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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended SEPTEMBER 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from______________ to ______________________
Commission file number 0-17455
COMM BANCORP, INC.
________________________________________________________________________________
(Exact name of registrant as specified in its charter)
PENNSYLVANIA 23-2242292
________________________________________ ___________________________________
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
125 N. STATE STREET, CLARKS SUMMIT, PA 18411
________________________________________ ___________________________________
(Address of principal executive offices) (Zip Code)
(570)586-0377
________________________________________________________________________________
(Registrant's telephone number, including area code)
________________________________________________________________________________
(Former name, former address and former fiscal year, if changed since
last report.)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding twelve 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 [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date: 1,952,569 at October 31, 2002.
Page 1 of 58
Exhibit Index on Page 52
COMM BANCORP, INC.
FORM 10-Q
SEPTEMBER 30, 2002
INDEX
CONTENTS PAGE NO.
- ----------------------------------------------------------------------------
PART I. FINANCIAL INFORMATION:
Item 1: Financial Statements.
Consolidated Statements of Income and Comprehensive Income -
for the Three Months and Nine Months Ended September 30,
2002 and 2001.............................................. 3
Consolidated Balance Sheets - September 30, 2002 and
December 31, 2001.......................................... 4
Consolidated Statement of Changes in Stockholders' Equity
for the Nine Months Ended September 30, 2002............... 5
Consolidated Statements of Cash Flows for the Nine Months
Ended September 30, 2002 and 2001.......................... 6
Notes to Consolidated Financial Statements.................. 7
Item 2: Management's Discussion and Analysis of Financial
Condition and Results of Operations................... 9
Item 3: Quantitative and Qualitative Disclosures About Market
Risk.................................................. *
Item 4: Controls and Procedures................................ 47
PART II. OTHER INFORMATION:
Item 1: Legal Proceedings...................................... 50
Item 2: Changes in Securities and Use of Proceeds.............. 50
Item 3: Defaults Upon Senior Securities........................ 50
Item 4: Submission of Matters to a Vote of Security Holders.... 50
Item 5: Other Information...................................... 50
Item 6: Exhibits and Reports on Form 8-K....................... 50
SIGNATURES..................................................... 51
Exhibit Index.................................................. 52
* Not Applicable
2
COMM BANCORP, INC.
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2002 2001 2002 2001
- -----------------------------------------------------------------------------------------------------------------------
INTEREST INCOME:
Interest and fees on loans:
Taxable............................................................... $5,684 $6,162 $17,137 $18,333
Tax-exempt............................................................ 177 124 522 312
Interest and dividends on investment securities available-for-sale:
Taxable............................................................... 804 916 2,769 2,424
Tax-exempt............................................................ 439 484 1,455 1,248
Dividends............................................................. 17 31 56 93
Interest on federal funds sold.......................................... 164 153 255 696
------ ------ ------- -------
Total interest income............................................... 7,285 7,870 22,194 23,106
------ ------ ------- -------
INTEREST EXPENSE:
Interest on deposits.................................................... 3,036 3,796 9,327 11,621
Interest on long-term debt.............................................. 1
------ ------ ------- -------
Total interest expense.............................................. 3,036 3,796 9,327 11,622
------ ------ ------- -------
Net interest income................................................. 4,249 4,074 12,867 11,484
Provision for loan losses............................................... 195 180 935 540
------ ------ ------- -------
Net interest income after provision for loan losses................. 4,054 3,894 11,932 10,944
------ ------ ------- -------
NONINTEREST INCOME:
Service charges, fees and commissions................................... 763 598 2,216 1,878
Net gains on sale of loans.............................................. 208 156 565 229
Net gains on sale of investment securities.............................. 17 86
------ ------ ------- -------
Total noninterest income............................................ 988 754 2,867 2,107
------ ------ ------- -------
NONINTEREST EXPENSE:
Salaries and employee benefits expense.................................. 1,721 1,446 4,992 4,102
Net occupancy and equipment expense..................................... 458 409 1,359 1,297
Other expenses.......................................................... 1,249 1,200 3,665 3,253
------ ------ ------- -------
Total noninterest expense........................................... 3,428 3,055 10,016 8,652
------ ------ ------- -------
Income before income taxes.............................................. 1,614 1,593 4,783 4,399
Provision for income tax expense........................................ 344 363 973 1,039
------ ------ ------- -------
Net income.......................................................... 1,270 1,230 3,810 3,360
------ ------ ------- -------
OTHER COMPREHENSIVE INCOME:
Unrealized gains on investment securities available-for-sale............ 1,561 1,256 3,580 1,512
Reclassification adjustment for gains included in net income............ (17) (86)
Income tax expense related to other comprehensive income................ 525 426 1,188 513
------ ------ ------- -------
Other comprehensive income, net of income taxes..................... 1,019 830 2,306 999
------ ------ ------- -------
Comprehensive income................................................ $2,289 $2,060 $ 6,116 $ 4,359
====== ====== ======= =======
PER SHARE DATA:
Net income.............................................................. $ 0.65 $ 0.62 $ 1.94 $ 1.69
Cash dividends declared................................................. $ 0.21 $ 0.19 $ 0.61 $ 0.55
Average common shares outstanding....................................... 1,956,741 1,985,726 1,963,665 1,985,682
See notes to consolidated financial statements.
3
COMM BANCORP, INC.
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
SEPTEMBER 30, DECEMBER 31,
2002 2001
- -----------------------------------------------------------------------------------------------------------------
ASSETS:
Cash and due from banks............................................................. $ 13,004 $ 13,934
Federal funds sold.................................................................. 31,550
Investment securities available-for-sale............................................ 117,586 120,357
Loans held for sale, net............................................................ 2,113 1,885
Loans, net of unearned income....................................................... 317,439 310,322
Less: allowance for loan losses................................................... 3,640 3,220
-------- --------
Net loans........................................................................... 313,799 307,102
Premises and equipment, net......................................................... 11,512 9,702
Accrued interest receivable......................................................... 2,239 2,483
Other assets........................................................................ 3,634 4,895
-------- --------
Total assets.................................................................... $495,437 $460,358
======== ========
LIABILITIES:
Deposits:
Noninterest-bearing............................................................... $ 52,537 $ 45,079
Interest-bearing.................................................................. 393,628 371,126
-------- --------
Total deposits.................................................................. 446,165 416,205
Accrued interest payable............................................................ 1,693 1,879
Other liabilities................................................................... 2,634 1,426
-------- --------
Total liabilities............................................................... 450,492 419,510
-------- --------
STOCKHOLDERS' EQUITY:
Common stock, par value $0.33, authorized 12,000,000 shares, issued and
outstanding:
September 30, 2002, 1,951,014 shares; December 31, 2001, 1,976,541 shares.......... 644 652
Capital surplus..................................................................... 6,456 6,396
Retained earnings................................................................... 34,884 33,145
Accumulated other comprehensive income.............................................. 2,961 655
-------- --------
Total stockholders' equity...................................................... 44,945 40,848
-------- --------
Total liabilities and stockholders' equity...................................... $495,437 $460,358
======== ========
See notes to consolidated financial statements.
4
COMM BANCORP, INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
ACCUMULATED
OTHER TOTAL
COMMON CAPITAL RETAINED COMPREHENSIVE STOCKHOLDERS'
STOCK SURPLUS EARNINGS INCOME EQUITY
- -----------------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 2001........................ $652 $6,396 $33,145 $ 655 $40,848
Net income........................................ 3,810 3,810
Dividends declared: $0.61 per share............... (1,195) (1,195)
Dividend reinvestment plan: 4,606 shares issued... 2 150 152
Repurchase and retirement: 30,133 shares.......... (10) (90) (876) (976)
Net change in other comprehensive income.......... 2,306 2,306
---- ------ ------- ------ -------
BALANCE, SEPTEMBER 30, 2002....................... $644 $6,456 $34,884 $2,961 $44,945
==== ====== ======= ====== =======
See notes to consolidated financial statements.
5
COMM BANCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NINE MONTHS ENDED SEPTEMBER 30, 2002 2001
- --------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income............................................................................... $ 3,810 $ 3,360
Adjustments:
Provision for loan losses.............................................................. 935 540
Depreciation, amortization and accretion............................................... 1,507 1,546
Amortization of loan fees.............................................................. (96) (80)
Deferred income tax expense ........................................................... 56 45
Gains on sale of investment securities available-for-sale.............................. (86)
Gains on sale of foreclosed assets..................................................... (174) (51)
Changes in:
Loans held for sale, net............................................................. (228) (903)
Accrued interest receivable.......................................................... 244 (594)
Other assets......................................................................... (543) (203)
Accrued interest payable............................................................. (186) 232
Other liabilities.................................................................... 4 (82)
------- --------
Net cash provided by operating activities.......................................... 5,243 3,810
------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sale of investment securities available-for-sale........................... 11,213
Proceeds from repayments of investment securities available-for-sale..................... 20,333 19,112
Purchases of investment securities available-for-sale.................................... (25,796) (62,343)
Proceeds from sale of foreclosed assets.................................................. 1,980 969
Net increase in lending activities....................................................... (7,816) (18,803)
Purchases of premises and equipment...................................................... (2,512) (469)
------- --------
Net cash used in investing activities.............................................. (2,598) (61,534)
------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net changes in:
Money market, NOW, savings and noninterest-bearing accounts............................ 34,938 25,048
Time deposits.......................................................................... (4,978) 6,944
Payments on long-term debt............................................................... (36)
Proceeds from issuance of common shares.................................................. 152 154
Repurchase and retirement of common shares............................................... (976) (232)
Cash dividends paid...................................................................... (1,161) (1,072)
------- --------
Net cash provided by financing activities.......................................... 27,975 30,806
------- --------
Net increase (decrease) in cash and cash equivalents............................... 30,620 (26,918)
Cash and cash equivalents at beginning of year..................................... 13,934 37,419
------- --------
Cash and cash equivalents at end of period......................................... $44,554 $ 10,501
======= ========
SUPPLEMENTAL DISCLOSURE:
Cash paid during the period for:
Interest............................................................................... $ 9,513 $ 11,390
Income taxes........................................................................... 988 923
Noncash items:
Transfer of loans to foreclosed assets................................................. 280 408
Unrealized gains on investment securities available-for-sale........................... $(2,306) $ (999)
See notes to consolidated financial statements.
6
COMM BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
1. BASIS OF PRESENTATION:
The accompanying unaudited consolidated financial statements of Comm Bancorp,
Inc. and subsidiaries, Community Bank and Trust Company, including its
subsidiaries, Community Leasing Corporation and Comm Financial Services
Corporation, and Comm Realty Corporation (collectively, the "Company") have been
prepared in accordance with accounting principles generally accepted in the
United States of America ("GAAP") for interim financial information and with the
instructions to Form 10-Q and Article 10-01 of Regulation S-X. In the opinion of
management, all normal recurring adjustments necessary for a fair presentation
of the financial position and results of operations for the periods have been
included. All significant intercompany balances and transactions have been
eliminated in the consolidation. Prior-period amounts are reclassified when
necessary to conform with the current year's presentation.
The preparation of financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reported periods. Actual results could differ from those
estimates. For additional information and disclosures required under GAAP,
reference is made to the Company's Annual Report on Form 10-K for the period
ended December 31, 2001.
2. COSTS ASSOCIATED WITH EXIT OR DISPOSAL ACTIVITIES:
On July 30, 2002, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 146, "Accounting for
Costs Associated with Exit or Disposal Activities." This Statement requires
companies to recognize costs associated with exit or disposal activities when
they are incurred rather than at the date of a commitment to an exit or disposal
plan. Statement No. 146 is effective for exit or disposal activities initiated
after December 31, 2002. The adoption of the provisions of SFAS No. 146 on
January 1, 2003, is not expected to have a material effect on the operating
results or financial position of the Company.
3. ACQUISITIONS OF CERTAIN FINANCIAL INSTITUTIONS:
On October 1, 2002, the FASB issued SFAS No. 147, "Acquisitions of Certain
Financial Institutions." This Statement provides guidance on the accounting for
the acquisition of a financial institution. Except for acquisitions between two
or more mutual enterprises, SFAS No. 147 removes acquisitions of financial
institutions from the scope of SFAS No. 72, "Accounting for Certain Acquisitions
of Banking or Thrift Institutions" and FASB
7
COMM BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
3. ACQUISITIONS OF CERTAIN FINANCIAL INSTITUTIONS (CONTINUED):
Interpretation No. 9, "Applying APB Opinion No. 16 and 17 When a Savings and
Loan Association or a Similar Institution Is Acquired in a Business Combination
Accounted for by the Purchase Method," and requires those transactions be
accounted for in accordance with SFAS No. 141, "Business Combinations" and SFAS
No. 142, "Goodwill and Other Intangible Assets." In addition, this Statement
amends SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets," to include in its scope long-term customer-relationship intangible
assets of financial institutions. The provisions of SFAS No. 147 are effective
on October 1, 2002. The adoption of the provisions of SFAS No. 147 on October 1,
2002, is not expected to have a material effect on the operating results or
financial position of the Company.
8
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
FORWARD-LOOKING DISCUSSION:
Certain statements in this Form 10-Q are forward-looking statements that involve
numerous risks and uncertainties. The following factors, among others, may cause
actual results to differ materially from projected results:
Local, domestic and international economic and political conditions, and
government monetary and fiscal policies affect banking both directly and
indirectly. Inflation, recession, unemployment, volatile interest rates, tight
money supply, real estate values, international conflicts, and other factors
beyond our control may also adversely affect our future results of operations.
Our management team, consisting of the Board of Directors and executive
officers, expects that no particular factor will affect the results of
operations. Downward trends in areas such as real estate, construction and
consumer spending, may adversely impact our ability to maintain or increase
profitability. Therefore, we cannot assure the continuation of our current rates
of income and growth.
Our earnings depend largely upon net interest income. The relationship between
our cost of funds, deposits and borrowings, and the yield on our
interest-earning assets, loans and investments all influence net interest income
levels. This relationship, defined as the net interest spread, fluctuates and is
affected by regulatory, economic and competitive factors that influence interest
rates, the volume, rate and mix of interest-earning assets and interest-bearing
liabilities, and the level of nonperforming assets. As part of our interest rate
risk ("IRR") strategy, we monitor the maturity and repricing characteristics of
interest-earning assets and interest-bearing liabilities to control our exposure
to interest rate changes.
In originating loans, some credit losses are likely to occur. This risk of loss
varies with, among other things:
- General economic conditions;
- Loan type;
- Creditworthiness and debt servicing capacity of the borrower over the
term of the loan; and
- The value and marketability of the collateral securing the loan.
We maintain an allowance for loan losses based on, among other things:
- Historical loan loss experience;
- Known inherent risks in the loan portfolio;
- Adverse situations that may affect a borrower's ability to repay;
9
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
- The estimated value of any underlying collateral; and
- An evaluation of current economic conditions.
We currently believe that the allowance for loan losses is adequate, but we
cannot assure that nonperforming loans will not increase in the future.
To a certain extent, our success depends upon the general economic conditions in
the geographic market that we serve. Although we expect economic conditions in
our market area to remain stable, assurance cannot be given that these
conditions will continue. Further adverse changes to economic conditions could
impair asset quality and loan collections and may have a materially adverse
effect on the consolidated results of operations and financial position.
The banking industry is highly competitive, with rapid changes in product
delivery systems and in consolidation of service providers. We compete with many
larger institutions in terms of asset size. These competitors also have
substantially greater technical, marketing and financial resources. The larger
size of these companies affords them the opportunity to offer products and
services not offered by us. We are constantly striving to meet the convenience
and needs of our customers and to enlarge our customer base, however, we cannot
assure that these efforts will be successful.
OPERATING ENVIRONMENT:
The United States economy expanded in the third quarter of 2002. The gross
domestic product ("GDP"), the value of all goods and services produced in the
United States, grew at an annual rate of 3.1 percent. This growth rate may
appear respectable after only modest growth of 1.3 percent in the second
quarter, however, the majority of the growth was concentrated in automobile
sales, which skyrocketed in the third quarter. Adjusting for car sales, third
quarter growth was a meager 1.5 percent. In addition, additional signs point to
further economic uncertainty. The consumer sector, which has kept the economy
from double dipping back into recession in 2002, appears to be waning. Consumer
confidence fell sharply in October, the fifth consecutive decline. The consumer
confidence index declined 14.3 points in October to 79.4, the lowest level since
November of 1993. The drop in confidence was further highlighted by a 0.4
percent decline in consumer spending in September. Given low inflation, consumer
worries, stagnant business investment and ailing equity markets, the Federal
Open Market Committee ("FOMC") decided to take aggressive action in order to
jolt the stalled economy. At its meeting on November 6, 2002, the FOMC lowered
the federal funds rate 50 basis points to an historical low of 1.25 percent.
10
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
REVIEW OF FINANCIAL POSITION:
Total assets were $495.4 million at September 30, 2002, an increase of $35.0
million from $460.4 million at December 31, 2001. Deposit growth was the primary
factor contributing to the overall growth in our balance sheet. Due to
uncertainty in equity markets, traditional deposit products have come back in
favor, as investors are unwilling to assume the added risk of an extremely
volatile stock market. Total deposits rose $30.0 million to $446.2 million at
the close of the third quarter, from $416.2 million at year-end 2001. Loans, net
of unearned income, increased $7.1 million to $317.4 million at September 30,
2002, from $310.3 million at the close of last year. Investment securities were
$117.6 million at September 30, 2002, compared to $120.4 million at December 31,
2001. We had $31.6 million in federal funds sold at the end of the third quarter
of 2002. There were no federal funds sold outstanding at year-end 2001.
Stockholders' equity strengthened by $4.1 million to $44.9 million at September
30, 2002, from $40.8 million at December 31, 2001. The improvement primarily
resulted from net income of $3,810. Also affecting capital was a positive net
change in other comprehensive income of $2,306, net cash dividends declared of
$1,043 and common stock repurchases of $976. Our asset quality improved from
year-end 2001, as evidenced by a reduction in the ratio of nonperforming assets
to loans, net of unearned income. This ratio equaled 0.68 percent at September
30, 2002, compared to 1.25 percent at year-end 2001.
Total assets increased $19.2 million from the end of the second quarter of 2002.
An increase in deposits of $17.4 million was primarily directed into the
investment portfolio. Investment securities, available-for-sale rose $15.1
million, while loans, net of unearned income, increased $1.9 million. Federal
funds sold remained relatively unchanged from the previous quarter-end.
Stockholders' equity improved $1.5 million.
We opened our sixteenth community banking office in Scranton, Lackawanna County,
Pennsylvania, on August 23, 2002. This office is located near the Steamtown
National Historic Site in a predominately commercial area of the city. The
architectural and interior design of the building reflects the area's
time-honored railroad motif and presents a welcomed addition to the community.
Moreover, we believe the location of this office, in one of the major commercial
markets in Northeastern Pennsylvania, offers our Company significant growth
opportunities.
In addition, during the third quarter, we decided to further expand our market
area into Monroe County by purchasing land in Tannersville, Pennsylvania, to
construct a full-service community banking office. We feel that this market area
also exhibits strong growth potential since this region is one of the fastest
developing areas in Pennsylvania.
11
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
INVESTMENT PORTFOLIO:
The demise of the equity markets, which escalated at the close of the second
quarter of 2002, intensified further by the end of the third quarter. The demand
for U.S. Treasury securities increased, due to investors worries about the stock
market and the economy. As a result of this renewed demand, the price for U.S.
Treasuries rose. Treasury yields, which react inversely to prices, have reached
historic lows. Changes in the yields of U.S. Treasuries impact the market value
of our investment portfolio. Specifically, our holdings of mortgage-backed
securities and municipal obligations have average lives that are closely related
to the two-year and ten-year U.S. Treasury securities. The ten-year U.S.
Treasury, related to our holdings of state and municipal obligations, plummeted
106 basis points to 3.87 percent at the close of the third quarter, from 4.93
percent at June 30, 2002. This drop in rates had a positive affect on the
unrealized holding gain on state and municipal obligations, which increased
$1,596 to $3,070 at September 30, 2002, from $1,474 at the end of the second
quarter. The two-year U.S. Treasury rate, which affects our mortgage-backed
securities, dropped 99 basis points to 2.00 percent at September 30, 2002, from
2.99 percent at the end of the previous quarter. Despite the yield reduction, we
experienced a $78 decline in the unrealized holding gain on mortgage-backed
securities as a result of the change in the yield spread between these
securities and U.S. Treasuries. Overall, the unrealized holding gain on the
investment portfolio increased $1,545 to $4,487 at September 30, 2002, from
$2,942 at June 30, 2002.
The carrying values of the major classifications of securities as they relate to
the total investment portfolio at September 30, 2002, and December 31, 2001, are
summarized as follows:
DISTRIBUTION OF INVESTMENT SECURITIES
SEPTEMBER 30, DECEMBER 31,
2002 2001
AMOUNT % AMOUNT %
- ---------------------------------------------------------------------------------------------
U.S. Government agencies............................ $ 11,404 9.70% $ 1,067 0.89%
State and municipals................................ 38,102 32.40 41,790 34.72
Mortgage-backed securities.......................... 66,058 56.18 75,558 62.78
Equity securities................................... 2,022 1.72 1,942 1.61
-------- ------ -------- ------
Total............................................ $117,586 100.00% $120,357 100.00%
======== ====== ======== ======
Our investment portfolio decreased $2.8 million to $117.6 million at September
30, 2002, from $120.4 million at December 31, 2001. However, in comparison to
the end of the previous quarter, investments increased $15.1 million. Due to
subdued loan demand and increased liquidity, in the third quarter we directed a
portion of our excess funds into the investment
12
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
portfolio. Specifically, we purchased $10.3 million in securities of U.S.
Government agencies, $13.8 million in mortgage-backed securities, $1.6 million
in obligations of states and municipalities and $0.1 million in other
investments. At September 30, 2002, investment securities equaled 25.1 percent
of earning assets, compared to 22.7 percent at June 30, 2002, and 27.8 percent
at December 31, 2001. During the nine months ended September 30, 2002, we sold
state and municipal obligations having an amortized cost of $6.2 million and
mortgage-backed securities having an amortized cost of $4.9 million. We realized
gains of $86 on the sale of these securities. No securities were sold during the
nine months ended September 30, 2001.
The investment portfolio averaged $98.2 million and $108.5 million for the three
months and nine months ended September 30, 2002, compared to $106.1 million and
$93.3 million for the same periods of last year. As a result of the lower
interest rate environment, the tax-equivalent yield on the investment portfolio
dropped 12 basis points to 6.20 percent for the nine months ended September 30,
2002, from 6.32 percent for the same period of 2001. The tax-equivalent yield
was 6.01 percent for the third quarter of 2002, a decline of 24 basis points
from 6.25 percent for the second quarter.
In addition to yield analysis, we utilize a total return approach to measure the
investment portfolio's performance. This approach gives a more complete picture
of a portfolio's overall performance since it takes into consideration both
market value and reinvestment income from repayments. The investment portfolio's
total return is the sum of all interest income, reinvestment income on all
proceeds from repayments and capital gains or losses, whether realized or
unrealized. Total return for the investment portfolio improved for the twelve
months ended September 30, 2002, to 8.6 percent, compared to 8.3 percent for the
twelve months ended June 30, 2002. Furthermore, our investment portfolio ranked
in the upper 96th percentile of all banks throughout the United States over the
past twelve months according to latest results provided by a national investment
performance ranking company.
13
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
The maturity distribution of the amortized cost, fair value and weighted-average
tax-equivalent yield of the available-for-sale portfolio at September 30,2002,
is summarized as follows. The weighted-average yield, based on amortized cost,
has been computed for state and municipals on a tax-equivalent basis using the
statutory tax rate of 34.0 percent. The distributions are based on contractual
maturity with the exception of mortgage-backed securities, CMOs and equity
securities. Mortgage-backed securities and CMOs have been presented based upon
estimated cash flows, assuming no change in the current interest rate
environment. Equity securities with no stated contractual maturities are
included in the after ten year maturity distribution. Expected maturities may
differ from contracted maturities because borrowers have the right to call or
prepay obligations with or without call or prepayment penalties.
MATURITY DISTRIBUTION OF AVAILABLE-FOR-SALE PORTFOLIO
AFTER ONE AFTER FIVE
WITHIN BUT WITHIN BUT WITHIN AFTER
ONE YEAR FIVE YEARS TEN YEARS TEN YEARS TOTAL
-------------------------------------------------------------------------------------
SEPTEMBER 30, 2002 AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD
- ----------------------------------------------------------------------------------------------------------------------
Amortized cost:
U.S. Government agencies..... $11,309 2.49% $ 11,309 2.49%
State and municipals......... $ 1,095 4.61% 305 5.61 $ 8,559 7.83% $25,073 7.61% 35,032 7.55
Mortgage-backed securities... 21,420 5.83 37,919 5.46 5,458 5.75 17 7.01 64,814 5.61
Equity securities............ 1,944 3.82 1,944 3.82
------- ------- ------- ------- --------
Total...................... $22,515 5.77% $49,533 4.78% $14,017 7.02% $27,034 7.34% $113,099 5.87%
======= ======= ======= ======= ========
Fair value:
U.S. Government agencies..... $11,404 $ 11,404
State and municipals......... $ 1,105 317 $ 9,441 $27,239 38,102
Mortgage-backed securities... 21,744 38,621 5,676 17 66,058
Equity securities............ 2,022 2,022
------- ------- ------- ------- --------
Total...................... $22,849 $50,342 $15,117 $29,278 $117,586
======= ======= ======= ======= ========
LOAN PORTFOLIO:
Loans to finance one-to-four family residential properties account for a
significant portion of our lending activities. Accordingly, the housing market
and the economic conditions affecting it significantly impact our lending
activities. During the first nine months of 2002, the housing sector provided
support to an ailing United States economy. With mortgage rates hitting record
lows and lackluster investment alternatives, consumers opted to invest or
reinvest in the housing market. The rate on a 30-year mortgage closed the third
quarter at 6.09 percent, a drop of 56 basis points from an already low 6.65
percent at the end of the previous quarter. As a result, new and existing home
sales, as well as, housing starts soared in the third quarter of 2002. New and
existing home sales reached 1,021 thousand and 5.4 million in September 2002, up
from 947 thousand and 5.1 million in June. In
14
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
addition, for the twelve months ended September 30, 2002, average annual sales
of new homes rose 2.4 percent, while average annual sales of existing homes
increased 4.9 percent in comparison to one year ago. Furthermore, housing starts
topped 1.8 million, the strongest pace in 16 years.
The prime rate remained at 4.75 percent throughout the nine months ended
September 30, 2002. Despite continued low interest rates, problems plaguing the
business sector caused the demand for commercial loans to subside for all banks
in the United States. Business investment was barely positive in the third
quarter of 2002, after falling six consecutive quarters. As a result, commercial
banks posted a decline of $19.2 billion in commercial loans to $978.5 billion at
September 30, 2002, from $997.7 billion at the end of the previous quarter, and
$54.7 billion from $1,033.2 billion at year-end 2001. Personal spending remained
vibrant despite equity losses and layoffs, which kept demand for consumer loans
strong. Consumer loans for all commercial banks grew $14.8 billion to $585.2
billion at the end of the third quarter of 2002, from $570.4 billion at the
previous quarter-end, and $28.5 billion from $556.7 billion at December 31,
2001.
The composition of the loan portfolio at September 30, 2002, and December 31,
2001, is summarized as follows:
DISTRIBUTION OF LOAN PORTFOLIO
SEPTEMBER 30, DECEMBER 31,
2002 2001
AMOUNT % AMOUNT %
- ------------------------------------------------------------------------------------------
Commercial, financial and others............ $ 90,633 28.55% $ 71,512 23.05%
Real estate:
Construction.............................. 4,835 1.53 5,285 1.70
Mortgage.................................. 186,219 58.66 195,915 63.13
Consumer, net............................... 34,162 10.76 36,346 11.71
Lease financing, net........................ 1,590 0.50 1,264 0.41
-------- ------ -------- ------
Loans, net of unearned income............. 317,439 100.00% 310,322 100.00%
====== ======
Less: allowance for loan losses............. 3,640 3,220
-------- --------
Net loans............................... $313,799 $307,102
======== ========
Loans, net of unearned income increased $7.1 million to $317.4 million at
September 30, 2002, from $310.3 million at the end of 2001. Contrary to the
overall banking industry, greater demand in the commercial sector was the
primary factor contributing to the growth. As a result of greater emphasis
placed on developing our commercial markets, commercial loans, including
commercial mortgages and commercial lease financing, grew $28.6 million or 23.0
percent to $153.0 million at September 30, 2002, from $124.4 million at December
31, 2001. With regard to the consumer sector, increased activity
15
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
in our secondary mortgage division directly caused a decline in residential
mortgages, as the majority of mortgages originated were subsequently sold on the
secondary market. In addition, special financing rates offered by automobile
manufacturers greatly reduced the demand for our consumer loan products.
Residential mortgage loans, including construction loans, declined $19.2 million
or 12.8 percent, while consumer loans decreased $2.2 million or 6.1 percent.
In comparison to the end of the previous quarter, loans, net of unearned income,
grew $1.9 million. Commercial loans, including commercial mortgages and lease
financing, grew $5.0 million or at an annual rate of 13.4 percent. Residential
mortgage loans, including construction loans, declined $3.4 million. Consumer
loans increased by a slight $0.3 million.
Loans, net of unearned income, averaged $316.3 million for the nine months ended
September 30, 2002, an increase of $19.2 million from $297.1 million for the
same period of 2001. The tax-equivalent yield on the loan portfolio fell 88
basis points to 7.58 percent for the nine months ended September 30, 2002, from
8.46 percent for the same period last year. The historically low interest rates
sustained for over a year caused the tax-equivalent yield on our loan portfolio
to decline steadily over the first three quarters of 2002. The tax-equivalent
yield for the third quarter of 2002 declined 9 basis points to 7.44 percent,
after declining 25 basis points in the second quarter and 35 basis points in the
first quarter in comparison to the previous quarter. We anticipate a further
decline in loan yields due to the additional 50 basis point reduction in the
prime rate to 4.25 percent on November 6, 2002.
We continually examine the maturity distribution and interest rate sensitivity
of the loan portfolio in an attempt to limit IRR and liquidity strains.
Approximately 50.4 percent of the loan portfolio is expected to reprice within
the next twelve months. Management will price loan products in the near term in
order to reduce the average term of fixed-rate loans and increase its holdings
of variable-rate loans in an attempt to reduce IRR in the loan portfolio.
16
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
The maturity and repricing information of the loan portfolio by major
classification at September 30, 2002, is summarized as follows:
MATURITY DISTRIBUTION AND INTEREST SENSITIVITY OF LOAN PORTFOLIO
AFTER ONE
WITHIN BUT WITHIN AFTER
SEPTEMBER 30, 2002 ONE YEAR FIVE YEARS FIVE YEARS TOTAL
- -----------------------------------------------------------------------------------------------
Maturity schedule:
Commercial, financial and others........ $ 39,660 $ 24,395 $ 26,578 $ 90,633
Real estate:
Construction.......................... 4,835 4,835
Mortgage.............................. 21,292 58,657 106,270 186,219
Consumer, net........................... 12,780 17,991 3,391 34,162
Lease financing, net.................. 585 1,005 1,590
-------- -------- -------- --------
Total............................... $ 79,152 $102,048 $136,239 $317,439
======== ======== ======== ========
Repricing schedule:
Predetermined interest rates............ $ 31,492 $ 72,847 $ 84,726 $189,065
Floating or adjustable interest rates... 128,374 128,374
-------- -------- -------- --------
Total............................... $159,866 $ 72,847 $ 84,726 $317,439
======== ======== ======== ========
ASSET QUALITY:
National, Pennsylvania and market area unemployment rates at September 30, 2002
and 2001, are summarized as follows:
SEPTEMBER 30, 2002 2001
- --------------------------------------------------------------------------------------
United States......................................................... 5.6% 5.0%
Pennsylvania.......................................................... 5.2 4.7
Lackawanna county..................................................... 4.9 5.8
Susquehanna county.................................................... 5.2 7.2
Wayne county.......................................................... 3.9 4.3
Wyoming county........................................................ 4.1% 4.1%
The national unemployment rate was 5.6 percent at September 30, 2002, up from
5.0 percent one year ago. Nonfarm employment growth edged up slightly, however
the gains were concentrated in the service-producing industries. Manufacturing
payrolls continued to decline, indicating that companies are continuing to focus
on cost containment. Similarly, the unemployment rate for the Commonwealth rose
to 5.2 percent at September 30, 2002, from 4.7 percent last year. Unlike the
deteriorating conditions of the Commonwealth of Pennsylvania and the Nation,
employment conditions in our market area
17
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
improved. Three of the four counties we serve experienced improvement in
employment conditions. Wyoming County's unemployment rate remained unchanged.
Although employment conditions in our market area have remained steady, further
economic weakening could cause conditions in the counties we serve to
deteriorate.
Our asset quality improved steadily over the course of the past nine months.
Nonperforming assets were $2,163 or 0.68 percent of loans, net of unearned
income, at September 30, 2002, compared to $2,634 or 0.83 percent at the end of
the previous quarter and $3,870 or 1.25 percent at year-end 2001. A reduction in
foreclosed assets was primarily responsible for the asset quality improvement.
Nonaccrual loans increased slightly while accruing loans past due 90 days or
more declined from the end of 2001.
Nonaccrual loans increased $153 to $1,501 at September 30, 2002, from $1,348 at
December 31, 2001. The amount of real estate and consumer loans on nonaccrual
status increased, while the amount of commercial loans decreased. Accruing loans
past due 90 days or more decreased $334 to $370 at the end of the third quarter
compared to $704 at year-end 2001. Foreclosed assets decreased $1,526 to $292 at
September 30, 2002, from $1,818 at December 31, 2001. Seven loans totaling $280
were transferred to foreclosed assets during the nine months ended September 30,
2002. Fifteen properties with an aggregate carrying value of $1,788 were sold
for $1,980, resulting in a net realized gain of $192. Write downs on foreclosed
assets, charged to noninterest expense, amounted to $18.
We anticipate the economic conditions in our local market area to remain stable
for the remainder of 2002. However, should economic conditions weaken,
borrowers' ability to make timely loan payments could be hindered. The
possibility exists that these levels could deteriorate should this occur.
18
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
Information concerning nonperforming assets at September 30, 2002, and December
31, 2001, is summarized as follows. The table includes loans or other extensions
of credit classified for regulatory purposes and all material loans or other
extensions of credit that cause management to have serious doubts as to the
borrowers' ability to comply with present loan repayment terms.
DISTRIBUTION OF NONPERFORMING ASSETS
SEPTEMBER 30, DECEMBER 31,
2002 2001
- ------------------------------------------------------------------------------------------
NONACCRUAL LOANS:
Commercial, financial and others............................. $ 91 $ 113
Real estate:
Construction...............................................
Mortgage................................................... 1,170 1,045
Consumer, net................................................ 240 190
Lease financing, net.........................................
------ ------
Total nonaccrual loans................................... 1,501 1,348
------ ------
ACCRUING LOANS PAST DUE 90 DAYS OR MORE:
Commercial, financial and others............................. 10 107
Real estate:
Construction...............................................
Mortgage................................................... 270 372
Consumer, net................................................ 90 225
Lease financing, net.........................................
------ ------
Total accruing loans past due 90 days or more............ 370 704
------ ------
Total nonperforming loans................................ 1,871 2,052
------ ------
Foreclosed assets............................................ 292 1,818
------ ------
Total nonperforming assets............................... $2,163 $3,870
====== ======
Ratios:
Nonperforming loans as a percentage of loans, net............ 0.59% 0.66%
Nonperforming assets as a percentage of loans, net........... 0.68% 1.25%
We perform a systematic analysis of the adequacy of our allowance for loan
losses account quarterly. We follow our systematic methodology in accordance
with procedural discipline by applying it in the same manner regardless to
whether the allowance is being determined at a higher point or a lower point in
the economic cycle. Each quarter, our loan review department identifies those
loans to be individually evaluated for impairment and those to be collectively
evaluated for impairment utilizing a standard criteria. Internal loan review
grades are assigned quarterly to loans identified to be individually evaluated.
A loan's grade may differ from period to period based on current conditions and
events, however, we consistently utilize the
19
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
same grading system each quarter. We consistently use loss experience from the
latest eight quarters in determining the historical loss factor for each pool
collectively evaluated for impairment. Qualitative factors are evaluated in the
same manner each quarter and are adjusted within a relative range of values
based on current conditions.
We maintain the allowance for loan losses at a level we believe adequate to
absorb probable credit losses related to specifically identified loans, as well
as probable incurred loan losses inherent in the remainder of the loan portfolio
as of the balance sheet date. The balance in the allowance for loan losses
account is based on past events and current economic conditions. As previously
mentioned, we employ the Federal Financial Institution Examination Council
("FFIEC") Interagency Policy Statement and GAAP in assessing the adequacy of the
allowance account. Under GAAP, the adequacy of the allowance account is
determined based on the provisions of Statement of Financial Accounting
Standards ("SFAS") No. 114 for loans specifically identified to be individually
evaluated for impairment and the requirements of SFAS No. 5 for large groups of
smaller-balance homogeneous loans to be collectively evaluated for impairment.
The allowance for loan losses account consists of an allocated element and an
unallocated element. The allocated element consists of a specific portion for
the impairment of loans individually evaluated under SFAS No. 114, and a formula
portion for the impairment of those loans collectively evaluated under SFAS
No. 5.
Identified loans individually evaluated for impairment under SFAS No. 114,
include:
- Loans to borrowers having an aggregate exposure of $500 or more;
- Loans that are past due 30 days or more; and
- Any loans internally classified with a loan review grade of
substandard, doubtful, loss, special mention or watch.
A loan is considered impaired when, based on current information and events, it
is probable that we will be unable to collect all amounts due according to the
contractual terms of the loan agreement. All amounts due according to the
contractual terms means that both the contractual interest payments and the
contractual principal payments of a loan will be collected as scheduled in the
loan agreement. Factors considered by us in determining impairment include
payment status, collateral value, and the probability of collecting scheduled
principal and interest payments when due. Loans that experience insignificant
payment delays and payment shortfalls generally are not classified as impaired.
We determine the significance of payment delays and payment shortfalls on a
case-by-case basis, taking into consideration all of the circumstances
surrounding the loan and the borrower, including
20
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
the length of the delay, the reasons for the delay, the borrower's prior payment
record and the amount of the shortfall in relation to the principal and interest
owed. Loans considered impaired under SFAS No. 114 are measured for impairment
based on the present value of expected future cash flows discounted at the
loan's effective interest rate or the fair value of the collateral if the loan
is collateral dependent. If the present value of expected future cash flows
discounted at the loan's effective interest rate or the fair value of the
collateral, if the loan is collateral dependent, is less than the recorded
investment in the loan, including accrued interest and net deferred loan fees,
we will recognize the impairment by adjusting the allowance for loan losses
account through charges to earnings as a provision for loan losses. For
identified loans considered not impaired, we determine if these loans share
similar risk characteristics with those grouped and collectively evaluated for
impairment under SFAS No. 5.
Large groups of smaller-balance homogeneous loans and those identified loans
considered not impaired having similar characteristics as these groups are
segregated into major pools and are collectively evaluated, on a pool-by-pool
basis, for impairment under SFAS No. 5. Impairment for each of the major loan
pools is determined by applying a total loss factor to the current balance
outstanding for each individual pool. The total loss factor is comprised of a
historical loss factor using the loss migration method plus a qualitative
factor, which adjusts the historical loss factor for changes in trends,
conditions and other relevant factors that may affect repayment of the loans in
these pools as of the evaluation date. Loss migration involves determining the
percentage of each pool that is expected to ultimately result in loss based on
historical loss experience. The historical loss factor is based on the ratio of
net loans charged-off to loans, net of unearned income. These historical loss
percentages are updated quarterly and are based on the average actual amount of
loans in each pool that resulted in loss over the past eight quarters. We add to
these historical loss factors a qualitative factor that represents a number of
environmental risks that may cause estimated credit losses associated with the
current portfolio to differ from historical loss experience. These environmental
risks include:
- Changes in lending policies and procedures including underwriting
standards and collection, charge-off and recovery policies;
- Changes in the composition and volume of the portfolio;
- Changes in national, local and industry conditions;
21
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
- Changes in the volume of classified loans, including past due,
nonaccrual, troubled debt restructuring and other loan modifications;
- Changes in the levels of, and trends in, charge-offs and recoveries;
- The existence and effect of any concentrations of credit and changes in
the level of such concentrations;
- Changes in the experience, ability, and depth of lending management and
other relevant staff;
- Changes in the quality of the loan review system and the degree of
oversight by the board of directors; and
- The effect of external factors such as competition and legal and
regulatory requirements.
Loans identified to be collectively evaluated for impairment are separated into
three major pools in order to determine applicable loss factors. These pools
include:
- Identified loans individually evaluated but considered not impaired
that share risk characteristics with other collectively evaluated loans
having an internal loan grading classification of substandard, special
mention or watch;
- Identified loans individually evaluated but considered not impaired
that share risk characteristics with other collectively evaluated loans
having an internal loan grading classification of superior,
satisfactory or marginal; and
- Identified loans to be collectively evaluated for impairment and not
having an internal loan grading classification.
Specifically, we apply loss factors to identified loans individually evaluated
but considered not impaired that share risk characteristics with other
collectively evaluated loans having an internal loan grading classification of
substandard, special mention or watch based on actual historical loss experience
over the latest eight quarters, adjusted for current environmental risks for our
portfolio of loans having these loan grading classifications. Loss factors
applied to identified loans individually evaluated but considered not impaired
that share risk
22
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
characteristics with other collectively evaluated loans having an internal loan
grading classification of superior, satisfactory or marginal are based on actual
historical loss experience and current environmental factors for our portfolio
of loans having these loan grading classifications. Loans collectively evaluated
under SFAS No. 5 and not internally classified are applied a loss factor based
on the actual historical loss experience and current environmental conditions
for the overall loan portfolio. The loss factors for these pools are further
defined for the major classifications of loans including:
- Commercial, financial and others;
- Real estate-construction;
- Real estate-mortgage;
- Consumer; and
- Lease financing.
The unallocated element is used to cover inherent losses that exist as of the
evaluation date, but which have not been identified as part of the allocated
allowance using the above impairment evaluation methodology due to limitations
in the process. One such limitation is the imprecision of accurately estimating
the impact current economic conditions will have on historical loss rates.
Variations in the magnitude of the impact may cause estimated credit losses
associated with the current portfolio to differ from historical loss experience,
resulting in an allowance that is higher or lower than the anticipated level. We
establish the unallocated element of the allowance by considering a number of
environmental risks similar to the ones used for determining the qualitative
factors. We continuously monitor trends in historical and qualitative factors,
including trends in the volume, composition, and credit quality of the
portfolio. We utilize these trends to evaluate the reasonableness of the
unallocated element.
We monitor the adequacy of the allocated portion of the allowance quarterly and
adjust the allowance for any deficiencies through normal operations. This
self-correcting mechanism reduces potential differences between estimates and
actual observed losses. In addition, the unallocated portion of the allowance is
examined quarterly to ensure that it remains relatively constant in relation to
the total allowance unless there are changes in the related criteria that would
indicate a need to either increase or decrease it. The determination of the
allowance for loan loss level is inherently subjective as it requires estimates
that are susceptible to significant revision as more information becomes
available. Accordingly, we cannot ensure that charge-offs in future periods will
not exceed the allowance for loan losses or that additional increases in the
allowance for loan losses will not be required resulting in an adverse impact on
operating results.
23
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
Information concerning impaired loans at September 30, 2002, and December 31,
2001, is summarized as follows. The table includes credits classified for
regulatory purposes and all material credits that cause management to have
serious doubts as to the borrower's ability to comply with present loan
repayment terms.
DISTRIBUTION OF IMPAIRED LOANS
SEPTEMBER 30, DECEMBER 31,
2002 2001
- ---------------------------------------------------------------------------------------
NONACCRUAL LOANS:
Commercial, financial and others........................... $ 91 $ 113
Real estate:
Construction.............................................
Mortgage................................................. 1,170 1,045
Consumer, net.............................................. 240 190
Lease financing, net.......................................
------ ------
Total nonaccrual loans................................. 1,501 1,348
------ ------
ACCRUING LOANS:
Commercial, financial and others........................... 1,244 407
Real estate:
Construction.............................................
Mortgage................................................. 467 65
Consumer, net.............................................. 91 125
Lease financing, net.......................................
------ ------
Total accruing loans................................... 1,802 597
------ ------
Total impaired loans................................... $3,303 $1,945
====== ======
Ratio:
Impaired loans as a percentage of loans, net............... 1.04% 0.63%
Information relating to the recorded investment in impaired loans at September
30, 2002 and December 31, 2001, is summarized as follows:
SEPTEMBER 30, DECEMBER 31,
2002 2001
- ----------------------------------------------------------------------------------------
Impaired loans:
With a related allowance................................... $2,182 $ 910
With no related allowance.................................. 1,121 1,035
------ ------
Total.................................................... $3,303 $1,945
====== ======
24
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
The analysis of changes affecting the allowance for loan losses related to
impaired loans for the nine months ended September 30, 2002, is summarized as
follows:
SEPTEMBER 30,
2002
- --------------------------------------------------------------------------------------------
Balance at January 1......................................................... $403
Provision for loan losses.................................................... 888
Loans charged-off............................................................ 411
Loans recovered.............................................................. 6
----
Balance at period-end........................................................ $886
====
Interest income on impaired loans that would have been recognized had the loans
been current and the terms of the loan not been modified, the aggregate amount
of interest income recognized and the amount recognized using the cash-basis
method and the average recorded investment in impaired loans for the three-month
and nine-month periods ended September 30, 2002 and 2001 are summarized as
follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2002 2001 2002 2001
- ---------------------------------------------------------------------------------------
Gross interest due under terms................. $ 53 $ 58 $ 133 $ 136
Interest income recognized..................... 92 182 139 212
------ ------ ------ ------
Interest income not recognized (recognized in
excess of due)................................ $ (39) $ (124) $ (6) $ (76)
====== ====== ====== ======
Interest income recognized (cash-basis)........ $ 92 $ 182 $ 139 $ 212
Average recorded investment in impaired loans.. $3,335 $2,887 $2,598 $2,131
Cash received on impaired loans applied as a reduction of principal totaled $399
and $100 for the nine and three months ended September 30, 2002. For the
respective periods of 2001 cash receipts on impaired loans totaled $166 and $74.
There were no commitments to extend additional funds to such parties at
September 30, 2002.
25
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
The allocation of the allowance for loan losses at September 30, 2002 and
December 31, 2001, is summarized as follows:
ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
SEPTEMBER 30, DECEMBER 31,
2002 2001
----------------- ------------------
CATEGORY CATEGORY
AS A AS A
% OF % OF
AMOUNT LOANS AMOUNT LOANS
- -----------------------------------------------------------------------------------------
Allocated allowance:
Specific:
Commercial, financial and others............... $ 575 0.42% $ 174 0.17%
Real estate:
Construction.................................
Mortgage..................................... 193 0.52 135 0.36
Consumer, net.................................. 118 0.10 94 0.10
Lease financing, net........................... ------ ------ ------ ------
Total specific............................. 886 1.04 403 0.63
------ ------ ------ ------
Formula:
Commercial, financial and others............... 995 28.13 1,433 22.88
Real estate:
Construction................................. 1.52 1.70
Mortgage..................................... 1,209 58.15 800 62.77
Consumer, net.................................. 530 10.66 452 11.61
Lease financing, net........................... 0.50 0.41
------ ------ ------ ------
Total formula.............................. 2,734 98.96 2,685 99.37
------ ------ ------ ------
Total allocated allowance.................. 3,620 100.00% 3,088 100.00%
====== ======
Unallocated allowance.......................... 20 132
------ ------
Total allowance for loan losses............ $3,640 $3,220
====== ======
The allocated allowance was $3,620 at September 30, 2002, an increase of $532
from $3,088 at December 31, 2001. The increase primarily resulted from an
increase in the specific portion of the allocated allowance for loans identified
as impaired under SFAS No. 114 with a recorded investment in excess of the fair
value of the underlying collateral. Specifically, the amount of commercial loans
with a recorded investment in excess of fair value was $1,283 with an impaired
balance of $575 at September 30, 2002, compared to $210 with an impaired balance
of $174 at December 31, 2002. The unallocated portion of the allowance for loan
losses decreased to $20 at the end of the third quarter of 2002, from $132 at
year-end 2001.
26
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
A reconciliation of the allowance for loan losses and illustration of
charge-offs and recoveries by major loan category for the nine months ended
September 30, 2002, is summarized as follows:
RECONCILIATION OF ALLOWANCE FOR LOAN LOSSES
SEPTEMBER 30,
2002
- ----------------------------------------------------------------------------------------
Allowance for loan losses at beginning of period.......................... $3,220
Loans charged-off:
Commercial, financial and others.......................................... 149
Real estate:
Construction............................................................
Mortgage................................................................ 182
Consumer, net............................................................. 274
Lease financing, net...................................................... 2
------
Total................................................................. 607
------
Loans recovered:
Commercial, financial and others.......................................... 27
Real estate:
Construction...........................................................
Mortgage............................................................... 8
Consumer, net............................................................. 57
Lease financing, net......................................................
------
Total................................................................. 92
------
Net loans charged-off..................................................... 515
------
Provision charged to operating expense.................................... 935
------
Allowance for loan losses at end of period................................ $3,640
======
Ratios:
Net loans charged-off as a percentage of average loans outstanding........ 0.22%
Allowance for loan losses as a percentage of period end loans............. 1.15%
At September 30, 2002, the allowance for loan losses account equaled $3,640, an
increase of $109 from the previous quarter-end. The provision for loan losses of
$195 exceeded net charge-offs of $86 for the three months ended September 30,
2002. The allowance for loan losses as a percentage of loans, net of unearned
income increased to 1.15 percent at September 30, 2002, from 1.12 percent at
June 30, 2002. For our peer group the allowance equaled 1.30 percent of loans,
net of unearned income, at September 30, 2002. The allowance account covered
168.3 percent of nonperforming assets at September 30, 2002 and 134.1 percent at
June 30, 2002.
Past due loans not satisfied through repossession, foreclosure or related
actions, are evaluated individually to determine if all or part of the
outstanding balance should be charged against the allowance for loan losses
account. Any subsequent recoveries are credited to the allowance account. Net
charge-offs were $515 or 0.22 percent of average loans outstanding for
27
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
the nine months ended September 30, 2002, compared to $415 or 0.19 percent for
the same period last year. Net charge-offs as a percentage of average loans
outstanding for our peer group equaled 0.17 percent and 0.16 percent for the
respective periods.
DEPOSITS:
The average amount of, and the rate paid on, the major classifications of
deposits for the nine months ended September 30, 2002 and 2001, are summarized
as follows:
DEPOSIT DISTRIBUTION
SEPTEMBER 30, SEPTEMBER 30,
2002 2001
------------------ ------------------
AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE RATE BALANCE RATE
- ---------------------------------------------------------------------------------------
Interest-bearing:
Money market accounts...................... $ 18,949 2.13% $ 29,407 4.01%
NOW accounts............................... 37,944 1.45 27,141 1.91
Savings accounts........................... 103,417 1.98 76,885 2.35
Time deposits less than $100............... 185,421 4.51 184,292 5.62
Time deposits $100 or more................. 28,921 3.80 31,643 5.28
-------- --------
Total interest-bearing................... 374,652 3.33% 349,368 4.45%
Noninterest-bearing........................ 48,480 41,253
-------- --------
Total deposits........................... $423,132 $390,621
======== ========
Stock market volatility, which began in the latter part of 2001 with economic
uncertainty, heightened in 2002 as lackluster earnings performance and corporate
accounting scandals forced equity prices down. Investors, not willing to take on
the added risk of equity markets are using traditional bank products as their
current investment choice. In addition, consumers, leery about economic
conditions, are opting to increase their personal savings. As a result the
personal savings rate, which was negative throughout most of 2001, has stayed
above 3.0 percent in 2002 and was 4.2 percent in September 2002.
We experienced increased demand for our deposit products. The above factors were
partially responsible for the deposit growth. In addition, our strategy of
placing greater emphasis on developing commercial business relationships led to
a 21.8 percent increase in commercial transaction accounts. Overall, total
deposits amounted to $446.2 million at September 30, 2002, an increase of $30.0
million or 7.2 percent from $416.2 million at December 31, 2001.
Noninterest-bearing deposits rose $7.5 million, and interest-bearing transaction
accounts, money market accounts, NOW accounts and savings accounts, rose $27.5
million. Depositors were hesitant to invest monies
28
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
long-term due to extremely low interest rates, as a result, demand for time
deposits waned as evidenced by only a slight increase of $1.6 million in time
deposits less than $100. Time deposits in excess of $100 fell $6.6 million,
primarily due to one large deposit of a local area school district which was
used to fund a building project. In comparison to the second quarter, total
deposits rose $17.4 million. Similarly, the growth was concentrated in our
noninterest-bearing accounts and interest-bearing transaction accounts.
Total deposits averaged $423.1 million for the nine months ended September 30,
2002, an increase of $32.5 million or 8.3 percent compared to $390.6 million for
the same period of 2001. For the nine months ended September 30, 2002, average
noninterest-bearing deposits rose $7.2 million, while interest-bearing deposits
increased $25.3 million, in comparison to last year. Increases of $26.5 million
in savings accounts, $10.8 million in NOW accounts and $1.1 million in time
deposits less than $100 were partially offset by declines of $10.4 million in
money market accounts and $2.7 million in time deposits $100 or more. Due to the
sustained low interest rate environment, our cost of deposits decreased
dramatically. For the nine months ended September 30, our cost of deposits fell
112 basis points to 3.33 percent in 2002, from 4.45 percent in 2001. In
addition, our cost of deposits for the third quarter of 2002 was 3.16 percent, a
19 basis point reduction from 3.35 percent for the previous quarter. At the end
of the third quarter, the FOMC's position with regard to economic conditions was
weighted toward weakness. In response to the lower than expected economic
growth, the FOMC, at their November meeting, chose to lower the federal funds
rate another 50 basis points. As a result, we anticipate a further reduction in
our deposit costs. However, should an economic rebound occur and inflationary
pressures pick up, interest rates could rise.
Volatile deposits, time deposits in denominations of $100 or more, equaled $25.2
million at September 30, 2002, a $6.6 million decline from $31.8 million at
December 31, 2001. As previously mentioned, the decline was due to withdrawal
requirements associated with a building project of a local area school district.
Due to the short-term structure of volatile deposits and significantly lower
market rates, the average cost of these deposits fell 148 basis points to 3.80
percent for the nine months ended September 30, 2002, compared to 5.28 percent
for the same period of last year.
29
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
Maturities of time deposits of $100 or more at September 30, 2002, and December
31, 2001, are summarized as follows:
MATURITY DISTRIBUTION OF TIME DEPOSITS OF $100 OR MORE
SEPTEMBER 30, DECEMBER 31,
2002 2001
- --------------------------------------------------------------------------------------
Within three months...................................... $12,303 $10,720
After three months but within six months................. 2,315 4,648
After six months but within twelve months................ 3,432 11,619
After twelve months...................................... 7,158 4,823
------- -------
Total.................................................. $25,208 $31,810
======= =======
MARKET RISK SENSITIVITY:
Market risk is the risk to our earnings or financial position resulting from
adverse changes in market rates or prices, such as, interest rates, foreign
exchange rates or equity prices. Our exposure to market risk is primarily IRR
associated with our lending, investing and deposit-gathering activities. During
the normal course of business, we are not exposed to foreign currency exchange
risk or commodity price risk. Our exposure to IRR can be explained as the
potential for change in our reported earnings and/or the market value of our net
worth. Variations in interest rates affect earnings by changing net interest
income and the level of other interest-sensitive income and operating expenses.
Interest rate changes also affect the underlying economic value of our assets,
liabilities and off-balance sheet items. These changes arise because the present
value of future cash flows, and often the cash flows themselves, change with
interest rates. The effects of the changes in these present values reflect the
change in our underlying economic value and provide a basis for the expected
change in future earnings related to interest rates. IRR is inherent in the role
of banks as financial intermediaries. However, a bank with a high degree of IRR
may experience lower earnings, impaired liquidity and capital positions, and
most likely, a greater risk of insolvency. Therefore, banks must carefully
evaluate IRR to promote safety and soundness in their activities.
Interest rate sensitivity management attempts to limit and, to the extent
possible, control the effects interest rate fluctuations have on net interest
income and the market value of financial instruments. The responsibility of this
management has been delegated to the Asset/Liability Management Committee
("ALCO"). Specifically, ALCO utilizes a number of computerized modeling
techniques to monitor and attempt to control the influence that market changes
have on our rate-sensitive assets and
30
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
liabilities. One such technique utilizes a static gap report, which attempts to
measure our interest rate exposure by calculating the net amount of
rate-sensitive assets ("RSA") and rate-sensitive liabilities ("RSL") that
reprice within specific time intervals. A positive gap, indicated by a RSA/RSL
ratio greater than 1.0, implies that earnings will be impacted favorably if
interest rates rise and adversely if interest rates fall during the period. A
negative gap, a RSA/RSL ratio less than 1.0, tends to indicate that earnings
will be affected inversely to interest rate changes.
Our interest rate sensitivity gap position, illustrating RSA and RSL at their
related carrying values, is summarized as follows. The distributions in the
table are based on a combination of maturities, call provisions, repricing
frequencies and prepayment patterns. Variable-rate assets and liabilities are
distributed based on the repricing frequency of the instrument. Mortgage
instruments are distributed in accordance with estimated cash flows, assuming
there is no change in the current interest rate environment.
INTEREST RATE SENSITIVITY
DUE AFTER DUE AFTER
THREE MONTHS ONE YEAR
DUE WITHIN BUT WITHIN BUT WITHIN DUE AFTER
SEPTEMBER 30, 2002 THREE MONTHS TWELVE MONTHS FIVE YEARS FIVE YEARS TOTAL
- ----------------------------------------------------------------------------------------------------------------
Rate sensitive assets:
Investment securities............. $ 5,148 $ 17,701 $ 50,342 $ 44,395 $117,586
Loans held for sale, net.......... 2,113 2,113
Loans, net of unearned income..... 139,203 20,663 72,847 84,726 317,439
Federal funds sold................ 31,550 31,550
-------- -------- -------- -------- --------
Total........................... $178,014 $ 38,364 $123,189 $129,121 $468,688
======== ======== ======== ======== ========
Rate sensitive liabilities:
Money market accounts............. $ 20,184 $ 20,184
NOW accounts...................... 38,854 38,854
Savings accounts.................. $121,646 121,646
Time deposits less than $100...... $ 46,160 52,637 87,736 $ 1,203 187,736
Time deposits $100 or more........ 12,303 5,747 7,058 100 25,208
-------- -------- -------- -------- --------
Total........................... $ 58,463 $117,422 $216,440 $ 1,303 $393,628
======== ======== ======== ======== ========
Rate sensitivity gap:
Period.......................... $119,551 $(79,058) $(93,251) $127,818
Cumulative...................... $119,551 $ 40,493 $(52,758) $ 75,060 $ 75,060
RSA/RSL ratio:
Period.......................... 3.04 0.33 0.57 99.10
Cumulative...................... 3.04 1.23 0.87 1.19 1.19
Our cumulative one-year RSA/RSL ratio equaled 1.23 at September 30 2002,
compared to 1.09 at June 30, 2002. Both ratios fell within our asset/liability
guidelines of 0.70 and 1.30. The increase in the ratio occurred as a result of a
$9.5 million increase in RSA maturing or repricing within one year coupled with
a $14.2 million decline in RSL
31
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
maturing or repricing within one year coupled with a $14.2 million decline in
RSL maturing or repricing within the same time frame. The increase in RSA
primarily resulted from increases of $5.3 million in loans, net of unearned
income, and $3.4 million in investment securities. The change in RSL was caused
by reductions of $10.9 million in time deposits less than $100, $5.0 million in
time deposits $100 or more and $3.7 million in NOW accounts maturing or
repricing within one year, partially offset by an increase of $5.6 million in
money market accounts maturing or repricing within the same time frame. During
the third quarter, we offered two certificate of deposit promotions, one
offering was in conjunction with the grand opening of our Scranton office. The
second promotion featured a preferential rate on a certificate of deposit with a
90-month term. Both promotions were designed to direct new monies and redirect
existing deposits into longer-term instruments in order to mitigate potential
IRR should market rates begin to turn around. As a result, the time frame when
time deposits less than $100 mature or reprice lengthened in comparison to the
previous quarter-end.
We experienced a decline in our three-month ratio to 3.04 at September 30, 2002,
from 4.31 at the end of the previous quarter. The decrease primarily resulted
from an $18.3 million rise in the amount of RSL maturing or repricing within
three months. Partially offsetting the rise in RSL was a $5.3 million increase
in RSA maturing or repricing within the same time frame.
According to the results of the static gap report, we were asset rate-sensitive
for the cumulative one-year period. This indicates that should general market
rates increase, the likelihood exists that net interest income would be
positively affected. Conversely, a decline in market rates would likely have an
unfavorable effect on net interest income. However, these forward-looking
statements are qualified in the aforementioned section entitled "Forward-Looking
Discussion" in this Management's Discussion and Analysis.
Static gap analysis, although a credible measuring tool, does not fully
illustrate the impact of interest rate changes on future earnings. First, market
rate changes normally do not equally or simultaneously affect all categories of
assets and liabilities. Second, assets and liabilities that can contractually
reprice within the same period may not do so at the same time or to the same
magnitude. Third, the interest rate sensitivity table presents a one-day
position. Variations occur daily as we adjust our rate sensitivity throughout
the year. Finally, assumptions must be made in constructing such a table. For
example, the conservative nature of our Asset/Liability Management Policy
assigns money market and NOW accounts to the due after three but within twelve
months repricing interval. In reality, these items may reprice less frequently
and in different magnitudes than changes in general interest rate levels.
32
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
As the static gap report fails to address the dynamic changes in the balance
sheet composition or prevailing interest rates, we utilize a simulation model to
enhance our asset/liability management. This model is used to create pro forma
net interest income scenarios under various interest rate shocks. Model results
at September 30, 2002, produced results contrary to those indicated by the
one-year static gap position. Given parallel and instantaneous shifts in
interest rates of plus 100 basis points and 200 basis points, net interest
income should decrease by 1.0 percent and 1.9 percent. Conversely, similar
declines in interest rates would result in increases in net interest income of
0.9 percent and 1.9 percent.
Financial institutions are affected differently by inflation than commercial and
industrial companies that have significant investments in fixed assets and
inventories. Most of our assets are monetary in nature and change
correspondingly with variations in the inflation rate. It is difficult to
precisely measure the impact inflation has on us, however we believe that our
exposure to inflation can be mitigated through asset/liability management.
LIQUIDITY:
Liquidity is defined as the ability to generate cash at a reasonable cost to
fulfill lending commitments and support asset growth, while satisfying the
withdrawal demands of customers and any borrowing requirements. Our principal
sources of liquidity are core deposits and loan and investment payments and
prepayments. Providing a secondary source of liquidity is our ability to sell
both available-for-sale securities and mortgage loans held for sale. As a final
source of liquidity, we can exercise existing credit arrangements. We manage
liquidity daily, thus enabling us to effectively monitor fluctuations in our
liquidity position and to adapt the position according to market fluctuations.
We believe our liquidity is adequate to meet both present and future financial
obligations and commitments on a timely basis. There are presently no known
trends, demands, commitments, events or uncertainties that have resulted or are
reasonably likely to result in material changes with respect to our liquidity.
Our liquidity position at September 30, 2002, improved from the previous quarter
end. The change in our net noncore funding dependence ratio and net short-term
noncore funding dependence ratio, two key liquidity ratios, best illustrate the
improvement. The net noncore funding dependence ratio, defined as the difference
between noncore funds, time deposits $100 or more and brokered time deposits
less than $100, and short-term investments to long-term assets, was negative 7.7
percent at September 30, 2002, compared to negative 5.9 percent at June 30,
2002. In addition, the net short-term noncore funding dependence ratio, defined
as the difference between noncore funds maturing within one year, including
borrowed funds, less short-term
33
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
investments to long-term assets, equaled negative 9.5 percent at the close of
the third quarter, and negative 7.2 percent at the end of the previous quarter.
We consider our liquidity position adequate to meet our present and future
financial obligations and commitments. Management believes maintaining adequate
volumes of short-term investments and remaining competitive in our deposit
pricing will ensure sufficient liquidity to support future growth.
The consolidated statements of cash flows present the changes in cash and cash
equivalents from operating, investing and financing activities and further
illustrate the improvement in our liquidity position. Cash and cash equivalents,
consisting of cash on hand, cash items in the process of collection,
noninterest-bearing deposits with other banks, balances with the Federal Reserve
Bank of Philadelphia ("FRB") and the Federal Home Loan Bank of Pittsburgh
("FHLB-Pgh"), and federal funds sold, increased $30.6 million during the nine
months ended September 30, 2002. The increase in net cash and cash equivalents
was primarily funded through financing activities, and, to a lesser extent,
operating activities. A net cash outflow from investing activities partially
offset these inflows.
With regard to cash inflows, net cash provided by financing activities totaled
$28.0 million for the nine months ended September 30, 2002, which primarily
resulted from a $30.0 million net increase in deposits. Partially offsetting the
net increase in deposits were net cash dividends paid of $1.0 million and common
stock repurchases of $1.0 million. For the nine months ended September 30, 2002,
net income of $3.8 million was the main factor contributing to the $5.2 million
increase in net cash from operating activities.
Net cash used in investing activities totaled $2.6 million for the nine months
ended September 30, 2002. Cash received from repayments of investment securities
of $20.3 million, the sale of investment securities of $11.2 million and the
sale of foreclosed assets of $2.0 million were more than offset by purchases of
investment securities of $25.8 million, a net increase in lending activities of
$7.8 million and purchases of fixed assets of $2.5 million.
CAPITAL ADEQUACY:
Stockholders' equity totaled $44.9 million at September 30, 2002, an increase of
$4.1 million from $40.8 million at December 31, 2001. The capital improvement
principally resulted from net income of $3,810. Also
34
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
affecting capital was a positive change in other comprehensive income of $2,306,
net cash dividends declared of $1,043 and the repurchase of 30,133 shares of
common stock for $976.
Dividends declared totaled $1,195 or $0.61 per share for the nine months ended
September 30, 2002, compared to $1,093 or $0.55 per share for the same period of
last year. The dividend payout ratio for the nine months ended September 30, was
31.4 percent in 2002 and 32.5 percent in 2001. It is the intention of the Board
of Directors to continue to pay cash dividends in the future. However, these
decisions are affected by operating results, financial and economic decisions,
capital and growth objectives, appropriate dividend restrictions and other
relevant factors.
Our dividend reinvestment plan allows stockholders to automatically reinvest
their dividends in shares of our common stock. During the nine months ended
September 30, 2002, 4,606 shares were issued under this plan.
We attempt to assure capital adequacy by monitoring our current and projected
capital positions to support future growth, while providing stockholders with an
attractive long-term appreciation of their investments. According to bank
regulation, at a minimum, banks must maintain a Tier I capital to risk-adjusted
assets ratio of 4.0 percent and a total capital to risk-adjusted assets ratio of
8.0 percent. Additionally, banks must maintain a Leverage ratio, defined as Tier
I capital to total average assets less intangibles, of 3.0 percent. The minimum
Leverage ratio of 3.0 percent only applies to institutions with a
35
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
composite rating of one under the Uniform Interagency Bank Rating System, that
are not anticipating or experiencing significant growth and have
well-diversified risk. An additional 100 to 200 basis points are required for
all but these most highly-rated institutions. Our minimum Leverage ratio was
4.0 percent at September 30, 2002 and 2001. If an institution is deemed to be
undercapitalized under these standards, banking law prescribes an increasing
amount of regulatory intervention, including the required institution of a
capital restoration plan and restrictions on the growth of assets, branches or
lines of business. Further restrictions are applied to significantly or
critically undercapitalized institutions, including restrictions on interest
payable on accounts, dismissal of management and appointment of a receiver. For
well capitalized institutions, banking law provides authority for regulatory
intervention where the institution is deemed to be engaging in unsafe and
unsound practices or receives a less than satisfactory examination report
rating.
Our and Community Bank's capital ratios at September 30, 2002 and 2001, as well
as the required minimum ratios for capital adequacy purposes and to be well
capitalized under the prompt corrective action provisions as defined by the
Federal Deposit Insurance Corporation Act of 1991 are summarized as follows:
REGULATORY CAPITAL
MINIMUM TO BE WELL
CAPITALIZED UNDER
MINIMUM FOR CAPITAL PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
-------------------------------------------------------------------
SEPTEMBER 30, 2002 2001 2002 2001 2002 2001
- ------------------------------------------------------------------------------------------------------------------
Basis for ratios:
Tier I capital to risk-weighted assets:
Consolidated........................... $ 40,719 $ 37,833 $13,246 $12,198 $19,868 $18,298
Community Bank......................... 38,969 36,097 13,211 12,152 19,816 18,228
Total capital to risk-weighted assets:
Consolidated........................... 44,359 41,243 26,491 24,397 33,114 30,496
Community Bank......................... 42,609 39,507 26,421 24,304 33,026 30,380
Tier I capital to total average assets
less goodwill:
Consolidated........................... 40,719 37,833 18,719 17,262 23,399 21,578
Community Bank......................... 38,969 36,097 $18,676 $17,780 $23,345 $22,224
Risk-weighted assets:
Consolidated........................... 308,182 287,513
Community Bank......................... 307,306 286,348
Risk-weighted off-balance sheet items:
Consolidated........................... 22,957 17,447
Community Bank......................... 22,957 17,447
Average assets for Leverage ratio:
Consolidated........................... 467,971 431,557
Community Bank......................... $466,895 $444,488
Ratios:
Tier I capital as a percentage of
risk-weighted assets and off-balance
sheet items:
Consolidated............................ 12.3% 12.4% 4.0% 4.0% 6.0% 6.0%
Community Bank.......................... 11.8 11.9 4.0 4.0 6.0 6.0
Total of Tier I and Tier II capital as a
percentage of risk-weighted assets and
off-balance sheet items:
Consolidated............................ 13.4 13.5 8.0 8.0 10.0 10.0
Community Bank.......................... 12.9 13.0 8.0 8.0 10.0 10.0
Tier I capital as a
percentage of total
average assets less goodwill:
Consolidated............................ 8.7 8.8 4.0 4.0 5.0 5.0
Community Bank.......................... 8.3% 8.1% 4.0% 4.0% 5.0% 5.0%
Our risk-based capital ratios remained relatively constant in comparison to one
year earlier, and we exceeded all relevant regulatory capital requirements and
were considered well capitalized at September 30, 2002 and
36
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
2001. Regulatory agencies define institutions not under a written directive to
maintain certain capital levels as well capitalized if they exceed the
following:
- A Tier I risk-based ratio of at least 6.0 percent,
- A total risk-based ratio of at least 10.0 percent, and
- A Leverage ratio of at least 5.0 percent.
REVIEW OF FINANCIAL PERFORMANCE:
The banking industry benefitted from higher net interest income and noninterest
income in 2002. Insured commercial banks recorded a 16.7 percent increase in
year-to-date net income in 2002 compared to the previous year. The favorable
interest rate environment led to a 12.2 percent increase in net interest income.
In addition, earnings were also favorably impacted by a 6.5 percent increase in
noninterest revenue. Partially limiting these favorable affects was a 33.7
percent increase in loan loss provisions. Year-to-date return on average assets
for insured commercial banks increased to 1.37 percent in 2002, compared to 1.23
percent in 2001.
For the nine months ended September 30, 2002, net income totaled $3,810 or $1.94
per share, an increase of $450 or 13.4 percent from $3,360 or $1.69 per share
for the same period last year. The earnings improvement resulted from greater
amounts of net interest income and noninterest income, partially offset by
additional noninterest expense and a higher provision for loan losses. For the
third quarter, net income was $1,270 or $0.65 per share in 2002 compared to
$1,230 or $0.62 per share in 2001. Return on average assets was 1.05 percent for
the three months and 1.09 percent for the nine months ended September 30, 2002,
compared to 1.09 percent and 1.04 percent for the respective periods of 2001.
Return on average equity was 11.39 percent for the third quarter and 11.91
percent year-to-date in 2002, compared to 12.17 percent and 11.49 percent for
the same periods one year ago. We had other comprehensive income, related
entirely to unrealized gains and losses on investment securities, of $2,306 for
the nine months ended September 30, 2002, compared to $999 for the nine months
of 2001.
NET INTEREST INCOME:
As previously mentioned, a favorable rate environment led to a boost in net
interest income for insured commercial banks. Year-to-date net interest income
improved $12.8 billion or 12.2 percent in comparison to last year. In addition,
the average net interest margin for insured commercial banks improved 27 basis
points to 4.13 percent in 2002, from 3.86 percent in 2001.
37
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
Our principle source of operating income is net interest income. Net interest
income is defined as the difference between income, interest and fees from
earning assets, and the cost of interest-bearing liabilities supporting those
assets. The primary sources of earning assets are loans and investment
securities, while deposits, short-term borrowings and long-term debt comprise
interest-bearing liabilities. Net interest income is impacted by:
- Variations in the volume, rate and composition of earning assets and
interest-bearing liabilities;
- Changes in general market rates; and
- The level of nonperforming assets.
Changes in net interest income are measured by the net interest spread and net
interest margin. Net interest spread, the difference between the average yield
earned on earning assets and the average rate incurred on interest-bearing
liabilities, illustrates the effects changing interest rates have on
profitability. Net interest margin, net interest income as a percentage of
average earning assets, is a more comprehensive ratio, as it reflects not only
spread, but also the change in the composition of interest-earning assets and
interest-bearing liabilities. Tax-exempt loans and investments carry pre-tax
yields lower than their taxable counterparts. Therefore, in order to make the
analysis of net interest income more comparable, tax-exempt income and yields
are reported on a tax-equivalent basis using the prevailing statutory tax rate
of 34.0 percent.
38
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
We analyze interest income and interest expense by segregating rate and volume
components of earning assets and interest-bearing liabilities. The impact
changes in the interest rates earned and paid on assets and liabilities, along
with changes in the volume of earning assets and interest-bearing liabilities
have on net interest income are summarized in the following table. The net
change attributable to the combined impact of rate and volume has been allocated
proportionately to the change due to rate and the change due to volume.
NET INTEREST INCOME CHANGES DUE TO RATE AND VOLUME
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2002 VS. 2001 2002 VS. 2001
INCREASE (DECREASE) INCREASE (DECREASE)
ATTRIBUTABLE TO ATTRIBUTABLE TO
---------------------- --------------------------
TOTAL TOTAL
CHANGE RATE VOLUME CHANGE RATE VOLUME
------ ---- ------ ------ ---- ------
Interest income:
Loans:
Taxable............................. $(478) $(608) $ 130 $(1,196) $(1,941) $ 745
Tax-exempt.......................... 80 (17) 97 318 (50) 368
Investments:
Taxable............................. (126) (55) (71) 308 (74) 382
Tax-exempt.......................... (67) 4 (71) 314 (10) 324
Federal funds sold.................... 11 (177) 188 (441) (431) (10)
----- ----- ----- ------- ------- ------
Total interest income............. (580) (853) 273 (697) (2,506) 1,809
----- ----- ----- ------- ------- ------
Interest expense:
Money market accounts................. (227) (128) (99) (580) (330) (250)
NOW accounts.......................... (9) (156) 147 24 (187) 211
Savings accounts...................... 102 (31) 133 182 (202) 384
Time deposits less than $100.......... (513) (479) (34) (1,493) (1,640) 147
Time deposits $100 or more............ (113) (65) (48) (427) (327) (100)
Long-term debt........................ (1) (1)
----- ----- ----- ------- ------- ------
Total interest expense............ (760) (859) 99 (2,295) (2,686) 391
----- ----- ----- ------- ------- ------
Net interest income............... $ 180 $ 6 $ 174 $ 1,598 $ 180 $1,418
===== ===== ===== ======= ======= ======
For the nine months ended September 30, tax-equivalent net interest income
improved $1,598 or 13.0 percent to $13,886 in 2002 from $12,288 in 2001. The
improvement resulted primarily from an increase in the volume of average earning
assets over that of average interest-bearing liabilities, coupled with a
slightly greater reduction in our cost of funds as compared to the decline in
our earning asset yield. A $34.0 million increase in average earning assets
exceeded a $25.3 million rise in average interest-bearing liabilities and
resulted in a positive volume variance of $1,418.
39
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
Average loans, net of unearned income, and average investments increased $19.2
million and $15.2 million, which resulted in positive effects to tax-equivalent
interest income of $1,113 and $706. Partially offsetting these increases was a
slight decline in average federal funds sold of $0.3 million, which caused a
negligible reduction in interest income of $10. Offsetting the improvement in
interest income was additional interest expense of $391 from the growth in
average interest-bearing liabilities. Increases in the average volumes of
savings accounts, NOW accounts and time deposits less than $100, partially
offset by reductions in the average volume of money market accounts and large
denomination time deposits, caused the rise in interest expense. Growth in
average volumes of savings accounts of $26.5 million, NOW accounts of $10.8
million and time deposits less than $100 of $1.1 million resulted in additional
interest expense of $384, $211 and $147. These increases were partially offset
by decreases of $10.4 million in average money market accounts and $2.7 million
in time deposits $100 or more. These declines caused reductions in interest
expense of $250 and $100 when comparing the nine months ended September 30, 2002
and 2001.
Tax-equivalent net interest income was also affected by changes in earning asset
yields and fund costs. Significant declines in both the yield on earning assets
and the cost of funds had an overall affect on net interest income of only $180
comparing the nine months ended September 30, 2002 and 2001. An 80 basis point
reduction in the weighted average yield on earning assets caused interest income
to decrease by $2,506. More than offsetting this decline was a 112 basis point
reduction in the cost of funds, which resulted in a $2,686 decrease in interest
expense. Although we experienced reductions in the yields of all earning asset
categories, the majority of the reduction was concentrated in the yield on loans
and federal funds sold. The weighted average tax-equivalent yield on loans
declined 88 basis points to 7.58 percent in 2002 from 8.46 percent in 2001. This
decline resulted in a reduction in interest income of $1,991. The average yield
earned on federal funds sold declined 289 basis points to 1.71 percent in 2002
from 4.60 percent in 2001, and resulted in a negative rate variance of $431.
With regard to the reduction in our cost of funds, we experienced declines in
the average rate paid on all our deposit products. Specifically, a 111 basis
point decrease in the cost of time deposits less than $100 to 4.51 percent in
2002 from 5.62 percent in 2001 accounted for $1,640 or 61.1 percent of the
reduction in interest expense due to variations in rate.
For the quarter ended September 30, 2002, net interest income on a
tax-equivalent basis increased $180 compared to the same period last year. The
favorable change was attributed primarily to a positive volume variance of
40
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
$174. Growth in average loans of $16.4 million and average federal funds sold of
$21.3 million resulted in additional interest income of $227 and $188.
Offsetting these gains was a reduction in average investments of $7.9 million
which caused a negative volume variance of $142. Interest expense increased $99
as a result of changes in the volumes of average interest-bearing liabilities.
Specifically, increases in the average volumes of NOW accounts and savings
accounts were partially offset by lower volumes of money market accounts and
time deposits. Net interest income increased $6 due to a positive rate variance.
Our cost of funds declined at a slightly faster pace of 103 basis points versus
a 100 basis point reduction in the weighted average tax-equivalent yield on
earning assets. As a result of these rate variances, interest expense declined
$859, while interest income fell $853 comparing the third quarters of 2002 and
2001.
Maintenance of an adequate net interest margin is one of our primary concerns.
Our net interest margin improved 17 basis points to 4.17 percent for the nine
months ended September 30, 2002 from 4.00 percent for the same period of 2001.
The low interest rate environment is expected to continue for the remainder of
2002. The recent additional 50 basis point reduction in market rates could have
a negative affect on our net interest margin, as loans could reprice downward
faster than deposits. No assurance can be given on how net interest income will
be affected by changes in general market rates and/or competition. We believe
following prudent pricing practices coupled with careful investing will keep our
net interest margin favorable.
41
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
The average balances of assets and liabilities, corresponding interest income
and expense and resulting average yields or rates paid for the nine months ended
September 30, 2002 and 2001, are summarized as follows. Earning assets averages
include nonaccrual loans. Investment averages include available-for-sale
securities at amortized cost. Income on investment securities and loans are
adjusted to a tax-equivalent basis using a statutory tax rate of 34.0 percent.
SUMMARY OF NET INTEREST INCOME
SEPTEMBER 30, 2002 SEPTEMBER 30, 2001
--------------------------- ---------------------------
INTEREST AVERAGE INTEREST AVERAGE
AVERAGE INCOME/ INTEREST AVERAGE INCOME/ INTEREST
BALANCE EXPENSE RATE BALANCE EXPENSE RATE
ASSETS:
Earning assets:
Loans:
Taxable..................................... $302,738 $17,137 7.57% $290,015 $18,333 8.45%
Tax-exempt.................................. 13,562 791 7.80 7,088 473 8.92
Investments:
Taxable..................................... 69,264 2,825 5.45 59,855 2,517 5.62
Tax-exempt.................................. 39,193 2,205 7.52 33,448 1,891 7.56
Federal funds sold............................ 19,951 255 1.71 20,244 696 4.60
-------- ------- -------- ------
Total earning assets...................... 444,708 23,213 6.98% 410,650 23,910 7.78%
Less: allowance for loan losses............... 3,426 3,409
Other assets.................................. 27,953 25,881
-------- --------
Total assets.............................. $469,235 $433,122
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY:
Interest-bearing liabilities:
Money market accounts......................... $ 18,949 302 2.13% $ 29,407 882 4.01%
NOW accounts.................................. 37,944 412 1.45 27,141 388 1.91
Savings accounts.............................. 103,417 1,535 1.98 76,885 1,353 2.35
Time deposits less than $100.................. 185,421 6,255 4.51 184,292 7,748 5.62
Time deposits $100 or more.................... 28,921 823 3.80 31,643 1,250 5.28
Short-term borrowings......................... 11
Long-term debt................................ 7 1 7.50
-------- ------- -------- -------
Total interest-bearing liabilities........ 374,663 9,327 3.33% 349,375 11,622 4.45%
Noninterest-bearing deposits.................. 48,480 41,253
Other liabilities............................. 3,339 3,397
Stockholders' equity.......................... 42,753 39,097
-------- --------
Total liabilities and stockholders' equity $469,235 $433,122
======== ------- ======== -------
Net interest/income spread................ $13,886 3.65% $12,288 3.33%
======= =======
Net interest margin....................... 4.17% 4.00%
Tax equivalent adjustments:
Loans......................................... $ 269 $ 161
Investments................................... 750 643
------- -------
Total adjustments......................... $ 1,019 $ 804
======= =======
Note: Average balances were calculated using average daily balances. Average
balances for loans include nonaccrual loans. Available-for-sale
securities, included in investment securities, are stated at amortized
cost with the related average unrealized holding gains of $2,165 and
$925 for the nine months ended September 30, 2002 and 2001 included in
other assets. Tax-equivalent adjustments were calculated using the
prevailing statutory tax rate of 34.0 percent.
42
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
PROVISION FOR LOAN LOSSES:
We evaluate the adequacy of the allowance for loan losses account on a quarterly
basis utilizing our systematic analysis in accordance with procedural
discipline. As previously mentioned, we take into consideration certain factors
such as composition of the loan portfolio, volumes of nonperforming loans,
volumes of net charge-offs, prevailing economic conditions and other relevant
factors when determining the adequacy of the allowance for loan losses account.
We make monthly provisions to the allowance for loan losses account in order to
maintain the allowance at the appropriate level indicated by our evaluations.
Based on our most current evaluation, we believe that the allowance is adequate
to absorb any known and inherent losses in the portfolio.
The provision for loan losses totaled $935 and $195 for the nine and three
months ended September 30, 2002, compared to $540 and $180 for the same periods
of 2001. We consider the provision to be appropriate according to our adequacy
calculations of the allowance for loan losses account.
NONINTEREST INCOME:
Noninterest income totaled $2,867 for the nine months ended September 30, 2002,
compared to $2,107 for the same nine months of 2001. Included in noninterest
income in 2002 were gains from the sale of investment securities of $86.
Adjusting for these gains, noninterest income improved $674 or 32.0 percent.
Service charges, fees and commissions rose $338 or 18.0 percent and gains on the
sale of residential mortgage loans increased $336 or 146.7 percent. For the
third quarter, noninterest income improved $234 to $988 in 2002 from $754 in
2001.
NONINTEREST EXPENSE:
In general, noninterest expense is categorized into three main groups:
employee-related expenses, occupancy and equipment expenses and other expenses.
Employee-related expenses are costs associated with providing salaries,
including payroll taxes and benefits, to our employees. Occupancy and equipment
expenses, the costs related to the maintenance of facilities and equipment,
include depreciation, general maintenance and repairs, real estate taxes, rental
expense offset by any rental income, and utility costs. Other expenses include
general operating expenses such as advertising, contractual services, insurance,
including FDIC assessment, other taxes and supplies. Several of these costs and
expenses are variable while the remainder are fixed. We utilize budgets and
other related strategies in an effort to control the variable expenses.
43
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
Major components of noninterest expense for the three months and nine months
ended September 30, 2002 and 2001, are summarized as follows:
NONINTEREST EXPENSES
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2002 2001 2002 2001
- -------------------------------------------------------------------------------------------
Salaries and employee benefits expense:
Salaries and payroll taxes..................... $1,421 $1,214 $ 4,172 $3,478
Employee benefits.............................. 300 232 820 624
------ ------ ------- ------
Salaries and employee benefits expense....... 1,721 1,446 4,992 4,102
------ ------ ------- ------
Net occupancy and equipment expense:
Net occupancy expense.......................... 205 180 624 591
Equipment expense.............................. 253 229 735 706
------ ------ ------- ------
Net occupancy and equipment expense.......... 458 409 1,359 1,297
------ ------ ------- ------
Other noninterest expenses:
Marketing expense.............................. 153 94 364 256
Other taxes.................................... 103 106 293 302
Stationery and supplies........................ 113 93 361 290
Contractual services........................... 373 329 1,083 934
Insurance including FDIC assessment............ 49 42 143 125
Other.......................................... 458 536 1,421 1,346
------ ------ ------- ------
Other expenses............................... 1,249 1,200 3,665 3,253
------ ------ ------- ------
Total noninterest expense.................. $3,428 $3,055 $10,016 $8,652
====== ====== ======= ======
Increases in employee related costs and other expenses primarily caused a
substantial $1,364 jump in noninterest expense. For the nine months ended
September 30, 2002, noninterest expense amounted to $10,016, a 15.8 percent
increase from $8,652 for the same nine months of last year. Noninterest expense
for the third quarter increased $373 or 12.2 percent to $3,428 in 2002, from
$3,055 in 2001. Both our efficiency ratio and overhead ratio deteriorated
slightly in comparison to the previous year. Our efficiency ratio, noninterest
expense less nonrecurring expenses as a percentage of net interest income and
noninterest income less nonrecurring income, was 64.0 percent for the nine
months ended September 30, 2002, compared to 63.3 percent for the same period
last year. Similarly, for the nine months ended September 30, our overhead
ratio, noninterest expense as a percentage of total average assets, weakened
slightly to 2.9 percent in 2002, from 2.7 percent in 2001.
Salaries and employee benefits expense, which comprise the majority of
noninterest expense, totaled $4,992 for the nine months ended September 30,
2002, an increase of $890 or 21.7 percent from $4,102 for the same period of
2001. For the third quarter, salaries and employee benefits expenses were $1,721
in 2002, an increase of $275 from $1,446 in 2001. The addition
44
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
of corporate relationship officers, additional staff and training expenses
related to the two new branch offices, health insurance rate increases and
employer matching contributions to the newly formed 401(k) plan all factored
into the rise in employee costs.
For the nine months ended September 30, net occupancy and equipment expense rose
$62 or 4.8 percent to $1,359 in 2002 from $1,297 in 2001. For the three months
ended September 30, 2002 and 2001, net occupancy and equipment expenses amounted
to $458 and $409, an increase of $49.
Other expenses increased $412 to $3,665 for the nine months ended September 30,
2002, from $3,253 for the same nine months of 2001. For the quarter ended
September 30, other expenses totaled $1,249 in 2002 and $1,200 in 2001. The rise
in other expenses resulted primarily from an increase in contractual service
expenses associated with increased activity in our secondary mortgage division,
coupled with additional marketing and supply costs associated with the opening
of the two new branch offices.
Recently, the Federal Deposit Insurance Corporation ("FDIC") decided to retain
the existing Bank Insurance Fund ("BIF") and Savings Association Insurance Fund
("SAIF") assessment schedules of 0 to 27 basis points per year for the second
semiannual assessment period of 2002. According to FDIC statistics:
- 92.5 percent of all BIF-member institutions and 90.4 percent of
SAIF-member institutions are estimated to be listed in the lowest risk
category, thus paying no premiums,
- Only 0.1 percent of BIF-member institutions and 0.2 percent of
SAIF-member institutions are estimated to be in the highest risk
category, paying a premium of 27 cents per 100 dollars in deposits,
- The average annual assessment rate is projected to be 20 cents per 100
dollars for BIF-member institutions and 25 cents per 100 dollars for
SAIF-member institutions,
- The FDIC-approved rate schedules are expected to maintain the reserve
ratios for both the BIF and SAIF above the Congressional mandated 1.25
percent through year-end 2002,
- At December 31, 2001, the BIF reserve ratio was 1.26 percent and the
SAIF reserve ratio was 1.36 percent, and
- There will continue to be a separate levy assessed on all FDIC-insured
institutions to bear the cost of bonds sold by the Finance Corporation
("FICO") between 1987 and 1989 in support of the former Federal Savings
and Loan Insurance Corporation. As of January 1, 2000, all institutions
are assessed the same rate by FICO, as provided for in the Deposit
Insurance Funds Act of 1996.
45
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
We were included in the 92.5 percent of all BIF-member institutions classified
in the well capitalized supervisory risk subgroup at September 30, 2002.
Accordingly, we will be exempt from paying a BIF assessment for the second half
of 2002. However, along with all banks, we continue to be assessed quarterly for
assistance in interest payments on FICO bonds used to capitalize the SAIF. For
the nine months ended September 30, 2002 and 2001, our assessments totaled $55
and $53.
INCOME TAXES:
Despite higher pretax income, we experienced a $66 reduction in our income tax
expense to $973 for the nine months ended September 30, 2002, from $1,039 for
the same period last year. Our effective tax rate improved to 20.3 percent
compared to 23.6 percent for the nine months ended September 30, 2002 and 2001.
The improvement in the effective tax rate directly resulted from a higher level
of tax-exempt income. Tax-exempt interest income as a percentage of total
interest income equaled 8.9 percent for the nine months ended September 30,
2002, compared to 6.8 percent for the nine months of 2001. Our effective tax
rate is more favorable in comparison to that of our peer group. For the nine
months ended September 30, 2002 and 2001, the peer group posted effective tax
rates of 25.5 percent and 26.3 percent. We expect our effective tax rate to
remain favorable for the remainder of 2002 through continued emphasis on income
from tax-exempt investments and loans, as well as through the utilization of
investment tax credits available through our investment in a residential housing
program for elderly and low- to moderate-income families.
The difference between the amount of income tax currently payable and the
provision for income tax expense reflected in the income statements arise from
temporary differences. Temporary differences are differences between the tax
bases of assets and liabilities and their reported amounts in the financial
statements, which result in deferred tax assets or liabilities. We perform
quarterly reviews on the tax criteria related to the recognition of deferred tax
assets. We decided not to establish a valuation reserve for the deferred tax
assets since it is likely that these assets will be realized through carry-back
to taxable income in prior years and by future reversals of existing taxable
temporary differences or, to a lesser extent, through future taxable income.
46
COMM BANCORP, INC.
CONTROLS AND PROCEDURES
QUARTERLY EVALUATION OF THE COMPANY'S DISCLOSURE CONTROLS AND INTERNAL CONTROLS:
Within the 90 days prior to the date of this Quarterly Report on Form 10-Q, the
Company evaluated the effectiveness of the design and operation of its
disclosure controls and procedures ("Disclosure Controls"), and its internal
controls and procedures for financial reporting ("Internal Controls"). This
evaluation ("the Controls Evaluation") was done under the supervision and with
the participation of management, including our Chief Executive Officer ("CEO")
and Chief Financial Officer ("CFO"). Rules adopted by the SEC require that in
this section of the Quarterly Report we present the conclusions of the CEO and
the CFO about the effectiveness of our Disclosure Controls and Internal Controls
based on and as of the date of the Controls Evaluation.
CEO AND CFO CERTIFICATIONS: Appearing as Exhibit 99(iii) and Exhibit 99(iv) of
this Quarterly Report are two separate forms of "Certifications" of the CEO and
the CFO. The Certifications are required in accord with Section 302 of the
Sarbanes-Oxley Act of 2002 ("the Section 302 Certification"). This section of
the Quarterly Report which you are currently reading is the information
concerning the Controls Evaluation referred to in the Section 302 Certifications
and this information should be read in conjunction with the Section 302
Certifications for a more complete understanding of the topics presented.
DISCLOSURE CONTROLS AND INTERNAL CONTROLS: Disclosure Controls are procedures
that are designed with the objective of ensuring that information required to be
disclosed in our reports filed under the Securities Exchange Act of 1934
("Exchange Act"), such as this Quarterly Report, is recorded, processed,
summarized and reported within the time periods specified in the Securities and
Exchange Commission's ("SEC") rules and forms. Disclosure Controls are also
designed with the objective of ensuring that such information is accumulated and
communicated to our management, including the CEO and CFO, as appropriate to
allow timely decisions regarding required disclosure. Internal Controls are
procedures which are designed with the objective of providing reasonable
assurance that (i) our transactions are properly authorized; (ii) our assets are
safeguarded against unauthorized or improper use; and (iii) our transactions are
properly recorded and reported, all to permit the preparation of our financial
statements in conformity with generally accepted accounting principles.
LIMITATIONS ON THE EFFECTIVENESS OF CONTROLS: The Company's management,
including the CEO and CFO, does not expect that our Disclosure Controls or our
Internal Controls will prevent all error and all fraud. 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. Further,
the design of a control system must reflect the fact that there are resource
constraints, and the benefits of controls must be considered relative to their
costs. 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, within the Company have been detected. These inherent
limitations include the
47
COMM BANCORP, INC.
CONTROLS AND PROCEDURES (CONTINUED)
realities that judgments in decision-making can be faulty, and that breakdowns
can occur because of simple error or mistake. Additionally, controls can be
circumvented by the individual acts of some persons, by collusion of two or more
people, or by management override of the control. The design of any system of
controls also is based in part upon certain assumptions about the likelihood of
future events, and there can be no assurance that any design will succeed in
achieving its stated goals under all potential future conditions; over time,
control may become inadequate because of changes in conditions, or the degree of
compliance with the policies or procedures may deteriorate. Because of the
inherent limitations in a cost-effective control system, misstatements due to
error or fraud may occur and not be detected.
SCOPE OF THE CONTROLS EVALUATION: The CEO/CFO evaluation of our Disclosure
Controls and our Internal Controls included a review of the controls' objectives
and design, the controls' implementation by the Company and the effect of the
controls on the information generated for use in this Quarterly Report. In the
course of the Controls Evaluation, we sought to identify data errors, controls
problems or acts of fraud and to confirm that appropriate corrective action,
including process improvements, were being undertaken. This type of evaluation
will be done on a quarterly basis so that the conclusions concerning controls
effectiveness can be reported in our Quarterly Reports on Form 10-Q and Annual
Report on Form 10-K. Our Internal Controls are also evaluated on an ongoing
basis by our Internal Audit Department, by other personnel in our Finance
organization and by our independent auditors in connection with their audit and
review activities. The overall goals of these various evaluation activities are
to monitor our Disclosure Controls and our Internal Controls and to make
modifications as necessary; our intent in this regard is that the Disclosure
Controls and the Internal Controls will be maintained as dynamic systems that
change, including with improvements and corrections, as conditions warrant.
Among other matters, we sought in our evaluation to determine whether there were
any "significant deficiencies" or "material weaknesses" in the company's
Internal Controls, or whether the company had identified any acts of fraud
involving personnel who have a significant role in the company's Internal
Controls. This information was important both for the Controls Evaluation
generally and because items 5 and 6 in the Section 302 Certifications of the CEO
and CFO require that the CEO and CFO disclose that information to our Board's
Audit Committee and to our independent auditors and to report on related matters
in this section of the Quarterly Report. In the professional auditing
literature, "significant deficiencies" are referred to as "reportable
conditions"; these are control issues that could have a significant adverse
effect on the ability to record, process, summarize and report financial data in
the financial statements. A "material weakness" is defined in the auditing
literature as a particularly serious reportable condition where the internal
control does not reduce to a relatively low level the risk that misstatements
caused by error or fraud may occur in amounts that would be material in relation
to the financial statements and not be detected within a timely period by
employees in the normal course of performing their assigned functions. We also
sought to
48
COMM BANCORP, INC.
CONTROLS AND PROCEDURES (CONTINUED)
deal with other controls matters in the Controls Evaluation, and in each case if
a problem was identified, we considered what revision, improvement and/or
correction to make in accord with our on-going procedures.
In accord with SEC requirements, the CEO and CFO note that, since the date of
the Controls Evaluation to the date of this Quarterly Report, there have been no
significant changes in Internal Controls or in other factors that could
significantly affect Internal Controls, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Conclusions: Based upon the Controls Evaluation, our CEO and CFO have concluded
that, subject to the limitations noted above, our Disclosure Controls are
effective to ensure that material information relating to Intel and its
consolidated subsidiaries is made known to management, including the CEO and
CFO, particularly during the period when our periodic reports are being
prepared, and that our Internal Controls are effective to provide reasonable
assurance that our financial statements are fairly presented in conformity with
generally accepted accounting principles.
49
COMM BANCORP, INC.
OTHER INFORMATION
PART II. Other Information
ITEM 1. LEGAL PROCEEDINGS
NONE
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
NONE
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
NONE
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
NONE
ITEM 5. OTHER INFORMATION
NONE
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
99(i) Certification pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-
Oxley Act of 2002
99(ii) Certification pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-
Oxley Act of 2002
99(iii) Certifications pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
99(iv) Certifications pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
(a) Reports on Form 8-K
None
50
COMM BANCORP, INC.
FORM 10-Q
SIGNATURE PAGE
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto, duly authorized.
Registrant, Comm Bancorp, Inc.
Date: November 11, 2002 /s/ William F. Farber, Sr.
----------------------------------
William F. Farber, Sr.
Chief Executive Officer
Date: November 11, 2002 /s/ Scott A. Seasock
----------------------------------
Scott A. Seasock
Chief Financial Officer
(Principal Financial Officer)
Date: November 11, 2002 /s/ Stephanie A. Ganz
----------------------------------
Stephanie A. Ganz, CPA
Vice President of Finance
(Principal Accounting Officer)
51
EXHIBIT INDEX
ITEM NUMBER DESCRIPTION PAGE
- ----------- ----------- ----
99(i) Certification pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002 53
99(ii) Certification pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002 54
99(iii) Certification pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002 55
99(iv) Certification pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002 57
52