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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended MARCH 31, 2004
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 NORTH STATE STREET, CLARKS SUMMIT, PA 18411
- ----------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
(570) 586-0377
- --------------------------------------------------------------------------------
(Registrant's telephone number, including area code)
- --------------------------------------------------------------------------------
(Former name, former address and former fiscal year, if changed since
last report.)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding twelve months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate by checkmark whether the registrant is an accelerated filer (as defined
in Rule 12b-2 of the Act). Yes [ ] No [X]
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: 1,902,151 at May 11, 2004.
Page 1 of 50
Exhibit Index on Page 44
COMM BANCORP, INC.
FORM 10-Q
MARCH 31, 2004
INDEX
CONTENTS PAGE NO.
- -------- --------
PART I. FINANCIAL INFORMATION:
Item 1: Financial Statements.
Consolidated Statements of Income and Comprehensive Income -
for the Three Months Ended March 31, 2004 and 2003......... 3
Consolidated Balance Sheets - March 31, 2004, and December
31, 2003................................................... 4
Consolidated Statement of Changes in Stockholders' Equity
for the Three Months Ended March 31, 2004.................. 5
Consolidated Statements of Cash Flows for the Three Months
Ended March 31, 2004 and 2003.............................. 6
Notes to Consolidated Financial Statements.................. 7
Item 2: Management's Discussion and Analysis of Financial
Condition and Results of Operations................... 8
Item 3: Quantitative and Qualitative Disclosures About Market
Risk.................................................. *
Item 4: Controls and Procedures................................ 40
PART II. OTHER INFORMATION:
Item 1: Legal Proceedings...................................... 41
Item 2: Changes in Securities and Use of Proceeds and Issuer
Purchases of Equity Securities......................... 41
Item 3: Defaults Upon Senior Securities........................ 41
Item 4: Submission of Matters to a Vote of Security Holders.... 41
Item 5: Other Information...................................... 41
Item 6: Exhibits and Reports on Form 8-K....................... 41
Signatures..................................................... 43
Exhibit Index.................................................. 44
* Not Applicable
2
COMM BANCORP, INC.
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
FOR THE THREE MONTHS ENDED MARCH 31 2004 2003
----------- -----------
INTEREST INCOME:
Interest and fees on loans:
Taxable ................................................................... $ 5,289 $ 5,552
Tax-exempt ................................................................ 205 191
Interest and dividends on investment
securities available-for-sale:
Taxable ................................................................... 535 658
Tax-exempt ................................................................ 393 400
Dividends ................................................................. 10 14
Interest on federal funds sold .............................................. 16 28
----------- -----------
Total interest income ................................................... 6,448 6,843
----------- -----------
INTEREST EXPENSE:
Interest on deposits ........................................................ 2,238 2,672
----------- -----------
Total interest expense .................................................. 2,238 2,672
----------- -----------
Net interest income ..................................................... 4,210 4,171
Provision for loan losses ................................................... 150 120
----------- -----------
Net interest income after provision for loan losses ..................... 4,060 4,051
----------- -----------
NONINTEREST INCOME:
Service charges, fees and commissions ....................................... 726 696
Net gains on sale of loans .................................................. 196 390
----------- -----------
Total noninterest income ................................................ 922 1,086
----------- -----------
NONINTEREST EXPENSE:
Salaries and employee benefits expense ...................................... 1,726 1,696
Net occupancy and equipment expense ......................................... 664 540
Other expenses .............................................................. 1,237 1,189
----------- -----------
Total noninterest expense ................................................... 3,627 3,425
----------- -----------
Income before income taxes .................................................. 1,355 1,712
Provision for income tax expense ............................................ 175 382
----------- -----------
Net income .............................................................. 1,180 1,330
----------- -----------
OTHER COMPREHENSIVE INCOME (LOSS):
Unrealized holding gains (losses) on investment securities available-for-sale 550 (236)
Income tax expense (benefit) related to other comprehensive income (loss) ... 187 (80)
----------- -----------
Other comprehensive income (loss), net of income taxes .................. 363 (156)
----------- -----------
Comprehensive income .................................................... $ 1,543 $ 1,174
=========== ===========
PER SHARE DATA:
Net income .................................................................. $ 0.62 $ 0.68
Cash dividends declared ..................................................... $ 0.22 $ 0.22
Average common shares outstanding ........................................... 1,907,573 1,946,217
See Notes to Consolidated Financial Statements.
3
COMM BANCORP, INC.
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
MARCH 31, DECEMBER 31,
2004 2003
--------- ------------
ASSETS:
Cash and due from banks ............................................................ $ 9,121 $ 17,099
Federal funds sold ................................................................. 9,750 11,500
Investment securities available-for-sale ........................................... 101,982 105,248
Loans held-for-sale, net ........................................................... 4,062 3,205
Loans, net of unearned income ...................................................... 365,280 357,940
Less: allowance for loan losses .................................................. 3,652 3,584
--------- ------------
Net loans .......................................................................... 361,628 354,356
Premises and equipment, net ........................................................ 12,361 12,484
Accrued interest receivable ........................................................ 2,170 2,229
Other assets ....................................................................... 3,556 3,331
--------- ------------
Total assets ................................................................... $ 504,630 $ 509,452
========= ============
LIABILITIES:
Deposits:
Noninterest-bearing .............................................................. $ 58,296 $ 59,119
Interest-bearing ................................................................. 395,071 400,347
--------- ------------
Total deposits ................................................................. 453,367 459,466
Accrued interest payable ........................................................... 1,108 1,143
Other liabilities .................................................................. 2,461 2,302
--------- ------------
Total liabilities .............................................................. 456,936 462,911
--------- ------------
STOCKHOLDERS' EQUITY:
Common stock, par value $0.33, authorized 12,000,000 shares, issued and outstanding:
March 31, 2004, 1,907,377 shares; December 31, 2003, 1,906,528 shares ............. 629 629
Capital surplus .................................................................... 6,637 6,576
Retained earnings .................................................................. 37,952 37,223
Accumulated other comprehensive income ............................................. 2,476 2,113
--------- ------------
Total stockholders' equity ..................................................... 47,694 46,541
--------- ------------
Total liabilities and stockholders' equity ..................................... $ 504,630 $ 509,452
========= ============
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, 2003........................ $ 629 $ 6,576 $ 37,223 $ 2,113 $ 46,541
Net income........................................ 1,180 1,180
Dividends declared: $0.22 per share............... (420) (420)
Dividend reinvestment plan: 1,699 shares issued... 63 63
Repurchase and retirement: 850 shares............. (2) (31) (33)
Net change in other comprehensive income.......... 363 363
------ ------- -------- ------------- -------------
BALANCE, MARCH 31, 2004........................... $ 629 $ 6,637 $ 37,952 $ 2,476 $ 47,694
====== ======= ======== ============= =============
See Notes to Consolidated Financial Statements.
5
COMM BANCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
FOR THE THREE MONTHS ENDED MARCH 31 2004 2003
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income ............................................................ $ 1,180 $ 1,330
Adjustments:
Provision for loan losses ........................................... 150 120
Depreciation, amortization and accretion ............................ 633 910
Amortization of loan fees ........................................... (26) (41)
Deferred income tax benefit ......................................... (11) (18)
Loss on disposition of equipment .................................... 17
Losses on sale of foreclosed assets ................................. 2 14
Changes in:
Loans held for sale, net .......................................... (857) 153
Accrued interest receivable ....................................... 59 (27)
Other assets ...................................................... (367) 164
Accrued interest payable .......................................... (35) (46)
Other liabilities ................................................. (22) (219)
-------- --------
Net cash provided by operating activities ....................... 706 2,357
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from repayments of investment securities available-for-sale .. 3,986 14,210
Purchases of investment securities available-for-sale ................. (410) (5,770)
Proceeds from sale of foreclosed assets ............................... 140 26
Net increase in lending activities .................................... (7,459) (4,685)
Purchases of premises and equipment ................................... (203) (305)
-------- --------
Net cash provided by (used in) investing activities ............. (3,946) 3,476
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net changes in:
Money market, NOW, savings and noninterest-bearing accounts ......... (6,811) (217)
Time deposits ....................................................... 712 4,298
Proceeds from the issuance of common shares ........................... 63 53
Repurchase and retirement of common shares ............................ (33) (10)
Cash dividends paid ................................................... (419) (408)
-------- --------
Net cash provided by (used in) financing activities ............. (6,488) 3,716
-------- --------
Net increase (decrease) in cash and cash equivalents ............ (9,728) 9,549
Cash and cash equivalents at beginning of year .................. 28,599 21,383
-------- --------
Cash and cash equivalents at end of period ...................... $ 18,871 $ 30,932
======== ========
SUPPLEMENTAL DISCLOSURES:
Cash paid during the period for:
Interest ............................................................ $ 2,273 $ 2,718
Noncash items:
Transfers of loans to foreclosed assets ............................. 63 202
Unrealized losses (gains) on investment securities available-for-sale $ (363) $ 156
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 & 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, 2003.
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.
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 improve, assurance cannot be given that this improvement will
occur. Further 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.
8
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
The larger size of these companies affords them the opportunity to offer some
specialized 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.
CRITICAL ACCOUNTING POLICIES:
Our financial statements are prepared in accordance with accounting principles
generally accepted in the United States of America ("GAAP"). The preparation of
financial statements in conformity with GAAP requires management to establish
critical accounting policies and make accounting estimates and assumptions that
affect the reported amounts of assets and liabilities at the date of the
financial statements, as well as the reported amounts of revenues and expenses
during the reporting periods.
An accounting estimate requires assumptions about uncertain matters that could
have a material effect on the financial statements if a different amount within
a range of estimates were used or if estimates changed from period to period.
Readers of this report should understand that estimates are made considering
facts and circumstances at a point in time, and changes in those facts and
circumstances could produce results that differ from when those estimates were
made. Significant estimates that are particularly susceptible to material change
in the next year relate to the allowance for loan losses, fair value of
financial instruments and the valuations of real estate acquired through
foreclosure and intangible assets. Actual amounts could differ from those
estimates.
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 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.
The allowance for loan losses account consists of an allocated element and an
unallocated element. The allocated element consists of a specific portion for
the impairment of loans individually evaluated and a formula portion for the
impairment of those loans collectively evaluated. The unallocated element is
used to cover inherent losses that exist as of the evaluation date, but which
have not been identified as part of the allocated allowance using the above
impairment evaluation methodology due to limitations in the process.
9
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
Management monitors the adequacy of the allocated portion of the allowance
quarterly and adjusts the allowance for any deficiencies through normal
operations. This self-correcting mechanism reduces potential differences between
estimates and actual observed losses. In addition, the unallocated portion of
the allowance is examined quarterly to ensure that it remains relatively
constant in relation to the total allowance unless there are changes in the
related criteria that would indicate a need to either increase or decrease it.
The determination of the allowance for loan loss level is inherently subjective
as it requires estimates that are susceptible to significant revision as more
information becomes available. Accordingly, management cannot ensure that
charge-offs in future periods will not exceed the allowance for loan losses or
that additional increases in the allowance for loan losses will not be required
resulting in an adverse impact on operating results.
Fair values of financial instruments, in cases where quoted market prices are
not available, are based on estimates using present value or other valuation
techniques which are subject to change.
Real estate acquired in connection with foreclosures or in satisfaction of loans
is written-down to the lower of the related loan balance or 80.0 percent of fair
market value for residential properties or 75.0 percent of fair market value for
commercial properties based upon estimates derived through independent
appraisals. However, proceeds realized from sales may ultimately be higher or
lower than those estimates.
Intangible assets include goodwill and a core deposit intangible. We evaluate
goodwill for impairment at least annually and we evaluate the useful life of the
core deposit each reporting period in order to determine if it should be
adjusted.
For a further discussion of our significant account policies, refer to the note
entitled, "Summary of significant accounting policies," in the Notes to
Consolidated Financial Statements to our Annual Report on Form 10-K for the
period ended December 31, 2003. This note lists the significant accounting
policies used by management in the development and presentation of our financial
statements. This Management's Discussion and Analysis, The Notes to the
Consolidated Financial Statements, and other financial statement disclosures
identify and address key variables and other qualitative and quantitative
factors that are necessary for the understanding and valuation of our financial
position, results of operations and cash flows.
10
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
OPERATING ENVIRONMENT:
The United States economy grew at a 4.2 percent annual rate in the first quarter
of 2004. Business investment rose 11.4 percent, the third straight quarter of
double-digit growth, and personal consumption grew 3.8 percent. In addition,
consumer confidence surged in April amid a positive outlook for the job market.
However, inflationary pressures appear to be building. Producer prices climbed
0.5 percent in March 2004 and, despite a 3.9 percent increase in productivity,
labor costs rose 1.1 percent in the first quarter, a 3.8 percent increase from
one year ago. The Federal Open Market Committee ("FOMC") left short-term
interest rates unchanged at the historic low of 1.00 percent during the first
quarter. However, Federal Reserve Chairman, Alan Greenspan, indicated in his
address to a congressional committee on April 21, 2004, that the FOMC was
prepared to raise short-term interest rates later in the year to prevent price
inflation.
REVIEW OF FINANCIAL POSITION:
Total assets decreased $4.8 million to $504.6 million at March 31, 2004, from
$509.4 million at December 31, 2003. The change resulted primarily from a
reduction of $6.1 million in total deposits to $453.4 million at the end of the
first quarter of 2004. Loans, net of unearned income grew $7.4 million to $365.3
million at March 31, 2004, from $357.9 million at year-end 2003. Investment
securities available-for-sale decreased $3.2 million to $102.0 million at the
end of the first quarter of 2004, from $105.2 million at December 31, 2003.
Federal funds sold outstanding at March 31, 2004, were $9.7 million, compared to
$11.5 million at the end of 2003. Stockholders' equity grew $1.2 million to
$47.7 million at the close of the first quarter, from $46.5 million at December
31, 2003. Net income and other comprehensive income of $1.2 million and $0.4
million, partially offset by net cash dividends declared of $0.4 million,
primarily caused the improvement in equity.
INVESTMENT PORTFOLIO:
Our investments are predominantly comprised of mortgage-backed securities
including, short-term collateralized mortgage obligations ("CMOs") of U.S.
Government-sponsored agencies, and intermediate-term, tax-exempt obligations of
states and municipalities. We utilize the cash flows from repayments of
mortgage-backed securities to fund future loan demand and the tax-exempt
obligations of states and municipalities to assist us in lowering our tax
burden. Mortgage-backed securities totaled $31.6 million and represented 31.0
percent of the investment portfolio at March 31, 2004,
11
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
while tax-exempt state and municipal obligations were $35.4 million and
represented 34.7 percent of the investment portfolio. Due to intense loan demand
our investment portfolio played a less prominent role in our earning asset mix.
In total, investments declined $3.2 million to $102.0 million at March 31, 2004,
from $105.2 million at December 31, 2003, as repayments were directed to the
loan portfolio. The investment portfolio represented 21.2 percent of earning
assets at March 31, 2004, compared to 22.0 percent at December 31, 2003 and 24.7
percent one year ago.
The carrying values of the major classifications of available-for-sale
securities as they relate to the total investment portfolio at March 31, 2004,
and December 31, 2003, are summarized as follows:
DISTRIBUTION OF INVESTMENT SECURITIES
MARCH 31, DECEMBER 31,
2004 2003
AMOUNT % AMOUNT %
-------- -------- -------- --------
U.S. Government agencies ................................ $ 16,382 16.06% $ 16,377 15.56%
State and municipals:
Taxable ............................................... 17,158 16.83 17,051 16.20
Tax-exempt ............................................ 35,350 34.66 34,788 33.05
Mortgage-backed securities .............................. 31,632 31.02 35,099 33.35
Equity securities ....................................... 1,460 1.43 1,933 1.84
-------- -------- -------- --------
Total ............................................... $101,982 100.00% $105,248 100.00%
======== ======== ======== ========
For the three months ended March 31, 2004, the investment portfolio averaged
$99.9 million, a decrease of $18.0 million or 15.3 percent compared to an
average of $117.9 million for the same three months of 2003. The tax-equivalent
yield on our investment portfolio rose 19 basis points to 4.59 percent for the
first quarter of 2004 compared to 4.40 percent for the same quarter last year.
In addition to yield analysis, we utilize a total return approach to measure the
investment portfolio's 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 proceed
from repayments and capital gains and losses, whether realized or unrealized.
Total return for the investment portfolio improved to 6.8 percent for the 12
months ended March 31, 2004, from 3.3 percent for the 12 months ended December
31, 2003.
We had an unrealized holding gain of $2,476, net of income taxes of $1,276 at
March 31, 2004, which was an increase of $363, net of income taxes of $187, from
$2,113 at the end of 2003. The increase was predominantly related to
appreciation in the market values of our holdings of taxable and tax-exempt
state and municipal obligations.
12
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
The maturity distribution of the amortized cost, fair value and weighted-average
tax-equivalent yield of the available-for-sale portfolio at March 31, 2004, 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 prevailing statutory tax rate of 34.0 percent. The distributions are
based on contractual maturity with the exception of mortgage-backed securities,
CMOs and equity securities. Mortgage-backed securities and CMOs have been
presented based upon estimated cash flows, assuming no change in the current
interest rate environment. Equity securities with no stated contractual
maturities are included in the "After ten 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
---------------- ---------------- ---------------- ---------------- ----------------
MARCH 31, 2004 AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Amortized cost:
U.S. Government agencies..... $ 4,027 2.21% $ 12,242 2.00% $ 16,269 2.05%
State and municipals:
Taxable.................... 1,403 1.60 15,776 2.60 17,179 2.52
Tax-exempt................. 656 3.31 985 2.32 $ 8,248 7.85% $ 22,451 7.59% 32,340 7.41
Mortgage-backed securities... 11,716 5.10 18,905 4.32 392 6.79 86 6.92 31,099 4.65
Equity securities............ 1,343 2.97 1,343 2.97
-------- -------- -------- -------- --------
Total.................... $ 17,802 4.10% $ 47,908 3.12% $ 8,640 7.80% $ 23,880 7.33% $ 98,230 4.73%
======== ======== ======== ======== ========
Fair value:
U.S. Government agencies..... $ 4,051 $ 12,331 $ 16,382
State and municipals:
Taxable.................... 1,403 15,755 17,158
Tax-exempt................. 665 1,006 $ 9,123 $ 24,556 35,350
Mortgage-backed securities... 11,882 19,249 411 90 31,632
Equity securities............ 1,460 1,460
-------- -------- -------- -------- --------
Total.................... $ 18,001 $ 48,341 $ 9,534 $ 26,106 $101,982
======== ======== ======== ======== ========
LOAN PORTFOLIO:
Mortgage rates remained at historical low levels. The rate on a 30-year
conventional mortgage fell 43 basis points to 5.45 percent at March 31, 2004,
from 5.88 percent at year-end 2003. The historically low rates kept the housing
market strong for the first quarter. Average annual sales of existing homes
increased 9.4 percent, while average new home sales rose 13.8 percent when
comparing the 12 months ended March 31, 2004 and 2003. In addition, strong
demand was reflected by an 8.8 percent increase in the
13
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
median price of existing homes in March 2004 compared to one year ago. Activity
in our secondary mortgage department, although still strong, appears to be
slowing from the intense pace experienced in the prior two years. Much of the
activity in recent periods was due to refinancings which have slowed.
Residential mortgage loans serviced for the Federal National Mortgage
Association ("FNMA") grew $3.8 million or at an annual rate of 17.0 percent to
$93.8 million at the end of the first quarter of 2004 from $90.0 million at the
end of 2003. In comparison, for the first quarter of 2003, residential mortgage
loans serviced for the FNMA grew at an annualized rate of 88.2 percent. For the
three months ended March 31, residential mortgages sold to the FNMA totaled $6.7
million in 2004 compared to $13.6 million in 2003. Net gains realized on the
sale of residential mortgages totaled $196 for the first quarter of 2004,
compared to $390 for the same quarter last year.
Despite the 11.4 percent increase in business investment, commercial and
industrial loans at all commercial banks decreased at an annualized rate of 4.3
percent by the end of the first quarter. Contrary to the banking industry, we
continued to experience strong demand for our commercial loan products. Our
business loans, including commercial loans, commercial mortgage loans and lease
financing grew $13.9 million or at an annualized rate of 24.9 percent to $238.0
million at March 31, 2004 from $224.1 million at the end of 2003. As previously
mentioned the majority of residential mortgage loans originated are subsequently
sold in the secondary market. As a result, residential mortgage loans, including
construction loans, decreased $5.6 million or 5.7 percent to $98.5 million at
the end of the first quarter of 2004 from $104.1 million at year-end 2003.
Manufacturers continued to offer attractive financing alternatives to consumers
for the purchase of automobiles and other durable goods. As a result, our
consumer loans decreased $0.8 million or 2.6 percent.
For the first quarter of 2004, loans averaged $368.1 million, an increase of
$35.5 million or 10.7 percent compared to $332.6 million for the same period of
2003. The tax-equivalent yield on the loan portfolio declined 100 basis points
to 6.12 percent for the first quarter of 2004, from 7.12 percent for the same
quarter of 2003. Interest rates are expected to remain low before increasing
towards the end of 2004, as a result we anticipate our loan yields to remain low
for much of the year.
14
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
The composition of the loan portfolio at March 31, 2004, and December 31, 2003,
is summarized as follows:
DISTRIBUTION OF LOAN PORTFOLIO
MARCH 31, DECEMBER 31,
2004 2003
AMOUNT % AMOUNT %
----------- ----------- ----------- -----------
Commercial, financial and others .. $ 107,939 29.55% $ 100,723 28.14%
Real estate:
Construction .................... 3,484 0.95 2,983 0.83
Mortgage ........................ 222,533 60.92 222,621 62.20
Consumer, net ..................... 28,968 7.93 29,726 8.30
Lease financing, net .............. 2,356 0.65 1,887 0.53
----------- ----------- ----------- -----------
Loans, net of unearned income ... 365,280 100.00% 357,940 100.00%
=========== ===========
Less: allowance for loan losses ... 3,652 3,584
----------- -----------
Net loans ..................... $ 361,628 $ 354,356
=========== ===========
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 loan products to increase our holdings of
adjustable-rate loans and reduce the average term of fixed-rate loans.
Approximately 42.0 percent of the lending portfolio is expected to reprice
within the next 12 months.
The maturity and repricing information of the loan portfolio by major
classification at March 31, 2004, is summarized as follows:
MATURITY DISTRIBUTION AND INTEREST SENSITIVITY OF LOAN PORTFOLIO
AFTER ONE
WITHIN BUT WITHIN AFTER
MARCH 31, 2004 ONE YEAR FIVE YEARS FIVE YEARS TOTAL
-------- ---------- ---------- --------
Maturity schedule:
Commercial, financial and others........... $ 55,986 $ 24,353 $ 27,600 $107,939
Real estate:
Construction............................. 3,484 3,484
Mortgage................................. 22,591 79,630 120,312 222,533
Consumer, net.............................. 11,015 15,201 2,752 28,968
Lease financing, net....................... 863 1,493 2,356
-------- ---------- ---------- --------
Total.................................. $ 93,939 $ 120,677 $ 150,664 $365,280
======== ========== ========== ========
Repricing schedule:
Predetermined interest rates............... $ 44,471 $ 64,727 $ 54,304 $163,502
Floating or adjustable interest rates 109,098 92,626 54 201,778
-------- ---------- ---------- --------
Total.................................. $153,569 $ 157,353 $ 54,358 $365,280
======== ========== ========== ========
15
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
In the normal course of business, we are also a party to financial instruments
with off-balance sheet risk to meet the financing needs of our customers. These
instruments include legally binding commitments to extend credit, unused
portions of home equity and credit card lines and commercial letters of credit,
and involve, to varying degrees, elements of credit risk and IRR in excess of
the amount recognized in the financial statements.
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Commercial letters of credit are conditional
commitments issued by us to support customers in the purchase of commercial
goods. These letters of credit are automatically renewable upon their
anniversary date unless canceled by us prior to that date.
The contractual amounts of off-balance sheet commitments at March 31, 2004 and
December 31, 2003, are summarized as follows:
MARCH 31, DECEMBER 31,
2004 2003
--------- ------------
Commitments to extend credit.................................... $ 45,491 $ 44,025
Unused portions of home equity and credit card lines............ 10,173 9,806
Commercial letters of credit.................................... 2,728 2,255
--------- ------------
Total......................................................... $ 58,392 $ 56,086
========= ============
These commitments are generally issued for one year or less and often expire
unused in whole or in part by the customer. We record an allowance for credit
losses, if deemed necessary, separately as a liability. No allowance was deemed
necessary at March 31, 2004 and December 31, 2003. We do not anticipate that
losses, if any, that may occur as a result of funding off-balance sheet
commitments, would have a material adverse effect on our operating results or
financial position.
ASSET QUALITY:
Our asset quality strengthened during the first quarter of 2004, as evidenced by
an improvement in the ratio of nonperforming assets as a percentage of loans,
net of unearned income, to 0.49 percent at March 31, 2004 from 0.67 percent at
December 31, 2003. Nonperforming assets were $1,801 at the end of the first
quarter of 2004, a decrease of $606 or 25.2 percent from year-end 2003. The
improved asset quality position resulted primarily from a reduction in the
amount of loans past due 90 days or more and still accruing.
Accruing loans past due 90 days or more decreased $449 to $251 at March 31,
2004, from $700 at December 31, 2003. The amount of commercial, real estate
16
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
and consumer loans, as well as lease financing, in this category decreased from
year-end. Nonaccrual loans at the end of the first quarter of 2004 were $1,368,
a decrease of $78 from $1,446 at the end of 2003. Foreclosed assets decreased
$79 to $182 at March 31, 2004, from $261 at the end of 2003. One loan of $63 was
transferred to foreclosed assets during the first quarter and two properties
with an aggregate carrying value of $140 were sold for $138, resulting in a
realized loss of $2.
We anticipate the economic conditions in our local market area to remain stable
for the remainder of 2004. 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.
Information concerning nonperforming assets at March 31, 2004, and December 31,
2003, is summarized as follows. The table includes loans or other extensions of
credit classified for regulatory purposes and all material loans or other
extensions of credit that cause management to have serious doubts as to the
borrowers' ability to comply with present loan repayment terms.
DISTRIBUTION OF NONPERFORMING ASSETS
MARCH 31, DECEMBER 31,
2004 2003
------------ ------------
NONACCRUAL LOANS:
Commercial, financial and others ........................... $ 333 $ 306
Real estate:
Construction
Mortgage ................................................. 995 1,077
Consumer, net .............................................. 40 63
Lease financing, net
------------ ------------
Total nonaccrual loans ................................. 1,368 1,446
------------ ------------
ACCRUING LOANS PAST DUE 90 DAYS OR MORE:
Commercial, financial and others ........................... 17 124
Real estate:
Construction
Mortgage ................................................. 122 352
Consumer, net .............................................. 112 151
Lease financing, net ....................................... 73
------------ ------------
Total accruing loans past due 90 days or more .......... 251 700
------------ ------------
Total nonperforming loans .............................. 1,619 2,146
------------ ------------
Foreclosed assets .......................................... 182 261
------------ ------------
Total nonperforming assets ............................. $ 1,801 $ 2,407
============ ============
Ratios:
Nonperforming loans as a percentage of loans, net .......... 0.44% 0.60%
Nonperforming assets as a percentage of loans, net ......... 0.49% 0.67%
17
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
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 Interagency Policy Statement
and GAAP in assessing the adequacy of the allowance account. Under GAAP, the
adequacy of the allowance account is determined based on the provisions of
Statement of Financial Accounting Standards ("SFAS") No. 114, "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 March 31, 2004, and December 31, 2003,
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
MARCH 31, DECEMBER 31,
2004 2003
------------ ------------
NONACCRUAL LOANS:
Commercial, financial and others ........................... $ 333 $ 306
Real estate:
Construction
Mortgage ................................................. 995 1,077
Consumer, net .............................................. 40 63
Lease financing, net
------------ ------------
Total nonaccrual loans ................................. 1,368 1,446
------------ ------------
ACCRUING LOANS:
Commercial, financial and others ........................... 782
Real estate:
Construction
Mortgage ................................................. 182 207
Consumer, net .............................................. 64 1
Lease financing, net
------------ ------------
Total accruing loans ................................... 1,028 208
------------ ------------
Total impaired loans ................................... $ 2,396 $ 1,654
============ ============
Ratio:
Impaired loans as a percentage of loans, net ............... 0.66% 0.46%
Information relating to the recorded investment in impaired loans at March 31,
2004 and December 31, 2003, is summarized as follows:
MARCH 31, DECEMBER 31,
2004 2003
------------ ------------
Impaired loans:
With a related allowance ................................... $ 1,518 $ 747
With no related allowance .................................. 878 907
------------ ------------
Total .................................................... $ 2,396 $ 1,654
============ ============
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 quarter ended March 31, 2004, is summarized as follows:
MARCH 31,
2004
---------
Balance at January 1..................... $ 377
Provision for loan losses................ 210
Loans charged-off........................ 20
Loans recovered.......................... 3
---------
Balance at period-end.................... $ 570
=========
Interest income on impaired loans that would have been recognized had the loans
been current, 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 months ended March 31, 2004 and 2003, are
summarized as follows:
THREE MONTHS ENDED MARCH 31 2004 2003
- --------------------------- ------ ------
Gross interest due under terms................................. $ 29 $ 45
Interest income recognized..................................... 32 25
------ ------
Interest income not recognized................................. $ (3) $ 20
====== ======
Interest income recognized (cash-basis)........................ $ 32 $ 25
Average recorded investment in impaired loans.................. $1,673 $2,396
Cash received on impaired loans applied as a reduction of principal totaled $212
for the quarter ended March 31, 2004, and $140 for the same period of 2003.
There were no commitments to extend additional funds to such parties at March
31, 2004.
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 March 31, 2004 and December
31, 2003, is summarized as follows:
ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
MARCH 31, DECEMBER 31,
2004 2003
-------------------------- --------------------------
CATEGORY CATEGORY
AS A AS A
% OF % OF
AMOUNT LOANS AMOUNT LOANS
----------- ----------- ----------- -----------
Allocated allowance:
Specific:
Commercial, financial and others .. $ 381 0.31% $ 237 0.09%
Real estate:
Construction
Mortgage ........................ 142 0.32 124 0.36
Consumer, net ..................... 47 0.03 16 0.01
Lease financing, net
----------- ----------- ----------- -----------
Total specific ................ 570 0.66 377 0.46
----------- ----------- ----------- -----------
Formula:
Commercial, financial and others .. 237 29.24 237 28.05
Real estate:
Construction .................... 0.95 0.83
Mortgage ........................ 894 60.60 974 61.84
Consumer, net ..................... 304 7.90 316 8.29
Lease financing, net .............. 1 0.65 1 0.53
----------- ----------- ----------- -----------
Total formula ................. 1,436 99.34 1,528 99.54
----------- ----------- ----------- -----------
Total allocated allowance ..... 2,006 100.00% 1,905 100.00%
=========== ===========
Unallocated allowance ............. 1,646 1,679
----------- -----------
Total allowance for loan losses $ 3,652 $ 3,584
=========== ===========
The allocated element of the allowance for loan losses account was $2,006 at
March 31, 2004, an increase of $101 from $1,905 at December 31, 2003. The change
from year-end primarily resulted from a $193 increase in the specific portion of
the allowance for impairment of loans individually evaluated under SFAS No. 114,
partially offset by a $92 reduction in the formula portion of the allowance for
impairment of loans collectively evaluated under SFAS No. 5. The increase in the
specific portion primarily resulted from an increase in commercial and consumer
loans which are still accruing loans but have been identified as impaired with a
recorded investment in excess of fair value.
21
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
The unallocated portion of the allowance for loan losses remained relatively
stable at $1,646 at the end of the first quarter of 2004 compared to $1,679 at
year-end 2003. We believe the unallocated portion of the allowance for loan
losses account is substantiated based on the continued growth in the loan
portfolio, specifically concentrated in commercial credit, which inherently
carry greater risk of loss.
A reconciliation of the allowance for loan losses and illustration of
charge-offs and recoveries by major loan category for the quarter ended March
31, 2004, is summarized as follows:
RECONCILIATION OF ALLOWANCE FOR LOAN LOSSES
MARCH 31,
2004
---------
Allowance for loan losses at beginning of period............................... $3,584
Loans charged-off:
Commercial, financial and others............................................... 10
Real estate:
Construction.................................................................
Mortgage.....................................................................
Consumer, net.................................................................. 118
Lease financing, net...........................................................
------
Total...................................................................... 128
------
Loans recovered:
Commercial, financial and others............................................... 9
Real estate:
Construction.................................................................
Mortgage..................................................................... 7
Consumer, net.................................................................. 30
Lease financing, net...........................................................
------
Total...................................................................... 46
------
Net loans charged-off.......................................................... 82
------
Provision charged to operating expense......................................... 150
------
Allowance for loan losses at end of period..................................... $3,652
======
Ratios:
Net loans charged-off as a percentage of average loans outstanding............. 0.09%
Allowance for loan losses as a percentage of period end loans.................. 1.00%
The allowance for loan losses account as a percentage of loans, net of unearned
income equaled 1.00 percent at the end of the first quarter and at year-end
2003. A provision for loan losses of $150 exceeded net charge-offs of $82, which
resulted in the $68 increase in the allowance for loan losses
22
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
account. At March 31, 2004, the allowance for loan losses was $3,652 and covered
202.8 percent of nonperforming assets. In comparison, the allowance for loan
losses account equaled $3,584 and covered 148.9 percent of nonperforming assets
at December 31, 2003.
Past due loans not satisfied through repossession, foreclosure or related
actions, are evaluated individually to determine if all or part of the
outstanding balance should be charged against the allowance for loan losses
account. Any subsequent recoveries are credited to the allowance account. Net
charge-offs were $82 and $143 for the first three months of 2004 and 2003. As a
percentage of average loans outstanding, net charge-offs equaled 0.09 percent
and 0.17 percent for the first quarters of 2004 and 2003.
DEPOSITS:
Deposits totaled $453.4 million at March 31, 2004, a decrease of $6.1 million
from $459.5 million at December 31, 2003. Noninterest-bearing accounts decreased
$0.8 million, while interest-bearing accounts fell $5.3 million. The decline was
primarily caused by a decrease of $8.0 million in NOW accounts. These accounts
were primarily those of local area school districts and municipalities whose
withdrawal patterns are cyclical in nature due to the timing of tax receipts.
Strong deposit growth experienced in recent years due to an ailing economy and
volatile stock market has appeared to subside with economic growth, a boost in
consumer confidence and a rebound in the stock market. The balances of other
major deposit categories remained relatively stable at the end of the first
quarter of 2004 in comparison to year-end 2003.
The average amount of, and the rate paid on, the major classifications of
deposits for the quarters ended March 31, 2004 and 2003, are summarized as
follows:
DEPOSIT DISTRIBUTION
MARCH 31, MARCH 31,
2004 2003
----------------- ------------------
AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE RATE BALANCE RATE
-------- ------- -------- -------
Interest-bearing:
Money market accounts....................... $ 18,735 0.88% $ 16,882 1.27%
NOW accounts................................ 38,165 0.80 38,455 1.07
Savings accounts............................ 126,579 0.72 122,293 1.49
Time deposits less than $100................ 180,694 3.68 185,154 4.07
Time deposits $100 or more.................. 29,454 3.28 24,462 3.51
-------- --------
Total interest-bearing.................... 393,627 2.29% 387,246 2.80%
Noninterest-bearing......................... 58,812 49,721
-------- --------
Total deposits............................ $452,439 $436,967
======== ========
23
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
For the three months ended March 31, 2004, total deposits averaged $452.4
million, an increase of $15.4 million or 3.5 percent, from $437.0 million for
the same three months of last year. Average noninterest-bearing deposits grew
$9.1 million or 18.3 percent, while average interest-bearing deposits rose $6.3
million or 1.6 percent when comparing the first quarters of 2004 and 2003. The
growth in our interest-bearing accounts was concentrated in savings accounts and
large denomination time deposits which increased $4.3 million and $5.0 million.
Our cost of funds declined 51 basis points to 2.29 percent for the first quarter
of 2004 from 2.80 percent one year ago due to the sustained low interest rate
environment.
Volatile deposits, time deposits in denominations of $100 or more, increased
$0.3 million to $29.4 million at March 31, 2004, from $29.1 million at December
31, 2003. The average cost of these deposits for the first three months of 2004
was 3.28 percent, a decline of 23 basis points from 3.51 percent for the same
three months of last year.
Maturities of time deposits $100 or more at March 31, 2004, and December 31,
2003, are summarized as follows:
MATURITY DISTRIBUTION OF TIME DEPOSITS OF $100 OR MORE
MARCH 31, DECEMBER 31,
2004 2003
--------- ------------
Within three months....................................... $ 6,116 $ 4,414
After three months but within six months.................. 2,767 4,845
After six months but within twelve months................. 4,395 3,861
After twelve months....................................... 16,159 15,969
------- -------
Total........................................................ $29,437 $29,089
======= =======
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 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
24
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
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.
Bank regulations require us to develop and maintain an IRR management program,
overseen by the Board of Directors and senior management, that involves a
comprehensive risk management process in order to effectively identify, measure,
monitor and control risk. Should we have material weaknesses in our risk
management process or high exposure relative to its capital, bank regulatory
agencies will take action to remedy these shortcomings. Moreover, the level of
IRR exposure and the quality of our risk management process is a determining
factor when evaluating capital adequacy.
The Asset/Liability Committee ("ALCO"), comprised of members of our Board of
Directors, senior management and other appropriate officers, oversees our IRR
management program. Specifically, ALCO analyzes economic data and market
interest rate trends, as well as competitive pressures, and utilizes several
computerized modeling techniques to reveal potential exposure to IRR. This
allows us to monitor and attempt to control the influence these factors may have
on our rate sensitive assets ("RSA") and rate sensitive liabilities ("RSL"), and
overall operating results and financial position. One such technique utilizes a
static gap model that considers repricing frequencies of RSA and RSL in order to
monitor IRR. Gap analysis attempts to measure our interest rate exposure by
calculating the net amount of RSA and RSL that reprice within specific time
intervals. A positive gap occurs when the amount of RSA repricing in a specific
period is greater than the 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 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,
25
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
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
MARCH 31, 2004 THREE MONTHS TWELVE MONTHS FIVE YEARS FIVE YEARS TOTAL
-------------- ------------ ------------- ---------- ---------- -----
Rate sensitive assets:
Investment securities ............ $ 3,213 $ 14,788 $ 48,341 $ 35,640 $ 101,982
Loans held for sale, net ......... 4,062 4,062
Loans, net of unearned income .... 104,217 49,352 157,353 54,358 365,280
Federal funds sold ............... 9,750 9,750
-------------- -------------- -------------- -------------- --------------
Total .......................... $ 121,242 $ 64,140 $ 205,694 $ 89,998 $ 481,074
============== ============== ============== ============== ==============
Rate sensitive liabilities:
Money market accounts ............ $ 19,099 $ 19,099
NOW accounts ..................... 35,358 35,358
Savings accounts ................. $ 129,867 129,867
Time deposits less than $100 ..... $ 22,098 45,914 97,261 $ 16,037 181,310
Time deposits $100 or more ....... 6,116 7,162 13,996 2,163 29,437
-------------- -------------- -------------- -------------- --------------
Total .......................... $ 28,214 $ 107,533 $ 241,124 $ 18,200 $ 395,071
============== ============== ============== ============== ==============
Rate sensitivity gap:
Period ......................... $ 93,028 $ (43,393) $ (35,430) $ 71,798
Cumulative ..................... $ 93,028 $ 49,635 $ 14,205 $ 86,003 $ 86,003
RSA/RSL ratio:
Period ......................... 4.30 0.60 0.85 4.94
Cumulative ..................... 4.30 1.37 1.04 1.22 1.22
At March 31, 2004 and 2003, we had positive, cumulative one-year RSA/RSL ratios
of 1.37 and 1.23. As previously mentioned, this indicated that if interest rates
increase our earnings would likely be favorably impacted. Given the current low
interest rate environment, ALCO focused on maintaining this advantageous
position by monitoring and making certain the gap position between RSA and RSL
remained positive. Specifically, we predominantly offer commercial loans with
adjustable-rate terms that either reprice immediately or within one year. In
addition, we continued to offer promotional rates on our longer-term
certificates of deposit in an attempt to extend the average maturities of these
types of funds. Should interest rates increase, a greater amount of RSA would
reprice upward in the near term and at a faster pace than RSL, thereby
positively affecting net interest income. However, these forward-looking
statements are qualified in the aforementioned section entitled "Forward-Looking
Discussion" in this Management's Discussion and Analysis.
26
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
In comparison to the end of the first quarter of 2003, the increase in our ratio
resulted from a $5.1 million or 2.8 percent increase in RSA coupled with a $10.5
million or 7.2 percent decrease in RSL maturing or repricing within one year.
The increase in RSA primarily resulted from a $35.0 million increase in loans,
net of unearned income, partially offset by reductions of $21.3 million in
investment securities and $8.9 million in federal funds sold. The reduction in
RSL was primarily caused by a $9.9 million decrease in total time deposits
maturing or repricing within this time frame. Moreover, the amount of total time
deposits maturing or repricing within the "Due after five years" category
increased $10.2 million or 126.2 percent.
Our three-month ratio at March 31, 2004, increased as compared to one year
earlier. At the end of the first quarter of 2004 this ratio equaled 4.30 as
compared to 3.19 at March 31, 2003. The change in the three-month ratio can be
explained by reasons similar to those for the one-year ratio.
Static gap analysis, although a credible measuring tool, does not fully
illustrate the impact of interest rate changes on future earnings. First, market
rate changes normally do not equally or simultaneously affect all categories of
assets and liabilities. Second, assets and liabilities that can contractually
reprice within the same period may not do so at the same time or to the same
magnitude. Third, the interest rate sensitivity table presents a one-day
position, variations occur daily as we adjust our rate sensitivity throughout
the year. Finally, assumptions must be made in constructing such a table. For
example, the conservative nature of our Asset/Liability Management Policy
assigns money market and NOW accounts to the "Due after three but within twelve
months" repricing interval. In reality, these items may reprice less frequently
and in different magnitudes than changes in general interest rate levels.
As the static gap report fails to address the dynamic changes in the balance
sheet composition or prevailing interest rates, we utilize a simulation model to
enhance our asset/liability management. This model is used to create pro forma
net interest income scenarios under various interest rate shocks. Model results
at March 31, 2004, produced results that were contrary to those indicated by the
one-year static gap position. Specifically, given instantaneous and parallel
shifts in general market rates of plus 100 basis points, net interest income
should decrease 0.9 percent. Based on the historically low interest rate
environment, we chose not to create a pro forma net interest income scenario
given an instantaneous and parallel shift in general market rates of minus 100
basis points as the results of this model would not be meaningful. We will
27
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
continue to monitor our IRR position in 2004 and employ deposit and loan pricing
strategies and direct the reinvestment of loan and investment repayments in
order to maintain a positive IRR position.
Financial institutions are affected differently by inflation than commercial and
industrial companies that have significant investments in fixed assets and
inventories. Most of our assets are monetary in nature and change
correspondingly with variations in the inflation rate. It is difficult to
precisely measure the impact inflation has on us. However, we believe that our
exposure to inflation can be mitigated through asset/liability management.
LIQUIDITY:
Liquidity management is essential to our continuing operations as it gives us
the ability to meet our financial obligations as they come due, as well as to
take advantage of new business opportunities as they arise. Our financial
obligations include, but are not limited to, the following:
- Funding new and existing loan commitments;
- Payment of deposits on demand or at their contractual maturity;
- Repayment of borrowings as they mature;
- Payment of lease obligations; and
- Payment of operating expenses.
Our contractual obligations did not change significantly from the amounts
reported in our Annual Report on Form 10-K for the period ended December 31,
2003. We believe our liquidity position will be adequate to support our
contractual obligations as they come due.
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
2004. 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 March 31, 2004, our net noncore funding dependence ratio, the difference
between noncore funds and short-investments to long-term assets, was 0.4
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 3.3 percent at the end of the first quarter of 2004. These
ratios indicated that at March 31, 2004, we did not rely on noncore sources to
fund our
28
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
long-term assets. However, our liquidity position weakened in comparison to one
year ago. These ratios at March 31, 2003, were negative 8.6 percent and negative
11.3 percent. The change in our position resulted from a decrease in federal
funds sold and investments maturing within one year. 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. Cash and cash
equivalents consist 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 Federal Home Loan Bank of Pittsburgh, and federal
funds sold. Cash and cash equivalents decreased $9.7 million in the first
quarter of 2004. In comparison, cash and cash equivalents increased $9.5 million
in the same period last year. For the three months ended March 31, 2004,
financing and investing activities resulted in net cash outflows, while
operating activities provided us with net cash. However, for the same three
months of 2003, financing and investing activities, as well as operating
activities provided us with net cash.
Deposit gathering is our predominant financing activity. Deposits decreased $6.1
million which primarily caused the net cash outflow from financing activities
for 2004. The decrease in deposits was, for the most part, concentrated in NOW
accounts of local area school districts, which have withdrawal patterns that are
cyclical. In comparison, for the first quarter of 2003, deposits increased $4.1
million. Although we experienced similar withdrawal patterns for these
customers, deposit gathering was aided by a volatile stock market, as investors
chose the safeness of bank deposits in 2003.
Primary investing activities involve transaction related to our investment
securities and lending activities. Net proceeds received from repayments of
investment securities decreased for the three months ended March 31, to $3.6
million in 2004 compared to $8.4 million in 2003, while cash used for lending
activities increased to $7.5 million in 2004 from $4.7 million in 2003.
Operating activities provided net cash of $0.7 million for the first three
months of 2004 compared to $2.4 million for the same three months of 2003. Net
income, adjusted for the effects of noncash transactions such as depreciation
and the provision for loan losses, and net changes in current assets, is the
primary source of funds from operations.
29
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
CAPITAL ADEQUACY:
Our stockholders' equity improved to $47.7 million or $25.01 per share at March
31, 2004, compared to $46.5 million or $24.41 per share at December 31, 2003.
Net income of $1,180 was the primary factor contributing to the capital
improvement.
We declared dividends of $420 or $0.22 per share for the quarter ended March 31,
2004. The dividend payout ratio was 35.6 percent and 32.2 percent for the first
quarter of 2004 and 2003. 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 first quarter of 2004,
1,699 shares were issued under this plan.
We attempt to assure capital adequacy by monitoring our current and projected
capital positions to support future growth, while providing stockholders with an
attractive long-term appreciation of their investments. According to bank
regulation, at a minimum, banks must maintain a Tier I capital to risk-weighted
assets ratio of 4.0 percent and a total capital to risk-weighted assets ratio of
8.0 percent. Additionally, banks must maintain a Leverage ratio, defined as Tier
I capital to total average assets less intangibles, of 3.0 percent. The minimum
Leverage ratio of 3.0 percent only applies to institutions with a composite
rating of one under the Uniform Interagency Bank Rating System, that are not
anticipating or experiencing significant growth and have well- diversified risk.
An additional 100 to 200 basis points are required for all but these most
highly-rated institutions. Our minimum Leverage ratio was 4.0 percent at March
31, 2004 and 2003. 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.
30
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
Our and Community Bank's capital ratios at March 31, 2004 and 2003, as well as
the required minimum ratios for capital adequacy purposes and to be well
capitalized under the prompt corrective action provisions as defined by the
Federal Deposit Insurance Corporation Act of 1991 are summarized as follows:
REGULATORY CAPITAL
MINIMUM TO BE WELL
CAPITALIZED UNDER
MINIMUM FOR CAPITAL PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
------------------ -------------------- ------------------
MARCH 31 2004 2003 2004 2003 2004 2003
- ----------------------------------------- -------- -------- ------- ------- ------- -------
Basis for ratios:
Tier I capital to risk-weighted assets:
Consolidated........................... $ 44,323 $ 42,548 $14,977 $13,247
Community Bank......................... 42,895 40,805 14,954 13,241 $22,432 $19,861
Total capital to risk-weighted assets:
Consolidated........................... 47,975 46,270 29,955 26,495
Community Bank......................... 46,547 44,527 29,909 26,481 37,386 33,102
Tier I capital to total average assets
less intangibles assets:
Consolidated........................... 44,323 42,548 20,077 19,399
Community Bank......................... 42,895 40,805 $20,046 $19,375 $25,058 $24,218
Risk-weighted assets:
Consolidated........................... 367,259 324,213
Community Bank......................... 366,683 324,047
Risk-weighted off-balance sheet items:
Consolidated........................... 7,175 6,971
Community Bank......................... 7,175 6,971
Average assets for Leverage ratio:
Consolidated........................... 501,917 484,986
Community Bank......................... $501,154 $484,366
Ratios:
Tier I capital as a percentage of
risk-weighted assets and off-balance
sheet items:
Consolidated............................ 11.8% 12.8% 4.0% 4.0%
Community Bank.......................... 11.5 12.3 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............................ 12.8 14.0 8.0 8.0
Community Bank.......................... 12.5 13.5 8.0 8.0 10.0 10.0
Tier I capital as a percentage of total
average assets less intangibles assets:
Consolidated............................ 8.8 8.8 4.0 4.0
Community Bank.......................... 8.6% 8.4% 4.0% 4.0% 5.0% 5.0%
We and Community Bank have consistently maintain regulatory capital ratios well
above the minimum levels of 4.0 percent and 8.0 percent required for
31
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
adequately capitalized institutions. Regulatory agencies define institutions,
not under a written directive to maintain certain capital levels, as well
capitalized if they exceed the following: (i) a Tier I risk-based ratio of at
least 6.0 percent; (ii) a total risk-based ratio of at least 10.0 percent; and
(iii) a Leverage ratio of at least 5.0 percent. Based on the most recent
notification from the Federal Deposit Insurance Corporation, Community Bank was
categorized as well capitalized under the regulatory framework for prompt
corrective action at March 31, 2004. There are no conditions or events since
this notification that we believe have changed Community Bank's category.
REVIEW OF FINANCIAL PERFORMANCE:
Net income for the first quarter of 2004 totaled $1,180 or $0.62 per share.
Comparable earnings for the first quarter of 2003 were $1,330 or $0.68 per
share. A reduction in noninterest income, coupled with increases in noninterest
expense and the provision for loan losses, were partially offset by a lower
provision for income taxes and a slight increase in net interest income. For the
three months ended March 31, 2004, return on average assets and return on
average equity were 0.94 percent and 10.03 percent, compared 1.11 percent and
11.77 percent for the same three months of 2003.
NET INTEREST INCOME:
Net interest income is still the fundamental source of earnings for commercial
banks. Moreover, fluctuations in the level of noninterest income can have the
greatest impact on net profits. Net interest income is defined as the difference
between interest revenue, interest and fees earned on interest-earning assets,
and interest expense, the cost of interest-bearing liabilities supporting those
assets. The primary sources of earnings assets are loans and investment
securities, while interest-bearing 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
earning assets, is a more comprehensive ratio, as it reflects
32
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
not only spread, but also the change in the composition of interest-earning
assets and interest-bearing liabilities. Tax-exempt loans and investments carry
pre-tax yields lower than their taxable counterparts. Therefore, in order to
make the analysis of net interest income more comparable, tax- exempt income and
yields are reported on a tax-equivalent basis using the prevailing statutory tax
rate of 34.0 percent.
We analyze interest income and interest expense by segregating rate and volume
components of earning assets and interest-bearing liabilities. The impact
changes in the interest rates earned and paid on assets and liabilities, along
with changes in the volume of earning assets and interest-bearing liabilities
have on net interest income are summarized as follows. 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
MARCH 31,
2004 VS. 2003
-----------------------
INCREASE (DECREASE)
ATTRIBUTABLE TO
-----------------------
TOTAL
CHANGE RATE VOLUME
------ ---- ------
INTEREST INCOME:
Loans:
Taxable...................................................... $(263) $(698) $ 435
Tax-exempt................................................... 22 (97) 119
Investments:
Taxable...................................................... (127) 13 (140)
Tax-exempt................................................... (10) (1) (9)
Federal funds sold............................................. (12) (5) (7)
----- ----- -----
Total interest income...................................... (390) (788) 398
----- ----- -----
INTEREST EXPENSE:
Money market accounts.......................................... (12) (17) 5
NOW accounts................................................... (25) (24) (1)
Savings accounts............................................... (223) (238) 15
Time deposits less than $100................................... (202) (158) (44)
Time deposits $100 or more..................................... 28 (13) 41
----- ----- -----
Total interest expense..................................... (434) (450) 16
----- ----- -----
Net interest income........................................ $ 44 $(338) $ 382
===== ===== =====
Tax-equivalent net interest income for the quarter ended March 31, 2004, totaled
$4,519, an increase of $44 compared to $4,475 for the same quarter of 2003.
Growth in earning assets over that of interest-bearing liabilities more than
offset the effects of a negative rate variance.
33
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
For the three months ended March 31, 2004, average earning assets grew $15.1
million or 3.3 percent to $474.5 million, compared to $459.4 million for the
same three months of 2003, while average interest-bearing liabilities rose $6.4
million to $393.6 million from $387.2 million. This resulted in a positive
volume variance of $382. The positive variance resulted from a $35.5 million
increase in average loans, partially offset by a $20.4 million reduction in
average investments and federal funds sold. The increase in loans caused
tax-equivalent interest revenue to increase $554, while the reduction in
investments and federal funds sold caused a $156 decrease in interest revenue.
With regard to interest-bearing liabilities, growth in average time deposits
$100 or more, savings accounts and money market accounts was partially offset by
a decline in time deposits less than $100 and NOW account, which resulted in an
increase in interest expense due to changes in volume of $16.
For the first quarter, the cost of funds declined 51 basis points to 2.29
percent in 2004 from 2.80 percent in 2003. This resulted in a $450 reduction in
interest expense. However, the tax-equivalent yield on earning assets fell 58
basis points to 5.73 percent in 2004 from 6.31 percent in 2003, which caused
tax-equivalent interest revenue to decrease $788. Accounting for the majority of
the decrease in interest expense were reductions of 77 basis points in the cost
of savings accounts and 39 basis points in the cost of time deposits less than
$100. The decline in tax- equivalent interest revenue was the result of a 100
basis point decrease in the tax-equivalent yield of the loan portfolio. Overall,
tax-equivalent net interest income decreased $338 due to the 7 basis point
reduction in the net interest spread.
Maintenance of an adequate net interest margin is one of our primary concerns.
We continued to experience net interest margin contraction due to the sustained
low interest rate environment. Loan and investment yields continue to reprice
downward as repayments are being reinvested at considerably lower rates.
However, deposit rates, already at historic lows, do not have the ability to
reprice downward to the same extent. As a result our net interest margin
contracted 12 basis points to 3.83 percent for the three months ended March 31,
2004, from 3.95 percent for the same three months of 2003. However, net interest
margins appear to be stabilizing, as evidenced by a 10 basis point improvement
from 3.73 percent for the fourth quarter of 2003. Economic conditions are
expected to continue to improve in 2004. In addition, interest rates are
expected to begin to increase later in the year. Should this occur, competition
in our market area could intensify and put further pressure on interest rates.
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 favorable.
34
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
The average balances of assets and liabilities, corresponding interest income
and expense and resulting average yields or rates paid for the quarters ended
March 31, 2004 and 2003, 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 prevailing statutory tax rate of
34.0 percent.
SUMMARY OF NET INTEREST INCOME
MARCH 31, 2004 MARCH 31, 2003
------------------------------ ------------------------------
INTEREST AVERAGE INTEREST AVERAGE
AVERAGE INCOME/ INTEREST AVERAGE INCOME/ INTEREST
BALANCE EXPENSE RATE BALANCE EXPENSE RATE
------- -------- -------- ------- -------- -------
ASSETS:
Earning assets:
Loans:
Taxable..................................... $339,100 $5,289 6.27% $313,318 $5,552 7.19%
Tax-exempt.................................. 29,008 311 4.31 19,300 289 6.07
Investments:
Taxable..................................... 67,907 545 3.23 85,368 672 3.19
Tax-exempt.................................. 32,030 596 7.48 32,527 606 7.56
Federal funds sold............................ 6,463 16 1.00 8,869 28 1.28
-------- ------ -------- ------
Total earning assets...................... 474,508 6,757 5.73% 459,382 7,147 6.31%
Less: allowance for loan losses............... 3,671 3,747
Other assets.................................. 31,975 30,497
-------- --------
Total assets.............................. $502,812 $486,132
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY:
Interest-bearing liabilities:
Money market accounts......................... $ 18,735 41 0.88% $ 16,882 53 1.27%
NOW accounts.................................. 38,165 76 0.80 38,455 101 1.07
Savings accounts.............................. 126,579 226 0.72 122,293 449 1.49
Time deposits less than $100.................. 180,694 1,655 3.68 185,154 1,857 4.07
Time deposits $100 or more.................... 29,454 240 3.28 24,462 212 3.51
Short-term borrowings......................... 1 1.30
Long-term debt................................
-------- ------ -------- ------
Total interest-bearing liabilities........ 393,628 2,238 2.29% 387,246 2,672 2.80%
Noninterest-bearing deposits.................. 58,812 49,721
Other liabilities............................. 3,038 3,320
Stockholders' equity.......................... 47,334 45,845
-------- --------
Total liabilities and stockholders' equity $502,812 $486,132
======== ------ ======== ------
Net interest/income spread................ $4,519 3.44% $4,475 3.51%
====== ======
Net interest margin....................... 3.83% 3.95%
Tax equivalent adjustments:
Loans......................................... $ 106 $ 98
Investments................................... 203 206
------ ------
Total adjustments......................... $ 309 $ 304
====== ======
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 $3,498 and
$3,657 for the first quarter of 2004 and 2003 included in other assets.
Tax-equivalent adjustments were calculated using the prevailing
statutory tax rate of 34.0 percent.
35
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
PROVISION FOR LOAN LOSSES:
We evaluate the adequacy of the allowance for loan losses account on a quarterly
basis utilizing our systematic analysis in accordance with procedural
discipline. We take into consideration certain factors such as composition of
the loan portfolio, volumes of nonperforming loans, volumes of net charge-offs,
prevailing economic conditions and other relevant factors when determining the
adequacy of the allowance for loan losses account. We make monthly provisions to
the allowance for loan losses account in order to maintain the allowance at the
appropriate level indicated by our evaluations. The provision for loan losses
totaled $150 for the three months ended March 31, 2004, compared to $120 for the
same period of 2003. Based on our most current evaluation, we believe that the
allowance is adequate to absorb any known and inherent losses in the portfolio.
NONINTEREST INCOME:
Noninterest income totaled $922 for the first quarter of 2004, a decrease of
$164 or 15.1 percent compared to $1,086 for the same quarter of 2003. The
reduction in noninterest revenue resulted from a $194 or 49.7 percent decrease
in net gains on the sale of residential mortgage loans. Service charges, fees
and commissions rose $30 or 4.3 percent when comparing the first quarters of
2004 and 2003.
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 Federal Deposit Insurance Corporation ("FDIC") assessment, other taxes
and supplies. Several of these costs and expenses are variable while the
remainder are fixed. We utilize budgets and other related strategies in an
effort to control the variable expenses.
For the three months ended March 31, 2004, noninterest expense totaled $3,627,
an increase of $202 or 5.9 percent from $3,425 for the same three months of
2003. The majority of the increase resulted from a 23.0 percent increase in
occupancy and equipment expense due primarily to additional
36
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
costs associated with the operation of our new community banking office in
Tannersville, Pennsylvania. Our productivity deteriorated as evidenced by an
increase in our operating efficiency ratio, an industry ratio used to measure
productivity. The operating efficiency ratio, noninterest expenses divided by
net interest income and noninterest income, weakened to 70.7 percent for the
first quarter of 2004 compared to 65.2 percent for the same quarter last year.
Another industry ratio, the overhead ratio, noninterest expense as a percentage
of total average assets, remained stable at 2.9 percent for the three months
ended March 31, 2004 and 2003.
Major components of noninterest expense for the quarters ended March 31, 2004
and 2003, are summarized as follows:
NONINTEREST EXPENSES
THREE MONTHS ENDED
MARCH 31,
2004 2003
----- ------
SALARIES AND EMPLOYEE BENEFITS EXPENSE:
Salaries and payroll taxes........................................ $1,395 $1,403
Employee benefits................................................. 331 293
------ ------
Salaries and employee benefits expense.......................... 1,726 1,696
------ ------
NET OCCUPANCY AND EQUIPMENT EXPENSE:
Net occupancy expense............................................. 318 274
Equipment expense................................................. 346 266
------ ------
Net occupancy and equipment expense............................. 664 540
------ ------
OTHER EXPENSES:
Marketing expense................................................. 134 104
Other taxes....................................................... 98 113
Stationery and supplies........................................... 80 90
Contractual services.............................................. 396 360
Insurance including FDIC assessment............................... 57 43
Other............................................................. 472 479
------ ------
Other expenses.................................................. 1,237 1,189
------ ------
Total noninterest expense..................................... $3,627 $3,425
====== ======
Salaries and employee benefits expense comprise the majority of our noninterest
expense. Employee related expenses rose $30 or 1.8 percent to $1,726 for the
three months ended March 31, 2004, from $1,696 for the same period of the
previous year. The rise in employee costs resulted from staffing requirements
associated with the opening of our Tannersville banking office in December of
2003, coupled with increases in our health insurance rates.
37
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
Net occupancy and equipment expenses totaled $664 for the first quarter of 2004,
an increase of $124 or 23.0 percent compared to $540 for first quarter of 2003.
The increase resulted from higher depreciation, rent and maintenance costs
associated with our new Tannersville office.
For the first three months of 2004, other expenses rose $48 or 4.0 percent to
$1,237 compared to $1,189 for the same three months of last year. Higher
marketing costs and contractual service cost primarily caused the slight
increase in other expenses.
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 March 31, 2004, and will be exempt from paying a BIF
assessment in the second quarter of 2004.
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 first quarter of 2004 at $0.0154 per 100
dollars of BIF-assessable deposits. Our FICO assessments were $18 for the first
quarters of 2004 and 2003.
INCOME TAXES:
Income tax expense totaled $175 for the three months ended March 31, 2004, a
decrease of $207 compared to $382 for the same three months of last year. For
the first quarter, our effective tax rate decreased to 12.9 percent in 2004 from
22.3 percent in 2003. The significant reduction in our effective tax rate
resulted from the recognition of $105 of a one-time Federal Historic Tax Credit
of $418 for 2004. Should we not be able to use the full tax credit in 2004 due
to alternative minimum tax requirements, the remainder of the tax credit can be
carried back one year and/or carried forward 20 years. In addition, we use
tax-exempt investments and loans as a means of lowering our tax burden.
Tax-exempt interest income as a percentage of total interest income increased to
9.3 percent for the first three months of 2004 from 8.6 percent for the same
three months of 2003.
38
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
The difference between the amount of income tax currently payable and the
provision for income tax expense reflected in the income statements arises from
temporary differences. Temporary differences are differences between the tax
bases of assets and liabilities and their reported amounts in the financial
statements, which result in deferred tax assets or liabilities. We perform
quarterly reviews on the tax criteria related to the recognition of deferred tax
assets. We decided not to establish a valuation reserve for the deferred tax
assets since it is likely that these assets will be realized through carry-back
to taxable income in prior years and by future reversals of existing taxable
temporary differences or, to a lesser extent, through future taxable income.
39
COMM BANCORP, INC.
CONTROLS AND PROCEDURES
EVALUATION OF CONTROLS AND PROCEDURES
The Company's management, with the participation of the Company's Chief
Executive Office and Chief Financial Officer, has evaluated the effectiveness of
the Company's disclosure controls and procedures (as such term is defined in
rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the,
"Exchange Act")) as of the end of the period covered by this report. Based on
such evaluation, the Company's Chief Executive Officer and Chief Financial
Officer have concluded that, as of the end of such period, the Company's
disclosure controls and procedures are effective in recording, processing,
summarizing, and reporting, on a timely basis, information required to be
disclosed by the Company in the reports that it files or submits under the
Exchange Act.
INTERNAL CONTROL OVER FINANCIAL REPORTING
There have not been any changes in the Company's internal control over financial
reporting (as such term is defined in rules 13a-15(f) and 15d- 15(f) under the
Exchange Act) during the fiscal quarter to which this report relates that have
materially affected, or are reasonably likely to materially effect the Company's
internal control over financial reporting, except as follows: as a result of a
recommendation from the Company's internal audit department, the Company made a
material change to its internal controls with respect to funds availability.
This change applies to transaction accounts for retail and corporate customers
and improves the Company's ability to prevent loss of funds as a result of
possible fraud, deception or a large NSF (not sufficient funds) balance.
40
COMM BANCORP, INC.
OTHER INFORMATION
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
NONE
ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY
SECURITIES
The following table presents information with respect to purchases made by us of
our common stock during the three months ended March 31, 2004, as defined in
Rule 10b-18(a)(3) under the Exchange Act. On March 17, 2004, the Board of
Directors ratified the purchase of an additional 3.0 percent or 57,221 shares of
our outstanding common stock.
Total Number of Maximum Number
Shares Purchased of Shares that may
Total Number Average as Part of Publicly yet be Purchased
of Shares Price Paid Announced Plans Under the Plans
Month Ending Purchased(1) Per Share or Programs or Programs
- ------------------------------------------------- ------------ ---------- ------------------- ------------------
January 31, 2004................................. 850 $39.54 850 2,171
February 29, 2004................................ 2,171
March 31, 2004................................... 59,392
--- ------ ---
Total........................................... 850 $39.54 850
=== ====== ===
(1) All purchases were made pursuant to resolutions given by our Board of
Directors, which authorize Management to repurchase shares of our common stock
from time to time in unsolicited open market purchases through a licensed
broker-dealer and in accordance with terms, conditions and restrictions
contained in Rule 10b-18 under the Exchange Act.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
NONE
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
NONE
ITEM 5. OTHER INFORMATION
NONE
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
31(i) CEO certification pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31(ii) CFO certification pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32(i) CEO certification pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32(ii) CEO certification pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
41
COMM BANCORP, INC.
OTHER INFORMATION (CONTINUED)
(b) Reports on Form 8-K
On January 21, 2004, we filed a current report on Form 8-K, to
disclose its results of operations for the three months and year
ended December 31, 2003 under Item 12.
42
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: May 12, 2004 /s/ William F. Farber, Sr.
----------------------------------------
President and Chief Executive Officer
Chairman of the Board/Director
(Principal Executive Officer)
Date: May 12, 2004 /s/ Scott A. Seasock
-----------------------------------------
Scott A. Seasock
Executive Vice President and
Chief Financial Officer
(Principal Financial Officer)
Date: May 12, 2004 /s/ Stephanie A. Ganz
-----------------------------------------
Stephanie A. Ganz
Vice President of Finance
(Principal Accounting Officer)
43
EXHIBIT INDEX
ITEM NUMBER DESCRIPTION PAGE
- ----------- ----------- ----
31(i) CEO Certification Pursuant to Section 302 45
of the Sarbanes-Oxley Act of 2002
31(ii) CFO Certification Pursuant to Section 302 47
of the Sarbanes-Oxley Act of 2002
32(i) CEO Certification Pursuant to Section 906 49
Of the Sarbanes-Oxley Act of 2002
32(ii) CFO Certification Pursuant to Section 906 50
Of the Sarbanes-Oxley Act of 2002
44