UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2004
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission File Number 333-78445
PENNSYLVANIA COMMERCE BANCORP, INC.
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(Exact name of registrant as specified in its charter)
Pennsylvania 25-1834776
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(State or other jurisdiction of (IRS Employer Identification
incorporation or organization) Number)
100 Senate Avenue, P.O. Box 8599, Camp Hill, PA 17001-8599
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(Address of principal executive offices) (Zip Code)
(717) 975-5630
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(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Exchange Act 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 whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act).
Yes ___ No X
State the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date: 2,325,966 Common shares
outstanding at 7/31/04
PENNSYLVANIA COMMERCE BANCORP, INC.
INDEX
Page
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets..........................................3
June 30, 2004 (Unaudited), and December 31, 2003
Consolidated Statements of Income (Unaudited)........................4
Three months ended June 30, 2004 and June 30, 2003
Six months ended June 30, 2004 and June 30, 2003
Consolidated Statements of Stockholders' Equity (Unaudited).........5
Six months ended June 30, 2004 and June 30, 2003
Consolidated Statements of Cash Flows (Unaudited)....................6
Six months ended June 30, 2004, and June 30, 2003
Notes to Consolidated Financial Statements (Unaudited)...............7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations...........................................10
Item 3. Quantitative and Qualitative Disclosures about Market Risk..........25
Item 4. Controls and Procedures.............................................25
PART II. OTHER INFORMATION
Item 1. Legal Proceedings...................................................26
Item 2. Changes in Securities and Use of Proceeds...........................26
Item 3. Defaults Upon Senior Securities.....................................26
Item 4. Submission of Matters to a Vote of Securities Holders...............26
Item 5. Other Information...................................................26
Item 6a. Exhibits............................................................26
Item 6b. Reports on Form 8-K.................................................26
Signatures
2
Pennsylvania Commerce Bancorp, Inc. and Subsidiaries
Consolidated Balance Sheets
June 30, December 31,
---------------------- ----------------------
2004 (unaudited) 2003
---------------------- ----------------------
(dollars in thousands, except share amounts)
Assets
Cash and due from banks............................................ $ 27,271 $ 37,715
Federal funds sold................................................. 0 0
----------------- ------------------
Cash and cash equivalents..................................... 27,271 37,715
Securities, available for sale at fair value....................... 303,904 275,400
Securities, held to maturity at cost
(fair value 2004: $197,390; 2003: $201,568)................... 199,838 199,863
Loans, held for sale............................................... 7,834 9,164
Loans receivable, net of allowance for loan losses
(allowance 2004: $7,019; 2003: $6,007)........................ 588,398 469,937
Restricted investments in bank stock............................... 8,505 5,227
Premises and equipment, net........................................ 38,767 38,178
Other assets....................................................... 10,353 16,505
----------------- ------------------
Total assets.................................................. $ 1,184,870 $ 1,051,989
================= ==================
Liabilities
Deposits:
Noninterest-bearing........................................... $ 182,282 $ 170,414
Interest-bearing.............................................. 795,976 736,113
----------------- ------------------
Total deposits............................................ 978,258 906,527
Short-term borrowings.............................................. 137,443 79,000
Junior subordinated debt........................................... 13,600 0
Trust capital securities........................................... 0 13,000
Other liabilities.................................................. 4,563 3,738
----------------- ------------------
Total liabilities......................................... 1,133,864 1,002,265
----------------- ------------------
Stockholders' Equity
Preferred stock-Series A noncumulative; $10.00 par value
1,000,000 shares authorized; 40,000 shares issued and
outstanding................................................... 400 400
Common stock-$1.00 par value; 10,000,000 shares authorized;
issued and outstanding - 2004: 2,322,948; 2003: 2,291,805... 2,323 2,292
Surplus............................................................ 39,902 38,725
Retained earnings.................................................. 11,588 7,758
Accumulated other comprehensive income (loss)...................... (3,207) 549
----------------- ------------------
Total stockholders' equity................................ 51,006 49,724
----------------- ------------------
Total liabilities and stockholders' equity.................... $ 1,184,870 $ 1,051,989
================= ==================
See accompanying notes.
3
Pennsylvania Commerce Bancorp, Inc. and Subsidiaries
Consolidated Statements of Income
(Unaudited)
Three Months Ended June 30, Six Months Ended June 30,
------------------------------------------------------------------
2004 2003 2004 2003
------------------------------------------------------------------
(dollars in thousands, except per share amounts)
Interest Income
Loans receivable, including fees:
Taxable ............................................. $8,413 $6,883 $16,031 $13,361
Tax-exempt........................................... 73 54 143 111
Securities:
Taxable.............................................. 6,248 4,013 12,337 8,081
Tax-exempt........................................... 100 121 201 212
Federal funds sold...................................... 0 56 0 140
------ ------ ------ ------
Total interest income....................... 14,834 11,127 28,712 21,905
------ ------ ------ ------
Interest Expense
Deposits................................................ 2,446 2,593 4,713 5,428
Short-term borrowings................................... 392 0 681 0
Trust capital securities................................ 355 339 709 678
------ ------ ------ ------
Total interest expense....................... 3,193 2,932 6,103 6,106
------ ------ ------ ------
Net interest income....................... 11,641 8,195 22,609 15,799
Provision for loan losses............................... 675 525 1,250 850
------ ------ ------ ------
Net interest income after provision for loan losses..... 10,966 7,670 21,359 14,949
------ ------ ------ ------
Noninterest Income
Service charges and other fees.......................... 2,517 1,928 4,758 3,732
Other operating income.................................. 94 88 184 186
Gains on sales of loans................................. 105 200 360 489
------ ------ ------ ------
Total noninterest income..................... 2,716 2,216 5,302 4,407
------ ------ ------ ------
Noninterest Expenses
Salaries and employee benefits.......................... 5,377 3,751 10,746 7,283
Occupancy............................................... 1,090 772 2,214 1,569
Furniture and equipment................................. 602 446 1,150 844
Advertising and marketing............................... 724 474 1,435 918
Data processing......................................... 836 587 1,447 1,102
Postage and supplies.................................... 285 216 573 454
Other................................................... 1,535 1,181 3,001 2,285
------ ------ ------ ------
Total noninterest expenses.................. 10,449 7,427 20,566 14,455
------ ------ ------ ------
Income before income taxes.............................. 3,233 2,459 6,095 4,901
Provision for federal income taxes...................... 1,052 801 1,986 1,595
------ ------ ------ ------
Net income.................................. $2,181 $1,658 $4,109 $3,306
====== ====== ====== ======
Net Income per Common Share
Basic....................................... $0.93 $0.73 $1.76 $1.46
Diluted..................................... $0.86 $0.68 $1.62 $1.36
See accompanying notes.
4
Pennsylvania Commerce Bancorp, Inc. and Subsidiaries
Consolidated Statement of Stockholders' Equity
(Unaudited)
Accumulated
Other
Preferred Common Retained Comprehensive
Stock Stock Surplus Earnings Income (Loss) Total
-------------------------------------------------------------------------
(dollars in thousands)
Balance: December 31, 2002................ $ 400 $ 2,117 $ 31,909 $ 6,866 $ 1,520 $ 42,812
Comprehensive income:
Net income............................... -- -- -- 3,306 -- 3,306
Change in unrealized gains (losses) on
securities, net of reclassification
adjustment.............................. -- -- -- -- (152) (152)
----------
Total comprehensive income................. 3,154
Dividends declared on preferred stock...... -- -- -- (40) -- (40)
Common stock of 22,571 shares issued under
stock option plans...................... -- 23 358 -- -- 381
Income tax benefit of stock options -- -- 107 -- -- 107
exercised...............................
Common stock of 70 shares issued under
employee stock purchase plan............ -- -- 2 -- -- 2
Proceeds from issuance of 9,307 shares of
common stock in connection with
dividend-reinvestment and stock -- 9 337 -- -- 346
purchase plan...........................
5% common stock dividend and cash paid in
lieu of fractional shares (453 shares
issued)................................. -- 1 17 (18) -- --
--------- --------- -------- -------- ------------ ----------
June 30, 2003.............................. $ 400 $ 2,150 $ 32,730 $ 10,114 $ 1,368 $ 46,762
========= ========= ======== ======== ============ ==========
Accumulated
Other
Preferred Common Retained Comprehensive
Stock Stock Surplus Earnings Income (Loss) Total
-------------------------------------------------------------------------
(dollars in thousands)
Balance: December 31, 2003.............. $ 400 $ 2,292 $ 38,725 $ 7,758 $ 549 $49,724
Comprehensive income:
Net income............................. -- -- -- 4,109 -- 4,109
Change in unrealized gains (losses) on
securities, net of reclassification
adjustment............................ -- -- -- -- (3,756) (3,756)
-------
Total comprehensive income............... 353
Dividends declared on preferred stock.... -- -- -- (40) -- (40)
Common stock of 24,246 shares issued
under stock option plans.............. -- 25 448 -- -- 473
Income tax benefit of stock options -- -- 188 -- -- 188
exercised.............................
Common stock of 400 shares issued under
employee stock purchase plan.......... -- -- 18 -- -- 18
Proceeds from issuance of 6,135 shares
of common stock in connection with
dividend reinvestment and stock -- 6 292 -- -- 298
purchase plan.........................
5% common stock dividend and cash paid
in lieu of fractional shares (362
shares issued)........................ -- -- 231 (239) -- (8)
--------- --------- -------- -------- ------------- -------
June 30, 2004............................ $ 400 $ 2,323 $ 39,902 $ 11,588 $ (3,207) $51,006
========= ========= ======== ======== ============= =======
See accompanying notes.
5
Pennsylvania Commerce Bancorp, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(Unaudited)
==============================================================================================================
Six Months Ended June 30,
2004 2003
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(in thousands)
Operating Activities
Net income ..................................................................$ 4,109 $ 3,306
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses ............................................... 1,250 850
Provision for depreciation and amortization ............................. 1,166 832
Deferred income taxes ................................................... (165) (103)
Amortization of securities premiums and accretion of discounts, net...... 598 1,405
Proceeds from sale of loans ............................................. 44,437 54,633
Loans originated for sale ............................................... (42,747) (56,442)
Gain on sales of loans .................................................. (360) (489)
Stock granted under stock purchase plan ................................. 18 2
(Increase) decrease in other assets .................................... 8,985 (488)
Increase (decrease) in other liabilities ................................ 825 (1,029)
----------------------------------------------------------------------------------------------------------
Net cash provided by operating activities ............................. 18,116 2,477
- --------------------------------------------------------------------------------------------------------------
Investing Activities
Security held to maturity:
Proceeds from principal repayments and maturities ....................... 25,090 23,312
Purchases ............................................................... (25,033) (52,812)
Securities available for sale:
Proceeds from principal repayments and maturities ....................... 60,298 93,113
Purchases ............................................................... (95,059) (102,729)
Net increase in loans receivable ............................................ (119,711) (38,188)
Purchases of restricted investments in bank stock ........................... (3,278) (405)
Purchases of premises and equipment ......................................... (1,755) (5,895)
- --------------------------------------------------------------------------------------------------------------
Net cash used by investing activities ................................ (159,448) (83,604)
- --------------------------------------------------------------------------------------------------------------
Financing Activities
Net increase in demand deposits, interest checking,
money market and savings deposits ....................................... 27,111 66,851
Net increase (decrease) in time deposits .................................... 44,620 (11,073)
Net increase in short-term borrowings ....................................... 58,443 0
Proceeds from common stock options exercised ................................ 473 381
Proceeds from dividend reinvestment and common stock purchase plans.......... 298 346
Cash dividends on preferred stock and cash in lieu of fractional shares...... (57) (50)
- --------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities ............................. 130,888 56,455
- --------------------------------------------------------------------------------------------------------------
Decrease in cash and cash equivalents ....................................... (10,444) (24,672)
Cash and cash equivalents at beginning of year .............................. 37,715 75,450
- --------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period ............................. $ 27,271 $ 50,778
- --------------------------------------------------------------------------------------------------------------
See accompanying notes.
6
PENNSYLVANIA COMMERCE BANCORP, INC.
NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2004
(Unaudited)
Note 1. BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Pennsylvania
Commerce Bancorp, Inc. ("the Company") and its wholly owned subsidiary Commerce
Bank/Harrisburg, N.A. ("the Bank"). All material intercompany accounts and
transactions have been eliminated.
The accompanying unaudited consolidated financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information. Accordingly, they do not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments considered
necessary for a fair presentation have been included and are of a normal,
recurring nature. Operating results for the six-month period ended June 30,
2004, are not necessarily indicative of the results that may be expected for the
year ending December 31, 2004.
Note 2. SIGNIFICANT ACCOUNTING POLICIES
Stock Dividends and Per Share Data
On January 23, 2004 the Board of Directors declared a 5% stock dividend on
common stock outstanding, paid on February 24, 2004, to stockholders of record
on February 6, 2004. Payment of the stock dividend resulted in the issuance of
approximately 109,000 additional common shares and cash of $16,592 in lieu of
fractional shares. The effect of the 5% common stock dividend has been recorded
as of December 31, 2003.
Stock Option Plan
The Company accounts for the stock option plan under the recognition and
measurements principles of APB Opinion No. 25, "Accounting for Stock Issued to
Employees," and related interpretations. No stock-based employee compensation
cost is reflected in net income, as all options granted under those plans had an
exercise price equal to the market value of the underlying common stock on the
date of grant. The following table illustrates the effect on net income and
earnings per share if the Company had applied the fair value recognition
provisions of FASB Statement 123, "Accounting for Stock-Based Compensation," to
stock-based compensation for three months ended and six months ended June 30,
2004 and 2003:
7
Three Months Six Months
Ended June 30, Ended June 30,
- ----------------------------------------------------------------------------------------------------------------
(dollars in thousands) 2004 2003 2004 2003
------------ ------------ ------------ ------------
Net income:
As reported............................... $ 2,181 $ 1,658 $ 4,109 $ 3,306
Total stock-based compensation cost,
net of tax, that would have been
included in the determination of net
income if the fair value based method had
been applied to all awards............. (310) (276) (497) (431)
------------ ------------ ------------ ------------
Pro-forma................................. $ 1,871 $ 1,382 $ 3,612 $ 2,875
============ ============ ============ ============
Reported earnings per share:
Basic.................................. $ 0.93 $ 0.73 $ 1.76 $ 1.46
Diluted................................ 0.86 0.68 1.62 1.36
Pro-forma earnings per share:
Basic.................................. $ 0.80 $ 0.61 1.55 $ 1.27
Diluted................................ 0.73 0.56 1.42 1.18
New Accounting Standards
In January 2003, the Financial Accounting Standards Board issued FASB
Interpretation No. 46, "Consolidation of Variable Interest Entities, an
Interpretation of ARB No. 51" which was revised in December 2003. This
Interpretation provides guidance for the consolidation of variable interest
entities (VIEs). The Company's wholly owned subsidiaries, Commerce Capital
Harrisburg Trust I and Commerce Capital Harrisburg Trust II, (the "Trusts")
qualify as variable interest entities under FIN 46. The Trusts issued mandatory
redeemable preferred securities (Trust Preferred Securities) to third-party
investors and loaned the proceeds to the Company. The Trusts hold, as their sole
asset, subordinated debentures issued by the Company.
FIN 46 required the Company to deconsolidate the Trusts from the consolidated
financial statements as of March 31, 2004. There has been no restatement of
prior periods. The impact of this deconsolidation was to increase junior
subordinated debentures by $13.6 million and reduce the trust capital securities
line item by $13.0 million that had represented the trust preferred securities
of the Trusts. The Company's equity interest in the trust subsidiaries of
$600,000, which had previously been eliminated in consolidation, is now reported
in "Other assets" as of June 30, 2004. For regulatory reporting purposes, the
Federal Reserve Board has indicated that the preferred securities will continue
to qualify as Tier 1 Capital subject to previously specified limitations, until
further notice. If regulators make a determination that Trust Preferred
Securities can no longer be considered in regulatory capital, the securities
become callable and the Company may redeem them. The adoption of FIN 46 did not
have an impact on the Company's results of operations or liquidity.
Adoption of this statement did not have a material impact on the Company's
financial condition or results of operations.
8
Note 3. COMMITMENTS AND CONTINGENCIES
The Company is subject to certain routine legal proceedings and claims arising
in the ordinary course of business. It is management's opinion that the ultimate
resolution of these claims will not have a material adverse effect on the
Company's financial position and results of operations.
Future Facilities
The Company has entered into an agreement to purchase the land located at the
corner of Friendship Road and TecPort Drive in Swatara Township, Dauphin County,
Pennsylvania. The Company plans to construct a Headquarters/Operations Facility
on this property to be opened in 2005.
The Company has purchased the parcel of land at 115 Bowman Street, City of
Lebanon, in Lebanon County, Pennsylvania. The Company is constructing a
full-service branch on this property to be opened in Fall 2004.
Note 4. COMPREHENSIVE INCOME
Comprehensive income for the Company consists of net income and unrealized gains
or losses on available for sale securities and is presented in the consolidated
statements of stockholders' equity. Unrealized securities gains or losses and
the related tax impact included in comprehensive income are as follows:
Three Months Ended Six Months Ended
June 30 June 30
(in thousands) 2004 2003 2004 2003
----------------------------------------------------------------
Unrealized holding gains (losses)
on available for sale securities occurring
during the period........................ $ (8,315) $ 318 $ (5,691) $ (230)
Reclassification adjustment for
gains included in net income............. -- -- -- --
----------------------------------------------------------------
Net unrealized gains (losses)............. (8,315) 318 (5,691) (230)
Tax effect................................ 2,827 (108) 1,935 78
----------------------------------------------------------------
Other comprehensive income (loss)......... $ (5,488) $ 210 $ (3,756) $ (152)
================================================================
9
Note 5. GUARANTEES
The Company does not issue any guarantees that would require liability
recognition or disclosure, other than its standby letters of credit. Standby
letters of credit are conditional commitments issued by the Company to guarantee
the performance of a customer to a third party. Generally, all letters of
credit, when issued have expiration dates within one year. The credit risk
involved in issuing letters of credit is essentially the same as those that are
involved in extending loan facilities to customers. The Company, generally,
holds collateral and/or personal guarantees supporting these commitments. The
Company had $8.8 million of standby letters of credit as of June 30, 2004.
Management believes that the proceeds obtained through a liquidation of
collateral and the enforcement of guarantees would be sufficient to cover the
potential amount of future payment required under the corresponding guarantees.
The current amount of the liability as of June 30, 2004 for guarantees under
standby letters of credit issued is not material.
10
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Management's Discussion and Analysis of Financial Condition and Results of
Operations analyzes the major elements of the Company's balance sheets and
statements of income. This section should be read in conjunction with the
Company's financial statements and accompanying notes.
EXECUTIVE SUMMARY
Our competitive strategy utilizes a retail model, which is built on the
gathering and retention of low cost deposits. Management believes deposit growth
continues to be the primary driver of our success and that service and a
superior retail experience, not interest rates, drives deposit growth. The
consistent growth of low cost, long-term deposit relationships allows us to
focus our investments on less risky loans and securities. In addition, our
significant cash flow allows us ongoing reinvestment opportunities as interest
rates change.
Total deposits increased $71.8 million from $906.5 million at December 31, 2003
to $978.3 million at June 30, 2004. The growth in total deposits was due to a
combination of growth from five new stores opened in the second half of 2003
along with same store deposit growth of 19%. We measure same store deposit
growth as the annual percentage increase in core deposits for store offices open
two years or more. As of June 30, 2004, 16 of our 23 stores had been open for
two years or more. Our core deposits include all deposits except for public fund
time deposits.
We expect that we will continue our pattern of expanding our footprint by
branching into contiguous areas of our existing market, and by filling gaps
between existing store locations. We are targeting to open approximately two to
six new stores in each of the next five years. We plan to open an additional two
new stores in the second half of 2004 bringing the total to 25 by year-end. In
addition, to accommodate our growth we plan to construct a new headquarters,
operations and training center in Harrisburg, which we expect to open in 2005.
As a result, we expect that expenses related to salaries, employee benefits,
occupancy, furniture and equipment, and advertising will increase in subsequent
periods. Our long-range plan targets a total of 36 store offices by the end of
2006. We believe that the demographics of the south central Pennsylvania market
should provide significant opportunities for us to continue to grow both deposit
and lending relationships.
During the first six months of 2004 our total loans (including loans held for
sale) increased by $117.1 million from $479.1 million as of December 31, 2003 to
$596.2 million at June 30, 2004. This growth was represented across all loan
categories, reflecting a continuing commitment to the credit needs of our market
areas. We have taken great strides over the past 24 months to strengthen the
structure and depth of our lending function and we believe that the growth in
total loans is a result of these efforts. In recent years, there has been
significant consolidation in financial institutions in our market areas. We
believe this consolidation has caused dislocation, and therefore has provided us
with the opportunity to gain customers and hire experienced local banking
professionals. Our loan to deposit ratio at June 30, 2004 was 61.7%, as compared
to 53.5% as of December 31, 2003.
During the first six months of 2004 our total assets grew by $132.9 million from
$1.05 billion at
11
December 31, 2003 to $1.18 billion as of June 30, 2004. During this same
six-month time period, interest earning assets (loans and investments) increased
by $146.6 million from $960.4 million to $1.11 billion. The growth in earning
assets was funded by the previously mentioned deposit growth of $71.8 million
plus an increase in short-term borrowings of $58.4 million from $79.0 million to
$137.4 million. Loan growth in the first six months of 2004 exceeded deposit
growth in terms of total dollars and we offset this difference with short-term
borrowings. We plan to use any excess deposit growth in the second half of 2004
to reduce the level of short-term borrowings. Our goal is to maintain our level
of short-term borrowings to around or below $100 million and plan to reduce this
level even further in 2005 by replacing borrowings with continued deposit
growth.
Long-term interest rates remained at historically low levels for the first six
months of 2004. Despite this, we were able to grow our net interest income by
$6.8 million, or 43%, compared to the first six months of 2003 almost entirely
due to the increased volume in interest earning assets. Total revenues (net
interest income plus non-interest income) increased by $7.7 million, or 38%, in
the first six months of 2004 compared to the first six months of 2003 and net
income increased by 24% from $3.3 million to $4.1 million. Earnings per share
increased by 19%, from $1.36 to $1.62.
The financial highlights for the first six months of 2004 are summarized below.
June 30, December 31, %
2004 2003 Change
----------- ----------- -----------
(dollars in millions)
Total Assets .................. $ 1,184.9 $1,052.0 13%
Total Loans (Net) ............. 588.4 469.9 25%
Total Deposits................. 978.3 906.5 8%
Six Months Six Months
Ended Ended %
June 30, 2004 June 30, 2003 Change
-------------- -------------- ---------
(dollars in millions, except per share data)
Total Revenues................. $ 27.9 $ 20.2 38%
Net Income..................... 4.1 3.3 24%
Net Income Per Share........... 1.62 1.36 19%
The Company has identified two critical accounting policies: the policies
related to the allowance for loan losses and stock-based compensation. The
foregoing critical accounting policies are more fully described in the Company's
annual report on Form 10-K for the year ended December 31, 2003.
On March 31, 2004, the Financial Accounting Standards Board issued an Exposure
Draft, Share-Based Payment, which is a proposed amendment to SFAS No. 123. The
Exposure Draft would eliminate the ability to account for share-based
compensation transactions using APB Opinion No.25, and generally would require
all share-based payments to employees, including grants of employee stock
options, to be recognized in the income statement at their grant-date fair
values. The Financial Accounting Standards Board expects to issue its final
standard in the second half of 2004.
OVERVIEW
Total revenues (net interest income plus other income) increased by 38% to $14.4
million for the quarter as compared to the second quarter of 2003 and net income
for the quarter increased 32% to $2.2 million as compared to $1.7 million for
the second quarter of 2003. Diluted net income per common share increased 26% to
$0.86 from $0.68 per share in the second quarter a year ago (after adjusting for
a 5% common stock dividend paid in February 2004). At June 30, 2004, we had
total assets of $1.18 billion, total net loans (including loans held for sale)
of $596.2 million, and total deposits of $978.3 million.
RESULTS OF OPERATIONS
Average Balances and Average Interest Rates
Interest earning assets averaged $1.08 billion for the second quarter of 2004 as
compared to $765.1 million for the same period in 2003. Approximately $160.0
million, or 51%, of this increase was in average loans outstanding and $148.1
million, or 48%, was in average investment securities and
12
federal funds sold. The yield on earning assets for the second quarter of 2004
was 5.54%, a decrease of 29 basis points (bps) from the comparable period in
2003. This decrease resulted primarily from decreased yields in the loan
portfolio.
The growth in interest earning assets was funded primarily by an increase in the
average balance of interest-bearing deposits of $145.8 million and an increase
in average short-term borrowings of $126.2 million over the second quarter of
2003. Average interest-bearing liabilities increased from $648.6 million during
the second quarter of 2003 to $921.1 million during the second quarter of 2004.
Average savings deposits increased $31.8 million over second quarter of 2003,
average public funds deposits increased $29.9 million, average interest bearing
demand deposits and money market accounts increased by $46.5 million, average
non-interest bearing demand deposits increased by $39.8 million, and average
time deposits increased $37.6 million during the quarter as compared to the
second quarter one year ago.
The average rate paid on interest-bearing liabilities for the second quarter of
2004 was 1.39%, a decrease of 42 basis points from the comparable period in
2003. The Company's aggregate cost of funding sources was 1.19% for the second
quarter of 2004, a decrease of 35 basis points from the prior year. This is
primarily the result of a decrease in the average rates paid on all
interest-bearing deposits.
Net Interest Income and Net Interest Margin
Net interest income is the difference between interest income earned on assets
and interest expense incurred on liabilities used to fund those assets. Interest
earning assets primarily include loans and investment securities. Liabilities
used to fund such assets include deposits, borrowed funds, and long-term debt.
Changes in net interest income and margin result from the interaction between
the volume and composition of earning assets, interest-bearing liabilities,
related yields and associated funding costs.
Interest income increased by $3.7 million, or 33%, over the second quarter of
2003. Interest income on loans outstanding increased by 22% over the second
quarter of 2003 and interest income on investment securities increased by 54%
over the same period. Total interest expense for the second quarter of 2004
increased by $261,000, or 9%, from the second quarter of 2003. Interest expense
on deposits decreased by $147,000, or 6%, during the second quarter of 2004 from
the second quarter of 2003. This was offset by an increase of interest expense
on other borrowed money of $392,000.
Net interest income for the second quarter of 2004 increased by $3.4 million, or
42%, over the same period in 2003. Changes in net interest income are frequently
measured by two statistics: net interest rate spread and net interest margin.
Net interest rate spread is the difference between the average rate earned on
earning assets and the average rate incurred on interest-bearing liabilities.
Net interest margin represents the difference between interest income, including
net loan fees earned, and interest expense, reflected as a percentage of average
earning assets. Our net interest rate spread was 4.15% during the second quarter
of 2004 compared to 4.02% during the same period of the previous year. The net
interest margin increased by 6 basis points from 4.29% for the second quarter
2003 to 4.35% during the second quarter of 2004.
For the six months ended June 30, 2004, interest income increased by $6.8
million, or 31%, over the same period in 2003. Interest income on loans
outstanding increased by 20% over the first six months of 2003 and interest
income on investment securities increased by 51% over the same period.
13
Interest expense for the first six months of 2004 totaled $6.1 million. The
first six months of 2003 resulted in a similar interest expense total of $6.1
million. Interest expense on deposits decreased by $715,000, or 13%, during the
first six months of 2004 from the same period in 2003. This was offset by an
increase of interest expense on other borrowed money of $681,000.
Net interest income for the first six months of 2004 increased by $6.8 million,
or 43%, over the same period in 2003. Our net interest margin increased 16 basis
points from 4.22% for the first six months of 2003 to 4.38% for the first half
of 2004.
Provision for Loan Losses
We recorded provisions of $675,000 to the allowance for loan losses for the
second quarter of 2004 as compared to $525,000 for the second quarter of 2003.
The total provisions for loan losses were $1.3 million and $850,000 for the
first six months of 2004 and 2003, respectively. The allowance for loan losses
as a percentage of period-end loans was 1.18% at June 30, 2004 as compared to
1.26% and 1.39% at December 31, 2003 and June 30, 2003, respectively.
We maintain an allowance for loan losses, which is a reserve established through
charges to expense in the form of a provision for loan losses and reduced by
loan charge-offs net of recoveries. We charge-off loans when we deem them to no
longer be collectible. We have established an allowance for loan losses that we
believe is adequate for estimated inherent losses in the current loan portfolio.
While the allowance for loan losses is maintained at a level believed to be
adequate by management for estimated losses in the loan portfolio, determination
of the allowance is inherently subjective, as it requires estimates, all of
which may be susceptible to significant change. Changes in these estimates may
impact the provisions charged to expense in future periods.
From December 31, 2003 to June 30, 2004, total nonperforming loans decreased
from $1.2 million to $821,000 and nonperforming loans as a percentage of total
loans decreased from 0.25% to 0.14%. The provisions we have made for loan losses
in the first six months of 2004 are based upon a combination of the reduction in
the level of nonperforming loans as well as managements' internal analysis of
the inherent losses in the current portfolio.
Noninterest Income
Noninterest income for the second quarter of 2004 increased by $500,000, or 23%,
over the same period in 2003. The increase is attributable to service charges
and fees associated with servicing a higher volume of deposit accounts and
transactions, offset by a $95,000 decrease in the gains on the sale of loans.
Included in noninterest income for the first six months of 2004 is income of
$119,000, as a result of the gain on the sale of student loans. Depending on
market conditions, the Bank typically sells its student loans during the first
quarter of each year. Included in noninterest income for the first six months of
2003 is income of $167,000 as a result of a gain on the sale of student loans.
Excluding these transactions, noninterest income for the first six months of
2004 totaled $5.2 million as compared to $4.2 million for the first six months
of 2003, an increase of 22%. The increase is mainly attributable to additional
service charges and fees associated with servicing a higher volume of deposit
accounts and transactions.
14
Noninterest Expenses
For the second quarter of 2004, noninterest expenses increased by $3 million, or
41%, over the same period in 2003. Staffing levels and related expenses
increased as a result of servicing more deposit and loan customers and
processing a higher volume of transactions. Noninterest expenses also increased
as a result of opening five additional stores, one each in June 2003, July 2003,
and September 2003, respectively and two in December 2003. A comparison of
noninterest expenses for certain categories for the three months ended June 30,
2004, and June 30, 2003, is presented in the following paragraphs.
Salary expenses and employee benefits, which represent the largest component of
noninterest expenses, increased by $1.6 million, or 43%, for the second quarter
of 2004 over the second quarter of 2003. This increase primarily reflects
increases in staff levels necessary to handle Company growth from second quarter
2003 to second quarter 2004, including the additional staff of the stores opened
in the period June 2003 through December 2003.
Occupancy expenses of $1.1 million were $318,000 higher for the second quarter
of 2004 than for the three months ended June 30, 2003. Increased occupancy
expenses primarily are a result of the five stores opened between June 2003 and
December 2003, along with the opening of a new and larger loan production office
in the York region during the summer of 2003.
Furniture and equipment expenses of $602,000 were $156,000, or 35%, higher for
the second quarter of 2004 then the three months ended June 30, 2003. This
increase was the result of higher levels of depreciation costs for furniture and
equipment incurred with the addition of five new stores opened between June 2003
and December 2003 and the expansion of the loan production office.
Advertising and marketing expenses totaled $724,000 for the three months ended
June 30, 2004, an increase of $250,000, or 53%, from the second quarter of 2003.
Advertising and marketing expenses increased due to additional marketing
initiatives in all of our markets and the addition of the Berks County market,
which occurred in the summer of 2003 when we opened two stores in this market.
Data processing expenses of $836,000 were $249,000, or 42%, higher in the second
quarter of 2004 than the three months ended June 30, 2003. The increase was due
to increased costs associated with processing additional transactions due to
growth in number of accounts serviced.
Postage and supplies expenses of $285,000 were $69,000, or 32%, higher for the
second quarter of 2004 than for the three months ended June 30, 2003. This was
due to a combination of increased usage of supplies with the addition of five
new stores and growth in the volume of customers and customer transaction
statements.
Other noninterest expenses increased by $354,000, or 30%, for the three-month
period ended June 30, 2004, as compared to the same period in 2003. Components
of the increase include:
o higher telecommunication and data line expenses due to the addition of
five new stores;
o higher loan related expenses due to an increase in loan volume over
the past 12 months;
o greater checkbook printing expenses due to an increase in the number
of new accounts
15
opened and offering standard checks free of charge when opening a
checking account;
o an increase in director and committee fees;
o an increase in customer relations expense;
o higher Pennsylvania shares tax expense due to company growth;
o an increase in the provision for other losses and differences; and
o an increase in audit, exams and shareholder expenses.
For the first six months of 2004, total noninterest expenses increased by $6.1
million, or 42%, over the comparable period in 2003. A comparison of noninterest
expenses for certain categories for these two periods is discussed below.
Salary expense and employee benefits increased by $3.5 million, or 48%, over the
first six months of 2003. The increase was due to normal increases and
additional salary and benefits costs due to an increase in the level of
full-time equivalent employees from 418 at June 30, 2003 to 531 at June 30, 2004
including the addition of new staff to operate the new stores opened in June
2003, July 2003, September 2003, and December 2003.
Occupancy and furniture and equipment expenses for the first six months of 2004
were $951,000, or 39%, higher for the first six months of 2004 over the similar
period in 2003. The majority of the increase is the result of costs associated
with the opening of five new stores between June 2003 and December 2003 and the
opening of a new and larger loan production office in the York region during the
summer of 2003.
Advertising and marketing expenses totaled $1.4 million for the six months ended
June 30, 2004, an increase of $517,000, or 56%, from the first six months of
2003. This increase was primarily due to additional marketing initiatives in all
of our markets along with supporting additional stores opened between June 2003
and December 2003. The Company's marketing expenses will continue to expand as
the branch network grows.
Data processing expenses increased $345,000, or 31%, for the first six months of
2004 as compared to the first six months of 2003. The increase is the result of
processing higher volumes of customer transactions.
Postage and supplies expenses of $573,000 were $119,000, or 26%, higher for the
first six months of 2004 than for the six months ended June 30, 2003. This was
due to a combination of increased usage of supplies with the addition of five
new stores and growth in the volume of customers and customer transaction
statements.
Other noninterest expenses for the first six months of 2004 were $3.0 million
compared to $2.3 million for the similar period in 2003. Components of the
increase include:
o higher telecommunication and data line expenses due to the addition of
five new stores;
o higher loan related expenses due to an increase in loan volume over
the past 12 months;
16
o higher audit and regulatory fees due to additional requirements
imposed by enactment of legislation by Regulatory Agencies to address
corporate governance;
o greater checkbook printing expenses due to an increase in the number
of new accounts opened and offering standard checks free of charge
when opening a checking account;
o an increase in director and committee fees;
o an increase in customer relations expense;
o higher Pennsylvania shares tax expense;
o an increase in the provision for other losses and differences; and
o an increase in shareholder expenses.
One key productivity measure is the operating efficiency ratio. This ratio
expresses the relationship of noninterest expenses to net interest income plus
noninterest income (excluding gain on sales of investment securities). For the
quarter ended June 30, 2004, the operating efficiency ratio was 72.8%, compared
to 71.3% for the similar period in 2003, and for the six months ended June 30,
2004, this ratio was 72.7%, compared to 71.5% for the first half of 2003.
Provision for Federal Income Taxes
The provision for federal income taxes was $1.1 million for the second quarter
of 2004 as compared to $801,000 for the same period in 2003. For the six months
ended June 30, the provision was $2.0 million and $1.6 million for 2004 and
2003, respectively. The effective tax rate, which is the ratio of income tax
expense to income before income taxes, was 32.6% for the six months of 2004 and
32.5% for the same period in 2003.
Net Income and Net Income Per Share
Net income for the second quarter of 2004 was $2.2 million, an increase of
$523,000, or 32%, over the $1.7 million recorded in the second quarter of 2003.
The increase was due to an increase in net interest income of $3.4 million, an
increase in noninterest income of $500,000, offset partially by an increase in
noninterest expenses of $3.0 million, a $150,000 increase in the provision for
loan losses, and an increase of $251,000 in the provision for income taxes.
Net income for the first six months of 2004 was $4.1 million compared to $3.3
million recorded in the first six months of 2003. The increase was due to an
increase in net interest income of $6.8 million, an increase in noninterest
income of $895,000, offset partially by an increase in noninterest expenses of
$6.1 million, an increase of $400,000 in the provision for loan losses, and an
increase of $391,000 in the provision for income taxes.
Basic earnings per common share, after adjusting for a 5% common stock dividend
paid in February 2004, increased 21% to $1.76 per common share for the first six
months of 2004 compared to $1.46 for the same period in 2003. Diluted earnings
per common share were $1.62 for the first six months of 2004 and $1.36 for the
same period in 2003, an increase of 19%.
17
Return on Average Assets and Average Equity
Return on average assets, referred to as "ROA," measures our net income in
relation to our total average assets. Our annualized ROA for the second quarter
of 2004 was 0.76% as compared to 0.79% for the second quarter of 2003. The ROA
for the first six months of 2004 was 0.74% compared to 0.81% for the first half
of 2003.
Return on average equity, referred to as "ROE," indicates how effectively we can
generate net income on the capital invested by our shareholders. ROE is
calculated by dividing net income by average stockholders' equity. The
annualized ROE for the second quarter of 2004 was 17.14%, as compared to 14.48%
for the second quarter of 2003. The annualized ROE for the first six months of
2004 was 15.99%, as compared to 14.83% for the first six months of 2003.
FINANCIAL CONDITION
Securities
During the first six months of 2004, securities available for sale increased by
$28.5 million from $275.4 million at December 31, 2003 to $303.9 million at June
30, 2004. This resulted from the purchase of $95.1 million in securities,
partially offset by $60.3 million in principal repayments.
The securities available for sale portfolio is comprised of U.S. Government
agency securities, mortgage-backed securities, collateralized mortgage
obligations, and corporate debt securities. The duration of the securities
available for sale portfolio was 4.5 years at June 30, 2004 and 3.9 years at
December 31, 2003 with a weighted average yield of 4.59% at June 30, 2004 and
4.55% at December 31, 2003.
During the first six months of 2004, securities held to maturity remained
relatively the same. During this period, we purchased $25.0 million in
securities, offset by principal repayments of $25.1 million. The securities held
in this portfolio include U.S. Government agency securities, tax-exempt
municipal bonds, collateralized mortgage obligations, corporate debt securities,
and mortgage-backed securities. The duration of the securities held to maturity
portfolio was 6.5 years at June 30, 2004 and 5.9 years at December 31, 2003 with
a weighted average yield of 5.54% at June 30, 2004 and 5.43% at December 31,
2003.
Total securities aggregated $503.7 million at June 30, 2004, and represented 43%
of total assets.
The average yield on the combined securities portfolio for the first six months
of 2004 was 4.99% as compared to 4.98% for the similar period of 2003.
Loans Held for Sale
Depending on market conditions, the Bank typically sells its student loans
during the first quarter of each year. Loans held for sale are comprised of
student loans and residential mortgage loans, which we intend to sell and
reinvest in higher yielding loans and securities. During the first six months of
2004, total loans held for sale decreased approximately $1.3 million, from $9.2
million at December 31, 2003 to $7.8 million at June 30, 2004. The change was
the result of the sale of $7.0 million of student loans and the sale of $37.1
million of residential loans, offset by originations of $42.7 million in new
loans held for sale. Loans held for sale represented 0.9% of total assets at
December 31, 2003 and 0.7% of total assets at June 30, 2004.
18
Loans Receivable
During the first six months of 2004, total gross loans receivable increased by
$119.5 million from $475.9 million at December 31, 2003, to $595.4 million at
June 30, 2004. The majority of the growth was in commercial real estate,
commercial business loans, and lines of credit. Loans receivable represented 61%
of total deposits and 50% of total assets at June 30, 2004, as compared to 53%
and 45%, respectively, at December 31, 2003.
Loan and Asset Quality and Allowance for Loan Losses
Total nonperforming assets (nonperforming loans, foreclosed real estate, and
loans past due 90 days or more and still accruing interest) at June 30, 2004,
were $1.3 million, or 0.11%, of total assets as compared to $1.4 million, or
0.13%, of total assets at December 31, 2003. Foreclosed real estate totaled
$464,000 at June 30, 2004 and $236,000 at December 31, 2003. Loans past due 90
days or more and still accruing as of June 30, 2004 consisted of one consumer
loan for $22,000. This amount was $385,000 at December 31, 2003 (consisting of
four commercial loans and four consumer loans) and $960,000 at June 30, 2003
(consisting of three commercial loans and three consumer loans.)
The summary table below presents information regarding nonperforming loans and
assets as of June 30, 2004 and 2003 and December 31, 2003.
Nonperforming Loans and Assets
========================================================================================
June 30, December 31, June 30,
2004 2003 2003
- ----------------------------------------------------------------------------------------
(dollars in thousands)
Nonaccrual loans:
Commercial .................................... $ 74 $ 143 $ 398
Consumer ...................................... 41 68 188
Real estate:
Construction ................................. 159 159 --
Mortgage ..................................... 525 417 196
- ----------------------------------------------------------------------------------------
Total nonaccrual loans ..................... 799 787 782
Loans past due 90 days or more and still accruing 22 385 960
- ----------------------------------------------------------------------------------------
Total nonperforming loans .................. 821 1,172 1,742
Foreclosed real estate .......................... 464 236 256
- ----------------------------------------------------------------------------------------
Total nonperforming assets ................. $1,285 $1,408 $1,998
========================================================================================
Nonperforming loans to total loans .............. 0.14% 0.25% 0.43%
Nonperforming assets to total assets ............ 0.11% 0.13% 0.24%
========================================================================================
Nonaccrual commercial loans were comprised of seven loans at June 30, 2004.
Management's Allowance for Loan Loss Committee reviewed the composition of the
nonaccrual loans and believes adequate collateralization exists.
Additional loans of $5.5 million, considered by our internal loan review
department as potential problem loans at June 30, 2004, have been evaluated as
to risk exposure in determining the adequacy for the allowance for loan losses.
19
The following table sets forth information regarding the Company's provision and
allowance for loan losses.
Allowance for Loan Losses
==============================================================================================
Six Months Year Ending Six Months
Ending December 31, Ending
June 30, 2004 2003 June 30, 2003
- ----------------------------------------------------------------------------------------------
(dollars in thousands)
Balance at beginning of period ............ $ 6,007 $ 5,146 $ 5,146
Provisions charged to operating expenses .. 1,250 1,695 850
- ----------------------------------------------------------------------------------------------
7,257 6,841 5,996
- ----------------------------------------------------------------------------------------------
Recoveries of loans previously charged-off:
Commercial ............................. 36 66 17
Consumer ............................... 96 85 57
Real estate ............................ -- 115 48
- ----------------------------------------------------------------------------------------------
Total recoveries .......................... 132 266 122
- ----------------------------------------------------------------------------------------------
Loans charged-off:
Commercial ............................. (30) (483) (174)
Consumer ............................... (223) (331) (46)
Real estate ............................ (117) (286) (231)
- ----------------------------------------------------------------------------------------------
Total charged-off ......................... (370) (1,100) (451)
- ----------------------------------------------------------------------------------------------
Net charge-offs ........................... (238) (834) (329)
- ----------------------------------------------------------------------------------------------
Balance at end of period .................. $ 7,019 $ 6,007 $ 5,667
==============================================================================================
Net charge-offs as a percentage of
average loans outstanding .............. 0.04% 0.20% 0.08%
Allowance for loan losses as a percentage
of period-end loans .................... 1.18% 1.26% 1.39%
==============================================================================================
Premises and Equipment
During the first six months of 2004, premises and equipment increased by
$589,000, or 1.5%, from $38.2 million at December 31, 2003 to $38.8 million at
June 30, 2004. The increase was a result of leasehold improvements and furniture
and equipment purchases necessary for additions to staff and replacing certain
fixed assets partially offset by the provision for depreciation and
amortization.
Other Assets
During the first six months of 2004, other assets decreased by $6.2 million from
$16.5 million at December 31, 2003, to $10.3 million at June 30, 2004. The
change was the result of the sale of committed securities included as other
assets at December 31, 2003, with a fair market value of $9.2 million. The
proceeds from the sale were received in the first quarter of 2004.
Deposits
Total deposits at June 30, 2004 were $978.3 million, up $71.7 million, or 8%,
over total deposits of $906.5 million at December 31, 2003. Core deposits (total
deposits less public fund time deposits) averaged $884.9 million at June 30,
2004 up $178.6 million, or 25%, over average core deposits at June 30, 2003. The
average balances and weighted average rates paid on deposits for the first six
20
months of 2004 and 2003 are presented in the following table.
Six months Ended June 30,
2004 2003
- ------------------------------------------------------------------------------------------------------------
Average Average Average Average
Balance Rate Balance Rate
- ------------------------------------------------------------------------------------------------------------
(dollars in thousands)
Demand deposits:
Noninterest-bearing........................... $ 171,406 $ 132,290
Interest-bearing (money market and checking).. 298,273 0.88% 214,130 0.93%
Savings.......................................... 257,466 0.90 228,550 1.15
Time deposits.................................... 205,748 2.22 185,347 3.41
- ------------------------------------------------------------------------------------------------------------
Total deposits................................... $ 932,893 $ 760,317
============================================================================================================
Short-Term Borrowings
Short-term borrowings, which consist of securities sold under agreements to
repurchase, federal funds purchased and dollar rolls, were $137.4 million at
June 30,2004, up $58.4 million, or 74%, over total short-term borrowings of
$79.0 million at December 31, 2003. The average rate paid on the short-term
borrowings was 1.24% during the first six months of 2004. There were no
short-term borrowings during the first six months of 2003.
Beginning in the third quarter and fourth quarter of 2003, we undertook an
earnings strategy to utilize short-term borrowings in an effort to increase the
level of interest earning assets and thus generate a higher level of net
interest income. The additional net interest income earned was used to offset
the expenses associated with opening five new stores between June 2003 and
December 2003. The borrowed funds were reinvested into short and medium term
investment securities, mainly mortgage-backed securities.
We continued to utilize short-term borrowings during the first six months of
2004 due to our strong loan growth of $117.1 million from December 31, 2003 to
June 30, 2004. During the second half of 2004, we plan to use a portion of our
deposit growth as well as cash flows from the loan and investment portfolios to
reduce the level of short term borrowings to around or below $100.0 million. We
also plan to reduce this level even further in 2005 by replacing borrowed funds
with continued deposit growth.
Long-Term Debt
As a result of the adoption of FASB Interpretation No. 46, "Consolidation of
Variable Interest Entities, an Interpretation of ARB No. 51," we deconsolidated
our wholly owned subsidiaries, Commerce Capital Harrisburg Trust I and Commerce
Capital Harrisburg Trust II, referred to as the "Trusts", from our consolidated
financial statements as of March 31, 2004. We have not restated prior periods.
The impact of this deconsolidation was to increase our junior subordinated
debentures by $13.6 million and reduce our trust capital securities line item by
$13.0 million that had represented the trust preferred securities of the Trusts.
Our equity interest in the trust subsidiaries of $600,000, which had previously
been eliminated in consolidation, is now reported in "Other assets" as of June
30, 2004. For regulatory reporting purposes, the FRB has indicated that the
preferred securities will continue to qualify as Tier 1 Capital subject to
previously specified limitations, until further notice. The adoption of FIN 46
did not have an impact on our results of operations or
21
liquidity.
Interest Rate Sensitivity
The management of interest rate sensitivity seeks to avoid fluctuating net
interest margins and to provide consistent net interest income through periods
of changing interest rates.
Our risk of loss arising from adverse changes in the fair value of financial
instruments, or market risk, is composed primarily of interest rate risk. The
primary objective of the Company's asset/liability management activities is to
maximize net interest income while maintaining acceptable levels of interest
rate risk. Our Asset/Liability Committee, referred to as ALCO, is responsible
for establishing policies to limit exposure to interest rate risk, and to ensure
procedures are established to monitor compliance with those policies. Our board
of directors reviews the guidelines established by ALCO.
Management believes the simulation of net interest income in different interest
rate environments provides a more meaningful measure of interest rate risk.
Income simulation analysis captures not only the potential of all assets and
liabilities to mature or reprice, but also the probability that they will do so.
Income simulation also attends to the relative interest rate sensitivities of
these items, and projects their behavior over an extended period of time.
Finally, income simulation permits management to assess the probable effects on
the balance sheet not only of changes in interest rates, but also of proposed
strategies for responding to them.
Our income simulation model analyzes interest rate sensitivity by projecting net
income over the next 24 months in a flat rate scenario versus net income in
alternative interest rate scenarios. Management continually reviews and refines
its interest rate risk management process in response to the changing economic
climate. Currently, our model projects a 200 basis point increase and a 100
basis point decrease during the next year, with rates remaining constant in the
second year.
The Company's ALCO policy has established that income sensitivity will be
considered acceptable if overall net income volatility in a plus 200 or minus
200 basis point scenario is within 12% of net income in a flat rate scenario in
the first year and 18% using a two year planning window. At June 30, 2004, our
income simulation model indicates net income would be higher by 0.3% in the
first year and lower by 4.6% over a two-year time frame, if rates decreased 100
basis points as compared to higher by 0.5% and lower by 4.7%, respectively, at
June 30, 2003. The model projects that net income would be lower by 4.2% and
higher by 1.2% in the first year and over a two-year time frame, respectively,
if rates increased 200 basis points, as compared to higher by 3.2% and 16.0%,
respectively, at June 2003. All of these forecasts are within an acceptable
level of interest rate risk per the policies established by ALCO.
Management also monitors interest rate risk by utilizing a market value of
equity model. The model assesses the impact of a change in interest rates on the
market value of all of our assets and liabilities, as well as any off balance
sheet items. The model calculates the market value of our assets and liabilities
in excess of book value in the current rate scenario, and then compares the
excess of market value over book value given an immediate 200 basis point
increase in rates and a 100 basis point decrease in rates. Our ALCO policy
indicates that the level of interest rate risk is unacceptable if the immediate
change would result in the loss of 50% or more of the excess of market value
over
22
book value in the current rate scenario. At June 30, 2004, the market value of
equity indicates an acceptable level of interest rate risk.
The market value of equity model reflects certain estimates and assumptions
regarding the impact on the market value of our assets and liabilities given an
immediate 200 basis point change in interest rates. One of the key assumptions
is the market value assigned to our core deposits, or the core deposit premium.
Using an independent consultant, we have completed and updated comprehensive
core deposit studies in order to assign its own core deposit premiums as
permitted by regulation. The studies have consistently confirmed management's
assertion that our core deposits have stable balances over long periods of time,
are relatively insensitive to changes in interest rates and have significant
longer average lives and durations than our loans and investment securities.
Thus, these core deposit balances provide an internal hedge to market
fluctuations in our fixed rate assets. Management believes the core deposit
premiums produced by its market value of equity model at June 30, 2004 provide
an accurate assessment of our interest rate risk.
Liquidity
Liquidity management involves the ability to generate cash or otherwise obtain
funds at reasonable rates to support asset growth and reduce assets to meet
deposit withdrawals, to maintain reserve requirements, and to otherwise operate
Pennsylvania Commerce on an ongoing basis. On an unconsolidated basis, the
principal source of our revenue is dividends paid to us by the Bank. The Bank is
subject to regulatory restrictions on its ability to pay dividends to us. Our
consolidated liquidity needs are generally met by converting assets into cash or
obtaining sources of additional funding, mainly deposits. Liquidity sources from
assets are provided primarily by cash and federal funds sold, and the cash flow
from the amortizing securities and loan portfolios. The primary source of
liquidity from liabilities is the generation of additional core deposit
balances.
We also maintain secondary sources of liquidity consisting of federal funds
lines of credit, repurchase agreements, and borrowing capacity at the Federal
Home Loan Bank, which can be drawn upon if needed. As of June 30, 2004, the
total potential liquidity through these secondary sources was $412 million. In
view of the primary and secondary sources of liquidity as previously mentioned,
management believes that we are capable of meeting its anticipated liquidity
needs for at least the next twelve months.
Capital Adequacy
At June 30, 2004, stockholders' equity totaled $51.0 million, up 3% over
stockholders' equity of $49.7 million at December 31, 2003. Stockholders' equity
at June 30, 2004 included $3.2 million of gross unrealized losses, net of income
taxes, on securities available for sale. Excluding these unrealized losses,
gross stockholders' equity increased by $5.0 million from $49.2 million at
December 31, 2003, to $54.2 million at June 30, 2004 due to retained net income
and the proceeds from the sale of stock under our stock option and stock
purchase plans.
On June 15, 2000, we issued $5.0 million of 11.00% Trust Capital Securities to
Commerce of New Jersey through Commerce Harrisburg Capital Trust I. Proceeds of
this offering were downstreamed to the Bank to be used for additional
capitalization purposes. All $5.0 million of the Trust Capital Securities
currently qualify as Tier 1 capital for regulatory capital purposes.
23
On September 28, 2001, we issued $8.0 million of 10.00% Trust Capital Securities
to Commerce of New Jersey through Commerce Harrisburg Capital Trust II. Proceeds
of this offering were downstreamed to the Bank to be used for additional
capitalization purposes. All $8.0 million of the Trust Capital Securities
currently qualify as Tier 1 capital for regulatory capital purposes.
Banks are evaluated for capital adequacy based on the ratio of capital to
risk-weighted assets and total assets. The risk-based capital standards require
all banks to have Tier 1 capital of at least 4% and total capital, including
Tier 1 capital, of at least 8% of risk-weighted assets. Tier 1 capital includes
common stockholders' equity and qualifying perpetual preferred stock together
with related surpluses and retained earnings. Total capital includes total Tier
1 capital, limited life preferred stock, qualifying debt instruments, and the
allowance for loan losses. The capital standard based on total assets, also
known as the "leverage ratio," requires all, but the most highly-rated, banks to
have Tier 1 capital of at least 4% of total assets.
The following table provides a comparison of the Bank's risk-based capital
ratios and leverage ratios to the minimum regulatory requirements for the
periods indicated:
======================================================================================================================
Minimum For Minimum For
June 30, December 31, Adequately Capitalized Well Capitalized
2004 2003 Requirements Requirements
- ----------------------------------------------------------------------------------------------------------------------
Risk-Based Capital Ratios:
Tier 1 8.71% 9.49% 4.00% 6.00%
Total 9.62 10.42 8.00 10.00
Leverage ratio 5.79 6.14 3.00 - 4.00 5.00
(to average assets)
======================================================================================================================
The consolidated capital ratios of Pennsylvania Commerce at June 30, 2004 are as
follows: our leverage ratio was 5.80%, our ratio of Tier 1 capital to
risk-weighted assets was 8.72%, and our ratio of total capital to risk-weighted
assets was 9.63%. At June 30, 2004, our consolidated capital levels met the
definition of an "adequately capitalized" institution. It is the desire of our
board and management to maintain sufficient capital levels for Pennsylvania
Commerce and the Bank in order for each to be considered a "well capitalized"
institution. Therefore, we intend to raise additional capital through a stock
offering in order to return to "well capitalized" status. We believe that the
amount of capital expected to be raised will support our future growth for the
next four to five years and continue to allow us to be considered "well
capitalized" throughout that period.
The Company may, from time to time, make written or oral "forward-looking
statements", including statements contained in the Company's filings with the
Securities and Exchange Commission (including the annual report on Form 10-K and
the exhibits thereto), in its reports to stockholders and in other
communications by the Company, which are made in good faith by the Company
pursuant to the "safe harbor" provisions of the Private Securities Litigation
Reform Act of 1995.
These forward-looking statements include statements with respect to the
Company's beliefs, plans, objectives, goals, expectations, anticipations,
estimates and intentions, that are subject to significant
24
risks and uncertainties and are subject to change based on various factors (some
of which are beyond the Company's control). The words "may", "could", "should",
"would", "believe", "anticipate", "estimate", "expect", "intend", "plan" and
similar expressions are intended to identify forward-looking statements. The
following factors, among others, could cause the Company's financial performance
to differ materially from that expressed in such forward-looking statements: the
strength of the United States economy in general and the strength of the local
economies in which the Company conducts operations; the effects of, and changes
in, trade, monetary and fiscal policies, including interest rate policies of the
Board of Governors of the Federal Reserve System; inflation; interest rate,
market and monetary fluctuations; the timely development of competitive new
products and services by the Company and the acceptance of such products and
services by customers; the willingness of customers to substitute competitors'
products and services for the Company's products and services and vice versa;
the impact of changes in financial services' laws and regulations (including
laws concerning taxes, banking, securities and insurance); the impact of the
rapid growth of the Company; the Company's dependence on Commerce Bancorp, Inc.
to provide various services to the Company; changes in the Company's allowance
for loan losses; effect of terrorists attacks and threats of actual war;
unanticipated regulatory or judicial proceedings; changes in consumer spending
and saving habits; and the success of the Company at managing the risks involved
in the foregoing.
The Company cautions that the foregoing list of important factors is not
exclusive. The Company does not undertake to update any forward-looking
statements, whether written or oral, that may be made from time to time by or on
behalf of the Company. For further information, refer to the Company's filings
with the SEC.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Our exposure to market risk principally includes interest rate risk, which is
discussed above. Our net interest margin has remained fairly stable. Our net
interest margin for the first six months of 2004 was 4.38%, a difference of 16
basis points over 4.22% for the first six months of 2003.
Currently, we have 94% of our deposits in accounts, which we consider core
deposits. These accounts, which have a relatively low cost of deposits, have
historically contributed significantly to the net interest margin.
Item 4. Controls and Procedures
The Company's management, with the participation of the Company's Chief
Executive Officer and Chief Financial Officer, evaluated the effectiveness of
the Company's disclosure controls and procedures (as defined in Rule 13a-15(e)
or 15d-15(e) under the Exchange Act) as of the end of the period covered by this
report. Based upon that evaluation, the Chief Executive Officer and the Chief
Financial Officer concluded that the Company's disclosure controls and
procedures were effective in reaching a reasonable level of assurance that
management is timely alerted to material information relating to the Company
(including its consolidated subsidiaries) during the period when the Company's
periodic reports are being prepared. There has not occurred any change in the
Company's internal control over financial reporting, as defined in Exchange Act
Rule 13a-15(f) or 15d-15(f), during the quarter ended June 30, 2004 that has
materially affected, or is reasonably likely to materially affect, the Company's
25
internal control over financial reporting.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
We are not party to any material pending legal proceeding, other than ordinary
routine litigation incidental to our business.
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity
Securities.
No items to report for the quarter ending June 30, 2004.
Item 3. Defaults Upon Senior Securities.
No items to report for the quarter ending June 30, 2004.
Item 4. Submission of Matters to a Vote of Securities Holders.
The Annual Meeting of the Registrant's Shareholders was held on May 19, 2004.
Proxies representing 1,363,740 shares were received (total shares outstanding as
of the record date were 2,309,209). The items of business acted upon at the
Annual Meeting were (i) the election of 8 directors to serve until the 2005
annual meeting; and (ii) approval of an amendment to the 1996 Employee Stock
Option Plan to increase the number of shares of common stock issuable under the
1996 Plan by 100,000 shares. The number of votes cast for, against, or withheld,
as well as the number of abstentions and broker non-votes was as follows:
(i) Election of directors:
Name of (Withhold Authority)
Nominee For Against
- ------- --- -------
Gary L. Nalbandian 1,349,237 14,503
James R. Adair 1,332,427 31,313
John J. Cardello, CPA 1,349,236 14,414
Douglas S. Gelder 1,349,236 14,414
Alan R. Hassman 1,349,236 14,414
Howell C. Mette 1,349,236 14,414
Michael A. Serluco 1,349,236 14,414
Samir J. Srouji, M.D. 1,349,236 14,414
(ii) Approval of amendment to the 1996 Employee Stock Option Plan:
Broker
For Against Abstain Non Vote
- --- ------- ------- --------
1,227,718 120,575 15,447 0
Item 5. Other Information.
No items to report for the quarter ending June 30, 2004.
Item 6. Exhibits and Reports on Form 8-K.
(a.) Exhibits
Computation of Net Income Per Share.................................Exhibit 11
Certification of Chief Executive Officer pursuant to Rules 13a-14(a) and
15d-14(a) promulgated under the Securities Exchange Act of 1934,
as amended ("Exchange Act").........................................Exhibit 31.1
Certification of Chief Financial Officer Pursuant to Rules 13a-14(a) and
15d-14(a) promulgated under the Exchange Act. .....................Exhibit 31.2
Certification of the Company's Chief Executive Officer and Chief Financial
Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002. ...................Exhibit 32
(b.) Reports on Form 8-K
On May 21, 2004, the Company filed a form 8-K, Item 5, announcing the following
information:
Pennsylvania Commerce Bancorp, Inc. issued a press release reporting that its
Board of Directors has amended the Company's Dividend Reinvestment and Stock
Purchase Plan to allow shareholders to make purchases monthly effective June 1,
2004. Purchases previously were permitted quarterly.
On May 20, 2004, the Company filed a form 8-K, Item 5, announcing the following
information:
Pennsylvania Commerce Bancorp, Inc. issued a press release reporting the bank's
plans to construct a new headquarters, operations and training center at the
TecPort Business Center in
26
Swatara Twp., Dauphin County.
On April 20, 2004, the Company furnished a form 8-K, Items 7 and 12, announcing
the following information:
Pennsylvania Commerce Bancorp, Inc. issued a press release reporting financial
results for its first quarter of 2004.
27
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PENNSYLVANIA COMMERCE BANCORP, INC.
(Registrant)
08/12/04 /s/ Gary L. Nalbandian
- ------------------------- -----------------------------------------
(Date) Gary L. Nalbandian
President/CEO
(Principal Executive Officer)
08/12/04 /s/ Mark A. Zody
- ------------------------- -----------------------------------------
(Date) Mark A. Zody
Chief Financial Officer
(Principal Financial and
Accounting Officer)
28
Exhibits.
Computation of Net Income Per Share.................................Exhibit 11
Certification of Chief Executive Officer pursuant to Rules 13a-14(a) and
15d-14(a) promulgated under the Securities Exchange Act of 1934,
as amended ("Exchange Act").........................................Exhibit 31.1
Certification of Chief Financial Officer Pursuant to Rules 13a-14(a) and
15d-14(a) promulgated under the Exchange Act........................Exhibit 31.2
Certification of the Company's Chief Executive Officer and Chief Financial
Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.......................Exhibit 32