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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
[x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2002 Commission File Number: 0-16084
------------------ -------------------------------
CITIZENS & NORTHERN CORPORATION
(Exact name of Registrant as specified in its charter)
PENNSYLVANIA 23-2451943
- ------------ ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
90-92 MAIN STREET, WELLSBORO, PA 16901
- --------------------------------------
(Address of principal executive offices) (Zip code)
570-724-3411
------------
(Registrant's telephone number including area code)
Securities registered pursuant to Section 12(b) of the Act: None
----
Securities registered pursuant to section 12(g) of the Act:
COMMON STOCK PAR VALUE $1.00
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
The aggregate market value of the registrant's common stock held by
non-affiliates at February 27, 2003 was $167,270,245.
The number of shares of common stock outstanding at February 27, 2003 was
5,335,574.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's proxy statement for the annual meeting of its
shareholders to be held April 15, 2003 are incorporated by reference into Part
III of this report.
1
PART I
ITEM 1. BUSINESS
Citizens & Northern Corporation ("Corporation") is a one-bank holding company
whose principal subsidiary is Citizens & Northern Bank ("Bank"). The
Corporation's principal office is located in Wellsboro, Pennsylvania. The
Corporation's other wholly-owned subsidiaries are Citizens & Northern Investment
Corporation and Bucktail Life Insurance Company ("Bucktail"). Citizens &
Northern Investment Corporation was formed in 1999 to engage in investment
activities. Bucktail reinsures credit and mortgage life and accident and health
insurance on behalf of the Bank. The operations of Citizens & Northern
Investment Corporation and Bucktail are insignificant in relation to the total
business of the Corporation.
The Bank is a Pennsylvania banking institution that was formed by the
consolidation of Northern National Bank of Wellsboro and Citizens National Bank
of Towanda on October 1, 1971. Subsequent mergers included: First National Bank
of Ralston in May 1972; Sullivan County National Bank in October 1977; Farmers
National Bank of Athens in January 1984; and First National Bank of East
Smithfield in May 1990. The Bank has held its current name since May 6, 1975, at
which time the Bank changed its charter from a National bank to a Pennsylvania
bank.
The Bank provides an extensive range of banking services, including deposit and
loan products for personal and commercial customers. The Bank also maintains a
trust division that provides a wide range of financial services, such as 401(k)
Plans, retirement planning, estate planning, estate settlements and asset
management. In January 2000, the Bank formed a subsidiary, C&N Financial
Services Corporation ("C&NFSC"). C&NFSC is a licensed insurance agency that
provides insurance products to individuals and businesses. In 2001, C&NFSC added
a broker-dealer division, which offers mutual funds, annuities, educational
savings accounts and other investment products through registered agents.
C&NFSC's operations are not significant in relation to the total operations of
the Bank.
All phases of the Bank's business are competitive. The Bank primarily competes
in Tioga, Bradford and Sullivan counties and portions of Lycoming County. The
Bank competes with local commercial banks headquartered in our market area as
well as other commercial banks with branches in our market area. Some of the
banks that have branches in the Bank's market area are larger in overall size
than the Bank. With respect to lending activities and attracting deposits, the
Bank also competes with savings banks, savings and loan associations, insurance
companies, regulated small loan companies and credit unions. Also, the Bank
competes with mutual funds for deposits. The Bank competes with insurance
companies, investment counseling firms, mutual funds and other business firms
and individuals for trust, investment management, broker dealer and insurance
services. The Bank is generally competitive with all financial institutions in
its service area with respect to interest rates paid on time and savings
deposits, service charges on deposit accounts and interest rates charged on
loans. The Bank serves a diverse customer base, and is not economically
dependent on any small group of customers or on any individual industry.
Although there have been no mergers or acquisitions within the last 5 years, the
Bank has engaged in several ventures designed to improve customer service and
generate financial growth. These ventures included the following major
initiatives:
- - expanded trust and financial services capabilities, including investment
management, employee benefits and insurance services;
- - installed 18 automated teller machines, beginning in 1997;
- - created the "customer repurchase agreement" cash management service for
commercial customers in 1998;
- - established internet banking services in 1999; and
- - constructed and opened new branches in Mansfield, PA (1998) and Muncy, PA
(2000).
At December 31, 2002, the Bank had total assets of $996,644,000, total deposits
of $641,164,000 and net loans outstanding of $445,356,000. At December 31, 2002,
the Bank had a total of 265 full-time equivalent employees.
Most of the activities of the Corporation and its subsidiaries are regulated by
federal or state agencies. The primary regulatory relationships are described as
follows:
2
- - The Corporation is a one-bank holding company formed under the provisions
of Section 3 of the Federal Reserve Act. The Corporation is under the
direct supervision of the Federal Reserve and must comply with the
reporting requirements of the Federal Bank Holding Company Act.
- - The Bank is a state-chartered, nonmember bank, supervised by the
Pennsylvania Department of Banking and the Federal Deposit Insurance
Corporation.
- - C&NFSC is a Pennsylvania corporation. The Pennsylvania Department of
Insurance regulates C&NFSC's insurance activities. Through October 31,
2002, the broker dealer division offered brokerage products as an office of
supervisory jurisdiction of Hackett Associates, Inc. Effective November 1,
2002, brokerage products are offered through a third party networking
agreement between the Bank and UVEST Financial Services, Inc.
- - Bucktail is incorporated in the state of Arizona and supervised by the
Arizona Department of Insurance.
ITEM 2. PROPERTIES
The Bank owns each of its properties, except for the facility located at 68 Main
Street, Wellsboro, which is leased. All of the properties are in good condition.
In 2001, the Bank entered into a lease of the property at 68 Main Street,
Wellsboro. This facility is used for C&NFSC's operations and for training. None
of the owned properties are subject to encumbrance.
A listing of properties is as follows:
Main administrative office:
90-92 Main Street
Wellsboro, PA 16901
Branch offices:
428 S. Main Street Main Street 41 Main Street
Athens, PA 18810 Liberty, PA 16930 Tioga, PA 16946
111 Main Street 1085 S. Main Street 428 Main Street
Dushore, PA 18614 Mansfield, PA 16933 Towanda, PA 18848
Main Street Route 220 Courthouse Square
East Smithfield, PA 18817 Monroeton, PA 18832 Troy, PA 16947
104 Main Street 3461 Route 405 Highway 90-92 Main Street
Elkland, PA 16920 Muncy, PA 17756 Wellsboro, PA 16901
102 E. Main Street Thompson Street Route 6
Knoxville, PA 16928 Ralston, PA 17763 Wysox, PA 18854
Main Street 503 N. Elmira Street
Laporte, PA 18626 Sayre, PA 18840
Other offices:
Bankcard Services Facilities Management
RR7 Box 503 One Brewery Lane
Wellsboro, PA 16901 Wellsboro, PA 16901
C&N Financial Services Corp. Audit and Compliance
64 Main Street Water Street
Wellsboro, PA 16901 Wellsboro, PA 16901
3
ITEM 3. LEGAL PROCEEDINGS
The Corporation and the Bank are involved in various legal proceedings
incidental to their business. Management believes the aggregate liability, if
any, resulting from such pending and threatened legal proceedings will not have
a material, adverse effect on the Corporation's financial condition or results
of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of 2002, no matters were submitted to a vote of
security holders, through the solicitation of proxies or otherwise.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
QUARTERLY SHARE DATA
Trades of the Corporation's stock are executed through various brokers who
maintain a market in the Corporation's stock. Information regarding sales prices
of the Corporation's stock is available through the OTC Bulletin Board
(www.otcbb.com). The Corporation's stock is not listed or traded on Nasdaq or a
national securities exchange. As of December 31, 2002, there were 2,406
shareholders of record of the Corporation's common stock.
The following table sets forth the approximate high and low sales prices of the
common stock during 2002 and 2001:
2002 2001
Dividend Dividend
Declared Declared
per per
High Low Quarter High Low Quarter
- ----------------------------------------------------------------------------------------------
First quarter $ 28.50 $ 24.50 $ 0.28 $ 22.00 $ 20.00 $ 0.26
Second quarter 30.00 27.70 0.28 21.75 20.41 0.26
Third quarter 32.00 29.30 0.30 23.45 21.00 0.26
Fourth quarter 33.00 30.15 0.30 26.50 23.10 0.28
plus 1% plus 1%
stock dividend stock dividend
Known "market makers" who handle Citizens & Northern Corporation stock
transactions are:
BAIRD PATRICK & CO. MONROE SECURITIES, INC. SANDLER O'NEILL & PARTNERS, LP
20 Exchange Place 47 State Street 919 Third Avenue
New York, NY 10005 Rochester, NY 14614 New York, NY 10022
(212) 493-6619 (800) 766-5560 (800) 635-6851
F. J. MORRISSEY & CO.
BOENNING & SCATTERGOOD, INC. RBC DAIN RAUSCHER RYAN, BECK & COMPANY
4 Tower Bridge - Suite 300 3 Times Square, 24th Floor 3 Parkway
200 Barr Harbor Drive New York, NY 10036 Philadelphia, PA 19102
West Conshohocken, PA 19428 (866) 835-1422 (800) 342-2325
(800) 842-8928
FERRIS, BAKER WATTS, INC.
6 Bird Cage Walk
Holidaysburg, PA 16648
(800) 343-5149
4
INVESTOR INFORMATION
ANNUAL MEETING OF STOCK TRANSFER AGENT INDEPENDENT AUDITORS
SHAREHOLDERS
The Annual Meeting of Shareholders AMERICAN STOCK TRANSFER &
will be held at the Arcadia Theatre in TRUST CO. PARENTE RANDOLPH, PC
Wellsboro, PA, at 2:00 p.m. on Tuesday, 59 Maiden Lane, Plaza Level 400 Market Street
April 15, 2003. New York, NY 10038 Williamsport, PA 17701
(800) 278-4353
GENERAL SHAREHOLDER INQUIRIES
SHOULD BE SENT TO:
CITIZENS & NORTHERN
CORPORATION
90-92 Main Street, P.O. Box 58
Wellsboro, PA 16901
COMMON STOCK AND PER SHARE DATA
2002 2001 2000 1999 1998
Net income per share - basic $ 2.80 $ 2.25 $ 1.58 $ 2.14 $ 2.06
Net income per share - diluted 2.79 2.25 1.58 2.14 2.06
Cash dividends declared per share 1.16 1.04 0.95 0.87 0.78
Cash dividends declared per share - historical basis 1.16 1.06 0.98 0.90 0.82
Stock dividend 1% 1% 1% 1% 1%
Stockholders' equity per share (a) 21.70 18.76 16.58 14.29 16.89
Stockholders' equity per share, excluding accumulated
other comprehensive income (loss) (a) 19.42 17.77 16.57 15.94 14.67
Weighted average shares outstanding - basic 5,339,449 5,348,963 5,363,232 5,362,861 5,367,497
Weighted average shares outstanding - diluted 5,354,041 5,350,452 5,364,386 5,368,325 5,377,392
Number of shares outstanding at year-end 5,285,606 5,234,800 5,207,244 5,153,729 5,102,028
Number of shares authorized 10,000,000 10,000,000 10,000,000 10,000,000 10,000,000
(a) For purposes of this computation, the number of outstanding shares has been
increased for the effects of 1% stock dividends issued in January following each
year-end.
EQUITY COMPENSATION PLAN INFORMATION
The following table sets forth information concerning the Stock Incentive Plan
and Independent Directors Stock Incentive Plan, both of which have been approved
by the Corporation's shareholders. The shareholders have approved all of the
Corporation's equity compensation plans. The figures shown are as of December
31, 2002, and do not include awards made in January 2003. More details related
to the Corporation's equity compensation plans are provided in Notes 1 and 12 to
the consolidated financial statements.
NUMBER OF SECURITIES
NUMBER OF SECURITIES REMAINING AVAILABLE
TO BE ISSUED UPON WEIGHTED-AVERAGE FOR FUTURE ISSUANCE
EXERCISE OF EXERCISE PRICE OF UNDER EQUITY
OUTSTANDING OPTIONS OUTSTANDING OPTIONS COMPENSATION PLANS
- ---------------------------------------------------------------------------------------------------------
Equity compensation plans
approved by shareholders 120,489 $27.17 96,829
5
ITEM 6. SELECTED FINANCIAL DATA (IN THOUSANDS)
INCOME STATEMENT 2002 2001 2000 1999 1998
Interest income $ 57,285 $54,661 $51,643 $48,036 $45,183
Interest expense 26,315 28,356 30,145 24,571 22,693
- ---------------------------------------------------------------------------------------------------------------
Interest margin 30,970 26,305 21,498 23,465 22,490
Provision for loan losses 940 600 676 760 763
- ---------------------------------------------------------------------------------------------------------------
Interest margin after provision for loan losses 30,030 25,705 20,822 22,705 21,727
Other income 6,624 6,120 5,002 6,823 6,359
Securities gains 2,888 1,920 1,377 3,043 3,001
Other expenses 20,849 18,671 16,906 17,732 16,483
- ---------------------------------------------------------------------------------------------------------------
Income before income tax provision 18,693 15,074 10,295 14,839 14,604
Income tax provision 3,734 3,022 1,819 3,354 3,527
- ---------------------------------------------------------------------------------------------------------------
Net income $ 14,959 $12,052 $ 8,476 $11,485 $11,077
===============================================================================================================
BALANCE SHEET AT YEAR END
Total securities (1) $513,597 $437,398 $343,596 $356,287 $327,309
Gross loans, excluding unearned discount 451,145 379,228 328,305 310,892 291,003
Total assets 1,018,768 866,999 719,335 705,898 646,298
Total deposits 640,304 576,274 528,967 500,474 476,518
Stockholders' equity, excluding accumulated
other comprehensive income 103,691 94,903 88,887 85,507 78,645
Total stockholders' equity 115,837 100,187 88,969 76,623 90,567
AVERAGE BALANCE SHEET
Total securities, at amortized cost (1) 470,764 412,654 371,360 349,133 300,692
Gross loans, excluding unearned discount 410,670 346,353 318,382 301,584 285,275
Earning assets 881,434 759,007 689,743 650,717 585,966
Total assets 943,001 805,229 704,221 680,864 626,102
Total assets, excluding unrealized gains/
Losses 930,539 798,590 717,052 672,999 606,163
Total deposits 613,392 544,579 503,848 483,858 448,601
Stockholders' equity, excluding accumulated
other comprehensive income 99,361 91,703 87,258 81,767 74,810
Stockholders' equity 107,595 96,021 78,792 87,143 87,997
FINANCIAL RATIOS
Return on stockholders' equity, excluding
accumulated other comprehensive income (2) 15.06% 13.14% 9.71% 14.05% 14.81%
Return on stockholders' equity (2) 13.90% 12.55% 10.76% 13.18% 12.59%
Return on assets (2) 1.59% 1.50% 1.20% 1.69% 1.77%
Stockholders' equity to assets, excluding
accumulated other comprehensive income (2) 10.68% 11.48% 12.17% 12.15% 12.34%
Stockholders' equity to assets (2) 11.41% 11.92% 11.19% 12.80% 14.05%
Stockholders' equity to loans (2) 26.20% 27.72% 24.75% 28.90% 30.85%
Net income to:
Total interest income 26.11% 22.05% 16.41% 23.91% 24.52%
Interest margin 48.30% 45.82% 39.43% 48.95% 49.25%
Dividends as a % of net income 41.17% 46.08% 60.19% 40.39% 37.81%
(1) Includes available-for-sale and held-to-maturity securities, and
interest-bearing cash and due from banks
(2) Financial ratios calculated based on average balance sheet data
6
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Certain statements in this section and elsewhere in this Annual Report on Form
10-K are forward-looking statements. Citizens & Northern Corporation and its
wholly-owned subsidiaries (collectively, the Corporation) intend such
forward-looking statements to be covered by the safe harbor provisions for
forward-looking statements contained in the Private Securities Reform Act of
1995. Forward-looking statements, which are not historical facts, are based on
certain assumptions and describe future plans, business objectives and
expectations, and are generally identifiable by the use of words such as,
"believe", "expect", "intend", "anticipate", "estimate", "project", and similar
expressions. These forward-looking statements are subject to risks and
uncertainties that are difficult to predict, may be beyond management's control
and could cause results to differ materially from those currently anticipated.
Factors which could have a material, adverse impact on the operations and future
prospects of the Corporation include, but are not limited to, the following:
- - changes in monetary and fiscal policies of the Federal Reserve Board and
the U.S. Government, particularly related to changes in interest rates
- - changes in general economic conditions
- - legislative or regulatory changes
- - downturn in demand for loan, deposit and other financial services in the
Corporation's market area
- - increased competition from other banks and non-bank providers of financial
services
- - technological changes and increased technology-related costs
- - changes in accounting principles, or the application of generally accepted
accounting principles (see "Critical Accounting Policies," later in
Management's Discussion and Analysis).
These risks and uncertainties should be considered in evaluating forward-looking
statements and undue reliance should not be placed on such statements.
EARNINGS OVERVIEW
The Corporation has enjoyed 2 consecutive years with record-high levels of net
income in 2002 and 2001. In 2002, net income was $14,959,000, or $2.80 per share
- - basic and $2.79 per share - diluted. This represents a 24.1% increase over
2001 net income of $12,052,000 ($2.25 per share - basic and diluted). Net income
for 2001 was 42.2% higher than in 2000. In 2000, net income amounted to
$8,476,000 ($1.58 per share - basic and diluted).
The most significant income statement changes between 2002 and 2001, and between
2001 and 2000, are as follows:
- The interest margin (excess of interest income over interest expense)
increased significantly in both 2002 and 2001. The interest margin
increased to $30,970,000 in 2002 from $26,305,000 in 2001, an increase
of $4,665,000 or 17.7%. Further, the interest margin in 2001 was
$4,807,000, or 22.4%, higher in 2001 than in 2000. As discussed in
more detail in the "Net Interest Margin" section of Management's
Discussion and Analysis, growth in the net interest margin over the
last 2 years has resulted from increases in volume of earning assets,
and from falling interest rates paid on deposits and borrowed funds.
For a variety of reasons, including market conditions, the opening of
the Muncy, PA, branch in October 2000, and the hiring of additional
commercial lending staff, the Corporation has achieved significant
growth in loans and deposits in 2002 and 2001. Also, management has
identified opportunities to borrow funds and invest the proceeds in
securities at positive spreads. Changes in interest rates have also
had a dramatic impact on operating results over the last 3 years. As
widely publicized, the Federal Reserve Board lowered its targeted
federal funds rate 11 times during 2001, from 6.5% to 1.75%. The
federal funds target rate remained at 1.75% throughout most of 2002,
until the Fed lowered it to its current level of 1.25% in November
2002. The ripple effects of the Fed's actions throughout the national
and local economy have substantially lowered the Corporation's cost of
funds. In contrast, in 2000, the Fed increased its target rate several
times, which resulted in increases in the Corporation's cost of funds.
- Other (noninterest) income (excluding securities gains) was $6,624,000
in 2002, an increase of $504,000 (8.2%) over 2001. As described in
more detail later in Management's Discussion and Analysis, the major
sources of increased noninterest revenue in 2002 were from Service
Charges on Deposit Accounts and Trust and Financial Management
services. Noninterest income increased $1,118,000, or 22.4%, in 2001
over 2000. The major source of this revenue growth in 2001 was from
recognition of an increase in cash surrender value of insurance of
$905,000. In late December 2000, the Corporation purchased bank-owned
life insurance (BOLI) at a cost of $15,000,000. The Corporation
purchased BOLI to help fund future anticipated increases in employee
benefits. Prior to December 2000, the Corporation had no BOLI
holdings.
7
- Net realized securities gains amounted to $2,888,000 in 2002,
$1,920,000 in 2001 and $1,377,000 in 2000. Most of the gains realized
throughout the 3-year period ended December 31, 2002, were from sales
of bank stocks. The amounts of such gains realized in any accounting
period depend on management's evaluation of the specific stocks owned
by the Corporation.
- Other (noninterest) operating expenses increased $2,178,000, or 11.7%,
in 2002 over 2001, and 10.4% in 2001 over 2000. Higher operating
expenses reflect increases in payroll costs, professional fees,
depreciation and maintenance expense associated with computer hardware
and software. These types of costs have increased as a result of the
need to add personnel and supplement existing systems to keep up with
expansions of services and growth in lending activity over the last
few years. Also, in 2001, the Corporation's operating expenses
increased due to the opening of the Muncy branch. Noninterest expenses
are discussed in more detail later in Management's Discussion and
Analysis.
- The income tax provision increased to $3,734,000 in 2002 from
$3,022,000 in 2001 and $1,819,000 in 2000, primarily because pre-tax
income was higher. The income tax provision, as a percentage of
pre-tax income, was 19.98% in 2002, 20.05% in 2001 and 17.67% in 2000.
More details related to the Corporation's income taxes are provided in
Note 13 to the Consolidated Financial Statements (included in Item 8
of this Form 10-K).
OUTLOOK FOR 2003
Looking into the future, management anticipates another year of good financial
performance in 2003. However, management believes it will be difficult to
continue the pace of earnings growth achieved in 2001 and 2002. With interest
rates at historic lows, there is not much farther for them to fall. Most
economists are predicting a rising interest rate environment as the U. S.
economy recovers from the brief recession and when the uncertainty of war with
Iraq is resolved. The Corporation's interest margin will be affected as higher
yielding loans mature or are refinanced and as higher yielding investments
mature or are called. The Corporation began seeing some reduction in the margin
in the last quarter of 2002. If interest rates do begin to rise, the Corporation
will experience some additional stress on the interest margin because its
interest-bearing liabilities (deposits and borrowings) reprice faster than its
earning assets (primarily, loans and investment securities). Management
continues to look for opportunities to increase noninterest revenues, in an
effort to reduce the Corporation's reliance upon interest rates. The
Corporation's interest rate risk is discussed in more detail in Section 7A of
this Annual Report on Form 10-K.
CRITICAL ACCOUNTING POLICIES
The presentation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect many of the reported amounts and disclosures. Actual results could differ
from these estimates.
A material estimate that is particularly susceptible to significant change is
the determination of the allowance for loan losses. Management believes that the
allowance for loan losses is adequate and reasonable. The Corporation's
methodology for determining the allowance for loan losses is described in a
separate section later in Management's Discussion and Analysis. Given the very
subjective nature of identifying and valuing loan losses, it is likely that
well-informed individuals could make materially different assumptions, and
could, therefore calculate a materially different allowance value. While
management uses available information to recognize losses on loans, changes in
economic conditions may necessitate revisions in future years. In addition,
various regulatory agencies, as an integral part of their examination process,
periodically review the Corporation's allowance for loan losses. Such agencies
may require the Corporation to recognize adjustments to the allowance based on
their judgments of information available to them at the time of their
examination. Further, in 2003, the American Institute of Certified Public
Accountants is expected to issue an exposure draft of a statement of position
that would establish detailed implementation guidance for calculating the
allowance for loan losses. This statement of position is expected to call for
implementation of its provisions beginning in 2004. Implementation of that
detailed implementation guidance, if it is approved, could result in an
adjustment to the Corporation's allowance.
8
Another material estimate is the calculation of fair values of the Corporation's
debt securities. The Corporation receives estimated fair values of debt
securities from an independent valuation service, or from brokers. In developing
these fair values, the valuation service and the brokers use estimates of cash
flows, based on historical performance of similar instruments in similar
interest rate environments. Based on experience, management is aware that
estimated fair values of debt securities tend to vary among brokers and other
valuation services. Accordingly, when selling debt securities, management
typically obtains price quotes from more than one source. As described in Notes
1 and 11 of the consolidated financial statements, the large majority of the
Corporation's securities are classified as available-for-sale. Accordingly,
these securities are carried at fair value on the consolidated balance sheet,
with unrealized gains and losses excluded from earnings and reported separately
through accumulated other comprehensive income (included in stockholders'
equity).
NET INTEREST MARGIN
2003/2002/2001
The Corporation's primary source of operating income is represented by the net
interest margin. The net interest margin is equal to the difference between the
amounts of interest income and interest expense. Tables I, II and III include
information regarding the Corporation's net interest margin in 2002, 2001 and
2000. In each of these tables, the amounts of interest income earned on
tax-exempt securities and loans have been adjusted to a fully taxable-equivalent
basis. Accordingly, the net interest margin amounts presented in these tables
exceed the amounts presented in the consolidated financial statements. Also,
dividends from the Corporation's investment in the Federal Home Loan Bank of
Pittsburgh (FHLB - Pittsburgh), which were included in interest and dividend
income in prior years, have been excluded from the amounts included in the
Tables for 2002, 2001 and 2000 in this year's Annual Report on Form 10-K.
Dividends from FHLB - Pittsburgh stock are now included in Other (Noninterest)
Income in the consolidated statement of income. The discussion that follows is
based on amounts in the Tables.
The net interest margin (also referred to as net interest income), on a
taxable-equivalent basis, was $33,963,000 in 2002, an increase of $5,413,000 or
19.0% over 2001. In turn, fully taxable-equivalent net interest income was
$5,038,000, or 21.4% higher in 2001 than in 2000. As described in the "Earnings
Overview" section of Management's Discussion and Analysis, these increases in
net interest margin were caused mainly by increases in volume of earning assets,
and from declining interest rates on the Corporation's deposits and borrowed
funds. Table III shows the effect of volume and rate changes on the
Corporation's major interest earning assets and interest-bearing liabilities.
Table III shows that changes in volume of earning assets and interest-bearing
liabilities resulted in an increase in net interest income of $4,264,000 in
2002, while changes in rates increased net interest income $1,149,000. In 2001,
when (as discussed in the "Earnings Overview" section) short-term interest rates
fell dramatically, rate changes had the effect of increasing net interest income
$4,472,000, and volume changes increased net interest income $566,000. Table II,
which shows average daily balances and rates, shows that the "Interest Rate
Spread" (excess of average rate of return on interest-earning assets over
average cost of funds on interest-bearing liabilities) widened substantially in
2001 over 2000, and widened a bit more in 2002 over 2001. The Interest Rate
Spread was 3.38% in 2002, 3.17% in 2001 and 2.53% in 2000.
INTEREST INCOME AND EARNING ASSETS
The Corporation's major categories of interest-bearing assets are
available-for-sale investment securities and loans. Total interest income
increased $3,372,000, or 5.9%, in 2002 over 2001. Interest and dividends from
available-for-sale securities increased $1,758,000, or 6.5%, and interest and
fees from loans increased $1,864,000, or 6.3%. In Table III, the growth in
interest income is broken down between the impact of volume changes and the
impact of interest rate changes. Higher average balances of available-for-sale
securities and loans in 2002 than in 2001 resulted in increases in interest
income in 2001, despite lower average rates of return.
Similarly, total interest income increased $3,249,000, or 6.1%, in 2001 over
2000, with the effects of increased average volume of earning assets more than
offsetting the impact of lower average rates. Income from available-for-sale
securities increased $1,544,000, or 6.1% in 2001 over 2000. Interest and fees
from loans increased $1,644,000, or 5.9%, in 2001 over 2000.
As shown in Table II, the average balance of the available-for-sale investment
portfolio (at amortized cost) was $465,650,000 in 2002, $395,908,000 in 2001 and
$359,265,000 in 2000. The major components of the portfolio are mortgage-backed
securities, obligations of state and political subdivisions (municipal bonds),
and U. S. Government Agency securities. Also, the Corporation holds other
corporate debt securities and equity securities (primarily stocks of banks and
bank holding companies). In total, available-for-sale securities grew because
management was able to identify opportunities to borrow funds and invest the
proceeds in securities at a positive spread. These opportunities were available
because of the "steep yield curve" (longer-term interest rates much higher than
shorter-term rates) that existed throughout most of 2002 and 2001. The average
rate of return on available-for-sale securities was 6.16% for 2002, considerably
lower than the 2001 (6.80%) and 2000 (6.92%). The average return on
available-for-sale securities was 5.87% in the 4th quarter 2002.
9
Table II also shows that the composition of the available-for-sale securities
portfolio has changed significantly. The average balance of U.S. Government
agency securities fell to 16% of the average balance of the total portfolio in
2002 from 29% in 2001 and 37% in 2000. In contrast, the average balance of
mortgage-backed securities increased to 45% of the total portfolio in 2002 from
38% in 2001 and 28% in 2000. In 2002 and in the latter part of 2001, as a result
of declining interest rates, substantial amounts of U.S. Government agency
securities were called. The Corporation reinvested much of the proceeds in
mortgage-backed securities. Also, much of the leveraged security purchases
described above consisted of mortgage-backed securities. The portfolio's
increased weighting in mortgage-backed securities is designed to provide
increased cash flow, in the form of monthly principal and interest payments.
This increased level of cash inflows will be available to be reinvested at
higher rates when interest rates rise.
Obligations of state and political subdivisions (municipal bonds) also were a
larger portion of the portfolio in 2002 than in 2001 and 2000. The average
balance of municipal bonds grew to $113,540,000, or 24% of the portfolio, in
2002 from 20% of the portfolio in 2001 and 23% of the portfolio in 2000. On a
taxable equivalent basis, municipal bonds are the highest yielding category of
available-for-sale security. The Corporation determines the levels of its
municipal bond holdings based on income tax planning and other considerations.
Other securities consist of corporate obligations, mainly "Trust Preferred
Securities" issued by financial institutions. Trust Preferred Securities are
long-term obligations (usually 20-40 year maturities, often callable at the
issuer's option after 5-10 years) which bear interest at fixed or variable
rates. The average balance of other securities increased to $43,826,000 in 2002
from $29,577,000 in 2001 and $22,572,000, primarily as a result of purchases of
Trust Preferred Securities.
The loan portfolio makes up most of the balance of the earning asset base and is
the largest contributor to total interest income. The Corporation's market area
consists of small rural communities. Consequently, the loan portfolio is
retail-oriented, consisting mostly of real estate secured mortgages on
one-to-four family dwellings. Total average real estate secured mortgage loans
made up approximately 80% of the loan portfolio during 2002, 2001 and 2000. In
2002 and 2001, there has been significant growth in lending activities. Average
loans outstanding increased $64,317,000, or 18.6%, in 2002, and $27,971,000, or
8.8%, in 2001. Much of the growth in the loan portfolio in 2002 and 2001 has
been in real estate secured loans, including commercial as well as residential
real estate loans. Lower market interest rates, which have spurred significant
levels of refinancing, and have resulted in many individuals' and businesses'
willingness to take on more debt, have contributed to the Corporation's loan
growth. Also, the Corporation's loan growth is attributable to the opening of
the Muncy office, along with the hiring of several additional lending personnel
in 2002 and 2001. The balance of the loan portfolio includes consumer
installment loans and commercial loans. The Corporation also has a credit card
operation, which is operated for the Corporation's customers and for other
banks.
The average return on the total loan portfolio for 2002 was 7.67%, down from
8.56% in 2001 and 8.79% in 2000. The lower return in 2002 was impacted by
significant levels of mortgage refinancings, and by lower returns on commercial
loans with variable rates. The average return on loans was 7.42% in the 4th
quarter 2002.
INTEREST EXPENSE AND INTEREST-BEARING LIABILITIES
Interest expense fell to $26,315,000 in 2002 from $28,356,000 in 2001 and
$30,145,000 in 2000. As reflected in Table III, lower average interest rates had
the effect of lowering expense $7,184,000 in 2002 and $5,994,000 in 2001. The
impact of lower rates more than offset the effects on interest expense of higher
average balances of interest-bearing liabilities. As shown in Table II. average
balances of interest-bearing liabilities increased 18.1%, to $760,738,000 in
2002, and 13.8%, to $643,980,000 in 2001.
As reflected in Table III, lower rates caused interest expense from money market
accounts to fall $1,392,000 in 2002, and $2,518,000 in 2001. Money market
accounts are repriced weekly, and thus are highly rate sensitive. As shown in
Table II, the average cost of money market funds was 2.31% in 2002, 3.49% in
2001 and 5.39% in 2000.
Table III also shows that interest expense from savings accounts declined in
2002 and 2001. Interest expense from savings accounts fell $508,000 in 2002 and
$132,000 in 2001. In 2001, the Corporation's savings rate fell 2 times, from
2.5% to 2%, and then to its current level of 1%. As a result, the average
interest rate incurred on savings accounts fell to 1.01% in 2002 from 2.16% in
2001 and 2.49% in 2000.
10
Interest expense from CDs decreased $1,532,000 in 2002 and increased $1,109,000
in 2001. Because CDs have terms that may range from 3 months to 5 years, they do
not reprice as quickly as money market accounts or IRAs. The average rate
incurred on CDs was 3.97% in 2002, 5.48% in 2001 and 5.64% in 2000.
In contrast to the other major types of deposits, interest expense from
Individual Retirement Accounts (IRAs) increased $455,000 in 2002. As shown in
Table II, in 2002, the average balance of IRAs increased 14.3%, to $90,856,000.
Throughout 2002, the Corporation offered the highest IRA rate in its
marketplace, which was instrumental in this growth. For several years, the
Corporation's IRA product was adjustable rate, repriced quarterly based on an
index, with a floor of 5%. Effective September 1, 2002, the Corporation made
changes to its IRA products, including: (1) for new IRAs, reduced the floor to
4%, and removed the tie to an external index, on the quarterly repricing IRA
product, and (2) began to offer the Index Powered CD as an additional IRA
product. (Index Powered CDs are described in detail in Note 10 to the
consolidated financial statements.) In 2001, interest expense from IRAs fell
$756,000, as falling interest rates gradually caused the Corporation's IRA rate
to fall to the floor of 5%. The average rate incurred on IRAs was 4.98% in 2002,
5.12% in 2001 and 6.32% in 2000.
As you can calculate from Table II, average total deposits (interest-bearing and
noninterest-bearing) increased $68,813,000, or 12.6%, in 2002. In 2001, average
total deposits increased $40,731,000, or 8.1%. In addition to IRAs, as described
above, the other major types of deposits that increased in 2002 and 2001 were
CDs, money market accounts and demand (checking) accounts. Management believes
that deposit growth has resulted, in part, from declines in the U.S stock
market, which has caused some investors to move funds to less volatile
investments. Also, deposit growth has been enhanced by the expansion of the
branch system in recent years, with relatively new offices opened in Mansfield
(1998) and Muncy (2000).
Interest expense on borrowed funds is presented in Table I in 2 categories -
"Overnight borrowings" and "Other borrowed funds." Overnight borrowings include
federal funds purchased from other banks and overnight repurchase agreements
with FHLB - Pittsburgh. Other borrowed funds include overnight repurchase
agreements with customers (the Corporation's "RepoSweep" accounts), borrowings
from FHLB - Pittsburgh and other repurchase agreements.
Interest expense on average other borrowed funds increased $1,278,000 in 2002
and $1,125,000 in 2001. Average other borrowed funds balances increased to
$211,092,000 in 2002 from $151,615,000 in 2001 and $108,581,000 in 2000. As
discussed in the "Interest Income - Earning Assets" section above, the
Corporation borrowed funds in 2002 and 2001 to fund purchases of
available-for-sale securities. Because of a favorable interest rate environment,
the Corporation extended the terms of most of its borrowings from very short
term (as of the end of 2000) to a "ladder" of staggered maturities extending out
(primarily) over 5 years. Note 9 to the consolidated financial statements
provides more details regarding the composition of borrowed funds as of December
31, 2002 and 2001. Average interest rates on other borrowed funds amounted to
4.29% in 2002, 5.13% in 2001 and 6.13% in 2000. Overall, Table III shows that
lower rates had the effect of reducing interest expense associated with other
borrowed funds in 2002 by $1,421,000, while higher average borrowing balances
increased interest expense $2,699,000. In 2001, lower average rates decreased
interest expense $1,208,000, while the increase in average borrowings increased
interest expense by $2,333,000.
11
TABLE I - ANALYSIS OF INTEREST INCOME AND EXPENSE
YEARS ENDED DECEMBER 31, INCREASE(DECREASE)
(IN THOUSANDS) 2002 2001 2000 02/01 01/00
INTEREST INCOME
Available-for-sale securities:
U.S. Treasury securities $ 75 $ 151 $ 154 $ (76) $ (3)
Securities of other U.S. Government agencies and corporations 4,728 7,718 9,417 (2,990) (1,699)
Mortgage-backed securities 11,097 9,487 6,874 1,610 2,613
Obligations of states and political subdivisions 8,641 6,216 6,342 2,425 (126)
Equity securities 1,148 1,090 851 58 239
Other securities 2,975 2,244 1,724 731 520
- ----------------------------------------------------------------------------------------------------------------------------------
Total available-for-sale securities 28,664 26,906 25,362 1,758 1,544
- ----------------------------------------------------------------------------------------------------------------------------------
Held-to-maturity securities:
U.S. Treasury securities 27 40 37 (13) 3
Securities of other U.S. Government agencies and corporations 20 43 68 (23) (25)
Mortgage-backed securities 9 16 21 (7) (5)
- ----------------------------------------------------------------------------------------------------------------------------------
Total held-to-maturity securities 56 99 126 (43) (27)
- ----------------------------------------------------------------------------------------------------------------------------------
Interest-bearing due from banks 17 82 114 (65) (32)
Federal funds sold 42 184 64 (142) 120
Loans:
Real estate loans 25,454 23,431 21,895 2,023 1,536
Consumer 2,974 3,055 3,056 (81) (1)
Agricultural 199 190 191 9 (1)
Commercial/industrial 1,934 1,831 1,847 103 (16)
Other 69 68 71 1 (3)
Political subdivisions 858 1,043 909 (185) 134
Leases 11 17 22 (6) (5)
- ----------------------------------------------------------------------------------------------------------------------------------
Total loans 31,499 29,635 27,991 1,864 1,644
- ----------------------------------------------------------------------------------------------------------------------------------
Total Interest Income 60,278 56,906 53,657 3,372
3,249
- ----------------------------------------------------------------------------------------------------------------------------------
INTEREST-BEARING LIABILITIES
Interest checking 425 651 1,036 (226) (385)
Money market 3,970 5,362 7,880 (1,392) (2,518)
Savings 504 1,012 1,144 (508) (132)
Certificates of deposit 7,752 9,284 8,175 (1,532) 1,109
Individual Retirement Accounts 4,528 4,073 4,829 455 (756)
Other time deposits 36 35 44 1 (9)
Overnight borrowings 44 161 384 (117) (223)
Other borrowed funds 9,056 7,778 6,653 1,278 1,125
- ----------------------------------------------------------------------------------------------------------------------------------
Total Interest Expense 26,315 28,356 30,145 (2,041) (1,789)
- ----------------------------------------------------------------------------------------------------------------------------------
Net Interest Income $33,963 $28,550 $23,512 $ 5,413 $ 5,038
==================================================================================================================================
(1) Interest income from tax-exempt securities and loans has been adjusted to a
fully taxable-equivalent basis, using the Corporation's marginal federal income
tax rate of 34%.
(2) Fees on loans are included with interest on loans and amounted to $1,286,000
in 2002, $1,054,000 in 2001 and $761,000 in 2000.
12
TABLE II - ANALYSIS OF AVERAGE DAILY BALANCES AND RATES
2002 2001 2000
(DOLLARS IN THOUSANDS) RATE OF RATE OF RATE OF
RETURN/ RETURN/ RETURN/
AVERAGE COST OF AVERAGE COST OF AVERAGE COST OF
BALANCE FUNDS BALANCE FUNDS BALANCE FUNDS
% % %
EARNING ASSETS
Available-for-sale securities, at amortized cost:
U.S. Treasury securities $ 1,241 6.04 $ 2,506 6.03 $ 2,512 6.13
Securities of other U.S. Government agencies and
corporations 75,646 6.25 113,186 6.82 133,063 7.08
Mortgage-backed securities 209,539 5.30 150,838 6.29 101,155 6.80
Obligations of states and political subdivisions 113,540 7.61 78,741 7.89 81,312 7.80
Equity securities 21,858 5.25 21,060 5.18 18,651 4.56
Other securities 43,826 6.79 29,577 7.59 22,572 7.64
- ---------------------------------------------------------------------------------------------------------------------------------
Total available-for-sale securities 465,650 6.16 395,908 6.80 359,265 7.06
- ---------------------------------------------------------------------------------------------------------------------------------
Held-to-maturity securities:
U.S. Treasury securities 511 5.28 742 5.39 685 5.40
Securities of other U.S. Government agencies and
corporations 331 6.04 680 6.32 1,019 6.67
Mortgage-backed securities 131 6.87 205 7.80 283 7.42
- ---------------------------------------------------------------------------------------------------------------------------------
Total held-to-maturity securities 973 5.76 1,627 6.08 1,987 6.34
- ---------------------------------------------------------------------------------------------------------------------------------
Interest-bearing due from banks 1,444 1.18 2,659 3.08 1,861 6.13
Federal funds sold 2,698 1.56 5,064 3.63 1,000 6.40
Loans:
Real estate loans 338,133 7.53 279,828 8.37 254,225 8.61
Consumer 29,720 10.01 28,062 10.89 27,760 11.01
Agricultural 2,556 7.79 2,070 9.18 1,963 9.73
Commercial/industrial 28,182 6.86 22,212 8.24 21,336 8.66
Other 1,028 6.71 892 7.62 886 8.01
Political subdivisions 10,929 7.85 13,108 7.96 12,009 7.57
Leases 122 9.02 181 9.39 203 10.84
- ---------------------------------------------------------------------------------------------------------------------------------
Total loans 410,670 7.67 346,353 8.56 318,382 8.79
- ---------------------------------------------------------------------------------------------------------------------------------
Total Earning Assets 881,435 6.84 751,611 7.57 682,495 7.86
Cash 13,318 11,871 10,887
Unrealized gain/loss on securities 12,462 6,639 (12,831)
Allowance for loan losses (5,453) (5,370) (5,233)
Bank premises and equipment 10,246 9,602 8,712
Other assets 30,993 30,876 20,191
- ---------------------------------------------------------------------------------------------------------------------------------
Total Assets $ 943,001 $ 805,229 $ 704,221
=================================================================================================================================
INTEREST-BEARING LIABILITIES
Interest checking $ 37,984 1.12 $ 37,192 1.75 $ 36,086 2.87
Money market 171,767 2.31 153,738 3.49 146,209 5.39
Savings 49,779 1.01 46,750 2.16 45,963 2.49
Certificates of deposit 195,099 3.97 169,275 5.48 144,997 5.64
Individual Retirement Accounts 90,856 4.98 79,482 5.12 76,439 6.32
Other time deposits 1,814 1.98 1,916 1.83 1,717 2.56
Overnight borrowings 2,347 1.87 4,012 4.01 5,721 6.71
Other borrowed funds 211,092 4.29 151,615 5.13 108,581 6.13
- ---------------------------------------------------------------------------------------------------------------------------------
Total Interest-bearing Liabilities 760,738 3.46 643,980 4.40 565,713 5.33
Demand deposits 66,093 56,226 52,437
Other liabilities 8,575 9,002 7,279
- -------------------------------------------------------------------------- --------------- --------------
Total Liabilities 835,406 709,208 625,429
- -------------------------------------------------------------------------- --------------- --------------
Stockholders' equity, excluding other comprehensive
income/loss 99,361 91,703 87,258
Other comprehensive income/loss 8,234 4,318 (8,466)
- -------------------------------------------------------------------------- --------------- --------------
Total Stockholders' Equity 107,595 96,021 78,792
- -------------------------------------------------------------------------- --------------- --------------
Total Liabilities and Stockholders' Equity $ 943,001 $ 805,229 $ 704,221
========================================================================== =============== ==============
Interest Rate Spread 3.38 3.17 2.53
Net Interest Income/Earning Assets 3.85 3.80 3.45
(1) Rates of return on tax-exempt securities and loans are calculated on a
fully-taxable equivalent basis, using the Corporation's marginal federal
income tax rate of 34%.
(2) Nonaccrual loans are included in the loan balances above.
13
TABLE III - THE EFFECT OF VOLUME AND RATE CHANGES ON INTEREST INCOME AND
INTEREST EXPENSE
YEARS ENDED 12/31/02 VS. 01 YEARS ENDED 12/31/01 VS. 00
(IN THOUSANDS) CHANGE IN CHANGE IN TOTAL CHANGE IN CHANGE IN TOTAL
VOLUME RATE CHANGE VOLUME RATE CHANGE
EARNING ASSETS
Available-for-sale securities:
U.S. Treasury securities $ (76) $ - $ (76) $ - $ (3) $ (3)
Securities of other U.S. Government agencies
and corporations (2,389) (601) (2,990) (1,364) (335) (1,699)
Mortgage-backed securities 3,277 (1,667) 1,610 3,158 (545) 2,613
Obligations of states and political
subdivisions 2,655 (230) 2,425 (202) 76 (126)
Equity securities 42 16 58 117 122 239
Other securities 987 (256) 731 531 (11) 520
- ------------------------------------------------------------------------------------------------------------------------------------
Total available-for-sale securities 4,496 (2,738) 1,758 2,240 (696) 1,544
- ------------------------------------------------------------------------------------------------------------------------------------
Held-to-maturity securities:
U.S. Treasury securities (12) (1) (13) 3 - 3
Securities of other U.S. Government agencies
and corporations (21) (2) (23) (21) (4) (25)
Mortgage-backed securities (5) (2) (7) (6) 1 (5)
- ------------------------------------------------------------------------------------------------------------------------------------
Total held-to-maturity securities (38) (5) (43) (24) (3) (27)
- ------------------------------------------------------------------------------------------------------------------------------------
Interest-bearing due from banks (27) (38) (65) 38 (70) (32)
Federal funds sold (64) (78) (142) 159 (39) 120
Loans:
Real estate loans 4,550 (2,527) 2,023 2,157 (621) 1,536
Consumer 174 (255) (81) 33 (34) (1)
Agricultural 41 (32) 9 10 (11) (1)
Commercial/industrial 442 (339) 103 74 (90) (16)
Other 9 (8) 1 - (3) (3)
Political subdivisions (171) (14) (185) 86 48 134
Leases (5) (1) (6) (2) (3) (5)
- ------------------------------------------------------------------------------------------------------------------------------------
Total loans 5,040 (3,176) 1,864 2,358 (714) 1,644
- ------------------------------------------------------------------------------------------------------------------------------------
Total Interest Income 9,407 (6,035) 3,372 4,771 (1,522) 3,249
- ------------------------------------------------------------------------------------------------------------------------------------
INTEREST-BEARING LIABILITIES
Interest checking 14 (240) (226) 31 (416) (385)
Money market 574 (1,966) (1,392) 388 (2,906) (2,518)
Savings 62 (570) (508) 20 (152) (132)
Certificates of deposit 1,277 (2,809) (1,532) 1,337 (228) 1,109
Individual Retirement Accounts 570 (115) 455 186 (942) (756)
Other time deposits (2) 3 1 5 (14) (9)
Overnight borrowings (51) (66) (117) (95) (128) (223)
Other borrowed funds 2,699 (1,421) 1,278 2,333 (1,208) 1,125
- ------------------------------------------------------------------------------------------------------------------------------------
Total Interest Expense 5,143 (7,184) (2,041) 4,205 (5,994) (1,789)
- ------------------------------------------------------------------------------------------------------------------------------------
Net Interest Income $ 4,264 $ 1,149 $ 5,413 $ 566 $ 4,472 $ 5,038
====================================================================================================================================
(1) Changes in interest income on tax-exempt securities and loans are presented
on a fully taxable-equivalent basis, using the Corporation's marginal federal
income tax rate of 34%.
(2) The change in interest due to both volume and rates has been allocated to
volume and rate changes in proportion to the relationship of the absolute dollar
amounts of the change in each.
14
NONINTEREST INCOME
2002/2001/2000
Total noninterest income increased $1,472,000, or 18.3%, in 2002 compared to
2001. The increase in net realized security gains is discussed in the "Earnings
Overview" section of Management's Discussion and Analysis. Other items of
significance are as follows:
2002 VS. 2001
- - Service charges on deposit accounts increased $349,000, or 25.4%. This
increase resulted from growth in deposits, as well as fee increases
implemented in the second half of 2001 on certain types of services.
- - Trust and financial management revenue increased $179,000, or 11.4%. This
increase resulted from fee increases implemented in the latter part of
2001, and from receipt of certain fees for services provided prior to 2002.
Trust revenue is recorded on a cash basis, which does not vary materially
from the accrual basis.
2001 VS. 2000
Total noninterest income increased $1,661,000, or 26.0%, in 2001 compared to
2000. The most significant changes - the increase in security gains and income
from the (BOLI) life insurance contract - are discussed in the "Earnings
Overview" section of Management's Discussion and Analysis. Other items of
significance are as follows:
- - Service charges on deposit accounts increased $226,000, or 19.7%. This
increase resulted from increased numbers of accounts and higher average
balances, as well as fee increases on certain types of services.
- - Insurance revenue increased $210,000, or 56.5%. This increase is mainly
attributable to revenue from the insurance agency division of C&N Financial
Services Corporation (C&NFSC). C&NFSC began operations in 2000, with
minimal revenues. C&NFSC generated insurance revenue of $216,000 in 2001
and $22,000 in 2000.
- - Noninterest fees from the credit card operation decreased $347,000, or
38.7%. In late 1999, the Corporation sold its merchant processing program,
which dramatically reduced the amount of interchange fees earned and costs
incurred. In the first quarter 2000, the Corporation recorded final
residual fees.
- - Other operating income increased $146,000. In 2001, C&NFSC began operating
a broker dealer division, which offers annuities, mutual funds and other
non-bank investment products. The broker dealer division generated revenue
of $84,000 in 2001. Another significant change within the items included in
other operating income is interchange fees received from the Bank's VISA
check card product. This product was introduced in late 1999, and has grown
in numbers of accounts and usage. These fees increased to $87,000 in 2001
from $42,000 in 2000. Also within other operating income, gains from sales
of other real estate properties increased to $135,000 in 2001 from $104,000
in 2000.
TABLE IV - COMPARISON OF NONINTEREST INCOME
(IN THOUSANDS) 2002 % CHANGE 2001 % CHANGE 2000
Service charges on deposit accounts $ 1,725 25.4 $ 1,376 19.7 $ 1,150
Service charges and fees 258 4.5 247 6.5 232
Trust and financial management revenue 1,755 11.4 1,576 (2.3) 1,613
Insurance commissions, fees and premiums 577 (0.9) 582 56.5 372
Increase in cash surrender value of life
insurance 853 (5.7) 905 N/A -
Fees related to credit card operation 631 14.7 550 (38.7) 897
Other operating income 825 (6.7) 884 19.8 738
- -----------------------------------------------------------------------------------------------------------------
Total other income before realized gains on
securities, net 6,624 8.2 6,120 22.4 5,002
Realized gains on securities, net 2,888 50.4 1,920 39.4 1,377
- -----------------------------------------------------------------------------------------------------------------
Total Other Income $ 9,512 18.3 $ 8,040 26.0 $ 6,379
=================================================================================================================
15
OTHER NONINTEREST EXPENSE
2002/2001/2000
Total noninterest expense increased 11.7% in 2002, to $20,849,000. In 2001,
total noninterest expense was $18,671,000, a 10.4% increase over 2000.
2002 VS. 2001
Salaries and wages increased $925,000, or 10.9%, in 2002 compared to 2001. The
increase is the result of annual merit raises ranging from 2%-5%, an increase in
the number of employees and an increase in incentive bonus expense. Increases in
staff during the last half of 2001 and throughout 2002 included the addition of
new positions in branch and commercial lending, branch administration,
compliance and marketing. The incentive bonus plan provides for compensation to
be paid to certain key officers based on a combination of corporate and personal
performance. Total incentive bonus expense increased $185,000 in 2002.
Pensions and other employee benefits increased $438,000, or 19.8%, in 2002 over
2001. A portion of this increase is directly related to the increase in salaries
and wages. Also, pension expense from the Corporation's defined benefit pension
plan increased $245,000 in 2002 over 2001. A decline in the market value of plan
assets was the main cause of the increase in expense in 2002. Note 12 to the
consolidated financial statements provides more information related to the
defined benefit pension plan.
Other expense increased $704,000, or 15.9%, in 2002 over 2001. This category
includes many different types of expenses. Some of the overall increase in this
category was caused by increases in number of transactions processed and number
of employees. The most significant changes within this category are as follows:
- Expenses of Bucktail Life Insurance Company, increased $111,000, to
$335,000. This increase resulted mainly from a larger amount of life
insurance claims incurred.
- Professional fees increased $101,000, to $276,000. This increase
reflected costs associated with organizational and product
profitability consultants, human resources consultants and other
consultants related to various aspects of the Corporation's
operations.
- Office and other supplies increased $77,000, to $502,000, as a result
of increased volumes of employees and customers.
- Restricted stock amortization increased $58,000, to $80,000. This
category of expense included amortization associated with 2 years of
awards to Directors and certain employees in 2002, compared to only 1
year in 2001 (the first year for which there were restricted stock
awards). Stock-based compensation plans are described in more detail
in Note 12 to the financial statements.
- In 2002, the Corporation wrote off asset-liability reporting software
of $41,000, due to management's decision to change to an outsourcing
provider of asset-liability reports.
2001 VS. 2000
Salaries and wages increased $896,000, or 11.8%, in 2001 compared to 2000. The
increase is the result of annual merit raises ranging from 2%-5%, and an
increase in the number of employees. Higher staffing levels were required for
the Muncy branch, commercial and retail lending, trust and financial management
and insurance sales and service.
Pensions and other employee benefits increased $274,000, or 14.1%, in 2001. In
addition to increased costs resulting from the higher number of employees, the
Corporation experienced an increase in medical insurance premium rates.
Occupancy expense increased $90,000, or 9.7%, in 2001. This increase is mainly
due to additional facilities. In 2000, the Corporation constructed a new branch
in Muncy, purchased a building for credit card operations, and purchased 2
buildings near the Wellsboro branch/administrative building for additional
administrative space.
16
Furniture and equipment expense increased $237,000, or 19.8%, in 2001. The major
categories of furniture and equipment expense that increased in 2001 compared to
2000 were maintenance costs associated with computer hardware and software, and
depreciation. The increase in computer maintenance costs is mainly attributable
to the timing of certain maintenance costs. Increased depreciation expense
resulted primarily from the addition of the Muncy branch, which began operations
in the 4th quarter 2000, and the opening of the new credit card operations
facility in mid-2000.
Credit card expenses decreased in 2001 because of lower interchange fees paid.
This change resulted from the sale of the merchant banking program, as discussed
in the "Noninterest Income" section of Management's Discussion and Analysis.
Other expense increased $346,000, or 8.5%, in 2001. This category includes many
different types of expenses. Some of the overall increase in this category was
caused by increases in number of transactions processed and number of employees.
The most significant fluctuations in individual types of expenses between years
are as follows:
- - Customer support and maintenance charges related to software products
increased $74,000, to $144,000, in 2001. This reflects increased use of
third-party software programs for specialized applications, which are used
as a complement to the Corporation's core, in house programs.
- - In 2001, the Corporation incurred consulting expense of $51,000 related to
sales and service training. This training program is a substantial
undertaking, aimed at improving the sales and service skills of virtually
all employees. The amount of expense noted here does not include costs of
miscellaneous training materials, nor more significantly, any allocation of
internal payroll-related costs associated with sales and service training.
- - Telephone expenses related to data lines increased $47,000, to $254,000, in
2001. These costs are mainly related to the Corporation's computer network
that allows all branches and operating locations to access mainframe and PC
applications. The Corporation's monthly data line costs increased to
approximately the current level starting in the 2nd quarter 2000.
- - Public relations expense increased $45,000, to $189,000, in 2001. This
increase includes new sponsorships of several community-oriented programs
located in the Corporation's market area, as well as costs related to
promotion of the Muncy office.
- - Expenses associated with maintaining other real estate properties increased
$42,000, to $76,000, in 2001.
- - In 2000, the Corporation incurred professional fees of $193,000 related to
a proposed merger with Peoples, Ltd. of Wyalusing, PA. In November 2000,
the vote by Peoples, Ltd.'s shareholders did not result in the 75%
affirmative count required to approve the deal.
TABLE V - COMPARISON OF NONINTEREST EXPENSE
(IN THOUSANDS) 2002 % CHANGE 2001 % CHANGE 2000
Salaries and wages $ 9,418 10.9 $ 8,493 11.8 $ 7,597
Pensions and other employee benefits 2,651 19.8 2,213 14.1 1,939
Occupancy expense, net 1,094 7.5 1,018 9.7 928
Furniture and equipment expense 1,532 7.1 1,431 19.8 1,194
Expenses related to credit card operation 285 (3.4) 295 (27.5) 407
Pennsylvania shares tax 734 (7.1) 790 4.5 756
Other operating expense 5,135 15.9 4,431 8.5 4,085
- ------------------------------------------------------------------------------------------------------------------
Total Other Expense $ 20,849 11.7 $ 18,671 10.4 $ 16,906
==================================================================================================================
17
FINANCIAL CONDITION
Significant changes in the average balances of the Corporation's earning assets
and interest-bearing liabilities are described in the "NET INTEREST MARGIN"
section of Management's Discussion and Analysis. In particular, the discussion
of changes in available-for-sale securities, loans, deposits and borrowed funds
in 2002 is sufficient to explain the overall change in the year-end balances in
2002 compared to 2001. Other significant balance sheet items - the allowance for
loan losses and stockholders' equity - are discussed in separate sections of
Management's Discussion and Analysis.
Table VI shows the composition of the investment portfolio at December 31, 2002,
2001 and 2000.
Premises and equipment, net of accumulated depreciation, increased to
$10,333,000 at December 31, 2002 from $9,967,000 at December 31, 2001. The total
cost of premises and equipment purchases was $1,712,000 in 2002, $1,935,000 in
2001 and $2,426,000 in 2000. In 2002, the most significant capital purchases
included renovations of the Tioga and Athens offices, and completion of
renovations to the leased facility on Main Street in Wellsboro. Other major
categories of capital purchases in 2002 included purchases of computer hardware
and software, and purchase and demolition of property adjacent to the Wysox
office. In 2001, the most significant capital purchases were for new proof of
deposit software, renovations to branches and a new telephone system. The most
significant capital investment in 2000 was the addition of the Muncy branch, for
which land, building construction and initial furniture and equipment cost
slightly more than $1,000,000. Depreciation expense amounted to $1,346,000 in
2002, $1,300,000 in 2001 and $1,086,000 in 2000.
The total cost of capital expenditures for 2003 is expected to be in the range
of the amounts spent in 2000-2002. Capital expenditures will not have a
detrimental effect on the Corporation's financial condition in 2003.
TABLE VI - INVESTMENT SECURITIES
AS OF DECEMBER 31,
2002 2001 2000
(IN THOUSANDS)
AMORTIZED FAIR AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE COST VALUE
AVAILABLE-FOR-SALE SECURITIES:
Obligations of the U.S. Treasury $ - $ - $ 2,503 $ 2,557 $ 2,509 $ 2,533
Obligations of other U.S. Government agencies 71,657 72,348 75,295 75,172 132,713 128,883
Obligations of states and political subdivisions 127,690 130,879 95,835 95,261 68,236 69,065
Other securities 62,296 63,592 34,315 34,532 22,111 20,964
Mortgage-backed securities 207,244 212,276 198,269 198,975 91,708 91,240
- ----------------------------------------------------------------------------------------------------------------------------------
Total debt securities 468,887 479,095 406,217 406,497 317,277 312,685
Marketable equity securities 24,886 33,080 19,745 27,472 22,098 26,814
- ----------------------------------------------------------------------------------------------------------------------------------
Total $ 493,773 $512,175 $ 425,962 $433,969 $ 339,375 $339,499
==================================================================================================================================
HELD-TO-MATURITY SECURITIES:
Obligations of the U.S. Treasury $ 321 $ 359 $ 726 $ 735 $ 707 $ 708
Obligations of other U.S. Government agencies 297 322 547 561 946 947
Mortgage-backed securities 89 93 175 181 258 259
- ----------------------------------------------------------------------------------------------------------------------------------
Total $ 707 $ 774 $ 1,448 $ 1,477 $ 1,911 $ 1,914
==================================================================================================================================
18
PROVISION AND ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is maintained at a level which, in management's
judgment, is adequate to absorb credit losses inherent in the loan portfolio.
The amount of the allowance is based on management's evaluation of the
collectibility of the loan portfolio. In evaluating collectibility, management
considers a number of factors, including the status of specific impaired loans,
trends in historical loss experience, delinquency trends, credit concentrations,
comparison of historical loan loss data to that of other financial institutions
and economic conditions within the Corporation's market area. Allowances for
impaired loans are determined based on collateral values or the present value of
estimated cash flows. The allowance is increased by a provision for loan losses,
which is charged to expense, and reduced by charge-offs, net of recoveries.
Each quarter, management performs a detailed assessment of the allowance and the
provision for loan losses. The loan quality committee performs this assessment.
This committee includes the Bank's President, Chief Financial Officer, Executive
Vice Presidents in charge of loans and branch administration and additional
commercial lending staff. The committee reviews the identified risk elements in
the loan portfolio, including the "Watch List", past due reports and other
information. The "Watch List" is a collection of loans that have a history of
delinquency, collateral deficiency, cash flow problems, or other factors that
have come to management's attention to create the need for special monitoring.
The Bank also engages a consulting firm each year to perform an independent
credit review. Their review is performed annually on credit relationships of
$250,000 and higher as well as other selected credit relationships. The loan
quality committee gives substantial consideration to the classifications and
recommendations of the independent credit reviewer in determining the allowance
for loan losses.
The allowance for loan losses includes two components, allocated and
unallocated. The allocated component of the allowance for loan losses reflects
expected losses resulting from the analysis of individual loans and historical
loss experience, as modified for identified trends and concerns, for each loan
category. The historical loan loss experience element is determined based on the
ratio of net charge-offs to average loan balances over a five-year period, for
each significant type of loan, modified for risk adjustment factors identified
by management for each type of loan. The charge-off ratio, as modified, is then
applied to the current outstanding loan balance for each type of loan (net of
Watch List and other loans that are individually evaluated).
The unallocated portion of the allowance is determined based on management's
assessment of general economic conditions as well as specific economic factors
in the market area. This determination inherently involves a higher degree of
uncertainty and considers current risk factors that may not have yet manifested
themselves in the Bank's historical loss factors used to determine the allocated
component of the allowance, and it recognizes that management's knowledge of
specific losses within the portfolio may be incomplete.
Table IX reflects an allowance of $1,877,000 for losses related to impaired
loans as of December 31, 2002. This reflects management's evaluation of
impairment associated with several commercial loan relationships. Management
believes it has been conservative, but reasonable, in its commercial loan
impairment calculations. However, the actual losses realized from these
relationships could vary materially from the allowances calculated as of
December 31, 2002.
As you can see in Table IX, the allowance for loan losses related to impaired
loans was much higher at December 31, 2002 than as of the ends of each of the
previous 4 years. In years prior to 2002, amounts disclosed related to impaired
loans were limited to commercial loans that had been classified as nonaccrual.
Effective in the fourth quarter 2002, management changed its method of
identifying impaired loans to include all individual loans for which an
allowance was calculated. Management believes this method of determining
disclosure information is more consistent with the applicable requirements of
FASB Statements No. 114 and 118. This change affects disclosures related to
impaired loans, and the allocation of the allowance for loan losses as presented
in Table IX, but does not represent a change in management's method for
calculating the allowance for loan losses.
As noted in Table IX, the unallocated portion of the allowance for loan losses
was $1,759,000 at December 31, 2002 and $2,187,000 at December 31, 2001. The
unallocated balances ranged from $1,759,000 to $2,222,000 in 2002 and $1,983,000
to $2,364,000 during 2001. In evaluating the unallocated portion of the
allowance, management considers several trends, including comparisons of loan
loss data to other financial institutions and tracking of delinquency and
charge-off trends. Loan delinquency data has been fairly consistent over the
last 2 years. Total 90 day or more past due loans, plus nonaccrual loans,
amounted to $3,570,000 (0.79% of total loans) at December 31, 2002, and
$3,117,000 (0.82% of total loans) at December 31, 2001. Total 30-89 day past due
loans amounted to $8,853,000 (1.96% of total loans) at December 31, 2002, and
$7,066,000 (1.86% of total loans) at December 31, 2001. As reflected in Table
VIII, gross and net charge-offs were slightly lower in 2002 than in any of the
previous 4 years; however, in light of the increase in allowances on impaired
loans, this may not be a sustainable trend.
19
The provision for loan losses amounted to $940,000 in 2002, $600,000 in 2001 and
$676,000 in 2000. The higher provision in 2002 reflects increased estimates of
allowances on impaired or Watch List loans, as described above. The amount of
the provision in each year is determined based on the amount required to
maintain an appropriate allowance in light of the factors described above.
Tables VII, VIII, IX and X present an analysis of the loan portfolio, the
allowance for loan losses, the allocation of the allowance and a five-year
summary of loans by type.
TABLE VII - FIVE-YEAR HISTORY OF LOAN LOSSES (IN THOUSANDS)
2002 2001 2000 1999 1998 AVERAGE
Year-end gross loans, excluding
unearned discount $451,145 $379,228 $328,305 $310,892 $291,003 $352,115
Year-end allowance for loan
Losses 5,789 5,265 5,291 5,131 4,820 5,259
Year-end nonaccrual loans 1,252 1,050 1,608 1,956 1,135 1,400
Year-end loans 90 days or more
past due and still accruing 2,318 2,067 1,221 1,797 1,628 1,806
Net charge-offs 416 626 516 449 856 573
Provision for loan losses 940 600 676 760 763 748
Earnings coverage of charge-
Offs 36.0 19.3 16.4 25.6 12.9 20.3
Allowance coverage of charge-
Offs 13.9 8.4 10.3 11.4 5.6 9.2
Net charge-offs as a % of
provision for loan losses 44.3% 104.3% 76.3% 59.1% 112.2% 76.6%
TABLE VIII - ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES
(IN THOUSANDS) YEARS ENDED DECEMBER 31,
2002 2001 2000 1999 1998
Balance, beginning of year $ 5,265 $ 5,291 $ 5,131 $ 4,820 $ 4,913
- ---------------------------------------------------------------------------------------------
Charge-offs:
Real estate loans 123 144 272 81 257
Installment loans 116 138 77 138 144
Credit cards and related plans 190 200 214 192 264
Commercial and other loans 123 231 53 219 301
- ---------------------------------------------------------------------------------------------
Total charge-offs 552 713 616 630 966
- ---------------------------------------------------------------------------------------------
Recoveries:
Real estate loans 30 6 26 81 12
Installment loans 30 27 23 60 43
Credit cards and related plans 18 20 28 30 40
Commercial and other loans 58 34 23 10 15
- ---------------------------------------------------------------------------------------------
Total recoveries 136 87 100 181 110
- ---------------------------------------------------------------------------------------------
Net charge-offs 416 626 516 449 856
Provision for loan losses 940 600 676 760 763
- ---------------------------------------------------------------------------------------------
Balance, end of year $ 5,789 $ 5,265 $ 5,291 $ 5,131 $ 4,820
=============================================================================================
20
TABLE IX - ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES BY TYPE
(IN THOUSANDS)
2002 2001 2000 1999 1998
Commercial $ 1,315 $ 1,837 $ 1,612 $ 2,081 $ 650
Consumer mortgage 460 674 952 834 97
Impaired loans 1,877 73 273 609 290
Consumer 378 494 471 437 702
All other commitments - - - 150 202
Unallocated 1,759 2,187 1,983 1,020 2,879
- -------------------------------------------------------------------------------------
Total Allowance $ 5,789 $ 5,265 $ 5,291 $ 5,131 $ 4,820
=====================================================================================
The above allocation is based on estimates and subjective judgments and is not
necessarily indicative of the specific amounts or loan categories in which
losses may occur. The calculation for 1998 did not include specific amounts for
"Watch List" loans. These loans were included in the total population of loans
and historical loss ratios applied.
TABLE X - FIVE-YEAR SUMMARY OF LOANS BY TYPE
(IN THOUSANDS)
2002 % 2001 % 2000 % 1999 % 1998 %
Real estate - construction $ 103 0.02 $ 1,814 0.48 $ 452 0.14 $ 649 0.21 $ 1,004 0.34
Real estate - mortgage 370,453 82.12 306,264 80.76 263,325 80.21 247,604 79.64 230,815 79.31
Consumer 31,532 6.99 29,284 7.72 28,141 8.57 29,140 9.37 30,924 10.63
Agricultural 3,024 0.67 2,344 0.62 1,983 0.60 1,899 0.61 1,930 0.66
Commercial 30,874 6.84 24,696 6.51 20,776 6.33 18,050 5.81 17,630 6.06
Other 2,001 0.44 1,195 0.32 948 0.29 1,025 0.33 1,062 0.36
Political subdivisions 13,062 2.90 13,479 3.55 12,462 3.80 12,332 3.97 7,449 2.56
Lease receivables 96 0.02 152 0.04 218 0.07 222 0.07 218 0.07
- ---------------------------------------------------------------------------------------------------------------------------------
Total 451,145 100.00 379,228 100.00 328,305 100.00 310,921 100.00 291,032 100.00
Less: unearned discount - - - (29) (29)
- ---------------------------------------------------------------------------------------------------------------------------------
451,145 379,228 328,305 310,892 291,003
Less: allowance for loan losses (5,789) (5,265) (5,291) (5,131) (4,820)
- ---------------------------------------------------------------------------------------------------------------------------------
Loans, net $ 445,356 $ 373,963 $ 323,014 $ 305,761 $ 286,183
=================================================================================================================================
LIQUIDITY
Liquidity is the ability to quickly raise cash at a reasonable cost. An adequate
liquidity position permits the Corporation to pay creditors, compensate for
unforeseen deposit fluctuations and fund unexpected loan demand. The Corporation
maintains overnight borrowing facilities with several correspondent banks that
provide a source of day-to-day liquidity. Also, the Corporation maintains
borrowing facilities with FHLB - Pittsburgh, secured by various securities and
mortgage loans. At December 31, 2002, the Corporation had unused borrowing
availability with correspondent banks and FHLB - Pittsburgh totaling
approximately $205,000,000. Additionally, the Corporation uses repurchase
agreements placed with brokers to borrow short-term funds secured by investment
assets, and uses "RepoSweep" arrangements to borrow funds from commercial
banking customers on an overnight basis.
On a longer-term basis, one of the tools used to measure liquidity is the loan
to deposit ratio. As of December 31, 2002, this ratio was 70%, which (by banking
industry standards) is a relatively low ratio (which indicates a relatively high
level of liquidity). This low loan to deposit ratio permits the Corporation to
utilize "excess" funds to purchase investment securities. If required to raise
cash in an emergency situation, the Corporation could sell non-pledged
investment securities to meet its obligations.
Management believes the combination of its strong capital position (discussed in
the next section), ample available borrowing facilities and low loan to deposit
ratio have placed the Corporation in a position of minimal short-term and
long-term liquidity risk.
21
STOCKHOLDERS' EQUITY AND CAPITAL ADEQUACY
The Corporation and the Bank are subject to various regulatory capital
requirements administered by the federal banking agencies. For many years, the
Corporation and the Bank have maintained strong capital positions. Details
concerning the Corporation's and the Bank's regulatory capital amounts and
ratios are presented in Note 16 to the consolidated financial statements. As
reflected in Note 16, at December 31, 2002 and 2001, the ratios of total capital
to risk-weighted assets, tier 1 capital to risk-weighted assets and tier 1
capital to average total assets are well in excess of the amounts necessary to
be classified as "well-capitalized" by the banking agencies.
The Corporation's total stockholders' equity is affected by fluctuations in the
fair values of available-for-sale securities. The difference between amortized
cost and fair value of available-for-sale securities, net of deferred income
tax, is classified as "Accumulated Other Comprehensive Income" within
stockholders' equity. Changes in accumulated other comprehensive income are
excluded from earnings and directly increase or decrease stockholders' equity.
COMPREHENSIVE INCOME
Comprehensive income is a measure of all changes in the equity of a corporation,
excluding transactions with owners in their capacity as owners (such as proceeds
from issuances of stock and dividends). The difference between net income and
comprehensive income is termed "Other Comprehensive Income". For the
Corporation, other comprehensive income consists of unrealized gains and losses
on available-for-sale securities, net of deferred income tax. Comprehensive
income should not be construed to be a measure of net income. The amount of
unrealized gains or losses reflected in comprehensive income may vary widely
from period-to-period, depending on the financial markets as a whole and how the
portfolio of available-for-sale securities is affected by interest rate
movements. Total comprehensive income (loss) was $21,821,000 in 2002,
$17,254,000 in 2001 and $17,442,000 in 2000. Other comprehensive income amounted
to $6,862,000 in 2002, $5,202,000 in 2001 and $8,966,000 in 2000.
INFLATION
Over the last several years, direct inflationary pressures on the Corporation's
payroll-related and other noninterest costs have been modest. In fact, some
economists have warned of the threat of deflationary pressures, similar to
recent experiences in Japan. The Corporation is significantly affected by the
Federal Reserve Board's efforts to control inflation through changes in interest
rates. Management monitors the impact of economic trends, including any
indicators of inflationary (or deflationary) pressure, in managing interest rate
and other financial risks.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, The Financial Accounting Standard Board ("FASB") issued Statement
No. 143, "Accounting for Asset Retirement Obligations." This statement addresses
financial accounting and reporting for obligations associated with the
retirement of tangible long-lived assets and the associated asset retirement
costs. It applies to legal obligations associated with the retirement of
long-lived assets that result from the acquisition, construction, development
and (or) the normal operation of a long-lived asset, except for certain
obligations of lessees. As used in this Statement, a legal obligation is an
obligation that a party is required to settle as a result of an existing or
enacted law, statute, ordinance or written or oral contract or by legal
construction of a contract under the doctrine of promissory estopple. This
Statement requires that the fair value of a liability for an asset retirement
obligation be recognized in the period in which it is incurred if a reasonable
estimate of fair value can be made. The associated asset retirement costs are
capitalized as part of the carrying amount of the long-lived asset. This
Statement amends FASB Statement No. 19 "Financial Accounting and Reporting by
Oil and Gas Producing Companies" and it applies to all entities. It is effective
for financial statements issued for fiscal years beginning after June 15, 2002.
The adoption of this Statement on January 1, 2003 is not expected to have an
impact on the Corporation's earnings, financial condition or equity.
22
In August 2001, the FASB issued Statement No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." This Statement addresses financial
accounting and reporting for the impairment or disposal of long-lived assets,
and supersedes FASB Statement No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of." However, the
Statement retains the fundamental provisions of Statement No. 121 for (a)
recognition and measurement of the impairment of long-lived assets to be held
and used and (b) measurement of long-lived assets to be disposed of by sale.
This Statement supersedes the accounting and recording provisions of APB Opinion
No. 30, "Reporting the Results of Operations-Reporting the Effects of Disposal
of a Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions," for the disposal of a segment of a business.
However, this Statement retains the requirement of Opinion No. 30 to report
discontinued operations separately from continuing operations and extends that
reporting to a component of an entity that either has been disposed of (by sale,
by abandonment or in the distribution to owners) or is classified as held for
sale. This Statement also amends ARB No. 51, "Consolidated Financial
Statements", to eliminate the exception to consolidation for a
temporarily-controlled subsidiary. The provisions of this Statement were
effective for financial statements issued for fiscal years beginning after
December 15, 2001. The Adoption of this Statement on January 1, 2002 did not
have an impact on the Corporation's earnings, financial condition or equity.
In April 2002, the FASB issued Statement No. 145 "Rescission of FASB Statements
No. 4, 44, and 64 Amendment of FASB Statement No. 13, and Technical
Corrections." "This Statement rescinds FASB Statement No. 4, "Reporting Gains
and Losses from Extinguishment of Debt, " and an amendment of that Statement,
FASB Statement No. 64, "Extinguishments of Debt Made to Satisfy Sinking-Fund
Requirements," along with rescinding FASB Statement No. 44, "Accounting for
Intangible Assets of Motor Carriers and amending FASB Statement No. 13,
Accounting for Leases." This Statement (1) eliminates an inconsistency between
the required accounting for sale-leaseback transactions and the required
accounting for certain lease modifications that have economic effects that are
similar to sale-leaseback transactions, (2) eliminates the extraordinary item
treatment of reporting gains and losses from extinguishments of debt, and (3)
makes certain other technical corrections. The provisions of this Statement
related to the rescission of Statement 4 shall be applied in fiscal years
beginning after May 15, 2002. Any gain or loss on extinguishments of debt that
was classified as an extraordinary item in prior periods presented that does not
meet the criteria in Opinion 30 for classification as an extraordinary item
shall be reclassified. The provisions of this Statement related to Statement 13
shall be effective for transactions occurring after May 15, 2002. All other
provisions of this Statement shall be effective for financial statements issued
on or after May 15, 2002. The adoption of the effective portions of this
Statement did not have an impact on the Corporation's earnings, financial
condition or equity, except that (as described in Note 9 to the consolidated
financial statements) the Corporation incurred prepayment penalties from the
early retirement of debt of $101,000 in 2002, and included these costs in
interest expense (prior to this Statement, the prepayment penalties would have
been presented as extraordinary items in the income statement). The adoption of
the remaining portions of this Statement is not expected to have an impact on
the Corporation's earnings, financial condition or equity.
In June 2002, the FASB issued Statement No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." This Statement addresses financial
accounting and reporting for costs associated with exit or disposal activities
and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)." The provisions
of this Statement are effective for exit or disposal activities that are
initiated after December 31, 2002. The Corporation does not expect the adoption
of this Statement to have an impact on its earnings, financial condition or
equity.
On October 1, 2002, the FASB issued Statement No. 147, "Acquisitions of Certain
Financial Institutions," effective for all business combinations initiated after
October 1, 2002. This Statement addresses the financial accounting and reporting
for the acquisition of all or part of a financial institution except for a
transaction between two or more mutual enterprises. This Statement removes
acquisitions of financial institutions, other than transactions between two or
more mutual enterprises, from the scope of Statement No 72, "Accounting for
Certain Acquisitions of Banking or Thrift Institutions," and FASB Interpretation
No. 9, "Applying APB Opinions No. 16 and 17 When a Savings and Loan Association
or a Similar Institution is Acquired in a Business Combination Accounted for by
the Purchase Method." The acquisition of all or part of a financial institution
that meets the definition of a business combination shall be accounted for by
the purchase method in accordance with Statement No. 141, "Business
Combinations," and Statement No. 142, "Goodwill and Other Intangible Assets."
This Statement also provides guidance on the accounting for the impairment or
disposal of acquired long-term customer-relationship intangible assets (such as
depositor-and-borrower-relationship intangible assets and credit cardholder
intangible assets), including those acquired in transactions between two or more
mutual enterprises. The Adoption of this Statement has not had an impact on the
Corporation's earnings, financial condition or equity.
23
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting
and Disclosure Requirement for Guarantees, Including Indirect Guarantees of the
Indebtedness of Others." This Interpretation clarifies the requirements for a
guarantor's accounting for and disclosures of certain guarantees issued and
outstanding. The Interpretation requires a guarantor to recognize a liability
for the fair value of the obligation it assumes under that guarantee. The
initial recognition and initial measurement provisions of the Interpretation are
applied on a prospective basis to guarantees issued or modified after December
31, 2002. The guarantor's accounting for guarantees issued prior to the date of
initial application should not be revised or restated to reflect the effect of
the recognition and measurement provisions of the Interpretation. The
Interpretation's disclosure requirements were implemented during the year ended
December 31, 2002 (see Note 15 to the consolidated financial statements for
expanded disclosures related to standby letters of credit). The adoption of the
recognition and measurement provisions of this statement are not expected to
have a significant impact on the Corporation's earnings, financial condition or
equity.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
MARKET RISK
The Corporation's two major categories of market risk, interest rate and equity
securities risk, are discussed in the following sections.
INTEREST RATE RISK
Business risk arising from changes in interest rates is an inherent factor in
operating a bank. The Corporation's assets are predominantly long-term, fixed
rate loans and debt securities. Funding for these assets comes principally from
shorter-term deposits and borrowed funds. Accordingly, there is an inherent risk
of lower future earnings or decline in fair value of the Corporation's financial
instruments when interest rates change.
The Bank uses a simulation model to calculate the potential effects of interest
rate fluctuations on net interest income and the market value of portfolio
equity. Only assets and liabilities of the Bank are included in management's
monthly simulation model calculations. Since the Bank makes up more than 90% of
the Corporation's total assets and liabilities, and because the Bank is the
source of the most volatile interest rate risk, management does not consider it
necessary to run the model for the remaining entities within the consolidated
group. For purposes of these calculations, the market value of portfolio equity
includes the fair values of financial instruments, such as securities, loans,
deposits and borrowed funds, and the book values of nonfinancial assets and
liabilities, such as premises and equipment and accrued interest. The model
measures and projects potential changes in net interest income, and calculates
the discounted present value of anticipated cash flows of financial instruments,
assuming an immediate increase or decrease in interest rates. Management
ordinarily runs a variety of scenarios within a range of plus or minus 50-300
basis points of current rates.
In the 3rd quarter 2002, the Bank changed to a different simulation (software)
model, and also changed some of the key methodologies and assumptions. The new
simulation model is run on an outsourcing basis, using data supplied by the
Bank. These changes were made in an effort to improve the accuracy and relevance
of the Bank's interest rate risk measurements. The more significant changes are
as follows:
- The new model permits more precise measurements, in that the estimated
impact of interest rate changes is calculated for each individual
investment security and for each individual loan and deposit
instrument. In contrast, the old model required management to make
assumptions regarding contractual cash flows for fairly broad
categories of investment securities, loans and deposits.
- Using the new model, the average principal repayment term for callable
investment securities has been substantially lengthened. This change
has increased the calculated impact of interest rate changes on the
fair value of investment securities under each interest rate scenario.
- Prior to the model change, management assumed no difference between
book value and fair value of nonmaturity deposits and borrowings, such
as money market accounts, NOW accounts, savings, customer repurchase
agreements and checking accounts. Using the new model, management has
estimated the "run-off" of nonmaturity deposits and borrowings, and
has calculated the fair value of these liabilities using market
interest rates consistent with the estimated terms. The effect of this
change was to increase the market value of portfolio equity in all
interest rate scenarios.
24
- Also related to nonmaturity deposits and borrowings, management has
changed its assumptions regarding the impact of rate changes on
interest expense. In the past, management estimated the impact of a
rate change based on 100% of the "shock" amount - e.g., the rate paid
on savings accounts would be assumed to increase from 1% to 3% in a
"+200 basis point" calculation. Using the new model, management has
limited the estimated impact of rate changes on interest expense. For
example, in a +200 basis point calculation, the rate paid on savings
accounts would be assumed to increase 50% of 200 basis points, or 1%,
resulting in an increase in rate from 1% to 2%. The effect of this
change was to decrease the impact of rate changes on net interest
income in all interest rate scenarios.
- In the past, the Bank's interest rate shock calculations compared
"Base Most Likely" values to amounts calculated assuming an immediate
increase or decrease in rates. In developing the Base Most Likely
calculations, management made assumptions regarding growth in loans
and deposits, and other balance sheet changes. Also, management used
an interest rate forecast to estimate changes in interest rates on a
monthly basis throughout the period of net interest income
calculations. Using the new model, management's baseline calculation
assumes a "flat" balance sheet, and uses current interest rates with
no forecasted changes in rates. Management believes this change in
methodology provides a measurement of interest rate risk that is more
consistent with the majority of the financial institutions industry.
The Bank's Board of Directors has established policy guidelines for acceptable
levels of interest rate risk, based on an immediate increase or decrease in
interest rates of 200 basis points. The policy limit for fluctuation in net
interest income is minus 20% from the baseline one-year scenario. The policy
limit for market value variance is minus 30% from the baseline one-year
scenario. The most sensitive scenario presented in Table XII below is the "+200
basis points" scenario. As the table below shows, as of December 31, 2002, the
result of the Bank's net interest income calculation is well within the policy
threshold. However, if interest rates were to immediately increase 200 basis
points, the Bank's calculations based on the model show that the market value of
portfolio equity would decrease 34.2%, which exceeds the policy threshold. Over
the next several months, management will evaluate whether to make any changes to
asset or liability holdings in an effort to reduce exposure to decline in market
value in a rising interest rate environment. The table also shows that, if
interest rates were to immediately rise 200 basis points, net interest income
over the next 12 months would decline by 1.8%, which is well under the 20%
policy mark. This estimated exposure level is also significantly less than the
18.9% decline calculated as of December 31, 2001. Changes in the model,
particularly the assumptions referred to above concerning the impact of rate
changes on nonmaturity deposits and borrowings, had a substantial impact on
these revised results. Also, some of management's actions during 2002, including
an increased concentration of the investment securities portfolio in
mortgage-backed securities (as discussed in the "Net Interest Margin" section of
Management's Discussion and Analysis), have helped to reduce the exposure of net
interest income to rising rates in the near term.
The table that follows was prepared using the simulation models described above.
The models make estimates, at each level of interest rate change, regarding cash
flows from principal repayments on loans and mortgage-backed securities and call
activity on other investment securities. Actual results could vary significantly
from these estimates, which could result in significant differences in the
calculations of projected changes in net interest margin and market value of
portfolio equity. Also, the models do not make estimates related to changes in
the composition of the deposit portfolio that could occur due to rate
competition and the table does not necessarily reflect changes that management
would make to realign the portfolio as a result of changes in interest rates.
THE EFFECT OF HYPOTHETICAL CHANGES IN INTEREST RATES
PERIOD ENDING DECEMBER 31, 2003
(IN THOUSANDS)
DECEMBER 31, 2002 DATA
CURRENT PLUS 200 MINUS 200
INTEREST BASIS BASIS
RATES POINTS POINTS
SCENARIO AMOUNT % CHANGE AMOUNT % CHANGE
Interest income $ 54,989 $ 59,608 $ 49,607
Interest expense 24,132 29,320 19,083
- -------------------------------------------------------------------------------------------------------------------
Net Interest Income $ 30,857 $ 30,288 -1.8% $ 30,524 -1.1%
===================================================================================================================
Market Value of Portfolio Equity at Dec. 31, 2002 $ 108,144 $ 71,117 -34.2% $ 130,764 20.9%
===================================================================================================================
25
PERIOD ENDING DECEMBER 31, 2002
(IN THOUSANDS)
DECEMBER 31, 2001 DATA
CURRENT PLUS 200 MINUS 200
INTEREST BASIS BASIS
RATES POINTS POINTS
SCENARIO AMOUNT % CHANGE AMOUNT % CHANGE
Interest income $ 56,943 $ 60,192 $ 52,767
Interest expense 26,652 35,633 17,827
- -------------------------------------------------------------------------------------------------------------------
Net Interest Income $ 30,291 $ 24,559 -18.9% $ 34,940 15.3%
===================================================================================================================
Market Value of Portfolio Equity at Dec. 31, 2001 $ 97,585 $ 69,980 -28.3% $ 118,667 21.6%
===================================================================================================================
EQUITY SECURITIES RISK
The Corporation's equity securities portfolio consists primarily of investments
in stocks of banks and bank holding companies, mainly based in Pennsylvania. The
Corporation also owns some other stocks and mutual funds.
Investments in bank stocks are subject to the risk factors affecting the banking
industry generally, including competition from non-bank entities, credit risk,
interest rate risk and other factors that could result in a decline in market
prices. Also, losses could occur in individual stocks held by the Corporation
because of specific circumstances related to each bank. Further, because of the
concentration of its holdings in Pennsylvania banks, these investments could
decline in value if there were a downturn in the state's economy.
The Corporation's management monitors its risk associated with its equity
securities holdings by reviewing its holdings on a detailed, individual security
basis, at least monthly, considering all of the factors described above.
Equity securities held as of December 31, 2002 and 2001 are as follows:
(IN THOUSANDS) HYPOTHETICAL HYPOTHETICAL
10% 20%
DECLINE IN DECLINE IN
FAIR MARKET MARKET
AT DECEMBER 31, 2002 COST VALUE VALUE VALUE
Banks and bank holding companies $ 22,936 $ 31,508 $ (3,151) $ (6,302)
Other equity securities 1,950 1,572 (157) (314)
- -------------------------------------------------------------------------------------------------
Total $ 24,886 $ 33,080 $ (3,308) $ (6,616)
=================================================================================================
(IN THOUSANDS) HYPOTHETICAL HYPOTHETICAL
10% 20%
DECLINE IN DECLINE IN
FAIR MARKET MARKET
AT DECEMBER 31, 2001 COST VALUE VALUE VALUE
Banks and bank holding companies $ 18,922 $ 26,636 $ (2,664) $ (5,327)
Other equity securities 823 836 (84) (167)
- -------------------------------------------------------------------------------------------------
Total $ 19,745 $ 27,472 $ (2,748) $ (5,494)
=================================================================================================
26
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
CONSOLIDATED BALANCE SHEET
(IN THOUSANDS EXCEPT SHARE DATA) DECEMBER 31, DECEMBER 31,
2002 2001
ASSETS
Cash and due from banks:
Noninterest-bearing $ 14,185 $ 14,055
Interest-bearing 715 1,981
- -----------------------------------------------------------------------------------------------------
Total cash and cash equivalents 14,900 16,036
Available-for-sale securities 512,175 433,969
Held-to-maturity securities 707 1,448
Loans, net 445,356 373,963
Bank-owned life insurance 16,758 15,905
Accrued interest receivable 5,960 4,871
Bank premises and equipment, net 10,333 9,967
Foreclosed assets held for sale 56 179
Other assets 12,523 10,661
- -----------------------------------------------------------------------------------------------------
TOTAL ASSETS $ 1,018,768 $ 866,999
=====================================================================================================
LIABILITIES
Deposits:
Noninterest-bearing $ 70,824 $ 63,858
Interest-bearing 569,480 512,416
- -----------------------------------------------------------------------------------------------------
Total deposits 640,304 576,274
Dividends payable 1,586 1,466
Short-term borrowings 43,635 58,064
Long-term borrowings 208,214 125,584
Accrued interest and other liabilities 9,192 5,424
- -----------------------------------------------------------------------------------------------------
TOTAL LIABILITIES 902,931 766,812
- -----------------------------------------------------------------------------------------------------
STOCKHOLDERS' EQUITY
Common stock, par value $1.00 per share; authorized 10,000,000
shares; issued 5,431,021 in 2002 and 5,378,212 in 2001 5,431 5,378
Stock dividend distributable 1,639 1,369
Paid-in capital 21,153 19,758
Retained earnings 77,584 70,352
- -----------------------------------------------------------------------------------------------------
Total 105,807 96,857
Accumulated other comprehensive income 12,146 5,284
Unamortized stock compensation (49) (17)
Treasury stock, at cost:
145,415 shares at December 31, 2002 (2,067)
143,412 shares at December 31, 2001 (1,937)
- -----------------------------------------------------------------------------------------------------
TOTAL STOCKHOLDERS' EQUITY 115,837 100,187
- -----------------------------------------------------------------------------------------------------
TOTAL LIABILITIES & STOCKHOLDERS' EQUITY $ 1,018,768 $ 866,999
=====================================================================================================
The accompanying notes are an integral part of the consolidated financial
statements.
27
CONSOLIDATED STATEMENT OF INCOME
YEARS ENDED DECEMBER 31,
(IN THOUSANDS EXCEPT PER SHARE DATA) 2002 2001 2000
INTEREST INCOME
Interest and fees on loans $ 30,641 $ 28,592 $ 27,082
Interest on balances with depository institutions 17 82 114
Interest on loans to political subdivisions 587 719 644
Interest on federal funds sold 42 184 64
Income from available-for-sale and held-to-maturity securities:
Taxable 19,051 19,752 18,296
Tax-exempt 5,799 4,242 4,483
Dividends 1,148 1,090 960
- ---------------------------------------------------------------------------------------------------------------
Total interest and dividend income 57,285 54,661 51,643
- ---------------------------------------------------------------------------------------------------------------
INTEREST EXPENSE
Interest on deposits 17,215 20,417 23,108
Interest on short-term borrowings 916 3,944 6,102
Interest on long-term borrowings 8,184 3,995 935
- ---------------------------------------------------------------------------------------------------------------
Total interest expense 26,315 28,356 30,145
- ---------------------------------------------------------------------------------------------------------------
Interest margin 30,970 26,305 21,498
Provision for loan losses 940 600 676
- ---------------------------------------------------------------------------------------------------------------
Interest margin after provision for loan losses 30,030 25,705 20,822
- ---------------------------------------------------------------------------------------------------------------
OTHER INCOME
Service charges on deposit accounts 1,725 1,376 1,150
Service charges and fees 258 247 232
Trust and financial management revenue 1,755 1,576 1,613
Insurance commissions, fees and premiums 577 582 372
Increase in cash surrender value of life insurance 853 905 -
Fees related to credit card operation 631 550 897
Other operating income 825 884 738
- ---------------------------------------------------------------------------------------------------------------
Total other income before realized gains on securities, net 6,624 6,120 5,002
Realized gains on securities, net 2,888 1,920 1,377
- ---------------------------------------------------------------------------------------------------------------
Total other income 9,512 8,040 6,379
- ---------------------------------------------------------------------------------------------------------------
OTHER EXPENSES
Salaries and wages 9,418 8,493 7,597
Pensions and other employee benefits 2,651 2,213 1,939
Occupancy expense, net 1,094 1,018 928
Furniture and equipment expense 1,532 1,431 1,194
Expenses related to credit card operation 285 295 407
Pennsylvania shares tax 734 790 756
Other operating expense 5,135 4,431 4,085
- ---------------------------------------------------------------------------------------------------------------
Total other expenses 20,849 18,671 16,906
- ---------------------------------------------------------------------------------------------------------------
Income before income tax provision 18,693 15,074 10,295
Income tax provision 3,734 3,022 1,819
- ---------------------------------------------------------------------------------------------------------------
NET INCOME $ 14,959 $ 12,052 $ 8,476
===============================================================================================================
NET INCOME PER SHARE - BASIC $ 2.80 $ 2.25 $ 1.58
===============================================================================================================
NET INCOME PER SHARE - DILUTED $ 2.79 $ 2.25 $ 1.58
===============================================================================================================
The accompanying notes are an integral part of the consolidated financial
statements.
28
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(IN THOUSANDS EXCEPT PER SHARE DATA)
STOCK
COMMON DIVIDEND PAID-IN RETAINED
STOCK DISTRIBUTABLE CAPITAL EARNINGS
- -------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1999 $ 5,272 $ 1,437 $ 17,355 $ 62,886
Comprehensive income:
Net income 8,476
Unrealized gain on securities,
net of reclassification
adjustment and tax effects
- -------------------------------------------------------------------------------------
Total comprehensive income
- -------------------------------------------------------------------------------------
Cash dividends declared, $.94 per
share (5,102)
Shares issued from treasury related
to exercise of stock options 3
Stock dividend issued 53 (1,437) 1,384
Stock dividend declared, 1% 1,054 (1,054)
Restricted stock granted 14
- -------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 2000
5,325 1,054 18,756 65,206
Comprehensive income:
Net income 12,052
Unrealized gain on securities,
net of reclassification
adjustment and tax effects
- -------------------------------------------------------------------------------------
Total comprehensive income
- -------------------------------------------------------------------------------------
Cash dividends declared, $1.02 per
share (5,554)
Treasury stock purchased
Amortization of restricted stock
Tax benefit from employee benefit
plan 17
Stock dividend issued 53 (1,054) 1,001
Stock dividend declared, 1% 1,369 (1,369)
Restricted stock granted 1
- -------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 2001 5,378 1,369 19,758 70,352
Comprehensive income:
Net income 14,959
Unrealized gain on securities,
net of reclassification
adjustment and tax effects
- -------------------------------------------------------------------------------------
Total comprehensive income
- -------------------------------------------------------------------------------------
Cash dividends declared, $1.16 per
share (6,158)
Treasury stock purchased
Amortization of restricted stock
Shares issued from treasury related
to exercise of stock options 26
Tax benefit from employee benefit
plan 70
Stock dividend issued 53 (1,369) 1,316
Stock dividend declared, 1% 1,639 (1,639)
Restricted stock granted 55
Forfeiture of restricted stock (2)
- -------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 2002 $ 5,431 $ 1,639 $ 21,153 $ 77,584
=====================================================================================
ACCUMULATED
OTHER UNAMORTIZED
COMPREHENSIVE STOCK TREASURY
INCOME COMPENSATION STOCK TOTAL
- -------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1999 $ (8,884) $ - $ (1,443) $ 76,623
Comprehensive income:
Net income 8,476
Unrealized gain on securities,
net of reclassification
adjustment and tax effects 8,966 8,966
- -------------------------------------------------------------------------------------------
Total comprehensive income 17,442
- -------------------------------------------------------------------------------------------
Cash dividends declared, $.94 per
share (5,102)
Shares issued from treasury related
to exercise of stock options 3 6
Stock dividend issued -
Stock dividend declared, 1% -
Restricted stock granted (35) 21 -
- -------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 2000
82 (35) (1,419) 88,969
Comprehensive income:
Net income 12,052
Unrealized gain on securities,
net of reclassification
adjustment and tax effects 5,202 5,202
- -------------------------------------------------------------------------------------------
Total comprehensive income 17,254
- -------------------------------------------------------------------------------------------
Cash dividends declared, $1.02 per
share (5,554)
Treasury stock purchased (521) (521)
Amortization of restricted stock 22 22
Tax benefit from employee benefit
plan 17
Stock dividend issued -
Stock dividend declared, 1% -
Restricted stock granted (4) 3 -
- -------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 2001 5,284 (17) (1,937) 100,187
Comprehensive income:
Net income 14,959
Unrealized gain on securities,
net of reclassification
adjustment and tax effects 6,862 6,862
- -------------------------------------------------------------------------------------------
Total comprehensive income 21,821
- -------------------------------------------------------------------------------------------
Cash dividends declared, $1.16 per
share (6,158)
Treasury stock purchased (239) (239)
Amortization of restricted stock 80 80
Shares issued from treasury related
to exercise of stock options 50 76
Tax benefit from employee benefit
plan 70
Stock dividend issued -
Stock dividend declared, 1% -
Restricted stock granted (116) 61 -
Forfeiture of restricted stock 4 (2) -
- -------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 2002 $ 12,146 $ (49) $ (2,067) $ 115,837
===========================================================================================
The accompanying notes are an integral part of the consolidated financial
statements.
29
CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS) YEARS ENDED DECEMBER 31,
2002 2001 2000
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 14,959 $ 12,052 $ 8,476
Adjustments to reconcile net income to net cash provided by
operating activities:
Provision for loan losses 940 600 676
Realized gains on securities, net (2,888) (1,920) (1,377)
Gain on sale of foreclosed assets, net (39) (88) (59)
Depreciation expense 1,346 1,300 1,086
Accretion and amortization, net (376) (1,869) (2,491)
Increase in cash surrender value of life insurance (853) (905) -
Amortization of restricted stock 80 22 -
Deferred income taxes (284) (349) (63)
Increase in accrued interest receivable and other assets (958) (126) (88)
Increase in accrued interest payable and other liabilities 669 579 1,247
- --------------------------------------------------------------------------------------------------------------------------
Net Cash Provided by Operating Activities 12,596 9,296 7,407
- --------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturity of held-to-maturity securities 731 1,083 156
Purchase of held-to-maturity securities - (626) (196)
Proceeds from sales of available-for-sale securities 29,345 25,788 32,173
Proceeds from calls and maturities of available-for-sale
securities 155,811 152,568 15,337
Purchase of available-for-sale securities (249,693) (261,148) (17,865)
Purchase of Federal Home Loan Bank of Pittsburgh stock (3,943) (1,750) -
Redemption of Federal Home Loan Bank of Pittsburgh stock 1,870 869 -
Net increase in loans (72,819) (51,984) (18,374)
Purchase of bank-owned life insurance - - (15,000)
Purchase of interest in low-income housing partnerships - (306) (697)
Purchase of premises and equipment (1,712) (1,935) (2,426)
Proceeds from sale of foreclosed assets 648 660 498
- --------------------------------------------------------------------------------------------------------------------------
Net Cash Used in Investing Activities (139,762) (136,781) (6,394)
- --------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits 64,030 47,307 28,493
Net (decrease) increase in short-term borrowings (14,429) (36,627) 5,655
Proceeds from long-term borrowings 117,653 125,000 -
Repayments of long-term borrowings (35,023) (21) (34,420)
Purchase of treasury stock (239) (521) -
Sale of treasury stock 76 - 6
Dividends paid (6,038) (5,441) (4,986)
- --------------------------------------------------------------------------------------------------------------------------
Net Cash Provided by (Used in) Financing Activities 126,030 129,697 (5,252)
- --------------------------------------------------------------------------------------------------------------------------
(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS
(1,136) 2,212 (4,239)
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 16,036 13,824 18,063
- --------------------------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 14,900 $ 16,036 $ 13,824
==========================================================================================================================
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Assets acquired through foreclosure of real estate loans $ 486 $ 435 $ 445
Interest paid $ 26,424 $ 28,665 $ 29,446
Income taxes paid $ 4,509 $ 2,961 $ 1,801
The accompanying notes are an integral part of the consolidated financial
statements.
30
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF CONSOLIDATION - The consolidated financial statements include the
accounts of Citizens & Northern Corporation ("Corporation"), and its
subsidiaries, Citizens & Northern Bank ("Bank"), Bucktail Life Insurance Company
and Citizens & Northern Investment Corporation. The consolidated financial
statements also include the accounts of the Bank's wholly-owned subsidiary, C&N
Financial Services Corporation, which began operations in 2000. All material
intercompany balances and transactions have been eliminated in consolidation.
NATURE OF OPERATIONS - The Corporation is primarily engaged in providing a full
range of banking and mortgage services to individual and corporate customers in
Northcentral Pennsylvania. Lending products include mortgage loans, commercial
loans, consumer loans and credit cards, as well as specialized instruments such
as commercial letters-of-credit. Deposit products include various types of
checking accounts, passbook and statement savings, money market accounts,
interest checking accounts, individual retirement accounts and certificates of
deposit. The Corporation also offers non-insured "Repo Sweep" accounts.
The Corporation provides Trust and Financial Management services, including
administration of trusts and estates, retirement plans, and other employee
benefit plans, and investment management services. In 2000, the Corporation
began offering a variety of personal and commercial insurance products through
C&N Financial Services Corporation. In 2001, C&N Financial Services Corporation
added a broker-dealer division, which offers mutual funds, annuities,
educational savings accounts and other investment products through registered
agents.
The Corporation is subject to competition from other financial institutions. It
is also subject to regulation by certain federal and state agencies and
undergoes periodic examination by those regulatory authorities.
USE OF ESTIMATES - The presentation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect reported amounts and disclosures. Actual results
could differ from these estimates.
A material estimate that is particularly susceptible to significant change is
the determination of the allowance for loan losses. Management believes that the
allowance for loan losses is adequate and reasonable. While management uses
available information to recognize losses on loans, changes in economic
conditions may necessitate revisions in future years. In addition, various
regulatory agencies, as an integral part of their examination process,
periodically review the Corporation's allowance for loan losses. Such agencies
may require the Corporation to recognize adjustments to the allowance based on
their judgments of information available to them at the time of their
examination.
INVESTMENT SECURITIES - Investment securities are accounted for as follows:
HELD-TO-MATURITY SECURITIES - includes debt securities that the Corporation has
the positive intent and ability to hold to maturity. These securities are
reported at cost adjusted for amortization of premiums and accretion of
discounts, computed using the level-yield method.
AVAILABLE-FOR-SALE SECURITIES - includes debt securities not classified as
held-to-maturity and unrestricted equity securities. Such securities are
reported at fair value, with unrealized gains and losses excluded from earnings
and reported separately through accumulated other comprehensive income, net of
tax. Amortization of premiums and accretion of discounts on available-for-sale
securities are recorded using the level yield method over the remaining
contractual life of the securities, adjusted for actual prepayments.
Realized gains and losses on sales of available-for-sale securities are computed
on the basis of specific identification of the adjusted cost of each security.
RESTRICTED EQUITY SECURITIES - Restricted equity securities consist primarily of
Federal Home Loan Bank of Pittsburgh stock, and are carried at cost and
evaluated for impairment. Holdings of restricted equity securities are included
in Other Assets in the Consolidated Balance Sheet, and dividends received on
restricted securities are included in Other Income in the Consolidated Statement
of Income.
31
LOANS - Loans are stated at unpaid principal balances, less the allowance for
loan losses and net deferred loan fees.
Loan origination and commitment fees, as well as certain direct origination
costs, are deferred and amortized as a yield adjustment over the lives of the
related loans using the interest method. Amortization of deferred loan fees is
discontinued when a loan is placed on nonaccrual status.
Loans are placed on nonaccrual status when, in the opinion of management,
collection of interest is doubtful. Any unpaid interest previously accrued on
those loans is reversed from income. Interest income is not recognized on
specific impaired loans unless the likelihood of further loss is remote.
Interest payments received on such loans are applied as a reduction of the loan
principal balance. Interest income on other nonaccrual loans is recognized only
to the extent of interest payments received.
The allowance for loan losses is maintained at a level which, in management's
judgment, is adequate to absorb credit losses inherent in the loan portfolio.
The amount of the allowance is based on management's evaluation of the
collectibility of the loan portfolio, based on factors such as credit
concentrations, trends in historical loss experience, specific impaired loans,
and economic conditions. Allowances for impaired loans are determined based on
collateral values or the present value of estimated cash flows. The allowance is
increased by a provision for loan losses, which is charged to expense, and
reduced by charge-offs, net of recoveries.
BANK PREMISES AND EQUIPMENT - Bank premises and equipment are stated at cost
less accumulated depreciation. Repair and maintenance expenditures which extend
the useful lives of assets are capitalized, and other repair and maintenance
expenditures are expensed as incurred. Depreciation expense is computed using
the straight-line method.
FORECLOSED ASSETS HELD FOR SALE - Foreclosed assets held for sale consist of
real estate acquired by foreclosure and are carried at estimated fair value,
less selling cost.
INCOME TAXES - Provisions for deferred income taxes are made as a result of
temporary differences in financial and income tax methods of accounting. These
differences relate principally to loan losses, securities gains or losses,
depreciation, pension and other postretirement benefits and amortization of loan
origination fees and costs.
STOCK COMPENSATION PLANS - As permitted by Accounting Principles Board Opinion
No. 25, the Corporation uses the intrinsic value method of accounting for stock
compensation plans. Utilizing the intrinsic value method, compensation cost is
measured by the excess of the quoted market price of the stock as of the grant
date (or other measurement date) over the amount an employee or director must
pay to acquire the stock. Stock options issued under the Corporation's stock
option plans have no intrinsic value, and accordingly, no compensation cost is
recorded for them.
The Corporation has also made awards of restricted stock. Compensation cost
related to restricted stock is recognized based on the market price of the stock
at the grant date over the vesting period.
32
The following table illustrates the effect on net income and earnings per share
if the Corporation had applied the fair value provisions of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-based
Compensation," to stock options.
(NET INCOME IN THOUSANDS)
2002 2001 2000
Net income, as reported $ 14,959 $ 12,052 $ 8,476
Deduct: Total stock option compensation
expense determined under fair value
method for all awards, net of tax effects (191) (63) (77)
- ----------------------------------------------------------------------------------------
Pro forma net income $ 14,768 $ 11,989 $ 8,399
========================================================================================
Earnings per share-basic:
As reported $2.80 $2.25 $1.58
Pro forma $2.77 $2.24 $1.57
Earnings per share-diluted:
As reported $2.79 $2.25 $1.58
Pro forma $2.76 $2.24 $1.57
OFF-BALANCE SHEET FINANCIAL INSTRUMENTS - In the ordinary course of business,
the Corporation has entered into off-balance sheet financial instruments
consisting of commitments to extend credit and standby letters of credit. Such
financial instruments are recorded in the financial statements when they become
payable.
CASH FLOWS - The Corporation utilizes the net reporting of cash receipts and
cash payments for certain deposit and lending activities. The Corporation
considers all cash and amounts due from depository institutions,
interest-bearing deposits in other banks, and federal funds sold to be cash
equivalents.
TRUST ASSETS AND INCOME - Assets held by the Corporation in a fiduciary or
agency capacity for its customers are not included in the financial statements
since such items are not assets of the Corporation. Trust income is recorded on
a cash basis, which is not materially different from the accrual basis.
RECLASSIFICATION - Certain 2001 and 2000 amounts have been reclassified to
conform to the 2002 presentation.
2. COMPREHENSIVE INCOME
Accounting principles generally require that recognized revenue, expenses, gains
and losses be included in net income. Although certain changes in assets and
liabilities, such as unrealized gains and losses on available-for-sale
securities, are reported as a separate component of the equity section of the
balance sheet, such items, along with net income, are components of
comprehensive income. The components of other comprehensive income and the
related tax effects are as follows:
YEARS ENDED DECEMBER 31,
(IN THOUSANDS) 2002 2001 2000
Unrealized holding gains on available-for-sale securities $ 13,283 $ 9,802 $ 14,963
Less: Reclassification adjustment for gains realized in income (2,888) (1,920) (1,377)
- -----------------------------------------------------------------------------------------------------------
Net unrealized gains 10,395 7,882 13,586
Tax effect (3,533) (2,680) (4,620)
- -----------------------------------------------------------------------------------------------------------
Net-of-tax amount $ 6,862 $ 5,202 $ 8,966
===========================================================================================================
33
3. PER SHARE DATA
Net income per share is based on the weighted-average number of shares of common
stock outstanding. The number of shares used in calculating net income and cash
dividends per share reflect the retroactive effect of stock dividends declared
in the fourth quarter of each year presented, payable in the first quarter of
the following year. The following data show the amounts used in computing basic
and diluted net income per share. The dilutive effect of stock options is
computed as the weighted-average common shares available from the exercise of
all dilutive stock options, less the number of shares that could be repurchased
with the proceeds of stock option exercises based on the average share price of
the Corporation's common stock during the period.
WEIGHTED-
AVERAGE EARNINGS
NET COMMON PER
INCOME SHARES SHARE
2002
Earnings per share - basic $ 14,959,000 5,339,449 $2.80
Dilutive effect of stock options 14,592
- ------------------------------------------------------------------------------
Earnings per share - diluted $ 14,959,000 5,354,041 $2.79
==============================================================================
2001
Earnings per share - basic $ 12,052,000 5,348,963 $2.25
Dilutive effect of stock options 1,489
- ------------------------------------------------------------------------------
Earnings per share - diluted $ 12,052,000 5,350,452 $2.25
==============================================================================
2000
Earnings per share - basic $ 8,476,000 5,363,232 $1.58
Dilutive effect of stock options 1,154
- ------------------------------------------------------------------------------
Earnings per share - diluted $ 8,476,000 5,364,386 $1.58
==============================================================================
4. CASH AND DUE FROM BANKS
Banks are required to maintain reserves consisting of vault cash and deposit
balances with the Federal Reserve Bank in their district. The reserves are based
on deposit levels during the year and account activity and other services
provided by the Federal Reserve Bank. Average daily currency, coin, and cash
balances with the Federal Reserve Bank needed to cover reserves against deposits
for 2002 ranged from $2,161,000 to $6,458,000. For 2001, these balances ranged
from $1,489,000 to $5,923,000. Average daily cash balances with the Federal
Reserve Bank required for services provided to the Bank ranged from $1,500,000
to $2,500,000 in 2002 and amounted to $1,500,000 throughout 2001. Total balances
restricted amounted to $6,332,000 at December 31, 2002 and $4,735,000 at
December 31, 2001.
Deposits with one financial institution are insured up to $100,000. The
Corporation maintains cash and cash equivalents with certain financial
institutions in excess of the insured amount.
34
5. SECURITIES
Amortized cost and fair value of securities at December 31, 2002 and 2001 are
summarized as follows:
DECEMBER 31, 2002
GROSS GROSS
UNREALIZED UNREALIZED
AMORTIZED HOLDING HOLDING FAIR
(IN THOUSANDS) COST GAINS LOSSES VALUE
AVAILABLE-FOR-SALE SECURITIES:
Obligations of the U.S. Treasury $ - $ - $ - $ -
Obligations of other U.S. Government agencies 71,657 1,624 (933) 72,348
Obligations of states and political subdivisions 127,690 3,482 (293) 130,879
Other securities 62,296 1,398 (102) 63,592
Mortgage-backed securities 207,244 5,188 (156) 212,276
- ------------------------------------------------------------------------------------------------------------------------
Total debt securities 468,887 11,692 (1,484) 479,095
Marketable equity securities 24,886 8,959 (765) 33,080
- ------------------------------------------------------------------------------------------------------------------------
Total $ 493,773 $ 20,651 $ (2,249) $ 512,175
========================================================================================================================
HELD-TO-MATURITY SECURITIES:
Obligations of the U.S. Treasury $ 321 $ 38 $ - $ 359
Obligations of other U.S. Government agencies 297 25 - 322
Mortgage-backed securities 89 4 - 93
- ------------------------------------------------------------------------------------------------------------------------
Total $ 707 $ 67 $ - $ 774
========================================================================================================================
DECEMBER 31, 2001
GROSS GROSS
UNREALIZED UNREALIZED
AMORTIZED HOLDING HOLDING FAIR
(IN THOUSANDS) COST GAINS LOSSES VALUE
AVAILABLE-FOR-SALE SECURITIES:
Obligations of the U.S. Treasury $ 2,503 $ 54 $ - $ 2,557
Obligations of other U.S. Government agencies 75,295 698 (821) 75,172
Obligations of states and political subdivisions 95,835 1,422 (1,996) 95,261
Other securities 34,315 395 (178) 34,532
Mortgage-backed securities 198,269 1,045 (339) 198,975
- ------------------------------------------------------------------------------------------------------------------------
Total debt securities 406,217 3,614 (3,334) 406,497
Marketable equity securities 19,745 7,993 (266) 27,472
- ------------------------------------------------------------------------------------------------------------------------
Total $ 425,962 $ 11,607 $ (3,600) $ 433,969
========================================================================================================================
HELD-TO-MATURITY SECURITIES:
Obligations of the U.S. Treasury $ 726 $ 9 $ - $ 735
Obligations of other U.S. Government agencies 547 14 - 561
Mortgage-backed securities 175 6 - 181
- ------------------------------------------------------------------------------------------------------------------------
Total $ 1,448 $ 29 $ - $ 1,477
========================================================================================================================
The amortized cost and fair value of investment debt securities at December 31,
2002 follow. Maturities of debt securities (including mortgage-backed
securities) are presented based on contractual maturities. Expected maturities
differ from contractual maturities because monthly principal payments are
received from mortgage-backed securities, and because borrowers may have the
right to prepay obligations with or without prepayment penalties.
35
DECEMBER 31, 2002
AMORTIZED FAIR
(IN THOUSANDS) COST VALUE
AVAILABLE-FOR-SALE SECURITIES:
Due in one year or less $ 5,008 $ 5,012
Due after one year through five years 29,314 30,626
Due after five years through ten years 59,744 60,762
Due after ten years 374,821 382,695
- ------------------------------------------------------------------------------------------
Total $ 468,887 $ 479,095
==========================================================================================
HELD-TO-MATURITY SECURITIES:
Due in one year or less $ 321 $ 359
Due after one year through five years 122 123
Due after five years through ten years 234 261
Due after ten years 30 31
- ------------------------------------------------------------------------------------------
Total $ 707 $ 774
==========================================================================================
The following table shows the amortized cost and maturity distribution of the
debt securities portfolio at December 31, 2002:
(IN THOUSANDS, EXCEPT FOR PERCENTAGES) WITHIN ONE - FIVE FIVE - TEN AFTER TEN
ONE YEAR YIELD YEARS YIELD YEARS YIELD YEARS YIELD TOTAL YIELD
AVAILABLE-FOR-SALE SECURITIES:
Obligations of other U.S. Government
agencies $ - - $ 26,104 5.05% $ 22,031 5.74% $ 23,522 5.66% $ 71,657 5.46%
Obligations of states and political
subdivisions - - 2,137 6.69% 4,154 5.81% 121,399 5.14% 127,690 5.19%
Other securities 5,008 4.39% 1,000 9.25% 11,000 5.74% 45,288 6.24% 62,296 6.05%
Mortgage-backed securities - - 73 7.92% 22,559 4.34% 184,612 5.11% 207,244 5.03%
- -----------------------------------------------------------------------------------------------------------------------------------
Total $ 5,008 0.00% $ 29,314 5.32% $ 59,744 5.22% $ 374,821 5.29% $ 468,887 5.27%
===================================================================================================================================
HELD-TO-MATURITY SECURITIES:
Obligations of the U.S. Treasury $ 321 5.30% $ - 0.00% $ - - $ - - $ 321 5.30%
Obligations of other U.S. Government
agencies - - 100 5.63% 197 6.76% - - 297 6.38%
Mortgage-backed securities - - 22 8.22% 37 5.73% 30 3.48% 89 5.59%
- -----------------------------------------------------------------------------------------------------------------------------------
Total $ 321 5.30% $ 122 6.10% $ 234 6.60% $ 30 3.48% $ 707 5.79%
===================================================================================================================================
Investment securities carried at $90,655,000 at December 31, 2002 and
$69,962,000 at December 31, 2001, were pledged as collateral for public
deposits, trusts and certain other deposits as provided by law. Also, see Note 9
for information concerning securities pledged to secure borrowing arrangements.
Gross realized gains and losses from the sales of available-for-sale securities,
and the income tax provision related to net realized gains, for 2002, 2001 and
2000 were as follows:
(IN THOUSANDS)
2002 2001 2000
Gross realized gains $ 2,926 $ 2,408 $ 2,163
Gross realized losses (38) (488) (786)
- ------------------------------------------------------------------------------------------------------
Net realized gains $ 2,888 $ 1,920 $ 1,377
======================================================================================================
Income tax provision related to net realized gains $ 982 $ 653 $ 468
======================================================================================================
36
6. LOANS
Major categories of loans and leases included in the loan portfolio are as
follows:
(IN THOUSANDS) DECEMBER 31, % OF DECEMBER 31, % OF
2002 TOTAL 2001 TOTAL
Real estate - construction $ 103 0.02% $ 1,814 0.48%
Real estate - mortgage 370,453 82.12% 306,264 80.76%
Consumer 31,532 6.99% 29,284 7.72%
Agricultural 3,024 0.67% 2,344 0.62%
Commercial 30,874 6.84% 24,696 6.51%
Other 2,001 0.44% 1,195 0.32%
Political subdivisions 13,062 2.90% 13,479 3.55%
Lease receivables 96 0.02% 152 0.04%
- -------------------------------------------------------------------------------------------------
Total 451,145 100.00% 379,228 100.00%
Less: allowance for loan losses (5,789) (5,265)
- ------------------------------------------------ -----------------
Loans, net $ 445,356 $ 373,963
================================================ =================
Net unamortized loan fees and costs of $1,564,000 at December 31, 2002 and
$1,512,000 at December 31, 2001 have been offset against the carrying value of
loans.
There is no concentration of loans to borrowers engaged in similar businesses or
activities that exceed 10% of total loans at December 31, 2002.
The Corporation grants commercial, residential and personal loans to customers
primarily in Tioga, Bradford, Sullivan and Lycoming Counties. Although the
Corporation has a diversified loan portfolio, a significant portion of its
debtors' ability to honor their contracts is dependent on the local economic
conditions within the region.
LOAN MATURITY DISTRIBUTION
(IN THOUSANDS)
FIXED RATE LOANS: VARIABLE OR ADJUSTABLE
RATE LOANS:
GREATER THAN GREATER THAN
1 YEAR OR 1-5 YEARS 5 YEARS TOTAL 1 YEAR OR 1-5 YEARS 5 YEARS TOTAL
LESS LESS
Real estate - construction $ 103 $ - $ - $ 103 $ - $ - $ - $ -
Real estate - mortgage 22,281 64,577 135,153 222,011 19,323 27,579 101,540 148,442
Consumer 7,189 12,609 2,277 22,075 9,014 244 199 9,457
Agricultural 779 1,021 55 1,855 436 646 87 1,169
Commercial 3,767 8,383 3,746 15,896 11,066 2,849 1,063 14,978
Other 1,066 375 362 1,803 198 - - 198
Political subdivisions 798 3,253 9,010 13,061 - - 1 1
Lease receivables 31 65 - 96 - - - -
- ----------------------------------------------------------------------------------------------------------------------------------
Total $36,014 $90,283 $ 150,603 $ 276,900 $40,037 $31,318 $ 102,890 $ 174,245
==================================================================================================================================
Loans in the preceding table that are due on demand are shown as one year or
less.
Loans on which the accrual of interest has been discontinued or reduced amounted
to $1,252,000 at December 31, 2002 and $1,050,000 at December 31, 2001. Interest
income on such loans is recorded only as received.
37
Loans on which the original terms have been restructured totaled $66,000 at
December 31, 2002 and $75,000 at December 31, 2001. None of the loans on which
the original terms were changed were past due at December 31, 2002 and 2001.
Loans which were more than 90 days past due and still accruing interest totaled
$2,318,000 at December 31, 2002 and $2,067,000 at December 31, 2001.
Transactions in the allowance for loan losses were as follows:
(IN THOUSANDS)
2002 2001 2000
Balance at beginning of year $ 5,265 $ 5,291 $ 5,131
Provision charged to operations 940 600 676
Loans charged off (552) (713) (616)
Recoveries 136 87 100
- -------------------------------------------------------------------------
Balance at end of year $ 5,789 $ 5,265 $ 5,291
=========================================================================
Information related to impaired loans as of December 31, 2002 and 2001 is as
follows:
(IN THOUSANDS)
2002 2001
Balance of impaired loans $ 3,714 $ 582
Specific allowance related to impaired loans $ 1,877 $ 73
The average balance of impaired loans amounted to $3,838,000 in 2002, $781,000
in 2001 and $1,079,000 in 2000.
The following is a summary of cash receipts on impaired loans and how they were
applied.
(IN THOUSANDS)
2002 2001 2000
Cash receipts applied to principal $ 497 $ 35 $ 503
Cash receipts recognized as interest income 247 14 87
- ----------------------------------------------------------------------------
Total cash receipts $ 744 $ 49 $ 590
============================================================================
7. BANK PREMISES AND EQUIPMENT
Bank premises and equipment are summarized as follows:
(IN THOUSANDS)
DECEMBER 31,
2002 2001
Land $ 1,275 $ 1,126
Buildings and improvements 12,295 11,313
Furniture and equipment 9,022 8,565
- ------------------------------------------------------------------------
Total 22,592 21,004
Less: accumulated depreciation (12,259) (11,037)
- ------------------------------------------------------------------------
Net $ 10,333 $ 9,967
========================================================================
38
Depreciation expense included in occupancy expense and furniture and equipment
expense was as follows:
(IN THOUSANDS)
2002 2001 2000
Occupancy expense $ 432 $ 401 $ 370
Furniture and equipment expense 914 899 716
- ----------------------------------------------------------------------------
Total $ 1,346 $ 1,300 $ 1,086
============================================================================
8. DEPOSITS
Balances and maturities of time deposits are as follows:
(IN THOUSANDS)
DECEMBER 31, 2002
2003 2004 2005 2006 2007 THEREAFTER TOTAL
Certificates of Deposit $127,796 $20,369 $14,648 $10,878 $19,743 $ 251 $ 193,685
Yield 3.18% 3.75% 4.38% 4.84% 4.83% 4.47% 3.59%
Individual Retirement Accounts 76,875 22,690 - - 169 - 99,734
Yield 5.00% 5.00% - - 4.62% - 5.00%
- -------------------------------------------------------------------------------------------------------------------------------
Total Time Deposits $204,671 $43,059 $14,648 $10,878 $19,912 $ 251 $ 293,419
- -------------------------------------------------------------------------------------------------------------------------------
Yield 3.86% 4.41% 4.38% 4.84% 4.83% 4.47% 4.07%
===============================================================================================================================
DECEMBER 31, 2001
2002 2003 2004 2005 2006 THEREAFTER TOTAL
Certificates of Deposit $136,845 $25,406 $ 7,004 $ 3,808 $ 6,289 $ 169 $ 179,521
Yield 4.59% 4.53% 4.99% 5.32% 5.01% 5.00% 4.63%
Individual Retirement Accounts 54,607 29,533 - - - - 84,140
Yield 5.00% 5.00% - - - - 5.00%
- -------------------------------------------------------------------------------------------------------------------------------
Total Time Deposits $191,452 $54,939 $ 7,004 $ 3,808 $ 6,289 $ 169 $ 263,661
- -------------------------------------------------------------------------------------------------------------------------------
Yield 4.71% 4.78% 4.99% 5.32% 5.01% 5.00% 4.75%
===============================================================================================================================
Included in interest-bearing deposits are time deposits in the amount of
$100,000 or more. As of December 31, 2002, the remaining maturities or repricing
frequency of time deposits of $100,000 or more are as follows:
(IN THOUSANDS)
Three months or less $28,973
Over 3 months through 12 months 33,212
Over 1year through 3 years 4,919
Over 3 years 5,859
- ---------------------------------------------------
Total $72,963
===================================================
Interest expense from deposits of $100,000 or more amounted to $3,238,000 in
2002, $3,220,000 in 2001 and $1,925,000 in 2000.
39
9. BORROWED FUNDS
SHORT-TERM BORROWINGS
Short-term borrowings include the following:
(IN THOUSANDS) AT DECEMBER 31,
2002 2001
Overnight borrowings (a) $ 14,350 $ 6,300
Federal Home Loan Bank of Pittsburgh borrowings (b) 2,500 22,000
Customer repurchase agreements (c) 20,218 19,764
Other repurchase agreements (d) 6,567 10,000
- --------------------------------------------------------------------------------
Total short-term borrowings $ 43,635 $ 58,064
================================================================================
The weighted average interest rate on total short-term borrowings outstanding
was 1.77% at December 31, 2002 and 3.44% at December 31, 2001. The maximum
amount of total short-term borrowings outstanding at any month-end was
$43,635,000 in 2002 and $96,167,000 in 2001.
(a) Overnight borrowings include federal funds purchased overnight from
correspondent banks and overnight borrowings from the Federal Home Loan Bank of
Pittsburgh (FHLB-Pittsburgh) on the "Open Repo Plus" facility. The maximum
month-end amount of such borrowings was $14,350,000 in 2002, $20,000,000 in 2001
and $16,500,000 in 2000. The average amount of such borrowings was $2,347,000 in
2002, $4,012,000 in 2001 and $5,721,000 in 2000. Weighted average interest rates
were 1.86% in 2002, 4.58% in 2001 and 6.70% in 2000.
(b) Short-term FHLB - Pittsburgh loans are as follows:
AT DECEMBER 31,
(IN THOUSANDS) 2002 2001
Fixed Rate 5.25% matured January 24, 2002 $ - $ 5,000
Fixed Rate 5.20% matured February 19, 2002 - 7,000
Fixed Rate 2.38% matured October 30, 2002 - 10,000
Fixed Rate 1.51% maturing February 19, 2003 1,000 -
Fixed Rate 1.68% maturing November 19, 2003 1,500 -
- --------------------------------------------------------------------------------
Total short-term FHLB - Pittsburgh borrowings $ 2,500 $ 22,000
================================================================================
Collateral for FHLB - Pittsburgh loans is described under the "Long-term
Borrowings" section of this note.
(c) Customer repurchase agreements mature overnight, and are collateralized by
securities with a carrying value of $23,305,000 at December 31, 2002 and
$32,431,000 at December 31, 2001.
(d) Other repurchase agreements included in short-term borrowings are as
follows:
AT DECEMBER 31,
(IN THOUSANDS) 2002 2001
Fixed Rate 5.72% matured January 3, 2002 $ - $ 10,000
Fixed Rate 2.91% maturing March 25, 2003 6,567 -
- --------------------------------------------------------------------------------
Total short-term other repurchase agreements $ 6,567 $ 10,000
================================================================================
The terms and collateral related to repurchase agreements are described under
the "Long-term Borrowings" section of this note.
40
LONG-TERM BORROWINGS
Long-term borrowings are as follows:
(IN THOUSANDS) AT DECEMBER 31,
2002 2001
Federal Home Loan Bank of Pittsburgh borrowings (e) $ 170,061 $ 125,584
Repurchase agreements (f) 38,153 -
- -------------------------------------------------------------------------------------------
Total long-term borrowings $ 208,214 $ 125,584
===========================================================================================
(e) Long-term borrowings from FHLB - Pittsburgh are as follows:
(IN THOUSANDS) AT DECEMBER 31,
2002 2001
Fixed rate at 5.095%, matured May 1, 2002 $ - $ 15,000
Fixed rate at 5.38%, matured July 24, 2002 - 5,000
Fixed rate at 5.37%, maturing January 12, 2003 (*) - 10,000
Fixed rate at 5.48%, maturing January 24, 2003 (*) - 5,000
Fixed rate at 4.79%, maturing April 26, 2003 10,000 10,000
Fixed rate at 4.82%, maturing May 14, 2003 10,000 10,000
Fixed rate at 4.63%, maturing July 11, 2003 10,000 10,000
Fixed rate at 4.65%, maturing August 30, 2004 10,000 10,000
Fixed rate at 3.84%, maturing October 22, 2004 10,000 10,000
Fixed rate at 2.34%, maturing November 19, 2004 3,000 -
Fixed rate at 2.16%, maturing December 20, 2004 5,000 -
Fixed rate at 4.19%, maturing January 24, 2005 5,000 -
Fixed rate at 4.04%, maturing February 22, 2005 7,000 -
Fixed rate at 5.05%, maturing August 29, 2005 5,000 5,000
Fixed rate at 4.145%, maturing October 31, 2005 5,000 5,000
Fixed rate at 2.84%, maturing November 21, 2005 2,500 -
Fixed rate at 2.68%, maturing December 20, 2005 5,000 -
Fixed rate at 4.83%, maturing February 21, 2006 20,000 20,000
Fixed rate at 4.455%, maturing October 30, 2006 5,000 5,000
Fixed rate at 3.28%, maturing November 20, 2006 2,000 -
Fixed rate at 3.09%, maturing December 20, 2006 5,000 -
Fixed rate at 4.58%, maturing May 1, 2007 15,000 -
Fixed rate at 3.66%, maturing October 15, 2007 10,000 -
Fixed rate at 3.45%, maturing December 24, 2007 10,000 -
Fixed rate at 4.98%, maturing March 23, 2011 5,000 5,000
Fixed rate at 4.54%, maturing January 4, 2012 10,000 -
Fixed rate at 6.86%, maturing December 30, 2016 498 518
Fixed rate at 6.83%, maturing June 5, 2017 63 66
- ------------------------------------------------------------------------------------------
Total long-term FHLB - Pittsburgh borrowings $ 170,061 $ 125,584
==========================================================================================
(*) In November 2002, the Corporation paid off these loans, and incurred
prepayment penalties totaling $101,000. The prepayment penalties are included in
interest expense in the Consolidated Statement of Income.
The FHLB - Pittsburgh loan facilities are collateralized by qualifying
securities and mortgage loans with a book value totaling $387,091,000 at
December 31, 2002. Also, the FHLB - Pittsburgh loan facilities require the
Corporation to invest in established amounts of FHLB - Pittsburgh stock. The
carrying values of the Corporation's holdings of FHLB - Pittsburgh stock were
$10,202,000 at December 31, 2002 and $8,129,000 at December 31, 2001.
41
(f) Repurchase agreements included in long-term borrowings are as follows:
AT DECEMBER 31,
(IN THOUSANDS) 2002 2001
Fixed Rate 2.53% maturing February 25, 2003 $ 7,500 $ -
Fixed Rate 3.45% maturing February 25, 2004 7,500 -
Fixed Rate 3.96% maturing March 25, 2004 6,567 -
Fixed Rate 4.15% maturing February 25, 2005 5,000 -
Fixed Rate 4.63% maturing March 25, 2005 6,766 -
Fixed Rate 4.63% maturing February 25, 2006 4,820 -
- -----------------------------------------------------------------------------
Total long-term repurchase agreements $ 38,153 $ -
=============================================================================
Securities sold under repurchase agreements were delivered to the broker-dealers
who arranged the transactions. The broker-dealers may have sold, loaned or
otherwise disposed of such securities to other parties in the normal course of
their operations, and have agreed to resell to the Corporation substantially
identical securities at the maturities of the agreements. The carrying value of
the underlying securities was $54,763,000 at December 31, 2002 and $9,975,000 at
December 31, 2001. Average daily repurchase agreement borrowings amounted to
$36,482,000 in 2002, $14,217,000 in 2001 and $14,372,000 in 2000. During 2002,
2001 and 2000, the maximum amounts of outstanding borrowings under repurchase
agreements with broker-dealers were $44,720,000, $19,450,000 and $35,731,000.
The weighted average interest rate on repurchase agreements was 3.72%, 6.20% in
2001 and 5.68% in 2000.
10. DERIVATIVE FINANCIAL INSTRUMENTS
In June 2001, the Corporation began to utilize derivative financial instruments
related to a new certificate of deposit product called the "Index Powered
Certificate of Deposit" (IPCD). IPCDs have a term of 5 years, with interest paid
at maturity based on 90% of the appreciation (as defined) in the S&P 500 index.
There is no guaranteed interest payable to a depositor of an IPCD - however,
assuming an IPCD is held to maturity, a depositor is guaranteed the return of
his or her principal, at a minimum.
Statement of Financial Accounting Standards No. 133 requires the Corporation to
separate the amount received from each IPCD issued into 2 components: (1) an
embedded derivative, and (2) the principal amount of each deposit. Embedded
derivatives are derived from the Corporation's obligation to pay each IPCD
depositor a return based on appreciation in the S&P 500 index. Embedded
derivatives are carried at fair value, and are included in other liabilities in
the consolidated balance sheet. Changes in fair value of the embedded derivative
are included in other expense in the consolidated income statement. The
difference between the contractual amount of each IPCD issued, and the amount of
the embedded derivative, is recorded as the initial deposit (included in
interest-bearing deposits in the consolidated balance sheet). Interest expense
is added to principal ratably over the term of each IPCD at an effective
interest rate that will increase the principal balance to equal the contractual
IPCD amount at maturity.
In connection with IPCD transactions, the Corporation has entered into Equity
Indexed Call Option (Swap) contracts with FHLB-Pittsburgh. Under the terms of
the Swap contracts, the Corporation must pay FHLB-Pittsburgh quarterly amounts
calculated based on the contractual amount of IPCDs issued times a negotiated
rate. In return, FHLB-Pittsburgh is obligated to pay the Corporation, at the
time of maturity of the IPCDs, an amount equal to 90% of the appreciation (as
defined) in the S&P 500 index. If the S&P 500 index does not appreciate over the
term of the related IPCDs, the FHLB-Pittsburgh would make no payment to the
Corporation. The effect of the Swap contracts is to limit the Corporation's cost
of IPCD funds to the market rate of interest paid to FHLB-Pittsburgh. (In
addition, the Corporation pays a fee of 0.75% to a consulting firm at inception
of each deposit. This fee is amortized to interest expense over the term of the
IPCDs.) Swap liabilities are carried at fair value, and included in other
liabilities in the consolidated balance sheet. Changes in fair value of swap
liabilities are included in other expense in the consolidated income statement.
42
Amounts recorded as of and for the years ended December 31, 2002 and 2001
related to IPCDs are as follows (in thousands):
AT DECEMBER 31,
2002 2001
Contractual amount of IPCDs (equal
to notional amount of Swap contracts) $ 3,028 $ 1,410
Carrying value of IPCDs 2,572 1,154
Carrying value of embedded derivative liabilities 156 233
Carrying value of Swap contract liabilities 309 31
FOR THE YEARS ENDED
DECEMBER 31,
2002 2001
Interest expense 88 17
Other expense 8 7
11. FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair value of a financial instrument is the current amount that would be
exchanged between willing parties, other than in a forced liquidation. Fair
value is best determined based upon quoted market prices. However, in many
instances, there are no quoted market prices for the Corporation's financial
instruments. In cases where quoted market prices are not available, fair values
are based on estimates using present value or other valuation techniques. Those
techniques are significantly affected by the assumptions used, including the
discount rate and estimates of future cash flows. Accordingly, the fair value
estimates may not be realized in an immediate settlement of the instrument.
Statement of Financial Accounting Standards No. 107 excludes certain financial
instruments and all nonfinancial instruments from its disclosure requirements.
Therefore, the aggregate fair value amounts presented may not represent the
underlying fair value of the Corporation.
The Corporation used the following methods and assumptions in estimating fair
value disclosures for financial instruments:
CASH AND CASH EQUIVALENTS - The carrying amounts of cash and short-term
instruments approximate fair values.
SECURITIES - Fair values for securities, excluding restricted equity securities,
are based on quoted market prices. The carrying value of restricted equity
securities approximates fair value based on applicable redemption provisions.
LOANS - Fair values are estimated for portfolios of loans with similar financial
characteristics. Loans are segregated by type such as commercial, commercial
real estate, residential mortgage, credit card and other consumer. Each loan
category is further segmented into fixed and adjustable rate interest terms and
by performing and nonperforming categories. The fair value of performing loans,
except residential mortgage and credit card loans, is calculated by discounting
scheduled cash flows through the estimated maturity using estimated market
discount rates that reflect the credit and interest rate risk inherent in the
loans. The estimate of maturity is based on the Corporation's historical
experience with repayments for each loan classification, modified, as required,
by an estimate of the effect of current economic and lending conditions. For
performing residential mortgage loans, fair value is estimated by discounting
contractual cash flows adjusted for prepayment estimates based on historical
experience. For credit card loans, cash flows and maturities are estimated based
on contractual interest rates and historical experience. Fair value of
nonperforming loans is based on recent appraisals or estimates prepared by the
Corporation's lending officers.
43
DEPOSITS - The fair value of deposits with no stated maturity, such as
noninterest-bearing demand deposits, savings, money market and interest checking
accounts, is (by definition) equal to the amount payable on demand at December
31, 2002 and 2001. The fair value of all other deposit categories is based on
the discounted value of contractual cash flows. The discount rate is estimated
using the rates currently offered for deposits of similar remaining maturities.
The fair value estimates of deposits do not include the benefit that results
from the low-cost funding provided by the deposit liabilities compared to the
cost of borrowing funds in the market, commonly referred to as the core deposit
intangible.
BORROWED FUNDS - The fair value of borrowings is estimated using discounted cash
flow analyses based on rates currently available to the Corporation for similar
types of borrowing arrangements.
ACCRUED INTEREST - The carrying amounts of accrued interest receivable and
payable approximate fair values.
EMBEDDED DERIVATIVE LIABILITIES - IPCDS - The fair values of embedded
derivatives are calculated by a third party. Factors that affect the fair value
of embedded derivatives include term to maturity, market interest rates and
other market factors that affect the present value of the Corporation's
obligation to pay each IPCD depositor a return based on appreciation in the S&P
500 index.
EMBEDDED DERIVATIVE LIABILITIES - EQUITY OPTION SWAP CONTRACTS - The fair values
of equity option Swap contracts are calculated by a third party. Factors that
affect the fair value of equity option Swap contracts include: (1) the
negotiated rate associated with the Corporation's obligation to make quarterly
payments to the FHLB-Pittsburgh over the term of each IPCD; and (2) term to
maturity, market interest rates and other market factors that affect the present
value of the FHLB-Pittsburgh's obligation to pay the Corporation a return based
on appreciation in the S&P 500 index.
The estimated fair values, and related carrying amounts, of the Corporation's
financial instruments are as follows:
(IN THOUSANDS) AT DECEMBER 31,
2002 2001
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
Financial assets:
Cash and cash equivalents $ 14,900 $14,900 $ 16,036 $ 16,036
Available-for-sale securities 512,175 512,175 433,969 433,969
Held-to-maturity securities 707 774 1,448 1,477
Restricted equity securities 10,202 10,202 8,129 8,129
Loans, net 445,356 447,382 373,963 377,124
Accrued interest receivable 5,960 5,960 4,871 4,871
Financial liabilities:
Deposits 640,304 643,305 576,274 578,319
Short-term borrowings 43,635 43,662 58,064 58,148
Long-term borrowings 208,214 215,875 125,584 128,977
Accrued interest payable 1,307 1,307 1,420 1,420
Embedded derivative liabilities -
IPCDs 156 156 233 233
Equity option Swap contracts -
IPCDs 309 309 31 31
44
12. EMPLOYEE AND POSTRETIREMENT BENEFIT PLANS
DEFINED BENEFIT PLANS
The Corporation has a noncontributory defined benefit pension plan for all
employees meeting certain age and length of service requirements. Benefits are
based primarily on years of service and the average annual compensation during
the highest five consecutive years within the final ten years of employment.
Also, the Corporation sponsors a defined benefit health care plan that provides
postretirement medical benefits and life insurance to employees who meet certain
age and length of service requirements. This plan contains a cost-sharing
feature, which causes participants to pay for all future increases in costs
related to benefit coverage. Accordingly, actuarial assumptions related to
health care cost trend rates do not affect the liability balance at December 31,
2002 and 2001, and will not affect the Corporation's future expenses.
The following tables show the funded status and components of net periodic
benefit cost from these defined benefit plans:
(IN THOUSANDS)
PENSION POSTRETIREMENT
BENEFITS BENEFITS
2002 2001 2002 2001
CHANGE IN BENEFIT
OBLIGATION:
Benefit obligation at beginning of year $ 7,679 $ 7,646 $ 888 $ 790
Service cost 349 271 24 19
Interest cost 553 497 57 58
Plan participants' contributions - - 115 80
Actuarial loss (gain) 617 (338) (25) 79
Benefits paid (429) (397) (173) (138)
- ----------------------------------------------------------------------------------------------
Benefit obligation at end of year $ 8,769 $ 7,679 $ 886 $ 888
==============================================================================================
2002 2001 2002 2001
CHANGE IN PLAN ASSETS:
Fair value of plan assets at
beginning of year $ 8,423 $ 9,317 $ - $ -
Actual return on plan assets (326) (497) - -
Employer contribution - - 58 58
Plan participants' contributions - - 115 80
Benefits paid (429) (397) (173) (138)
- ----------------------------------------------------------------------------------------------
Fair value of plan assets at end of year $ 7,668 $ 8,423 $ - $ -
==============================================================================================
Funded status $(1,101) $ 744 $ (886) $ (888)
Unrecognized net actuarial loss (gain) 1,726 90 (43) (17)
Unrecognized transition obligation (182) (205) 365 401
- ----------------------------------------------------------------------------------------------
Prepaid (accrued) benefit cost $ 443 $ 629 $ (564) $ (504)
==============================================================================================
2002 2001 2002 2001
WEIGHTED-AVERAGE ASSUMPTIONS:
Discount rate 6.75% 7.00% 6.75% 7.00%
Expected return on plan assets 8.50% 8.50% N/A N/A
Rate of compensation increase 4.75% 5.00% N/A N/A
45
PENSION BENEFITS POSTRETIREMENT BENEFITS
COMPONENTS OF NET
PERIODIC BENEFIT COST: 2002 2001 2000 2002 2001 2000
Service cost $ 349 $ 271 $ 308 $ 24 $ 19 $ 27
Interest cost 553 497 491 57 58 52
Expected return on plan assets (702) (787) (815) - - -
Amortization of transition obligation (23) (23) (23) 36 37 37
Recognized net actuarial loss (gain) 8 (30) (64) 1 1 (2)
- ------------------------------------------------------------------------------------------------------------
Net periodic benefit cost (benefit) $ 185 $ (72) $ (103) $ 118 $ 115 $ 114
============================================================================================================
PROFIT SHARING AND DEFERRED COMPENSATION PLANS
The Corporation has a profit sharing plan that incorporates the deferred salary
savings provisions of Section 401(k) of the Internal Revenue Code. The
Corporation's matching contributions to the Plan depend upon the tax deferred
contributions of employees. The Corporation's total basic and matching
contributions were $667,000 in 2002, $588,000 in 2001 and $511,000 in 2000.
Effective December 31, 2001, the Corporation amended the 401(k) Plan to convert
the "Basic Stock Fund" component of the Plan to an Employee Stock Ownership Plan
(ESOP). A portion of the Corporation's basic contributions to the Plan are made
to the ESOP, and the Plan uses these funds to purchase Corporation stock for the
accounts of Plan participants. These purchases are made on the market (not
directly from the Corporation), and employees are not permitted to purchase
Corporation stock under the Plan. The Plan includes a diversification feature
which permits Plan participants, upon reaching age 55 and 10 years of service
(as defined), to sell up to 50% of their Corporation shares back to the Plan
over a period of 6 years. This diversification feature will become effective in
2003, and accordingly, as of December 31, 2002, there were no shares allocated
for repurchase by the Plan.
Dividends paid on shares held by the ESOP are charged to retained earnings. All
Corporation shares owned through the ESOP are included in the calculation of
weighted-average shares outstanding for purposes of calculating earnings per
share - basic and diluted. As of December 31, 2002, the ESOP held 189,263 shares
of Corporation stock, all of which had been allocated to Plan participants. The
Corporation's contributions to the ESOP portion of the Plan for 2002 (included
in total contributions reported above) totaled $343,000.
The Corporation also has a nonqualified supplemental deferred compensation
arrangement with its key officers. Charges to expense for officers' supplemental
deferred compensation were $44,000 in 2002, $38,000 in 2001 and $70,000 in 2000.
STOCK-BASED COMPENSATION PLANS
The Corporation has a Stock Incentive Plan for a selected group of senior
officers. A total of 180,000 shares of common stock may be issued under the
Stock Incentive Plan. Awards may be made under the Stock Incentive Plan in the
form of qualified options ("Incentive Stock Options," as defined in the Internal
Revenue Code), nonqualified options, stock appreciation rights or restricted
stock. Through 1999, all awards under the Stock Incentive Plan were Incentive
Stock Options, with exercise prices equal to the market price of the stock at
the date of grant, ratable vesting over 5 years and a contractual expiration of
10 years. In 2000 and 2002, there were awards of Incentive Stock Options and
restricted stock. The Incentive Stock Options granted in 2000 and 2002 have an
exercise price equal to the market value of the stock at the date of grant, vest
after 6 months and expire after 10 years. The restricted stock awards vest
ratably over 3 years.
Also, the Corporation has an Independent Directors Stock Incentive Plan
(formerly called the Independent Directors Stock Option Plan). In 2001, this
plan was amended to permit awards of nonqualified stock options and/or
restricted stock to non-employee directors. As amended, a total of 50,000 shares
of common stock may be issued under the Independent Directors Stock Incentive
Plan. The recipients' rights to exercise stock options under this plan expire 10
years from the date of grant. The exercise prices of all stock options awarded
under the Independent Directors Stock Incentive Plan are equal to market value
as of the dates of grant. The restricted stock awards vest ratably over 3 years.
Effective January 2, 2003, the Corporation granted options to purchase a total
of 30,942 shares of common stock through the Stock Incentive and Independent
Directors Stock Incentive Plans. The exercise price for these options is $31.10
per share, which was the market price at the date of grant. Also, effective
January 2, 2003, the Corporation awarded a total of 3,444 shares of restricted
stock under the Stock Incentive and Independent Directors Stock Incentive Plans.
The stock options and restricted stock awards that were awarded in January 2003
are not included in the tables that follow.
46
As described in Note 1, the Corporation applies Accounting Principles Board
Opinion 25 and related interpretations in accounting for stock options.
Accordingly, no compensation expense has been recognized for the stock options.
Had compensation cost for the stock options been determined based on the fair
value at the grant dates for awards consistent with the method of SFAS No. 123,
the effect on the Corporation's net income and earnings per share would have
been adjusted to the pro forma amounts indicated in the following table.
(NET INCOME IN THOUSANDS)
2002 2001 2000
Net income
As reported $14,959 $12,052 $8,476
Pro forma $14,768 $11,989 $8,399
Earnings per share-basic
As reported $2.80 $2.25 $1.58
Pro forma $2.77 $2.24 $1.57
Earnings per share-diluted
As reported $2.79 $2.25 $1.58
Pro forma $2.76 $2.24 $1.57
For purposes of the calculations of SFAS No. 123, the fair value of each option
grant is estimated on the date of grant using the Black-Scholes option-pricing
model with the following assumptions:
2002 2001 2000
Volatility 17% 17% 18%
Expected option lives 6 Years 6 Years 6 Years
Risk-free interest rate 5.00% 5.08% 5.00%
Dividend yield 4.16% 3.57% 3.96%
A summary of the status of the Corporation's stock option plans is presented
below:
2002 2001 2000
- -----------------------------------------------------------------------------------------------------------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
Outstanding, beginning of year 83,236 $ 27.73 100,810 $ 28.04 82,420 $ 29.63
Granted 40,815 $ 25.50 1,976 $ 21.25 18,615 $ 20.91
Exercised (3,562) $ 20.97 - $ - (225) $ 20.00
Forfeited - $ - (19,550) $ 28.72 - -
- -----------------------------------------------------------------------------------------------------------------------------
Outstanding, end of year 120,489 $ 27.17 83,236 $ 27.73 100,810 $ 28.04
=============================================================================================================================
Options exercisable at year-end 110,549 $ 26.95 64,906 $ 26.94 48,215 $ 28.69
Fair value of options granted $ 3.67 $ 3.48 $ 3.14
47
The following table summarizes information about stock options outstanding as of
December 31, 2002:
OUTSTANDING EXERCISABLE
AT REMAINING AT
DECEMBER 31, CONTRACTUAL DECEMBER 31,
EXERCISE PRICES 2002 LIFE IN YEARS 2002
$20.00 2,995 3 2,995
$25.50 - $27.84 9,700 4 9,700
$33.25-$36.50 12,850 5 12,850
$33.13-$36.38 16,500 6 13,760
$25.00-$27.00 20,400 7 13,200
$20.25-$21.25 17,587 8 17,587
$25.50 40,457 9 40,457
- -------------------------------------------------------------------------------
120,489 110,549
===============================================================================
The following table summarizes restricted stock awards through December 31,
2002:
2002 2001 2000
Number of shares awarded 4,431 221 1,752
Market price of stock at date of grant $ 25.50 $ 21.25 $ 20.25
Compensation expense related to restricted stock was $80,000 in 2002 and $22,000
in 2001. There was no compensation expense related to restricted stock awards in
2000.
13. INCOME TAXES
The following temporary differences gave rise to the net deferred tax liability
at December 31, 2002 and 2001:
(IN THOUSANDS)
2002 2001
Deferred tax liabilities:
Depreciation $ 275 $ 240
Prepaid pension 155 220
Accretion on securities 6 2
Investments in limited partnerships 21 24
Unrealized holding gains on securities 6,257 2,722
- ---------------------------------------------------------------------
Total 6,714 3,208
- ---------------------------------------------------------------------
Deferred tax assets:
Allowance for loan losses (2,026) (1,843)
Postretirement and sick benefits (216) (194)
Loan fees and costs (76) (60)
Supplemental executive retirement plan (175) (168)
Restricted stock compensation (27) -
- ---------------------------------------------------------------------
Total (2,520) (2,265)
- ---------------------------------------------------------------------
Deferred tax liability, net $ 4,194 $ 943
=====================================================================
Tax provision:
2002 2001 2000
Currently payable $ 4,018 $ 3,371 $ 1,882
Deferred (284) (349) (63)
- --------------------------------------------------------------------------------
Total provision $ 3,734 $ 3,022 $ 1,819
================================================================================
48
Reconciliation of tax provision:
2002 2001 2000
AMOUNT % AMOUNT % AMOUNT %
Expected provision $ 6,543 35.00% $ 5,276 35.00% $ 3,603 35.00%
Tax-exempt interest income (2,223) (11.89) (1,730) (11.48) (1,738) (16.88)
Nondeductible interest expense 239 1.28 226 1.50 280 2.72
Dividends received deduction (280) (1.50) (267) (1.77) (235) (2.28)
Increase in cash surrender value of
life insurance (299) (1.60) (317) (2.10) - -
Surtax exemption (176) (0.94) (151) (1.00) (103) (1.00)
Other, net (70) (0.37) (15) (0.10) 12 0.11
- ---------------------------------------------------------------------------------------------------------------------
Effective income tax provision $ 3,734 19.98% $ 3,022 20.05% $ 1,819 17.67%
=====================================================================================================================
14. RELATED PARTY TRANSACTIONS
Loans to executive officers, directors of the Corporation and its subsidiaries
and any associates of the foregoing persons are as follows:
(IN THOUSANDS)
BEGINNING NEW OTHER ENDING
BALANCE LOANS REPAYMENTS CHANGES BALANCE
14 directors, 6 executive officers 2002 $ 6,535 $ 2,464 $ (2,722) $ 346 $ 6,623
14 directors, 6 executive officers 2001 5,730 658 (1,833) 1,980 6,535
14 directors, 6 executive officers 2000 6,640 724 (1,450) (184) 5,730
The above transactions were made in the ordinary course of business on
substantially the same terms, including interest rates and collateral, as those
prevailing at the time for comparable transactions with other persons and do not
involve more than normal risks of collectibility. Other changes represent net
increases in existing lines of credit and transfers in and out of the related
party category.
15. OFF-BALANCE SHEET RISK
The Corporation is a party to financial instruments with off-balance sheet risk
in the normal course of business to meet the financial needs of its customers.
These financial instruments include commitments to extend credit and financial
standby letters of credit. These instruments involve, to varying degrees,
elements of credit, interest rate or liquidity risk in excess of the amount
recognized in the consolidated balance sheet. The contract amounts of these
instruments express the extent of involvement the Corporation has in particular
classes of financial instruments.
The Corporation's exposure to credit loss from nonperformance by the other party
to the financial instruments for commitments to extend credit and financial
standby letters of credit is represented by the contractual amount of these
instruments. The Corporation uses the same credit policies in making commitments
and conditional obligations as it does for on-balance sheet instruments.
Financial instruments whose contract amounts represent credit risk at December
31, 2002 and 2001 are as follows:
(IN THOUSANDS) 2002 2001
Commitments to extend credit $ 103,138 $ 86,498
Financial standby letters of credit 10,753 5,508
Commitments to extend credit are legally binding agreements to lend to
customers. Commitments generally have fixed expiration dates or other
termination clauses and may require payment of fees. Since many of the
commitments are expected to expire without being drawn upon, the total
commitment amounts do not necessarily represent future liquidity requirements.
The Corporation evaluates each customer's creditworthiness on a case-by-case
basis. The amount of
49
collateral obtained, if deemed necessary by the Corporation, for extensions of
credit is based on management's credit assessment of the counterparty.
Financial standby letters of credit are conditional commitments issued by the
Corporation guaranteeing performance by a customer to a third party. Those
guarantees are issued primarily to support public and private borrowing
arrangements, including commercial paper, bond financing and similar
transactions. The credit risk involved in issuing letters of credit is
essentially the same as that involved in extending loan facilities to customers.
Some of the financial standby letters of credit are collateralized by real
estate or other assets, while others are unsecured. The extent to which proceeds
from liquidation of collateral would be expected to cover the maximum potential
amount of future payments related to financial standby letters of credit is not
estimable. The Corporation has recorded no liability associated with financial
standby letters of credit as of December 31, 2002 and 2001.
Financial standby letters of credit as of December 31, 2002 expire as follows:
(IN THOUSANDS)
YEAR OF EXPIRATION AMOUNT
- ----------------------------------------
2003 $ 5,462
2004 2,605
2005 1,165
2006 593
2007 928
- ----------------------------------------
Total $ 10,753
========================================
16. CONTINGENCIES
In the normal course of business, the Corporation may be subject to pending and
threatened lawsuits in which claims for monetary damages could be asserted. In
management's opinion, the Corporation's financial position and results of
operations would not be materially affected by the outcome of such legal
proceedings.
17. REGULATORY MATTERS
The Corporation (on a consolidated basis) and the Bank are subject to various
regulatory capital requirements administered by the federal banking agencies.
Failure to meet minimum capital requirements can initiate certain mandatory -
and possibly additional discretionary - actions by regulators that, if
undertaken could have a direct material effect on the Corporation's financial
statements. Under capital adequacy guidelines and the regulatory framework for
prompt corrective action, the Corporation and the Bank must meet specific
capital guidelines that involve quantitative measures of their assets,
liabilities and certain off-balance sheet items as calculated under regulatory
accounting practices. The capital amounts and classification are also subject to
qualitative judgments by the regulators about components, risk weightings and
other factors. Prompt corrective action provisions are not applicable to bank
holding companies.
Quantitative measures established by regulation to ensure capital adequacy
require the Corporation and the Bank to maintain minimum amounts and ratios (set
forth in the table below) of total and Tier I capital (as defined in the
regulations) to risk-weighted assets (as defined) and of Tier I capital (as
defined) to average assets (as defined). Management believes, as of December 31,
2002 and 2001, that the Corporation and the Bank meet all capital adequacy
requirements to which they are subject.
To be categorized as well capitalized, an institution must maintain minimum
total risk based, Tier I risk based and Tier I leverage ratios as set forth in
the following table. The Corporation's and the Bank's actual capital amounts and
ratios are also presented in the following table.
50
(DOLLARS IN THOUSANDS) MINIMUM
TO BE WELL
MINIMUM CAPITALIZED UNDER
CAPITAL PROMPT CORRECTIVE
ACTUAL REQUIREMENT ACTION PROVISIONS
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
-------------------------------------------------------------------------------
DECEMBER 31, 2002:
Total capital to risk-
weighted assets:
Consolidated $113,168 20.09% $ 45,055 greater than $ 56,319 greater than
or equal to 8% or equal to 10%
Bank 94,044 17.17% 43,825 greater than 54,782 greater than
or equal to 8% or equal to 10%
Tier 1 capital to risk-
weighted assets:
Consolidated 103,691 18.41% 22,528 greater than 33,792 greater than
or equal to 4% or equal to 6%
Bank 86,140 15.72% 21,913 greater than 32,869 greater than
or equal to 4% or equal to 6%
Tier 1 capital to
average assets:
Consolidated 103,691 10.53% 39,372 greater than 49,215 greater than
or equal to 4% or equal to 5%
Bank 86,140 8.94% 38,520 greater than 48,150 greater than
or equal to 4% or equal to 5%
DECEMBER 31, 2001:
Total capital to risk-
weighted assets:
Consolidated $103,645 22.94% $ 36,144 greater than $ 45,180 greater than
or equal to 8% or equal to 10%
Bank 87,070 19.69% 35,372 greater than 44,215 greater than
or equal to 8% or equal to 10%
Tier 1 capital to risk-
weighted assets:
Consolidated 94,903 21.01% 18,072 greater than 27,108 greater than
or equal to 4% or equal to 6%
Bank 79,855 18.06% 17,686 greater than 26,529 greater than
or equal to 4% or equal to 6%
Tier 1 capital to
average assets:
Consolidated 94,903 11.18% 33,960 greater than 42,450 greater than
or equal to 4% or equal to 5%
Bank 79,855 9.63% 33,164 greater than 41,455 greater than
or equal to 4% or equal to 5%
Restrictions imposed by Federal Reserve Regulation H limit dividend payments in
any year to the current year's net income plus the retained net income of the
prior two years without approval of the Federal Reserve Board. Accordingly, the
Corporation's dividends in 2003 may not exceed $15,299,000, plus consolidated
net income for 2003. Additionally, banking regulators limit the amount of
dividends that may be paid by the Bank to the Corporation. Retained earnings
against which dividends may be paid without prior approval of the banking
regulators amounted to approximately $76,113,000 at December 31, 2002, subject
to the minimum capital ratio requirements noted above.
Restrictions imposed by federal law prohibit the Corporation from borrowing from
the Bank unless the loans are secured in specific amounts. Such secured loans to
the Corporation are generally limited to 10% of the Bank's stockholder's equity
(excluding accumulated other comprehensive income) or $8,614,000 at December 31,
2002.
51
18. PARENT COMPANY ONLY
The following is condensed financial information for Citizens & Northern
Corporation.
CONDENSED BALANCE SHEET
DECEMBER 31,
(IN THOUSANDS) 2002 2001
ASSETS
Cash $ 592 $ 333
Investment in subsidiaries:
Citizens & Northern Bank 95,879 82,914
Citizens & Northern Investment Corporation 18,929 16,383
Bucktail Life Insurance company 2,006 2,010
Other assets 45 13
- ---------------------------------------------------------------------------
TOTAL ASSETS $117,451 $101,653
===========================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Dividends payable $ 1,586 $ 1,466
Other liabilities 28 -
Stockholders' equity 115,837 100,187
- ---------------------------------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $117,451 $101,653
===========================================================================
CONDENSED INCOME STATEMENT
YEARS ENDED DECEMBER 31,
(IN THOUSANDS) 2002 2001 2000
Dividends from Citizens & Northern Bank $ 7,063 $ 6,286 $ 4,077
Other dividend income 174 250 -
Securities gains - - -
Expenses (140) (74) (179)
- ------------------------------------------------------------------------------------
Income before equity in undistributed income
of subsidiaries 7,097 6,462 3,898
Equity in undistributed income of subsidiaries 7,862 5,590 4,578
- ------------------------------------------------------------------------------------
NET INCOME $14,959 $12,052 $ 8,476
====================================================================================
52
CONDENSED STATEMENT OF CASH FLOWS
YEARS ENDED DECEMBER 31,
(IN THOUSANDS) 2002 2001 2000
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 14,959 $ 12,052 $ 8,476
Adjustments to reconcile net income to net
cash provided by operating activities:
Equity in undistributed net income of
subsidiaries (7,862) (5,590) (4,578)
Amortization of restricted stock 80 22 -
(Increase) decrease in other assets (32) 14 (28)
Increase in other liabilities 98 - 17
- ------------------------------------------------------------------------------------------------
Net Cash Provided by Operating Activities 7,243 6,498 3,887
- ------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES,
Investment in subsidiary (783) (266) (225)
- ------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from sale of treasury stock 76 - 6
Purchase of treasury stock (239) (521) -
Dividends paid (6,038) (5,441) (4,986)
- ------------------------------------------------------------------------------------------------
Net Cash Used in Investing Activities (6,201) (5,962) (4,980)
- ------------------------------------------------------------------------------------------------
INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS 259 270 (1,318)
CASH AND CASH EQUIVALENTS, BEGINNING
OF YEAR 333 63 1,381
- ------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 592 $ 333 $ 63
================================================================================================
19. SUMMARY OF QUARTERLY CONSOLIDATED FINANCIAL DATA (UNAUDITED)
The following table presents summarized quarterly financial data for 2002 and
2001:
(IN THOUSANDS, EXCEPT PER SHARE DATA) 2002 QUARTER ENDED
Mar. 31, June 30, Sept. 30, Dec. 31,
Interest income $ 13,642 $ 14,523 $ 14,675 $ 14,445
Interest expense 6,316 6,745 6,675 6,579
- -----------------------------------------------------------------------------------------------------------------
Interest margin 7,326 7,778 8,000 7,866
Provision for loan losses 180 180 280 300
- -----------------------------------------------------------------------------------------------------------------
Interest margin after provision for loan losses 7,146 7,598 7,720 7,566
Other income 1,687 1,681 1,642 1,614
Securities gains 1,226 781 489 392
Other expenses 5,106 5,248 5,310 5,185
- -----------------------------------------------------------------------------------------------------------------
Income before income tax provision 4,953 4,812 4,541 4,387
Income tax provision 1,115 992 831 796
- -----------------------------------------------------------------------------------------------------------------
Net income $ 3,838 $ 3,820 $ 3,710 $ 3,591
=================================================================================================================
Net income per share - basic $ 0.72 $ 0.72 $ 0.70 $ 0.67
=================================================================================================================
Net income per share - diluted $ 0.72 $ 0.71 $ 0.69 $ 0.67
=================================================================================================================
53
(IN THOUSANDS, EXCEPT PER SHARE DATA) 2001 QUARTER ENDED
Mar. 31, June 30, Sept. 30, Dec. 31,
Interest income $ 13,093 $ 13,830 $ 13,962 $ 13,776
Interest expense 7,492 7,278 7,037 6,549
- ----------------------------------------------------------------------------------------------------------------
Interest margin 5,601 6,552 6,925 7,227
Provision for loan losses 150 150 150 150
- ----------------------------------------------------------------------------------------------------------------
Interest margin after provision for loan losses 5,451 6,402 6,775 7,077
Other income 1,434 1,516 1,600 1,570
Securities gains 455 742 520 203
Other expenses 4,598 4,580 4,575 4,918
- ----------------------------------------------------------------------------------------------------------------
Income before income tax provision 2,742 4,080 4,320 3,932
Income tax provision 477 891 914 740
- ----------------------------------------------------------------------------------------------------------------
Net income $ 2,265 $ 3,189 $ 3,406 $ 3,192
================================================================================================================
Net income per share - basic $ 0.42 $ 0.60 $ 0.64 $ 0.60
================================================================================================================
Net income per share - diluted $ 0.42 $ 0.60 $ 0.64 $ 0.60
================================================================================================================
54
INDEPENDENT AUDITORS' REPORT
To the Stockholders and Board of Directors of Citizens & Northern Corporation:
We have audited the accompanying consolidated balance sheet of Citizens &
Northern Corporation and subsidiaries as of December 31, 2002 and 2001, and the
related consolidated statements of income, changes in stockholders' equity, and
cash flows for each of the three years in the period ended December 31, 2002.
These financial statements are the responsibility of the Corporation's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Citizens & Northern
Corporation and subsidiaries as of December 31, 2002 and 2001, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 2002, in conformity with accounting principles
generally accepted in the United States of America.
Parente Randolph, PC /s/
Williamsport, Pennsylvania
February 7, 2003
55
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information concerning Directors and Executive Officers is incorporated herein
by reference to disclosure under the captions "Proposal 1 - Election of
Directors," "Corporation's and Bank's Executive Officers," and "Section 16(a)
Beneficial Ownership Reporting Compliance" of the Corporation's proxy statement
dated March 18, 2003 for the annual meeting of stockholders to be held on April
15, 2003.
ITEM 11. EXECUTIVE COMPENSATION
Information concerning executive compensation information is incorporated herein
by reference to disclosure under the caption "Executive Compensation" of the
Corporation's proxy statement dated March 18, 2003 for the annual meeting of
stockholders to be held on April 15, 2003.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information concerning security ownership of certain beneficial owners and
management is incorporated herein by reference to disclosure under the caption
"Security Ownership of Management" of the Corporation's proxy statement dated
March 18, 2003 for the annual meeting of stockholders to be held on April 15,
2003.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information concerning loans to Directors and Executive Officers is provided in
Note 14 to the Consolidated Financial Statements, which is included in Part II,
Item 8 of this Annual Report on Form 10-K. Additional information is
incorporated herein by reference to disclosure appearing under the caption
"Certain Transactions" of the Corporation's proxy statement dated March 18, 2003
for the annual meeting of stockholders to be held on April 15, 2003.
ITEM 14. CONTROLS AND PROCEDURES
Within 90 days prior to the filing date of this report, the Corporation's Chief
Executive Officer and Chief Financial Officer carried out an evaluation of the
design and effectiveness of the Corporation's disclosure controls and procedures
pursuant to Rule 13a-14(c) and Rule 15d-14(c) of the Securities Exchange Act of
1934. Based upon that evaluation, the Chief Executive Officer and Chief
Financial Officer concluded that the Corporation's disclosure controls and
procedures are effective to ensure that information required to be disclosed in
reports the Corporation files or submits under the Securities Exchange Act of
1934 is recorded, processed, summarized and reported, within the time periods
specified in the Securities and Exchange Commission's rules and forms.
There have been no significant changes in the Corporation's internal controls or
in other factors that could significantly affect these controls subsequent to
the date of the Chief Executive Officer's and Chief Financial Officer's most
recent evaluation. There were no significant deficiencies or material weaknesses
noted in the evaluation, and therefore there were no corrective actions taken.
56
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) (1). The following consolidated financial statements are set forth in Part
II, Item 8:
Page
----
Independent Auditors' Report 55
Financial Statements:
Consolidated Balance Sheet - December 31, 2002 and 2001 27
Consolidated Statement of Income - Years Ended
December 31, 2002, 2001 and 2000 28
Consolidated Statement of Changes in Stockholders' Equity -
Years Ended December 31, 2002, 2001 and 2000 29
Consolidated Statement of Cash Flows - Years Ended
December 31, 2002, 2001 and 2000 30
Notes to Consolidated Financial Statements 31- 54
(a)(2) Financial statement schedules are not applicable or included in the
financial statements or related notes.
(a)(3) Exhibits (numbered as in Item 601 of Regulation S-K):
2. Plan of acquisition, reorganization, arrangement,
liquidation or
succession Not applicable
3. (i) Articles of Incorporation Incorporated by reference to the exhibits
filed with the Corporation's registration
statement on Form S-4 on March 27, 1987.
3. (ii) By-laws Incorporated by reference to the exhibits
filed with the Corporation's registration
statement on Form S-4 on March 27, 1987.
4. Instruments defining the rights of security holders,
including indentures Not applicable
9. Voting trust agreement Not applicable
10. Material contracts:
Citizens & Northern Corporation Independent Directors Incorporated by reference to the exhibits
Stock Incentive Plan filed with the Corporation's proxy statement
dated March 19, 2001 for the annual
meeting of stockholders held on
April 17, 2001.
First Amendment to Citizens & Northern Corporation Incorporated by reference to the exhibits
Stock Incentive Plan filed with the Corporation's proxy statement
dated March 22, 1999 for the annual
meeting of stockholders held on
April 20, 1999.
57
Citizens & Northern Corporation Stock Incentive plan Incorporated by reference to the exhibits
filed with the Corporation's proxy statement
dated March 20, 1995 for the annual
meeting of stockholders held on
April 18, 1995.
11. Statement re: computation of per share earnings Information concerning the computation of
earnings per share is provided in Note 3
to the Consolidated Financial Statements,
which is included in Part II, Item 8 of
Form 10-K.
12. Statements re: computation of ratios Not applicable
13. Annual report to security holders, Form 10-Q or
quarterly report to security holders Not applicable
16. Letter re: change in certifying accountant Not applicable
18. Letter re: change in accounting principles Not applicable
21. Subsidiaries of the registrant Filed herewith
22. Published report regarding matters submitted to
vote of security holders Not applicable
23. Consents of experts and counsel Not applicable
24. Power of attorney Not applicable
99. Additional exhibits:
99.1 Certifications pursuant to 18 U.S.C. Section 1350 as
adopted pursuant to Section 906 of the Sarbanes-
Oxley Act of 2002 Filed herewith
99.2 Additional information mailed to stockholders
with proxy statement and Form 10-K on March 19, 2002 Filed herewith
(b) On October 11, 2002, a Current Report on Form 8-K was filed to report the
Corporation's consolidated earnings results for the three-month and nine-month
periods ended September 30, 2002.
(c) Exhibits - The required exhibits are listed under Part IV, Item 14(a)(3) of
Form 10-K.
(d) Financial statement schedules are omitted because the required information
is not applicable or is included elsewhere in Form 10-K.
58
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, Citizens & Northern Corporation has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized:
CITIZENS & NORTHERN CORPORATION
By: Craig G. Litchfield /s/
- ---------------------------
Craig G. Litchfield
Chairman, President and Chief Executive Officer
Date: March 18, 2003
By: Mark A. Hughes /s/
- ---------------------------
Treasurer and Principal Accounting Officer
Date: March 18, 2003
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
BOARD OF DIRECTORS
/s/ Dennis F. Beardslee /s/ Edward L. Learn
Dennis F. Beardslee Edward L. Learn
Date: March 18, 2003 Date: March 18, 2003
/s/ R. Robert DeCamp /s/ Craig G. Litchfield
R. Robert DeCamp Craig G. Litchfield
Date: March 18, 2003 Date: March 18, 2003
/s/ Jan E. Fisher /s/ Lawrence F. Mase
Jan E. Fisher Lawrence F. Mase
Date: March 18, 2003 Date: March 18, 2003
/s/ R. Bruce Haner /s/ Leonard Simpson
R. Bruce Haner Leonard Simpson
Date: March 18, 2003 Date: March 18, 2003
/s/ Susan E. Hartley /s/ James E. Towner
Susan E. Hartley James E. Towner
Date: March 18, 2003 Date: March 18, 2003
/s/ Karl W. Kroeck /s/ Ann M. Tyler
Karl W. Kroeck Ann M. Tyler
Date: March 18, 2003 Date: March 18, 2003
/s/ Leo F. Lambert
Leo F. Lambert
Date: March 18, 2003
59
CERTIFICATIONS
I, Craig G. Litchfield, Chairman, Chief Executive Officer and President of
Citizens & Northern Corporation, certify that:
1. I have reviewed this annual report on Form 10-K of Citizens & Northern
Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in
this annual report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
March 18, 2003 By: Craig G. Litchfield /s/
- -------------- -----------------------
Date Chairman, President and Chief Executive Officer
60
I, Mark A. Hughes, Treasurer and Chief Financial Officer of Citizens & Northern
Corporation, certify that:
1. I have reviewed this annual report on Form 10-K of Citizens & Northern
Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in
this annual report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
March 18, 2003 By: Mark A. Hughes /s/
- -------------- -----------------------
Date Treasurer and Chief Financial Officer
61