) (5,828) (689)
Cash dividends (7,645) (6,654) (5,880)
-------- -------- --------
Net cash provided by (used in) financing activities 10,500 4,369 (2,995)
-------- -------- --------
Net change in cash and cash equivalents 583 (1,711) 2,263
Cash and cash equivalents at beginning of year 658 2,369 106
-------- -------- --------
Cash and cash equivalents at end of year $ 1,241 $ 658 $ 2,369
======== ======== ========
57
Community Banks, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
14. REGULATORY MATTERS:
The dividends that may be paid by Community Banks, the subsidiary bank, to the
Corporation are subject to certain legal and regulatory limitations. Under such
limitations, the total amount available for payment of dividends by Community
Banks was approximately $134 million at December 31, 2003.
Under current Federal Reserve regulations, Community Banks is limited in the
amount it may loan to affiliates, including the Corporation. Loans to a single
affiliate may not exceed 10%, and the aggregate of loans to all affiliates may
not exceed 20% of bank capital and surplus. At December 31, 2003, the maximum
amount available for transfer from Community Banks to the Corporation in the
form of loans was approximately $31 million.
Community Banks and the Corporation are subject to various regulatory capital
requirements administered by banking regulators. Failure to meet minimum capital
requirements can initiate certain mandatory - and possibly additional
discretionary - actions by regulators that, if undertaken, could have a direct
material effect on the Corporations' financial statements. Under capital
adequacy guidelines and the regulatory framework for prompt corrective action,
Community Banks must meet specific capital guidelines that involve quantitative
measures of the bank's assets, liabilities, and certain off-balance-sheet items
as calculated under regulatory accounting practices. Community Banks capital
amounts and classification are also subject to qualitative judgments by the
regulators about components, risk weightings and other factors.
Quantitative measures established by regulations to ensure capital adequacy
require Community Banks and the Corporation to maintain minimum amounts and
ratios of total and Tier 1 capital to risk-weighted assets, and of Tier 1
capital to average assets (as defined in the regulations). Management believes,
as of December 31, 2003, that Community Banks and the Corporation meet the
capital adequacy requirements to which they are subject.
As of December 31, 2003 and 2002, Community Banks was "well capitalized" under
the regulatory framework for prompt corrective action based on its capital ratio
calculations. In order to be "well capitalized", the bank must maintain minimum
total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in
the following table. There are no conditions or events since December 31, 2003
that management believes have changed the bank's classification.
The following tables present the total risk-based, Tier 1 risk-based and Tier 1
leverage requirements for the Corporation and Community Banks.
As of December 31, 2003
-------------------------------------------------------------------
Actual Regulatory Minimum "Well Capitalized"
------ ------------------ ------------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
Leverage ratio
Community Banks, Inc. $159,958 8.8% $ 72,736 4% n/a n/a
Bank only $138,569 7.7% $ 72,295 4% $ 90,369 5%
Tier 1 capital ratio
Community Banks, Inc. $159,958 11.6% $ 55,176 4% n/a n/a
Bank only $138,569 10.1% $ 54,956 4% $ 82,434 6%
Total risk-based capital ratio
Community Banks, Inc. $174,367 12.6% $110,352 8% n/a n/a
Bank only $152,605 11.1% $109,912 8% $137,390 10%
58
As of December 31, 2002
-------------------------------------------------------------------
Actual Regulatory Minimum "Well Capitalized"
------ ------------------ ------------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
Leverage ratio
Community Banks, Inc. $134,354 8.2% $ 65,284 4% n/a n/a
Bank only $121,281 7.5% $ 65,037 4% $ 81,297 5%
Tier 1 capital ratio
Community Banks, Inc. $134,354 11.2% $ 48,093 4% n/a n/a
Bank only $121,281 10.1% $ 47,996 4% $ 71,994 6%
Total risk-based capital ratio
Community Banks, Inc. $147,508 12.3% $ 96,186 8% n/a n/a
Bank only $133,980 11.2% $ 95,992 8% $119,990 10%
Under current Federal Reserve guidelines, the Corporation includes trust
preferred securities in Tier 1 capital. As noted in "Recent Accounting
Pronouncements" in the Summary of Significant Accounting Policies section, FASB
Interpretation No. 46 may require the Corporation to deconsolidate its
investment in its subsidiary trusts. If trust preferred securities are no longer
included in regulatory capital, the Corporation will still meet all regulatory
capital requirements.
Community Banks is required to maintain reserves, in the form of cash and
balances with the Federal Reserve Bank, against its deposit liabilities. The
amounts of such reserves totaled $6.2 million at December 31, 2003 and $2.3
million at December 31, 2002.
15. COMMITMENTS AND CONTINGENCIES:
In the normal course of business, the Corporation is a party to financial
instruments with off-balance-sheet risk to meet the financing needs of its
customers and to reduce its own exposure to fluctuations in interest rates.
These financial instruments include commitments to originate loans and standby
letters of credit, which involve, to varying degrees, elements of credit and
interest rate risk in excess of the amount recognized in the Consolidated
Balance Sheets.
Financial instruments with off-balance-sheet risk at December 31 are as follows
(in thousands):
Contract Amount
---------------------------
2003 2002
---------------------------
Commitments to fund loans $ 76,499 $ 63,199
Unused lines of credit $ 292,813 $ 194,877
Standby letters of credit $ 34,974 $ 23,060
Unadvanced portions of construction loans $ 28,443 $ 22,177
Substantially all of the Corporation's unused commitments to originate loans and
unused lines of credit are at variable rates or will be provided at the
prevailing fixed rate when the loans are originated or the lines are used.
Commitments to extend credit are agreements to lend to a customer provided there
is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Lines of credit are similar to commitments as they
have fixed expiration dates and are driven by certain criteria contained within
the loan agreement. Lines of credit normally do not extend beyond a period of
one year. The Corporation evaluates each customer's credit worthiness on a
case-by-case basis. The amount of collateral obtained, if deemed necessary by
the Corporation upon extension of credit, is based on management's credit
evaluation of the borrower. Collateral held varies but may include accounts
receivable, inventory, and plant and equipment and personal guarantees.
59
Community Banks, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
15. COMMITMENTS AND CONTINGENCIES: (continued)
Standby letters of credit are conditional commitments issued by the subsidiary
bank to guarantee the financial or performance obligation of a customer to a
third party. Community's exposure to credit loss in the event of nonperformance
by the other party to the financial instrument for standby letters of credit is
represented by the contractual amount of those instruments. The subsidiary bank
uses the same credit policies in making conditional obligations as it does for
on-balance sheet instruments. The majority of these standby letters of credit
expire within the next twelve months. The credit risk involved in issuing
letters of credit is essentially the same as that involved in extending other
loan commitments. The subsidiary bank requires collateral and personal
guarantees supporting these letters of credit as deemed necessary. Management
believes that the proceeds obtained through a liquidation of such collateral and
the enforcement of personal guarantees would be sufficient to cover the maximum
potential amount of future payments required under the corresponding guarantees.
The current amount of the liability as of December 31, 2003 for guarantees under
standby letters of credit issued is not material.
Since a portion of the commitments are expected to expire without being drawn
upon, the total commitment amount does not necessarily represent future cash
requirements.
From time to time, the Corporation and its subsidiaries may be defendants in
legal proceedings relating to the conduct of their business. Most of such legal
proceedings are a normal part of doing business, and in management's opinion,
the financial position and results of operations of the Corporation would not be
affected materially by the outcome of such legal proceedings.
16. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED):
The following is a summary of the quarterly results of operations for the years
ended December 31, 2003 and 2002:
Three Months Ended
---------------------------------------------------------------------------------------
2003 2002
---------------------------------------------------------------------------------------
Mar.31 June 30 Sept. 30 Dec. 31 Mar. 31 June 30 Sept. 30 Dec. 31
---------------------------------------------------------------------------------------
(dollars in thousands except per share data)
Interest income $ 23,771 $ 23,723 $ 23,769 $ 23,602 $ 24,107 $ 24,215 $ 24,413 $ 23,965
Interest expense 10,698 10,694 10,515 10,422 11,638 11,876 11,465 11,233
--------- --------- -------- -------- -------- ------- -------- --------
Net interest income 13,073 13,029 13,254 13,180 12,469 12,339 12,948 12,732
Provision for loan losses 400 600 900 600 1,600 650 500 600
--------- --------- -------- -------- -------- -------- -------- --------
Net interest income after provision for
loan losses 12,673 12,429 12,354 12,580 10,869 11,689 12,448 12,132
Investment security gains, net 1,047 500 302 78 518 18 64 434
Mortgage banking activities 426 445 936 725 385 101 310 425
Other income 2,916 4,061 4,263 4,742 2,779 3,544 2,602 2,795
Other expenses 10,789 11,389 11,578 11,962 9,423 10,027 9,563 10,287
--------- --------- -------- -------- -------- -------- -------- --------
Income before income taxes 6,273 6,046 6,277 6,163 5,128 5,325 5,861 5,499
Income taxes 1,172 1,070 1,130 987 677 706 1,121 863
--------- --------- --------- -------- -------- -------- -------- --------
Net income $ 5,101 $ 4,976 $ 5,147 $ 5,176 $ 4,451 $ 4,619 $ 4,740 $ 4,636
========= ========= ======== ======== ======== ======== ======== ========
Basic earnings per share $ .44 $ .43 $ .44 $ .45 $ .38 $ .40 $ .41 $ .40
Diluted earnings per share $ .43 $ .42 $ .43 $ .43 $ .37 $ .39 $ .40 $ .39
Dividends declared $ .16 $ .16 $ .17 $ .17 $ .13 $ .14 $ .14 $ .16
Per share and share data have been adjusted to reflect a 5% stock dividend paid
to shareholders of record April 16, 2003, and a stock split to be paid in the
form of a 20% stock dividend to shareholders of record January 16, 2004.
60
17. FAIR VALUES OF FINANCIAL INSTRUMENTS:
The following methodologies and assumptions were used by the Corporation to
estimate its fair value disclosures:
CASH AND DUE FROM BANKS, INTEREST-BEARING TIME DEPOSITS, AND FEDERAL FUNDS SOLD:
The fair values for cash and due from banks, interest-bearing time deposits, and
federal funds sold is deemed to be the same as those assets' carrying amounts.
INVESTMENT SECURITIES:
Fair values for investment securities are based on quoted market prices, where
available. If quoted market prices are not available, fair values are based on
quoted market prices of comparable instruments.
ACCRUED INTEREST RECEIVABLE AND PAYABLE:
The fair values of accrued interest receivable and payable approximate their
carrying amounts.
LOANS:
For variable-rate loans that reprice frequently with no significant change in
credit risk, fair value equals carrying amount. The fair values of all other
loans held in portfolio are estimated by discounting the future cash flows using
comparable current rates at which similar loans would be made to borrowers with
similar credit risk. The fair value of loans held for sale is based on quoted
market prices for similar loans sold in securitization transactions.
DEPOSIT LIABILITIES:
The fair values of demand and savings deposits equal their carrying values. The
carrying amounts for variable rate money market accounts approximate their fair
values at the reporting date. Fair values for fixed-rate certificates of deposit
are estimated by discounting expected future cash flows using rates currently
offered for similar deposits.
SHORT-TERM BORROWINGS AND TRUST PREFERRED SECURITIES:
The fair values of short-term borrowings and trust preferred securities
approximate their carrying amounts.
LONG-TERM DEBT:
The fair values of the Corporation's long-term borrowings are estimated using
discounted cash flows analyses, based on rates available to the Corporation for
similar types of borrowings.
OFF-BALANCE-SHEET INSTRUMENTS:
Fair values for off-balance-sheet, credit-related financial instruments are
based on fees currently charged to enter into similar agreements, taking into
account the remaining terms of the agreements and the counterparties' credit
standing.
The following table summarizes the carrying amounts and fair values of financial
instruments at December 31, 2003 and 2002:
2003 2002
----------------------------------------------------------
Estimated Estimated
Carrying Fair Carrying Fair
Amount Value Amount Value
----------------------------------------------------------
(in thousands)
Financial assets:
Cash and due from banks, interest-bearing
time deposits, and federal funds sold $ 63,188 $ 63,188 $ 37,088 $ 37,088
Investment securities 646,961 646,961 667,801 667,801
Loans held for sale 6,067 6,067 11,483 11,483
Net loans 1,065,433 1,070,977 892,225 911,547
Interest receivable 8,819 8,819 9,999 9,999
Financial liabilities:
Deposits $ 1,230,685 $ 1,237,438 $ 1,132,913 $ 1,144,891
Short-term borrowings 27,764 27,764 69,125 69,125
Long-term debt 411,422 420,306 320,533 344,236
Trust preferred securities 30,000 30,000 15,000 15,000
Interest payable 3,289 3,289 3,271 3,271
Off-balance-sheet instruments --- --- --- ---
61
Community Banks, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
18. COMPLETED ACQUISITIONS:
In April 2003, Community completed the acquisition of Abstracting Company of
York County (ABCO), a title insurance abstracting company. Shareholders of ABCO
received 25,760 shares for the 96,920 shares of outstanding ABCO common shares
in a tax-free exchange.
The following cash acquisitions were completed during 2003: In June, Community
acquired The Shultz Agency, an insurance agency providing both commercial and
personal lines of insurance; in July, Community acquired Erie Financial Group,
LTD., a company providing mortgage origination services; and in September,
Community acquired Your Insurance Partnership, an insurance agency group
specializing in personal insurance services.
All of the above acquisitions were accounted for as purchases, and accordingly,
the results of operations of each entity are included in Community's
consolidated statement of income from the date of acquisition. The acquisitions,
individually and in the aggregate, are immaterial to Community's financial
position and results of operations. Goodwill arising from the acquisitions will
be subject to periodic impairment testing and other intangibles will be
amortized over their estimated useful lives.
62
[GRAPHIC OMITTED]
Beard Miller Company LLP
Certified Public Accountants
[GRAPHIC OMITTED]
Report of Independent Accountants
---------------------------------
The Board of Directors and Stockholders
Community Banks, Inc.
Harrisburg, Pennsylvania
We have audited the accompanying consolidated balance sheet of Community Banks,
Inc. and subsidiaries as of December 31, 2003, and the related consolidated
statements of income, changes in stockholders' equity, and cash flows for the
year then ended. These consolidated financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these consolidated financial statements based on our audit. The consolidated
financial statements of Community Banks, Inc. for the years ended December 31,
2002 and 2001 were audited by other auditors, whose report dated January 24,
2003, expressed an unqualified opinion on those statements.
We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the 2003 consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Community
Banks, Inc. and subsidiaries as of December 31, 2003 and the results of their
operations and their cash flows for the year ended in conformity with accounting
principles generally accepted in the United States of America.
/S/ Beard Miller Company LLP
Harrisburg, Pennsylvania
January 19, 2004
63
Item 9. Changes in and Disagreements With Accountants on Accounting and
- --------------------------------------------------------------------------------
Financial Disclosure:
- ---------------------
On June 4, 2003, Community dismissed its independent accountants,
PricewaterhouseCoopers LLP (PricewaterhouseCoopers) and appointed Beard Miller
Company LLP (Beard) as its new independent accountants, each effective
immediately. The decisions to dismiss PricewaterhouseCoopers and to engage Beard
were approved by Community's Audit Committee.
PricewaterhouseCoopers' report on Community's consolidated financial statements
for 2002 and 2001 contained no adverse opinion or disclaimer of opinion or
qualification or modification as to uncertainty, audit scope or accounting
principles.
During the fiscal years 2002 and 2001 and subsequent interim periods, there were
no disagreements or reportable events relating to any matter of accounting
principles and practices, financial statements disclosure or auditing scope or
procedure, which PricewaterhouseCoopers would have referred to in connection
with its report if the disagreement was not resolved to its satisfaction.
Community acknowledges that disagreements required to be reported in response to
the preceding sentence include both those resolved to PricewaterhouseCoopers'
satisfaction and those not resolved to PricewaterhouseCoopers' satisfaction.
Community further acknowledges that disagreements contemplated by this rule are
those which occurred at the decision-making level, i.e., between Community
personnel responsible for the presentation of its financial statements and
PricewaterhouseCoopers personnel responsible for rendering its report. There
have been no reportable events within the meaning of Item 304 of Regulation S-K.
Item 9A. Controls and Procedures:
- ---------------------------------
Under the supervision and with the participation of the Company's management,
including its Chief Executive Officer and Chief Financial Officer, the Company
has evaluated the effectiveness of its disclosure controls and procedures as of
December 31, 2003. Based upon this evaluation, the Chief Executive Officer and
Chief Financial Officer have concluded that the Company's disclosure controls
and procedures are adequate and effective to ensure that material information
relating to the Company and its consolidated subsidiaries is made known to them
by others within those entities, particularly during the period in which this
report was prepared. There have not been any changes in the Company's internal
control over financial reporting (as such term is defined in Rules 13a-15(f) and
15d-15(f) under the Exchange Act) during the most recent fiscal quarter that
have materially affected, or are reasonably likely to materially affect, the
Company's internal control over financial reporting.
64
PART III
Item 10. Directors and Executive Officers of the Registrant:
- ------------------------------------------------------------
Incorporated by reference to the Corporation's definitive Proxy Statement for
its 2004 Annual Meeting of Shareholders, which will be filed on or before April
29, 2004.
Copies of Community's Code of Ethics for the Chief Executive Officer and
Financial Professionals are available on Community's website,
www.communitybanks.com, or by writing to Donald F. Holt, EVP/CFO, Community
Banks, Inc., 750 East Park Drive, Harrisburg, PA 17111.
Item 11. Executive Compensation:
- --------------------------------
Incorporated by reference to the Corporation's definitive Proxy Statement for
its 2004 Annual Meeting of Shareholders, which will be filed on or before April
29, 2004.
Item 12. Security Ownership of Certain Beneficial Owners and Management and
- --------------------------------------------------------------------------------
Related Stockholder Matters:
- ----------------------------
Incorporated by reference to the Corporation's definitive Proxy Statement for
its 2004 Annual Meeting of Shareholders, which will be filed on or before April
29, 2004.
Item 13. Certain Relationships and Related Transactions:
- --------------------------------------------------------
Incorporated by reference to the Corporation's definitive Proxy Statement for
its 2004 Annual Meeting of Shareholders, which will be filed on or before April
29, 2004.
Item 14. Principal Accounting Fees and Services:
- ------------------------------------------------
Information concerning the fees billed by our independent auditor and the nature
of services comprising the fees for each of the two most recent fiscal years in
each of the following categories: (i) audit fees, (ii) audit - related fees,
(iii) tax fees and (iv) all other fees, is set forth in the Audit Committee
Report segment of the Corporation's definitive Proxy Statement for its 2004
Annual Meeting of Shareholders and is incorporated herein by reference.
Information concerning our Audit Committee's policies and procedures pertaining
to pre-approval of audit and non-audit services rendered by our independent
auditor is set forth in the Audit Committee segment of the Corporation's
definitive Proxy Statement for its 2004 Annual Meeting of Shareholders and is
incorporated herein by reference.
65
PART IV
Item 15. Exhibits, Financial Statements Schedules and Reports on Form 8-K:
- ---------------------------------------------------------------------------
(a) The following documents are filed as part of this report:
1. Financial Statements - The following consolidated financial statements
of Community Banks, Inc. and Subsidiaries are incorporated herein by
reference in response to Item 8 above:
(i) Consolidated Balance Sheets at December 31, 2003 and 2002
(ii) Consolidated Statements of Income for the Years Ended December 31,
2003, 2002 and 2001 (
iii) Consolidated Statements of Changes in Stockholders' Equity for the
Years Ended December 31, 2003, 2002 and 2001.
(iv) Consolidated Statements of Cash Flows for the Years Ended December 31,
2003, 2002 and 2001.
(v) Notes to Consolidated Financial Statements
(vi) Report of Beard Miller Company LLP, Independent Accountants
2. Financial Statement Schedules - All financial statement schedules for
which provision is made in the applicable accounting regulations of
the Securities and Exchange Commission are not required under the
related instructions or are inapplicable and have therefore been
omitted.
3. Exhibits
3(i) Amended Articles of Incorporation (Incorporated by reference to
Exhibit 3.1, attached to Community's registration on Form 8-A,
filed on May 13, 2002)
3(ii)Amended By-Laws (Incorporated by reference to Exhibit 3.2,
attached to Community's Quarterly Report on Form 10-Q for the
quarter ended March 31, 2003, filed with the Commission on May
15, 2003)
4 Instruments defining the rights of the holders of trust capital
securities and sold by Community in December 2002 and in December
2003 are not attached, as the amount of such securities is less
than 10% of the consolidated assets of Community and its
subsidiaries, and the securities have not been registered.
Community agrees to provide copies of such instruments to the SEC
upon request.
10.1 2000 Directors' Stock Option Plan, incorporated by reference to
Exhibit 4 to Community's registration on Form S-8, filed on May
17, 2000 (Incorporated by reference to Exhibit 10.1 to
Community's Annual Report on Form 10-K for the year ended
December 31, 2002, filed with the Commission on March 28, 2003)
10.2 1998 Long-Term Incentive Plan, incorporated by reference to
Exhibit 4 to Community's registration on Form S-8, filed on June
18, 1998(Incorporated by reference to Exhibit 10.2 to Community's
Annual Report on Form 10-K for the year ended December 31, 2002,
filed with the Commission on March 28, 2003)
10.3 Form of Stock Option Agreement - Directors Stock Option Plan
(Incorporated by reference to Exhibit 10.3 to Community's Annual
Report on Form 10-K for the year ended December 31, 2002, filed
with the Commission on March 28, 2003)
10.4 Form of Stock Option Agreement - Long-Term Incentive Plan
(Incorporated by reference to Exhibit 10.4 to Community's Annual
Report on Form 10-K for the year ended December 31, 2002, filed
with the Commission on March 28, 2003)
10.5 Employment Agreement of Eddie L. Dunklebarger (Incorporated by
reference to Exhibit 10.5 to Community's Annual Report on Form
10-K for the year ended December 31, 2002, filed with the
Commission on March 28, 2003)*
10.6 Employment Agreement of Donald F. Holt (Incorporated by reference
to Exhibit 10.6 to Community's Annual Report on Form 10-K for the
year ended December 31, 2002, filed with the Commission on March
28, 2003) *
10.7 Employment Agreement, and amendment thereto, of Robert W. Lawley
(Incorporated by reference to Exhibit 10.7 to Community's Annual
Report on Form 10-K for the year ended December 31, 2002, filed
with the Commission on March 28, 2003)*
10.8 Employment Agreement, and amendment thereto, of Anthony N. Leo
(Incorporated by reference to Exhibit 10.8 to Community's Annual
Report on Form 10-K for the year ended December 31, 2002, filed
with the Commission on March 28, 2003) *
10.9 Employment Agreement, and amendment thereto, of Jeffrey M.
Seibert (Incorporated by reference to Exhibit 10.9 to Community's
Annual Report on Form 10-K for the year ended December 31, 2002,
filed with the Commission on March 28, 2003) *
66
10.10 Salary Continuation Agreement, and amendment thereto, of Eddie
L. Dunklebarger (Incorporated by reference to Exhibit 10.10 to
Community's Annual Report on Form 10-K for the year ended
December 31, 2002, filed with the Commission on March 28, 2003) *
10.11 Salary Continuation Agreement, and amendment thereto, of Robert
W. Lawley (Incorporated by reference to Exhibit 10.11 to
Community's Annual Report on Form 10-K for the year ended
December 31, 2002, filed with the Commission on March 28, 2003) *
10.12 Salary Continuation Agreement, and amendment thereto, of Anthony
N. Leo (Incorporated by reference to Exhibit 10.12 to Community's
Annual Report on Form 10-K for the year ended December 31, 2002,
filed with the Commission on March 28, 2003) *
10.13 Salary Continuation Agreement, and amendment thereto, of Jeffrey
M. Seibert (Incorporated by reference to Exhibit 10.13 to
Community's Annual Report on Form 10-K for the year ended
December 31, 2002, filed with the Commission on March 28, 2003) *
10.14 Rights Agreement between Community Banks, Inc. and Community
Banks, dated February 28, 2002, incorporated by reference to
Exhibit 1 to Community's registration on Form 8-A, filed on
February 27, 2002
10.15 Community Banks, Inc. 401(k) Plan (Incorporated by reference to
Exhibit 10.15 to Community's Annual Report on Form 10-K for the
year ended December 31, 2002, filed with the Commission on March
28, 2003)
10.16 Survivor Income Agreement, with Split Dollar Addendum thereto,
of Eddie L. Dunklebarger (Incorporated by reference to Exhibit
3.2, attached to Community's Quarterly Report on Form 10-Q for
the quarter ended September 30, 2003) *
10.17 Survivor Income Agreement, with Split Dollar Addendum thereto,
of Robert W. Lawley (Incorporated by reference to Exhibit 3.2,
attached to Community's Quarterly Report on Form 10-Q for the
quarter ended September 30, 2003) *
10.18 Survivor Income Agreement, with Split Dollar Addendum thereto,
of Anthony N. Leo (Incorporated by reference to Exhibit 3.2,
attached to Community's Quarterly Report on Form 10-Q for the
quarter ended September 30, 2003) *
10.19 Survivor Income Agreement, with Split Dollar Addendum thereto,
of Jeffrey M. Seibert (Incorporated by reference to Exhibit 3.2,
attached to Community's Quarterly Report on Form 10-Q for the
quarter ended September 30, 2003) *
14 Code of Ethics (for the Chief Executive Officer and Financial
Professionals)
16 Letter re: Change In Certifying Accountant (Incorporated by
reference to Exhibit 16, attached to Community's Current Report
on Form 8-K, filed with the Commission on June 9, 2003)
21 Subsidiaries of the Registrant (See Item 1, page #3)
23.1 Consent of Independent Accountants - Beard Miller Company LLP
23.2 Consent of Independent Accountants - PricewaterhouseCoopers LLP
31.1 Rule 13a-14(a)/15d-14(a) Certification (Chief Executive Officer)
31.2 Rule 13a-14(a)/15d-14(a) Certification (Chief Financial Officer)
32.1 Section 1350 Certification (Chief Executive Officer)
32.2 Section 1350 Certification (Chief Financial Officer)
99 Report of Independent Accountants - PricewaterhouseCoopers LLP
*identifies a management contract or compensatory plan or arrangement
b) The registrant filed the following reports on Form 8-K during the
fourth calendar quarter of the year ended December 31, 2003:
Report Dated October 16, 2003
------------------------------
Registrant announced its earnings for the period ended September 30,
2003.
Report Dated November 3, 2003
-----------------------------
Registrant announced its intentions to enter into an agreement with
Bryn Mawr Trust Co. pursuant to which registrant's subsidiary,
CommunityBanks, will engage Bryn Mawr Trust to provide investment
management services to its trust and asset management department.
Report Dated November 4, 2003
-----------------------------
Registrant released information pursuant to Regulation FD with respect
to presentation materials, which were made available to the investment
community by Community Banks, Inc.
Report Dated November 4, 2003
-----------------------------
Registrant announced a cash dividend payable January 2, 2004.
Registrant also announced a stock split payable in the form of a 20%
stock dividend payable January 30, 2004.
Report Dated December 16, 2003
------------------------------
Registrant announced the issuance of $15 million of trust preferred
securities.
67
(c) Exhibits - The exhibits required to be filed as part of this report
are submitted as a separate section of this report.
(d) Financial Statement Schedules - None required.
68
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
Community Banks, Inc.
By: /S/ (Eddie L. Dunklebarger)
---------------------------
(Eddie L. Dunklebarger)
Chairman of the Board, President, Chief Executive Officer and Director
Date: March 10, 2004
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
/S/ (Donald F. Holt) Ex. Vice President and 03/10/04
- ------------------------------------ Chief Financial Officer --------
(Donald F. Holt) (Principal Accounting Officer)
/S/ (Ronald E. Boyer) Director 03/10/04
- ------------------------------------ --------
(Ronald E. Boyer)
/S/ (Samuel E. Cooper) Director 03/10/04
- ------------------------------------ --------
(Samuel E. Cooper)
/S/ (Kenneth L. Deibler) Director 03/10/04
- ------------------------------------ --------
(Kenneth L. Deibler)
/S/ (Peter Desoto) Director 03/10/04
- ------------------------------------ --------
(Peter DeSoto)
/S/ (Thomas W. Long) Director 03/10/04
- ------------------------------------ --------
(Thomas W. Long)
/S/ (Donald L. Miller) Director 03/10/04
- ------------------------------------ --------
(Donald L. Miller)
/S/ (Thomas L. Miller) Director 03/10/04
- ------------------------------------ --------
(Thomas L. Miller)
/S/ (Earl L. Mummert) Director 03/10/04
- ------------------------------------ --------
(Earl L. Mummert)
/S/ (Wayne H. Mummert) Director 03/10/04
- ------------------------------------ --------
(Wayne H. Mummert)
/S/ (Scott J. Newkam) Director 03/10/04
- ------------------------------------ --------
(Scott J. Newkam)
/S/ (Robert W. Rissinger) Director 03/10/04
- ------------------------------------ --------
(Robert W. Rissinger)
/S/ (Allen Shaffer) Director 03/10/04
- ------------------------------------ --------
(Allen Shaffer)
/S/ (John W. Taylor, Jr.) Director 03/10/04
- ------------------------------------ --------
(John W. Taylor, Jr.)
/S/ (James A. Ulsh) Director 03/10/04
- ------------------------------------ --------
(James A. Ulsh)
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