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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, 2005
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: 1,863,219 at April 30, 2005
Page 1 of 66
Exhibit Index on Page 44
COMM BANCORP, INC.
FORM 10-Q
MARCH 31, 2005
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, 2005 and 2004... 3
Consolidated Balance Sheets - March 31, 2005, and December 31, 2004............................................... 4
Consolidated Statement of Changes in Stockholders' Equity for the Three Months Ended March 31, 2005............... 5
Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2005 and 2004.......................... 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 2005 2004
- ----------------------------------- ----------- -----------
INTEREST INCOME:
Interest and fees on loans:
Taxable...................................................................... $ 5,489 $ 5,289
Tax-exempt................................................................... 330 205
Interest and dividends on investment securities available-for-sale:
Taxable...................................................................... 555 535
Tax-exempt................................................................... 391 393
Dividends.................................................................... 8 10
Interest on federal funds sold................................................. 16
----------- -----------
Total interest income...................................................... 6,773 6,448
----------- -----------
INTEREST EXPENSE:
Interest on deposits........................................................... 2,380 2,238
Interest on short-term borrowings.............................................. 79
----------- -----------
Total interest expense..................................................... 2,459 2,238
----------- -----------
Net interest income........................................................ 4,314 4,210
Provision for loan losses...................................................... 300 150
----------- -----------
Net interest income after provision for loan losses........................ 4,014 4,060
----------- -----------
NONINTEREST INCOME:
Service charges, fees and commissions.......................................... 837 726
Net gains on sale of loans..................................................... 156 196
Net gains on sale of merchant services......................................... 125
----------- -----------
Total noninterest income................................................... 1,118 922
----------- -----------
NONINTEREST EXPENSE:
Salaries and employee benefits expense......................................... 1,795 1,726
Net occupancy and equipment expense............................................ 638 664
Other expenses................................................................. 1,187 1,237
----------- -----------
Total noninterest expense................................................. 3,620 3,627
----------- -----------
Income before income taxes..................................................... 1,512 1,355
Provision for income tax expense............................................... 232 175
----------- -----------
Net income................................................................. 1,280 1,180
----------- -----------
OTHER COMPREHENSIVE INCOME (LOSS):
Unrealized holding gains (losses) on investment securities available-for-sale (813) 550
Income tax expense (benefit) related to other comprehensive income (loss)...... (276) 187
----------- -----------
Other comprehensive income (loss), net of income taxes..................... (537) 363
----------- -----------
Comprehensive income....................................................... $ 743 $ 1,543
=========== ===========
PER SHARE DATA:
Net income..................................................................... $ 0.69 $ 0.62
Cash dividends declared........................................................ $ 0.23 $ 0.22
Average common shares outstanding.............................................. 1,865,848 1,907,573
See Notes to Consolidated Financial Statements.
3
COMM BANCORP, INC.
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
MARCH 31, DECEMBER 31,
2005 2004
--------- ------------
ASSETS:
Cash and due from banks................................................... $ 12,310 $ 11,802
Federal funds sold........................................................ 900
Investment securities available-for-sale.................................. 109,804 118,756
Loans held-for-sale, net.................................................. 3,905 1,917
Loans, net of unearned income............................................. 391,210 381,723
Less: allowance for loan losses......................................... 4,018 3,859
-------- --------
Net loans................................................................. 387,192 377,864
Premises and equipment, net............................................... 11,486 11,628
Accrued interest receivable............................................... 2,439 2,319
Other assets.............................................................. 3,095 3,136
-------- --------
Total assets.......................................................... $530,231 $528,322
======== ========
LIABILITIES:
Deposits:
Noninterest-bearing..................................................... $ 66,936 $ 67,714
Interest-bearing........................................................ 405,870 410,770
-------- --------
Total deposits........................................................ 472,806 478,484
Short-term borrowings..................................................... 7,800
Accrued interest payable.................................................. 1,033 1,075
Other liabilities......................................................... 900 1,445
-------- --------
Total liabilities..................................................... 482,539 481,004
-------- --------
STOCKHOLDERS' EQUITY:
Common stock, par value $0.33, authorized 12,000,000 shares, issued and
outstanding:
March 31, 2005, 1,865,848 shares; December 31, 2004, 1,864,391 shares 616 615
Capital surplus........................................................... 6,734 6,675
Retained earnings......................................................... 39,345 38,494
Accumulated other comprehensive income.................................... 997 1,534
-------- --------
Total stockholders' equity............................................ 47,692 47,318
-------- --------
Total liabilities and stockholders' equity............................ $530,231 $528,322
======== ========
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, 2004........................ $ 615 $ 6,675 $38,494 $ 1,534 $47,318
Net income........................................ 1,280 1,280
Dividends declared: $0.23 per share............... (429) (429)
Dividend reinvestment plan: 1,457 shares issued 1 59 60
Net change in other comprehensive income.......... (537) (537)
------- ------- ------- ------- -------
BALANCE, MARCH 31, 2005........................... $ 616 $ 6,734 $39,345 $ 997 $47,692
======= ======= ======= ======= =======
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 2005 2004
- ----------------------------------- -------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income................................................................ $ 1,280 $ 1,180
Adjustments:
Provision for loan losses............................................... 300 150
Depreciation, amortization and accretion................................ 545 633
Amortization of loan costs (fees)....................................... 34 (26)
Deferred income tax benefit............................................. (138) (11)
Loss (gain) on sale of foreclosed assets................................ (50) 2
Changes in:
Loans held for sale, net.............................................. (1,988) (857)
Accrued interest receivable........................................... (120) 59
Other assets.......................................................... (73) (367)
Accrued interest payable.............................................. (42) (35)
Other liabilities..................................................... (282) (22)
-------- --------
Net cash provided by (used in) operating activities................. (534) 706
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from repayments of investment securities available-for-sale...... 9,155 3,986
Purchases of investment securities available-for-sale..................... (1,234) (410)
Proceeds from sale of foreclosed assets................................... 304 140
Net increase in lending activities........................................ (9,738) (7,459)
Purchases of premises and equipment....................................... (117) (203)
-------- --------
Net cash used in investing activities............................... (1,630) (3,946)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net changes in:
Money market, NOW, savings and noninterest-bearing accounts............. (3,749) (6,811)
Time deposits........................................................... (1,929) 712
Short-term borrowings................................................... 7,800
Proceeds from the issuance of common shares............................... 60 63
Repurchase and retirement of common shares................................ (33)
Cash dividends paid....................................................... (410) (419)
-------- --------
Net cash provided by (used in) financing activities................. 1,772 (6,488)
-------- --------
Net decrease in cash and cash equivalents........................... (392) (9,728)
Cash and cash equivalents at beginning of year...................... 12,702 28,599
-------- --------
Cash and cash equivalents at end of period.......................... $ 12,310 $ 18,871
======== ========
SUPPLEMENTAL DISCLOSURES:
Cash paid during the period for:
Interest................................................................ $ 2,501 $ 2,273
Noncash items:
Transfers of loans to foreclosed assets................................. 76 63
Unrealized losses (gains) on investment securities available-for-sale... $ 537 $ (363)
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, 2004.
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 remain stable, assurance cannot be given that this
improvement will occur. 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 United States generally
accepted accounting principles ("GAAP"). The preparation of financial statements
in conformity with GAAP requires us 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 those 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 our 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)
We monitor 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, we cannot ensure that charge-offs in future periods will
not exceed the allowance for loan losses or that additional increases in the
allowance for loan losses will not be required resulting in an adverse impact on
operating results.
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 in 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, 2004. 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:
Rising energy costs hindered economic growth in the first quarter of 2005, as
the gross domestic product, the value of all goods and services produced
nationally, rose at an annual rate of 3.1 percent, the worst performance in two
years. Spending slowed in all sectors. Consumer spending increased 3.5 percent
in the first quarter, compared to 4.2 percent in the fourth quarter of 2004.
Business investment, which rose 14.5 percent in the fourth quarter, slowed to
4.7 percent in the first quarter. Inflationary pressures also continued to
build, as the consumer price index, excluding food and energy prices, rose at a
2.2 percent annual rate, the highest pace in seven years. Despite the slowdown,
the Federal Open Market Committee ("FOMC"), concerned about rising inflation,
tightened monetary policy by raising the federal funds rate 50 basis points, in
two 25 basis point increments, during the first quarter. In addition, subsequent
to the release of quarterly data, the FOMC, at their meeting on May 3, 2005,
again raised the federal funds target rate another 25 basis points to 3.00
percent.
REVIEW OF FINANCIAL POSITION:
Total assets increased $1.9 million to $530.2 million at March 31, 2005, from
$528.3 million at December 31, 2004. Loan demand remained relatively strong and
resulted in an increase in loans, net of unearned income, of $9.5 million to
$391.2 million at the end of the first quarter of 2005, from $381.7 million at
year-end 2004. However, demand for deposits began to wane. Total deposits
declined $5.7 million to $472.8 million at March 31, 2005, from $478.5 million
at the close of 2004. The change in the balance sheet was primarily funded by
repayments of investment securities and supplemented by short-term borrowings
from the Federal Home Loan Bank of Pittsburgh ("FHLB-Pgh"). Investment
securities decreased $9.0 million, while short-term borrowings outstanding at
the end of the first quarter amounted to $7.8 million. Stockholders' equity grew
$0.4 million to $47.7 million at the close of the first quarter, from $47.3
million at December 31, 2004. Net income of $1.3 million was partially offset by
net cash dividends declared of $0.4 million and an other comprehensive loss of
$0.5 million.
INVESTMENT PORTFOLIO:
Our investments are predominantly comprised of short-term obligations of U.S.
Government agencies and intermediate-term, tax-exempt obligations of states and
municipalities. We utilize the cash flows from maturities of U.S. Government
agencies to fund future loan demand. Tax-exempt obligations of states and
municipalities assist us in lowering our tax burden. U.S. Government agency
securities totaled $40.5 million at March 31, 2005, while tax-exempt state and
municipal obligations totaled $33.3 million. The balance of these investment
categories together equaled 67.2 percent of the investment portfolio at
March 31,2005.
11
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
The carrying values of the major classifications of available-for-sale
securities as they relate to the total investment portfolio at March 31, 2005,
and December 31, 2004, are summarized as follows:
DISTRIBUTION OF INVESTMENT SECURITIES
MARCH 31, DECEMBER 31,
2005 2004
---------------- -------------------
AMOUNT % AMOUNT %
-------- ----- -------- ------
U.S. Government agencies.... $ 40,495 36.88% $ 44,645 37.59%
State and municipals:
Taxable .................. 15,209 13.85 16,898 14.23
Tax-exempt ............... 33,275 30.30 34,605 29.14
Mortgage-backed securities.. 19,232 17.52 21,281 17.92
Equity securities:
Restricted .............. 1,419 1.29 1,153 0.97
Other ................... 174 0.16 174 0.15
-------- ----- -------- ------
Total ................. $109,804 100.0 $118,756 100.00%
======== ===== ======== ======
Investment securities were $109.8 million at March 31, 2005, a decrease of $9.0
million from $118.8 million at December 31, 2004. We received $9.2 million in
maturities and repayments from investment securities during the first quarter of
2005. These funds were primarily used to fund loan demand. Securities purchased
during the three months ended March 31, 2005, totaled $1.2 million and were
primarily comprised of restricted equity securities of the FHLB-Pgh in order to
satisfy collateral requirements for short-term borrowings outstanding.
We had an unrealized holding gain of $997, net of income taxes of $514 at March
31, 2005, compared to $1,534, net of income taxes of $790 at the end of 2004.
The decline was predominantly related to depreciation in the market values of
our holdings of tax-exempt state and municipal obligations caused by increases
in general market rates.
For the three months ended March 31, 2005, the investment portfolio averaged
$111.4 million, an increase of $11.5 million or 11.5 percent compared to an
average of $99.9 million for the same three months of 2004. The tax-equivalent
yield on our investment portfolio fell 39 basis points to 4.20 percent for the
first quarter of 2005 compared to 4.59 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 proceeds
from repayments and capital gains and losses, whether realized or unrealized.
Due to the
12
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
depreciation in market value of our investment portfolio, the total return for
the investment portfolio weakened to 2.2 percent for the 12 months ended March
31, 2005, from 3.5 percent for the 12 months ended December 31, 2004.
The maturity distribution of the amortized cost, fair value and weighted-average
tax-equivalent yield of the available-for-sale portfolio at March 31, 2005, is
summarized in the table that 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 federal 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, 2005 AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD
- -------------- ------ ----- ------ ----- ------ ----- ------ ----- ------ -----
Amortized cost:
U.S. Government agencies..... $32,702 2.76% $ 8,077 2.65% $ 40,779 2.74%
State and municipals:
Taxable.................... 1,667 2.08 14,046 2.61 15,713 2.55
Tax-exempt................. 400 1.91 1,991 5.50 $ 9,520 7.94% $19,270 7.55% 31,181 7.47
Mortgage-backed securities... 7,388 5.66 11,342 4.54 420 5.40 13 6.36 19,163 4.99
Equity securities:
Restricted................. 1,419 1.96 1,419 1.96
Other...................... 38 17.06 38 17.06
------- ------- ------- ------- --------
Total.................... $42,157 3.23% $35,456 3.40% $ 9,940 7.83% $20,740 7.18% $108,293 4.47%
======= ======= ======= ======= ========
Fair value:
U.S. Government agencies..... $32,542 $ 7,953 $ 40,495
State and municipals:
Taxable.................... 1,664 13,545 15,209
Tax-exempt................. 400 2,089 $10,187 $20,599 33,275
Mortgage-backed securities... 7,402 11,392 425 13 19,232
Equity securities:
Restricted................. 1,419 1,419
Other...................... 174 174
------- ------- ------- ------- --------
Total.................... $42,008 $34,979 $10,612 $22,205 $109,804
======= ======= ======= ======= ========
13
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
LOAN PORTFOLIO:
Rising short-term interest rates had little effect on mortgage rates, which
remained at historically low levels during the first quarter of 2005. The rate
for a 30-year conventional mortgage was 5.93 percent at March 31, 2005, compared
to 5.75 percent at the close of 2004. The low mortgage rates continued to
bolster the housing market, as new home sales rose 12.2 percent in March, a
record high, and existing home sales continued at near record pace. Despite the
continued strength in the housing market, activity in our secondary mortgage
department continued to slow with the halt in refinancings. Residential mortgage
loans serviced for the Federal National Mortgage Association ("FNMA") grew $2.6
million or at an annual rate of 10.8 percent to $100.4 million at the end of the
first quarter of 2005 from $97.8 million at the end of 2004. In comparison, for
the first quarter of 2004, residential mortgage loans serviced for the FNMA grew
at an annualized rate of 17.0 percent. For the three months ended March 31,
residential mortgages sold to the FNMA totaled $5.4 million in 2005 compared to
$6.7 million in 2004. Net gains realized on the sale of residential mortgages
totaled $156 for the first quarter of 2005, compared to $196 for the same
quarter last year. In addition, our total residential mortgage portfolio
decreased $2.4 million or 2.5 percent to $94.1 million at March 31, 2005, from
$96.5 million at the end of 2004.
Business spending slowed considerably in the first quarter of 2005. Spending for
equipment and software rose by a modest 6.9 percent, the slowest increase in two
years, while nonresidential construction declined 2.6 percent. However,
businesses expanded inventories at a strong pace, which contributed to a 3.4
percent increase in commercial and industrial loans at all commercial banks from
the end of 2004. Our business loans, including commercial loans, commercial
mortgage loans and lease financing grew $12.1 million or at an annualized rate
of 19.1 percent to $269.5 million at March 31, 2005 from $257.4 million at the
end of 2004. Similar to the banking industry, the growth was due to strong
demand for commercial loans, which grew 13.2 percent from year-end 2004.
Commercial mortgage loans and commercial lease financing declined 2.0 percent
and 5.8 percent.
With regard to our consumer portfolio, we have experienced a slowing in demand
for personal loans. Total consumer loans decreased $275 or at an annualized rate
of 4.0 percent from December 31, 2004, to March 31, 2005. Many individuals are
using home equity loans to finance large purchases and consolidate
higher-interest personal loans. In addition, automobile manufacturers and
electronic and appliance retailers are continuing to offer attractive financing
alternatives.
14
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
For the first quarter of 2005, loans averaged $400.4 million, an increase of
$32.3 million or 8.8 percent compared to $368.1 million for the same period of
2004. The tax-equivalent yield on the loan portfolio remained relatively stable,
declining only 5 basis points to 6.07 percent for the first quarter of 2005,
from 6.12 percent for the same quarter of 2004. We anticipate loan yields to
increase over the remainder of 2005, as the FOMC is expected to continue to
raise interest rates.
The composition of the loan portfolio at March 31, 2005, and December 31, 2004,
is summarized as follows:
DISTRIBUTION OF LOAN PORTFOLIO
MARCH 31, DECEMBER 31,
2005 2004
------------------- ---------------------
AMOUNT % AMOUNT %
-------- -------- --------- --------
Commercial, financial and others............ $129,475 33.10% $ 114,341 29.95%
Real estate:
Construction.............................. 5,224 1.33 6,704 1.76
Mortgage.................................. 226,792 57.97 230,555 60.40
Consumer, net............................... 27,618 7.06 27,893 7.31
Lease financing, net........................ 2,101 0.54 2,230 0.58
-------- ------ --------- ------
Loans, net of unearned income............. 391,210 100.00% 381,723 100.00%
====== ======
Less: allowance for loan losses............. 4,018 3,859
-------- ---------
Net loans............................... $387,192 $ 377,864
======== =========
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 45.9 percent of the lending portfolio is expected to reprice
within the next 12 months.
15
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
The maturity and repricing information of the loan portfolio by major
classification at March 31, 2005, is summarized as follows:
MATURITY DISTRIBUTION AND INTEREST SENSITIVITY OF LOAN PORTFOLIO
AFTER ONE
WITHIN BUT WITHIN AFTER
MARCH 31, 2005 ONE YEAR FIVE YEARS FIVE YEARS TOTAL
- ---------------------------------------- -------- ---------- ---------- --------
Maturity schedule:
Commercial, financial and others ....... $ 60,431 $ 17,795 $ 51,249 $129,475
Real estate:
Construction ......................... 5,224 5,224
Mortgage ............................. 14,196 52,002 160,594 226,792
Consumer, net .......................... 9,511 14,965 3,142 27,618
Lease financing, net ................... 766 1,335 2,101
-------- ---------- ---------- --------
Total .............................. $ 90,128 $ 86,097 $ 214,985 $391,210
======== ========== ========== ========
Repricing schedule:
Predetermined interest rates ........... $ 52,493 $ 69,482 $ 48,011 $169,986
Floating or adjustable interest rates... 127,188 93,956 80 221,224
-------- ---------- ---------- --------
Total .............................. $179,681 $ 163,438 $ 48,091 $391,210
======== ========== ========== ========
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 guarantees of funding and do not obligate us
to make payments to the guaranteed party. These letters of credit are
automatically renewable upon their anniversary date unless canceled by us prior
to that date.
16
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
DISTRIBUTION OF OFF-BALANCE SHEET COMMITMENTS
The contractual amounts of off-balance sheet commitments at March 31, 2005 and
December 31, 2004, are summarized as follows:
MARCH 31, DECEMBER 31,
2005 2004
--------- ------------
Commitments to extend credit ............................ $ 56,153 $ 49,504
Unused portions of home equity and credit card lines..... 13,209 12,776
Commercial letters of credit ............................ 9,786 9,062
--------- ------------
Total ................................................. $ 79,148 $ 71,342
========= ============
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, 2005 and December 31, 2004. 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 nonperforming asset levels improved $323 to $2,961 at March 31, 2005, from
$3,284 at year-end 2004. The ratio of nonperforming assets to loans, net of
unearned income, equaled 0.76 percent at March 31, 2005 and 0.86 percent at
December 31, 2004. The improvement resulted from reductions of $288 in accruing
loans past due 90 days or more and $178 in foreclosed assets. An increase of
$143 in nonaccrual loans partially offset these reductions.
With regard to foreclosed assets, three loans with an aggregate carrying value
of $76 were transferred to foreclosed assets during the first quarter and two
properties with an aggregate carrying value of $225 were sold for $275,
resulting in a realized gain of $50. We also received $29 on the partial sale of
a third property. No gain or loss was recognized on this partial sale.
We anticipate the economic conditions in our local market area to remain stable
for the remainder of 2005. 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. In
addition, rising interest rates could pose credit risk, as borrowers with
adjustable-rate loans may not be able to meet higher debt service requirements.
17
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
Information concerning nonperforming assets at March 31, 2005, and December 31,
2004, 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,
2005 2004
--------- ------------
NONACCRUAL LOANS:
Commercial, financial and others ...................... $ 920 $ 849
Real estate: ..........................................
Construction ........................................
Mortgage ............................................ 1,195 1,123
Consumer, net .........................................
Lease financing, net ..................................
-------- ------------
Total nonaccrual loans ............................ 2,115 1,972
-------- ------------
ACCRUING LOANS PAST DUE 90 DAYS OR MORE: ..............
Commercial, financial and others ...................... 73 91
Real estate: ..........................................
Construction ........................................
Mortgage ............................................ 428 653
Consumer, net ......................................... 124 169
Lease financing, net ..................................
-------- ------------
Total accruing loans past due 90 days or more...... 625 913
-------- ------------
Total nonperforming loans ......................... 2,740 2,885
-------- ------------
Foreclosed assets ..................................... 221 399
-------- ------------
Total nonperforming assets ........................ $ 2,961 $ 3,284
======== ============
Ratios: ...............................................
Nonperforming loans as a percentage of loans, net ..... 0.70% 0.76%
Nonperforming assets as a percentage of loans, net .... 0.76% 0.86%
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.
18
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
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.
Information concerning impaired loans at March 31, 2005, and December 31, 2004,
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,
2005 2004
--------- ------------
NONACCRUAL LOANS:
Commercial, financial and others ......................... $ 920 $ 849
Real estate: .............................................
Construction ...........................................
Mortgage ............................................... 1,195 1,123
Consumer, net ............................................
Lease financing, net .....................................
-------- ------------
Total nonaccrual loans ............................... 2,115 1,972
-------- ------------
ACCRUING LOANS: ..........................................
Commercial, financial and others ......................... 1,895 3,889
Real estate: .............................................
Construction ...........................................
Mortgage ............................................... 2,666 1,205
Consumer, net ............................................
Lease financing, net .....................................
-------- ------------
Total accruing loans ................................. 4,561 5,094
-------- ------------
Total impaired loans ................................. $ 6,676 $ 7,066
======== ============
Ratio: ...................................................
Impaired loans as a percentage of loans, net.............. 1.71% 1.85%
19
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
Information relating to the recorded investment in impaired loans at March 31,
2005 and December 31, 2004, is summarized as follows:
MARCH 31, DECEMBER 31,
2005 2004
--------- ------------
Impaired loans:
With a related allowance ........... $ 4,320 $ 2,930
With no related allowance .......... 2,356 4,136
--------- ------------
Total ............................ $ 6,676 $ 7,066
========= ============
The analysis of changes affecting the allowance for loan losses related to
impaired loans for the quarter ended March 31, 2005, is summarized as follows:
MARCH 31,
2005
---------
Balance at January 1 .............. $ 1,179
Provision for loan losses ......... 783
Loans charged-off ................. 64
Loans recovered
---------
Balance at period-end ............. $ 1,898
=========
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, 2005 and 2004, are
summarized as follows:
THREE MONTHS ENDED MARCH 31 2005 2004
--------------------------- ---- ----
Gross interest due under terms ......................... $ 108 $ 29
Interest income recognized ............................. 67 32
------- -------
Interest income not recognized ......................... $ 41 $ (3)
======= =======
Interest income recognized (cash-basis) ................ $ 67 $ 32
Average recorded investment in impaired loans .......... $ 6,736 $ 1,673
Cash received on impaired loans applied as a reduction of principal totaled $3.9
million for the quarter ended March 31, 2005, compared to $212 for the same
period of 2004. The majority of the reduction in principal was related to a line
of credit with one commercial customer. The credit was inadequately
collateralized. In addition to receiving the majority of the outstanding
principal balance, additional collateral was obtained during the first quarter.
As of March 31, 2005, this credit was no longer considered impaired. There were
no commitments to extend additional funds to parties having impaired loans at
March 31, 2005.
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, 2005 and December
31, 2004, is summarized as follows:
ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
MARCH 31, DECEMBER 31,
2005 2004
CATEGORY CATEGORY
AS A AS A
% OF % OF
AMOUNT LOANS AMOUNT LOANS
------ -------- ------ --------
Allocated allowance: ...................................
Specific: ..............................................
Commercial, financial and others ....................... $1,212 0.72% $ 728 1.24%
Real estate: ...........................................
Construction .........................................
Mortgage ............................................. 686 0.99 451 0.61
Consumer, net ..........................................
Lease financing, net ...................................
------ ------- ------ --------
Total specific ..................................... 1,898 1.71 1,179 1.85
------ ------- ------ --------
Formula: ...............................................
Commercial, financial and others ....................... 68 32.38 149 28.71
Real estate: ...........................................
Construction ......................................... 1.33 1.76
Mortgage ............................................. 1,000 56.98 878 59.79
Consumer, net .......................................... 311 7.06 288 7.31
Lease financing, net ................................... 1 0.54 1 0.58
------ ------- ------ --------
Total formula ...................................... 1,380 98.29 1,316 98.15
------ ------- ------ --------
Total allocated allowance .......................... 3,278 100.00% 2,495 100.00%
======= ========
Unallocated allowance .................................. 740 1,364
------ ------
Total allowance for loan losses .................... $4,018 $3,859
====== ======
The allocated element of the allowance for loan losses account was $3,278 at
March 31, 2005, an increase of $783 from $2,495 at December 31, 2004. The change
from year-end primarily resulted from a $719 increase in the specific portion of
the allowance for impairment of loans individually evaluated under SFAS No. 114,
coupled with a $64 increase 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 loans and
commercial mortgage loans which are still accruing loans but have been
identified as impaired with a recorded investment in excess of fair value.
The unallocated portion of the allowance for loan losses was $740 at the end of
the first quarter of 2005 compared to $1,364 at year-end 2004. We believe the
unallocated portion of the allowance for loan losses account is
21
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
sufficient to cover any inherent losses in the loan portfolio that have not been
identified as part of the allocated allowance using our impairment methodology.
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, 2005, is summarized as follows:
RECONCILIATION OF ALLOWANCE FOR LOAN LOSSES
MARCH 31,
2005
---------
Allowance for loan losses at beginning of period .......................... $ 3,859
Loans charged-off: ........................................................
Commercial, financial and others .......................................... 4
Real estate: ..............................................................
Construction ............................................................
Mortgage ................................................................ 65
Consumer, net ............................................................. 90
Lease financing, net ......................................................
--------
Total ................................................................. 159
--------
Loans recovered: ..........................................................
Commercial, financial and others .......................................... 1
Real estate: ..............................................................
Construction ..............................................................
Mortgage ................................................................
Consumer, net ............................................................. 17
Lease financing, net ......................................................
--------
Total ................................................................. 18
--------
Net loans charged-off ..................................................... 141
--------
Provision charged to operating expense .................................... 300
--------
Allowance for loan losses at end of period ................................ $ 4,018
========
Ratios:
Net loans charged-off as a percentage of average loans outstanding......... 0.14%
Allowance for loan losses as a percentage of period end loans ............. 1.03%
The allowance for loan losses account as a percentage of loans, net of unearned
income equaled 1.03 percent at the end of the first quarter and 1.01 percent at
year-end 2004. The provision for loan losses of $300 exceeded net charge-offs of
$141, which resulted in the $159 increase in the allowance for loan losses
account. At March 31, 2005, the allowance for loan losses was $4,018 and covered
135.7 percent of nonperforming assets. In comparison, the allowance for loan
losses account equaled $3,859 and covered 117.5 percent of nonperforming assets
at December 31, 2004.
22
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
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 $141 and $82 for the first three months of 2005 and 2004. As a
percentage of average loans outstanding, net charge-offs equaled 0.14 percent
and 0.09 percent for the first quarters of 2005 and 2004.
DEPOSITS:
Strong deposit growth experienced in recent years began to subside at the end of
2004. As a result, competition for deposits in our market area started to
escalate during the first quarter of 2005. We chose not to aggressively compete
for deposits. We also have several significant deposit account relationships
with local school districts and municipalities. The balances of these accounts
vary cyclically due to timing of tax receipts and disbursements. As a result of
these factors, total deposits decreased $5.7 million to $472.8 million at March
31, 2005, from $478.5 million at December 31, 2004. Noninterest-bearing accounts
decreased $0.8 million, while interest-bearing accounts fell $4.9 million. The
decline in interest-bearing accounts was caused by decreases of $6.2 million in
savings accounts, $4.3 million in large denomination time deposits and $2.0
million in money market accounts. Partially offsetting these decreases were
increases of $5.2 million in NOW accounts and $2.4 million in time deposits less
than $100.
The average amount of, and the rate paid on, the major classifications of
deposits for the quarters ended March 31, 2005 and 2004, are summarized as
follows:
DEPOSIT DISTRIBUTION
MARCH 31, MARCH 31,
2005 2004
----------------- -----------------
AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE RATE BALANCE RATE
-------- ------- -------- -------
Interest-bearing:
Money market accounts ............. $ 22,011 1.33% $ 18,735 0.88%
NOW accounts ...................... 51,367 1.48 38,165 0.80
Savings accounts .................. 122,484 0.81 126,579 0.72
Time deposits less than $100....... 177,879 3.65 180,694 3.68
Time deposits $100 or more ........ 33,603 3.31 29,454 3.28
-------- --------
Total interest-bearing .......... 407,344 2.37% 393,627 2.29%
Noninterest-bearing................ 68,322 58,812
-------- --------
Total deposits................... $475,666 $452,439
======== ========
23
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
For the three months ended March 31, 2005, total deposits averaged $475.6
million, an increase of $23.2 million or 5.2 percent, from $452.4 million for
the same three months of last year. Average noninterest-bearing deposits grew
$9.5 million or 16.2 percent, while average interest-bearing deposits rose $13.7
million or 3.5 percent when comparing the first quarters of 2005 and 2004. The
growth in our interest-bearing accounts was concentrated in NOW accounts and
large denomination time deposits which increased $13.2 million and $4.1 million.
The shift in monetary policy began to impact our cost of funds which rose 9
basis points to 2.38 percent for the first quarter of 2005 from 2.29 percent one
year ago. We anticipate higher funding costs for the remainder of 2005, as the
FOMC is expected to continue tightening monetary policy and competitive
pressures in our market area escalate.
Volatile deposits, time deposits in denominations of $100 or more, decreased
$4.3 million to $30.2 million at March 31, 2005, from $34.5 million at December
31, 2004. The average cost of these deposits for the first three months of 2005
was 3.31 percent, an increase of 3 basis points from 3.28 percent for the same
three months of last year.
Maturities of time deposits $100 or more at March 31, 2005, and December 31,
2004, are summarized as follows:
MATURITY DISTRIBUTION OF TIME DEPOSITS OF $100 OR MORE
MARCH 31, DECEMBER 31,
2005 2004
--------- ------------
Within three months................................... $ 6,488 $ 7,353
After three months but within six months.............. 2,163 4,426
After six months but within twelve months............. 5,909 6,198
After twelve months................................... 15,612 16,515
--------- ------------
Total............................................... $ 30,172 $ 34,492
========= ============
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
24
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
items. These changes arise because the present value of future cash flows, and
often the cash flows themselves, change with interest rates. The effects of the
changes in these present values reflect the change in our underlying economic
value and provide a basis for the expected change in future earnings related to
interest rates. IRR is inherent in the role of banks as financial
intermediaries. However, a bank with a high degree of IRR may experience lower
earnings, impaired liquidity and capital positions, and most likely, a greater
risk of insolvency. Therefore, banks must carefully evaluate IRR to promote
safety and soundness in their activities.
Short-term interest rates, which were at historically low levels for a
considerable period, began rising steadily since mid-2004. Due to these recent
changes in the interest rate environment, IRR and effectively managing it have
become very important to both bank management and regulators. 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 our 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.
25
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
Our interest rate sensitivity gap position, illustrating RSA and RSL at their
related carrying values, is summarized as follows. The distributions in the
table are based on a combination of maturities, call provisions, repricing
frequencies and prepayment patterns. Variable-rate assets and liabilities are
distributed based on the repricing frequency of the instrument. Mortgage
instruments are distributed in accordance with estimated cash flows, assuming
there is no change in the current interest rate environment.
INTEREST RATE SENSITIVITY
DUE AFTER DUE AFTER
THREE MONTHS ONE YEAR
DUE WITHIN BUT WITHIN BUT WITHIN DUE AFTER
MARCH 31, 2005 THREE MONTHS TWELVE MONTHS FIVE YEARS FIVE YEARS TOTAL
- ------------------------------------ ------------ ------------- ---------- ---------- --------
Rate sensitive assets:
Investment securities............... $ 13,363 $ 28,645 $ 34,979 $32,817 $109,804
Loans held for sale, net............ 3,905 3,905
Loans, net of unearned income....... 115,016 64,665 163,438 48,091 391,210
-------- -------- -------- ------- --------
Total............................. $132,284 $ 93,310 $198,417 $80,908 $504,919
======== ======== ======== ======= ========
Rate sensitive liabilities:
Money market accounts............... $ 22,112 $ 22,112
NOW accounts........................ 53,717 53,717
Savings accounts.................... $121,051 121,051
Time deposits less than $100........ $ 27,895 46,505 76,534 $27,884 178,818
Time deposits $100 or more.......... 6,488 8,072 11,199 4,413 30,172
Short-term borrowings............... 7,800 7,800
-------- -------- -------- ------- --------
Total............................. $ 42,183 $130,406 $208,784 $32,297 $413,670
======== ======== ======== ======= ========
Rate sensitivity gap:
Period............................ $ 90,101 $(37,096) $(10,367) $48,611
Cumulative........................ $ 90,101 $ 53,005 $ 42,638 $91,249 $ 91,249
RSA/RSL ratio:
Period............................ 3.14 0.72 0.95 2.51
Cumulative........................ 3.14 1.31 1.11 1.22 1.22
At March 31, 2005 and 2004, we had positive, cumulative one-year RSA/RSL ratios
of 1.31 and 1.37. As previously mentioned, this indicated that if interest rates
increase our earnings would likely be favorably impacted. Given the current
rising interest rate environment, ALCO continued to focus 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 2004, the decrease in our ratio
resulted from a $40.2 million or 21.7 percent increase in RSA offset by a $36.8
million or 27.1 percent increase in RSL maturing or repricing within one year.
The higher amount of RSA primarily resulted from increases of $26.1 million in
loans, net of unearned income, and $24.0 million in investment securities
partially offset by a reduction of $9.7 million in federal funds sold. All major
categories of RSL increased. Specifically, NOW accounts, money market accounts
and time deposits rose $18.4 million, $3.0 million and $7.6 million. In
addition, there were $7.8 million in short-term borrowings outstanding at March
31, 2005.
Our three-month ratio at March 31, 2005, decreased as compared to one year
earlier. At the end of the first quarter of 2005 this ratio equaled 3.14 as
compared to 4.30 at March 31, 2004. 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, 2005, 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 and 200 basis point, net
interest income should increase 1.7 percent and 3.3 percent. Conversely, given
instantaneous and parallel shifts in general market rates of minus 100 basis
points and 200 basis points, net interest income should decrease by 1.6 percent
and 6.5 percent. We will continue to monitor our IRR position in 2005 and employ
deposit and loan pricing strategies and direct the reinvestment of loan and
investment repayments in order to maintain a favorable IRR position.
27
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
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.
With the exception of $7.8 million in short-term borrowings outstanding with the
FHLB-Pgh at March 31, 2005, 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, 2004. 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
2005. Our noncore funds at March 31, 2005, consisted of short-term borrowings
with the FHLB-Pgh and time deposits in denominations of $100 or more. Time
deposits in denominations of $100 or more 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, 2005, our net noncore funding
dependence ratio, the difference between noncore funds and short-investments to
long-term assets, was negative 0.9 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 4.3 percent at the
end of the first quarter of 2005. Despite having short-term borrowings
outstanding, negative ratios indicated that at March 31, 2005, we did not rely
on noncore sources to fund our long-term assets.
28
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
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 FHLB-Pgh, and federal funds sold. Cash and cash
equivalents decreased $0.4 million in the first quarter of 2005. In comparison,
cash and cash equivalents decreased $9.7 million in the same period last year.
For the three months ended March 31, 2005, operating and investing activities
resulted in net cash outflows, while financing activities resulted in a net cash
inflow. In comparison to the same three months of 2004, financing and investing
activities resulted in net outflows, while operating activities provided us with
net cash.
Deposit gathering is our predominant financing activity. Deposit demand began to
wane in the first quarter of 2005, which resulted in a $5.7 million decrease in
deposits. As a result, short-term borrowings of $7.8 million from the FHLB-Pgh
were used as a source of liquidity. Similarly, for the first quarter of 2004,
deposits declined $6.1 million. However, we did not need to utilize our
borrowing arrangements at the FHLB-Pgh.
Primary investing activities involve transactions related to our investment
securities and lending activities. Net proceeds received from repayments of
investment securities increased for the three months ended March 31, to $7.9
million in 2005 compared to $3.6 million in 2004, while cash used for lending
activities increased to $9.7 million in 2005 from $7.5 million in 2004.
Operating activities used net cash of $0.5 million for the first three months of
2005, compared to provided net cash of $0.7 million for the same period of 2004.
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. A reduction of $2.0
million in loans held for sale, net was primarily responsible for the change in
cash related to operating activities.
CAPITAL ADEQUACY:
Our stockholders' equity equaled $47.7 million or $25.56 per share at March 31,
2005, compared to $47.3 million or $25.38 per share at December 31, 2004. Net
income of $1,280 was partially offset by cash dividends declared, net of
dividend reinvestment, of $369 and an other comprehensive loss of $537.
29
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
We declared dividends of $429 or $0.23 per share for the quarter ended March 31,
2005. The dividend payout ratio was 33.5 percent and 35.6 percent for the first
quarter of 2005 and 2004. 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 2005,
1,457 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, 2005 and 2004. 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, 2005 and 2004, 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 2005 2004 2005 2004 2005 2004
- ----------------------------------------- --------- --------- -------- --------- -------- --------
Basis for ratios:
Tier I capital to risk-weighted assets:
Consolidated........................... $ 46,072 $ 44,323 $16,212 $14,977
Community Bank......................... 43,914 42,895 16,196 14,954 $24,294 $22,432
Total capital to risk-weighted assets:
Consolidated........................... 50,090 47,975 32,423 29,955
Community Bank......................... 47,932 46,547 32,392 29,909 40,490 37,386
Tier I capital to total average assets
less intangibles assets:
Consolidated........................... 46,072 44,323 21,498 20,077
Community Bank......................... 43,914 42,895 $21,472 $20,046 $26,840 $25,058
Risk-weighted assets:
Consolidated........................... 394,572 367,259
Community Bank......................... 394,176 366,683
Risk-weighted off-balance sheet items:
Consolidated........................... 10,719 7,175
Community Bank......................... 10,719 7,175
Average assets for Leverage ratio:
Consolidated........................... 537,439 501,917
Community Bank......................... $536,806 $501,154
Ratios:
Tier I capital as a percentage of risk-
weighted assets and off-balance sheet
items:
Consolidated........................... 11.4% 11.8% 4.0% 4.0%
Community Bank......................... 10.8 11.5 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........................... 12.4 12.8 8.0 8.0
Community Bank......................... 11.8 12.5 8.0 8.0 10.0 10.0
Tier I capital as a percentage of total
average assets less intangibles assets:
Consolidated........................... 8.6 8.8 4.0 4.0
Community Bank......................... 8.2% 8.6% 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 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
31
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
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
("FDIC"), Community Bank was categorized as well capitalized under the
regulatory framework for prompt corrective action at March 31, 2005. 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 improved $100 or 8.5 percent to $1,280 or $0.69
per share in 2005 from $1,180 or $0.62 per share in 2004. Strong earning asset
growth contributed to higher net interest income, while new product offerings
implemented in the first quarter factored into increased fee income. We also
entered into an asset purchase and revenue sharing agreement with a third party
regarding our merchant services portfolio. As a result, we recorded an initial
gain of $125 upon the sale, which is included in noninterest income. Return on
average assets and return on average equity for the quarter ended March 31,
2005, equaled 0.96 percent and 10.82 percent, compared to 0.94 percent and 10.03
percent for the same quarter of 2004.
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 not only spread,
but also the change in the composition of interest-earning
32
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
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,
2005 VS. 2004
------------------------
INCREASE (DECREASE)
ATTRIBUTABLE TO
------------------------
TOTAL
CHANGE RATE VOLUME
------ ------ ------
INTEREST INCOME:
Loans:
Taxable...................................................... $200 $ (99) $ 299
Tax-exempt................................................... 189 39 150
Investments:
Taxable...................................................... 18 (72) 90
Tax-exempt................................................... (4) 12 (16)
Federal funds sold............................................. (16) 14 (30)
---- ----- -----
Total interest income...................................... 387 (106) 493
---- ----- -----
INTEREST EXPENSE:
Money market accounts.......................................... 31 23 8
NOW accounts................................................... 111 79 32
Savings accounts............................................... 18 25 (7)
Time deposits less than $100................................... (52) (26) (26)
Time deposits $100 or more..................................... 34 34
Short-term borrowings.......................................... 79 1 78
---- ----- -----
Total interest expense..................................... 221 102 119
---- ----- -----
Net interest income........................................ $166 $(208) $ 374
==== ===== =====
Tax-equivalent net interest income for the first quarter improved $166 or 3.7
percent to $4,685 in 2005 from $4,519 in 2004. 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, 2005, average earning assets grew $37.3
million or 7.9 percent to $511.8 million, compared to $474.5 million for the
same three months of 2004, while average interest-bearing liabilities rose $25.9
million to $419.5 million from $393.6 million. This resulted in a positive
volume variance of $374. Earning asset growth added $493 to tax-equivalent
interest revenue, while growth in interest-bearing liabilities caused an
increase in interest expense of $119. An increase of $32.3 million in average
loans was primarily responsible for the growth in earning assets and positively
impacted tax-equivalent net interest income by $449 or 91.1 percent of the added
interest revenue. With regard to interest-bearing liabilities, a $12.2 million
increase in short-term borrowings added $78 to interest expense. Also affecting
interest expense due to changes in volume were increases of $13.2 million in NOW
accounts, $4.1 million time deposits $100 or more and $3.3 million in money
market accounts. Partially offsetting these higher volumes were reductions of
$4.1 million in savings accounts and $2.8 million time deposits less than $100.
For the first quarter, the tax-equivalent yield on earning assets declined 7
basis points from 5.73 percent in 2004 to 5.66 percent in 2005 and negatively
impacted interest revenue by $106. However, funding costs, which have also
declined in recent periods, began reacting to the shift in monetary policy and
escalating competitive pressures. As a result, the cost of funds increased 9
basis points to 2.38 percent in 2005 from 2.29 percent in 2004. This resulted in
a $102 increase in interest expense. Specifically, the average rate paid for NOW
and money market accounts rose 68 basis points and 45 basis points, which
resulted in additional interest expense of $79 and $23. Overall, tax-equivalent
net interest income decreased $208 due to changes in interest rates.
Maintenance of an adequate net interest margin is one of our primary concerns.
Loan and investment yields trended downward in comparison to the previous year.
However, deposit costs started to react to competitive pressures within are
market area. As a result our net interest margin contracted 12 basis points to
3.71 percent for the three months ended March 31, 2005, from 3.83 percent for
the same three months of 2004. Despite the decline, net interest margins appear
to be stabilizing, as evidenced by a 5 basis point improvement from 3.66 percent
for the fourth quarter of 2004. Interest rates are expected to continue to
increase through the remainder of 2005. 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, 2005 and 2004, 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, 2005 MARCH 31, 2004
------------------------------ ------------------------------
INTEREST AVERAGE INTEREST AVERAGE
AVERAGE INCOME/ INTEREST AVERAGE INCOME/ INTEREST
BALANCE EXPENSE RATE BALANCE EXPENSE RATE
-------- -------- -------- -------- -------- --------
ASSETS:
Earning assets:
Loans:
Taxable..................................... $358,544 $5,489 6.21% $339,100 $5,289 6.27%
Tax-exempt.................................. 41,828 500 4.85 29,008 311 4.31
Investments:
Taxable..................................... 80,009 563 2.85 67,907 545 3.23
Tax-exempt.................................. 31,389 592 7.65 32,030 596 7.48
Federal funds sold............................ 57 2.62 6,463 16 1.00
-------- ------ -------- ------
Total earning assets...................... 511,827 7,144 5.66% 474,508 6,757 5.73%
Less: allowance for loan losses............... 3,903 3,671
Other assets.................................. 30,138 31,975
-------- --------
Total assets.............................. $538,062 $502,812
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY:
Interest-bearing liabilities:
Money market accounts......................... $ 22,011 72 1.33% $ 18,735 41 0.88%
NOW accounts.................................. 51,367 187 1.48 38,165 76 0.80
Savings accounts.............................. 122,484 244 0.81 126,579 226 0.72
Time deposits less than $100.................. 177,879 1,603 3.65 180,694 1,655 3.68
Time deposits $100 or more.................... 33,603 274 3.31 29,454 240 3.28
Short-term borrowings......................... 12,234 79 2.62 1 1.30
-------- ------ -------- ------
Total interest-bearing liabilities........ 419,578 2,459 2.38% 393,628 2,238 2.29%
Noninterest-bearing deposits.................. 68,322 58,812
Other liabilities............................. 2,192 3,038
Stockholders' equity.......................... 47,970 47,334
-------- --------
Total liabilities and stockholders' equity $538,062 $502,812
======== ------ ======== ------
Net interest/income spread................ $4,685 3.28% $4,519 3.44%
====== ======
Net interest margin....................... 3.71% 3.83%
Tax equivalent adjustments:
Loans......................................... $ 170 $ 106
Investments................................... 201 203
------ ------
Total adjustments......................... $ 371 $ 309
====== ======
Note: Average balances were calculated using average daily balances. Average
balances for loans include nonaccrual loans. Available-for-sale
securities, included in investment securities, are stated at amortized
cost with the related average unrealized holding gains of $2,452 and
$3,498 for the first quarter of 2005 and 2004 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 $300 for the three months ended March 31, 2005, compared to $150 for the
same period of 2004. 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 for the first quarter improved $196 or 21.3 percent to $1,118
in 2005, compared to $922 in 2004. As previously mentioned, included in
noninterest income in 2005 was an initial gain of $125 on the sale of the
merchant services portfolio in an asset purchase and revenue sharing agreement
with a third party. In addition, to this gain we will also receive on-going
referral fees and residual payments on net revenue for each merchant contract.
Service charges, fees and commissions increased $111 or 15.3 percent to $837 for
the three months ended March 31, 2005, from $726 for the same period of 2004.
During the first quarter of 2005, we introduced new overdraft protection
alternatives to our customers. These new alternatives include an automatic
transfer from a savings account for a daily fee and the implementation of an
automated overdraft privilege program for certain individual and sole proprietor
customers.
NONINTEREST EXPENSE:
In general, noninterest expense is categorized into three main groups:
employee-related expenses, occupancy and equipment expenses and other expenses.
Employee-related expenses are costs associated with providing salaries,
including payroll taxes and benefits, to our employees. Occupancy and equipment
expenses, the costs related to the maintenance of facilities and equipment,
include depreciation, general maintenance and repairs, real estate taxes, rental
expense offset by any rental income, and utility costs. Other expenses include
general operating expenses such as advertising, contractual services, insurance,
including FDIC assessment,
36
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
other taxes and supplies. Several of these costs and expenses are variable while
the remainder are fixed. We utilize budgets and other related strategies in an
effort to control the variable expenses.
Noninterest expense for the first quarter was $3,620 in 2005 and $3,627 in 2004.
The slight decline resulted from decreases in net occupancy and equipment
expense and other expenses, which were almost entirely offset by an increase in
salaries and employee benefits expense. Our productivity improved as evidenced
by decreases in both the operating efficiency and overhead ratios, two industry
ratios used to measure productivity. The operating efficiency ratio, noninterest
expenses divided by net interest income and noninterest income, improved to 66.6
percent for the first quarter of 2005 compared to 70.7 percent for the same
quarter last year. Similarly, the overhead ratio, noninterest expense as a
percentage of total average assets, improved to 2.7 percent from 2.9 percent for
the three months ended March 31, 2005 and 2004.
Major components of noninterest expense for the quarters ended March 31, 2005
and 2004, are summarized as follows:
NONINTEREST EXPENSES
THREE MONTHS ENDED
MARCH 31,
2005 2004
------ ------
SALARIES AND EMPLOYEE BENEFITS EXPENSE:
Salaries and payroll taxes........................................ $1,456 $1,395
Employee benefits................................................. 339 331
------ ------
Salaries and employee benefits expense.......................... 1,795 1,726
------ ------
NET OCCUPANCY AND EQUIPMENT EXPENSE:
Net occupancy expense............................................. 333 318
Equipment expense................................................. 305 346
------ ------
Net occupancy and equipment expense............................. 638 664
------ ------
OTHER EXPENSES:
Marketing expense................................................. 144 134
Other taxes....................................................... 122 98
Stationery and supplies........................................... 88 80
Contractual services.............................................. 452 396
Insurance including FDIC assessment............................... 69 57
Other............................................................. 312 472
------ ------
Other expenses................................................. 1,187 1,237
------ ------
Total noninterest expense................................... $3,620 $3,627
====== ======
37
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
Salaries and employee benefits expense comprise the majority of our noninterest
expense. Employee related expenses rose $69 or 4.0 percent to $1,795 for the
three months ended March 31, 2005, from $1,726 for the same period of the
previous year. A reduction in the volume of loans originated in the first
quarter led to the increase, as payroll-related costs deferred in conjunction
with loan originations declined 34.4 percent.
Net occupancy and equipment expenses totaled $638 for the first quarter of 2005,
a decrease of $26 or 3.9 percent compared to $664 for first quarter of 2003.
Lower amounts of equipment and software depreciation were partially offset by
higher maintenance costs for snowplowing caused by harsh winter weather
conditions.
For the first three months of 2005, other expenses decreased $50 or 4.0 percent
to $1,187 compared to $1,237 for the same three months of last year.
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, 2005, and will be exempt from paying a BIF
assessment in the second quarter of 2005.
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 2005 at $0.0144 per 100
dollars of BIF-assessable deposits. Our FICO assessments were $17 and $18 for
the first quarters of 2005 and 2004.
INCOME TAXES:
Income tax expense increased $57 or 32.6 percent to $232 for the three months
ended March 31, 2005, from $175 for the same three months of last year. For the
first quarter, our effective tax rate increased to 15.3 percent in 2005 from
12.9 percent in 2004. During the first quarter of 2004 we recognized $105 of a
one-time Federal Historic Tax Credit of $418 for 2004. We did not recognize any
tax credits in 2005. Partially mitigating
38
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
the increase in tax burden was a $123 or 20.6 percent increase in tax-exempt
income. Tax-exempt interest income as a percentage of total interest income
increased to 10.6 percent for the first three months of 2005 from 9.3 percent
for the same three months of 2004.
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
As of March 31, 2005, the end of the period covered by this Quarterly Report on
Form 10-Q, our Chief Executive Officer ("CEO") and Chief Financial Officer
("CFO"), evaluated the effectiveness of our disclosure controls and procedures
as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of
1934 (the, "Exchange Act"). Based upon that evaluation, the CEO and CFO
concluded that as of the period covered by this Quarterly Report on Form 10-Q,
we maintained effective disclosure controls and procedures.
INTERNAL CONTROL OVER FINANCIAL REPORTING
There were no changes in our internal control over financial reporting as
defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act during the
fiscal quarter ended March 31, 2005, that materially affected, or is reasonably
likely to materially effect, our internal control over financial reporting.
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 or on
behalf of us or any "affiliated purchaser," as defined in the Exchange Act Rule
10b-18(a)(3), of our common stock during each of the three months ended March
31, 2005:
TOTAL NUMBER OF MAXIMUM NUMBER
TOTAL NUMBER AVERAGE SHARES PURCHASED OF SHARES THAT MAY
OF SHARES PRICE PAID AS PART OF PUBLICLY YET BE PURCHASED
MONTH ENDING PURCHASED PER SHARE ANNOUNCED PROGRAMS UNDER THE PROGRAMS
- ---------------------------------------------- ------------ ---------- ------------------- ------------------
January 31, 2005.............................. 67,808
February 28, 2005............................. 67,808
March 31, 2005................................ 67,808
------ ------ ------
Total....................................... 0 0 0
====== ====== ======
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:
10(i) Severance Compensation Agreement between Comm Bancorp,
Inc, and its subsidiary, Community Bank & Trust Co., and
Timothy P. O'Brien.
10(ii) Severance Compensation Agreement between Comm Bancorp,
Inc. and its subsidiary, Community Bank & Trust Co., and
James E. Jackson.
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 22, 2005, we filed a current
report on Form 8-K, to disclose our results of operations for the
three months and year ended December 31, 2004 under Item 2.02.
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, 2005 /s/ William F. Farber, Sr.
-------------------------------------
President and Chief Executive Officer
Chairman of the Board/Director
(Principal Executive Officer)
Date: May 12, 2005 /s/ Scott A. Seasock
-------------------------------------
Scott A. Seasock
Executive Vice President and
Chief Financial Officer
(Principal Financial Officer)
Date: May 12, 2005 /s/ Stephanie A. Ganz
-------------------------------------
Stephanie A. Ganz, CPA
Vice President of Finance
(Principal Accounting Officer)
43
EXHIBIT INDEX
ITEM NUMBER DESCRIPTION PAGE
- ----------- ----------- ----
10(i) Severance Compensation Agreement between Comm Bancorp, Inc. and
its subsidiary, Community Bank & Trust Co., and Timothy P.
O'Brien. 45
10(ii) Severance Compensation Agreement between Comm Bancorp, Inc. and
its subsidiary, Community Bank & Trust Co., and James E. Jackson. 53
31(i) CEO Certification Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002 61
31(ii) CFO Certification Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002 63
32(i) CEO Certification Pursuant to Section 906 Of the Sarbanes-Oxley
Act of 2002 65
32(ii) CFO Certification Pursuant to Section 906 Of the Sarbanes-Oxley
Act of 2002 66
44