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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 JUNE 30, 2003
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 incorporation (I.R.S. Employer Identification
or organization) 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 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
Indicate by checkmark whether the registrant is an accelerated filer (as defined
in Rule 12b-2 of the Act). [ ]
APPLICABLE ONLY TO CORPORATE REGISTRANTS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date: 1,911,007 at July 31, 2003.
Page 1 of 51
Exhibit Index on Page 45
COMM BANCORP, INC.
FORM 10-Q
JUNE 30, 2003
INDEX
CONTENTS PAGE NO.
- ----------------------------------------------------------------------------
PART I. FINANCIAL INFORMATION:
Item 1: Financial Statements.
Consolidated Statements of Income and Comprehensive Income -
for the Three Months and Six Months Ended June 30, 2003
and 2002................................................... 3
Consolidated Balance Sheets - June 30, 2003 and December
31, 2002................................................... 4
Consolidated Statement of Changes in Stockholders' Equity
for the Six Months Ended June 30, 2003..................... 5
Consolidated Statements of Cash Flows for the Six Months
Ended June 30, 2003 and 2002............................... 6
Notes to Consolidated Financial Statements.................. 7
Item 2: Management's Discussion and Analysis of Financial
Condition and Results of Operations................... 8
Item 3: Quantitative and Qualitative Disclosures About Market
Risk.................................................. *
Item 4: Controls and Procedures................................ 40
PART II. OTHER INFORMATION:
Item 1: Legal Proceedings...................................... 42
Item 2: Changes in Securities and Use of Proceeds.............. 42
Item 3: Defaults Upon Senior Securities........................ 42
Item 4: Results of Votes of Security Holders................... 42
Item 5: Other Information...................................... 43
Item 6: Exhibits and Reports on Form 8-K....................... 43
Signatures..................................................... 44
Exhibit Index.................................................. 45
* Not Applicable
2
COMM BANCORP, INC.
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2003 2002 2003 2002
- -----------------------------------------------------------------------------------------------------------------------------------
INTEREST INCOME:
Interest and fees on loans:
Taxable ............................................................... $ 5,612 $ 5,686 $ 11,164 $ 11,453
Tax-exempt ............................................................ 187 177 378 345
Interest and dividends on investment securities available-for-sale:
Taxable ............................................................... 430 942 1,088 1,965
Tax-exempt ............................................................ 399 504 799 1,016
Dividends ............................................................. 11 17 25 39
Interest on federal funds sold .......................................... 86 68 114 91
----------- ----------- ----------- -----------
Total interest income ............................................... 6,725 7,394 13,568 14,909
----------- ----------- ----------- -----------
INTEREST EXPENSE:
Interest on deposits .................................................... 2,582 3,111 5,254 6,291
----------- ----------- ----------- -----------
Total interest expense .............................................. 2,582 3,111 5,254 6,291
----------- ----------- ----------- -----------
Net interest income ................................................. 4,143 4,283 8,314 8,618
Provision for loan losses ............................................... 120 370 240 740
----------- ----------- ----------- -----------
Net interest income after provision for loan losses ................. 4,023 3,913 8,074 7,878
----------- ----------- ----------- -----------
NONINTEREST INCOME:
Service charges, fees and commissions ................................... 695 679 1,391 1,453
Net gains on sale of loans .............................................. 295 172 685 357
Net gains on sale of investment securities .............................. 69 69
----------- ----------- ----------- -----------
Total noninterest income ............................................ 990 920 2,076 1,879
----------- ----------- ----------- -----------
NONINTEREST EXPENSE:
Salaries and employee benefits expense .................................. 1,773 1,690 3,469 3,271
Net occupancy and equipment expense ..................................... 548 450 1,088 901
Other expenses .......................................................... 1,257 1,176 2,446 2,416
----------- ----------- ----------- -----------
Total noninterest expense ........................................... 3,578 3,316 7,003 6,588
----------- ----------- ----------- -----------
Income before income taxes .............................................. 1,435 1,517 3,147 3,169
Provision for income tax expense ........................................ 290 291 672 629
----------- ----------- ----------- -----------
Net income .......................................................... 1,145 1,226 2,475 2,540
----------- ----------- ----------- -----------
OTHER COMPREHENSIVE INCOME (LOSS):
Unrealized gains (losses) on investment securities available-for-sale ... 212 1,990 (24) 2,019
Reclassification adjustment for gains included in net income ............ (69) (69)
Income tax expense (benefit) related to other comprehensive income (loss) 72 653 (8) 663
----------- ----------- ----------- -----------
Other comprehensive income (loss), net of income taxes .............. 140 1,268 (16) 1,287
----------- ----------- ----------- -----------
Comprehensive income ................................................ $ 1,285 $ 2,494 $ 2,459 $ 3,827
=========== =========== =========== ===========
PER SHARE DATA:
Net income .............................................................. $ 0.60 $ 0.62 $ 1.28 $ 1.29
Cash dividends declared ................................................. $ 0.22 $ 0.20 $ 0.44 $ 0.40
Average common shares outstanding ....................................... 1,923,082 1,961,755 1,934,586 1,967,185
See Notes to Consolidated Financial Statements.
3
COMM BANCORP, INC.
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
JUNE 30, DECEMBER 31,
2003 2002
- -------------------------------------------------------------------------------------------------
ASSETS:
Cash and due from banks ............................................... $ 13,983 $ 10,883
Federal funds sold .................................................... 34,350 10,500
Investment securities available-for-sale .............................. 106,186 124,203
Loans held for sale, net .............................................. 7,522 3,916
Loans, net of unearned income ......................................... 336,853 323,575
Less: allowance for loan losses ..................................... 3,677 3,745
-------- --------
Net loans ............................................................. 333,176 319,830
Premises and equipment, net ........................................... 12,134 11,861
Accrued interest receivable ........................................... 2,062 2,164
Other assets .......................................................... 3,492 3,061
-------- --------
Total assets ...................................................... $512,905 $486,418
======== ========
LIABILITIES:
Deposits:
Noninterest-bearing ................................................. $ 59,612 $ 49,820
Interest-bearing .................................................... 403,853 387,393
-------- --------
Total deposits .................................................... 463,465 437,213
Accrued interest payable .............................................. 1,306 1,358
Other liabilities ..................................................... 2,416 2,514
-------- --------
Total liabilities ................................................. 467,187 441,085
-------- --------
STOCKHOLDERS' EQUITY:
Common stock, par value $0.33, authorized 12,000,000 shares, issued and
outstanding:
June 30, 2003, 1,909,518 shares; December 31, 2002, 1,944,769 shares 630 642
Capital surplus ....................................................... 6,478 6,484
Retained earnings ..................................................... 36,042 35,623
Accumulated other comprehensive income ................................ 2,568 2,584
-------- --------
Total stockholders' equity ........................................ 45,718 45,333
-------- --------
Total liabilities and stockholders' equity ........................ $512,905 $486,418
======== ========
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, 2002 ...................... $ 642 $ 6,484 $ 35,623 $ 2,584 $ 45,333
Net income ...................................... 2,475 2,475
Dividends declared: $0.44 per share ............. (849) (849)
Dividend reinvestment plan: 3,199 shares issued.. 1 110 111
Repurchase and retirement: 38,450 shares ........ (13) (116) (1,207) (1,336)
Net change in other comprehensive income ........ (16) (16)
-------- -------- -------- -------- --------
BALANCE, JUNE 30, 2003 .......................... $ 630 $ 6,478 $ 36,042 $ 2,568 $ 45,718
======== ======== ======== ======== ========
See Notes to Consolidated Financial Statements.
5
COMM BANCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
SIX MONTHS ENDED JUNE 30 2003 2002
- ----------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income ............................................................ $ 2,475 $ 2,540
Adjustments:
Provision for loan losses ........................................... 240 740
Depreciation, amortization and accretion ............................ 1,807 1,003
Amortization of loan fees ........................................... (79) (68)
Deferred income tax expense (benefit) ............................... (2) 52
Gains on sale of investment securities available-for-sale ........... (69)
Loss on disposition of equipment .................................... 17
Losses (gains) on the sale of foreclosed assets ..................... 2 (105)
Changes in:
Loans held for sale, net .............................................. (3,606) 1,161
Accrued interest receivable ....................................... 102 343
Other assets ...................................................... (455) (504)
Accrued interest payable .......................................... (52) (88)
Other liabilities ................................................. (89) 62
-------- --------
Net cash provided by operating activities ....................... 360 5,067
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sale of investment securities available-for-sale ........ 9,993
Proceeds from repayments of investment securities available-for-sale .. 35,291 13,236
Purchases of investment securities available-for-sale ................. (18,415) (3,731)
Proceeds from sale of foreclosed assets ............................... 122 1,406
Net increase in lending activities .................................... (13,753) (5,792)
Purchases of premises and equipment ................................... (845) (1,245)
-------- --------
Net cash provided by investing activities ....................... 2,400 13,867
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net changes in:
Money market, NOW, savings and noninterest-bearing accounts ......... 16,901 18,727
Time deposits ....................................................... 9,351 (6,132)
Proceeds from issuance of common shares ............................... 111 101
Repurchase and retirement of common shares ............................ (1,336) (572)
Cash dividends paid ................................................... (837) (768)
-------- --------
Net cash provided by financing activities ....................... 24,190 11,356
-------- --------
Net increase in cash and cash equivalents ....................... 26,950 30,290
Cash and cash equivalents at beginning of year .................. 21,383 13,934
-------- --------
Cash and cash equivalents at end of period ...................... $ 48,333 $ 44,224
======== ========
SUPPLEMENTAL DISCLOSURES:
Cash paid during the period for:
Interest ............................................................ $ 5,306 $ 6,379
Income taxes ........................................................ 797 773
Noncash items:
Transfer of loans to foreclosed assets .............................. 246 280
Unrealized losses (gains) on investment securities available-for-sale $ 16 $ (1,287)
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, 2002.
7
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;
8
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 favorable, assurance cannot be given that these
conditions will continue. Adverse changes to economic conditions would likely
impair 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 economy showed signs of strengthening in the second quarter of 2003. The
gross domestic product, the value of all goods and services produced in the
United States, grew at a higher than expected annual rate of 2.4 percent. Much
of the growth was due to a 44.0 percent increase in defense spending. In
addition, consumer spending rose 3.2 percent, the fastest pace since last
summer, and business investment grew 6.9 percent, the fastest rate in three
years. However, the Federal Open Market Committee ("FOMC") on June 25, 2003,
lowered the target rate for federal funds by 25 basis points to 1.00 percent,
the lowest level since 1958. According to the FOMC, the United States economy
had yet to exhibit sustainable economic growth and the risk of possible
deflation outweighed the risk of inflation. The FOMC indicated that the federal
funds rate could remain at this low level for quite some time and a further cut
could be made if needed.
REVIEW OF FINANCIAL POSITION:
At June 30, 2003, total assets surpassed the one-half $1.0 billion milestone and
reached $512.9 million. This was an increase of $26.5 million from $486.4
million at December 31, 2002. The balance sheet growth was driven by strong
deposit demand. Although the stock market rebounded slightly in
9
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
the second quarter, demand for traditional deposit products remained favorable
due to the continued unwillingness of investors to assume the added risk of an
extremely volatile stock market. Total deposits reached $463.5 million at the
close of the second quarter, an increase of $26.3 million from $437.2 million at
year-end 2002. Loans, net of unearned income, increased $13.3 million to $336.9
million at June 30, 2003, from $323.6 million at the close of last year.
Investment securities decreased $18.0 million to $106.2 million at June 30,
2003, from $124.2 million at December 31, 2002. At the close of the second
quarter, we had $34.4 million in federal funds sold outstanding as compared to
$10.5 million at year-end 2002. Stockholders' equity increased $0.4 million to
$45.7 million at June 30, 2003, from $45.3 million at December 31, 2002.
In comparison to the end of the first quarter of 2003, total assets grew $21.9
million. Deposits grew $22.2 million or at an annual rate of 20.2 percent and
loans, net of unearned income, increased $8.9 million or at an annual rate of
10.9 percent. The investment portfolio decreased $8.8 million, while federal
funds sold increased $15.7 million. Stockholders' equity decreased $0.4 million.
During the second quarter of 2003, we broke ground on our seventeenth community
banking office in Tannersville, Monroe County, Pennsylvania. This office,
located in a new market area for us, offers significant growth opportunities
since it will be located in one of the fastest developing areas in the
Commonwealth of Pennsylvania.
Also during the second quarter, Community Abstract Services, LLC, became fully
operational. On November 7, 2002, the Company's subsidiary, Community Bank and
Trust Company received approval from the Pennsylvania Department of Banking to
form and become a 40.0 percent member of this limited liability company. This
company offers title insurance and abstract services to residential mortgage
loan customers and affords us the opportunity to generate additional fee income.
INVESTMENT PORTFOLIO:
As previously mentioned, the FOMC decided on June 25, 2003, to reduce the target
federal funds rate 25 basis points to 1.00 percent in order to combat the
possibility for deflation. The markets had been expecting a 50 basis point cut
in the federal funds rate. As a result, yields on Treasury securities rebounded
slightly at the close of the second quarter but remained below March 31, 2003
levels. 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 two-year U.S. Treasury rate,
which affects our mortgage-backed securities, declined 19 basis points to 1.32
10
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
percent at June 30, 2003, from 1.51 percent at the end of the previous quarter.
The ten-year U.S. Treasury, related to our municipals holdings, decreased 29
basis points to 3.54 percent at the close of the second quarter, from 3.83
percent at March 31, 2003. As a result, we experienced an increase in the market
value of our investment portfolio. The unrealized holding gain on the investment
portfolio increased $212 to $3,891 at June 30, 2003, from $3,679 at the end of
the first quarter.
The carrying values of the major classifications of securities as they relate to
the total investment portfolio at June 30, 2003, and December 31, 2002, are
summarized as follows:
DISTRIBUTION OF INVESTMENT SECURITIES
JUNE 30, DECEMBER 31,
2003 2002
AMOUNT % AMOUNT %
- ---------------------------------------------------------------------------------------------------
U.S. Government agencies............................ $ 10,286 9.69% $ 10,350 8.33%
State and municipals................................ 45,768 43.10 35,003 28.18
Mortgage-backed securities.......................... 48,471 45.65 77,579 62.46
Equity securities................................... 1,661 1.56 1,271 1.03
-------- ------ -------- ------
Total............................................. $106,186 100.00% $124,203 100.00%
======== ====== ======== ======
Our investment portfolio decreased $18.0 million or 14.5 percent to $106.2
million at June 30, 2003, from $124.2 million at December 31, 2002. In
comparison to the end of the previous quarter, investments declined $8.8
million. At June 30, 2003, investment securities equaled 21.9 percent of earning
assets, compared to 24.7 percent at March 31, 2003, and 26.9 percent at December
31, 2002.
For the three months and six months ended June 30, 2003, the investment
portfolio averaged $104.3 million and $111.1 million, compared to $110.5 million
and $113.7 million for the respective periods last year. The tax- equivalent
yield on the investment portfolio dropped 207 basis points to 4.22 percent for
the six months ended June 30, 2003, from 6.29 percent for the same six months of
2002. For the second quarter of 2003, the tax- equivalent yield was 4.02
percent, 38 basis points lower compared to 4.40 percent for the first 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,
11
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
(CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
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 June 30, 2003, to 5.5 percent,
compared to 3.6 percent for the twelve months ended March 31, 2003.
The maturity distribution of the amortized cost, fair value and weighted-
average tax-equivalent yield of the available-for-sale portfolio at June 30,
2003, is summarized as follows. The weighted-average yield, based on amortized
cost, has been computed for tax-exempt 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
-------------------------------------------------------------------------------------
JUNE 30, 2003 AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD
- ---------------------------------------------------------------------------------------------------------------------
Amortized cost:
U.S. Government agencies..... $ 4,053 2.04% $ 6,126 2.20% $ 10,179 2.14%
State and municipals......... 750 4.15 10,956 2.44 $7,603 7.90% $23,275 7.60% 42,584 6.27
Mortgage-backed securities... 29,816 4.54 18,040 5.13 108 6.57 47,964 4.77
Equity securities............ 1,568 3.13 1,568 3.13
------- ------- ------ ------- --------
Total...................... $34,619 4.24% $35,122 3.78% $7,711 7.88% $24,843 7.32% $102,295 5.11%
======= ======= ====== ======= ========
Fair value:
U.S. Government agencies..... $ 4,083 $ 6,203 $ 10,286
State and municipals......... 751 10,834 $8,520 $25,663 45,768
Mortgage-backed securities... 29,933 18,427 111 48,471
Equity securities............ 1,661 1,661
------- ------- ------ ------- --------
Total...................... $34,767 $35,464 $8,631 $27,324 $106,186
======= ======= ====== ======= ========
LOAN PORTFOLIO:
The housing market, fueled by very low mortgage rates, remained strong for the
first half of 2003. The rate on a 30-year conventional mortgage, which reached a
record low of 5.75 percent at the end of the first quarter of 2003, fell another
52 basis points and closed the second quarter at 5.23 percent. Average annual
sales of new and existing homes increased 13.3 percent and 5.3 percent for the
twelve months ended June 30, 2003. In addition, new home construction increased
as evidenced by a 5.2 percent rise in the average annual number of housing
starts for the twelve months ended June 30, 2003,
12
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
compared to the same period last year. Due to the robust housing market,
activity in our secondary mortgage department flourished. Residential mortgages
sold to the Federal National Mortgage Association ("FNMA") totaled $11.3 million
and $24.9 million for the three months and six months ended June 30, 2003. Net
gains realized on the sale of residential mortgages totaled $295 for the second
quarter and $685 year-to-date 2003, compared to $172 and $357 for the same
periods last year.
After over two years of retrenchment, business investment grew nearly 7.0
percent in the second quarter of 2003. Outlays for equipment and software rose
7.5 percent, while structural investment increased 4.8 percent. In direct
response to the FOMC lowering short-term interest rates 25 basis points, the
prime rate declined to 4.00 percent from 4.25 percent. Despite low interest
rates and increased business investment, commercial and industrial loans at all
commercial banks declined 3.0 percent over the first five months of the year.
During the second quarter, we continued to focus our efforts on commercial
business development. As a result of our efforts, commercial loans, including
commercial mortgages and lease financing grew $16.4 million or at an annual rate
of 36.3 percent to $197.4 million at June 30, 2003, from $181.0 million at the
end of the first quarter.
Although consumers increased spending, they used the equity in their homes,
through cash-out refinancing, to fund their purchases. Consumer loans for all
commercial banks decreased $0.3 billion during the first half of 2003. Although
we experienced strong demand for mortgages, our holdings of residential mortgage
loans declined $7.0 million to $108.1 million, as the majority of mortgage loans
originated were subsequently sold in the secondary market. In addition, our
consumer loans decreased $0.5 million to $31.3 million at the close of the first
half of 2003.
For the six months ended June 30, 2003, loans averaged $335.7 million, an
increase of $20.1 million or 6.4 percent compared to $315.6 million averaged for
the same period of 2002. The tax-equivalent yield on the loan portfolio fell 60
basis points to 7.05 percent for the first six months of 2003, from 7.65 percent
for the same six months of last year. In addition, the tax- equivalent yield on
the loan portfolio decreased 14 basis points in the second quarter of 2003 in
comparison to the previous quarter. Given the recent 25 basis point decline in
the prime rate, we anticipate a further reduction in loan yields in the second
half of 2003.
13
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
The composition of the loan portfolio at June 30, 2003, and December 31, 2002,
is summarized as follows:
DISTRIBUTION OF LOAN PORTFOLIO
JUNE 30, DECEMBER 31,
2003 2002
AMOUNT % AMOUNT %
- ------------------------------------------------------------------------------------------
Commercial, financial and others............ $ 98,008 29.10% $ 90,747 28.05%
Real estate:
Construction.............................. 4,244 1.26 5,398 1.67
Mortgage.................................. 201,436 59.80 193,012 59.65
Consumer, net............................... 31,329 9.30 32,631 10.08
Lease financing, net........................ 1,836 0.54 1,787 0.55
-------- ------ -------- ------
Loans, net of unearned income............. 336,853 100.00% 323,575 100.00%
====== ======
Less: allowance for loan losses............. 3,677 3,745
-------- --------
Net loans............................... $333,176 $319,830
======== ========
In an attempt to limit IRR and liquidity strains, we continually examine the
maturity distribution and interest rate sensitivity of the loan portfolio. As
part of our asset/liability management strategy to reduce the amount of IRR in
the loan portfolio, we price our loan products to increase our holdings of
adjustable-rate loans and reduce the average term of fixed-rate loans.
Approximately 36.8 percent of the lending portfolio is expected to reprice
within the next twelve months.
The maturity and repricing information of the loan portfolio by major
classification at June 30, 2003, is summarized as follows:
MATURITY DISTRIBUTION AND INTEREST SENSITIVITY OF LOAN PORTFOLIO
AFTER ONE
WITHIN BUT WITHIN AFTER
JUNE 30, 2003 ONE YEAR FIVE YEARS FIVE YEARS TOTAL
- ------------------------------------------------------------------------------------------
Maturity schedule:
Commercial, financial and others..... $ 44,557 $ 24,342 $ 29,109 $ 98,008
Real estate:
Construction....................... 4,244 4,244
Mortgage........................... 17,030 67,647 116,759 201,436
Consumer, net........................ 11,559 16,664 3,106 31,329
Lease financing, net................. 672 1,164 1,836
-------- -------- -------- --------
Total............................ $ 78,062 $109,817 $148,974 $336,853
======== ======== ======== ========
Repricing schedule:
Predetermined interest rates......... $ 30,340 $ 63,987 $ 70,766 $165,093
Floating or adjustable interest rates 93,486 77,993 281 171,760
-------- -------- -------- --------
Total............................ $123,826 $141,980 $ 71,047 $336,853
======== ======== ======== ========
14
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
ASSET QUALITY:
National, Pennsylvania and market area unemployment rates at June 30, 2003 and
2002, are summarized as follows:
JUNE 30, 2003 2002
- ---------------------------------------------------------------------------------------
United States........................................................... 6.4% 5.8%
Pennsylvania............................................................ 5.7 5.6
Lackawanna county....................................................... 5.8 5.5
Susquehanna county...................................................... 5.6 7.5
Wayne county............................................................ 4.3 4.8
Wyoming county.......................................................... 5.8% 5.4%
The employment conditions in our market area improved, for the most part, in
comparison to the declining conditions of the Commonwealth of Pennsylvania and
the Nation. The national unemployment rate rose to 6.4 percent at June 30, 2003,
from 5.8 percent one year ago. Job gains in service-providing industries and
construction were more than offset by continued job erosion in the manufacturing
sector and the telecommunications and air transportation industries. Although
employment conditions in our market area are favorable in comparison to the
Nation and Commonwealth, further economic weakening could cause conditions in
the counties we serve to deteriorate.
Nonperforming assets were $2,288 or 0.63 percent of loans, net of unearned
income, at June 30, 2003, compared to $2,542 or 0.77 percent at year-end 2002.
The asset quality improvement resulted from a reduction in nonaccrual loans,
partially offset by slight increases in accruing loans past due 90 days or more
and foreclosed assets.
Nonaccrual loans decreased $478 to $1,514 at June 30, 2003, from $1,992 at
December 31, 2002. The amount of commercial, real estate and consumer loans on
nonaccrual status all decreased from year-end 2002. Accruing loans past due 90
days or more increased $102 to $612 at the end of the second quarter compared to
$510 at the end of 2002. Foreclosed assets increased $122 to $162 at June 30,
2003, from $40 at December 31, 2002. Four loans totaling $246 were transferred
to foreclosed assets during the first half of 2003. Three properties with an
aggregate carrying value of $124 were sold for $122, resulting in a net realized
loss of $2.
We anticipate the economic conditions in our local market area to remain stable
for the remainder of 2003. 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.
15
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
Information concerning nonperforming assets at June 30, 2003, and December 31,
2002, 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
JUNE 30, DECEMBER 31,
2003 2002
- -----------------------------------------------------------------------------------------
NONACCRUAL LOANS:
Commercial, financial and others............................... $ 404 $ 541
Real estate:
Construction.................................................
Mortgage..................................................... 981 1,213
Consumer, net.................................................. 129 238
Lease financing, net...........................................
------ ------
Total nonaccrual loans..................................... 1,514 1,992
------ ------
ACCRUING LOANS PAST DUE 90 DAYS OR MORE:
Commercial, financial and others............................... 110 97
Real estate:
Construction.................................................
Mortgage..................................................... 443 281
Consumer, net.................................................. 59 132
Lease financing, net...........................................
------ ------
Total accruing loans past due 90 days or more.............. 612 510
------ ------
Total nonperforming loans.................................. 2,126 2,502
------ ------
Foreclosed assets.............................................. 162 40
------ ------
Total nonperforming assets................................. $2,288 $2,542
====== ======
Ratios:
Nonperforming loans as a percentage of loans, net.............. 0.63% 0.77%
Nonperforming assets as a percentage of loans, net............. 0.68% 0.79%
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. We employ the
Federal Financial Institution Examination Council ("FFIEC") Interagency Policy
Statement and generally accepted accounting principals ("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, "Accounting by
16
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
Creditors for Impairment of a Loan," for loans specifically identified to be
individually evaluated for impairment and the requirements of SFAS No. 5,
"Accounting for Contingencies," for large groups of smaller-balance homogeneous
loans to be collectively evaluated for impairment.
We follow our systematic methodology in accordance with procedural discipline by
applying it in the same manner regardless of whether the allowance is being
determined at a high point or a low point in the economic cycle. Each quarter,
our loan review department identifies those loans to be individually evaluated
for impairment and those loans 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 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 relevant
range of values based on current conditions.
17
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
Information concerning impaired loans at June 30, 2003, and December 31, 2002,
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
JUNE 30, DECEMBER 31,
2003 2002
- ------------------------------------------------------------------------------------------
NONACCRUAL LOANS:
Commercial, financial and others............................... $ 404 $ 541
Real estate:
Construction.................................................
Mortgage..................................................... 981 1,213
Consumer, net.................................................. 129 238
Lease financing, net...........................................
------ ------
Total nonaccrual loans..................................... 1,514 1,992
------ ------
ACCRUING LOANS:
Commercial, financial and others............................... 134 889
Real estate:
Construction.................................................
Mortgage..................................................... 839 485
Consumer, net.................................................. 178 292
Lease financing, net...........................................
------ ------
Total accruing loans....................................... 1,151 1,666
------ ------
Total impaired loans....................................... $2,665 $3,658
====== ======
Ratio:
Impaired loans as a percentage of loans, net................... 0.79% 1.13%
Information relating to the recorded investment in impaired loans at June 30,
2003 and December 31, 2002, is summarized as follows:
JUNE 30, DECEMBER 31,
2003 2002
- -------------------------------------------------------------------------------------------
Impaired loans:
With a related allowance....................................... $1,671 $2,500
With no related allowance...................................... 994 1,158
------ ------
Total........................................................ $2,665 $3,658
====== ======
18
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 six months ended June 30, 2003, is summarized as follows:
JUNE 30,
2003
- --------------------------------------------------------------------------------------------
Balance at January 1.............................................................. $877
Provision for loan losses......................................................... (84)
Loans charged-off................................................................. 282
Loans recovered................................................................... 6
----
Balance at period-end............................................................. $517
====
Interest income on impaired loans that would have been recognized had the loans
been current and the terms of the loans 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 six-month periods ended June 30, 2003 and 2002 are summarized as follows:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2003 2002 2003 2002
- ------------------------------------------------------------------------------------------
Gross interest due under terms................. $ 214 $ 38 $ 259 $ 80
Interest income recognized..................... 26 25 51 47
------ ------ ------ ------
Interest income not recognized................. $ 188 $ 13 $ 208 $ 33
====== ====== ====== ======
Interest income recognized (cash-basis)........ $ 26 $ 25 $ 51 $ 47
Average recorded investment in impaired loans.. $2,879 $2,470 $2,638 $2,224
Cash received on impaired loans applied as a reduction of principal totaled $259
and $119 for the six and three months ended June 30, 2003. For the respective
periods of 2002 cash receipts on impaired loans totaled $299 and $127. There
were no commitments to extend additional funds to such parties at June 30, 2003.
19
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 June 30, 2003 and December
31, 2002, is summarized as follows:
ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
JUNE 30, DECEMBER 31,
2003 2002
------------------- -------------------
CATEGORY CATEGORY
AS A AS A
% OF % OF
AMOUNT LOANS AMOUNT LOANS
- ----------------------------------------------------------------------------------------------------
Allocated allowance:
Specific:
Commercial, financial and others................. $ 214 0.16% $ 597 0.44%
Real estate:
Construction...................................
Mortgage....................................... 208 0.54 173 0.53
Consumer, net.................................... 95 0.09 107 0.16
Lease financing, net............................. 0.00
------ ------ ------ ------
Total specific............................... 517 0.79 877 1.13
------ ------ ------ ------
Formula:
Commercial, financial and others................. 349 28.94 367 27.61
Real estate:
Construction................................... 1.26 1.67
Mortgage....................................... 2,308 59.26 2,071 59.12
Consumer, net.................................... 391 9.21 419 9.92
Lease financing, net............................. 0.54 0.55
------ ------ ------ ------
Total formula................................ 3,048 99.21 2,857 98.87
------ ------ ------ ------
Total allocated allowance.................... 3,565 100.00% 3,734 100.00%
====== ======
Unallocated allowance............................ 112 11
------ ------
Total allowance for loan losses.............. $3,677 $3,745
====== ======
The allocated allowance for loan losses account decreased $169 to $3,565 at June
30, 2003, from $3,734 at December 31, 2002. The reduction occurred as a result
of a decrease in the specific portion of the allowance for impairment of loans
individually evaluated under SFAS No. 114, partially offset by an increase in
the formula portion of the allowance for loans collectively evaluated for
impairment under SFAS No. 5.
The unallocated portion of the allowance for loan losses equaled $112 at the end
of the second quarter of 2003 compared to $11 at year-end 2002. The increase in
the unallocated portion of the allowance for loan losses account was deemed
appropriate due to the significant increase in the level of commercial loans in
the portfolio, which inherently carry a higher degree of risk.
20
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 six months ended June 30,
2003, is summarized as follows:
RECONCILIATION OF ALLOWANCE FOR LOAN LOSSES
JUNE 30,
2003
- ------------------------------------------------------------------------------------------
Allowance for loan losses at beginning of period............................... $3,745
Loans charged-off:
Commercial, financial and others............................................... 95
Real estate:
Construction.................................................................
Mortgage..................................................................... 128
Consumer, net.................................................................. 140
Lease financing, net...........................................................
------
Total...................................................................... 363
------
Loans recovered:
Commercial, financial and others............................................... 5
Real estate:
Construction.................................................................
Mortgage..................................................................... 1
Consumer, net.................................................................. 49
Lease financing, net...........................................................
------
Total...................................................................... 55
------
Net loans charged-off.......................................................... 308
------
Provision charged to operating expense......................................... 240
------
Allowance for loan losses at end of period..................................... $3,677
======
Ratios:
Net loans charged-off as a percentage of average loans outstanding............. 0.19%
Allowance for loan losses as a percentage of period end loans.................. 1.09%
The allowance for loan losses decreased $45 to $3,677 at June 30, 2003, from
$3,722 at the previous quarter-end. Net charge-offs of $165 for the three months
ended June 30, 2003, exceeded the $120 provision for loan losses. As a
percentage of loans, net of unearned income, the allowance equaled 1.09 percent
at the end of the second quarter of 2003 and 1.13 percent at March 31, 2003. The
allowance account covered 160.7 percent of nonperforming assets at June 30, 2003
and 163.9 percent at March 31, 2003.
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 $308 or 0.19 percent of average loans outstanding for the six
months ended June 30, 2003, compared to $429 or 0.27 percent for the
21
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
same period last year. Net charge-offs as a percentage of average loans
outstanding for our peer group equaled 0.14 percent and 0.13 percent for the
respective periods.
DEPOSITS:
The average amount of, and the rate paid on, the major classifications of
deposits for the six months ended June 30, 2003 and 2002, are summarized as
follows:
DEPOSIT DISTRIBUTION
JUNE 30, JUNE 30,
2003 2002
----------------- -------------------
AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE RATE BALANCE RATE
- -------------------------------------------------------------------------------------------
Interest-bearing:
Money market accounts....................... $ 15,756 1.24% $ 20,743 2.45%
NOW accounts................................ 38,413 1.03 37,534 1.47
Savings accounts............................ 124,692 1.34 97,274 2.02
Time deposits less than $100................ 187,235 3.99 185,987 4.58
Time deposits $100 or more.................. 25,830 3.36 29,798 3.82
-------- --------
Total interest-bearing.................... 391,926 2.70% 371,336 3.42%
Noninterest-bearing......................... 51,980 47,106
-------- --------
Total deposits............................ $443,906 $418,442
======== ========
Despite a slight rebound in the stock market in the second quarter of 2003,
investors are still seeking the safety of traditional bank products. In
addition, consumers continued to be leery about economic conditions and chose to
keep spending in check. The personal savings rate averaged approximately 3.5
percent for the first half of 2003, similar to the rate exhibited last year.
We continued to experience strong demand for our deposit products. Deposits
totaled $463.5 million at June 30, 2003, an increase of $22.2 million from the
end of the first quarter of 2003 and $26.3 million from year-end 2002. The
growth from the end of the first quarter resulted from a $14.6 million increase
in interest-bearing accounts, coupled with a $7.6 million rise in
noninterest-bearing accounts. The growth in interest-bearing accounts arose
primarily from an $8.9 million increase in savings accounts. In addition, we
continued to offer promotional rates on our 60- and 90-month certificates of
deposit and on our longer-term IRAs. As a result, time deposits less than $100
increased $2.0 million and time deposits $100 or more rose $3.1 million from the
previous quarter-end.
22
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
For the six months ended June 30, 2003, average total deposits increased $25.5
million or 6.1 percent to $443.9 million compared to $418.4 million for the same
period of 2002. Interest-bearing deposits averaged $20.6 million or 5.5 percent
higher and noninterest-bearing deposits averaged $4.9 million or 10.4 percent
higher when comparing the second quarters of 2003 and 2002. Due to customer
preference for liquidity given the low interest rate environment, the growth in
our interest-bearing accounts was primarily concentrated in savings accounts.
Average savings accounts grew $27.4 million or 28.2 percent. As a result of the
promotional rates offered on longer-term certificates of deposit and IRA
accounts, time deposits less than $100 averaged slightly higher. Average money
market accounts and large denomination time deposits declined by $4.9 million
and $4.0 million, while average NOW accounts rose $0.9 million. The low interest
rate environment, coupled with the shift into lower-costing deposits, caused our
cost of funds to decline 72 basis points to 2.70 percent for the first half of
2003, from 3.42 percent for the same period of 2002. Low interest rates are
expected to continue throughout the second half of 2003. Therefore, we
anticipate our deposit costs to remain low. However, should an economic rebound
occur and inflationary pressures pick up, our cost of funds could escalate.
Volatile deposits, time deposits in denominations of $100 or more, equaled $28.2
million at June 30, 2003, a $3.7 million increase from $24.5 million at December
31, 2002. The decline was due to withdrawal requirements associated with
building projects of local area school districts. Due to the short-term
structure of volatile deposits and significantly lower market rates, the average
cost of these deposits fell 46 basis points to 3.36 percent for the six months
ended June 30, 2003, compared to 3.82 percent for the same six months of last
year.
Maturities of time deposits of $100 or more at June 30, 2003, and December 31,
2002, are summarized as follows:
MATURITY DISTRIBUTION OF TIME DEPOSITS OF $100 OR MORE
JUNE 30, DECEMBER 31,
2003 2002
- ------------------------------------------------------------------------------------------
Within three months............................................ $ 3,905 $ 3,020
After three months but within six months....................... 8,785 3,333
After six months but within twelve months...................... 3,894 8,230
After twelve months............................................ 11,588 9,961
------- -------
Total........................................................ $28,172 $24,544
======= =======
23
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
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.
In accordance with regulation, each bank is required to develop its own IRR
management program depending on its structure, including certain fundamental
components which are mandatory to ensure sound IRR management. These elements
include appropriate board and management oversight, as well as a comprehensive
risk management process that effectively identifies, measures, monitors and
controls risk. Should a bank have material weaknesses in its risk management
process or high exposure relative to its capital, the bank regulatory agencies
will take action to remedy these shortcomings. Moreover, the level of a bank's
IRR exposure and the quality of its risk management process is a determining
factor when evaluating a bank's capital adequacy.
The responsibility for our market risk sensitivity 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
("RSA") and rate-sensitive liabilities ("RSL"). One such technique utilizes a
static gap model that considers repricing frequencies of RSA and RSL in order to
monitor IRR. Gap analysis attempts to measure our interest rate exposure by
calculating the net amount of RSA and RSL that reprice within specific time
intervals. A positive gap occurs when the amount of RSA repricing in a specific
period is greater than the
24
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
amount of RSL repricing within that same time frame and is indicated by a
RSA/RSL ratio greater than 1.0. A negative gap occurs when the amount of RSL
repricing is greater than the amount of RSA repricing and is indicated by a
RSA/RSL ratio less than 1.0. A positive gap implies that earnings will be
impacted favorable if interest rates rise and adversely if interest rates fall
during the period. A negative gap 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
JUNE 30, 2003 THREE MONTHS TWELVE MONTHS FIVE YEARS FIVE YEARS TOTAL
- -----------------------------------------------------------------------------------------------------------------
Rate-sensitive assets:
Investment securities............... $ 13,873 $ 20,894 $ 35,464 $ 35,955 $106,186
Loans held for sale, net............ 7,522 7,522
Loans, net of unearned income....... 82,341 41,485 141,980 71,047 336,853
Federal funds sold.................. 34,350 34,350
-------- -------- -------- -------- --------
Total............................. $138,086 $ 62,379 $177,444 $107,002 $484,911
======== ======== ======== ======== ========
Rate-sensitive liabilities:
Money market accounts............... $ 13,576 $ 13,576
NOW accounts........................ 42,132 42,132
Savings accounts.................... $130,268 130,268
Time deposits less than $100........ $ 24,229 44,639 109,841 $ 10,996 189,705
Time deposits $100 or more.......... 3,905 12,679 9,752 1,836 28,172
-------- -------- -------- -------- --------
Total............................. $ 28,134 $113,026 $249,861 $ 12,832 $403,853
======== ======== ======== ======== ========
Rate sensitivity gap:
Period............................ $109,952 $(50,647) $(72,417) $ 94,170
Cumulative........................ $109,952 $ 59,305 $(13,112) $ 81,058 $ 81,058
RSA/RSL ratio:
Period............................ 4.91 0.55 0.71 8.34
Cumulative........................ 4.91 1.42 0.97 1.20 1.20
Our cumulative one-year RSA/RSL ratio equaled 1.42 at June 30, 2003, compared to
1.23 at March 31, 2003. Due to the historically low interest rate environment,
our goal in managing IRR has been to increase the amount of RSA repricing within
one year and extend the repricing time frame of RSL. Accordingly, the amount of
RSA maturing or repricing within one year increased $20.2 million while RSL
maturing or repricing within the same time
25
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
frame declined $5.1 million. The increase in RSA primarily resulted from
increases of $5.3 million in loans, net of unearned income, and $15.7 million in
federal funds sold. As part of our ongoing strategy to limit the amount of IRR
in our loan portfolio, we consistently price our loan products to increase our
holdings of floating- or adjustable-rate loans which reprice in the near term.
With regard to RSL, we continued to offer promotional rates on our 60- and
90-month term certificates of deposit in order to extend the average maturities
of these types of funds. Time deposits less than $100 repricing within one year
declined $7.4 million from the end of the first quarter of 2003, while those
repricing after five years increased $4.0 million. At June 30, 2003, our RSA/RSL
ratio fell outside our asset/liability guidelines of 0.70 to 1.30. However, we
believe by continuously monitoring our IRR position we can effectively control
the influence changes in market interest rates could have on our RSA and RSL. In
addition, our gap position at June 30, 2003, indicated that we were asset
rate-sensitive and should market interest rates increase, the likelihood exists
that net interest income would be favorably affected. However, this
forward-looking statement is qualified in the aforementioned section entitled
"Forward-Looking Discussion" in this Management's Discussion and Analysis.
We experienced an increase in our three-month ratio to 4.91 at June 30, 2003,
from 3.19 at the end of the previous quarter. The increase primarily resulted
from a $26.4 million increase in the amount of RSA coupled with a $6.9 million
reduction in RSL maturing or repricing within three months. Similar to the
reasons discussed for the change in the one-year ratio, increases in federal
funds sold and loans, net of unearned income, contributed to the increase in
RSA, while a reduction in time deposits less than $100 accounted for the
decrease in RSL.
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.
26
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 June 30, 2003, 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 1.5 percent and 3.1 percent. Conversely, similar declines in
interest rates would result in increases in net interest income of 0.7 percent
and 3.6 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 essential to our continuing operations as it gives us the ability
to generate cash at a reasonable cost to fulfill our lending commitments and
support our asset growth, while satisfying the withdrawal demands of our
customers and meeting our 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 with the
Federal Home Loan Bank of Pittsburgh ("FHLB-Pgh"). We manage liquidity daily,
thus enabling us to effectively monitor fluctuations in our liquidity position
and to adapt our 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.
We employ a number of analytical techniques in assessing the adequacy of our
liquidity position. One such technique is the use of ratio analysis related to
our reliance on noncore funds to fund our investments and loans maturing after
2003. Our noncore funds consist of time deposits in denominations of $100 or
more. These funds are not considered to be a strong source of liquidity since
they are very interest rate sensitive and are considered to be highly volatile.
At June 30, 2003, our net noncore funding dependence ratio, the difference
between noncore funds and short-term investments to
27
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
long-term assets, was negative 11.1 percent. Similarly, our net short-term
noncore funding dependence ratio, noncore funds maturing within one-year, less
short-term investments to long-term assets equaled negative 14.2 percent at the
end of the second quarter of 2003. Negative ratios indicated that at June 30,
2003, we did not rely on noncore sources to fund our long- term assets. We
believe that by maintaining adequate volumes of short-term investments and
implementing competitive pricing strategies on deposits, we can ensure adequate
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
illustrates 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 and the FHLB-Pgh, and federal funds sold,
increased $27.0 million during the six months ended June 30, 2003. Financing
activities provided us with net cash of $24.2 million. The net cash inflow
primarily resulted from a $26.3 million increase in deposits. Cash outflows of
$1.3 million for the repurchase of our common stock and $0.8 million for the
payment of cash dividends partially offset the increase in deposits.
In addition, investing activities provided us with net cash of $2.4 million,
while operating activities contributed $0.4 million to the increase in net cash.
The cash provided by investing activities primarily resulted from $35.3 million
received from repayments of investment securities, partially offset by purchases
of investment securities of $18.4 million and a net increase in lending
activities of $13.8 million. With regard to operating activities, net income of
$2.5 million was the primary source of funds.
CAPITAL ADEQUACY:
Stockholders' equity totaled $45.7 million at June 30, 2003, compared to $45.3
million at December 31, 2002. On a per share basis, stockholders' equity equaled
$23.94 per share at the end of the second quarter of 2003, an increase of $0.63
per share compared to $23.31 per share at year-end 2002.
During the first six months of 2003, 38,450 shares of our common stock totaling
$1.3 million were repurchased. For the six months ended June 30, dividends
declared totaled $849 or $0.44 per share in 2003 and $785 or $0.40 per share in
2002. The dividend payout ratio was 34.3 percent and 30.9 percent for the six
months ended June 30, 2003 and 2002. 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. Stockholders may automatically
28
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
reinvest their dividends in shares of our common stock through our dividend
reinvestment plan. During the six months ended June 30, 2003, 3,199 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 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 June
30, 2003 and 2002. 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.
29
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
Our and Community Bank's capital ratios at June 30, 2003 and 2002, 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 Improvement 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
-------------------------------------------------------------------------
JUNE 30, 2003 2002 2003 2002 2003 2002
- -----------------------------------------------------------------------------------------------------------------------
Basis for ratios:
Tier I capital to risk-weighted assets:
Consolidated........................... $ 42,067 $ 40,149 $ 14,829 $ 12,938 $ 22,243 $ 19,407
Community Bank......................... 40,697 38,421 14,801 12,896 22,202 19,344
Total capital to risk-weighted assets:
Consolidated........................... 45,744 43,680 29,658 25,875 37,072 32,344
Community Bank......................... 44,374 41,952 29,603 25,792 37,003 32,240
Tier I capital to total average assets
less goodwill:
Consolidated........................... 42,067 40,149 19,686 18,490 24,608 23,112
Community Bank......................... 40,697 38,421 $ 19,662 $ 18,476 $ 24,578 $ 23,095
Risk-weighted assets:
Consolidated........................... 341,738 300,856
Community Bank......................... 341,049 299,818
Risk-weighted off-balance sheet items:
Consolidated........................... 28,985 22,587
Community Bank......................... 28,985 22,587
Average assets for Leverage ratio:
Consolidated........................... 492,156 462,239
Community Bank......................... $491,561 $461,897
Ratios:
Tier I capital as a percentage of risk-
weighted assets and off-balance sheet
items:
Consolidated............................ 11.4% 12.4% 4.0% 4.0% 6.0% 6.0%
Community Bank.......................... 11.0 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............................ 12.3 13.5 8.0 8.0 10.0 10.0
Community Bank.......................... 12.0 13.0 8.0 8.0 10.0 10.0
Tier I capital as a percentage of total
average assets less intangible assets:
Consolidated............................ 8.6 8.7 4.0 4.0 5.0 5.0
Community Bank.......................... 8.3% 8.3% 4.0% 4.0% 5.0% 5.0%
We and Community Bank have consistently maintained regulatory capital ratios
well above the minimum levels of 4.0 percent and 8.0 percent required for
adequately capitalized institutions. Regulatory agencies define
30
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
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.
Based on the most recent notification from the Federal Deposit Insurance
Corporation ("FDIC"), Community Bank was categorized as well capitalized under
the regulatory framework for prompt corrective action at June 30, 2003. There
are no conditions or events since this notification that we believe have changed
Community Bank's category.
REVIEW OF FINANCIAL PERFORMANCE:
Net income for the three months and six months ended June 30, 2003 totaled
$1,145 or $0.60 per share and $2,475 or $1.28 per share. Net income for the
comparable 2002 periods were $1,226 or $0.62 per share and $2,540 or $1.29 per
share. A decline in net interest income, coupled with an increase in noninterest
expense, more than offset a reduction in the provision for loan losses and an
increase in noninterest income. Return on average assets was 0.92 percent for
the second quarter and 1.01 percent for the first half of 2003, compared to 1.05
percent and 1.10 percent for the respective 2002 periods. Return on average
equity was 9.96 percent for the second quarter and 10.85 percent year-to-date
2003, compared to 11.61 percent and 12.20 percent for same periods of 2002.
NET INTEREST INCOME:
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 o 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
31
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
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.
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 SIX MONTHS ENDED
JUNE 30, JUNE 30,
2003 VS. 2002 2003 VS. 2002
INCREASE (DECREASE) INCREASE (DECREASE)
ATTRIBUTABLE TO ATTRIBUTABLE TO
--------------------------- -----------------------------
TOTAL TOTAL
CHANGE RATE VOLUME CHANGE RATE VOLUME
------ ---- ------ ------ ---- ------
Interest income:
Loans:
Taxable............................ $ (74) $ (979) $ 905 $ (289) $(1,464) $1,175
Tax-exempt......................... 15 (273) 288 50 (306) 356
Investments:
Taxable............................ (518) (797) 279 (891) (1,333) 442
Tax-exempt......................... (158) (5) (153) (328) (9) (319)
Federal funds sold................... 18 (68) 86 23 (71) 94
----- ------- ------ ------- ------- ------
Total interest income............ (717) (2,122) 1,405 (1,435) (3,183) 1,748
----- ------- ------ ------- ------- ------
Interest expense:
Money market accounts................ (44) (33) (11) (155) (104) (51)
NOW accounts......................... (64) (73) 9 (78) (96) 18
Savings accounts..................... (151) (565) 414 (146) (683) 537
Time deposits less than $100......... (217) (323) 106 (523) (606) 83
Time deposits $100 or more........... (53) (38) (15) (135) (64) (71)
----- ------- ------ ------- ------- ------
Total interest expense........... (529) (1,032) 503 (1,037) (1,553) 516
----- ------- ------ ------- ------- ------
Net interest income.............. $(188) $(1,090) $ 902 $ (398) $(1,630) $1,232
===== ======= ====== ======= ======= ======
For the six months ended June 30, 2003, tax-equivalent net int erest income
totaled $8,921, a decrease of $398 compared to $9,319 for the same six
32
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
months of 2002. A negative rate variance was responsible for the decline. An
increase in the volume of average earning assets over that of average
interest-bearing liabilities partially offset the effects of the negative rate
variance.
The tax-equivalent yield on earning assets fell 101 basis points to 6.14 percent
for the six months ended June 30, 2003, from 7.15 percent for the same six
months of 2002. This resulted in a reduction of $3,183 of tax- equivalent
interest revenue. The yields on taxable loans and investments fell 52 basis
points and 271 basis points and accounted for reductions in interest revenue of
$1,464 and $1,333. Partially offsetting the decline in tax-equivalent interest
revenue was a $1,553 decrease in interest expense resulting from a 72 basis
point decline in our cost of funds. Specifically, the average rate paid on money
market accounts, savings accounts and time deposits less than $100 decreased 121
basis points, 68 basis points and 59 basis points. These rate declines resulted
in reductions to interest expense of $104, $683 and $606. In total, the negative
rate variance caused a decrease in tax-equivalent net interest income of $1,630.
Partially offsetting the negative rate variance was a positive volume variance.
Earning assets averaged $465.7 million for the six months ended June 30, 2003,
an increase of $25.7 million from $440.0 million for the same period last year.
Average interest-bearing liabilities also increased but not to the same extent.
Interest-bearing liabilities averaged $391.9 million for the first half of 2003,
an increase of $20.5 million from $371.4 million averaged for the same period of
2002. This positive volume variance caused net interest income to increase by
$1,232. The majority of the positive volume variance was due to a $20.1 million
increase in average loans, which caused tax-equivalent net interest income to
increase by $1,531.
For the quarter ended June 30, 2003, tax-equivalent interest income decreased
$188 in comparison to the same three months of last year. Similarly, the decline
was due to a negative rate variance of $1,090, partially offset by a positive
volume variance of $902. The tax-equivalent yield on earning assets fell 103
basis points to 5.97 percent for the three months ended June 30, 2003, from 7.00
percent for the same period of 2002 and reduced tax-equivalent interest income
by $2,122. The tax-equivalent yield on loans fell 55 basis points, while the
tax-equivalent yield on investments fell 223 basis points. The yield on federal
funds sold declined 50 basis points. Partially mitigating the effects of the
decline in the tax- equivalent yield on earning assets was a 74 basis point
reduction in the cost of funds. For the second quarter of 2003, the cost of
funds equaled 2.61 percent compared to 3.35 percent for the same quarter of
2002. This reduced interest expense by $1,032 for the second quarter. A positive
volume variance partially offset the reduction in net interest income caused by
the negative rate variance. Earning assets averaged $28.1 million higher for the
second quarter of 2003, compared to the same quarter of 2002. Loans, net of
33
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
unearned income increased $21.5 million, while federal funds sold averaged $12.8
million higher. Partially offsetting the increases in loans and federal funds
sold was a $6.2 million reduction in average investments. Average interest
bearing liabilities also increased, but not to the extent of average earning
assets. For the second quarter, interest-bearing liabilities averaged $396.6
million in 2003, an increase of $23.6 million compared to $373.0 million in
2002.
Maintenance of an adequate net interest margin is one of our primary concerns.
We experienced some margin contraction during the first six months of 2003 as a
result of the sustained low interest rate environment. Loan and investment
yields continued to reprice downward as repayments were being reinvested at
considerably lower rates. However, deposits rates, already at historic lows, did
not have the ability to reprice downward to the same extent. As a result, our
net interest margin contracted 41 basis points to 3.86 percent for the six
months ended June 30, 2003, from 4.27 percent for the same six months of 2002.
Due to the slowness of the economic recovery and the possibility of deflation,
the low interest rate environment is expected to continue throughout the
remainder of 2003. However, should economic conditions rebound and/or
competition in our market area intensify, interest rates could increase. No
assurance can be given that net interest income will not be adversely affected
by changes in general market rates or increased competition. We believe
following prudent pricing practices, coupled with careful investing, will keep
our net interest margin from further contraction.
34
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 six months ended
June 30, 2003 and 2002, 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 the statutory tax rate of 34.0 percent.
SUMMARY OF NET INTEREST INCOME
JUNE 30, 2003 JUNE 30, 2002
------------------------------- ---------------------------------
INTEREST AVERAGE INTEREST AVERAGE
AVERAGE INCOME/ INTEREST AVERAGE INCOME/ INTEREST
BALANCE EXPENSE RATE BALANCE EXPENSE RATE
------- ------- -------- ------- -------- ---------
ASSETS:
Earning assets:
Loans:
Taxable....................................... $ 316,376 $11,164 7.12% $ 302,163 $11,453 7.64%
Tax-exempt.................................... 19,343 573 5.97 13,470 523 7.83
Investments:
Taxable....................................... 78,488 1,113 2.86 72,502 2,004 5.57
Tax-exempt.................................... 32,574 1,211 7.50 41,159 1,539 7.54
Federal funds sold.............................. 18,912 114 1.22 10,721 91 1.71
--------- ------- --------- -------
Total earning assets........................ 465,693 14,175 6.14% 440,015 15,610 7.15%
Less: allowance for loan losses................. 3,720 3,343
Other assets.................................... 31,266 26,895
--------- ---------
Total assets................................ $ 493,239 $ 463,567
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY:
Interest-bearing liabilities:
Money market accounts........................... $ 15,756 97 1.24% $ 20,743 252 2.45%
NOW accounts.................................... 38,413 196 1.03 37,534 274 1.47
Savings accounts................................ 124,692 828 1.34 97,274 974 2.02
Time deposits less than $100.................... 187,235 3,703 3.99 185,987 4,226 4.58
Time deposits $100 or more...................... 25,830 430 3.36 29,798 565 3.82
Short-term borrowings........................... 17
--------- ------- --------- -------
Total interest-bearing liabilities.......... 391,926 5,254 2.70% 371,353 6,291 3.42%
Noninterest-bearing deposits.................... 51,980 47,106
Other liabilities............................... 3,352 3,110
Stockholders' equity............................ 45,981 41,998
--------- ---------
Total liabilities and stockholders' equity $ 493,239 $ 463,567
========= ------- ========= -------
Net interest/income spread.................. $ 8,921 3.44% $ 9,319 3.73%
======= =======
Net interest margin......................... 3.86% 4.27%
Tax equivalent adjustments:
Loans........................................... $ 195 $ 178
Investments..................................... 412 523
------- -------
Total adjustments........................... $ 607 $ 701
======= =======
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 $3,844 and
$1,481 for the six months ended June 30, 2003 and 2002 included in
other assets. Tax-equivalent adjustments were calculated using the
prevailing statutory tax rate of 34.0 percent.
35
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. 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 $240 for the six months ended June 30,
2003, compared to $740 for the same six months of 2002. For the second quarter,
the provision for loan losses was $120 in 2003 and $370 in 2002.
NONINTEREST INCOME:
Noninterest income totaled $2,076 for the six months ended June 30, 2003, an
increase of $197 or 10.5 percent from $1,879 for the same six months of last
year. Included in noninterest income in 2002 was $69 in gains from the sale of
investment securities. There were no gains from the sale of investment
securities in 2003. Gains on the sale of residential mortgages increased $328
while service charges, fees and commissions declined $62. For the second
quarter, noninterest income increased $70 to $990 in 2003, compared to $920 in
2002.
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.
36
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 six months
ended June 30, 2003 and 2002, are summarized as follows:
NONINTEREST EXPENSES
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2003 2002 2003 2002
- --------------------------------------------------------------------------------------------
SALARIES AND EMPLOYEE BENEFITS EXPENSE:
Salaries and payroll taxes..................... $ 1,455 $ 1,414 $ 2,858 $ 2,751
Employee benefits.............................. 318 276 611 520
-------- ------- ------- -------
Salaries and employee benefits expense....... 1,773 1,690 3,469 3,271
-------- ------- ------- -------
NET OCCUPANCY AND EQUIPMENT EXPENSE:
Net occupancy expense.......................... 234 208 508 419
Equipment expense.............................. 314 242 580 482
-------- ------- ------- -------
Net occupancy and equipment expense.......... 548 450 1,088 901
-------- ------- ------- -------
OTHER EXPENSES:
Marketing expense.............................. 97 116 201 211
Other taxes.................................... 114 85 227 190
Stationery and supplies........................ 89 120 179 248
Contractual services........................... 414 349 774 710
Insurance including FDIC assessment............ 54 46 97 94
Other.......................................... 489 460 968 963
-------- ------- ------- -------
Other expenses............................... 1,257 1,176 2,446 2,416
-------- ------- ------- -------
Total noninterest expense.................. $ 3,578 $ 3,316 $ 7,003 $ 6,588
======== ======= ======= =======
For the six months ended June 30, 2003, noninterest expense amounted to $7,003,
an increase of $415 or 6.3 percent from $6,588 for the same six months of 2002.
Higher salaries and employee benefits expense and net occupancy and equipment
expense associated with the operation of our two newest branch offices opened in
the second half of 2002 and the relocation of our Clifford office into a new
facility factored into the increase. The increase in noninterest expense,
coupled with the reduction in net interest income, resulted in a decline in our
productivity. The efficiency ratio, defined as noninterest expense as a
percentage of net interest income and noninterest income, is a key industry
ratio that measures productivity. Our efficiency ratio weakened to 67.4 percent
for the first six months of 2003 from 62.8 percent for the same period last
year. However, our overhead ratio, another measure of productivity defined as
noninterest expense as a percentage of total average assets, remained constant
at 2.9 percent for the first half of 2003 and 2002. For the second quarter of
2003, noninterest expense increased $262 or 7.9 percent in comparison to the
same quarter last year.
37
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
Salaries and employee benefits expense, which comprise the majority of
noninterest expense, totaled $3,469 or 49.5 percent of noninterest expense for
the six months ended June 30, 2003. In comparison, these expenses were $3,271 or
49.7 percent of noninterest expense for the same period of 2002. Additional
staffing needs relative to the opening of our two most recent branch offices in
the second half of 2002, health insurance rate increases and merit increases
related to personnel performance appraisals all factored into the rise in
employee costs. For the second quarter of 2003, employee-related expenses
totaled $1,773, an increase of $83 compared to the second quarter of 2002.
Net occupancy and equipment expense rose $187 to $1,088 for the first half of
2003, from $901 for the same period last year. Additional expenses associated
with the operation of the new offices, as well as data processing enhancements,
contributed to the increase. For the three months ended June 30, 2003 and 2002,
net occupancy and equipment expenses amounted to $548 and $450, an increase of
$98.
Other expenses increased $30 to $2,446 for the six months ended June 30, 2003,
from $2,416 for the same six months of the prior year. For the quarter ended
June 30, other expenses totaled $1,257 in 2003 and $1,176 in 2002. The rise in
other expenses resulted primarily from additional contractual service expenses
associated with increased activity in our secondary mortgage division.
Our deposits are insured by the FDIC and are subject to deposit assessments to
maintain the Bank Insurance Fund ("BIF") administered by the FDIC. The FDIC
places each insured bank into one of nine risk categories based on the bank's
capitalization and supervisory evaluations provided to the FDIC by the bank's
primary federal regulator. An insured bank's assessment rate is then determined
by the risk category into which it is classified. Recently, the FDIC decided to
retain the existing BIF assessment schedules of $0.00 per 100 dollars of
deposits for banks classified in the highest capital and supervisory evaluation
category and $0.27 per 100 dollars of deposits for banks classified in the
lowest category. We were classified in the highest capital and supervisory
evaluation category at June 30, 2003, and will be exempt from paying a BIF
assessment in the second half of 2003.
There is a separate levy assessed on all FDIC-insured institutions to cover the
cost of Finance Corporation ("FICO") funding. The FDIC established the annual
FICO assessment rates effective for the second quarter of 2003 at $0.0162 per
100 dollars of BIF-assessable deposits. Our assessments totaled $36 and $37 for
the six months ended June 30, 2003 and 2002.
INCOME TAXES:
For the six months ended June 30, 2003, income tax expense totaled $672 and
resulted in an effective tax rate of 21.4 percent. For the same period of
38
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION & ANALYSIS (CONTINUED)
DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
2002, income tax expense was $629 with an effective tax rate of 19.8 percent.
The increase in the effective tax rate resulted from a lower level of tax-exempt
income. Tax-exempt interest income as a percentage of total interest income
equaled 8.7 percent for the first six months of 2003, compared to 9.1 percent
for the same period of 2002. Our effective tax rate is more favorable in
comparison to that of our peer group. For the six months ended June 30, 2003 and
2002, the peer group posted effective tax rates of 22.9 percent and 26.2
percent. We expect our effective tax rate to improve for the remainder of 2003
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.
39
COMM BANCORP, INC.
CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES:
The Securities and Exchange Commission requires that as of the end of the period
covered by this quarterly report, the Chief Executive Officer ("CEO") and the
Chief Financial Officer ("CFO") evaluate the effectiveness of the design and
operation of our disclosure controls and procedures (as defined in Rule 13(a)
and Rule 15(d) under the Securities Exchange Act of 1934), and report on the
effectiveness of the design and operation of our disclosure controls and
procedures. Accordingly, under the supervision and with the participation of our
management, including our CEO and CFO, we evaluated the effectiveness of the
design and operation of our disclosure controls and procedures as of the end of
the period.
CEO/CFO CONCLUSIONS ABOUT THE EFFECTIVENESS OF THE DISCLOSURE CONTROLS AND
PROCEDURES:
Based upon their evaluation of the disclosure controls and procedures, our CEO
and CFO have concluded that, subject to the limitations noted below, our
disclosure controls and procedures are effective to provide reasonable assurance
that material information relating to the Company and its consolidated
subsidiaries is made known to management, including the CEO and CFO, on a timely
basis and particularly during the period in which this Quarterly Report on Form
10-Q was being prepared.
LIMITATIONS ON THE EFFECTIVENESS OF CONTROLS:
Our management, including the CEO and CFO, does not expect that our disclosure
controls and procedures or our internal control over financial reporting 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 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 procedure 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. While we
40
COMM BANCORP, INC.
CONTROLS AND PROCEDURES (CONTINUED)
believe that our disclosure controls and procedures have been effective, in
light of the foregoing we intend to continue to examine and refine our
disclosure controls and procedures and to monitor ongoing developments in this
area.
CHANGES IN INTERNAL CONTROLS:
There were no changes in our internal control over financial reporting
identified in connection with the evaluation of such internal control over
financial reporting that occurred during the period covered by this quarterly
report, that has materially affected, or is reasonably likely to materially
affect our internal control over financial reporting.
41
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. RESULTS OF VOTES OF SECURITY HOLDERS AT THE COMPANY'S ANNUAL MEETING OF
STOCKHOLDERS HELD ON JUNE 6, 2003, FOR WHICH PROXIES WERE SOLICITED
PURSUANT TO SECTION 14 UNDER THE SECURITIES EXCHANGE ACT OF 1934, THE
FOLLOWING MATTERS WERE VOTED UPON BY THE STOCKHOLDERS.
1. To elect thirteen directors to serve for a one-year term and until
their successors are duly elected and qualified.
All nominees of the Board of Directors were elected. The number of
votes cast for or opposed to each of the nominees for election to the
Board of Directors were as follows:
Nominee For Against
- ------- ------------- ----------
David L. Baker 1,673,894.393 41,322.677
Thomas M. Chesnick 1,674,280.794 40,936.276
William F. Farber, Sr. 1,659,223.937 55,993.133
Judd B. Fitze 1,674,860.794 40,356.276
Dean L. Hesser 1,699,900.794 15,316.276
John P. Kameen 1,671,660.794 43,556.276
William A. Kerl 1,687,420.794 27,796.276
Erwin T. Kost 1,699,900.794 15,316.276
Susan F. Mancuso 1,701,013.503 14,203.567
Robert A. Mazzoni 1,687,900.794 27,316.276
J. Robert McDonnell 1,699,420.794 15,796.276
Joseph P. Moore, III 1,699,900.794 15,316.276
Eric G. Stephens 1,699,900.794 15,316.276
2. To ratify the selection of Kronick, Kalada, Berdy & Co. of Kingston,
Pennsylvania, Certified Public Accountants, as the independent auditors
for the year ending December 31, 2003. The votes cast on this matter
were as follows:
For Against
- ------------- ---------
1,709,814.405 5,402.665
42
COMM BANCORP, INC.
OTHER INFORMATION (CONTINUED)
ITEM 5. OTHER INFORMATION
NONE
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
31.1 Certification of Chief Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer pursuant to 18
U.S.C.Section 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K
Item 12 - On April 18, 2003, the Company filed a report on
Form 8-K, to disclose its results of operations for the three
months ended March 31, 2003.
43
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: August 12, 2003 /s/William F. Farber, Sr.
--------------------------------------------
William F. Farber, Sr.
President and Chief Executive Officer
Chairman of the Board/Director
(Principal Executive Officer)
Date: August 12, 2003 /s/ Scott A. Seasock
--------------------------------------------
Scott A. Seasock
Executive Vice President and
Chief Financial Officer
(Principal Financial Officer)
Date: August 12, 2003 /s/ Stephanie A. Ganz
--------------------------------------------
Stephanie A. Ganz
Vice President of Finance
(Principal Accounting Officer)
44
EXHIBIT INDEX
ITEM NUMBER DESCRIPTION PAGE
- ----------- ----------- ----
31.1 Certification of Chief Executive Officer
pursuant to Section 302 of the Sarbanes-
Oxley Act of 2002 46
31.2 Certification of Chief Financial Officer
pursuant to Section 302 of the Sarbanes-
Oxley Act of 2002 48
32.1 Certification of Chief Executive Officer
pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the
Sarbanes- Oxley Act of 2002 50
32.2 Certification of Chief Financial Officer
pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the
Sarbanes- Oxley Act of 2002 51
45