SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the Quarter Ended June 30, 2002
No. 0-15786
-----------
(Commission File Number)
COMMUNITY BANKS, INC.
--------------------
(Exact Name of Registrant as Specified in its Charter)
PENNSYLVANIA 23-2251762
------------------ ------------------------
(State of Incorporation) (IRS Employer ID Number)
750 East Park Dr., Harrisburg, PA 17111
- ------------------------------------------- --------------
(Address of Principal Executive Offices) (Zip Code)
(717) 920-1698
---------------
(Registrant's Telephone Number)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Sections 12, 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
------------ ------------
Number of shares outstanding as of June 30, 2002
CAPITAL STOCK-COMMON 9,239,000
- -------------------- ----------------------
(Title of Class) (Outstanding Shares)
COMMUNITY BANKS, INC. and SUBSIDIARIES
INDEX 10-Q
PART I
Financial Information........................................................3
Consolidated Interim Balance Sheets......................................... 4
Consolidated Interim Statements of Income................................... 5
Consolidated Interim Statements of Changes in Stockholders' Equity.......... 6
Consolidated Interim Statements of Cash Flows............................... 7
Notes to Consolidated Interim Financial Statements....................... 8-13
Management's Discussion and Analysis of Financial
Condition and Results of Operation................................... 14-18
Financial Condition........................................................ 19
PART II
Other Information and Signatures........................................ 20-21
Exhibits................................................................ 22-23
2
PART I - FINANCIAL INFORMATION
COMMUNITY BANKS, INC. and SUBSIDIARIES
The following financial information sets forth the operations of Community
Banks, Inc. and Subsidiaries for the three month and six month periods ending
June 30, 2002 and 2001.
In the opinion of management, the following interim Consolidated Balance Sheets
and related Consolidated Statements of Income, Changes in Stockholders' Equity,
and Cash Flows reflect all adjustments (consisting of normal recurring accrual
adjustments) necessary to present fairly the financial position and results of
operations for such periods.
3
COMMUNITY BANKS, INC. AND SUBSIDIARIES
Consolidated Interim Balance Sheets
(Unaudited)
(Dollars in thousands except per share data)
June 30, December 31,
2002 2001
---- ----
ASSETS
Cash and due from banks..................................... $ 46,087 $ 44,764
Interest-bearing time deposits in other banks............... 618 1,372
Investment securities, available for sale................... 569,157 543,901
Federal funds sold.......................................... 36,331 ---
Total loans................................................. 883,026 857,278
Less: Allowance for loan losses......................... (12,626) (12,132)
-------------- ------------
Net loans..................................... 870,400 845,146
Premises and equipment, net................................. 22,883 22,640
Goodwill.................................................... 294 151
Identifiable intangible assets.............................. 766 817
Other real estate owned..................................... 411 631
Loans held for sale......................................... 5,009 10,479
Accrued interest receivable and other assets................ 39,453 39,833
-------------- ------------
Total assets........................................... $ 1,591,409 $ 1,509,734
============== ============
LIABILITIES
Deposits:
Demand (non-interest bearing)............................ $ 173,998 $ 160,387
Savings.................................................. 322,168 309,913
Time..................................................... 507,892 453,533
Time in denominations of $100,000 or more................ 109,618 79,392
-------------- ------------
Total deposits.......................................... 1,113,676 1,003,225
Short-term borrowings....................................... 42,922 60,002
Long-term debt.............................................. 300,778 322,155
Accrued interest payable and other liabilities.............. 12,171 13,103
-------------- ------------
Total liabilities........................................ 1,469,547 1,398,485
-------------- ------------
STOCKHOLDERS' EQUITY
Preferred stock, no par value; 500,000 shares
authorized; no shares issued and outstanding............. --- ---
Common stock-$5.00 par value; 20,000,000
shares authorized; 9,412,000 shares
issued in 2002 and 2001.................................. 47,064 44,839
Surplus..................................................... 46,083 35,906
Retained earnings........................................... 30,025 36,923
Accumulated other comprehensive income (loss),
net of tax (benefit) of $1,347 and $(2,167),
respectively........................................... 2,502 (4,024)
Less: Treasury stock of 173,000 and 125,000
shares at cost, respectively............................. (3,812) (2,395)
-------------- ------------
Total stockholders' equity................................ 121,862 111,249
-------------- ------------
Total liabilities and stockholders' equity................ $ 1,591,409 $ 1,509,734
============== ============
The accompanying notes are an integral part of the consolidated interim
financial statements.
4
COMMUNITY BANKS, INC. AND SUBSIDIARIES
Consolidated Interim Statements of Income
(Unaudited)
(Dollars in thousands except per share data)
Three Months Ended Six Months Ended
June 30, June 30,
-------- --------
2002 2001 2002 2001
--------------------------- -------------------------
Interest income:
Interest and fees on loans..................................... $ 16,897 $ 17,673 $ 33,505 $ 35,380
Interest and dividends on investment securities:
Taxable..................................................... 4,818 4,903 9,773 9,760
Exempt from federal income tax.............................. 2,363 1,723 4,870 3,198
Federal funds interest........................................ 129 205 155 510
Other interest income.......................................... 8 19 19 51
---------- ---------- ---------- ----------
Total interest income....................................... 24,215 24,523 48,322 48,899
---------- ---------- ---------- ----------
Interest expense:
Interest on deposits:
Savings..................................................... 1,121 1,817 2,245 3,715
Time........................................................ 5,412 6,499 10,611 12,969
Time in denominations of $100,000 or more................... 970 926 1,937 2,052
Interest on short-term borrowings and long-term debt........... 4,192 3,824 8,372 7,522
Federal funds purchased and repo interest...................... 181 214 349 423
---------- ---------- ---------- ----------
Total interest expense..................................... 11,876 13,280 23,514 26,681
---------- ---------- ---------- ----------
Net interest income......................................... 12,339 11,243 24,808 22,218
Provision for loan losses......................................... 650 871 2,250 2,444
---------- ---------- ---------- ----------
Net interest income after provision for loan losses........ 11,689 10,372 22,558 19,774
---------- ---------- ---------- ----------
Other income:
Investment management and trust services....................... 304 193 505 300
Service charges on deposit accounts........................... 816 728 1,576 1,402
Other service charges, commissions and fees.................... 636 464 1,287 895
Investment security gains (losses)............................. 18 366 536 238
Insurance premium income and commissions....................... 652 425 1,182 702
Gains on loan sales............................................ 101 378 486 541
Other income................................................... 1,136 354 1,773 813
---------- ---------- ---------- ----------
Total other income.......................................... 3,663 2,908 7,345 4,891
---------- ---------- ---------- ----------
Other expenses:...................................................
Salaries and employee benefits................................. 5,178 4,678 10,330 9,232
Net occupancy expense.......................................... 1,609 1,360 2,805 2,735
Operating expense of insurance subsidiary...................... 194 198 352 337
Merger and restructuring related expenses...................... --- (101) --- 1,798
Other operating expense........................................ 3,046 2,037 5,963 4,682
---------- ---------- ---------- ----------
Total other expenses........................................ 10,027 8,172 19,450 18,784
---------- ---------- ---------- ----------
Income before income taxes.................................. 5,325 5,108 10,453 5,881
Income taxes ..................................................... 706 1,077 1,383 1,042
---------- ---------- ---------- ----------
Net income.................................................. $ 4,619 $ 4,031 $ 9,070 $ 4,839
========== ========== ========== ==========
Consolidated per share data:
Basic earnings per share....................................... $ .50 $ .44 $ .98 $ .52
Diluted earnings per share..................................... $ .49 $ .43 $ .96 $ .51
Dividends declared.............................................. $ .18 $ .16 $ .34 $ .32
Per share data has been restated to reflect stock dividends.
The accompanying notes are an integral part of the consolidated interim
financial statements.
Certain amounts reported in the periods ending June 30, 2001 have been
reclassified to conform with the 2002 presentation. These reclassifications did
not impact the Corporation's financial condition or results of operations.
5
COMMUNITY BANKS, INC. AND SUBSIDIARIES
Consolidated Interim Statements of Changes in Stockholders' Equity
(Dollars in thousands except per share data)
Six Month Periods Ended June 30
Accumulated
Other
Common Retained Comprehensive Treasury Total
Stock Surplus Earnings Income Stock Equity
----- ------- -------- ------ ----- ------
Balance, January 1, 2001................. $42,726 $29,155 $38,723 $ (694) $ (5,932) $103,978
Comprehensive income:
Net income......................... 4,839 4,839
Change in unrealized gain (loss)
on securities, net of tax of $1,312
and reclassification adjustment
of $238 ........................ 2,436 2,436
--------
Total comprehensive income.......... 7,275
Cash dividends ($.32 per share).......... (2,869) (2,869)
5% stock dividend (426,000 shares)....... 2,130 6,773 (8,903)
Issuance of additional shares
(2,000 shares of common stock
canceled and 140,000 shares, net,
of treasury stock reissued............ (13) (35) (347) 2,939 2,544
------- ------- ------- ---------- ---------- --------
Balance, June 30, 2001................... $44,843 $35,893 $31,443 $ 1,742 $ (2,993) $110,928
======= ======= ======= ========== ========== ========
Balance, January 1, 2002................. $44,839 $35,906 $36,923 $ (4,024) $ (2,395) $111,249
Comprehensive income:
Net income.......................... 9,070 9,070
Change in unrealized gain (loss)
on securities, net of tax of $3,514
and reclassification adjustment
of $536............................ 6,526 6,526
--------
Total comprehensive income.......... 15,596
Cash dividends ($.34 per share).......... (3,161) (3,161)
5% stock dividend (440,000 shares)....... 2,241 10,177 (12,418)
Purchases of treasury stock
(98,000 shares)....................... (2,493) (2,493)
Issuance of additional shares
(51,000 net shares of treasury
stock reissued and 3,000 shares
of common stock canceled)............ (16) (389) 1,076 671
------- ---------- ------- ---------- ---------- --------
Balance, June 30, 2002................... $47,064 $46,083 $30,025 $ 2,502 $ (3,812) $121,862
======= ======= ======= ========== ========== ========
Per share data for all periods has been restated to reflect stock dividends. The
accompanying notes are an integral part of the consolidated interim financial
statements.
6
COMMUNITY BANKS, INC. AND SUBSIDIARIES
Consolidated Interim Statements of Cash Flows
(Unaudited)
(Dollars in thousands)
Six Months Ended
June 30,
---------------------------------------
2002 2001
---------------------------------------
Operating Activities:
Net income..................................................... $ 9,070 $ 4,839
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses.................................... 2,250 2,444
Depreciation and amortization................................ 1,324 2,270
Investment security gains.................................... (536) (238)
Loans originated for sale.................................... (28,027) (34,496)
Proceeds from sales of loans................................. 33,983 33,607
Gains on loan sales.......................................... (486) (541)
Change in other assets, net.................................. (667) (4,560)
Increase (decrease) in accrued interest payable and
other liabilities, net...................................... (932) 1,430
----------- ---------
Net cash provided by operating activities.................... 15,979 4,755
----------- ---------
Investing Activities:
Net decrease in interest-bearing time
deposits in other banks....................................... 754 1,418
Proceeds from sales of investment securities................... 134,510 52,299
Proceeds from maturities of investment securities.............. 3,127 30,932
Purchases of investment securities............................. (152,434) (135,024)
Net increase in total loans.................................... (29,880) (25,910)
Net increase in premises and equipment......................... (1,413) (1,182)
----------- ---------
Net cash used by investing activities....................... (45,336) (77,467)
----------- ---------
Financing Activities:
Net increase in total deposits................................. 110,451 69,981
Net decrease in short-term borrowings.......................... (17,080) (29,084)
Proceeds from issuance of long-term debt....................... --- 33,048
Repayment of long-term debt.................................... (21,377) (664)
Cash dividends................................................. (3,161) (2,869)
Purchases of treasury stock.................................... (2,493) ---
Proceeds from issuance of common stock......................... 671 2,544
----------- ---------
Net cash provided by financing activities................... 67,011 72,956
----------- ---------
Increase in cash and cash equivalents........................ 37,654 244
Cash and cash equivalents at beginning of period............... 44,764 48,446
----------- ---------
Cash and cash equivalents at end of period..................... $ 82,418 $ 48,690
=========== =========
The accompanying notes are an integral part of the consolidated interim
financial statements.
7
COMMUNITY BANKS, INC. AND SUBSIDIARIES
Notes to Consolidated Interim Financial Statements
(Unaudited)
(Dollars in thousands)
1. Accounting Policies
-------------------
These financial statements have been prepared in accordance with
instructions for Form 10-Q and therefore do not include certain information or
footnotes necessary for the presentation of financial condition, results of
operations, stockholders' equity, and cash flows in conformity with accounting
principles generally accepted in the United States of America. However, in the
opinion of management, the consolidated financial statements reflect all
adjustments (which consist of normal recurring accruals) necessary for a fair
presentation of the results for the unaudited periods.
The accounting policies of Community Banks, Inc. and Subsidiaries, as
applied in the consolidated interim financial statements presented herein, are
substantially the same as those followed on an annual basis as presented on
pages 10, 11, and 12 of the 2001 Annual Report to shareholders.
8
2. Investment Securities
---------------------
The amortized cost and fair values of investment securities at June 30,
2002 and December 31, 2001 were as follows:
June 30, 2002
-------------
Amortized Fair
Cost Value
---- -----
U.S. Treasury securities and obligations of
U.S. government corporations and
agencies.............................................................. $ 145,755 $ 146,661
Mortgage-backed U.S. government agencies................................. 111,670 113,537
Obligations of states and political subdivisions......................... 167,601 170,882
Corporate securities..................................................... 93,417 91,405
Equity securities........................................................ 45,446 46,672
---------- -----------
Total............................................................... $ 563,889 $ 569,157
========== ===========
December 31, 2001
-----------------
Amortized Fair
Cost Value
---- -----
U.S. Treasury securities and obligations of
U.S. government corporations and
agencies.............................................................. $ 144,640 $ 142,544
Mortgage-backed U.S. government agencies................................. 74,403 74,370
Obligations of states and political subdivisions......................... 172,223 169,993
Corporate securities..................................................... 99,561 98,405
Equity securities........................................................ 57,846 58,589
---------- -----------
Total............................................................... $ 548,673 $ 543,901
========== ===========
9
3. Allowance for loan losses
-------------------------
Changes in the allowance for loan losses are as follows:
Six Months Ended Year Ended Six Months Ended
June 30, December 31, June 30,
2002 2001 2001
---- ---- ----
Balance, January 1................................... $ 12,132 $10,328 $10,328
Provision for loan losses............................ 2,250 5,080 2,444
Loan charge-offs..................................... (2,046) (3,776) (733)
Recoveries........................................... 290 500 219
--------- ------- -------
Balance, June 30, 2002, December 31,
2001, and June 30, 2001............................. $ 12,626 $12,132 $12,258
========= ======= =======
RISK ELEMENTS (a)
June 30, December 31, June 30,
2002 2001 2001
---- ---- ----
Loans on which accrual of interest has been
discontinued:
Commercial, financial and agricultural.................... $ 4,643 $ 3,783 $ 3,299
Mortgages................................................. 4,237 6,952 5,516
Other..................................................... 214 355 692
--------- ------- -------
9,094 11,090 9,507
Other real estate.............................................. 411 631 550
--------- ------- -------
Total non-performing assets............................. 9,505 11,721 10,057
Loans past due 90 days or more and still accruing interest:
Commercial, financial and agricultural.................... 495 1,002 317
Mortgages................................................. 440 405 932
Personal installment...................................... 33 239 105
Other..................................................... 13 13 ---
--------- ------- -------
981 1,659 1,354
--------- ------- -------
Total risk elements..................................... $ 10,486 $13,380 $11,411
========= ======= =======
(a) The determination to discontinue the accrual of interest on non-performing
loans is made on the individual case basis. Such factors as the character and
size of the loan, quality of the collateral and the historical creditworthiness
of the borrower and/or guarantors are considered by management in assessing the
collectibility of such amounts.
Impaired Loans
At June 30, 2002 and December 31, 2001, the recorded investment in loans
for which impairment has been recognized totaled $6,671,000 and $8,558,000,
respectively. The valuation allowance for impaired loans totaled $1,878,000 and
$1,835,000 at June 30, 2002 and December 31, 2001, respectively. For the six
months ended June 30, 2002, the average recorded investment in impaired loans
approximated $6,765,000. The average balance for the six months ended June 30,
2001, approximated $6,138,000. Interest recognized on impaired loans on the cash
basis for the six month periods ending June 30, 2002 and 2001 was not
significant.
10
4. Statement of Cash Flows
-----------------------
Cash and cash equivalents include cash and due from banks and federal funds
sold. The company made cash payments of $1,754,000 and $1,677,000 and
$23,728,000 and $26,611,000 for income taxes and interest, respectively, for
each of the six month periods ended June 30, 2002 and 2001.
Excluded from the consolidated statements of cash flows for the periods
ended June 30, 2002 and 2001 was the effect of certain non-cash activities. The
company acquired real estate through foreclosure totaling $2,376,000 and
$297,000, respectively. The company also recorded a decrease in deferred tax
assets of $2,167,000 and an increase of $1,347,000 in deferred tax liabilities
in 2002. A decrease in deferred tax assets of $374,000 and an increase in
deferred tax liabilities of $938,000 was recognized in 2001. These are
variations related to the effects of changes in net unrealized gain (loss) on
investment securities available for sale.
5. Earnings Per Share:
-------------------
The following table sets forth the calculations of Basic and Diluted
Earnings Per Share for the periods indicated:
Three Months Ended June 30,
----------------------------------------------------------------
2002 2001
----------------------------------------------------------------
Per-Share Per-Share
Income Shares Amount Income Shares Amount
----------------------------------------------------------------
(In thousands except per share data) Basic EPS:
Income available to common stockholders....................... $ 4,619 9,252 $.50 $4,031 9,237 $.44
======= ==== ====== ====
Effect of Dilutive Securities:
Incentive stock options outstanding........................... 226 200
----- -----
Diluted EPS:
Income available to common stockholders &
assumed conversion......................................... $ 4,619 9,478 $.49 $4,031 9,437 $.43
======= ==== ====== ====
Six Months Ended June 30,
----------------------------------------------------------------
2002 2001
----------------------------------------------------------------
Per-Share Per-Share
Income Shares Amount Income Shares Amount
----------------------------------------------------------------
(In thousands except per share data) Basic EPS:
Income available to common stockholders....................... $ 9,070 9,260 $.98 $4,839 9,177 $.52
======= ==== ====== ====
Effect of Dilutive Securities:
Incentive stock options outstanding........................... 220 169
----- -----
Diluted EPS:
Income available to common stockholders &
assumed conversion...................................... $ 9,070 9,480 $.96 $4,839 9,346 $.51
======= ==== ====== ====
Per share and share data has been adjusted to reflect stock dividends.
11
6. Goodwill and Identifiable Intangible Assets
-------------------------------------------
In June 2001, the Financial Accounting Standards Board issued SFAS No.
141, "Business Combinations", and SFAS No. 142, "Goodwill and Other
Intangible Assets". SFAS No. 141 requires companies to use the purchase
method of accounting for all business combinations initiated after June 30,
2001 and addresses the initial recognition and measurement of goodwill and
other intangible assets acquired in a business combination. SFAS No. 142,
which the Corporation adopted on January 1, 2002, addresses the initial
recognition and measurement of intangible assets acquired outside a business
combination and the recognition and measurement of goodwill and other
intangible assets subsequent to acquisition. Under the new standard, goodwill
is no longer amortized but, instead, is tested at least annually for
impairment. Other intangible assets continue to be amortized over their
useful lives. During the second quarter of 2002, the Corporation assessed its
goodwill and determined that there was no impairment of the recorded amount,
which is not considered material.
Goodwill
The costs of acquired companies in excess of the fair value of net assets
at acquisition date is recorded as goodwill. As of June 30, 2002, goodwill of
$294,000 was included on the consolidated interim balance sheets. Through
December 31, 2001, goodwill was amortized on a straight-line basis over 15
years. The following table sets forth reported net earnings and EPS, as adjusted
to exclude goodwill amortization expense:
Six Months Ended
June 30,
2001
---------------------------------------
(in thousands, except per share amounts)
Net earnings, as reported $ 4,839
Net earnings, as adjusted............ 4,959
EPS, as reported:
Basic............................. $ .52
Diluted........................... .51
EPS, as adjusted:
Basic............................. $ .54
Diluted............................... .53
Per share data has been restated to reflect the 5% stock dividend paid
April 30, 2002.
12
Identifiable Intangible Assets
The following table sets forth the gross carrying amount, accumulated
amortization and net carrying amount of identifiable intangible assets:
As of
June 30, 2002 December 31, 2001
------------- -----------------
(in thousands)
Gross carrying amount................ $ 1,101 $ 1,116
Accumulated amortization............. (335) (299)
--------- --------
Net carrying amount.................. $ 766 $ 817
========= ========
Identifiable intangible assets relate to acquisition of branch offices
from other banks and are amortized over their assumed useful lives.
Amortization expense associated with identifiable intangible assets was
$18,000 for each of the three months ended June 30, 2002 and 2001. Estimated
amortization expense for existing identifiable intangible assets is $73,000 for
each of the fiscal years ending December 31, 2002 through December 31, 2010 and
thereafter decreasing through December 31, 2014.
13
COMMUNITY BANKS, INC. AND SUBSIDIARIES
Management's Discussion of Financial Condition and Results of Operation
- -----------------------------------------------------------------------
Overview
Community Banks, Inc. (Community) is a financial holding company whose
wholly-owned subsidiaries include Community Banks, Community Bank Investments,
Inc. (CBII) and Community Banks Life Insurance Co. (CBLIC). Community Banks
provides a wide range of services through its network of offices in Adams,
Cumberland, Dauphin, Luzerne, Northumberland, Schuylkill, Snyder, and York
counties in Pennsylvania.
The purpose of this review is to provide additional information necessary
to fully understand the consolidated financial condition and results of
operations of Community. Throughout this review, net interest income and the
yield on earning assets are stated on a fully taxable-equivalent basis and
balances represent average daily balances unless otherwise indicated. In
addition, income statement comparisons are based on the first six months of 2002
compared to the same period of 2001 unless otherwise indicated.
Forward-Looking Statements
Periodically, Community has made and will continue to make statements that may
include forward-looking information. The Corporation cautions that
forward-looking information disseminated through financial presentations should
not be construed as guarantees of future performance. Furthermore, actual
results may differ from expectations contained in such forward-looking
information as a result of factors that are not predictable. Financial
performance can be affected by any number of factors that are not predictable or
are out of management's control. Examples include: the effect of prevailing
economic conditions; unforeseen or dramatic changes in the general interest rate
environment; actions or changes in policies of the Federal Reserve Board and
other government agencies; and business risk associated with the management of
the credit extension function and fiduciary activities. Each of these factors
could affect estimates, assumptions, uncertainties and risk used to develop
forward-looking information, and could cause actual results to differ materially
from management's expectations regarding future performance.
Summary of Financial Results
Community Banks, Inc. reported record profit performance for both the
second quarter and the first half of 2002. Fully diluted earnings per share for
the second quarter reached $0.49 compared to $0.43 in same period of 2001, an
increase of nearly 14%. Net income also grew 14% to $4.6 million versus $4.0
million in the year earlier period. This performance resulted in a return on
average assets (ROA) of 1.19% and a return on average equity (ROE) of 16.25% for
the quarter, an increase over the ROA of 1.18% and ROE of 14.90% that were
reported in the second quarter of 2001.
Comparisons for the six months ended June 30 reflected more dramatic
increases over the first half of 2001, which had been reduced by merger and
restructuring expenses incurred in connection with the March, 2001 merger with
Glen Rock State Bank. Earnings per share for the first half of 2002 reached
$0.96 compared to $0.51 in 2001, an increase of 88%. Net income reached $9.1
million for the six-month period and ROA and ROE were 1.19% and 15.86%,
respectively.
For the quarter, Community reflected substantial improvement in revenue,
including increases in both net interest income and income from fee-based
services. Net interest income, the difference between interest received from
earning assets and interest paid on deposits, reflected an increase of 9.7% from
the same quarter of the prior year. Likewise, fee-based services continue to
exhibit improvement from the expansion of financial services now available
through Community's office network, many of which are due to expanded
relationships with strategic partners. Community also was able to reflect a
lower loan loss provision attributable to improvements in past due loan volumes
and reductions in problem credits since the first quarter. Nonperforming loans
declined by 15% and past due loans dropped 52% since the end of the first
quarter. These improvements marked a return to levels that are more consistent
with Community's historical trends. The allowance for loan losses as a percent
of total loans reached 1.43% and the coverage of the allowance to nonperforming
loans grew to 139%, compared to 109% at the end of December 2001.
14
Management's Discussion, Continued
- ----------------------------------
Balance sheet growth trends were also positive as average loans for the six
months ended June 30, 2002 grew 6% to $873 million. Earning assets and average
deposits also reflected even higher growth of 15% and 12%, respectively, as
average earning assets rose to nearly $1.5 billion and deposits reached $1.1
billion.
While increases in net interest income reflected substantial growth from
the prior year, improvement from the first quarter of 2002 was constrained by
the impact of a lower interest rate environment since March 31. Such rate
trends, combined with competitive pricing pressure on both loans and deposits,
resulted in a compression of net interest margin from 3.96% to 3.76%, offsetting
the favorable effect of earning asset growth during the period. Community's
current balance sheet posture has been restructured in anticipation of higher
interest rates later in 2002 and into 2003. Prospects for more substantial
margin improvement may be constrained if rates were to decline substantially
from their current levels. Management is confident that extended periods of
additional rate declines are unlikely, and believes that it is properly
positioned to take advantage of a gradual increase in the overall level of
interest rates.
Average Statement of Condition
The average balance sheets for the six months ended June 30, 2002 and 2001 were
as follows (in thousands):
Change
2002 2001 Volume %
- ----------------------------------------------------------------------------------------------------------------------
Cash and due from banks $ 36,818 $ 33,719 $ 3,099 9%
Federal funds sold and other 20,207 20,055 152 1%
Investments 551,028 412,334 138,694 34%
Loans 873,771 823,121 50,650 6%
Allowance for loan losses 12,610 11,309 1,301 12%
- ----------------------------------------------------------------------------------------------------------------------
Net loans 861,161 811,812 49,349 6%
Goodwill and other identifiable intangibles 992 968 24 2%
Loans held for resale 6,887 3,688 3,199 87%
Other assets 64,956 60,726 4,230 7%
- ----------------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $1,542,049 $1,343,302 $198,747 15%
- ----------------------------------------------------------------------------------------------------------------------
Noninterest-bearing deposits $ 160,092 $ 146,053 $ 14,039 10%
Interest-bearing deposits 906,393 805,196 101,197 13%
Short-term borrowings 48,305 5,676 42,629 751%
Long-term debt 300,270 268,759 31,511 12%
Other liabilities 11,687 9,806 1,881 19%
- ----------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES 1,426,747 1,235,490 191,257 15%
- ----------------------------------------------------------------------------------------------------------------------
STOCKHOLDERS' EQUITY 115,302 107,812 7,490 7%
- ----------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $1,542,049 $1,343,302 $198,747 15%
- ----------------------------------------------------------------------------------------------------------------------
Balance sheet trends for the first six months of 2002 reflect continued
growth in the deposit base accompanied by less robust trends for loan growth.
Deposit growth, which was particularly strong during the first quarter of 2002,
continued at a more sustainable pace during the second quarter as Community
successfully improved its share of deposit market share through its competitive
product mix. Growth was particularly evident in its "no penalty CD" product as
well as some longer-term certificate of deposit categories. The pace of loan
growth, which remained steady during the quarter, slowed somewhat as measured
against the first quarter 2002 and full year 2001 pace. Community also engaged
in limited use of low cost borrowings and increased its investment holdings to
increase net interest income during the period.
15
Management's Discussion, Continued
- ----------------------------------
Net Interest Income
The following table summarizes, on a fully taxable equivalent basis,
changes in net interest income and net interest margin for the six months ended
June 30, 2002 and 2001 (in thousands):
- -----------------------------------------------------------------------------------------------------------------
2002 2001 Increase (Decrease)
Amount Yield/rate Amount Yield/rate Amount Yield/rate
- -----------------------------------------------------------------------------------------------------------------
Interest income $ 51,217 7.13% $ 50,801 8.13% $ 416 (1.00)
Interest expense 23,514 3.78% 26,681 4.98% (3,167) (1.20)
- -----------------------------------------------------------------------------------------------------------------
Net interest income $ 27,703 $ 24,120 $ 3,583
Interest spread 3.35% 3.15% 0.20
Impact of noninterest funds 0.51% 0.71% (0.20)
- -----------------------------------------------------------------------------------------------------------------
Net interest margin 3.86% 3.86% 0.00
- -----------------------------------------------------------------------------------------------------------------
Community's major source of revenue is derived from intermediation
activities and is reflected as net interest income. Net interest income
represents the difference between interest income on earning assets and interest
expense on deposits and borrowed funds, and is heavily dependent on the volume
and composition of earning assets and interest bearing liabilities as well as
the yield or rate earned or paid on these earning assets or funding sources.
Net interest income increased $3.6 million or 14.9% in 2002 compared to
2001. Both earning asset and interest-bearing liability levels increased and a
decline in funding costs outpaced a decline in asset yields. As such, the net
interest spread increased 20 basis points.
Interest income increased $416,000 or less than 1% during 2002 and was
influenced by an increase in earning assets of approximately $190 million while
the yield on loans and investments decreased in line with a general decline in
overall rates.
Interest expense declined $3.2 million or 11.9%, as interest bearing
liabilities increased approximately $180 million while the benefit of a lower
interest rate environment resulted in a decrease in the total rate paid on
funding sources of 120 basis points.
In isolating second quarter 2002 performance, net interest margin exhibited
a decline from the levels achieved in the first quarter of 2002. Second quarter
net interest margin reached 3.76% compared to 3.96% in the first quarter. Within
the scope of its asset/liability management policy, Community has repositioned
its balance sheet posture in anticipation of a gradual rise in interest rates
from the levels in effect in the first quarter. The lower rate environment
actually experienced during the second quarter compressed the margin between the
two periods, though net interest income remained relatively constant.
Expectations are such that further substantial declines in overall interest
rates are considered to be unlikely and that Community is well positioned to
benefit from a measured increase in the rate environment in late 2002 and 2003.
Provision for Loan Losses
Community remains attuned to the influence of unfolding economic conditions
and their potential impact on credit conditions and the adequacy of the reserve
for loan losses. The provision for loan losses charged to income in 2002 was
$2.3 million compared to $2.4 million in 2001. Net loan charge-offs in 2002 were
$1.8 million compared to $514,000 in 2001. Net loan charge-offs as a percentage
of average net loans approximated .20% and .06% during 2002 and 2001,
respectively. Total risk elements decreased from $13.4 million at December 31,
2001, to $10.5 million at June 30, 2002.
16
Management's Discussion, Continued
- ----------------------------------
Non-Interest Income
The strategic initiatives Community has undertaken to meet customer needs
and provide access to expanded financial services through their distribution
network continues to be a critical driver of Community's performance.
Non-interest income exclusive of security gains increased $2.2 million or 46.3%
in 2002 compared to 2001.
After the first quarter of 2001, Community acquired ownership interest in
two title insurance companies that operate within the Corporation's geographic
footprint. These important acquisitions provided a tangible sign of Community's
strategic commitment to expand its product base and to anticipate the financial
needs of its growing customer base. Increases in insurance premium income and
commissions of $480,000 or 68.4% for 2002 compared to 2001 are a reflection of
the increase in title insurance activities as well as an increase in consumer
loan demand and additional credit life and accident and health insurance
premiums realized at CBLIC.
Community derives revenue from the origination and sale of mortgage loans
into the secondary market. Gains on loan sales decreased $55,000 or 10.2% in
2002 as a result of decreased demand for fixed-rate real estate loans.
Other income increased in 2002 by $960,000 or 118.1% compared to 2001. More
that half of this increase was attributed to the gains realized from the sale of
two office locations and the effected deposit base. This sale was executed
pursuant to Community's ongoing analysis and rationalization of its current
office structure. Community is constantly monitoring the performance of its
office locations and will continue to consider expansion into markets with more
vibrant growth characteristics. Other income was also impacted by increases in
the cash surrender value of bank-owned life insurance policies.
Investment security gains of $536,000 were recognized during 2002
compared to $238,000 in 2001. Such gains were realized in the first quarter
pursuant to management's ongoing effort to review investment holdings and
portfolio strategy.
Non-Interest Expenses
The increase in salaries and employee benefits of $1.1 million or 11.9% for
2002 compared to 2001 was affected by a number of factors including the annual
merit increase, employees added through the expansion of Community's
distribution network and by expenses related to employees added in fee-based
activities such as title insurance and investment management services.
Other operating expense increased $1.3 million or 27.4% in 2002 compared to
2001. Affecting these changes were increases in banking facilities and
additional marketing and business development initiatives.
Income Taxes
Income tax expense for 2002 was $1.4 million, resulting in an effective tax
rate of 13.2%. The Corporation increased its level of tax-exempt investment
during calendar 2001 and these investments will continue to favorably influence
the effective tax rate through their maturity dates.
Stockholders' Equity
Capital strength has always been a critical metric with which to judge the
overall stability of a financial institution. A strong capital base is also a
prerequisite for sustaining franchise growth through both internal expansion and
strategic acquisition opportunities. Regulatory authorities impose constraints
and restrictions on bank capital levels that are designed to help ensure the
vitality of the nation's banking system.
The primary source of capital for Community is through earnings retention. The
Corporation's capital management and planning process is reviewed by its Board
of Directors and seeks to provide its shareholders with a sustainable level of
dividends that is considerate of a variety of factors, including the prospects
for sustainable core profit performance. Management of overall capital levels
requires the use of various techniques designed to meet
17
Management's Discussion, Continued
- ----------------------------------
or exceed regulatory guidelines, to ensure suitable levels of capital for a
given asset base, and to provide an appropriate rate of return to shareholders.
Community uses a number of these techniques, including share repurchase,
issuance of cash dividends and regular stock dividends, to manage the level of
capital to optimum levels.
Community's regulatory capital measures, which include the leverage ratio,
"Tier 1" capital, and "Total capital" ratios, continued to be well in excess of
both regulatory minimums and the thresholds established for "well capitalized"
institutions. The following presentation of these ratios at June 30, 2002 and
regulatory standards is provided:
June 30, "Well Regulatory
2002 Capitalized" Minimums
---- ------------ --------
Leverage ratio 7.52% 5% 4%
Tier 1 capital ratio 10.00% 6% 4%
Total risk-based capital ratio 11.12% 10% 8%
At June 30, 2002, total stockholders' equity reflected accumulated other
comprehensive income of $2.5 million compared to the accumulated other
comprehensive loss of $4.0 million reflected in total stockholder's equity at
year-end 2001. This increase can be attributed to the change in the net
unrealized gain (loss) on investment securities available for sale, net of
taxes. Much of this change was a function of declines in interest rates and
corresponding increases in fair values of debt securities. Community reissued
approximately 51,000 shares and purchased approximately 98,000 shares of
treasury stock during the first half of 2002. At June 30, 2002 treasury shares
totaled 173,000. Community currently has board approval to purchase an
additional 154,000 shares.
Asset/Liability Management and Liquidity
The process by which financial institutions manage earning assets and
funding sources under different interest rate environments is called
asset/liability management. The primary goal of asset/liability management is to
increase net interest income through the prudent control of market risk,
liquidity, interest rate risk and capital. Two important barometers of
performance are net interest margin and liquidity. Widening interest spread
while controlling interest rate sensitivity increases net interest margin. The
adequacy of liquidity is determined by the ability to meet the cash flow
requirements of both depositors and customers requesting bank credit. The Board
of Directors governs and monitors asset/liability management processes and
delegates the responsibility for management of these processes to the corporate
Asset/Liability Management Committee (ALCO).
Liquidity is defined as the ability to meet maturing obligations and
customers' demand for funds on a continuous basis. Liquidity is sustained by
stable core deposits, a diversified mix of liabilities, strong credit perception
and the presence of sufficient assets convertible to cash without material loss
or disruption of normal operations. Community actively manages liquidity within
a defined range and has developed reasonable liquidity contingency plans,
ensuring availability of alternate funding sources to maintain adequate
liquidity under a variety of business conditions. The Corporation's investing
and financing activities are conducted within the overall constraints of its
liquidity management policy and practices.
Inflation
Community's ability to cope with the impact of inflation is best measured
by its ability to respond to changing interest rates and manage non-interest
income and expense. Within its ALCO processes, the Corporation manages the mix
of interest rate-sensitive assets and liabilities in order to limit the impact
of changing interest rates on net interest income. Inflation also has a direct
impact on non-interest income and expense such as service fee income, salary and
benefits expenses, and other overhead expenses. Inflationary pressures over the
last several years have been modest but this trend is subject to change.
Management will continue to monitor the potential for inflation and its impact
on the pricing of products and services.
18
COMMUNITY BANKS, INC. AND SUBSIDIARIES
FINANCIAL CONDITION
- -------------------
Community's financial condition can be examined in terms of developing
trends in its sources and uses of funds. These trends are the result of both
external environmental factors, such as changing economic conditions, regulatory
changes and competition, and internal environmental factors such as management's
evaluation as to the best use of funds under these changing conditions.
Increase (Decrease)
Balance Since
June 30, 2002 December 31, 2001
------------- -----------------
(dollars in thousands)
Amount %
------ -
Funding Sources:
Deposits and borrowed funds:
Non-interest bearing.................................... $ 173,998 $ 13,611 8.5 %
Interest-bearing........................................ 939,678 96,840 11.5
------------ ----------- ------
Total deposits...................................... 1,113,676 110,451 11.0
Borrowed funds.............................................. 343,700 (38,457) (10.1)
Other liabilities........................................... 12,171 (932) (7.1)
Shareholders' equity........................................ 121,862 10,613 9.5
------------- ----------- ------
Total sources....................................... $ 1,591,409 $ 81,675 5.4 %
============= =========== ======
Funding uses:
Interest-earning assets:
Short-term investments.................................. $ 36,949 $ 35,577 N/M %
Investment securities................................... 569,157 25,256 4.7
Loans, net of unearned income........................... 886,288 26,686 3.1
------------- ----------- ------
Total interest-earning assets....................... 1,492,394 87,519 6.2
Cash and due from banks..................................... 46,087 1,323 3.0
Other assets................................................ 52,928 (7,167) (11.9)
------------- ----------- ------
Total uses.......................................... $ 1,591,409 $ 81,675 5.4%
============= =========== =======
19
COMMUNITY BANKS, INC. and SUBSIDIARIES
PART II - OTHER INFORMATION AND SIGNATURES
Items 1,2,3 and 5 have been omitted since they are not applicable.
Item 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
The annual meeting of shareholders of Community Banks, Inc. was held on
May 7, 2002 for the purpose of considering and voting upon the following matter:
1. To elect four (4) directors: Kenneth L. Deibler, Allen Shaffer, and Earl
L. Mummert, to serve until the 2006 annual meeting of shareholders. Each
director received affirmative votes representing at least 73.69% of the shares
outstanding.
Item 6(a). Exhibits
--------
Exhibit # Description
- --------- -----------
99.1 Certification Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002 (Chief Executive Officer)
99.2 Certification Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002 (Chief Financial Officer)
Item 6(b). Reports on Form 8-K
-------------------
Registrant filed the following report on Form 8-K during the quarter
ending June 30, 2002:
Report Dated May 7, 2002
------------------------
Registrant announced that its stock would begin trading on the NASDAQ
National Market on Tuesday, May 14, 2002 under the symbol "CMTY" and that
its holding company executive offices will be formally designated as
Harrisburg, PA.
20
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 hereunto duly authorized.
COMMUNITY BANKS, INC.
(Registrant)
Date August 14, 2002 /s/ Eddie L. Dunklebarger
- ---- --------------- -------------------------
Eddie L. Dunklebarger
Chairman and President
(Chief Executive Officer)
Date August 14, 2002 /s/ Donald F. Holt
- ---- --------------- ------------------
Donald F. Holt
Executive Vice President
(Chief Financial Officer)
21
Exhibit 99.1
COMMUNITY BANKS, INC.
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Community Banks, Inc. (the "Company")
on Form 10-Q for the period ending June 30, 2002 as filed with the Securities
and Exchange Commission on the date hereof (the "Report"), I, Eddie L.
Dunklebarger, Chief Executive Officer, Chairman, and President of the Company,
certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the
Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of section 13(a) or 15
(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all
material respects, the financial condition and result of operations of
the Company.
/s/ Eddie L. Dunklebarger
- --------------------------------------------------
Chief Executive Officer, Chairman, and President
August 14, 2002
22
Exhibit 99.2
COMMUNITY BANKS, INC.
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Community Banks, Inc. (the "Company")
on Form 10-Q for the period ending June 30, 2002 as filed with the Securities
and Exchange Commission on the date hereof (the "Report"), I, Donald F. Holt,
Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. ss. 1350,
as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of section 13(a) or 15
(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all
material respects, the financial condition and result of operations of
the Company.
/s/ Donald F. Holt
- --------------------------------------------------
Chief Financial Officer
August 14, 2002
23