Back to GetFilings.com
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 March 31, 2005
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 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 April 30, 2005
CAPITAL STOCK-COMMON 12,370,000
-------------------- ------------------
(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 - 10
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 11 - 18
Item 3. Quantitative and Qualitative Disclosures About Market Risk 19
Item 4. Controls and Procedures 20
PART II - Other Information
Item 1. Legal Proceedings 21
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 21
Item 3. Defaults Upon Senior Securities 21
Item 4. Submission of Matters to a Vote of Security Holders 21
Item 5. Other Information 21
Item 6. Exhibits 21
SIGNATURES 22
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)
March 31, December 31,
2005 2004
-------------------- --------------------
ASSETS (Unaudited)
Cash and due from banks $ 38,030 $ 43,486
Federal funds sold 56,669 ---
-------------------- --------------------
Cash and cash equivalents 94,699 43,486
Interest-bearing deposits in other banks 611 1,787
Investment securities, available for sale 590,545 619,110
Loans held for sale 2,410 1,505
Loans, net of allowance for loan losses of $14,754 and $14,421 1,231,150 1,201,530
Premises and equipment, net 25,552 25,517
Accrued interest receivable and other assets 67,686 61,864
-------------------- --------------------
Total assets $ 2,012,653 $ 1,954,799
==================== ====================
LIABILITIES
Deposits
Non-interest bearing $ 192,410 $ 184,359
Interest bearing 1,155,840 1,121,178
-------------------- --------------------
Total deposits 1,348,250 1,305,537
Short-term borrowings 38,217 47,116
Long-term debt 427,942 404,662
Subordinated debt 30,928 30,928
Accrued interest payable and other liabilities 15,558 14,215
-------------------- --------------------
Total liabilities 1,860,895 1,802,458
-------------------- --------------------
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; 12,421,000 shares issued 62,103 62,107
Surplus 73,374 73,304
Retained Earnings 21,229 18,134
Accumulated other comprehensive income (loss),
net of tax (2,350) 3,211
Treasury stock; 109,000 and 185,000 shares, at cost (2,598) (4,415)
-------------------- --------------------
Total stockholders' equity 151,758 152,341
-------------------- --------------------
Total liabilities and stockholders' equity $ 2,012,653 $ 1,954,799
==================== ====================
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
March 31,
---------------------------------
2005 2004
---------------------------------
INTEREST INCOME:
Loans, including fees $ 19,058 $ 16,658
Investment securities:
Taxable 4,249 4,562
Tax exempt 2,184 2,195
Dividends 541 552
Other 151 13
--------------- -------------
Total interest income 26,183 23,980
--------------- -------------
INTEREST EXPENSE:
Deposits 6,060 5,458
Short-term borrowings 157 124
Long-term debt 4,817 4,581
Subordinated debt 459 378
--------------- -------------
Total interest expense 11,493 10,541
--------------- -------------
Net interest income 14,690 13,439
Provision for loan losses 550 850
--------------- -------------
Net interest income after provision for loan losses 14,140 12,589
--------------- -------------
NON-INTEREST INCOME:
Investment management and trust services 414 267
Service charges on deposit accounts 1,793 1,405
Other service charges, commissions and fees 1,010 902
Investment security gains 51 1,332
Insurance premium income and commissions 902 654
Mortgage banking activities 515 627
Earnings on investment in life insurance 399 365
Other 126 71
--------------- -------------
Total non-interest income 5,210 5,623
--------------- -------------
NON-INTEREST EXPENSES:
Salaries and employee benefits 7,293 6,835
Net occupancy 2,148 2,033
Marketing expense 445 420
Telecommunications expense 304 317
Other 2,469 2,278
--------------- -------------
Total non-interest expenses 12,659 11,883
--------------- -------------
Income before income taxes 6,691 6,329
Income taxes 1,204 1,154
--------------- -------------
Net income $ 5,487 $ 5,175
=============== =============
CONSOLIDATED PER SHARE DATA:
Basic earnings per share $ 0.45 $ 0.42
Diluted earnings per share $ 0.44 $ 0.41
Dividends declared $ 0.17 $ 0.16
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
For the Three Months Ended March 31, 2005 and 2004
(Unaudited: Dollars in Thousands)
Accumulated
Other
Outstanding Common Retained Comprehensive Treasury Total
Shares Stock Surplus Earnings Income(Loss) Stock Equity
------------ --------------------------------------------------------------- ------------
Balance, January 1, 2004 11,648 $ 59,256 $ 57,563 $ 24,297 $ 6,596 $ (4,306) $ 143,406
Comprehensive income:
Net income 5,175 5,175
Unrealized loss on securities,
net of reclassification
adjustment and tax effect 4,008 4,008
------------
Total comprehensive income 9,183
Cash dividends (1,989) (1,989)
5% stock dividend 592 2,954 15,127 (18,110) (29)
Purchases of treasury
stock (25) (747) (747)
Exercise of common stock options
and issuances under stock
purchase plan 63 (89) (1,400) 2,020 531
Tax benefits from employee stock
transactions 149 149
------------ --------------------------------------------------------------- ------------
Balance, March 31, 2004 12,278 $ 62,121 $ 72,839 $ 7,973 $ 10,604 $ (3,033) $ 150,504
============ =============================================================== ============
Balance, January 1, 2005 12,236 $ 62,107 $ 73,304 $ 18,134 $ 3,211 $ (4,415) $ 152,341
Comprehensive income (loss):
Net income 5,487 5,487
Unrealized loss on securities,
net of reclassification
adjustment and tax effect (5,471) (5,471)
Change in unfunded pension
liability, net of tax (90) (90)
------------
Total comprehensive income (loss) (74)
Cash dividends (2,093) (2,093)
Exercise of common stock options
and issuances under stock
purchase plan 76 (4) (299) 1,817 1,514
Tax benefits from employee stock
transactions 70 70
------------ --------------------------------------------------------------- ------------
Balance, March 31, 2005 12,312 $ 62,103 $ 73,374 $ 21,229 $ (2,350) $ (2,598) $ 151,758
============ =============================================================== ============
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)
Three Months Ended
March 31,
-----------------------------------------
2005 2004
-----------------------------------------
Operating Activities:
Net income $ 5,487 $ 5,175
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 550 850
Depreciation and amortization 840 815
Net amortization of securities 281 296
Realized gains on sales of available-for-sale securities, net (51) (1,332)
Loans originated for sale (1,974) (5,492)
Proceeds from sales of loans held for sale 1,115 6,812
Gains on loan sales (47) (209)
Earnings on investment in life insurance (399) (365)
Net change in other assets (2,294) (206)
Net change in accrued interest payable and other liabilities 1,205 (1,146)
Tax benefits from employee stock transactions 70 149
------------------ -----------------
Net cash provided by operating activities 4,783 5,347
------------------ -----------------
Investing Activities:
Net change in interest-bearing deposits in other banks 1,175 764
Activity in available-for-sale securities:
Sales 14,678 11,915
Maturities, prepayments and calls 16,773 64,844
Purchases (11,722) (137,404)
Net increase in total loans (30,234) (34,143)
Investment in life insurance --- (5,000)
Net additions to premises and equipment (755) (1,528)
------------------ -----------------
Net cash used by investing activities (10,085) (100,552)
------------------ -----------------
Financing Activities:
Net increase in deposits 42,713 51,725
Net change in short-term borrowings (8,899) 37,243
Proceeds from issuance of long-term debt 25,000 ---
Repayment of long-term debt (1,720) (11,672)
Cash dividends and cash paid in lieu of fractional shares (2,093) (2,018)
Purchases of treasury stock --- (747)
Proceeds from issuance of common stock 1,514 531
------------------ -----------------
Net cash provided by financing activities 56,515 75,062
------------------ -----------------
Net change in cash and cash equivalents 51,213 (20,143)
Cash and cash equivalents at beginning of period 43,486 59,887
------------------ -----------------
Cash and cash equivalents at end of period $ 94,699 $ 39,744
================== =================
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 three months ended March 31, 2005, are not necessarily
indicative of the results that may be expected for the year ending December 31,
2005.
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, 2004.
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 County 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 FHLB
advances were repaid through short-term borrowings with the FHLB.
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 SFAS No. 123, "Accounting for Stock-Based
Compensation," to stock-based compensation (in thousands, except per share
data).
Three Months Ended
March 31,
2005 2004
---------------------------
Net income, as reported $ 5,487 $ 5,175
Deduct: Total stock-based compensation
expense determined under fair value based
method for all awards, net of related tax effect (776) (322)
----------- -----------
Pro forma net income $ 4,711 $ 4,853
=========== ===========
Earnings per share:
Basic - as reported $ 0.45 $ 0.42
Basic - pro forma $ 0.38 $ 0.40
Diluted - as reported $ 0.44 $ 0.41
Diluted - pro forma $ 0.37 $ 0.38
7
Community Banks, Inc. and Subsidiaries
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS, (continued)
(Unaudited)
In late 2004, SFAS No. 123 was replaced by the issuance of Statement No. 123(R),
"Share-Based Payment." Community is currently evaluating the various provisions
of SFAS 123(R) and the optional transition methods that may be applied when
adopting this new accounting standard. It is expected that Community will adopt
the modified prospective method on January 1, 2006. Total stock-based
compensation expense, net of related tax effects, for existing option grants
will not have a material impact on the financial statements in years beyond
2005. The impact of future option or stock grants is dependent upon the quantity
and nature of stock-based compensation Community decides to grant.
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
Community 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.
Earnings per share for the three months ended March 31 have been computed as
follows (in thousands, except per share data):
---------------------------
2005 2004
------------ -----------
Net income $ 5,487 $ 5,175
============ ===========
Weighted average shares outstanding (basic) 12,292 12,271
Effect of dilutive stock options 272 382
------------ -----------
Weighted average shares outstanding (diluted) 12,564 12,653
============ ===========
Per share information:
Basic earnings per share $ 0.45 $ 0.42
Diluted earnings per share 0.44 0.41
8
Community Banks, Inc. and Subsidiaries
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS, (continued)
(Unaudited)
Comprehensive Income (Loss) - The components of comprehensive income (loss) and
related tax effect for the three months ended March 31 are as follows (in
thousands):
2005 2004
--------------------------------
Unrealized holding gains (losses)
on available-for-sale securities $ (8,366) $ 7,498
Reclassification adjustments for
gains included in net income (51) (1,332)
-------------- --------------
Net unrealized gains (losses) (8,417) 6,166
Tax effect 2,946 (2,158)
-------------- --------------
Net-of-tax amount (5,471) 4,008
-------------- --------------
Unfunded pension liability (138) ---
Tax effect 48 ---
-------------- --------------
Net-of-tax amount (90) ---
-------------- --------------
$ (5,561) $ 4,008
============== ==============
The components of accumulated other comprehensive income (loss), included in
stockholders' equity, are as follows (in thousands):
March 31, December 31,
2005 2004
------------------------------------------
Net unrealized gain on
available-for-sale securities $ 99 $ 8,515
Tax effect (35) (2,980)
------------------- -------------------
Net-of-tax amount 64 5,535
------------------- -------------------
Unfunded pension liability (3,714) (3,576)
Tax effect 1,300 1,252
------------------- -------------------
Net-of-tax amount (2,414) (2,324)
------------------- -------------------
Accumulated other comprehensive income (loss) $ (2,350) $ 3,211
=================== ===================
Recent Accounting Prouncements
SAB 107 - In March 2005, the SEC issued Staff Accounting Bulletin No. 107 )"SAB
No. 107"), "Share-Based Payment", providing guidance on option valuation
methods, the accounting for income tax effects of share-based payment
arrangements upon adoption of SFAS No. 123 (R), and the disclosures in MD&A
subsequent to the adoption. Community will provide SAB No. 107 required
disclosures upon adoption of SFAS No. 123(R) on January 1, 2006.
Reclassifications - Certain amounts reported in the prior year have been
reclassified to conform with the 2005 presentation. These reclassifications did
not impact the Corporation's financial condition or results of operations.
9
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):
Three Months Ended Year Ended Three Months Ended
March 31, December 31, March 31,
2005 2004 2004
------------------------- ---------------- ------------------------
Balance, January 1 $ 14,421 $ 13,178 $ 13,178
Provision for loan losses 550 3,100 850
Loan charge-offs (460) (2,910) (450)
Recoveries 243 1,053 284
------------------------- ---------------- ------------------------
Balance, end of period $ 14,754 $ 14,421 $ 13,862
========================= ================ ========================
The following table summarizes period-end risk elements (in thousands):
March 31, December 31, March 31,
2005 2004 2004
-------------------- ---------------- ------------------
Non-accrual loans $ 5,807 $ 5,428 $ 7,541
Foreclosed real estate 1,935 2,094 2,057
-------------------- ---------------- ------------------
Total non-performing assets 7,742 7,522 9,598
Accruing loans 90 days past due --- --- 98
-------------------- ---------------- ------------------
Total risk elements $ 7,742 $ 7,522 $ 9,696
==================== ================ ==================
3. 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
$43.8 million and $36.3 million of standby letters of credit as of March 31,
2005 and December 31, 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 March 31,
2005 and December 31, 2004 for guarantees under standby letters of credit issued
is not material.
4. Acquisitions:
-------------
In November 2004, Community and PennRock Financial Services Corp. (PennRock)
announced the signing of a definitive agreement pursuant to which Community and
PennRock will combine under Community's charter. PennRock, the parent company of
Blue Ball National Bank, is a financial holding company with approximately $1.2
billion in assets. Under the terms of the definitive agreement, each shareholder
of PennRock will receive 1.4 shares of Community in exchange for each share of
PennRock common stock. Based upon Community's ten-day average share price of
$29.85 prior to the announcement, the total purchase price will approximate $340
million. The transaction has received approval from various banking regulators
and is in the process of meeting the various requirements necessary for
shareholder approval from both organizations. Pending these final approvals,
consummation is expected to occur at or near the middle of 2005.
10
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 three months of 2005 compared to
the same period of 2004 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
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) and in the evaluation of "other than
temporary" impairment of investment securities should be considered to be
critical accounting policies to ensure the fair presentation of Community's
financial statements.
o Community applies a systemic methodology in order to estimate the
allowance for loan losses. This methodology incorporates 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 (SFAS) 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 collectibility, 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.
o Investment securities are written down to their net realizable value when
there is an impairment in value that is considered to be "other than temporary."
The determination of whether or not other than temporary impairment exists is a
matter of judgment. Management reviews these investment securities regularly for
possible impairment that is "other than temporary" by analyzing the facts and
circumstances of each investment and the expectations for that investment's
performance. "Other than temporary" impairment in the value of an investment may
be indicated by the length of time and the extent to which market value has been
less than cost; the financial condition and near term prospects of the issuer;
or the intent and ability of Community to retain its investment for a period of
time sufficient to allow for any anticipated recovery in market value.
11
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
- ----------------------------
Community's earnings per share for the first quarter of 2005 rose to $0.44, an
increase of over 7% from the prior year's first quarter, while net income
reached $5.5 million. Results for the first quarter of 2004 reflected earnings
per share of $0.41 and net income of $5.2 million. Previously-reported 2004
results had included $1.3 million of pretax gains from the sale of investments,
primarily bank equity securities, while 2005 results included only modest gains
from investment sales. Results in the first quarter of 2005 produced a return on
average assets of 1.12% and a return on average equity of 14.23%.
The improvement in earnings during the quarter was especially significant
considering the favorable trends reported in many of the key measures vital to
achieving earnings improvement. Net interest income, the largest single source
of revenue in financial institutions, improved nearly 9% when compared to the
first quarter of 2004. Net interest margin, a measure of the difference between
interest received on earning assets and interest paid on deposits and
borrowings, grew to 3.55% from 3.40% a year earlier, a signal that pricing
compression may be subsiding. Pricing compression has been a major obstacle to
earnings improvement in the last several years as interest rates declined to the
lowest levels in over 40 years. At the same time, revenue growth from service
and fee income sources continued to be critical to Community's revenue
diversification initiatives. Excluding gains from investment transactions, total
non-interest income grew by 20% from the first quarter of 2004 as Community
continued to fully integrate financial services capabilities from non-bank
acquisitions. Non-interest expenses remained under control despite the influence
of core banking growth and the impact of acquired businesses on Community's
expense structure. The efficiency ratio, expressed as the ratio of operating
expenses to tax-equivalent revenues, declined to 58.8%, the third straight
quarterly decline in this important ratio. This return to an efficiency ratio
more consistent with Community's historical trends suggests that expenses are
being well-managed, even with the effect of added expenses from volume increases
in both traditional and complementary financial services.
Growth continued to be a hallmark of Community's balance sheet trends as total
assets exceeded the $2 billion mark at the end of the first quarter of 2005.
Average loan and deposit growth reached 12% and 7%, respectively, when compared
to the first quarter of 2004. Importantly, the growth in loans over the last
several years has been accompanied by steady improvement in most of the metrics
critical to maintaining the highest levels of asset quality in the loan
portfolio. Total nonperforming assets to period end loans remained below 1%, at
..62%, while net charge-offs to loans were an almost negligible 0.07% on an
annualized basis. Additionally, the coverage ratio of the allowance for credit
losses to non-accrual loans was at 254%, substantially the same as the 266% at
the end of 2004.
12
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
- ---------------------
Net Interest Income
The following table compares net interest income and net interest margin
components between the first three months of 2005 and 2004 (dollars in
thousands):
Net Interest Margin - Year to Date
-------------------------------------------------------------------------------------------------------------------------
March 31, 2005 March 31, 2004
------------------------------------ --------------------------------------- --------------------------------------
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- $ 24,022 $ 151 2.55% $ 6,399 $ 13 0.82%
bearing deposits in banks
Investment securities 613,074 8,354 5.53% 671,746 8,699 5.21%
Loans - commercial 419,713 6,476 6.26% 393,786 5,581 5.70%
- commercial real estate 362,149 5,593 6.26% 283,302 4,209 5.98%
- residential real estate 91,326 1,501 6.67% 96,119 1,675 7.01%
- consumer 359,770 5,797 6.53% 332,001 5,426 6.57%
------------------------------------ --------------------------------------- --------------------------------------
Total earning assets $1,870,054 $ 27,872 6.04% $1,783,353 $ 25,603 5.77%
------------------------------------ --------------------------------------- --------------------------------------
Deposits - savings and NOW accounts $ 501,945 $ 1,313 1.06% $ 457,269 $ 889 0.78%
- time 641,767 4,747 3.00% 621,030 4,569 2.96%
Short-term borrowings 31,106 157 2.05% 52,020 124 0.96%
Long-term debt 425,318 4,817 4.59% 410,148 4,581 4.49%
Subordinated debt 30,928 459 6.02% 30,928 378 4.92%
------------------------------------ --------------------------------------- --------------------------------------
Total interest-bearing liabilities $1,631,064 $ 11,493 2.86% $1,571,395 $ 10,541 2.70%
------------------------------------ ---------------------------------------- --------------------------------------
Interest income to earning assets 6.04% 5.77%
Interest expense to paying
liabilities 2.86% 2.70%
------------------------------------ --------------------------------------- --------------------------------------
Interest spread 3.18% 3.07%
Impact of non-interest funds 0.37% 0.33%
------------------------------------ --------------------------------------- --------------------------------------
Net interest margin $ 16,379 3.55% $ 15,062 3.40%
------------------------------------ --------------========================= ------------==========================
Interest income totaled $27.9 million in 2005, or 9.0% more than the $25.6
million recorded in 2004. From 2004 to 2005, earning assets grew $87 million,
including growth of $128 million in loans. Loan growth continued its trend of
recent years of being focused in the commercial and commercial real estate
categories accompanied by continued increases in the consumer home equity
market. Funding for loan growth came from scheduled runoff in the investment
portfolio and by an $84 million increase in total deposits. Growth in earning
assets was complemented by an increase of 27 basis points in earning asset
yields, from 5.77% in 2004 to 6.04% in 2005, reflecting the trend of increasing
interest rates begun in the third and fourth quarters of 2004 pursuant to the
reversal of the Fed's accommodative monetary policy.
13
COMMUNITY BANKS, INC. AND SUBSIDIARIES
PART I - Item 2. Management's Discussion and Analysis of Financial Condition
- --------------------------------------------------------------------------------
and Results of Operations (continued)
- --------------------------------------
Interest expense on deposits and borrowings increased from $10.5 million in 2004
to $11.5 million in 2005 as a result of increases in both average rates paid and
average balances. The average rate paid on interest-bearing liabilities
increased from 2.70% to 2.86%, reflecting the overall increase in rates since
2004. Community's popular Power Checking account offering, which is responsive
to customer preferences for liquidity and flexibility, continued to be the
primary driver in interest-bearing deposit growth as it increased $65 million
from 2004. Short-term borrowings decreased $21 million and long-term debt
increased $15 million from 2004. Community has gradually reduced its dependence
on selected short term funding sources that are more sensitive to increases in
short term interest rates. Long-term borrowings have increased to mitigate the
impact of rising rates on funding costs.
As a result of rate trends and other dynamics specific to its balance sheet,
Community reported an increase in net interest spread from 3.07% in 2004 to
3.18% in 2005, and an increase in net interest margin from 3.40% to 3.55%. The
increase in margin was also linked to the impact of increased contribution from
non-interest funding sources, which increased from 0.33% to 0.37%.
Provision for Loan Losses
Community has experienced ongoing stability in its credit quality the last two
years, even as dramatic loan growth has occurred. The provision for loan losses
decreased from $850 thousand for the three months ended March 31, 2004, to $550
thousand for 2005 and the relationship of the allowance for loan losses to loans
declined slightly from 1.19% at December 31, 2004 to 1.18% at March 31, 2005.
The provision and the level of the allowance reflect Community's response to
changing credit quality patterns and to risks inherent in both seasoned loans
and in incremental additions to Community's growing portfolio. Net charge-offs
during the first three months of 2005 were $217 thousand, or 0.07% of average
loans annualized, compared to $166 thousand, or .06% of average loans in 2004.
Non-accrual loans aggregated $5.8 million at March 31, 2005, compared to $7.5
million a year earlier. The ratio of the allowance to non-accrual loans, an
important measure of credit quality, was 254% at March 31, 2005, compared to
184% at March 31, 2004.
Non-Interest Income
Excluding investment securities gains, non-interest income for the three months
ended March 31, 2005, increased $868 thousand, or 20%, from 2004. Enhancement
and expansion of traditional fee-based banking services, coupled with the
development of new financial service offerings, have been the catalysts for
steady growth in this revenue source.
Investment management and trust services increased 55%, from $267 thousand in
2004 to $414 thousand in 2005, primarily reflecting an increase in income
related to the sale of various retail investment products (annuities, brokerage
services, mutual funds, etc.).
Revenue from service charges on deposit accounts increased 28%, to $1.8 million,
over 2004's $1.4 million, principally due to increased income from Community's
"OverdraftHonor" service. Demand deposit customers can now avoid adverse credit
implications of an occasional overdraft situation and simultaneously facilitate
timely payment of overdraft items. Since its introduction in 2003,
OverdraftHonor income has grown as consumers became aware of the benefits of the
service, leading to increased utilization that was also influenced by increases
in the number of demand deposit accounts.
Other service charges totaled $1.0 million for 2005, an increase of 12% from
$902 thousand in 2004. Other service charges include letter of credit fees and
interchange fees from Community's ATM network and debit card transactions. The
most significant volume of fees in this category relates to interchange fees,
but approximately one half of the increase in total income from 2004 is from
letter of credit fees, as issued standby letters of credit increased from $36
million in 2004 to $44 million in 2005.
14
COMMUNITY BANKS, INC. AND SUBSIDIARIES
PART I - Item 2. Management's Discussion and Analysis of Financial Condition
- --------------------------------------------------------------------------------
and Results of Operations (continued)
- --------------------------------------
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
2005 totaled $902 thousand, an increase of $248 thousand over the $654 thousand
reported for 2004. The increase was primarily related to agency-based
commissions.
Mortgage banking income decreased $112 thousand, or 18%, to $515 thousand for
2005. Mortgage banking activities have been adversely impacted by a steady
decline in mortgage refinancing, which had experienced a dramatic upturn for two
or three years prior to 2004.
Investment security gains were a negligible $51 thousand for 2005, compared to
$1.3 million for 2004. The majority of gains in 2004 related to sales of equity
holdings in bank stocks.
Non-Interest Expenses
Total non-interest expenses reached $12.7 million for the three months ended
March 31, 2005, a 7% increase from the $11.9 million recorded in 2004.
Salaries and employee benefits totaled $7.3 million for 2005, represented 58% of
operating costs, and increased $458 thousand, or 7%, compared to 2004. The
increase was affected by the annual merit increase and increased benefit costs
among other factors.
Occupancy expenses, marketing expense, telecommunications expense, and other
expenses all showed modest changes from 2004 to 2005. Expenses in prior quarters
were influenced by additional expenses from the absorption of acquired
businesses. Such businesses, the last of which was acquired in October 2003, are
becoming fully integrated, resulting in more efficient delivery of financial
services.
Income Taxes
Income tax expense for 2005 totaled $1.2 million, resulting in an effective tax
rate of 18.0%, compared to 18.2% for 2004. The relative mix of tax exempt to
taxable 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.
15
COMMUNITY BANKS, INC. AND SUBSIDIARIES
PART I - Item 2. Management's Discussion and Analysis of Financial Condition
- --------------------------------------------------------------------------------
and Results of Operations (continued)
- --------------------------------------
FINANCIAL CONDITION
- -------------------
The average balance sheets for the three months ended March 31, 2005 and 2004
were as follows (dollars in thousands):
March 31, Change
----------------------------------- --------------------------------
2005 2004 Volume %
------------------------------------------------------------------------------------------------------------------
Cash and due from banks $ 37,994 $ 36,065 $ 1,929 5%
Federal funds sold and other 24,022 6,399 17,623 275%
Investments 613,074 671,746 (58,672) (9)%
Loans held for sale 1,955 5,786 (3,831) (66)%
Loans 1,231,192 1,100,432 130,760 12%
Allowance for loan losses 14,533 13,484 1,049 8%
------------------------------------------------------------------------------------------------------------------
Net loans 1,216,659 1,086,948 129,711 12%
Goodwill and identifiable intangibles 5,029 4,756 273 6%
Other assets 84,386 85,081 (695) (1)%
------------------------------------------------------------------------------------------------------------------
Total assets $ 1,983,119 $ 1,896,781 $ 86,338 5%
==================================================================================================================
Noninterest-bearing deposits $ 183,048 $ 164,295 $ 18,753 11%
Interest-bearing deposits 1,143,712 1,078,299 65,413 6%
Short-term borrowings 31,106 52,020 (20,914) (40)%
Long-term debt 425,318 410,148 15,170 4%
Subordinated debt 30,928 30,928 --- ---
Other liabilities 12,612 13,783 (1,171) (9)%
------------------------------------------------------------------------------------------------------------------
Total liabilities 1,826,724 1,749,473 77,251 4%
------------------------------------------------------------------------------------------------------------------
Stockholders' equity 156,395 147,308 9,087 6%
------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $ 1,983,119 $ 1,896,781 $ 86,338 5%
==================================================================================================================
Average loans reached $1.2 billion for the three months ended March 31, 2005, a
12% increase over the $1.1 billion of average loans recorded for the three
months ended March 31, 2004. The following table provides a summary of the
changes in the various categories of loans (dollars in thousands):
Change
2005 2004 Amount %
------------------------------------------------------------------------------------------------------
Commercial $ 419,713 $ 393,786 $ 25,927 7%
Commercial real estate 362,149 283,302 78,847 28%
Residential real estate 91,326 97,784 (6,458) (7)%
Consumer 358,004 325,560 32,444 10%
------------------------------------------------------------------------------------------------------
Total $ 1,231,192 $ 1,100,432 $ 130,760 12%
======================================================================================================
16
COMMUNITY BANKS, INC. AND SUBSIDIARIES
PART I - Item 2. Management's Discussion and Analysis of Financial Condition
- --------------------------------------------------------------------------------
and Results of Operations (continued)
- --------------------------------------
Community has consistently made efforts to position itself to ensure its ability
to compete with large and small competitors alike and has improved its
visibility within its core markets, particularly in the commercial and
commercial real estate sectors. The addition of experienced lenders with
long-term ties to the business communities in these markets has enhanced
Community's profile and increased its access to commercial lending
opportunities. As a result, Community increased its commercial and commercial
real estate portfolios by nearly $105 million on an aggregate basis. Commercial
lending activity continues to be driven almost exclusively by in-market
transactions.
Significant growth, totalling $32 million, also occurred in consumer lending,
particularly in home equity lending. During 2004, promotions for revolving home
equity lines of credit with preferential terms generated substantial increases
in consumer lending opportunities and expansion of customer relationships.
Increases in the volume of home equity loans with specific terms were also
noted.
Residential real estate lending, primarily loans to single-family creditors,
continues its decline as a result of the 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, conforming mortgages 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 and Community recognized
growth of nearly 7%, as indicated by the following summary of average balances
for the three months ended March 31 (dollars in thousands):
Change
2005 2004 Amount %
------------------------------------------------------------------------------------------------
Demand $ 183,048 $ 164,295 $ 18,753 11%
Savings & NOW accounts 501,945 457,269 44,676 10%
Time 528,686 501,571 27,115 5%
Time $100,000 or more 113,081 119,459 (6,378) (5)%
------------------------------------------------------------------------------------------------
$ 1,326,760 $ 1,242,594 $ 84,166 7%
================================================================================================
Deposit growth occurred primarily in savings and NOW deposits; more specifically
Community's Power Checking account, which utilizes characteristics of both a
money market and checking account. Balances grew steadily throughout 2004. At
the same time, longer term time deposit trends were stable. More recent trends
continue to reflect consumer preferences for liquidity, though activity in
longer term certificates of deposit has begun to emerge.
17
COMMUNITY BANKS, INC. AND SUBSIDIARIES
PART I - Item 2. Management's Discussion and Analysis of Financial Condition
- --------------------------------------------------------------------------------
and Results of Operations (continued)
- --------------------------------------
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 March 31, 2005, along with a
comparison to the various current regulatory capital requirements:
March 31, Regulatory "Well
2005 Minimum Capitalized"
---------------------------------------------------
Leverage ratio
--------------
Community Banks, Inc. 8.9% 4% n/a
Community Banks 8.4% 4% 5%
Tier 1 capital ratio
--------------------
Community Banks, Inc. 11.6% 4% n/a
Community Banks 10.9% 4% 6%
Total risk-based capital ratio
------------------------------
Community Banks, Inc. 12.5% 8% n/a
Community Banks 11.9% 8% 10%
At March 31, 2005, total stockholders' equity reflected accumulated other
comprehensive loss of $2.4 million compared to accumulated other comprehensive
income of $3.2 million at December 31, 2004. This decrease can be attributed to
the change in the unrealized gain on investment securities available for sale,
net of taxes.
18
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 March
31, 2005.
Interest Rate Sensitivity
-----------------------------------------------------------------------------------------------------------------
1-90 90-180 180-365 1 year or
Dollars in thousands days days days more Total
-----------------------------------------------------------------------------------------------------------------
Assets
Federal funds sold $ 56,669 $ --- $ --- $ --- $ 56,669
Interest-bearing deposits in other
banks 611 --- --- --- 611
Loans held for sale --- --- --- 1,919 1,919
Investment securities 103,208 24,036 29,520 433,781 590,545
Loans((1)) 477,089 61,243 99,941 607,631 1,245,904
-----------------------------------------------------------------------------------------------------------------
Earning assets 637,577 85,279 129,461 1,043,331 1,895,648
Non-earning assets 492 --- --- 116,513 117,005
-----------------------------------------------------------------------------------------------------------------
Total assets $ 638,069 $ 85,279 $ 129,461 $ 1,159,844 $ 2,012,653
-----------------------------------------------------------------------------------------------------------------
Liabilities
Savings $ 207,269 $ --- $ --- $ 299,976 $ 507,245
Time 71,213 67,211 101,318 295,916 535,658
Time in denominations of $100,000
or more 19,495 13,625 21,026 58,791 112,937
Short-term borrowings 38,217 --- --- --- 38,217
Long-term debt 11,732 1,744 28,526 385,940 427,942
Subordinated debt 23,196 --- --- 7,732 30,928
-----------------------------------------------------------------------------------------------------------------
Interest bearing liabilities 371,122 82,580 150,870 1,048,355 1,652,927
Other liabilities and equity 5,856 5,856 11,712 336,302 359,726
-----------------------------------------------------------------------------------------------------------------
Total liabilities and equity $ 376,978 $ 88,436 $ 162,582 $ 1,384,657 $ 2,012,653
-----------------------------------------------------------------------------------------------------------------
(1) Includes non-accrual loans.
Interest Sensitivity GAP
---------------------------------------------------------------------------------------------------
1-90 90-180 180-365 1 year or
Dollars in thousands days days days more
---------------------------------------------------------------------------------------------------
Periodic $ 261,091 $ (3,157) $ (33,121) $ (224,813)
Cumulative 257,934 224,813 ---
Cumulative GAP as a percentage
of total assets 12.97% 12.82% 11.17% 0%
The 11.2% positive GAP between interest-earning assets and interest-bearing
liabilities maturing or repricing within one year at March 31, 2005, was
comparable to the 10.3% GAP at December 31, 2004.
19
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
March 31, 2005. 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.
Because of inherent limitations, our disclosure controls and procedures may not
prevent or detect misstatements. A control system, no matter how well conceived
and operated, can provide only reasonable, not absolute, assurance that the
objectives of the control system are met. Because of the inherent limitations in
all control systems, no evaluation of controls can provide absolute assurance
that all control issues and instances of fraud, if any, have been detected.
20
COMMUNITY BANKS, INC. AND SUBSIDIARIES
PART II - OTHER INFORMATION
Item 1 - Legal Proceedings
- --------------------------
Various actions and proceedings are presently pending to which Community and/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 or results of
operations.
Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds
- --------------------------------------------------------------------
No shares were purchased during the first quarter of 2005 as part of Community's
Share Repurchase Program.
Item 3 - Defaults Upon Senior Securities
- ----------------------------------------
Not applicable.
Item 4 - Submission of Matters to a Vote of Security Holders
- ------------------------------------------------------------
Not applicable.
Item 5 - Other Information
- --------------------------
Not applicable.
Item 6 - Exhibits
- -----------------
2 Merger agreement between PennRock Financial Services Corp. and
Community Banks, Inc., dated November 16, 2004, not including
schedules. Community will furnish the omitted schedules to the
Securities and Exchange Commission upon request. (Incorporated by
reference to Exhibit 10.1 to Community's Current Report on Form
8-K, filed with the Commission on November 22, 2004)
3.1 Amended Articles of Incorporation (Incorporated by reference to
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.
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)
21
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 May 10, 2005 /s/ Eddie L. Dunklebarger
--------------------------- -------------------------------
Eddie L. Dunklebarger
Chairman and President
(Chief Executive Officer)
Date May 10, 2005 /s/ Donald F. Holt
--------------------------- -------------------------------
Donald F. Holt
Executive Vice President
(Chief Financial Officer)
22