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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2004
0-15786
-------
(Commission File Number)
COMMUNITY BANKS, INC.
---------------------
(Exact name of registrant as specified in its charter)
PENNSYLVANIA 23-2251762
------------ ----------
(State of incorporation) (I.R.S. Employer Identification Number)
750 East Park Dr., Harrisburg, PA 17111
- ---------------------------------------- -------------
(Address of principal executive offices) (Zip Code)
(717) 920-1698
--------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Sections 12, 13, or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
------------ -----------
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes X No
------------ ------------
Number of shares outstanding as of October 31, 2004
CAPITAL STOCK-COMMON 12,221,503
-------------------- ----------
(Title of Class) (Outstanding Shares)
COMMUNITY BANKS, INC. AND SUBSIDIARIES
FORM 10-Q
INDEX
PART I - Financial Information Page
Item 1. Financial Statements
Consolidated Interim Balance Sheets 3
Consolidated Interim Statements of Income 4
Consolidated Interim Statements of Changes in Stockholders' Equity 5
Consolidated Interim Statements of Cash Flows 6
Notes to Consolidated Interim Financial Statements 7-11
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 12-21
Item 3. Quantitative and Qualitative Disclosures About Market Risk 22
Item 4. Controls and Procedures 23
PART II - Other Information
Item 1. Legal Proceedings 24
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 24
Item 3. Defaults Upon Senior Securities 24
Item 4. Submission of Matters to a Vote of Security Holders 24
Item 5. Other Information 24
Item 6. Exhibits 25
SIGNATURES 26
2
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
- -----------------------------
Community Banks, Inc. and Subsidiaries
CONSOLIDATED INTERIM BALANCE SHEETS
(Dollars in thousands except per share data)
September 30, December 31,
2004 2003
-------------------- --------------------
ASSETS (Unaudited)
Cash and due from banks $ 38,736 $ 42,790
Federal funds sold 9,566 17,097
-------------------- --------------------
Cash and cash equivalents 48,302 59,887
Interest-bearing time deposits in other banks 1,770 3,301
Investment securities, available for sale 643,591 646,961
Loans held for sale 1,168 6,067
Loans 1,188,280 1,078,611
Less: Allowance for loans losses (14,436) (13,178)
-------------------- --------------------
Net loans 1,173,844 1,065,433
Premises and equipment, net 24,914 24,153
Goodwill and identifiable intangible assets 5,036 4,773
Accrued interest receivable and other assets 57,186 50,488
-------------------- --------------------
Total assets $ 1,955,811 $ 1,861,063
==================== ====================
LIABILITIES
Deposits
Non-interest bearing $ 186,613 $ 165,174
Interest bearing 1,133,863 1,065,511
-------------------- --------------------
Total deposits 1,320,476 1,230,685
Short-term borrowings 34,699 27,764
Long-term debt 406,370 411,422
Subordinated debt 30,928 30,928
Accrued interest payable and other liabilities 13,919 16,858
-------------------- --------------------
Total liabilities 1,806,392 1,717,657
-------------------- --------------------
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; 12,422,000 and 11,851,000 shares issued 62,108 59,256
Surplus 73,229 57,563
Retained Earnings 14,694 24,297
Accumulated other comprehensive income,
net of tax 5,050 6,596
Treasury stock; 238,000 and 203,000
shares in 2004 and 2003, at cost (5,662) (4,306)
-------------------- --------------------
Total stockholders' equity 149,419 143,406
-------------------- --------------------
Total liabilities and stockholders' equity $ 1,955,811 $ 1,861,063
==================== ====================
The accompanying notes are an integral part of the consolidated interim
financial statements.
3
Community Banks, Inc. and Subsidiaries
CONSOLIDATED INTERIM STATEMENTS OF INCOME
(Unaudited)
(Dollars in thousands except per share data)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------- ---------------------------------
2004 2003 2004 2003
------------------------------- ---------------------------------
INTEREST INCOME:
Loans, including fees $ 17,712 $ 16,691 $ 51,366 $ 49,121
Investment securities:
Taxable 4,816 4,297 14,469 13,869
Tax exempt 2,176 2,246 6,629 6,777
Dividends 501 531 1,564 1,489
Other 22 4 61 7
-------------- ------------- -------------- --------------
Total interest income 25,227 23,769 74,089 71,263
-------------- ------------- -------------- --------------
INTEREST EXPENSE:
Deposits 5,669 5,663 16,802 17,555
Short-term borrowings 202 365 524 1,129
Long-term debt 4,655 4,316 13,664 12,697
Subordinated debt 408 176 1,163 542
-------------- ------------- -------------- --------------
Total interest expense 10,934 10,520 32,153 31,923
-------------- ------------- -------------- --------------
Net interest income 14,293 13,249 41,936 39,340
Provision for loan losses 750 900 2,350 1,900
-------------- ------------- -------------- --------------
Net interest income after provision for loan losses 13,543 12,349 39,586 37,440
-------------- ------------- -------------- --------------
NON-INTEREST INCOME:
Investment management and trust services 443 292 1,119 942
Service charges on deposit accounts 1,996 1,350 5,108 3,686
Other service charges, commissions and fees 888 799 2,565 2,329
Investment security gains 108 302 2,284 1,849
Insurance premium income and commissions 708 819 2,387 2,077
Mortgage banking activities 558 936 2,013 1,807
Earnings on investment in life insurance 433 372 1,210 1,144
Other 878 636 1,105 1,078
-------------- ------------- -------------- --------------
Total non-interest income 6,012 5,506 17,791 14,912
-------------- ------------- -------------- --------------
NON-INTEREST EXPENSES:
Salaries and employee benefits 6,975 6,623 20,851 18,799
Net occupancy 1,962 1,820 5,990 5,364
Marketing expense 611 412 1,900 1,497
Telecommunications expense 318 425 979 952
Other 2,664 2,298 7,655 7,144
-------------- ------------- -------------- --------------
Total non-interest expenses 12,530 11,578 37,375 33,756
-------------- ------------- -------------- --------------
Income before income taxes 7,025 6,277 20,002 18,596
Income taxes 1,379 1,130 3,744 3,372
-------------- ------------- -------------- --------------
Net income $ 5,646 $ 5,147 $ 16,258 $ 15,224
============== ============= ============== ==============
CONSOLIDATED PER SHARE DATA:
Basic earnings per share $ 0.46 $ 0.42 $ 1.33 $ 1.25
Diluted earnings per share $ 0.45 $ 0.41 $ 1.29 $ 1.22
Dividends declared $ 0.17 $ 0.16 $ 0.50 $ 0.47
The accompanying notes are an integral part of the consolidated interim
financial statements.
4
Community Banks, Inc. and Subsidiaries
CONSOLIDATED INTERIM STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(Unaudited)
(In thousands)
Accumulated
Other
Outstanding Common Retained Comprehensive Treasury Total
Income
Shares Stock Surplus Earnings (Loss) Stock Equity
----------- ----------- ----------- ------------ ------------- ------------ -----------
Balance, January 1, 2003 9,151 $ 47,053 $ 46,418 $ 35,344 $ 6,538 $ (6,191) $ 129,162
Comprehensive income:
Net income 15,224 15,224
Unrealized loss on securities,
net of reclassification
adjustment and tax effect (2,087) (2,087)
-----------
Total comprehensive income 13,137
Cash dividends (5,678) (5,678)
5% stock dividend 458 2,346 10,612 (12,984) (26)
Stock split paid in the form of a
20% stock dividend 1,975 9,878 (9,878) ---
Purchases of treasury
stock (115) (3,275) (3,275)
Exercise of common stock options
and issuances under stock
purchase plan 179 (11) (619) 3,661 3,031
Tax benefits from employee stock
transactions 359 359
----------- ----------- ----------- ------------ ------------- ------------ -----------
Balance, September 30, 2003 11,648 $ 59,266 $ 57,389 $ 21,409 $ 4,451 $ (5,805) $ 136,710
=========== =========== =========== ============ ============= ============ ===========
Balance, January 1, 2004 11,648 $ 59,256 $ 57,563 $ 24,297 $ 6,596 $ (4,306) $ 143,406
Comprehensive income (loss):
Net income 16,258 16,258
Unrealized loss on securities,
net of reclassification
adjustment and tax effect (1,546) (1,546)
-----------
Total comprehensive income (loss) 14,712
Cash dividends (6,136) (6,136)
5% stock dividend 584 2,953 15,103 (18,085) (29)
Stock split paid in the form of a
20% stock dividend (fractional
shares) (4) (25) (29)
Purchases of treasury stock (144) (4,151) (4,151)
Exercise of common stock options
and issuances under stock
purchase plan 96 (97) (1,615) 2,795 1,083
Tax benefits from employee stock
transactions 563 563
----------- ----------- ----------- ------------ ------------- ------------ -----------
Balance, September 30, 2004 12,184 $ 62,108 $ 73,229 $ 14,694 $ 5,050 $ (5,662) $ 149,419
=========== =========== =========== ============ ============= ============ ===========
The accompanying notes are an integral part of the consolidated interim
financial statements.
5
Community Banks, Inc. and Subsidiaries
CONSOLIDATED INTERIM STATEMENTS OF CASH FLOWS
(Unaudited)
(Dollars in thousands)
> Nine Months Ended
September 30,
-------------------------------------------
2004 2003
-------------------------------------------
Operating Activities:
Net income $ 16,258 $ 15,224
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 2,350 1,900
Depreciation and amortization 2,480 2,309
Amortization of security premiums and discounts, net 929 2,109
Investment security gains (2,284) (1,849)
Loans originated for sale (9,331) (58,880)
Proceeds from sales of loans held for sale 14,571 64,866
Gains on loan sales (1,065) (1,338)
Earnings on investment in life insurance (1,210) (1,144)
Change in other assets, net 1,259 3,989
Change in accrued interest payable and other liabilities, net (2,405) (2,554)
------------------ -------------------
Net cash provided by operating activities 21,552 24,632
------------------ -------------------
Investing Activities:
Net (increase) decrease in interest-bearing time deposits
in other banks 1,531 (228)
Proceeds from sales of investment securities 109,450 153,233
Proceeds from maturities of investment securities 100,908 126,803
Purchases of investment securities (207,978) (248,966)
Net increase in total loans (115,739) (165,852)
Proceeds from sale of credit card portfolio 4,556 ---
Investment in life insurance (5,000) ---
Net additions to premises and equipment (2,895) (2,311)
Other (382) (2,584)
------------------ -------------------
Net cash used by investing activities (115,549) (139,905)
------------------ -------------------
Financing Activities:
Net increase in deposits 89,791 77,719
Net increase (decrease) in short-term borrowings (18,065) 23,810
Proceeds from issuance of long-term debt 35,000 30,000
Repayment of long-term debt (15,052) (2,451)
Cash dividends and cash paid in lieu of fractional shares (6,194) (5,704)
Purchases of treasury stock (4,151) (3,275)
Proceeds from issuance of common stock 1,083 2,281
------------------ -------------------
Net cash provided by financing activities 82,412 122,380
------------------ -------------------
Increase (decrease) in cash and cash equivalents (11,585) 7,107
Cash and cash equivalents at beginning of period 59,887 36,137
------------------ -------------------
Cash and cash equivalents at end of period $ 48,302 $ 43,244
================== ===================
The accompanying notes are an integral part of the consolidated interim
financial statements.
6
Community Banks, Inc. and Subsidiaries
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Unaudited)
1. Summary of Significant Accounting Policies
- ----------------------------------------------
Basis of Presentation - The accompanying unaudited consolidated financial
statements of Community Banks, Inc. and Subsidiaries ("Community") have been
prepared in accordance with accounting principles generally accepted in the
United States for interim financial information and instructions to Form 10-Q
and Article 10 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by accounting principles generally accepted
in the United States for complete financial statements. In the opinion of
management, all adjustments, consisting of normal recurring accruals, considered
necessary for a fair presentation have been included.
Operating results for the nine months ended September 30, 2004, are not
necessarily indicative of the results that may be expected for the year ending
December 31, 2004.
For further information, refer to the audited consolidated financial statements,
and footnotes thereto, included in the Annual Report on Form 10-K, for the year
ended December 31, 2003.
Community is a financial holding company whose wholly-owned subsidiaries include
Community Banks, Community Bank Investments, Inc. (CBII), and Community Banks
Life Insurance Co. (CBLIC). Community Banks provides a wide range of services
through its network of offices in Adams, Cumberland, Dauphin, Luzerne,
Northumberland, Schuylkill, Snyder, and York Counties in Pennsylvania and
Carroll and Montgomery Counties in Maryland.
Statement of Cash Flows - Cash and cash equivalents include cash and due from
banks and federal funds sold. In 2004, $25 million of maturing long-term debt
was refinanced with short-term borrowings in a non-cash transaction.
Stock-Based Compensation - Community has a stock-based compensation plan and
accounts for this plan under the recognition and measurement principles 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 Community had applied the
fair value recognition provisions of FASB No. 123, "Accounting for Stock-Based
Compensation," to stock-based compensation.
(Dollars in thousands, except per share data)
Three Months Ended Nine Months Ended
September 30, September 30,
2004 2003 2004 2003
---------------------------- -----------------------------
Net income, as reported $ 5,646 $ 5,147 $ 16,258 $ 15,224
Deduct: Total stock-based compensation
expense determined under fair value based
method for all awards, net of related tax effect (322) (187) (967) (560)
------------ ------------ ------------ -------------
Pro forma net income $ 5,324 $ 4,960 $ 15,291 $ 14,664
============ ============ ============ =============
Earnings per share:
Basic - as reported $ 0.46 $ 0.42 $ 1.33 $ 1.25
Basic - pro forma $ 0.44 $ 0.41 $ 1.25 $ 1.21
Diluted - as reported $ 0.45 $ 0.41 $ 1.29 $ 1.22
Diluted - pro forma $ 0.43 $ 0.40 $ 1.22 $ 1.18
7
Community Banks, Inc. and Subsidiaries
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS, (continued)
(Unaudited)
Comprehensive Income (Loss):
The components of other comprehensive income (loss) and related tax effects for
periods ended September 30 are as follows (in thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------------- --------------------------------
2004 2003 2004 2003
-------------------------------- --------------------------------
Unrealized holding gains (losses)
on available-for-sale securities $ 16,503 $ (13,813) $ (94) $ (1,362)
Reclassification adjustments for
gains included in net income (108) (302) (2,284) (1,849)
-------------- -------------- -------------- --------------
Net unrealized gains (losses) 16,395 (14,115) (2,378) (3,211)
Tax effect (5,738) 4,940 832 1,124
-------------- -------------- -------------- --------------
$ 10,657 $ (9,175) $ (1,546) $ (2,087)
============== ============== ============== ==============
The components of accumulated other comprehensive income, included in
stockholders' equity, are as follows (in thousands):
September 30, December 31,
2004 2003
------------------- -------------------
Net unrealized gain on
available-for-sale securities $ 10,968 $ 13,347
Tax effect (3,839) (4,672)
------------------- -------------------
Net-of-tax amount 7,129 8,675
------------------- -------------------
Unfunded pension liability (3,199) (3,199)
Tax effect 1,120 1,120
------------------- -------------------
Net-of-tax amount (2,079) (2,079)
------------------- -------------------
Accumulated other comprehensive income $ 5,050 $ 6,596
=================== ===================
Reclassifications - Certain amounts reported in the prior year have been
reclassified to conform with the 2004 presentation. These reclassifications did
not impact the Corporation's financial condition or results of operations.
Recent Accounting Developments - In March 2004, the Emerging Issues Task Force
(EITF) reached consensus on Issue 03-01, "The Meaning of Other-Than-Temporary
Impairment and Its Application to Certain Investments." EITF No. 03-01 includes
new guidance for evaluating and recording impairment losses on debt and equity
investments, as well as new disclosure requirements for investments that are
deemed to be temporarily impaired. The accounting guidance of EITF No. 03-01 is
effective for fiscal years beginning after June 15, 2004, while the disclosure
requirements are effective for fiscal years ending after June 15, 2004. The
Corporation has not yet determined the impact that adoption will have on its
financial position or results of operations as the impact is heavily dependent
on the interest rate environment at the date of adoption and pending
implementation guidance from the Financial Accounting Standards Board.
8
Community Banks, Inc. and Subsidiaries
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS, (continued)
(Unaudited)
2. Allowance for loan losses:
- ------------------------------
Changes in the allowance for loan losses are as follows (in thousands):
Nine Months Ended Year Ended Nine Months Ended
September 30, December 31, September 30,
2004 2003 2003
------------------- ---------------- --------------------
Balance, January 1 $ 13,178 $ 12,343 $ 12,343
Provision for loan losses 2,350 2,500 1,900
Loan charge-offs (1,988) (2,839) (1,360)
Recoveries 896 1,174 557
------------------- ---------------- --------------------
Balance, end of period $ 14,436 $ 13,178 $ 13,440
=================== ================ ====================
The following table summarizes period-end risk elements (in thousands):
September 30, December 31, September 30,
2004 2003 2003
------------------- ---------------- ------------------
Non-accrual loans $ 5,990 $ 8,151 $ 11,310
Foreclosed real estate 2,203 4,865 572
------------------- ---------------- ------------------
Total non-performing assets 8,193 13,016 11,882
Accruing loans 90 days past due 16 90 71
------------------- ---------------- ------------------
Total risk elements $ 8,209 $ 13,106 $ 11,953
=================== ================ ==================
9
Community Banks, Inc. and Subsidiaries
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS, (continued)
(Unaudited)
3. Earnings Per Share:
- -----------------------
Basic earnings per share is computed as net income divided by the weighted
average number of shares outstanding. Diluted earnings per share reflects
additional common shares that would have been outstanding as a result of
converting common stock equivalents, calculated using the treasury stock method.
Common stock equivalents consist solely of outstanding stock options.
Earnings per share for the three months and nine months ended September 30, 2004
and 2003 have been computed as follows (in thousands, except per share data):
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------- --------------------------
2004 2003 2004 2003
------------ ----------- ----------- -----------
Net income $ 5,646 $ 5,147 $ 16,258 $ 15,224
============ =========== =========== ===========
Weighted average shares outstanding (basic) 12,189 12,139 12,235 12,120
Effect of dilutive stock options 319 362 347 328
------------ ----------- ----------- -----------
Weighted average shares outstanding (diluted) 12,508 12,501 12,582 12,448
============ =========== =========== ===========
Per share information:
Basic earnings per share $ 0.46 $ 0.42 $ 1.33 $ 1.25
Diluted earnings per share 0.45 0.41 1.29 1.22
Per share and number of share amounts reflect stock splits and dividends.
4. Guarantees:
- ----------------
Community does not issue any guarantees that would require liability recognition
or disclosure, other than its standby letters of credit. Standby letters of
credit written are conditional commitments issued by Community to guarantee the
performance of a customer to a third party. Generally, all letters of credit,
when issued have expiration dates within one year. The credit risk involved in
issuing letters of credit is essentially the same as those that are involved in
extending loan facilities to customers. Community generally holds collateral
and/or personal guarantees supporting these commitments. Community had issued
$35.6 million of standby letters of credit as of September 30, 2004. Management
believes that the proceeds obtained through a liquidation of collateral and the
enforcement of guarantees would be sufficient to cover the potential amount of
future payment required under the corresponding guarantees. The current amount
of the liability as of September 30, 2004, for guarantees under standby letters
of credit issued is not material.
10
Community Banks, Inc. and Subsidiaries
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS, (continued)
(Unaudited)
5. Subordinated Debt to Unconsolidated Subsidiary Trusts
- ---------------------------------------------------------
In January 2003, the Financial Accounting Standards Board issued FASB
Interpretation No. 46, "Consolidation of Variable Interest Entities, an
Interpretation of ARB No. 51" which was revised in December 2003. This
Interpretation provides guidance for the consolidation of variable interest
entities (VIEs). CMTY Capital Trust I and CMTY Capital Statutory Trust II (the
trusts) qualify as VIEs under FIN 46. The trusts issued mandatorily redeemable
preferred securities (Trust Preferred Securities) to third- party investors and
loaned the proceeds to Community. The debentures held by each trust are the sole
assets of that trust.
In the first quarter of 2004, as a result of applying the provisions of FIN 46,
which represents new accounting guidance governing the consolidation of an
equity interest, Community was required to deconsolidate the trusts from its
consolidated financial statements. Prior periods have been restated. The
deconsolidation of the net assets and results of operations of the trusts had
virtually no impact on Community's financial statements or liquidity position
since Community continues to be obligated to repay the debentures held by the
trusts and guarantees repayment of the capital securities issued by the trusts.
Community's total debt obligation related to the trusts did increase, however,
from $30 million to $30.9 million upon deconsolidation, with the difference
representing Community's common ownership interest in the trusts, which is now
reported in "Other assets."
For regulatory reporting purposes, the Federal Reserve Board has an outstanding
proposal under which Trust Preferred Securities will continue to qualify as Tier
1 Capital subject to new restrictions. It is anticipated that Community will
continue to meet its minimum capital requirements under the proposed rule.
11
COMMUNITY BANKS, INC. AND SUBSIDIARIES
Part 1 - Item 2. Management's Discussion and Analysis of Financial Condition
- -------------------------------------------------------------------------------
and Results of Operations
- -------------------------
Overview
The purpose of this review is to provide additional information necessary to
fully understand the consolidated financial condition and results of operations
of Community. Throughout this review, net interest income and the yield on
earning assets are stated on a fully taxable-equivalent basis and balances
represent average daily balances unless otherwise indicated. In addition, income
statement comparisons are based on the first nine months of 2004 compared to the
same period of 2003 unless otherwise indicated. Per share and number of share
amounts reflect stock splits and dividends.
Forward-Looking Statements
Periodically, Community has made and will continue to make statements that may
include forward-looking information. Community 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. Examples of factors that may not be
predictable or may be out of management's control 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; and 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 Policies
The following is a summary of those accounting policies that Community considers
to be most important to the portrayal of its financial condition and results of
operations as they require management's most difficult judgments as a result of
the need to make estimates about the effects of matters that are inherently
uncertain.
Provision and Allowance for Loan Losses - The allowance for loan losses is
evaluated on a regular basis by management and is based upon management's
periodic review of the collectibility of the loans in light of historical
experience, the nature and volume of the loan portfolio, adverse situations that
may affect the borrower's ability to repay, estimated value of any underlying
collateral and prevailing economic conditions. This evaluation is inherently
subjective as it requires estimates that are susceptible to significant revision
as additional information becomes available.
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.
Large groups of smaller balance homogeneous loans are collectively evaluated for
impairment. Accordingly, Community 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 to the allowance
for loan losses, and subsequent recoveries, if any, are credited to the
allowance for loan losses.
12
COMMUNITY BANKS, INC. AND SUBSIDIARIES
PART I - Item 2. Management's Discussion and Analysis of Financial Condition
- --------------------------------------------------------------------------------
and Results of Operations (continued)
- -------------------------------------
SUMMARY OF FINANCIAL RESULTS
- ----------------------------
Earnings per share for the third quarter reached $0.45, a 10% increase over the
$0.41 recorded in the third quarter of 2003. Net income for the quarter rose to
$5.6 million versus $5.1 million in the third quarter of the previous year, a
quarter-to-quarter increase of almost 10%. Return on average assets and return
on average equity reached 1.15% and 15.84%, respectively, for the three month
period ended September 30, 2004.
For the first nine months of 2004, earnings grew at a slightly less vigorous
pace than the quarterly comparisons. Earnings per share grew to $1.29 for the
first three quarters of 2004 compared to $1.22 in the same period of 2003, an
increase of almost 6%. Net income for the period grew to $16.3 million compared
to $15.2 million in 2003.
Results during the third quarter continued to reflect many of the trends that
have influenced performance throughout the first half of 2004. Loan and deposit
growth patterns have remained consistently strong throughout the year. Average
loans for the nine months ended September 30, 2004 have grown 17%, to $1.14
billion, from a year ago, while average deposits have grown 11% to almost $1.3
billion. Earnings for the third quarter included a nonrecurring gain of
approximately $725,000 from the sale of the credit card portfolio, which is
included in other income. On a comparative basis with the third quarter of 2003,
the credit card gain served to offset declines in gains from security sales and
reduced fees from mortgage brokerage and title insurance activities. Declines in
refinancing activity have influenced the reductions in related mortgage and
title insurance income.
Financial performance also continues to be favorably impacted by the overall
quality of the loan portfolio. Even with growth in loan balances, asset quality
measures continue to improve as evidenced by modest charge-offs, improved
allowance for loan loss coverage, and low levels of problem credits. These
trends have precluded the need for substantial increases in loan loss
provisions.
The record low level of interest rates continues to moderate growth in net
interest income. Performance in this area was constricted through much of 2003
due to declining interest rates. Increases in the volume of activity during 2004
have mitigated the adverse impact of the extended low interest rate environment.
Interest spreads appear to have stabilized, resulting in steady, but modest
improvements in net interest income. Additionally, revenues from fee-based
services augmented the growth in net interest income and included increased fees
from the sales of annuities, brokerage products, and deposit fees from overdraft
privilege services. At the same time, more recent expense trends suggested the
potential for a more moderate growth rate for core operating expenses. Higher
expense growth in the first half of 2004 had been influenced by acquisitions
which occurred in 2003 and by planned increases in marketing expenditures. Third
quarter expenses in 2004 actually declined from the second quarter of the year,
including reduced salary and marketing costs.
13
COMMUNITY BANKS, INC. AND SUBSIDIARIES
PART I - Item 2. Management's Discussion and Analysis of Financial Condition
- --------------------------------------------------------------------------------
and Results of Operations (continued)
- --------------------------------------
RESULTS OF OPERATIONS
Nine months ended September 30, 2004, compared to nine months ended September
- --------------------------------------------------------------------------------
30, 2003
- --------
Overview
Net income for the nine months ended September 30, 2004, was $16.3 million
compared to $15.2 million in 2003, an increase of $1.1 million or 7%. Diluted
earnings per share were $1.29 for 2004 and $1.22 for 2003, resulting in a return
on average stockholders' equity of 15.10% for 2004 compared to 15.12% for 2003.
The return on average assets was 1.12% for 2004 compared to 1.15% for 2003.
Net Interest Income
The following table compares net interest income and net interest margin
components between the first nine months of 2004 and 2003 (dollars in
thousands):
Net Interest Margin - Year to Date
-------------------------------------------------------------------------------------------------------------------------
(dollars in thousands) September 30, 2004 September 30, 2003
------------------------------------ --------------------------------------- --------------------------------------
FTE Average FTE Average
Interest Rate Interest Rate
Average Income/ Earned/ Average Income/ Earned/
Balance Expense Paid Balance Expense Paid
------------------------------------ --------------------------------------- --------------------------------------
Federal funds sold and interest-
bearing deposits in banks $ 8,124 $ 61 1.00% $ 1,116 $ 7 0.84%
Investment securities 678,865 26,820 5.28% 688,069 26,346 5.12%
Loans - commercial 405,534 17,132 5.64% 329,523 15,359 6.23%
- commercial real estate 298,111 13,450 6.03% 265,187 13,107 6.61%
- residential real estate 96,162 4,808 6.68% 103,721 5,872 7.57%
- consumer (1) 340,820 16,693 6.54% 279,042 15,309 7.34%
------------------------------------ --------------------------------------- --------------------------------------
Total earning assets $1,827,616 $ 78,964 5.77% $1,666,658 $ 76,000 6.10%
------------------------------------ --------------------------------------- --------------------------------------
Deposits - savings and NOW accounts $ 496,532 $ 3,155 0.85% $ 387,112 $ 2,387 0.82%
- time 621,963 13,647 2.93% 610,772 15,168 3.32%
Short-term borrowings 62,763 524 1.12% 115,357 1,129 1.31%
Long-term debt 391,387 13,664 4.66% 322,774 12,697 5.26%
Subordinated debt 30,928 1,163 5.02% 15,464 542 4.69%
------------------------------------ --------------------------------------- --------------------------------------
Total interest-bearing liabilities $1,603,573 $ 32,153 2.68% $1,451,479 $ 31,923 2.94%
------------------------------------ --------------------------------------- --------------------------------------
Interest income to earning assets 5.77% 6.10%
Interest expense to paying
liabilities 2.68% 2.94%
------------------------------------ --------------------------------------- --------------------------------------
Interest spread 3.09% 3.16%
Impact of non-interest funds 0.33% 0.39%
------------------------------------ --------------------------------------- --------------------------------------
Net interest margin $ 46,811 3.42% $ 44,077 3.55%
------------------------------------ --------------------------------------- --------------------------------------
(1) Education loans held for sale are included in consumer loan earning
assets.
14
COMMUNITY BANKS, INC. AND SUBSIDIARIES
PART I - Item 2. Management's Discussion and Analysis of Financial Condition
- --------------------------------------------------------------------------------
and Results of Operations (continued)
- --------------------------------------
Interest income totaled $79.0 million in 2004, 3.9% more than the $76.0 million
recorded in 2003, despite an earning asset yield decline from 6.10% to 5.77%.
The increase in earning assets offset the effect of lower earning asset yields.
From 2003 to 2004, earning assets grew $161 million, with an increase of $163
million in loans and a decrease of $9 million in investment securities. Growth
in loans was funded principally by an increase in deposits.
Interest expense on deposits and borrowings increased modestly, from $31.9
million in 2003 to $32.1 million in 2004. The average rate paid on
interest-bearing liabilities declined from 2.94% to 2.68%, while
interest-bearing deposits grew by nearly $121 million. The majority of the
increase in deposits occurred in savings, Power Checking and other accounts that
were responsive to customer preferences for liquidity.
As a result of rate trends and other dynamics specific to its balance sheet,
Community reported a slight decline in net interest spread from 3.16% in 2003 to
3.09% in 2004, and a decline in net interest margin from 3.55% to 3.42% 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 0.39% to
0.33%. As noted in the discussion comparing third quarter 2004 results of
operations to 2003, interest margins on a quarterly basis appear to have
stabilized.
Provision for Loan Losses
The provision for loan losses increased from $1.9 million for the nine months
ended September 30, 2003, to $2.4 million for 2004 while the relationship of the
allowance for loan losses to loans declined from 1.26% at September 30, 2003 to
1.21% at September 30, 2004. The provision and the level of the allowance
reflect Community's response to changing credit quality conditions of both
seasoned loans and the incremental risk identified within the growing loan
portfolio noted above. Net charge-offs during the first nine months of 2004 were
$1.1 million, or 0.13% of average loans annualized, compared to $803 thousand,
or .11% of average loans in 2003.
Non-Interest Income
Non-interest income totaled $17.8 million for the nine months ended September
30, 2004, increasing $2.9 million, or 19%, from $14.9 million reported for 2003.
Excluding investment securities gains, non-interest income increased $2.4
million. The growth of non-interest income reflected important steps Community
has undertaken to solidify and expand its integrated businesses and
complementary banking services.
A substantial increase in fees occurred in the area of service charges on
deposits. Income of $5.1 million for 2004 increased 39% over 2003 results. In
the first quarter of 2003, Community initiated a new service known as "Overdraft
Honor," a carefully designed program which enabled customers who so choose to
have access to a service that facilitates payment of periodic overdraft items
while simultaneously avoiding adverse credit history events. Fees from these
services, coupled with considerable growth in the number of new checking
accounts, were responsible for virtually all of the increase in this category.
Other service charges totaled $2.6 million for 2004, an increase of 10% from the
same period in 2003. Other service charges include interchange fees from
Community's ATM network and debit card transactions. Nearly all of the increase
in these sources of fee income resulted from increased usage, reflecting growing
consumer acceptance of electronic transaction mediums.
15
COMMUNITY BANKS, INC. AND SUBSIDIARIES
PART I - Item 2. Management's Discussion and Analysis of Financial Condition
- --------------------------------------------------------------------------------
and Results of Operations (continued)
- --------------------------------------
Investment security gains were $2.3 million for 2004, compared to $1.8 million
for 2003. Improvements in the valuation of Community's bank equity portfolio
produced increased realized security gains.
Insurance premiums and commissions include agency-based commissions from
commercial and personal lines, fees from credit insurance related to consumer
lending, and the revenue from title insurance and settlement activities
conducted through Community's title insurance subsidiary. Income reported for
2004 totaled $2.4 million, an increase of $310 thousand over the $2.1 million
reported for 2003. The increase was related to agency-based commissions,
including activity generated over a full nine month period from the acquisitions
of insurance agencies later in 2003. Revenues from title insurance and
settlement activity declined $423 thousand from 2003 to 2004, and was directly
influenced by the decrease in mortgage refinancing activity by consumers.
Mortgage banking income increased $200 thousand, or 11%, to $2.0 million for
2004. The increase is attributable to activity generated over a full nine month
period from the acquisition of Erie Financial Group, Ltd., a mortgage broker
service, in July, 2003. 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 totaling $1.1 million for 2004 included a non-recurring gain of
$724 thousand in the third quarter from the sale of Community's credit card
portfolio. Community will continue to provide credit card services to its
customer base, but will no longer retain the credits within its loan portfolio.
For 2003, other income totaling $1.1 million included $497 thousand of
nonrecurring income from a curtailment of benefits in Community's defined
benefit pension plan.
Non-Interest Expenses
Total non-interest expenses reached $37.4 million for the nine months ended
September 30, 2004, and reflected an 11% increase from the $33.8 million
recorded in 2003. Comparisons between 2004 and 2003 were influenced by the
acquisitions of integrated businesses acquired in the second half of 2003, for
which a full nine months of expenses were included in 2004. Comparisons to the
most recent prior quarter yielded modest declines.
Salaries and employee benefits totaling $20.9 million for 2004, represented 56%
of operating costs, and increased $2.1 million, or 11%, compared to 2003. The
increase was affected by a number of factors, including: the annual merit
increase; employees added through the expansion of Community's office network
and its fee-based activities; and the acquisitions of Abstracting Company of
York County in April 2003, Erie Financial Group, Ltd., in July 2003, and Your
Insurance Partnership in September 2003.
Occupancy expenses were $6.0 million for 2004, an increase of $.5 million, or
12%, over 2003 and similarly includes the effect of branch expansion and
the acquisitions of fee-based companies.
Marketing expenses increased $400 thousand, or 27%, to a total of $1.9 million
for 2004, versus 2003. During the first half of 2003, increased marketing and
promotional efforts had been undertaken to increase Community's market share in
new markets and to preserve and extend share in its legacy communities. Those
increased efforts have carried over to 2004 as Community continues to execute a
targeted strategic marketing campaign that includes radio, billboard, direct
mail, and television mediums.
Income Taxes
Income tax expense for the nine months ended September 30, 2004, totaled $3.7
million, resulting in an effective tax rate of 18.7%, compared to 18.1% for
2003. The relative mix of tax exempt income influences the effective income tax
rate and remains the primary reason for the difference between the effective tax
rate and the statutory federal tax rate for corporations.
16
COMMUNITY BANKS, INC. AND SUBSIDIARIES
PART I - Item 2. Management's Discussion and Analysis of Financial Condition
- --------------------------------------------------------------------------------
and Results of Operations (continued)
- --------------------------------------
RESULTS OF OPERATIONS
- ---------------------
Quarter ended September 30, 2004, compared to quarter ended September 30, 2003
- ------------------------------------------------------------------------------
Overview
Net income for the third quarter of 2004 increased $500 thousand, or 10%, in
comparison to net income for the third quarter of 2003. Diluted earnings per
share increased $.04, or 10%, to $.45 for 2004, from $.41 for 2003. Net income
of $5.6 million for 2004 resulted in an annualized return on average
stockholders' equity of 15.84% and an annualized return on assets of 1.15%.
Net Interest Income
Net Interest Margin - Quarter to Date
-------------------------------------------------------------------------------------------------------------------------
(dollars in thousands) September 30, 2004 September 30, 2003
------------------------------------ --------------------------------------- --------------------------------------
Average FTE Average Average FTE Average
Interest Rate Interest
Income/ Earned/ Income/ Rate Earned/
Balance Expense Paid Balance Expense Paid
------------------------------------ --------------------------------------- --------------------------------------
Federal funds sold and interest-
bearing deposits in banks $ 6,013 $ 22 1.46% $ 1,277 $ 4 1.24%
Investment securities 663,153 8,854 5.31% 682,608 8,484 4.93%
Loans - commercial 420,252 6,034 5.71% 348,904 5,273 6.00%
- commercial real estate 308,927 4,667 6.01% 273,196 4,376 6.35%
- residential real estate 95,693 1,559 6.48% 99,469 1,853 7.39%
- consumer (1) 351,181 5,704 6.46% 308,824 5,409 6.95%
------------------------------------ --------------------------------------- --------------------------------------
Total earning assets $1,845,219 $ 26,840 5.79% $1,714,278 $ 25,399 5.88%
------------------------------------ --------------------------------------- --------------------------------------
Deposits - savings and NOW accounts $ 515,917 $ 1,139 0.88% $ 417,872 $ 825 0.78%
- time 615,023 4,530 2.93% 604,951 4,838 3.17%
Short-term borrowings 59,464 202 1.35% 124,568 365 1.16%
Long-term debt 399,085 4,655 4.64% 328,508 4,316 5.21%
Subordinated debt 30,928 408 5.25% 15,464 176 4.52%
------------------------------------ --------------------------------------- --------------------------------------
Total interest-bearing liabilities $1,620,417 $ 10,934 2.68% $1,491,363 $ 10,520 2.80%
------------------------------------ --------------------------------------- --------------------------------------
Interest income to earning assets 5.79% 5.88%
Interest expense to paying
liabilities 2.68% 2.80%
------------------------------------ --------------------------------------- --------------------------------------
Interest spread 3.11% 3.08%
Impact of non-interest funds 0.32% 0.36%
------------------------------------ --------------------------------------- --------------------------------------
Net interest margin $ 15,906 3.43% $ 14,879 3.44%
------------------------------------ --------------------------------------- --------------------------------------
(1) Education loans held for sale are included in consumer loan earning
assets.
Interest income increased from the $25.3 million recorded in 2003 to $26.8
million in 2004, with an increase in earning assets from $1.71 billion to $1.85
billion offset by a decline in earning asset yields from 5.88% to 5.79%. Loans
grew $145 million and were principally funded by a $108 million increase in
deposits.
Interest expense on deposits remained steady, with an increase in
interest-bearing liabilities offset by a decrease in rates from 2.80% to 2.68%.
17
COMMUNITY BANKS, INC. AND SUBSIDIARIES
PART I - Item 2. Management's Discussion and Analysis of Financial Condition
- --------------------------------------------------------------------------------
and Results of Operations (continued)
- --------------------------------------
Net interest spread increased modestly from 3.08% in 2003 to 3.11% in 2004, with
a reduced contribution from non-interest funding sources resulting in flat net
interest margin performance from 3.44% in 2003 to 3.43% in 2004. On a quarterly
basis, net interest margin appears to have stabilized and has shown only modest
improvement since the fourth quarter of 2003 and the first quarter of 2004, when
it was 3.41% and 3.40%, respectively.
Provision for Loan Losses
The provision for loan losses decreased from $900 thousand for the quarter ended
September 30, 2003, to $750 thousand for 2004 based on management's quarterly
review of the loan portfolio and its assessment of loan quality; identification
of impaired loans; analysis of delinquencies and loan growth; evaluation of
potential charge-offs and recoveries; and assessment of general economic
conditions.
Non-Interest Income
Non-interest income increased from $5.5 million for the quarter ended September
30, 2003, to $6.0 million for the quarter ended September 30, 2004. Excluding
investment securities gains, non-interest income increased $700 thousand, or
13%. Factors contributing to changes between 2003 and 2004 are substantially the
same as those discussed above in the comparison of year-to-date results.
Investment management and trust services income totaled $443 thousand, an
increase of $151 thousand, or 52%, over 2003, reflecting a general increase in
income related to the sale of retail investment products.
Income from service charges on deposit accounts increased 48%, from $1.4 million
in 2003 to $2.0 million in 2004, reflecting primarily the "Overdraft Honor"
service started in the first quarter of 2003.
Investment security gains were $108 thousand for 2004, compared to $302 thousand
for 2003. The gains recorded in 2004 were principally related to sales of bank
equity holdings.
Insurance premiums and commissions income reported for 2004 totaled $708
thousand, a decrease of $111 thousand over 2003. Income from agency-based
commissions and credit insurance fees increased $147 thousand, while revenues
from title insurance and settlement activities decreased $258 thousand,
reflecting the impact from the decrease in mortgage refinancing activity by
consumers.
Mortgage banking income decreased $378 thousand, or 40%, to $558 thousand for
2004 which is also attributable to the decrease in mortgage refinancings by
consumers.
Other income for 2004 included the aforementioned non-recurring gain of $724
thousand from the sale of Community's credit card portfolio. In 2003, Community
recognized $497 thousand of nonrecurring income from a curtailment of benefits
in its defined benefit pension plan.
Non-Interest Expenses
Non-interest expenses totaled $12.5 million for the quarter ended September 30,
2004, and reflected an 8% increase, or $1.0 million, from the $11.5 million
recorded in 2003. Factors contributing to changes between 2004 and 2003 are
substantially the same as those discussed above in the comparison of
year-to-date results, including the influence of integrated businesses acquired
in the first nine months of 2003, for which a full nine months of expenses was
included in 2004.
Salaries and employee benefits totaling $7.0 million for 2004, represented 56%
of operating costs, and increased $352 thousand, or 5%, compared to 2003.
18
COMMUNITY BANKS, INC. AND SUBSIDIARIES
PART I - Item 2. Management's Discussion and Analysis of Financial Condition
- --------------------------------------------------------------------------------
and Results of Operations (continued)
- --------------------------------------
Marketing expenses increased $199 thousand, or 48%, to a total of $611 thousand
for 2004 versus 2003, for continued expansion of marketing and promotional
efforts.
Income Taxes
Income tax expense for the quarter ended September 30, 2004, totaled $1.4
million, resulting in an effective tax rate of 19.6%, compared to the effective
rate of 18.0% for 2003. The relative mix of tax exempt income influences the
effective income tax rate.
FINANCIAL CONDITION
- -------------------
The average balance sheets for the nine months ended September 30, 2004 and 2003
were as follows (dollars in thousands):
September 30, Change
----------------------------------- --------------------------------
2004 2003 Volume %
------------------------------------------------------------------------------------------------------------------
Cash and due from banks $ 36,192 $ 35,804 $ 388 1
Federal funds sold and other 8,124 1,116 7,008 628
Investments 678,865 688,069 (9,204) (1)
Loans held for sale 3,006 8,048 (5,042) (63)
Loans 1,138,093 973,752 164,341 17
Allowance for loan losses 14,025 12,874 1,151 9
------------------------------------------------------------------------------------------------------------------
Net loans 1,124,068 960,878 163,190 17
Goodwill and identifiable intangibles 4,858 2,375 2,483 105
Other assets 80,602 70,008 10,594 15
------------------------------------------------------------------------------------------------------------------
Total assets $ 1,935,715 $ 1,766,298 $ 169,417 10
------------------------------------------------------------------------------------------------------------------
Noninterest-bearing deposits $ 174,611 $ 167,130 $ 7,481 4
Interest-bearing deposits 1,118,495 997,885 120,610 12
Short-term borrowings 62,763 115,357 (52,594) (46)
Long-term debt 391,387 322,774 68,613 21
Subordinated debt 30,928 15,464 15,464 100
Other liabilities 13,716 13,066 650 5
------------------------------------------------------------------------------------------------------------------
Total liabilities 1,791,900 1,631,676 160,224 10
------------------------------------------------------------------------------------------------------------------
Stockholders' equity 143,815 134,622 9,193 7
------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders'
equity $ 1,935,715 $ 1,766,298 $ 169,417 10
==================================================================================================================
19
COMMUNITY BANKS, INC. AND SUBSIDIARIES
PART I - Item 2. Management's Discussion and Analysis of Financial Condition
- --------------------------------------------------------------------------------
and Results of Operations (continued)
- --------------------------------------
Average loans reached $1.1 billion at September 30, 2004, a 17% increase over
the $974 million of average loans recorded at September 30, 2003. The following
presentation of average loans at September 30 is an indication of the relative
mix of loans included in the portfolio (dollars in thousands):
Change
2004 2003 Amount %
--------------------------------------------------------------------------------------------------
Commercial $ 405,534 $ 329,523 $ 76,011 23%
Commercial real estate 298,111 265,187 32,924 12%
Residential real estate 96,162 103,721 (7,559) (7)%
Consumer 338,286 275,321 62,965 23%
--------------------------------------------------------------------------------------------------
Total $ 1,138,093 $ 973,752 $ 164,341 17%
==================================================================================================
Declining interest rate trends have caused many commercial borrowers 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, Community has been able to
increase both its commercial and commercial real estate portfolios by nearly
$110 million on an aggregate basis. Much of the growth in the commercial sector
was attributed to Community's ability to acquire existing market share. 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.
Significant growth also occurred in consumer lending, which grew by $63 million
between September 30, 2003, and September 30, 2004, particularly in home equity
lending. Community has made efforts to increase its visibility in core markets
as a more effective consumer lender, in part by substantial increases in
marketing and advertising efforts. Consumer demand for credit was aided by the
high levels of consumer confidence and improved credit affordability experienced
in the current interest rate environment. Expansion of the office network and
increased sales efforts over the last several years have also aided growth in
this area.
Residential real estate lending, primarily 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 fixed-rate 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.
Deposit balances remain the primary source of funding. Growth of nearly 12% was
reported, as indicated by the following summary of average balances at September
30 (dollars in thousands):
Change
2004 2003 Amount %
-------------------------------------------------------------------------------------------
Demand $ 174,611 $ 167,130 $ 7,481 4%
Savings & NOW accounts 496,532 387,113 109,419 28%
Time 508,544 499,872 8,672 2%
Time $100,000 or more 113,419 110,900 2,519 2%
-------------------------------------------------------------------------------------------
$ 1,293,106 $ 1,165,015 $ 128,091 11%
===========================================================================================
20
COMMUNITY BANKS, INC. AND SUBSIDIARIES
PART I - Item 2. Management's Discussion and Analysis of Financial Condition
- --------------------------------------------------------------------------------
and Results of Operations (continued)
- --------------------------------------
Deposit growth occurred primarily in savings and NOW deposits; more specifically
Community's Power Checking account. This account utilizes characteristics of
both a money market and checking account and balances have grown steadily
throughout 2003 and 2004. At the same time, longer term time deposit growth was
relatively flat. Consumer preferences have been weighted in favor of maintaining
adequate liquidity in anticipation of a rise in rates. 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.
Beginning in the latter part of 2003, Community extended the maturities of
overnight borrowings through the Federal Home Loan Bank to take advantage of
lower long-term rates on longer borrowings.
Capital
Regulators have established standards for the monitoring and maintenance of
appropriate levels of capital for financial institutions. Regulatory capital
guidelines are based on 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 banking subsidiary, Community Banks, at September 30, 2004, along with a
comparison to the various current regulatory capital requirements:
September 30, Regulatory "Well
2004 Minimum Capitalized"
--------------------------------------------------
Leverage ratio
--------------
Community Banks, Inc. 8.56% 4% n/a
Community Banks 7.94% 4% 5%
Tier 1 capital ratio
--------------------
Community Banks, Inc. 11.48% 4% n/a
Community Banks 10.63% 4% 6%
Total risk-based capital ratio
------------------------------
Community Banks, Inc. 12.49% 8% n/a
Community Banks 11.63% 8% 10%
At September 30, 2004, total stockholders' equity reflected accumulated other
comprehensive income of $5.1 million compared to $6.6 million at December 31,
2003. This decrease can be attributed to the change in the net unrealized gain
on investment securities available for sale, net of taxes.
Off-Balance-Sheet Commitments
Financial instruments with off-balance-sheet risk at September 30, 2004, are as
follows (in thousands):
Contract Amount
----------------------
Commitments to fund loans $ 111,772
Unused lines of credit $ 329,825
Standby letters of credit $ 38,222
Unadvanced portions of construction loans $ 56,481
21
COMMUNITY BANKS, INC. AND SUBSIDIARIES
PART I - Item 3. Quantitative and Qualitative Disclosures About Market Risk
- -------------------------------------------------------------------------------
Market risk, 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, 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.
The following table provides a measure of interest rate sensitivity for each
category of interest earning assets and interest bearing liabilities at
September 30, 2004.
Interest Rate Sensitivity
-----------------------------------------------------------------------------------------------------------------
1-90 90-180 180-365 1 year or Total
Dollars in thousands days days days more
-----------------------------------------------------------------------------------------------------------------
Assets
Federal funds sold $ 9,566 $ --- $ --- $ --- $ 9,566
Interest-bearing deposits in other
banks 1,770 --- --- --- 1,770
Loans held for sale(1) --- --- --- 946 946
Investment securities 112,150 55,918 24,969 450,554 643,591
Loans(2) 454,204 65,430 92,603 576,043 1,188,280
-----------------------------------------------------------------------------------------------------------------
Earning assets 577,690 121,348 117,572 1,027,543 1,844,153
Non-earning assets 222 --- --- 111,436 111,658
-----------------------------------------------------------------------------------------------------------------
Total assets $ 577,912 $ 121,348 $ 117,572 $ 1,138,979 $ 1,955,811
-----------------------------------------------------------------------------------------------------------------
Liabilities
Savings $ 268,171 $ --- $ --- $ 247,131 $ 515,302
Time 87,050 61,025 97,407 267,281 512,763
Time in denominations of $100,000
or more 22,971 12,834 21,507 48,486 105,798
Short-term borrowings 34,699 --- --- --- 34,699
Long-term debt 1,803 1,803 13,606 389,158 406,370
Subordinated debt 23,196 --- --- 7,732 30,928
-----------------------------------------------------------------------------------------------------------------
Interest bearing liabilities 437,890 75,662 132,520 959,788 1,605,860
Other liabilities and equity --- --- --- 349,951 349,951
-----------------------------------------------------------------------------------------------------------------
Total liabilities and equity $ 437,890 $ 75,662 $ 132,520 $ 1,309,739 $ 1,955,811
-----------------------------------------------------------------------------------------------------------------
(1) Only education loans held for sale are included in earning assets. (2)
Includes non-accrual loans.
Interest Sensitivity GAP
--------------------------------------------------------------------------------------------------
Dollars in 1-90 90-180 180-365 1 year or
thousands days days days more
--------------------------------------------------------------------------------------------------
Periodic $ 140,022 $ 45,686 $ (14,948) $ (170,760)
Cumulative 140,022 185,708 170,760
Cumulative GAP as a percentage
of total assets 7.2% 9.50% 8.73% 0.00%
The positive GAP between interest-earning assets and interest-bearing
liabilities maturing or repricing within one year approximated 8.7% at September
30, 2004 and has increased from 1.7% since December 31, 2003.
22
COMMUNITY BANKS, INC. AND SUBSIDIARIES
PART I - Item 4. Controls and Procedures
- -----------------------------------------
Under the supervision and with the participation of Community's management,
including its Chief Executive Officer and Chief Financial Officer, Community has
evaluated the effectiveness of its disclosure controls and procedures as of
September 30, 2004. Based upon this evaluation, the Chief Executive Officer and
Chief Financial Officer have concluded that Community's disclosure controls and
procedures are adequate and effective to ensure that material information
relating to Community and its consolidated subsidiaries is made known to them by
others within those entities, particularly during the period in which this
quarterly report was prepared. There have not been any changes in Community'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, Community's internal control over financial reporting.
23
COMMUNITY BANKS, INC. AND SUBSIDIARIES
PART II - OTHER INFORMATION
Item 1 - Legal Proceedings
- --------------------------
The nature of Community's business generates a certain amount of litigation
involving matters arising out of the ordinary course of business. In the opinion
of management, there are no legal proceedings that might have a material effect
on the results of operations, liquidity, or the financial position of Community
at this time.
Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds
- --------------------------------------------------------------------
The following shares were purchased during the quarter as part of Community's
Share Repurchase Program:
Average Price Shares Purchased Capacity to
Shares Paid as part of Purchase
Purchased Per Share Repurchase Program More Shares
---------------------------------------------------------------------------------
07/1/04-07/31/04 20,500 $26.74 20,500 109,434
08/1/04-08/31/04 21,500 $26.37 21,500 87,934
09/1/04-09/30/04 --- --- --- 87,934
Item 3 - Defaults Upon Senior Securities
- ----------------------------------------
Not applicable.
Item 4 - Submission of Matters to a Vote of Security Holders
- ------------------------------------------------------------
Not applicable.
Item 5 - Other Information
- --------------------------
Not applicable.
24
COMMUNITY BANKS, INC. AND SUBSIDIARIES
PART II - Other Information (continued)
- ---------------------------------------
Item 6 - Exhibits
- ------------------
3.1 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)
3.2 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 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 Employment agreement for Eddie L. Dunklebarger
10.2 Employment agreement for Donald F. Holt
10.3 Employment agreement for Robert W. Lawley
10.4 Employment agreement for Anthony N. Leo
10.5 Employment agreement for Jeffrey M. Seibert
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)
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
COMMUNITY BANKS, INC.
(Registrant)
Date November 9, 2004 /s/ Eddie L. Dunklebarger
--------------------- -----------------------------
Eddie L. Dunklebarger
Chairman and President
(Chief Executive Officer)
Date November 9, 2004 /s/ Donald F. Holt
--------------------- -----------------------------
Donald F. Holt
Executive Vice President
(Chief Financial Officer)
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