Back to GetFilings.com
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended SEPTEMBER 30, 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 (I.R.S. Employer Identification Number)
incorporation or organization)
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 Exchange 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: 1,906,528 at October 31, 2003.
Page 1 of 52
Exhibit Index on Page 46
COMM BANCORP, INC.
FORM 10-Q
SEPTEMBER 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 Nine Months Ended September 30,
2003 and 2002 .................................................. 3
Consolidated Balance Sheets - September 30, 2003 and
December 31, 2002 .............................................. 4
Consolidated Statement of Changes in Stockholders' Equity
for the Nine Months Ended September 30, 2003 ................... 5
Consolidated Statements of Cash Flows for the Nine Months
Ended September 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 .................................... 43
PART II. OTHER INFORMATION:
Item 1: Legal Proceedings .......................................... 44
Item 2: Changes in Securities and Use of Proceeds .................. 44
Item 3: Defaults Upon Senior Securities ............................ 44
Item 4: Results of Votes of Security Holders ....................... 44
Item 5: Other Information .......................................... 44
Item 6: Exhibits and Reports on Form 8-K ........................... 44
Signatures ......................................................... 45
Exhibit Index ...................................................... 46
* Not Applicable
2
COMM BANCORP, INC.
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------- -------------------------
2003 2002 2003 2002
----------- ----------- ----------- -----------
INTEREST INCOME:
Interest and fees on loans:
Taxable ............................................................... $ 5,617 $ 5,684 $ 16,781 $ 17,137
Tax-exempt ............................................................ 199 177 577 522
Interest and dividends on investment securities available-for-sale:
Taxable ............................................................... 397 804 1,485 2,769
Tax-exempt ............................................................ 394 439 1,193 1,455
Dividends ............................................................. 9 17 34 56
Interest on federal funds sold .......................................... 49 164 163 255
----------- ----------- ----------- -----------
Total interest income ............................................... 6,665 7,285 20,233 22,194
----------- ----------- ----------- -----------
INTEREST EXPENSE:
Interest on deposits .................................................... 2,392 3,036 7,646 9,327
----------- ----------- ----------- -----------
Total interest expense .............................................. 2,392 3,036 7,646 9,327
----------- ----------- ----------- -----------
Net interest income ................................................. 4,273 4,249 12,587 12,867
Provision for loan losses ............................................... 120 195 360 935
----------- ----------- ----------- -----------
Net interest income after provision for loan losses ................. 4,153 4,054 12,227 11,932
----------- ----------- ----------- -----------
NONINTEREST INCOME:
Service charges, fees and commissions ................................... 702 763 2,093 2,216
Net gains on sale of loans .............................................. 328 208 1,013 565
Net gains on sale of investment securities .............................. 17 86 86
----------- ----------- ----------- -----------
Total noninterest income ............................................ 1,030 988 3,106 2,867
----------- ----------- ----------- -----------
NONINTEREST EXPENSE:
Salaries and employee benefits expense .................................. 1,859 1,721 5,328 4,992
Net occupancy and equipment expense ..................................... 558 458 1,646 1,359
Other expenses .......................................................... 1,322 1,249 3,768 3,665
----------- ----------- ----------- -----------
Total noninterest expense ........................................... 3,739 3,428 10,742 10,016
----------- ----------- ----------- -----------
Income before income taxes .............................................. 1,444 1,614 4,591 4,783
Provision for income tax expense ........................................ 289 344 961 973
----------- ----------- ----------- -----------
Net income .......................................................... 1,155 1,270 3,630 3,810
----------- ----------- ----------- -----------
OTHER COMPREHENSIVE INCOME (LOSS):
Unrealized gains (losses) on investment securities available-for-sale ... (408) 1,561 (432) 3,580
Reclassification adjustment for gains included in net income ............ (17) (86)
Income tax expense (benefit) related to other comprehensive income (loss) (139) 525 (147) 1,188
----------- ----------- ----------- -----------
Other comprehensive income (loss), net of income taxes .............. (269) 1,019 (285) 2,306
----------- ----------- ----------- -----------
Comprehensive income ................................................ $ 886 $ 2,289 $ 3,345 $ 6,116
=========== =========== =========== ===========
PER SHARE DATA:
Net income .............................................................. $ 0.61 $ 0.65 $ 1.89 $ 1.94
Cash dividends declared ................................................. $ 0.22 $ 0.21 $ 0.66 $ 0.61
Average common shares outstanding ....................................... 1,908,995 1,956,741 1,925,962 1,963,665
See Notes to Consolidated Financial Statements.
3
COMM BANCORP, INC.
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
SEPTEMBER 30, DECEMBER 31,
2003 2002
------------- ------------
ASSETS:
Cash and due from banks .................................................. $ 12,611 $ 10,883
Federal funds sold ....................................................... 22,600 10,500
Investment securities available-for-sale ................................. 116,121 124,203
Loans held for sale, net ................................................. 5,677 3,916
Loans, net of unearned income ............................................ 352,593 323,575
Less: allowance for loan losses ........................................ 3,723 3,745
---------- ----------
Net loans ................................................................ 348,870 319,830
Premises and equipment, net .............................................. 12,129 11,861
Accrued interest receivable .............................................. 2,335 2,164
Other assets ............................................................. 2,801 3,061
---------- ----------
Total assets ......................................................... $ 523,144 $ 486,418
========== ==========
LIABILITIES:
Deposits:
Noninterest-bearing .................................................... $ 62,918 $ 49,820
Interest-bearing ....................................................... 410,552 387,393
---------- ----------
Total deposits ....................................................... 473,470 437,213
Accrued interest payable ................................................. 1,314 1,358
Other liabilities ........................................................ 2,343 2,514
---------- ----------
Total liabilities .................................................... 477,127 441,085
---------- ----------
STOCKHOLDERS' EQUITY:
Common stock, par value $0.33, authorized 12,000,000 shares, issued and
outstanding:
September 30, 2003, 1,904,869 shares; December 31, 2002, 1,944,769 shares 629 642
Capital surplus .......................................................... 6,517 6,484
Retained earnings ........................................................ 36,572 35,623
Accumulated other comprehensive income ................................... 2,299 2,584
---------- ----------
Total stockholders' equity ........................................... 46,017 45,333
---------- ----------
Total liabilities and stockholders' equity ........................... $ 523,144 $ 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 .................................... 3,630 3,630
Dividends declared: $0.66 per share ........... (1,268) (1,268)
Dividend reinvestment plan: 4,888 shares issued 2 168 170
Repurchase and retirement: 44,788 shares ...... (15) (135) (1,413) (1,563)
Net change in other comprehensive income ...... (285) (285)
-------- -------- -------- -------- --------
BALANCE, SEPTEMBER 30, 2003 ................... $ 629 $ 6,517 $ 36,572 $ 2,299 $ 46,017
======== ======== ======== ======== ========
See Notes to Consolidated Financial Statements.
5
COMM BANCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NINE MONTHS ENDED SEPTEMBER 30 2003 2002
- -------------------------------------------------------------------------------- -------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income ..................................................................... $ 3,630 $ 3,810
Adjustments:
Provision for loan losses .................................................... 360 935
Depreciation, amortization and accretion ..................................... 2,703 1,507
Amortization of loan fees .................................................... (135) (96)
Deferred income tax expense .................................................. 19 56
Gains on sale of investment securities available-for-sale .................... (86)
Loss on disposition of equipment ............................................. 17
Gains on the sale of foreclosed assets ....................................... (8) (174)
Changes in:
Loans held for sale, net ................................................... (1,761) (228)
Accrued interest receivable ................................................ (171) 244
Other assets ............................................................... 105 (543)
Accrued interest payable ................................................... (44) (186)
Other liabilities .......................................................... (17) 4
-------- --------
Net cash provided by operating activities ................................ 4,698 5,243
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sale of investment securities available-for-sale ................. 11,213
Proceeds from repayments of investment securities available-for-sale ........... 53,044 20,333
Purchases of investment securities available-for-sale .......................... (47,040) (25,796)
Proceeds from sale of foreclosed assets ........................................ 206 1,980
Net increase in lending activities ............................................. (29,549) (7,816)
Purchases of premises and equipment ............................................ (1,138) (2,512)
-------- --------
Net cash used in investing activities .................................... (24,477) (2,598)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net changes in:
Money market, NOW, savings and noninterest-bearing accounts .................. 27,742 34,938
Time deposits ................................................................ 8,515 (4,978)
Proceeds from issuance of common shares ........................................ 170 152
Repurchase and retirement of common shares ..................................... (1,563) (976)
Cash dividends paid ............................................................ (1,257) (1,161)
-------- --------
Net cash provided by financing activities ................................ 33,607 27,975
-------- --------
Net increase in cash and cash equivalents ................................ 13,828 30,620
Cash and cash equivalents at beginning of year ........................... 21,383 13,934
-------- --------
Cash and cash equivalents at end of period ............................... $ 35,211 $ 44,554
======== ========
SUPPLEMENTAL DISCLOSURES:
Cash paid during the period for:
Interest ..................................................................... $ 7,690 $ 9,513
Income taxes ................................................................. 1,012 988
Noncash items:
Transfer of loans to foreclosed assets ....................................... 284 280
Unrealized losses (gains) on investment securities available-for-sale ........ $ 285 $ (2,306)
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:
Additional monetary and fiscal stimulus quickened the pace of economic recovery
in the third quarter of 2003. The gross domestic product, the value of all goods
and services produced in the United States and the broadest measure of economic
performance, grew at a higher than expected annual rate of 7.2 percent. This
pace was more than double that of the 3.3 percent growth rate in the second
quarter and the strongest pace in nearly two decades. Growth in all sectors,
except for a slight reduction in inventories, aided the expansion. Consumer
spending, which has been the strong arm of the economy, rose at an annual rate
of 6.6 percent. Businesses also started spending, as evidenced by a 15.4 percent
increase in investment for equipment and software. In addition, residential
construction grew at a 20.4 percent rate and both government spending and
exports also rose. Due to the growth in the economy, the Federal Open Market
Committee ("FOMC") decided to hold its target rate for federal funds at a
45-year low of 1.0 percent at its meeting on October 28, 2003. Despite the
strong third quarter growth, the FOMC appears to be slow to raise rates since
inflation continued to be low at 1.0 percent. Economists anticipate the
expansion will continue into the fourth quarter with the economy growing at a
slower, but still strong pace of 4.0 percent.
9
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
REVIEW OF FINANCIAL POSITION:
We experienced significant growth in our balance sheet in 2003. Total assets
grew $36.7 million or 10.1 percent annualized to $523.1 million at September 30,
2003, from $486.4 million at December 31, 2002. The balance sheet growth was
driven by strong deposit demand. Although the stock market began to rebound in
recent months, demand for traditional deposit products remained favorable due to
the continued unwillingness of investors to assume the added risk given
uncertainty as to economic and employment conditions. Total deposits grew $36.3
million or 11.1 percent annualized to $473.5 million at the close of the third
quarter from $437.2 million at year-end 2002. Loans, net of unearned income,
increased $29.0 million or 12.0 percent annualized to $352.6 million at
September 30, 2003, from $323.6 million at the close of last year. Investment
securities decreased $8.1 million to $116.1 million at September 30, 2003, from
$124.2 million at December 31, 2002. At the close of the third quarter, we had
$22.6 million in federal funds sold outstanding as compared to $10.5 million at
year-end 2002. Stockholders' equity increased $0.7 million to $46.0 million at
September 30, 2003, from $45.3 million at December 31, 2002.
In comparison to the end of the previous quarter of 2003, total assets grew
$10.2 million. Deposits grew $10.0 million or at an annual rate of 8.6 percent
and loans, net of unearned income, increased $15.7 million or at an annual rate
of 18.5 percent. The investment portfolio increased $9.9 million, while federal
funds sold decreased $11.8 million. Stockholders' equity increased $0.3 million.
During the third quarter of 2003, construction continued 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. We anticipate the opening of this branch by
year end.
Also during the third quarter, we restructured our lending division. Prior to
the restructuring, lending operations were performed in each branch office, as
well as our corporate center. We decided to centralize all lending functions. We
placed qualified personnel as managers of each major division: commercial
lending, retail lending and credit administration. The managers are responsible
for their specific area and report directly to the Chief Credit Officer. We
believe this restructuring will promote sound lending decisions, improve
internal control over lending functions, eliminate duplication of duties, reduce
documentation errors and improve the overall quality of our loan portfolio.
10
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
INVESTMENT PORTFOLIO:
Yields on Treasury securities rose slightly in response to the higher than
anticipated GDP at the end of the third quarter, and closed above comparable
yields of the previous quarter end. 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,
increased 18 basis points to 1.50 percent at September 30, 2003, from 1.32
percent at June 30, 2003. The ten-year U.S. Treasury, related to our municipals
holdings, increased 42 basis points to 3.96 percent at the close of the third
quarter, from 3.54 percent at the end of the previous quarter. Treasury prices,
which react inversely to yields, fell and as a result, we experienced a decline
in the market value of our investment portfolio. The unrealized holding gain on
the investment portfolio decreased $408 to $3,483 at September 30, 2003, from
$3,891 at the end of the second quarter.
The carrying values of the major classifications of securities as they relate to
the total investment portfolio at September 30, 2003, and December 31, 2002, are
summarized as follows:
DISTRIBUTION OF INVESTMENT SECURITIES
SEPTEMBER 30, DECEMBER 31,
2003 2002
AMOUNT % AMOUNT %
-------- -------- -------- --------
U.S. Government agencies ..................................................... $ 20,436 17.60% $ 10,350 8.33%
State and municipals ......................................................... 51,822 44.63 35,003 28.18
Mortgage-backed securities ................................................... 42,192 36.33 77,579 62.46
Equity securities ............................................................ 1,671 1.44 1,271 1.03
-------- -------- -------- --------
Total ...................................................................... $116,121 100.00% $124,203 100.00%
======== ======== ======== ========
Our investment portfolio decreased $8.1 million to $116.1 million at September
30, 2003, from $124.2 million at December 31, 2002. In comparison to the end of
the previous quarter, investments increased $9.9 million. During the third
quarter, investment securities purchased totaled $28.6 million. The purchases
included $10.2 million in U.S. Government agency securities, $11.1 million in
mortgage-backed securities and $7.3 million in taxable state and municipal
obligations. Year-to-date investment securities purchased totaled $47.0 million.
At September 30, 2003, investment securities equaled 23.4 percent of earning
assets, compared to 21.9 percent at June 30, 2003, and 26.9 percent at December
31, 2002.
For the three months and nine months ended September 30, 2003, the investment
portfolio averaged $110.0 million and $110.7 million, compared
11
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
to $98.2 million and $108.5 million for the respective periods of last year. The
tax-equivalent yield on the investment portfolio dropped 218 basis points to
4.02 percent for the nine months ended September 30, 2003, from 6.20 percent for
the same nine months of 2002. For the third quarter of 2003, the tax-equivalent
yield was 3.62 percent, 40 basis points lower compared to 4.02 percent for the
previous quarter.
In addition to yield analysis, we utilize a total return approach to measure the
investment portfolio's performance. This approach gives a more complete picture
of a portfolio's overall performance since it takes into consideration both
market value and reinvestment income from repayments. The investment portfolio's
total return is the sum of all interest income, reinvestment income on all
proceeds from repayments and capital gains or losses, whether realized or
unrealized. Total return for the investment portfolio weakened for the twelve
months ended September 30, 2003, to 3.5 percent, compared to 5.9 percent for the
twelve months ended June 30, 2003.
The maturity distribution of the amortized cost, fair value and weighted-average
tax-equivalent yield of the available-for-sale portfolio at September 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. Included in the "State and
municipals" category are both taxable and tax-exempt obligations. 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 years"
maturity distribution. Expected maturities may differ from contracted maturities
because borrowers have the right to call or prepay obligations with or without
call or prepayment penalties.
MATURITY DISTRIBUTION OF AVAILABLE-FOR-SALE PORTFOLIO
AFTER ONE AFTER FIVE
WITHIN BUT WITHIN BUT WITHIN AFTER
ONE YEAR FIVE YEARS TEN YEARS TEN YEARS TOTAL
---------------------------------------------------------------------------------------------
SEPTEMBER 30, 2003 AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD
- -----------------------------------------------------------------------------------------------------------------------------
Amortized cost:
U.S. Government agencies ..... $ 7,093 2.09% $13,197 2.03% $ 20,290 2.05%
State and municipals ......... 340 4.04 18,058 2.50 $ 7,881 7.90% $22,981 7.60% 49,260 5.75
Mortgage-backed securities ... 15,746 4.91 23,738 4.35 1,573 5.04 461 6.59 41,518 4.61
Equity securities ............ 1,570 2.88 1,570 2.88
------- ------- ------ ------- --------
Total ...................... $23,179 4.03% $54,993 3.19% $ 9,454 7.42% $25,012 7.29% $112,638 4.63%
======= ======= ======= ======= ========
Fair value:
U.S. Government agencies ..... $ 7,138 $13,298 $ 20,436
State and municipals ......... 347 17,888 $ 8,728 $24,859 51,822
Mortgage-backed securities ... 15,917 24,182 1,612 481 42,192
Equity securities ............ 1,671 1,671
------- ------- ------- ------- --------
Total ...................... $23,402 $55,368 $10,340 $27,011 $116,121
======= ======= ======= ======= ========
12
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
LOAN PORTFOLIO:
Despite an increase in mortgage rates from the end of the second quarter, the
housing industry remained strong. The rate on a 30-year conventional mortgage,
which reached a record low of 5.23 percent at the end of the second quarter of
2003, rose 92 basis points and closed the third quarter at 6.15 percent. Sales
of existing homes in September rose 3.6 percent to a seasonally adjusted annual
rate of 6.7 percent. Existing home sales in the Northeast increased 7.0 percent.
Although, September new home sales fell slightly, by 0.2 percent, new home sales
in the Northeast jumped 26.0 percent. New home construction also increased as
evidenced by a 3.4 percent rise in the average annual number of housing starts
in September. Furthermore, the Northeast experienced the biggest growth in
housing starts at 15.5 percent. Due to the robust housing market, activity in
our secondary mortgage department flourished. Residential mortgages sold to the
Federal National Mortgage Association ("FNMA") totaled $18.0 million and $42.9
million for the three months and nine months ended September 30, 2003. Net gains
realized on the sale of residential mortgages totaled $328 for the third quarter
and $1,013 year-to-date 2003, compared to $208 and $565 for the same periods
last year.
After over two years of retrenchment, business investment grew for the second
quarter in a row. In total, business investment rose 11.0 percent in the third
quarter. Outlays for equipment and software rose 15.4 percent, the largest
increase since the first quarter of 2000 and up from 8.3 percent last quarter.
The prime rate remained at a historic low of 4.00 percent. Despite low interest
rates and increased business investment, commercial and industrial loans at all
commercial banks declined 5.6 percent from year-end and 1.7 percent from the end
of the second quarter. Conversely, we continued our success of growing our
commercial loan portfolio in the third quarter. Commercial loans, including
commercial mortgages and lease financing grew $16.6 million or at an annual rate
of 33.4 percent to $214.0 million at September 30, 2003, from $197.4 million at
June 30, 2003. From year-end 2002, commercial loans, including commercial
mortgages and lease financing, grew $46.7 million or 27.9 percent.
During the third quarter consumers increased spending, as well as their debt.
Consumer loans for all commercial banks increased $6.2 billion or 1.0 percent
from the end of the previous quarter and $13.9 billion or 2.4 percent from
year-end. Contrary to the industry, our retail loan portfolio declined during
the third quarter of 2003. Although we experienced strong demand for mortgages,
our holdings of residential mortgage loans declined $15.4 million or 12.5
percent to $108.2 million at the end of the third quarter, as the majority of
mortgage loans originated were subsequently
13
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
sold in the secondary market. In addition, our consumer loans decreased $2.3
million or 7.0 percent to $30.4 million at September 30, 2003.
For the nine months ended September 30, 2003, loans averaged $342.6 million, an
increase of $26.3 million or 8.3 percent compared to $316.3 million averaged for
the same period of 2002. The tax-equivalent yield on the loan portfolio fell 69
basis points to 6.89 percent for the nine months ended September 30, 2003, from
7.58 percent for the nine months of 2002. As a result of the 25 basis point
decline in the prime rate at the close of the previous quarter, the
tax-equivalent yield on the loan portfolio decreased 39 basis points in the
third quarter of 2003 in comparison to the previous quarter. We anticipate loan
yields to decline further in the final quarter of 2003, as the low rate
environment is expected to persist.
The composition of the loan portfolio at September 30, 2003, and December 31,
2002, is summarized as follows:
DISTRIBUTION OF LOAN PORTFOLIO
SEPTEMBER 30, DECEMBER 31,
2003 2002
AMOUNT % AMOUNT %
----------- ------- ----------- -------
Commercial, financial and others ... $ 104,302 29.58% $ 90,747 28.05%
Real estate:
Construction ..................... 4,351 1.24 5,398 1.67
Mortgage ......................... 211,710 60.04 193,012 59.65
Consumer, net ...................... 30,363 8.61 32,631 10.08
Lease financing, net ............... 1,867 0.53 1,787 0.55
----------- ------- ----------- -------
Loans, net of unearned income .... 352,593 100.00% 323,575 100.00%
======= =======
Less: allowance for loan losses .... 3,723 3,745
----------- -----------
Net loans ...................... $ 348,870 $ 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 40.4 percent of the lending portfolio is expected to reprice
within the next twelve months.
14
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
The maturity and repricing information of the loan portfolio by major
classification at September 30, 2003, is summarized as follows:
MATURITY DISTRIBUTION AND INTEREST SENSITIVITY OF LOAN PORTFOLIO
AFTER ONE
WITHIN BUT WITHIN AFTER
SEPTEMBER 30, 2003 ONE YEAR FIVE YEARS FIVE YEARS TOTAL
- ------------------------------------- -------- ---------- ---------- --------
Maturity schedule:
Commercial, financial and others .... $ 51,465 $ 24,150 $ 28,687 $104,302
Real estate:
Construction ...................... 4,351 4,351
Mortgage .......................... 20,971 73,428 117,311 211,710
Consumer, net ....................... 11,289 16,193 2,881 30,363
Lease financing, net ................ 684 1,183 1,867
-------- -------- -------- --------
Total ........................... $ 88,760 $114,954 $148,879 $352,593
======== ======== ======== ========
Repricing schedule:
Predetermined interest rates ........ $ 37,541 $ 65,798 $ 66,326 $169,665
Floating or adjustable interest rates 105,047 77,818 63 182,928
-------- -------- -------- --------
Total ........................... $142,588 $143,616 $ 66,389 $352,593
======== ======== ======== ========
ASSET QUALITY:
National, Pennsylvania and market area unemployment rates at September 30, 2003
and 2002, are summarized as follows:
SEPTEMBER 30, 2003 2002
- ------------------------- ------ ------
United States ........... 6.1% 5.7%
Pennsylvania ............ 5.3 5.7
Lackawanna county ....... 4.6 5.2
Susquehanna county ...... 4.7 6.1
Wayne county ............ 3.5 4.3
Wyoming county .......... 4.2% 4.7%
Employment conditions, for the most part, appear to be improving. Conditions in
the Commonwealth and in our market area improved in comparison to last year and
the previous quarter. Although the national unemployment rate rose to 6.1
percent at September 30, 2003, from 5.7 percent one year ago, the change was an
improvement from 6.4 percent at June 30, 2003. In comparison to the previous
quarter-end, job losses in the manufacturing sector slowed, while employment in
service-providing industries and construction trended upward. Although
employment conditions in our market area are more favorable in comparison to the
Nation and Commonwealth, no assurance can be given that these conditions will
continue.
15
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
Nonperforming assets were $2,679 or 0.76 percent of loans, net of unearned
income, at September 30, 2003, compared to $2,542 or 0.79 percent at year-end
2002. The change in the volume of nonperforming assets resulted from slight
increases of $51 in nonperforming loans and $86 in foreclosed assets.
Nonperforming loans consist of nonaccrual loans and accruing loans past due 90
days or more. Nonaccrual loans decreased $533 to $1,459 at the end of the third
quarter from $1,992 at year-end 2002, while accruing loans past due 90 days or
more increased $584 to $1,094 at the end of the third quarter compared to $510
at the end of 2002. Foreclosed assets totaled $126 at September 30, 2003,
compared to $40 at December 31, 2002. During the nine months ended September 30,
2003, six loans totaling $284 were transferred to foreclosed assets, four loans
having an aggregate carrying value of $198 were sold for $206, resulting in a
net realized gain on sale of $8.
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.
16
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
Information concerning nonperforming assets at September 30, 2003, and December
31, 2002, is summarized as follows. The table includes loans and other
extensions and credit classified for regulatory purposes and all material loans
and other extensions of credit that cause management to have serious doubts as
to the borrowers' ability to comply with present loan repayment terms.
DISTRIBUTION OF NONPERFORMING ASSETS
SEPTEMBER 30, DECEMBER 31,
2003 2002
------------- ------------
NONACCRUAL LOANS:
Commercial, financial and others ...................... $ 378 $ 541
Real estate:
Construction
Mortgage ............................................ 958 1,213
Consumer, net ......................................... 123 238
Lease financing, net
-------- --------
Total nonaccrual loans ............................ 1,459 1,992
-------- --------
ACCRUING LOANS PAST DUE 90 DAYS OR MORE:
Commercial, financial and others ...................... 49 97
Real estate:
Construction
Mortgage ............................................ 882 281
Consumer, net ......................................... 163 132
Lease financing, net
-------- --------
Total accruing loans past due 90 days or more ..... 1,094 510
-------- --------
Total nonperforming loans ......................... 2,553 2,502
-------- --------
Foreclosed assets ..................................... 126 40
-------- --------
Total nonperforming assets ........................ $ 2,679 $ 2,542
======== ========
Ratios:
Nonperforming loans as a percentage of loans, net ..... 0.72% 0.77%
Nonperforming assets as a percentage of loans, net .... 0.76% 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 Institutions Examination Council ("FFIEC") Interagency Policy
Statement and generally accepted accounting principals ("GAAP") in assessing the
adequacy of the allowance
17
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
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 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.
18
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
Information concerning impaired loans at September 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
SEPTEMBER 30, DECEMBER 31,
2003 2002
------------- ------------
NONACCRUAL LOANS:
Commercial, financial and others ........... $ 378 $ 541
Real estate:
Construction
Mortgage ................................. 958 1,213
Consumer, net .............................. 123 238
Lease financing, net
------ ------
Total nonaccrual loans ................. 1,459 1,992
------ ------
ACCRUING LOANS:
Commercial, financial and others ........... 49 889
Real estate:
Construction
Mortgage ................................. 882 485
Consumer, net .............................. 85 292
Lease financing, net
------ ------
Total accruing loans ................... 1,016 1,666
------ ------
Total impaired loans ................... $2,475 $3,658
====== ======
Ratio:
Impaired loans as a percentage of loans, net 0.70% 1.13%
Information relating to the recorded investment in impaired loans at September
30, 2003 and December 31, 2002, is summarized as follows:
SEPTEMBER 30, DECEMBER 31,
2003 2002
------------- ------------
Impaired loans:
With a related allowance ..... $1,253 $2,500
With no related allowance .... 1,222 1,158
------ ------
Total ...................... $2,475 $3,658
====== ======
19
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
The analysis of changes affecting the allowance for loan losses related to
impaired loans for the nine months ended September 30, 2003, is summarized as
follows:
SEPTEMBER 30,
2003
-------------
Balance at January 1 ......... $ 877
Provision for loan losses .... (111)
Loans charged-off ............ 355
Loans recovered .............. 9
-----
Balance at period-end ........ $ 420
=====
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 nine-month periods ended September 30, 2003 and 2002 are summarized as
follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2003 2002 2003 2002
-------- -------- -------- --------
Gross interest due under terms ....................... $ 44 $ 53 $ 144 $ 133
Interest income recognized ........................... 53 92 104 139
-------- -------- -------- --------
Interest income not recognized (recognized in
excess of due) ...................................... $ (9) $ (39) $ 40 $ (6)
======== ======== ======== ========
Interest income recognized (cash-basis) .............. $ 53 $ 92 $ 104 $ 139
Average recorded investment in impaired loans......... $ 2,354 $ 3,335 $ 2,543 $ 2,598
Cash received on impaired loans applied as a reduction of principal totaled $707
and $448 for the nine and three months ended September 30, 2003. For the
respective periods of 2002, cash receipts on impaired loans totaled $399 and
$100. There were no commitments to extend additional funds to such parties at
September 30, 2003.
20
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
The allocation of the allowance for loan losses at September 30, 2003 and
December 31, 2002, is summarized as follows:
ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
SEPTEMBER 30, DECEMBER 31,
2003 2002
------------------- -------------------
CATEGORY CATEGORY
AS A AS A
% OF % OF
AMOUNT LOANS AMOUNT LOANS
-------- -------- -------- --------
Allocated allowance:
Specific:
Commercial, financial and others .. $ 191 0.12% $ 597 0.44%
Real estate:
Construction.....................
Mortgage ........................ 159 0.52 173 0.53
Consumer, net ..................... 70 0.06 107 0.16
Lease financing, net...............
Total specific .............. 420 0.70 877 1.13
-------- -------- -------- --------
Formula:
Commercial, financial and others .. 231 29.46 367 27.61
Real estate:
Construction .................... 1.24 1.67
Mortgage ........................ 2,537 59.52 2,071 59.12
Consumer, net ..................... 328 8.55 419 9.92
Lease financing, net .............. 0.53 0.55
-------- -------- -------- --------
Total formula ................. 3,096 99.30 2,857 98.87
-------- -------- -------- --------
Total allocated allowance ..... 3,516 100.00% 3,734 100.00%
======== ========
Unallocated allowance ............. 207 11
-------- --------
Total allowance for loan losses $ 3,723 $ 3,745
======== ========
The allocated allowance for loan losses account decreased $218 to $3,516 at
September 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 $207 at the end
of the third 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.
21
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
A reconciliation of the allowance for loan losses and illustration of
charge-offs and recoveries by major loan category for the nine months ended
September 30, 2003, is summarized as follows:
RECONCILIATION OF ALLOWANCE FOR LOAN LOSSES
SEPTEMBER 30,
2003
------------
Allowance for loan losses at beginning of period ................. $3,745
Loans charged-off:
Commercial, financial and others ................................. 107
Real estate:
Construction
Mortgage ....................................................... 180
Consumer, net .................................................... 163
Lease financing, net
------
Total ........................................................ 450
------
Loans recovered:
Commercial, financial and others ................................. 6
Real estate:
Construction ...................................................
Mortgage ....................................................... 3
Consumer, net .................................................... 59
Lease financing, net .............................................
------
Total ........................................................ 68
------
Net loans charged-off ............................................ 382
------
Provision charged to operating expense ........................... 360
------
Allowance for loan losses at end of period ....................... $3,723
======
Ratios:
Net loans charged-off as a percentage of average loans outstanding 0.15%
Allowance for loan losses as a percentage of period end loans .... 1.06%
The allowance for loan losses was $3,723 or 1.06 percent of loans, net of
unearned income at September 30, 2003, compared to $3,677 or 1.09 percent of
loans, net of unearned income, at the end of the previous quarter. The increase
resulted from the provision for loan losses of $120 for the quarter ended
September 30, 2003, exceeding net charge-offs of $74. The coverage ratio, the
allowance for loan losses as a percentage of nonperforming assets, equaled 139.0
percent at the end of the third quarter, compared to 160.7 percent at June 30,
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.
22
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
Net charge-offs were $382 or 0.15 percent of average loans outstanding for the
nine months ended September 30, 2003, compared to $515 or 0.22 percent for the
same period last year. Net charge-offs as a percentage of average loans
outstanding for our peer group equaled 0.21 percent and 0.17 percent for the
respective periods.
DEPOSITS:
The average amount of, and the rate paid on, the major classifications of
deposits for the nine months ended September 30, 2003 and 2002, are summarized
as follows:
DEPOSIT DISTRIBUTION
SEPTEMBER 30, SEPTEMBER 30,
2003 2002
------------------- -------------------
AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE RATE BALANCE RATE
-------- -------- -------- --------
Interest-bearing:
Money market accounts ......... $ 15,739 1.10% $ 18,949 2.13%
NOW accounts .................. 38,553 0.94 37,944 1.45
Savings accounts .............. 126,837 1.14 103,417 1.98
Time deposits less than $100 .. 187,191 3.92 185,421 4.51
Time deposits $100 or more .... 27,269 3.31 28,921 3.80
-------- --------
Total interest-bearing ...... 395,589 2.58% 374,652 3.33%
Noninterest-bearing ........... 55,042 48,480
-------- --------
Total deposits .............. $450,631 $423,132
======== ========
Tax refund checks allowed consumers to spend at a brisk 6.6 percent pace in the
third quarter of 2003 and still save, as evidenced by the personal savings rate
averaging 3.9 percent. Investors were still uncertain about the stock market and
overall recovery. Due to their stability, bank deposits were still the
investment of choice.
Deposits totaled $473.5 million at September 30, 2003, an increase of $10.0
million from $463.5 million at the end of the previous quarter of 2003 and $36.3
million from $437.2 million at year-end 2002. The growth from the end of the
second quarter resulted from a $6.7 million increase in interest-bearing
accounts, coupled with a $3.3 million rise in noninterest-bearing accounts. With
regard to our interest-bearing accounts, increases of $5.6 million in money
market accounts, $4.5 million in time deposits $100 or more and $2.0 million in
savings accounts, were partially offset by decreases of $5.3 million in time
deposits less than $100 and $0.1 million in NOW accounts. The growth in money
market accounts resulted from a cyclical influx of tax monies from local area
school districts.
23
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
For the nine months ended September 30, 2003, average total deposits increased
$27.5 million or 6.5 percent to $450.6 million compared to $423.1 million for
the same period of 2002. Interest-bearing deposits averaged $20.9 million or 5.6
percent higher and noninterest-bearing deposits averaged $6.6 million or 13.6
percent higher when comparing the nine months ended September 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 $23.4 million or 22.6 percent.
As a result of the promotional rates offered on longer-term certificates of
deposit and IRA accounts, time deposits less than $100 averaged $1.8 million
higher. Average money market accounts and large denomination time deposits
declined by $3.2 million and $1.7 million, while average NOW accounts rose $0.6
million. The low interest rate environment, coupled with the shift into
lower-costing deposits, caused our cost of funds to decline 75 basis points to
2.58 percent for the nine months ended September 30, 2003, from 3.33 percent for
the same period of 2002. Low interest rates are expected to continue throughout
the remainder of 2003. Therefore, we anticipate our deposit costs to remain low.
However, should competition and inflationary pressures pick up during the
economic recovery, interest rates could rise and our cost of funds escalate.
Volatile deposits, time deposits in denominations of $100 or more, equaled $32.6
million at September 30, 2003, an increase of $4.4 million from $28.2 million at
the end of the previous quarter and $8.1 million from $24.5 million at year-end
2002. The majority of the increase arose from the promotional rates offered for
our longer-term certificates of deposit. For the nine months ended September 30,
these time deposits averaged $27.3 million with an average cost of 3.31 percent
in 2003 and $28.9 million with an average cost of 3.80 percent in 2002.
Maturities of time deposits of $100 or more at September 30, 2003, and December
31, 2002, are summarized as follows:
MATURITY DISTRIBUTION OF TIME DEPOSITS OF $100 OR MORE
SEPTEMBER 30, DECEMBER 31,
2003 2002
------------ ------------
Within three months ....................... $ 10,391 $ 3,020
After three months but within six months... 6,971 3,333
After six months but within twelve months.. 12,826 8,230
After twelve months ....................... 2,451 9,961
-------- --------
Total ................................... $ 32,639 $ 24,544
======== ========
24
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
25
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
when the amount of RSA repricing in a specific period is greater than the 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 favorably
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
SEPTEMBER 30, 2003 THREE MONTHS TWELVE MONTHS FIVE YEARS FIVE YEARS TOTAL
- ---------------------------------- ------------ ------------- ---------- ---------- --------
Rate-sensitive assets:
Investment securities............. $ 6,167 $ 17,235 $ 55,368 $ 37,351 $116,121
Loans held for sale, net.......... 5,677 5,677
Loans, net of unearned income..... 94,197 48,391 143,616 66,389 352,593
Federal funds sold................ 22,600 22,600
-------- -------- -------- -------- --------
Total........................... $128,641 $ 65,626 $198,984 $103,740 $496,991
======== ======== ======== ======== ========
Rate-sensitive liabilities:
Money market accounts............. $ 19,210 $ 19,210
NOW accounts...................... 42,033 42,033
Savings accounts.................. $132,268 132,268
Time deposits less than $100...... $ 30,902 34,113 106,960 $ 12,427 184,402
Time deposits $100 or more........ 10,391 6,971 12,826 2,451 32,639
-------- -------- -------- -------- --------
Total........................... $ 41,293 $102,327 $252,054 $ 14,878 $410,552
======== ======== ======== ======== ========
Rate sensitivity gap:
Period.......................... $ 87,348 $(36,701) $(53,070) $ 88,862
Cumulative...................... $ 87,348 $ 50,647 $( 2,423) $ 86,439 $ 86,439
RSA/RSL ratio:
Period.......................... 3.12 0.64 0.79 6.97
Cumulative...................... 3.12 1.35 0.99 1.21 1.21
Although no assurance can be given to fluctuations in market interest rates,
with inflationary conditions stable, current market rates are anticipated to
remain at historically low levels throughout the next twelve
26
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
months before beginning to rise. Therefore, our current IRR strategy is to
monitor the maturity and repricing intervals of RSA and extend the repricing
time frame of RSL. Our cumulative one-year RSA/RSL ratio equaled 1.35 at
September 30, 2003, compared to 1.42 at June 30, 2003. The change in the
one-year RSA/RSL ratio resulted from a $6.2 million decrease in RSA maturing or
repricing within one year, coupled with a $2.5 million increase in RSL maturing
or repricing within the same time frame. An increase in loans, net of unearned
income, was more than offset by decreases in investment securities and federal
funds sold. As part of monitoring RSA and limiting the amount of IRR in our loan
portfolio, we have consistently priced our loan products to increase our
holdings of floating- or adjustable-rate loans which reprice in the near term.
Loans, net of unearned income, maturing or repricing within twelve months
increased $18.8 million to $142.6 million from $123.8 million three months ago.
Federal funds sold decreased $11.8 million to $22.6 million at the end of the
third quarter from $34.4 million at June 30, 2003. The funds were primarily used
to purchase U.S. Government agencies and mortgage-backed securities having
maturities of 18 to 24 months. Should interest rates rise as anticipated, these
purchases would ensure cash flows which could be reinvested in higher yielding
instruments. A reduction in the amount of anticipated cash flows from
mortgage-backed securities primarily led to the $11.4 million decline in
investment securities maturing or repricing within one year. With regard to RSL,
the overall increase primarily resulted from a $5.6 million increase in money
market accounts due to a cyclical influx of tax monies from deposits of local
area school districts. During the third quarter, we continued to offer
promotional rates on our 90-month term certificates of deposit in order to
extend the average maturities of these types of funds. Time deposits repricing
within one year declined $3.1 million from the end of the second quarter of
2003, while those repricing after five years increased $2.0 million. At
September 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 September
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 a decrease in our three-month ratio to 3.12 at September 30, 2003
from 4.91 at June 30, 2003. The decrease resulted from a $9.5 million decrease
in the amount of RSA maturing or repricing within three months
27
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
coupled with a $13.2 million rise in RSL maturing or repricing within the same
time frame. Similar to the reasons discussed for the change in the one-year
ratio, an increase in loans, net of unearned income, was more than offset by
reductions in federal funds sold and investment securities. Time deposits
maturing or repricing within three months were responsible for the increase 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 months 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.
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. Given the
current rate environment, parallel shifts of plus or minus 100 basis points were
not practical. At September 30, 2003, we performed asymmetrical shifts of 100
basis points up and 50 basis points down. The model results produced results
similar to those indicated by the one-year static gap position. Given parallel
and instantaneous shifts in interest rates of plus 100 basis points, net
interest income should increase by 4.7 percent and a decline of 50 basis points
would result in a decrease in net interest income of 1.9 percent.
Financial institutions are affected differently by inflation than commercial and
industrial companies that have significant investments in fixed assets and
inventories. Most of our assets are monetary in nature and change
correspondingly with variations in the inflation rate. It is difficult to
precisely measure the impact inflation has on us, however we believe that our
exposure to inflation can be mitigated through asset/liability management.
28
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
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 September 30, 2003, our net noncore funding dependence ratio, the difference
between noncore funds and short-term investments to long-term assets, was
negative 6.8 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 3.2 percent at the end of the third quarter of
2003. Negative ratios indicated that at September 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 $13.8 million during the nine months ended September 30, 2003. Net
cash provided by operating and financing activities totaled $4.7 million and
$33.6 million, while net cash used in investing activities
29
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
equaled $24.5 million. Net income of $3.6 million for the nine months ended
September 30, 2003, was the primary factor contributing to the net cash inflow
from operating activities.
The net cash provided by financing activities resulted primarily from a $36.3
million increase in deposits. Transaction accounts increased $27.8 million,
while time deposits rose $8.5 million from year-end 2002. Partially offsetting
the affects of the increase in deposits, were cash outflows of $1.1 million for
net cash dividends paid and $1.6 million for the repurchase of 44,788 shares of
common stock.
The $24.5 million used in investing activities primarily resulted from purchases
of investment securities totaling $47.0 million and a $29.5 million net increase
in lending activities, partially offset by proceeds received from repayments of
investment securities of $53.0 million.
CAPITAL ADEQUACY:
At September 30, 2003, stockholders' equity totaled $46.0 million compared to
$45.3 million at December 31, 2002. On a per share basis, stockholders' equity
equaled $24.16 per share at the end of the third quarter of 2003, an increase of
$0.85 per share compared to $23.31 per share at year-end 2002.
During the third quarter of 2003, we repurchased 6,338 shares of our common
stock for $227. Year-to-date 2003 common stock repurchases totaled 44,788 shares
for $1,563. For the three and nine months ended September 30, dividends declared
totaled $419 or $0.22 per share and $1,268 or $0.66 per share in 2003 and $410
or $0.21 per share and $1,195 or $0.61 per share in 2002. The dividend payout
ratio was 34.9 percent and 31.4 percent for the nine months ended September 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 conditions, capital and growth objectives,
appropriate dividend restrictions and other relevant factors. Stockholders may
automatically reinvest their dividends in shares of our common stock through our
dividend reinvestment plan. During the third quarter of 2003, we issued 1,689
shares under this plan. Shares issued year-to-date under the dividend
reinvestment plan totaled 4,888 in 2003.
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,
30
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
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 September 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.
31
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
Our and Community Bank's capital ratios at September 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
--------------------- ------------------- -------------------
SEPTEMBER 30, 2003 2002 2003 2002 2003 2002
- ----------------------------------------- --------- --------- -------- -------- -------- --------
Basis for ratios:
Tier I capital to risk-weighted assets:
Consolidated........................... $ 42,695 $ 40,720 $ 15,306 $ 13,246
Community Bank......................... 41,325 38,969 15,283 12,810 $ 22,924 $ 19,816
Total capital to risk-weighted assets:
Consolidated........................... 46,418 44,360 30,612 26,491
Community Bank......................... 45,048 42,609 30,565 26,421 38,207 33,026
Tier I capital to total average assets
less goodwill:
Consolidated........................... 42,695 40,720 19,944 18,719
Community Bank......................... 45,048 38,969 $ 19,918 $ 18,676 $ 24,898 $ 23,345
Risk-weighted assets:
Consolidated........................... 355,042 308,182
Community Bank......................... 354,455 307,306
Risk-weighted off-balance sheet items:
Consolidated........................... 27,610 22,957
Community Bank......................... 27,610 22,957
Average assets for Leverage ratio:
Consolidated........................... 498,612 467,971
Community Bank......................... $ 497,956 $ 466,895
Ratios:
Tier I capital as a percentage of risk-
weighted assets and off-balance sheet
items:
Consolidated........................... 11.2% 12.3% 4.0% 4.0%
Community Bank......................... 10.8 11.8 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........................... 12.1 13.4 8.0 8.0
Community Bank......................... 11.8 12.9 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
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
32
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
define institutions, not under a written directive to maintain certain capital
levels, as well capitalized if they exceed the following:
- A Tier I risk-based ratio of at least 6.0 percent;
- A total risk-based ratio of at least 10.0 percent; and
- A Leverage ratio of at least 5.0 percent.
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 September 30, 2003.
There are no conditions or events since this notification that we believe have
changed Community Bank's category.
REVIEW OF FINANCIAL PERFORMANCE:
Despite contracting interest margins, the banking industry recorded record
earnings in 2003. Year-to-date net income for all Federal Deposit Insurance
Corporation- ("FDIC") insured commercial banks increased $5.2 billion or 11.5
percent in 2003 in comparison to last year. The low interest rate environment
allowed banks to realize significant gains on the sale of investments. Gains on
the sale of investment securities were up 181.2 percent in 2003 in comparison to
2002. However, the interest rate environment had the opposite affect on net
interest margins. Declining short-term interest rates caused asset yields to
fall faster than funding costs, as evidenced by a 28 basis point decline in the
net interest margin for all FDIC-commercial banks. The industry's return on
average assets and return on average equity was 1.39 percent and 15.26 percent
in 2003 compared to 1.37 percent and 14.90 percent in 2002.
Despite significant growth in loans, net of unearned income, and higher
noninterest revenue, the additional overhead required to sustain such growth was
not able to be absorbed due to a decline in the net interest margin. As a
result, we experienced a $180 decline in net income for the nine months ended
September 30, 2003, to $3,630 or $1.89 per share from $3,810 or $1.94 per share
for the same nine months of 2002. Net income for the third quarter was $1,155 or
$0.61 per share in 2003 and $1,270 or $0.65 per share in 2002. Return on average
assets was 0.89 percent for the third quarter and 0.97 percent year-to-date
2003, compared to 1.05 percent and 1.09 percent for the respective 2002 periods.
Return on average equity for the three months and nine months ended September
30, 2003, was 10.10 percent and 10.60 percent, as compared to 11.39 percent and
11.91 percent for the same periods of 2002.
33
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NET INTEREST INCOME:
Our principal source of operating income is net interest income. Net interest
income is defined as the difference between income, interest and fees from
earning assets, and the cost of interest-bearing liabilities supporting those
assets. The primary sources of earning assets are loans and investment
securities, while deposits, short-term borrowings and long-term debt comprise
interest-bearing liabilities. Net interest income is impacted by:
- Variations in the volume, rate and composition of earning assets and
interest-bearing liabilities;
- Changes in general market rates; and
- The level of nonperforming assets.
Changes in net interest income are measured by the net interest spread and net
interest margin. Net interest spread, the difference between the average yield
earned on earning assets and the average rate incurred on interest-bearing
liabilities, illustrates the effects changing interest rates have on
profitability. Net interest margin, net interest income as a percentage of
average earning assets, is a more comprehensive ratio, as it reflects not only
spread, but also the change in the composition of interest-earning assets and
interest-bearing liabilities. Tax-exempt loans and investments carry pre-tax
yields lower than their taxable counterparts. Therefore, in order to make the
analysis of net interest income more comparable, tax-exempt income and yields
are reported on a tax-equivalent basis using the prevailing statutory tax rate
of 34.0 percent.
34
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
We analyze interest income and interest expense by segregating rate and volume
components of earning assets and interest-bearing liabilities. The impact
changes in the interest rates earned and paid on assets and liabilities, along
with changes in the volume of earning assets and interest-bearing liabilities
have on net interest income are summarized in the following table. The net
change attributable to the combined impact of rate and volume has been allocated
proportionately to the change due to rate and the change due to volume.
NET INTEREST INCOME CHANGES DUE TO RATE AND VOLUME
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
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............................ $ (67) $(337) $ 270 $ (356) $(1,801) $1,445
Tax-exempt......................... 34 (53) 87 84 (359) 443
Investments:
Taxable............................ (415) (504) 89 (1,306) (1,837) 531
Tax-exempt......................... (70) (7) (63) (398) (16) (382)
Federal funds sold................... (115) (11) (104) (92) (82) (10)
----- ----- ----- ------- ------- ------
Total interest income............ (633) (912) 279 (2,068) (4,095) 2,027
----- ----- ----- ------- ------- ------
Interest expense:
Money market accounts................ (17) (24) 7 (172) (128) (44)
NOW accounts......................... (62) (65) 3 (140) (161) 21
Savings accounts..................... (312) (349) 37 (458) (1,032) 574
Time deposits less than $100......... (240) (254) 14 (763) (860) 97
Time deposits $100 or more........... (13) (39) 26 (148) (103) (45)
----- ----- ----- ------- ------- ------
Total interest expense........... (644) (731) 87 (1,681) (2,284) 603
----- ----- ----- ------- ------- ------
Net interest income.............. $ 11 $(181) $ 192 $ (387) $(1,811) $1,424
===== ===== ===== ======= ======= ======
Tax-equivalent net interest income for the nine months ended September 30, 2003
totaled $13,499, a decrease of $387 from $13,886 for the same nine months of
2002. A negative rate variance, partially offset by a positive volume variance,
was responsible for the decline.
The tax-equivalent yield on earning assets fell 100 basis points to 5.98 percent
for the nine months ended September 30, 2003, from 6.98 percent for the same
nine months of 2002. This resulted in a reduction in tax-
35
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
equivalent interest revenue of $4,095. The tax-equivalent yields on loans and
investments fell 69 basis points and 218 basis points and accounted for
reductions in interest revenue of $2,160 and $1,853. Partially offsetting the
decline in tax-equivalent interest revenue was a $2,284 decrease in interest
expense resulting from a 75 basis point decline in our cost of funds. Although
we experienced a decline in the cost of all major deposit categories, accounting
for 82.8 percent of the reduction in interest expense were declines of 84 basis
points in the average rate paid for savings accounts and 59 basis points in the
average rate paid on time deposits less than $100. These lower costs resulted in
reductions to interest expense of $1,032 and $860.
Partially offsetting the negative rate variance was a positive volume variance.
Earning assets averaged $472.4 million for the nine months ended September 30,
2003, an increase of $27.7 million from $444.7 million for the same period last
year. Average interest-bearing liabilities also increased but not to the same
extent. For the nine months ended September 30, 2003, interest-bearing
liabilities averaged $395.6 million, an increase of $20.9 million from $374.7
million for the same period of 2002. This positive volume variance caused an
increase in net interest income of $1,424. The majority of the positive volume
variance was due to a $26.3 million increase in average loans, which caused
tax-equivalent net interest income to increase by $1,888.
For the quarter ended September 30, 2003, tax-equivalent interest income
increased by $11 in comparison to the same three months of last year. A positive
volume variance of $192 was almost entirely offset by a $181 negative rate
variance. Earning assets averaged $31.7 million higher for the third quarter of
2003, compared to the same quarter of 2002. Loans, net of unearned income
increased $38.5 million, while investment securities averaged $11.8 million
higher. Partially offsetting the increases in loans and investments was an $18.6
million reduction in average federal funds sold. The growth in average earning
assets added $279 to tax-equivalent interest revenue. Average interest bearing
liabilities also increased, but not to the extent of average earning assets. For
the third quarter, interest-bearing liabilities averaged $402.8 million in 2003,
an increase of $21.6 million compared to $381.2 million in 2002, which resulted
in additional interest expense of $87. With regard to the negative rate
variance, the tax-equivalent yield on earning assets fell 85 basis points to
5.69 percent for the three months ended September 30, 2003, from 6.64 percent
for the same period of 2002 and reduced tax-equivalent interest income by $912.
The tax-equivalent yield on loans fell 85 basis points, while the tax-equivalent
yield on investments fell 239 basis points. The
36
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
yield on federal funds sold declined 71 basis points. Partially mitigating the
effects of the decline in the tax-equivalent yield on earning assets was an 80
basis point reduction in the cost of funds. For the third quarter of 2003, the
cost of funds equaled 2.36 percent compared to 3.16 percent for the same quarter
of 2002. This reduced interest expense by $731 in the third quarter.
Maintenance of an adequate net interest margin is one of our primary concerns.
We experienced some margin contraction during the nine months ended September
30, 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 35 basis points to 3.82 percent
for the nine months ended September 30, 2003, from 4.17 percent for the same
nine months of 2002. Due to the lack of inflationary pressures during the early
stages of economic recovery, the low interest rate environment is expected to
continue throughout the remainder of 2003 and into 2004. However, should
inflationary pressures begin to escalate 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.
37
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
The average balances of assets and liabilities, corresponding interest income
and expense and resulting average yields or rates paid for the nine months ended
September 30, 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
SEPTEMBER 30, 2003 SEPTEMBER 30, 2002
--------------------------- ---------------------------
INTEREST AVERAGE INTEREST AVERAGE
AVERAGE INCOME/ INTEREST AVERAGE INCOME/ INTEREST
BALANCE EXPENSE RATE BALANCE EXPENSE RATE
------- ------- -------- ------- ------- --------
ASSETS:
Earning assets:
Loans:
Taxable..................................... $321,791 $16,781 6.97% $302,738 $17,137 7.57%
Tax-exempt.................................. 20,810 875 5.62 13,562 791 7.80
Investments:
Taxable..................................... 78,340 1,519 2.59 69,264 2,825 5.45
Tax-exempt.................................. 32,349 1,807 7.47 39,193 2,205 7.52
Federal funds sold............................ 19,120 163 1.14 19,951 255 1.71
-------- ------- -------- -------
Total earning assets...................... 472,410 21,145 5.98% 444,708 23,213 6.98%
Less: allowance for loan losses............... 3,720 3,426
Other assets.................................. 30,945 27,953
-------- --------
Total assets.............................. $499,635 $469,235
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY:
Interest-bearing liabilities:
Money market accounts......................... $ 15,739 130 1.10% $ 18,949 302 2.13%
NOW accounts.................................. 38,553 272 0.94 37,944 412 1.45
Savings accounts.............................. 126,837 1,077 1.14 103,417 1,535 1.98
Time deposits less than $100.................. 187,191 5,492 3.92 185,421 6,255 4.51
Time deposits $100 or more.................... 27,269 675 3.31 28,921 823 3.80
Short-term borrowings......................... 11
-------- ------- -------- -------
Total interest-bearing liabilities........ 395,589 7,646 2.58% 374,663 9,327 3.33%
Noninterest-bearing deposits.................. 55,042 48,480
Other liabilities............................. 3,229 3,339
Stockholders' equity.......................... 45,775 42,753
-------- --------
Total liabilities and stockholders' equity $499,635 $469,235
======== ------- ======== -------
Net interest/income spread................ $13,499 3.40% $13,886 3.65%
======= =======
Net interest margin....................... 3.82% 4.17%
Tax equivalent adjustments:
Loans......................................... $ 298 $ 269
Investments................................... 614 750
------- -------
Total adjustments......................... $ 912 $ 1,019
======= =======
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 $3,395 and
$2,165 for the nine months ended September 30, 2003 and 2002 included
in other assets. Tax-equivalent adjustments were calculated using the
prevailing statutory tax rate of 34.0 percent.
38
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
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 $360 for the nine months ended September
30, 2003, compared to $935 for the same nine months of 2002. For the third
quarter, the provision for loan losses was $120 in 2003 and $195 in 2002.
NONINTEREST INCOME:
Noninterest income increased $239 or 8.3 percent to $3,106 for the nine months
ended September 30, 2003, from $2,867 for the same nine months of last year. For
the third quarter, noninterest income improved $42 or 4.3 percent to $1,030
compared to $988 for the same quarter of 2002. The increases for both the
nine-month period and current quarter resulted primarily from greater gains on
the sale of residential mortgages partially offset by reductions in service
charges, fees and commissions. Gains on the sale of residential mortgages rose
$448 or 79.3 percent year-to-date and $120 or 57.7 percent for the third quarter
when comparing 2003 and 2002. Service charges, fees and commissions declined
$123 or 5.6 percent and $61 or 8.0 percent when comparing the nine-month and
three-month periods ended September 30, 2003 and 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,
39
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
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.
Major components of noninterest expense for the three months and nine months
ended September 30, 2003 and 2002, are summarized as follows:
NONINTEREST EXPENSES
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2003 2002 2003 2002
------------------ -----------------
SALARIES AND EMPLOYEE BENEFITS EXPENSE:
Salaries and payroll taxes..................... $1,510 $1,421 $ 4,368 $ 4,172
Employee benefits.............................. 349 300 960 820
------ ------ ------- -------
Salaries and employee benefits expense....... 1,859 1,721 5,328 4,992
------ ------ ------- -------
NET OCCUPANCY AND EQUIPMENT EXPENSE:
Net occupancy expense.......................... 227 205 735 624
Equipment expense.............................. 331 253 911 735
------ ------ ------- -------
Net occupancy and equipment expense.......... 558 458 1,646 1,359
------ ------ ------- -------
OTHER EXPENSES:
Marketing expense.............................. 109 153 310 364
Other taxes.................................... 113 103 340 293
Stationery and supplies........................ 103 113 282 361
Contractual services........................... 434 373 1,208 1,083
Insurance including FDIC assessment............ 54 49 151 143
Other.......................................... 509 458 1,477 1,421
------ ------ ------- -------
Other expenses............................... 1,322 1,249 3,768 3,665
------ ------ ------- -------
Total noninterest expense.................. $3,739 $3,428 $10,742 $10,016
====== ====== ======= =======
Noninterest expense for the nine months ended September 30, 2003, increased $726
or 7.2 percent to $10,742 compared to $10,016 for same nine months of last year.
For the third quarter, noninterest expense increased $311 or 9.1 percent to
$3,739 from $3,428 when comparing 2003 and 2002. Increases in all three major
categories of expenses contributed to the overall rise in noninterest expense
over the prior year. 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 68.5 percent for the nine months
ended September 30, 2003, from 63.7 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 nine months ended September 30, 2003 and 2002.
40
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 $5,328 for the nine months ended September 30,
2003, an increase of $336 or 6.7 percent from $4,992 for the same period of
2002. For the third quarter, employee related expenses totaled $1,859 in 2003,
an increase of $138 compared to 2002. New staff and training required for the
anticipated opening of the Tannersville Office in the fourth quarter and
personnel added as part of restructuring the lending division were responsible
for the higher third quarter employee-related costs. Also factoring into the
rise in salaries and employee benefits expense year-to-date were additional
staffing needs relative to recent branch openings in the later part of 2002,
health insurance rate increases and merit increases related to personnel
performance appraisals.
Net occupancy and equipment expense rose $287 to $1,646 for the nine months
ended September 30, 2003, from $1,359 for the same nine months of last year. For
the three months ended September 30, 2003 and 2002, net occupancy and equipment
expenses amounted to $558 and $458, an increase of $100 or 21.8 percent.
Additional expenses associated with the operation of two new offices, the
relocation of our Clifford office and the installation of a document imaging
system factored into the increase in occupancy and equipment costs.
Other expenses increased $103 to $3,768 for the nine months ended September 30,
2003, from $3,665 for the same nine months of the prior year. For the quarter
ended September 30, other expenses totaled $1,322 in 2003 and $1,249 in 2002.
Other expenses were impacted by higher contractual services relative to
increased activity in the secondary mortgage division and increased state shares
tax, partially offset by reductions in marketing costs, stationery and supply
costs and other real estate expense.
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 September 30, 2003, and will be exempt from paying a BIF
assessment for the remainder 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 third quarter of 2003 at
41
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
$0.0162 per 100 dollars of BIF-assessable deposits. Our assessments totaled $53
and $55 for the nine months ended September 30, 2003 and 2002.
INCOME TAXES:
For the nine months ended September 30, 2003, income tax expense totaled $961
and resulted in an effective tax rate of 20.9 percent. For the same period of
2002, income tax expense was $973 with an effective tax rate of 20.3 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 nine months ended September 30, 2003, compared to
8.9 percent for the same period of 2002. Our effective tax rate is more
favorable in comparison to that of our peer group. For the nine months ended
September 30, 2003 and 2002, the peer group posted effective tax rates of 27.5
percent and 25.5 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.
42
COMM BANCORP, INC.
CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES:
Within the 90-day period prior to the filing date of this report, our Chief
Executive Officer ("CEO") and Chief Financial Officer ("CFO") carried out an
evaluation of the effectiveness of the design and operation of our disclosure
controls and procedures pursuant to Rule 13a-14 of the Securities Exchange Act
of 1934 (the "Exchange Act"). Based upon their evaluation, the CEO and CFO
concluded that our disclosure controls and procedures were adequate and
effective and designed to ensure that material information related to us and our
consolidated subsidiaries would be made known to them by others within those
entities.
CHANGES IN INTERNAL CONTROLS:
There were no significant changes in our internal controls or in other factors
that could significantly affect these controls subsequent to the date of the
evaluation referred to above.
43
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
NONE
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 July 21, 2003, the Company filed a report on
Form 8-K, to disclose its results of operations for the
three months ended June 30, 2003.
44
COMM BANCORP, INC.
FORM 10-Q
SIGNATURE PAGE
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto, duly authorized.
Registrant, Comm Bancorp, Inc.
Date: November 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: November 12, 2003 /s/ Scott A. Seasock
-----------------------------------------
Scott A. Seasock
Executive Vice President and
Chief Financial Officer
(Principal Financial Officer)
Date: November 12, 2003 /s/ Stephanie A. Ganz
-----------------------------------------
Stephanie A. Ganz
Vice President of Finance
(Principal Accounting Officer)
45
EXHIBIT INDEX
ITEM NUMBER DESCRIPTION PAGE
- ----------- ----------- ----
31.1 Certification of Chief Executive Officer
pursuant to Section 302 of the Sarbanes-
Oxley Act of 2002. 47
31.2 Certification of Chief Financial Officer
pursuant to Section 302 of the Sarbanes-
Oxley Act of 2002. 49
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. 51
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. 52
46