UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2004
0-15786
-------
(Commission File Number)
COMMUNITY BANKS, INC.
---------------------
(Exact name of registrant as specified in its charter)
PENNSYLVANIA 23-2251762
- ----------------------- ---------------------------------------
(State of incorporation) (I.R.S. Employer Identification Number)
750 East Park Dr., Harrisburg, PA 17111
- ---------------------------------------- --------------
(Address of principal executive offices) (Zip Code)
(717) 920-1698
--------------
(Registrant's telephone number, including area code)
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
------------ ------------
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes X No
------------ ------------
Number of shares outstanding as of July 31, 2004
CAPITAL STOCK-COMMON 12,193,000
--------------------- --------------------
(Title of Class) (Outstanding Shares)
COMMUNITY BANKS, INC. AND SUBSIDIARIES
FORM 10-Q
INDEX
PART I - Financial Information Page
Item 1. Financial Statements
Consolidated Interim Balance Sheets 3
Consolidated Interim Statements of Income 4
Consolidated Interim Statements of Changes in Stockholders' Equity 5
Consolidated Interim Statements of Cash Flows 6
Notes to Consolidated Interim Financial Statements 7-11
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 12-21
Item 3. Quantitative and Qualitative Disclosures About Market Risk 22
Item 4. Controls and Procedures 23
PART II - Other Information
Item 1. Legal Proceedings 24
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases 24
of Equity Securities
Item 3. Defaults Upon Senior Securities 24
Item 4. Submission of Matters to a Vote of Security Holders 24
Item 5. Other Information 24
Item 6. Exhibits and Reports on Form 8-K 25
SIGNATURES 26
2
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
- -----------------------------
Community Banks, Inc. and Subsidiaries
CONSOLIDATED INTERIM BALANCE SHEETS
(Dollars in thousands except per share data)
June 30, December 31,
2004 2003
------------------- -------------------
ASSETS (Unaudited)
Cash and due from banks $ 41,434 $ 42,790
Federal funds sold --- 17,097
------------------- -------------------
Cash and cash equivalents 41,434 59,887
Interest-bearing time deposits in other banks 2,803 3,301
Investment securities, available for sale 678,856 646,961
Loans held for sale 648 6,067
Loans: 1,161,368 1,078,611
Less: Allowance for loans losses (14,294) (13,178)
------------------- -------------------
Net loans 1,147,074 1,065,433
Premises and equipment, net 25,002 24,153
Goodwill and identifiable intangible assets 4,976 4,773
Accrued interest receivable and other assets 60,268 50,488
------------------- -------------------
Total assets $ 1,961,061 $ 1,861,063
=================== ===================
LIABILITIES
Deposits
Non-interest bearing $ 184,114 $ 165,174
Interest bearing 1,113,256 1,065,511
------------------- -------------------
Total deposits 1,297,370 1,230,685
Short-term borrowings 110,475 27,764
Long-term debt 373,066 411,422
Subordinated debt 30,928 30,928
Accrued interest payable and other liabilities 13,087 16,858
------------------- -------------------
Total liabilities 1,824,926 1,717,657
------------------- -------------------
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; 12,422,000 and 11,851,000 shares issued 62,108 59,256
Surplus 73,224 57,563
Retained Earnings 11,302 24,297
Accumulated other comprehensive income (loss),
net of tax (5,607) 6,596
Treasury stock; 210,000 and 203,000
shares in 2004 and 2003, at cost (4,892) (4,306)
------------------- -------------------
Total stockholders' equity 136,135 143,406
------------------- -------------------
Total liabilities and stockholders' equity $ 1,961,061 $ 1,861,063
=================== ===================
The accompanying notes are an integral part of the consolidated interim
financial statements.
3
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,
------------------------------- --------------------------------
2004 2003 2004 2003
-------------- ------------- -------------- --------------
INTEREST INCOME:
Loans, including fees $ 16,996 $ 16,364 $ 33,654 $ 32,430
Investment securities:
Taxable 5,091 4,595 9,653 9,572
Tax exempt 2,258 2,251 4,453 4,531
Dividends 511 512 1,063 958
Other 26 1 39 3
-------------- ------------- -------------- --------------
Total interest income 24,882 23,723 48,862 47,494
-------------- ------------- -------------- --------------
INTEREST EXPENSE:
Deposits 5,675 5,874 11,133 11,892
Short-term borrowings 198 430 322 764
Long-term debt 4,428 4,214 9,009 8,381
Subordinated debt 377 181 755 365
-------------- ------------- -------------- --------------
Total interest expense 10,678 10,699 21,219 21,402
-------------- ------------- -------------- --------------
Net interest income 14,204 13,024 27,643 26,092
Provision for loan losses 750 600 1,600 1,000
-------------- ------------- -------------- --------------
Net interest income after provision for loan
losses 13,454 12,424 26,043 25,092
-------------- ------------- -------------- --------------
NON-INTEREST INCOME:
Investment management and trust services 409 333 676 650
Service charges on deposit accounts 1,707 1,295 3,112 2,336
Other service charges, commissions and fees 775 776 1,677 1,530
Investment security gains 844 500 2,176 1,547
Insurance premium income and commissions 1,025 848 1,679 1,258
Mortgage banking activities 828 445 1,455 871
Earnings on investment in life insurance 412 443 777 772
Other 156 371 227 441
-------------- ------------- -------------- --------------
Total non-interest income 6,156 5,011 11,779 9,405
-------------- ------------- -------------- --------------
NON-INTEREST EXPENSES:
Salaries and employee benefits 7,041 6,276 13,876 12,176
Net occupancy 1,995 1,778 4,028 3,544
Marketing expense 869 571 1,289 1,085
Telecommunications expense 344 327 661 527
Other 2,713 2,437 4,991 4,846
-------------- ------------- -------------- --------------
Total non-interest expenses 12,962 11,389 24,845 22,178
-------------- ------------- -------------- --------------
Income before income taxes 6,648 6,046 12,977 12,319
Income taxes 1,211 1,070 2,365 2,242
-------------- ------------- -------------- --------------
Net income $ 5,437 $ 4,976 $ 10,612 $ 10,077
============== ============= ============== ==============
CONSOLIDATED PER SHARE DATA:
Basic earnings per share $ .45 $ .41 $ .87 $ .83
Diluted earnings per share $ .43 $ .40 $ .84 $ .81
Dividends declared $ .17 $ .16 $ .33 $ .31
The accompanying notes are an integral part of the consolidated interim
financial statements.
4
Community Banks, Inc. and Subsidiaries
CONSOLIDATED INTERIM STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(Unaudited)
(In thousands)
Accumulated
Other
Comprehensive
Outstanding Common Retained Income Treasury Total
Shares Stock Surplus Earnings (Loss) Stock Equity
----------- -------------------------------------------------------------- -----------
Balance, January 1, 2003 9,151 $ 47,053 $ 46,418 $ 35,344 $ 6,538 $ (6,191) $ 129,162
Comprehensive income:
Net income 10,077 10,077
Unrealized gain on securities,
net of reclassification
adjustment and tax effect 7,088 7,088
-----------
Total comprehensive income 17,165
Cash dividends (3,750) (3,750)
5% stock dividend 458 2,346 10,612 (12,984) (26)
Purchases of treasury
stock (100) (2,822) (2,822)
Exercise of common stock options
and issuances under stock
purchase plan 107 (11) (590) 2,646 2,045
Tax benefits from employee stock
transactions 288 288
----------- -------------------------------------------------------------- -----------
Balance, June 30, 2003 9,616 $ 49,388 $ 57,318 $ 28,097 $ 13,626 $ (6,367) $ 142,062
=========== ============================================================== ===========
Balance, January 1, 2004 11,648 $ 59,256 $ 57,563 $ 24,297 $ 6,596 $ (4,306) $ 143,406
Comprehensive income (loss):
Net income 10,612 10,612
Unrealized loss on securities,
net of reclassification
adjustment and tax effect (12,203) (12,203)
-----------
Total comprehensive income (loss) (1,591)
Cash dividends (4,065) (4,065)
5% stock dividend 584 2,953 15,103 (18,085) (29)
Stock split paid in the form of a
20% stock dividend (fractional
shares) (4) (25) (29)
Purchases of treasury stock (102) (3,036) (3,036)
Exercise of common stock options
and issuances under stock
purchase plan 82 (97) (1,432) 2,450 921
Tax benefits from employee stock
transactions 558 558
----------- -------------------------------------------------------------- -----------
Balance, June 30, 2004 12,212 $ 62,108 $ 73,224 $ 11,302 $ (5,607) $ (4,892) $ 136,135
=========== ============================================================== ===========
The accompanying notes are an integral part of the consolidated interim
financial statements.
5
Community Banks, Inc. and Subsidiaries
CONSOLIDATED INTERIM STATEMENTS OF CASH FLOWS
(Unaudited)
(Dollars in thousands)
Six Months Ended
June 30,
----------------------------------------
2004 2003
----------------------------------------
Operating Activities:
Net income $ 10,612 $ 10,077
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 1,600 1,000
Depreciation and amortization 1,641 1,532
Amortization of security premiums and discounts, net 607 1,436
Investment security gains (2,176) (1,547)
Loans originated for sale (6,601) (39,711)
Proceeds from sales of loans 12,297 45,284
Gains on loan sales (277) (871)
Earnings on investment in life insurance (777) (772)
Change in other assets, net 3,058 4,219
Change in accrued interest payable and other liabilities, net (3,175) (3,946)
----------------- ----------------
Net cash provided by operating activities 16,809 16,701
----------------- ----------------
Investing Activities:
Net (increase) decrease in interest-bearing time deposits
in other banks 498 (89)
Proceeds from sales of investment securities 69,049 110,442
Proceeds from maturities of investment securities 83,196 73,013
Purchases of investment securities (201,484) (218,154)
Net increase in total loans (83,780) (100,170)
Investment in life insurance (5,000) ---
Net additions to premises and equipment (2,261) (1,448)
Other (282) (322)
----------------- ----------------
Net cash used by investing activities (140,064) (136,728)
----------------- ----------------
Financing Activities:
Net increase in deposits 66,685 61,312
Net increase in short-term borrowings 57,711 86,890
Repayment of long-term debt (13,356) (1,421)
Cash dividends and cash paid in lieu of fractional shares (4,123) (3,750)
Purchases of treasury stock (3,036) (2,822)
Proceeds from issuance of common stock 921 2,045
----------------- ----------------
Net cash provided by financing activities 104,802 142,254
----------------- ----------------
Increase (decrease) in cash and cash equivalents (18,453) 22,227
Cash and cash equivalents at beginning of period 59,887 36,137
----------------- ----------------
Cash and cash equivalents at end of period $ 41,434 $ 58,364
================= ================
The accompanying notes are an integral part of the consolidated interim
financial statements.
6
Community Banks, Inc. and Subsidiaries
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Unaudited)
1. Summary of Significant Accounting Policies
------------------------------------------
Basis of Presentation - The accompanying unaudited consolidated financial
statements of Community Banks, Inc. and Subsidiaries ("Community") have been
prepared in accordance with accounting principles generally accepted in the
United States for interim financial information and instructions to Form 10-Q
and Article 10 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by accounting principles generally accepted
in the United States for complete financial statements. In the opinion of
management, all adjustments, consisting of normal recurring accruals, considered
necessary for a fair presentation have been included.
Operating results for the six months ended June 30, 2004, are not necessarily
indicative of the results that may be expected for the year ending December 31,
2004.
For further information, refer to the audited consolidated financial statements,
and footnotes thereto, included in the Annual Report on Form 10-K, for the year
ended December 31, 2003.
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 and
Carroll and Montgomery Counties in Maryland.
Statement of Cash Flows - Cash and cash equivalents include cash and due from
banks and federal funds sold.
Stock-Based Compensation - Community has a stock-based compensation plan and
accounts for this plan under the recognition and measurement principles of APB
No. 25, "Accounting for Stock Issued to Employees," and related Interpretations.
No stock-based compensation cost is reflected in net income, as all options
granted under this plan 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 Community had applied the
fair value recognition provisions of FASB No. 123, "Accounting for Stock-Based
Compensation," to stock-based compensation.
(Dollars in thousands, except per share data)
Three Months Ended Six Months Ended
June 30, June 30,
2004 2003 2004 2003
--------------------------- ----------------------------
Net income, as reported $ 5,437 $ 4,976 $ 10,612 $ 10,077
Deduct: Total stock-based compensation
expense determined under fair value based
method for all awards, net of related tax effect 322 187 644 373
------------ ----------- ------------ -------------
------------ ----------- ------------ -------------
Pro forma net income $ 5,115 $ 4,789 $ 9,968 $ 9,704
============ =========== ============ =============
============ =========== ============ =============
Earnings per share:
Basic - as reported $ .45 $ .41 $ .87 $ .83
Basic - pro forma $ .41 $ .39 $ .81 $ .80
Diluted - as reported $ .43 $ .40 $ .84 $ .81
Diluted - pro forma $ .41 $ .38 $ .79 $ .78
7
Community Banks, Inc. and Subsidiaries
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS, (continued)
(Unaudited)
Comprehensive Income (Loss):
The components of other comprehensive income (loss) and related tax effects for
periods ended June 30 are as follows (in thousands):
Three Months Ended Six Months Ended
June 30, June 30,
-------------------------------- --------------------------------
2004 2003 2004 2003
-------------------------------- --------------------------------
Unrealized holding gains (losses)
on available-for-sale securities $ (24,096) $ 12,275 $ (16,598) $ 12,451
Reclassification adjustments for
gains included in net income (844) (500) (2,176) (1,547)
-------------- -------------- -------------- --------------
Net unrealized gains (losses) (24,940) 11,775 (18,774) 10,904
Tax effect 8,729 (4,121) 6,571 (3,816)
-------------- -------------- -------------- --------------
$ (16,211) $ 7,654 $ (12,203) $ 7,088
============== ============== ============== ==============
The components of accumulated other comprehensive income (loss), included in
stockholders' equity, are as follows (in thousands):
June 30, December 31,
2004 2003
---------------- ----------------
Net unrealized gain (loss) on
available-for-sale securities $ (5,428) $ 13,347
Tax effect 1,900 (4,672)
---------------- ----------------
Net-of-tax amount (3,528) 8,675
---------------- ----------------
Unfunded pension liability (3,199) (3,199)
Tax effect 1,120 1,120
---------------- ----------------
Net-of-tax amount (2,079) (2,079)
---------------- ----------------
Accumulated other comprehensive income (loss) $ (5,607) $ 6,596
================ ================
Reclassifications - Certain amounts reported in the prior year have been
reclassified to conform with the 2004 presentation. These reclassifications did
not impact the Corporation's financial condition or results of operations.
8
Community Banks, Inc. and Subsidiaries
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS, (continued)
(Unaudited)
2. Allowance for loan losses:
--------------------------
Changes in the allowance for loan losses are as follows (in thousands):
Six Months Ended Year Ended Six Months Ended
June 30, December 31, June 30,
2004 2003 2003
---------------- ---------------- ----------------
Balance, January 1 $ 13,178 $ 12,343 $ 12,343
Provision for loan losses 1,600 2,500 1,000
Loan charge-offs (1,202) (2,839) (796)
Recoveries 718 1,174 375
---------------- ---------------- ----------------
Balance, end of period $ 14,294 $ 13,178 $ 12,922
================ ================ ================
The following table summarizes period-end risk elements (in thousands):
June 30, December 31, June 30,
2004 2003 2003
---------------- ---------------- ----------------
Non-accrual loans $ 6,244 $ 8,151 $ 11,281
Foreclosed real estate 1,788 4,865 359
---------------- ---------------- ----------------
Total non-performing assets 8,032 13,016 11,640
Accruing loans 90 days past due 32 90 61
---------------- ---------------- ----------------
Total risk elements $ 8,064 $ 13,106 $ 11,701
================ ================ ================
9
Community Banks, Inc. and Subsidiaries
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS, (continued)
(Unaudited)
3. Earnings Per Share:
-------------------
Basic earnings per share is computed as net income divided by the weighted
average number of shares outstanding. Diluted earnings per share reflects
additional common shares that would have been outstanding as a result of
converting common stock equivalents, calculated using the treasury stock method.
Common stock equivalents consist solely of outstanding stock options.
Earnings per share for the three months and six months ended June 30, 2004 and
2003 have been computed as follows (in thousands, except per share data):
Three Months Ended Six Months Ended
June 30, June 30,
--------------------------- ---------------------------
2004 2003 2004 2003
------------ ----------- ------------ -----------
Net income $ 5,437 $ 4,976 $ 10,612 $ 10,077
============ =========== ============ ===========
Weighted average shares outstanding (basic) 12,244 12,127 12,258 12,111
Effect of dilutive stock options 343 306 361 290
------------ ----------- ------------ -----------
Weighted average shares outstanding (diluted) 12,587 12,433 12,619 12,401
============ =========== ============ ===========
Per share information:
Basic earnings per share $ 0.45 $ 0.41 $ 0.87 $ 0.83
Diluted earnings per share 0.43 0.40 0.84 0.81
Per share and number of share amounts reflect stock splits and dividends.
4. Guarantees:
-----------
Community does not issue any guarantees that would require liability recognition
or disclosure, other than its standby letters of credit. Standby letters of
credit written are conditional commitments issued by Community 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. Community generally holds collateral
and/or personal guarantees supporting these commitments. Community had issued
$36.0 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
Community Banks, Inc. and Subsidiaries
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS, (continued)
(Unaudited)
5. Subordinated Debt to Unconsolidated Subsidiary Trusts
-----------------------------------------------------
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). CMTY Capital Trust I and CMTY Capital Statutory Trust II (the
trusts) qualify as VIEs under FIN 46. The trusts issued mandatorily redeemable
preferred securities (Trust Preferred Securities) to third- party investors and
loaned the proceeds to Community. The debentures held by each trust are the sole
assets of that trust.
In the first quarter of 2004, as a result of applying the provisions of FIN 46,
which represents new accounting guidance governing the consolidation of an
equity interest, Community was required to deconsolidate the trusts from its
consolidated financial statements. Prior periods have been restated. The
deconsolidation of the net assets and results of operations of the trusts had
virtually no impact on Community's financial statements or liquidity position
since Community continues to be obligated to repay the debentures held by the
trusts and guarantees repayment of the capital securities issued by the trusts.
Community's total debt obligation related to the trusts did increase, however,
from $30 million to $30.9 million upon deconsolidation, with the difference
representing Community's common ownership interest in the trusts, which is now
reported in "Other assets."
For regulatory reporting purposes, the Federal Reserve Board has an outstanding
proposal under which Trust Preferred Securities will continue to qualify as Tier
1 Capital subject to new restrictions. It is anticipated that Community will
continue to meet its minimum capital requirements under the proposed rule.
11
COMMUNITY BANKS, INC. AND SUBSIDIARIES
Part 1 - Item 2. Management's Discussion and Analysis of Financial Condition and
- --------------------------------------------------------------------------------
Results of Operations
- ---------------------
Overview
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 2004 compared to the
same period of 2003 unless otherwise indicated. Per share and number of share
amounts reflect stock splits and dividends.
Forward-Looking Statements
Periodically, Community has made and will continue to make statements that may
include forward-looking information. Community 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. Examples of factors that may not be
predictable or may be out of management's control 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.
Critical Accounting Policies
The following is a summary of those accounting policies that Community considers
to be most important to the portrayal of its financial condition and results of
operations as they require management's most difficult judgments as a result of
the need to make estimates about the effects of matters that are inherently
uncertain.
Provision and Allowance for Loan Losses - The allowance for loan losses is
evaluated on a regular basis by management and is based upon management's
periodic review of the collectibility of the loans in light of historical
experience, the nature and volume of the loan portfolio, adverse situations that
may affect the borrower's ability to repay, estimated value of any underlying
collateral and prevailing economic conditions. This evaluation is inherently
subjective as it requires estimates that are susceptible to significant revision
as additional information becomes available.
Impairment is measured on a loan by loan basis for commercial and construction
loans over $250,000 by either the present value of expected future cash flows
discounted at the loan's effective interest rate, the loan's obtainable market
price, or the fair value of the collateral if the loan is collateral dependent.
Large groups of smaller balance homogeneous loans are collectively evaluated for
impairment. Accordingly, Community does not separately identify individual
consumer and residential loans for impairment disclosures.
Loans continue to be classified as impaired unless they are brought fully
current and the collection of scheduled interest and principal is considered
probable. When an impaired loan or portion of an impaired loan is determined to
be uncollectible, the portion deemed uncollectible is charged to the allowance
for loan losses, and subsequent recoveries, if any, are credited to the
allowance for loan losses.
12
COMMUNITY BANKS, INC. AND SUBSIDIARIES
PART I - Item 2. Management's Discussion and Analysis of Financial Condition
- --------------------------------------------------------------------------------
and Results of Operations (continued)
- -------------------------------------
SUMMARY OF FINANCIAL RESULTS
- ----------------------------
Earnings for the second quarter of 2004 rose to $0.43 per share, an 8% increase
over $0.40 recorded in the second quarter of 2003. Net income for the quarter
rose to $5.4 million versus $5.0 in the second quarter of the previous year, a
quarter-to-quarter increase of 9%. Return on average assets and return on
average equity reached 1.11% and 15.37%, respectively, for the quarter.
For the first six months of 2004, earnings grew at a slightly less robust pace
than the quarterly comparisons. Earnings per share grew to $0.84 for the first
half of 2004 compared to $0.81 in the same period of 2003, an increase of just
under 4%. Net income for the period grew to $10.6 million compared to $10.1
million in 2003.
In spite of an uncertain economic and political climate, operating results for
the periods ended June 30, 2004 reflected meaningful improvement in a number of
key performance areas. Growth in average balances between the second quarter of
2003 and 2004 resulted in an increase in loans and deposits of 16% and 13%,
respectively. Balances at the end of June for loans and deposits reached $1.2
billion and $1.3 billion, respectively. Additionally, critical metrics
associated with asset quality within the loan portfolio continued to reflect
improving trends, including reduced levels of nonperforming assets and declining
net charge offs. At the same time, the allowance for loan losses continues to
provide adequate coverage over credit risk inherent in the portfolio.
For the first time in several quarters Community recorded a slight improvement
in net interest margin, or the difference between the yield on earning assets
and the cost of funding sources. More recent changes in interest rate indices
have the potential for financial institutions such as CommunityBanks to increase
the spread between asset yields and funding sources.
13
COMMUNITY BANKS, INC. AND SUBSIDIARIES
PART I - Item 2. Management's Discussion and Analysis of Financial Condition
- --------------------------------------------------------------------------------
and Results of Operations (continued)
- -------------------------------------
RESULTS OF OPERATIONS
Six months ended June 30, 2004, compared to six months ended June 30, 2003
- --------------------------------------------------------------------------
Overview
Net income for the six months ended June 30, 2004, was $10.6 million compared to
$10.1 million in 2003, an increase of $.5 million or 5%. Diluted earnings per
share were $.84 for 2004 and $.81 for 2003, resulting in a return on average
assets of 1.11% for 2004 versus 1.17% for 2003. The return on average
stockholders' equity was 14.74% for 2004 compared to 15.21% for 2003, while the
return on average realized equity was 15.26% for 2004 and 16.18% for 2003.
Net Interest Income
The following table compares net interest income and net interest margin
components between the first six months of 2004 and 2003 (dollars in thousands):
Net Interest Margin - Year to Date
----------------------------------
(dollars in thousands) June 30, 2004 June 30, 2003
------------------------------------ --------------------------------------- ----------------------------------------
FTE Average FTE Average
Interest Rate Interest Rate
Average Income/ Earned/ Average Income/ Earned/
Balance Expense Paid Balance Expense Paid
------------------------------------ --------------------------------------- ----------------------------------------
Federal funds sold and interest- $ 9,179 $ 39 0.85% $ 1,036 $ 3 0.58%
bearing deposits in banks
Investment securities 686,825 17,966 5.26% 690,800 17,862 5.21%
Loans - commercial 398,176 11,098 5.61% 319,833 10,086 6.36%
- commercial real estate 292,703 8,783 6.03% 261,183 8,731 6.74%
- residential real estate 96,397 3,249 6.78% 105,847 4,019 7.66%
- consumer (1) 335,639 10,989 6.58% 264,149 9,900 7.56%
------------------------------------ --------------------------------------- ----------------------------------------
Total earning assets $1,818,919 $ 52,124 5.76% $1,642,848 $ 50,601 6.21%
------------------------------------ --------------------------------------- ----------------------------------------
Deposits - savings and NOW accounts $ 486,839 $ 2,016 0.83% $ 371,733 $ 1,562 0.85%
- time 625,433 9,117 2.93% 613,683 10,330 3.39%
Short-term borrowings 67,677 322 0.96% 110,751 764 1.39%
Long-term debt 388,952 9,009 4.66% 319,906 8,381 5.28%
Subordinated debt 30,928 755 4.91% 15,464 365 4.76%
------------------------------------ --------------------------------------- ----------------------------------------
Total interest-bearing liabilities $1,599,829 $ 21,219 2.67% $1,431,537 $ 21,402 3.01%
------------------------------------ --------------------------------------- ----------------------------------------
Interest income to earning assets 5.76% 6.21%
Interest expense to paying
liabilities 2.67% 3.01%
------------------------------------ --------------------------------------- ----------- ----------------------------
Interest spread 3.09% 3.20%
Impact of non-interest funds 0.33% 0.39%
------------------------------------ --------------------------------------- ----------------------------------------
Net interest margin $ 30,905 3.42% $ 29,199 3.59%
------------------------------------ --------------------------------------- ----------------------------------------
(1) Education loans held for sale are included in consumer loan earning
assets.
14
COMMUNITY BANKS, INC. AND SUBSIDIARIES
PART I - Item 2. Management's Discussion and Analysis of Financial Condition
- --------------------------------------------------------------------------------
and Results of Operations (continued)
- --------------------------------------
Interest Income /Earning Assets
Interest income totaled $52.1 million in 2004, slightly ahead of the $50.6
million recorded in 2003, despite an earning asset yield decline from 6.21% to
5.76%. Earning assets increased from $1.64 billion to $1.82 billion and helped
to offset the effect of lower earning asset yields. From 2003 to 2004, earning
assets grew $176 million, with an increase of $172 million in loans and a
decrease of $4 million in investment securities. Growth in loans was funded
principally by an increase in deposits.
Interest Expense / Funding Sources
Interest expense on deposits declined, contributing to the increase in net
interest income. The rate environment that generated modest improvement in
interest income also enabled Community to marginally reduce its overall funding
costs from $21.4 million in 2003 to $21.2 million in 2004 while interest-bearing
deposits grew by nearly $127 million. The majority of this increase occurred in
savings, Power Checking and other accounts that were responsive to customer
preferences for liquidity.
At various times during 2003, Community increased its long-term borrowings,
which are composed principally of term funding available through the Federal
Home Loan Bank program. Community experienced a 25% increase in long-term
funding, which included the $15 million in trust preferred instruments issued at
the end of 2003.
Interest Spread and Net Interest Margin
As a result of rate trends and other dynamics specific to its balance sheet,
Community reported a decline in net interest spread from 3.20% in 2003 to 3.09%
in 2004, and a decline in net interest margin from 3.59% to 3.42% over the same
period. The decline in margin was also linked to the impact of reduced
contribution from non-interest funding sources, which declined from 0.39% to
0.33%.
Provision for Loan Losses
The provision for loan losses increased from $1.0 million for the six months
ended June 30, 2003, to $1.6 million for 2004 while the relationship of the
allowance for loan losses to loans declined from 1.29% at June 30, 2003 to 1.23%
at June 30, 2004. The provision and the level of the allowance were responsive
to the changing credit quality conditions of both seasoned loans and the
incremental risk identified within a growing loan portfolio. Net charge-offs
during the first six months of 2004 were $.5 million, or 0.09% of average loans
annualized.
Non-Interest Income
Non-interest income totaled $11.8 million for the six months ended June 30,
2004, an increase of $2.4 million, or 25%, from $9.4 million reported for 2003.
Excluding investment securities gains, non-interest income increased $1.7
million, or 22%. The growth of non-interest income reflected important steps
undertaken in 2003 to solidify and expand Community's integrated businesses and
complementary banking services.
A substantial increase in fees occurred in the area of service charges on
deposits. Income was $3.1 million for 2004, an increase of 33% over 2003
results. In the first quarter of 2003, Community initiated a new service known
as "Overdraft Honor." Under this carefully designed program, customers who so
choose now have access to a service that facilitates payment of periodic
overdraft items while simultaneously avoiding adverse credit history events.
Fees from these services, which were not provided prior to 2003, coupled with
considerable growth in the number of new checking accounts, were responsible for
virtually all of the increase in this category.
15
COMMUNITY BANKS, INC. AND SUBSIDIARIES
PART I - Item 2. Management's Discussion and Analysis of Financial Condition
- --------------------------------------------------------------------------------
and Results of Operations (continued)
- --------------------------------------
Other service charges totaled $1.7 million for 2004, an increase of 10% from the
same period in 2003. Other service charges include interchange fees from
Community's ATM network and debit card transactions. Nearly all of the increase
in these sources of fee income resulted from increased usage and growing
consumer acceptance of electronic mediums as a substitute for cash or paper
check-based transactions.
Investment security gains were $2.2 million for 2004, compared to $1.5 million
for 2003. Improvements in the valuation of Community's bank equity portfolio
produced increased realized security gains.
Insurance premiums and commissions include agency-based commissions from
commercial and personal lines, fees from credit reinsurance activities related
to consumer lending, and the revenue from title insurance and settlement
activities conducted through Community's title insurance subsidiary. Income
reported for 2004 totaled $1.7 million, an increase of $400 thousand over the
$1.3 million reported for 2003. The increase was related to an overall increase
in mortgage loan originations, the addition of the ABCO franchise at the
beginning of the second quarter of 2003 and to the acquisitions of insurance
agencies later in 2003.
Mortgage banking income increased $600 thousand, or 67%, to $1.5 million for
2004. The increase is attributable to activity generated from the acquisition of
Erie Financial Group, Ltd., a mortgage broker service, in July, 2003. Community
has more than doubled its capacity to originate mortgages with the acquisition
of Erie and has become a more significant and efficient competitor in its core
and extended Maryland markets.
Non-Interest Expenses
Total non-interest expenses reached $24.9 million for the six months ended June
30, 2004, and reflected a 12% increase, or $2.7 million, from the $22.2 million
recorded in 2003. Comparisons between 2004 and 2003 were influenced by the
acquisitions of integrated businesses acquired in the second half of 2003, for
which a full six months of expenses were included in 2004. Comparisons to the
most recent prior quarter yielded only modest increases.
Salaries and employee benefits totaling $13.9 million for 2004, represented 56%
of operating costs, and increased $1.7 million, or 14%, compared to 2003. The
increase was affected by a number of factors, including: the annual merit
increase; employees added through the expansion of Community's office network
and its fee-based activities; and the acquisitions of Abstracting Company of
York County in April 2003, Erie Financial Group, Ltd., in July 2003, and Your
Insurance Partnership in September 2003.
Occupancy expenses were $4.0 million for 2004, an increase of $.5 million, or
14%, over 2003 and similarly includes the effect of branch expansion and
corporate acquisitions.
Marketing expenses increased $204 thousand, or 19%, to a total of $1.3 million
for 2004, versus 2003. During the first half of 2003, increased marketing and
promotional efforts had been undertaken to increase Community's market share in
new markets and to preserve and extend share in its legacy communities. Those
increased efforts have carried over to 2004 as Community continues to execute a
targeted strategic marketing campaign that includes radio, billboard, direct
mail, and television mediums.
Telecommunications expenses increased $134 thousand, or 25%, from 2003 to 2004,
for costs associated with upgrades of existing systems and increased costs for
the growing office network.
Income Taxes
Income tax expense for the six months ended June 30, 2004, totaled $2.4 million,
resulting in an effective tax rate of 18.2%, which was the same effective rate
for 2003. The relative mix of tax exempt income influences the effective income
tax rate and remains the primary reason for the difference between the effective
tax rate and the statutory federal tax rate for corporations.
16
COMMUNITY BANKS,
INC. AND SUBSIDIARIES
PART I - Item 2. Management's Discussion and Analysis of Financial Condition
- --------------------------------------------------------------------------------
and Results of Operations (continued)
- --------------------------------------
RESULTS OF OPERATIONS
- ---------------------
Quarter ended June 30, 2004, compared to quarter ended June 30, 2003
- --------------------------------------------------------------------
Overview
Net income for the second quarter of 2004 increased $461,000, or 9%, in
comparison to net income for the second quarter of 2003. Diluted earnings per
share increased $.03, or 8%, to $.43 for 2004, from $.40 for 2003. Net income of
$5.4 million for 2004 resulted in an annualized return on average assets of
1.11% and an annualized return on average stockholders' equity of 15.37%.
Net Interest Income
Net Interest Margin - Quarter to Date
-------------------------------------
(dollars in thousands) June 30, 2004 June 30, 2003
------------------------------------ --------------------------------------- ---------------------------------------
FTE Average FTE Average
Interest Rate Interest Rate
Average Income/ Earned/ Average Income/ Earned/
Balance Expense Paid Balance Expense Paid
------------------------------------ --------------------------------------- ---------------------------------------
Federal funds sold and interest- $ 11,960 $ 26 0.87% $ 914 $ 1 0.44%
bearing deposits in banks
Investment securities 701,904 9,268 5.31% 695,395 8,763 5.05%
Loans - commercial 402,566 5,516 5.51% 334,026 5,137 6.17%
- commercial real estate 302,104 4,574 6.09% 271,094 4,422 6.54%
- residential real estate 95,009 1,574 6.66% 103,291 1,943 7.55%
- consumer (1) 340,942 5,563 6.56% 274,439 5,046 7.37%
------------------------------------ --------------------------------------- ---------------------------------------
Total earning assets $1,854,485 $ 26,521 5.75% $1,679,159 $ 25,312 6.05%
------------------------------------ --------------------------------------- ---------------------------------------
Deposits - savings and NOW accounts $ 516,409 $ 1,127 0.88% $ 386,797 $ 807 0.84%
- time 629,837 4,548 2.90% 614,035 5,067 3.31%
Short-term borrowings 83,333 198 0.96% 125,384 430 1.38%
Long-term debt 367,757 4,428 4.84% 319,550 4,214 5.29%
Subordinated debt 30,928 377 4.90% 15,464 181 4.49%
------------------------------------ --------------------------------------- ---------------------------------------
Total interest-bearing liabilities $1,628,264 $ 10,678 2.64% $1,461,230 $ 10,699 2.94%
------------------------------------ --------------------------------------- ---------------------------------------
Interest income to earning assets 5.75% 6.05%
Interest expense to paying
liabilities 2.64% 2.94%
------------------------------------ --------------------------------------- ---------------------------------------
Interest spread 3.11% 3.11%
Impact of non-interest funds 0.33% 0.38%
------------------------------------ --------------------------------------- ---------------------------------------
Net interest margin $ 15,843 3.44% $ 14,613 3.49%
------------------------------------ --------------------------------------- ---------------------------------------
(1) Education loans held for sale are included in consumer loan earning
assets.
Interest income increased from the $25.3 million recorded in 2003 to $26.5
million in 2004, with an increase in earning assets from $1.68 billion to $1.85
billion offset by a decline in earning asset yields from 6.05% to 5.75%. Loans
grew $158 million and were principally funded by a $145 million increase in
deposits.
Interest expense on deposits remained steady, with an increase in
interest-bearing liabilities offset by a decrease in rates from 2.94% to 2.64%.
17
COMMUNITY BANKS, INC. AND SUBSIDIARIES
PART I - Item 2. Management's Discussion and Analysis of Financial Condition
- --------------------------------------------------------------------------------
and Results of Operations (continued)
- -------------------------------------
Net interest spread was 3.11% for each quarter, with a reduced contribution from
non-interest funding sources resulting in a decrease in net interest margin from
3.49% in 2003 to 3.44% in 2004.
Provision for Loan Losses
The provision for loan losses increased from $600 thousand for the quarter ended
June 30, 2003, to $750 thousand for 2004 based on management's quarterly review
of the loan portfolio and its assessment of loan quality; identification of
impaired loans; analysis of delinquencies and loan growth; evaluation of
potential charge-offs and recoveries; and assessment of general economic
conditions.
Non-Interest Income
Non-interest income increased from $5.0 million for the quarter ended June 30,
2003, to $6.2 million for the quarter ended June 30, 2004. Excluding investment
securities gains, non-interest income increased $801 thousand, or 18%. Factors
contributing to changes between 2003 and 2004 are substantially the same as
those discussed above in the comparison of year-to-date results.
Investment management and trust services income totaled $409 thousand, an
increase of $76 thousand, or 23%, over 2003, reflecting a general increase in
income related to Community's limited trust department activities as well as
from the sale of additional investment products.
Income from service charges on deposit accounts increased 32%, from $1.3 million
in 2003 to $1.7 million in 2004, reflecting primarily the "Overdraft Honor"
service started in the first quarter of 2003.
Investment security gains were $844 thousand for 2004, compared to $500 thousand
for 2003. The gains recorded in 2004 were principally related to sales of bank
equity holdings.
Insurance premiums and commissions income reported for 2004 totaled $1.0
million, an increase of $177 thousand over 2003. Income from insurance agencies
acquired after the second quarter of 2003 contributed to the increase.
Mortgage banking income increased $383 thousand, or 86%, to $828 thousand for
2004. The increase is attributable to activity generated from the acquisition of
Erie Financial Group, LTD, in July, 2003.
Non-Interest Expenses
Non-interest expenses totaled $13.0 million for the quarter ended June 30, 2004,
and reflected a 14% increase, or $1.6 million, from the $11.4 million recorded
in 2003. Factors contributing to changes between 2004 and 2003 are substantially
the same as those discussed above in the comparison of year-to-date results,
including the influence of integrated businesses acquired in the second half of
2003, for which a full six months of expenses was included in 2004.
Salaries and employee benefits totaling $7.0 million for 2004, represented 54%
of operating costs, and increased $765 thousand, or 12%, compared to 2003.
Occupancy expenses were $2.0 million for 2004, an increase of $217 thousand, or
12%, over 2003.
Marketing expenses increased $298 thousand, or 52%, to a total of $869 thousand
for 2004 versus 2003, for continued expansion of marketing and promotional
efforts.
Other non-interest expenses increased $276 thousand, or 11%, to $2.7 million for
2004 compared to 2003.
18
COMMUNITY BANKS, INC. AND SUBSIDIARIES
PART I - Item 2. Management's Discussion and Analysis of Financial Condition
- --------------------------------------------------------------------------------
and Results of Operations (continued)
- -------------------------------------
Income Taxes
Income tax expense for the quarter ended June 30, 2004, totaled $1.2 million,
resulting in an effective tax rate of 18.2%, which was similar to the effective
rate of 17.7% for 2003. The relative mix of tax exempt income influences the
effective income tax rate.
FINANCIAL CONDITION
- -------------------
The average balance sheets for the six months ended June 30, 2004 and 2003 were
as follows (dollars in thousands):
June 30, Change
--------------------------------- --------------------------
2004 2003 Volume %
------------------------------------------------------------------------------------------------------------
Cash and due from banks $ 35,215 $ 35,187 $ 28 ---
Federal funds sold and other 9,179 1,036 8,143 786
Investments 686,825 690,800 (3,975) 1
Loans held for sale 4,151 8,335 (4,184) (50)
Loans 1,119,358 947,413 171,945 18
Allowance for loan losses 13,828 12,750 1,078 8
------------------------------------------------------------------------------------------------------------
Net loans 1,105,530 934,663 170,867 18
Goodwill and identifiable intangibles 4,800 1,953 2,847 146
Other assets 83,627 69,629 13,998 20
------------------------------------------------------------------------------------------------------------
Total assets $ 1,929,327 $ 1,741,603 $ 187,724 11
============================================================================================================
Noninterest-bearing deposits $ 170,700 $ 163,674 $ 7,026 4
Interest-bearing deposits 1,112,272 985,416 126,856 13
Short-term borrowings 67,677 110,751 (43,074) (39)
Long-term debt 388,952 319,906 69,046 22
Subordinated debt 30,928 15,464 15,464 100
Other liabilities 13,980 12,747 1,233 10
------------------------------------------------------------------------------------------------------------
Total liabilities 1,784,509 1,607,958 176,551 11
------------------------------------------------------------------------------------------------------------
Stockholders' equity 144,818 133,645 11,173 8
------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders'
equity $ 1,929,327 $ 1,741,603 $ 187,724 11
============================================================================================================
Average loans reached $1.1 billion at June 30, 2004, an 18 % increase over the
$947 million of average loans recorded at June 30, 2003. The following
presentation of average loans at June 30 is an indication of the relative mix of
loans included in the portfolio (dollars in thousands):
Change
2004 2003 Amount %
--------------------------------------------------------------------------------------------------
--------------------------------------------------------------------------------------------------
Commercial $ 398,176 $ 319,833 $ 78,343 25%
Commercial real estate 292,703 261,183 31,520 12%
Residential real estate 96,397 105,847 (9,450) (9)%
Consumer 332,082 260,550 71,532 27%
--------------------------------------------------------------------------------------------------
--------------------------------------------------------------------------------------------------
Total $ 1,119,358 $ 947,413 $ 171,945 18%
==================================================================================================
19
COMMUNITY BANKS, INC. AND SUBSIDIARIES
PART I - Item 2. Management's Discussion and Analysis of Financial Condition
- --------------------------------------------------------------------------------
and Results of Operations (continued)
- --------------------------------------
Commercial borrowing began to increase during the second quarter of 2003,
leveled off in the fourth quarter, then resumed in the first and second quarter
of 2004. After the end of the first quarter of 2003, declines in interest rate
trends caused many borrowers to reevaluate their existing credit arrangements in
search of improved funding terms and more responsive credit relationships.
Community has consistently made efforts to position itself in the marketplace to
ensure its ability to compete with large and small competitors alike. As a
result, Community was able to increase both its commercial and commercial real
estate portfolios by nearly $110 million on an aggregate basis. Much of the
growth in the commercial sector was attributed to Community's ability to acquire
existing market share since business lending has been constrained on both a
national level and in certain segments of Community's market. A portion of this
growth also can be attributed to the addition of certain key lending personnel
made available as a result of mergers of local financial institutions by
out-of-market acquirers.
Significant growth also occurred in consumer lending, which grew by $72 million
between June 30, 2003, and June 30, 2004, particularly in home equity lending.
As part of Community's effort to increase its visibility in core markets, a
concerted effort was made to become a more effective consumer lender, including
substantial increases in marketing and advertising efforts. Consumer demand for
credit was aided by the high levels of consumer confidence and improved credit
affordability experienced in the current interest rate environment. These
efforts were also aided by the growth achieved as a result of the expansion of
the office network and sales efforts over the last several years.
Residential real estate lending, which is composed primarily of loans to
single-family creditors, has experienced a steady decline as a result of the
increasing accessibility of secondary market liquidity through mortgage banking
activities. Community-based banks continue to provide a convenient avenue for
consumers to access funding for residential lending, but most fixed-rate credits
continue to be sold in the secondary market. This strategy has reduced the
interest rate risk associated with consumer preferences for long-term, fixed
rate lending, and continues to provide valuable liquidity for other forms of
relationship lending.
Deposit balances remain the primary source of funding. Growth of nearly 12% was
recognized, as indicated by the following summary of average balances at June 30
(dollars in thousands):
Change
2004 2003 Amount %
-------------------------------------------------------------------------------------------
Demand $ 170,700 $ 163,674 $ 7,026 4%
Savings & NOW accounts 486,839 371,733 115,106 31%
Time 506,177 501,335 4,842 1%
Time $100,000 or more 119,256 112,348 6,908 6%
-------------------------------------------------------------------------------------------
$ 1,282,972 $ 1,149,090 $ 133,882 12%
===========================================================================================
Deposit growth occurred primarily in savings and NOW deposits; more specifically
Community's Power Checking account. This account, with characteristics of both a
money market and checking account, grew steadily throughout 2003 and 2004. At
the same time, longer term time deposit growth was relatively flat. Consumer
preferences were clearly weighted in favor of maintaining adequate liquidity in
anticipation of a gradual rise in rates. Downward pressure on rates, combined
with lack of confidence in other more risky investment vehicles, increased
consumer preference for the flexibility, liquidity and guaranteed return
provided by these accounts.
Beginning in the latter part of 2003, Community extended the maturities of
overnight borrowings through the Federal Home Loan Bank to take advantage of
lower long-term rates on longer borrowings.
20
COMMUNITY BANKS, INC. AND SUBSIDIARIES
PART I - Item 2. Management's Discussion and Analysis of Financial Condition
- --------------------------------------------------------------------------------
and Results of Operations (continued)
- -------------------------------------
Capital
Capital strength is 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.
Regulators have established standards for the monitoring and maintenance of
appropriate levels of capital for financial institutions. All regulatory capital
guidelines are now based upon a risk-based supervisory approach that has been
designed to ensure effective management of capital levels and associated
business risk. Such regulatory guidelines are continually under review and are
expected to undergo some change as a result of the Basel II capital accords
which are currently under review by U.S. banking regulators. The following table
provides the risk-based capital positions of Community and its banking
subsidiary, Community Banks, at June 30, 2004, along with a comparison to the
various current regulatory capital requirements:
June 30, Regulatory "Well
2004 Minimum Capitalized"
---------------------------------------------
Leverage ratio
Community Banks, Inc. 8.41% 4% n/a
Community Banks 7.59% 4% 5%
Tier 1 capital ratio
Community Banks, Inc. 11.22% 4% n/a
Community Banks 10.12% 4% 6%
Total risk-based capital ratio
Community Banks, Inc. 12.20% 8% n/a
Community Banks 11.10% 8% 10%
At June 30, 2004, total stockholders' equity reflected accumulated other
comprehensive loss of $5.6 million compared to accumulated other comprehensive
income of $6.6 million at December 31, 2003. This decrease can be attributed to
the change in the net unrealized gain(loss) on investment securities available
for sale, net of taxes, and is considered a temporary impairment due to the
influence of increasing interest rates.
Off-Balance-Sheet Commitments
Financial instruments with off-balance-sheet risk at June 30, 2004, are as
follows (in thousands):
Contract Amount
---------------
Commitments to fund loans $ 118,469
Unused lines of credit $ 311,497
Standby letters of credit $ 35,960
Unadvanced portions of construction loans $ 38,435
21
COMMUNITY BANKS, INC. AND SUBSIDIARIES
PART I - Item 3. Quantitative and Qualitative Disclosures About Market Risk
- -------------------------------------------------------------------------------
Market risk is defined as the exposure to economic loss that arises from changes
in the values of certain financial instruments pursuant to factors arising out
of the various categories of market risk. Market risk can include a number of
categories, including interest rate risk, foreign currency risk, exchange rate
risk, commodity price risk, etc. For domestic, community-based banks, the vast
majority of market risk is related to interest rate risk.
The following table provides a measure of interest rate sensitivity for each
category of interest earning assets and interest bearing liabilities at June 30,
2004.
Interest Rate Sensitivity
-----------------------------------------------------------------------------------------------------------
1-90 90-180 180-365 1 year or
Dollars in thousands days days days more Total
-----------------------------------------------------------------------------------------------------------
Assets
Interest-bearing deposits in
other banks $ 2,803 $ --- $ --- $ --- $ 2,803
Loans held for sale(1) --- --- --- 235 235
Investment securities 117,662 44,014 55,041 462,138 678,856
Loans(2) 420,106 69,170 102,159 569,934 1,161,368
-----------------------------------------------------------------------------------------------------------
Earning assets 540,571 113,184 157,200 1,032,307 1,843,262
Non-earning assets 412 --- --- 117,387 117,799
-----------------------------------------------------------------------------------------------------------
Total assets $ 540,983 $ 113,184 $ 157,200 $ 1,149,694 $ 1,961,061
-----------------------------------------------------------------------------------------------------------
Liabilities
Savings $ 255,819 $ --- $ --- $ 243,825 $ 499,644
Time 107,281 79,484 100,474 222,858 510,097
Time in denominations of
$100,000 or more 28,289 15,374 20,605 39,247 103,515
Short-term borrowings 110,475 --- --- --- 110,475
Long-term debt 1,797 1,797 13,595 355,877 373,066
Subordinated debt 23,196 --- --- 7,732 30,928
-----------------------------------------------------------------------------------------------------------
Interest bearing liabilities 526,857 96,655 134,674 869,539 1,627,725
Other liabilities and equity --- --- --- 333,336 333,336
-----------------------------------------------------------------------------------------------------------
Total liabilities and equity $ 526,857 $ 96,655 $ 134,674 $ 1,202,875 $ 1,961,061
-----------------------------------------------------------------------------------------------------------
(1) Only education loans held for sale are included in earning assets. (2)
Includes non-accrual loans.
Interest Sensitivity GAP
---------------------------------------------------------------------------------------------------------
1 year or
Dollars in thousands 1-90 days 90-180 days 180-365 days more
---------------------------------------------------------------------------------------------------------
Periodic $ 14,126 $ 16,529 $ 22,526 $ (53,181)
Cumulative 14,126 30,655 53,181 ---
Cumulative GAP as a percentage
of total assets .72% 1.56% 2.71% 0.00%
The positive GAP between interest-earning assets and interest-bearing
liabilities maturing or repricing within one year approximated 2.71% at June 30,
2004 and has increased modestly from 1.7% since December 31, 2003.
22
COMMUNITY BANKS, INC. AND SUBSIDIARIES
PART I - Item 4. Controls and Procedures
- -----------------------------------------
Under the supervision and with the participation of Community's management,
including its Chief Executive Officer and Chief Financial Officer, Community has
evaluated the effectiveness of its disclosure controls and procedures as of June
30, 2004. Based upon this evaluation, the Chief Executive Officer and Chief
Financial Officer have concluded that Community's disclosure controls and
procedures are adequate and effective to ensure that material information
relating to Community and its consolidated subsidiaries is made known to them by
others within those entities, particularly during the period in which this
quarterly report was prepared. There have not been any changes in Community's
internal control over financial reporting (as such term is defined in Rules
13a-15(f) and 15d-15(f) under the Exchange Act) during the most recent fiscal
quarter that have materially affected, or are reasonably likely to materially
affect, Community's internal control over financial reporting.
23
COMMUNITY BANKS, INC. AND SUBSIDIARIES
PART II - OTHER INFORMATION
Item 1 - Legal Proceedings
- --------------------------
The nature of Community's business generates a certain amount of litigation
involving matters arising out of the ordinary course of business. In the opinion
of management, there are no legal proceedings that might have a material effect
on the results of operations, liquidity, or the financial position of Community
at this time.
Item 2 - Changes in Securities, Use of Proceeds and Issuer Purchases of Equity
- --------------------------------------------------------------------------------
Securities
- ----------
The following shares were purchased during the quarter as part of
Community's Share Repurchase Program:
Average Price Shares Purchased Capacity to
Shares Paid as part of Purchase
Purchased Per Share Repurchase Program More Shares
---------------------------------------------------------------------------------
04/1/04-04/30/04 13,000 $30.27 13,000 194,334
05/1/04-05/31/04 45,400 $29.78 45,400 148,934
06/1/04-06/30/04 19,000 $28.61 19,000 129,934
Item 3 - Defaults Upon Senior Securities
- ----------------------------------------
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 4, 2004, for the purpose of considering and voting upon the
following matter:
To elect four (4) directors: Ronald E. Boyer, Peter DeSoto, Thomas L.
Miller, and James A. Ulsh, to serve until the 2008 annual meeting of
shareholders. Each director received affirmative votes representing at
least 69.7% of the shares outstanding.
Item 5 - Other Information
- --------------------------
Not applicable.
24
COMMUNITY BANKS, INC. AND SUBSIDIARIES
PART II - Other Information (continued)
- ---------------------------------------
Item 6 - Exhibits and Reports on Form 8-K
- -----------------------------------------
(a) Exhibits
---------------------
3.1 Amended Articles of Incorporation (Incorporated by reference
to Exhibit 3.1, attached to Community's registration on Form
8-A, filed on May 13, 2002)
3.2 Amended By-Laws (Incorporated by reference to Exhibit 3.2,
attached to Community's Quarterly Report on Form 10-Q for
the quarter ended March 31, 2003, filed with the Commission
on May 15, 2003)
4 Instruments defining the rights of the holders of trust
capital securities sold by Community in December 2002 and in
December 2003 are not attached, as the amount of such
securities is less than 10% of the consolidated assets of
Community and its subsidiaries, and the securities have not
been registered. Community agrees to provide copies of such
instruments to the SEC upon request.
31.1 Rule 13a-14(a)/15d-14(a) Certification (Chief Executive Officer)
31.2 Rule 13a-14(a)/15d-14(a) Certification (Chief Financial Officer)
32.1 Section 1350 Certification (Chief Executive Officer)
32.2 Section 1350 Certification (Chief Financial Officer)
(b) Reports on Form 8-K
- --------------------------
Registrant filed the following reports on Form 8-K during the quarter
ended June 30, 2004:
Report Dated April 19, 2004
---------------------------
Registrant announced its earnings for the period ended March 31, 2004.
Report Dated May 5, 2004
------------------------
Registrant announced the declaration of a second quarter cash dividend
payable July 1, 2004.
Report Dated May 5, 2004
------------------------
Registrant announced that its annual shareholders' meeting was held on
May 4, 2004. The presentation was included by exhibit.
25
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 9, 2004 /s/ Eddie L. Dunklebarger
----------------------------------------------- ----------------------------------------------
Eddie L. Dunklebarger
Chairman and President
(Chief Executive Officer)
Date August 9, 2004 /s/ Donald F. Holt
----------------------------------------------- ----------------------------------------------
Donald F. Holt
Executive Vice President
(Chief Financial Officer)
26