EXHIBIT 13
EXCERPTS FROM THE 2002 ANNUAL REPORT TO STOCKHOLDERS
25
Selected Financial Data
2002 2001 2000 1999 1998
- ------------------------------------------------------------------------------------------------------------------------
SUMMARY OF OPERATIONS
(in thousands)
Total interest income $ 20,674 $ 22,602 $ 21,904 $ 20,314 $ 19,978
Total interest expense 8,907 10,871 11,064 9,534 9,265
- ------------------------------------------------------------------------------------------------------------------------
Net interest income 11,767 11,731 10,840 10,780 10,713
Provision for loan losses 515 143 119 225 375
Noninterest income 3,534 2,496 2,164 2,110 1,779
Noninterest expense 11,008 10,298 9,124 8,927 8,393
- ------------------------------------------------------------------------------------------------------------------------
Income before income taxes 3,778 3,786 3,761 3,738 3,724
Provision for income taxes 677 932 1,054 1,074 1,188
- ------------------------------------------------------------------------------------------------------------------------
Net income $ 3,101 $ 2,854 $ 2,707 $ 2,664 $ 2,536
========================================================================================================================
RATIOS
(in percentages)
Return on average stockholders' equity 10.1% 10.0% 10.3% 10.2% 10.0%
Return on average assets 0.91 0.91 0.94 0.95 0.98
Tier I risk-based capital 11.3 10.9 11.3 11.2 12.4
Total risk-based capital 11.9 11.6 12.1 12.1 13.3
Average stockholders' equity to average assets 9.0 9.1 9.1 9.3 9.8
PER COMMON SHARE
(adjusted for stock dividends)
Net income, basic and diluted $ 1.15 $ 1.06 $ 1.02 $ 0.99 $ 0.93
Cash dividends paid $ 0.47 $ 0.45 $ 0.41 $ 0.36 $ 0.33
Stock dividend paid 5% 5% 5% 5% 5%
Stock split effected as stock dividend paid -- -- -- -- 100%
Book value $ 11.95 $ 10.90 $ 10.18 $ 9.62 $ 9.62
Cash dividend payout ratio 40.7% 42.1% 40.7% 38.0% 36.4%
Weighted average shares outstanding 2,693,361 2,691,242 2,666,615 2,691,119 2,706,663
SUMMARY OF FINANCIAL CONDITION AT YEAR-END
(in thousands)
Securities, available-for-sale $ 70,366 $ 38,362 $ 40,572 $ 46,268 $ 56,225
Securities, held-to-maturity 9,357 9,358 9,360 9,361 0
Loans held for sale 4,586 12,349 0 0 0
Loans 233,960 225,785 217,926 207,318 189,111
Assets 349,897 330,455 295,092 291,156 273,082
Deposits 292,627 276,945 247,414 238,458 241,913
Borrowings 23,253 19,573 19,034 25,999 3,805
Equity 32,223 29,368 27,391 25,372 26,058
OTHER DATA
Number of bank offices 11 10 8 8 8
Number of employees (full-time equivalent) 163 152 136 131 130
Trust and investment services
(in thousands)
Assets under management (market value) $ 80,780 $ 78,203 $ 79,850 $ 76,838 $ 70,825
Fee income 758 678 670 542 549
========================================================================================================================
1
Consolidated Statements of Financial Condition
DECEMBER 31,
(dollars in thousands, except per share data) 2002 2001
- ----------------------------------------------------------------------------------------
ASSETS
Interest bearing deposits with banks $ 242 $ 388
Cash and due from banks 10,878 9,722
Federal funds sold 0 14,925
- ----------------------------------------------------------------------------------------
Total cash and cash equivalents 11,120 25,035
Securities, available-for-sale 70,366 38,362
Securities, held-to-maturity (fair value $9,539 for 2002
and $9,216 for 2001) 9,357 9,358
Loans held for sale 4,586 12,349
Loans (net of deferred fees of $645 in 2002 and $691 in 2001) 233,960 225,785
Less-allowance for loan losses (1,515) (1,898)
- ----------------------------------------------------------------------------------------
Net loans 232,445 223,887
Premises and equipment 9,335 9,449
Other assets 12,688 12,015
- ----------------------------------------------------------------------------------------
Total assets $ 349,897 $ 330,455
========================================================================================
LIABILITIES
Deposits
Noninterest bearing $ 30,120 $ 26,093
Interest bearing 262,507 250,852
- ----------------------------------------------------------------------------------------
Total deposits 292,627 276,945
Short-term borrowings 7,089 0
Long-term debt 16,164 19,573
Other liabilities 1,794 4,569
- ----------------------------------------------------------------------------------------
Total liabilities 317,674 301,087
STOCKHOLDERS' EQUITY
Preferred stock, par value $2.50 per share;
1,000,000 shares authorized; 0 shares issued and outstanding 0 0
Common stock, par value $2.50 per share;
10,000,000 shares authorized; 2,697,035 shares issued
for 2002 and 2,564,261 for 2001 6,743 6,411
Additional paid-in capital 15,549 14,004
Retained earnings 8,551 8,526
Accumulated other comprehensive income 1,380 427
- ----------------------------------------------------------------------------------------
Total stockholders' equity 32,223 29,368
- ----------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $ 349,897 $ 330,455
========================================================================================
See accompanying notes.
2
Consolidated Statements of Income
YEARS ENDED DECEMBER 31,
(dollars in thousands, except per share data) 2002 2001 2000
- ----------------------------------------------------------------------------------------------
INTEREST INCOME
Loans, including fees $17,231 $19,013 $18,342
Investment securities
Taxable 2,655 2,348 2,683
Tax-exempt 522 546 473
Dividends 37 120 227
Other 229 575 179
- ----------------------------------------------------------------------------------------------
Total interest income 20,674 22,602 21,904
INTEREST EXPENSE
Deposits 7,698 9,704 9,762
Federal funds purchased and other
short-term borrowings 10 7 607
Long-term debt 1,199 1,160 695
- ----------------------------------------------------------------------------------------------
Total interest expense 8,907 10,871 11,064
- ----------------------------------------------------------------------------------------------
Net interest income 11,767 11,731 10,840
PROVISION FOR LOAN LOSSES 515 143 119
- ----------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 11,252 11,588 10,721
NONINTEREST INCOME
Trust and investment services fees 758 678 670
Service charges on deposit accounts 792 705 662
Income from bank owned life insurance 325 294 272
Other income 708 660 531
Gain on sale of securities 179 0 29
Gain on mortgages, net of unrealized losses 772 159 0
- ----------------------------------------------------------------------------------------------
Total noninterest income 3,534 2,496 2,164
NONINTEREST EXPENSE
Salaries and benefits 6,005 5,281 4,824
Occupancy of premises, net 808 832 624
Furniture and equipment 1,072 1,083 1,035
Postage, stationery and supplies 410 395 340
Professional and legal 226 306 191
Marketing and advertising 432 414 369
Foreclosed real estate, net 71 239 139
Other 1,984 1,748 1,602
- ----------------------------------------------------------------------------------------------
Total noninterest expense 11,008 10,298 9,124
- ----------------------------------------------------------------------------------------------
Income before income taxes 3,778 3,786 3,761
PROVISION FOR INCOME TAXES 677 932 1,054
- ----------------------------------------------------------------------------------------------
Net income $ 3,101 $ 2,854 $ 2,707
==============================================================================================
Net income per share, basic and diluted $ 1.15 $ 1.06 $ 1.02
==============================================================================================
See accompanying notes.
3
Consolidated Statements of Cash Flows
YEARS ENDED DECEMBER 31,
(dollars in thousands) 2002 2001 2000
- ----------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 3,101 $ 2,854 $ 2,707
Adjustments to reconcile net income to cash provided by operations:
Depreciation 958 945 908
Provision for loan losses 515 143 119
Provision for losses on foreclosed real estate 30 62 56
Deferred federal income tax benefit (614) (8) (21)
Amortization of investment in real estate partnership 777 0 0
Increase in cash surrender value of life insurance investment (325) (294) (272)
Originations of held for sale mortgages (54,488) (21,510) 0
Proceeds from sales of held for sale mortgages 63,023 9,320 0
Gain on sales of held for sale mortgages (772) (218) 0
Unrealized loss on held for sale mortgages 0 59 0
Gain on sales of securities (179) 0 (29)
Gain on sales of foreclosed real estate (58) (89) (71)
(Increase) decrease in accrued interest receivable (116) 176 (164)
(Increase) decrease in other assets (552) (183) 143
Decrease in accrued interest payable (163) (101) (59)
Increase (decrease) in other liabilities 200 322 (15)
Other, net 684 194 (118)
- ----------------------------------------------------------------------------------------------------------
Net cash provided by (used in) operating activities 12,021 (8,328) 3,184
CASH FLOWS FROM INVESTING ACTIVITIES
Securities, available-for-sale:
Purchases (69,094) (14,606) (10,059)
Maturities and calls 23,704 17,255 15,789
Sales 14,544 0 983
Net increase in loans made to customers (9,615) (9,285) (12,425)
Purchases of premises and equipment (899) (746) (398)
Investment in real estate partnership (2,982) 0 0
Investment in life insurance (306) 0 0
Purchase of assets of insurance agency (125) 0 0
Proceeds from sales of foreclosed real estate 674 2,765 816
- ----------------------------------------------------------------------------------------------------------
Net cash used in investing activities (44,099) (4,617) (5,294)
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in demand and savings deposits 20,671 11,675 12,327
Net (decrease) increase in time deposits (4,989) 17,856 (3,371)
Net increase (decrease) in short-term borrowings 7,089 0 (15,657)
Proceeds from issuance of long-term debt 0 2,000 9,000
Repayment of long-term debt (3,409) (2,110) (308)
Dividends paid (1,262) (1,201) (1,102)
Issuance of common stock 67 27 0
Purchases of treasury stock 0 0 (231)
Cash paid in lieu of fractional shares (4) (4) (4)
- ----------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 18,163 28,243 654
- ----------------------------------------------------------------------------------------------------------
Net (decrease) increase in cash and cash equivalents (13,915) 15,298 (1,456)
Cash and cash equivalents at beginning of year 25,035 9,737 11,193
- ----------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 11,120 $ 25,035 $ 9,737
==========================================================================================================
SUPPLEMENTAL DISCLOSURES
Interest paid on deposits and borrowed funds $ 9,070 $ 10,952 $ 11,168
Income taxes paid $ 725 $ 1,099 $ 1,032
See accompanying notes.
4
Consolidated Statements of Changes in Stockholders' Equity
ACCUMULATED
ADDITIONAL OTHER
COMMON PAID-IN RETAINED COMPREHENSIVE TREASURY
(dollars in thousands, except per share data) STOCK CAPITAL EARNINGS INCOME (LOSS) STOCK TOTAL
- -----------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1999 $ 6,019 $ 11,978 $ 9,050 $ (523) $ (1,152) $ 25,372
Comprehensive income:
Net income 2,707 2,707
Other comprehensive income, net of tax:
Unrealized gains on securities net of reclassification
adjustment for gains included in net income 649 649
---
Total comprehensive income 3,356
Cash dividends ($.41 per share) (1,102) (1,102)
5% stock dividend - 116,640 shares at fair value 118 469 (1,811) 1,220 (4)
Purchase of treasury stock (19,400 shares) (231) (231)
- -----------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2000 6,137 12,447 8,844 126 (163) 27,391
Comprehensive income:
Net income 2,854 2,854
Other comprehensive income, net of tax:
Unrealized gains on securities 301 301
---
Total comprehensive income 3,155
Cash dividends ($.45 per share) (1,201) (1,201)
5% stock dividend - 121,738 shares at fair value 268 1,535 (1,970) 163 (4)
Issuance of common stock under stock option plan 6 22 (1) 27
- -----------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2001 6,411 14,004 8,526 427 0 29,368
Comprehensive income:
Net income 3,101 3,101
Other comprehensive income, net of tax:
Unrealized gains on securities net of reclassification
adjustment for gains included in net income 953 953
---
Total comprehensive income 4,054
Cash dividends ($.47 per share) (1,262) (1,262)
5% stock dividend - 127,927 shares at fair value 320 1,490 (1,814) (4)
Issuance of common stock under dividend reinvestment plan 6 33 39
Issuance of common stock under stock option plan 6 22 28
- -----------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2002 $ 6,743 $ 15,549 $ 8,551 $ 1,380 $ 0 $ 32,223
===================================================================================================================================
See accompanying notes.
5
Notes to Consolidated Financial Statements
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS AND BASIS OF PRESENTATION
Codorus Valley Bancorp, Inc. (Corporation or Codorus Valley) is a one-bank
holding company headquartered in York, Pennsylvania that provides a full range
of banking services through its subsidiary, PeoplesBank, A Codorus Valley
Company (PeoplesBank). PeoplesBank operates two wholly owned subsidiaries, SYC
Insurance Services, Inc. which sells nondeposit investment products and SYC
Settlement Services, Inc. which provides real estate settlement services.
PeoplesBank operates under a state charter subject to regulation by the
Pennsylvania Department of Banking and by the Federal Deposit Insurance
Corporation.
The consolidated financial statements include the accounts of Codorus Valley and
its wholly owned bank subsidiary, PeoplesBank, and its wholly owned nonbank
subsidiary, SYC Realty Company, Inc. All significant intercompany account
balances and transactions have been eliminated in consolidation. The accounting
and reporting policies of Codorus Valley and subsidiaries conform to accounting
principles generally accepted in the United States of America and have been
followed on a consistent basis.
INVESTMENT SECURITIES
The classification of securities is determined at the time of acquisition and is
reevaluated at each reporting date. Securities classified as available-for-sale
are debt securities that the Corporation intends to hold for an indefinite
period of time, but not necessarily to maturity, and all equity securities. Any
decision to sell a security classified as available-for-sale would be based on
various factors, including significant movements in interest rates, changes in
maturity mix of assets and liabilities, liquidity needs, regulatory
considerations and other factors. Securities available-for-sale are carried at
fair value, with unrealized gains and losses, net of taxes, reported as a
component of accumulated other comprehensive income in stockholders' equity.
Premiums and discounts are recognized in interest income using the interest
method over the estimated life of the securities. Realized gains and losses from
the sale of available-for-sale securities are computed on the basis of specific
identification of the adjusted cost of each security and are shown net as a
separate line item in the statement of income. Federal law requires a member
institution of the Federal Home Loan Bank to hold stock of its district FHLB
according to a predetermined formula. The stock is carried at cost.
Securities classified as held-to-maturity are those debt securities that the
Corporation has both the intent and ability to hold to maturity regardless of
changes in market conditions, liquidity needs or general economic conditions.
These securities are carried at cost adjusted for amortization of premium and
accretion of discount, computed by the interest method over the estimated life
of the securities.
LOANS
Loans receivable that management has the intent and ability to hold for the
foreseeable future or until maturity or payoff are stated at their outstanding
unpaid principal balances, net of any deferred fees and costs. Interest income
is accrued on the unpaid principal balance. Loan origination fees and costs are
generally deferred and recognized as adjustments of interest rate yields, by
being amortized to interest income over the terms of the related loans. When
circumstances indicate that collection of a loan is doubtful, the accrual of
interest income is discontinued, and unpaid interest previously credited to
income is reversed and charged against current income. Loans are returned to
accrual status when management determines that circumstances have improved to
the extent that both principal and interest are deemed collectible. In those
cases where collection of principal is in doubt, additions are made to the
allowance for loan losses.
LOANS HELD FOR SALE
Loans held for sale are reported at the lower of cost or fair value, as
determined in the aggregate. The amount, by which cost exceeds fair value, if
any, is accounted for as a valuation allowance and is charged to expense in the
period of the change.
MORTGAGE SERVICING RIGHTS
An asset is recognized for mortgage servicing rights acquired through purchase
or origination. Amounts capitalized are amortized in proportion to, and over the
period of, estimated net servicing income. If mortgage loans are sold or
securitized with servicing retained, the total cost of the mortgage loans is
allocated to loans and the servicing rights based on their relative fair values.
Loans serviced for others were $7,611,000 at December 31, 2002, $12,005,000 at
December 31, 2001, and $11,733,000 at December 31, 2000. Related servicing
rights were $52,000 at December 31, 2002, $83,000 at December 31, 2001, and
$67,000 at December 31, 2000.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is established through provisions for loan losses
charged against income. Loans deemed to be uncollectible are charged against the
allowance for loan losses, and subsequent recoveries, if any, are credited to
the allowance. The
6
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT'D)
allowance for loan losses is maintained at a level considered adequate to
provide for losses that can be reasonably anticipated. Management's periodic
evaluation of the adequacy of the allowance is based on current economic
conditions, prior loss experience, adequacy of collateral, risk characteristics
of the loan portfolio and other relevant factors. This evaluation is inherently
subjective, as it requires material estimates that may be susceptible to
significant change, including the amounts and timing of future cash flows
expected to be received on impaired loans. A loan is considered impaired when,
based on current information and events, it is probable that PeoplesBank will be
unable to collect all amounts due according to contractual terms of the loan
agreement. An insignificant delay or shortfall in the amount of payments would
not cause a loan to be rendered impaired. Impairment is measured on an
individual loan basis for business loans by either the present value of expected
future cash flows discounted at the loan's effective interest rate, the loan's
observable 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 using loss factors derived in part from
historical charge-offs. Income on impaired loans is recognized under the same
policy as disclosed under Loans.
PREMISES AND EQUIPMENT
Premises and equipment are carried at cost less accumulated depreciation.
Depreciation expense is calculated principally on the straight-line method over
the assets estimated useful lives. Estimated useful lives are ten to forty years
for buildings and improvements, and three to ten years for furniture and
equipment. Maintenance and repairs are charged to expense as incurred. The cost
of significant improvements to existing assets is capitalized. When facilities
are retired or otherwise disposed of, the cost is removed from the asset
accounts and any gain or loss is reflected in the statement of income.
FORECLOSED REAL ESTATE
Foreclosed real estate, included in other assets, is comprised of property
acquired through a foreclosure proceeding or acceptance of a deed-in-lieu of
foreclosure. Foreclosed real estate is initially recorded at fair value at the
date of foreclosure, establishing a new cost basis. After foreclosure,
management reviews valuations quarterly and the asset is carried at the lower of
cost or fair value minus estimated costs to sell. Costs related to the
improvement of foreclosed real estate are generally capitalized until the real
estate reaches a saleable condition. Revenue and expense from operations and
changes in the valuation allowance are included in expense. When a foreclosed
real estate asset is ultimately sold, any gain or loss on the sale is included
in the income statement as a component of foreclosed real estate expense.
INVESTMENT IN REAL ESTATE PARTNERSHIP
PeoplesBank is a 99.99 percent limited partner in a real estate joint venture to
rehabilitate and operate seven buildings in the City of York (Pennsylvania) as
part of a revitalization initiative. An affiliate of the YMCA of York holds the
remaining partnership interest. The buildings will mainly provide low-income
housing to qualified families and to a lesser degree, space for commercial
purposes. The investment and related tax credits are accounted for under the
effective yield method of accounting whereby tax credits are recognized as they
are allocated and the cost of the investment is amortized to provide a constant
yield over the period that tax credits are allocated. The investment balance,
recorded in other assets, is $2,205,000 at December 31, 2002, as compared to the
investment commitment of $2,982,000, recorded in other assets and other
liabilities at December 31, 2001.
TRUST AND INVESTMENT SERVICES ASSETS
Assets held by PeoplesBank in a fiduciary or agency capacity for its customers
are not included in the consolidated statements of financial condition since
these items are not assets of PeoplesBank.
ADVERTISING
Advertising costs are charged to expense when incurred.
INCOME TAXES
Deferred income taxes are provided on the liability method whereby deferred tax
assets are recognized for deductible temporary differences and deferred tax
liabilities are recognized for taxable temporary differences. Temporary
differences are the differences between the reported amounts of assets and
liabilities and their tax bases. Deferred tax assets are reduced by a valuation
allowance, when in the opinion of management, it is more likely than not that
some portion or all the deferred tax assets will not be realized. Deferred tax
assets and liabilities are adjusted through the provision for income taxes for
the effects of changes in tax laws and rates on the effective date.
7
Notes to Consolidated Financial Statements
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT'D)
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.
PER SHARE DATA
Basic earnings per share represent income available to common shareholders
divided by the weighted average number of common shares outstanding during the
period. The weighted average number of shares of common stock outstanding,
adjusted for stock dividends, was 2,693,361 for 2002, 2,691,242 for 2001 and
2,666,615 for 2000. Diluted earnings per share reflect additional common shares
that would have been outstanding if dilutive potential common shares had been
issued as well as any adjustments to income that would result from the presumed
issuance. Potential common shares that may be issued by the Corporation relate
solely to outstanding stock options, and are determined using the treasury stock
method. The weighted average number of dilutive shares was 11,603 for 2002,
9,150 for 2001 and 1,027 for 2000. All per share amounts have been adjusted for
stock dividends.
STOCK-BASED COMPENSATION
Stock options issued under shareholder approved employee and director stock
option plans are accounted for under Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" (APB 25). Stock options are granted
at exercise prices not less than the fair value of the common stock on the date
of grant. Under APB 25, no compensation expense is recognized related to these
plans. The pro forma impact on net income and earnings per share that would
occur if compensation expense were recognized based on the estimated fair value
of the options on the date of the grant is disclosed in Note 13 to the
consolidated financial statements.
CASH FLOW INFORMATION
For purposes of the statements of cash flows, the Corporation considers interest
bearing deposits with banks, cash and due from banks, and federal funds sold to
be cash and cash equivalents.
Noncash items for the year ended December 31, 2002, consisted of the transfer of
loans to foreclosed real estate for $356,000. Noncash items for the year ended
December 31, 2001, included a real estate partnership investment commitment for
$2,982,000, an asset acquired under a capital lease for $649,000, and the
transfer of loans to foreclosed real estate for $1,346,000. Noncash items for
the year ended December 31, 2000 consisted of the transfer of loans to
foreclosed real estate for $1,795,000.
OFF-BALANCE SHEET FINANCIAL INSTRUMENTS
In the ordinary course of business, the Corporation has entered into off-balance
sheet financial instruments consisting of commitments to extend credit and
standby letters of credit. These financial instruments are recorded on the
balance sheet when they become payable by the borrower to the Corporation.
COMPREHENSIVE INCOME
Accounting principles generally require that recognized revenue, expenses, gains
and losses be included in net income. Although certain changes in assets and
liabilities, such as unrealized gains and losses on available-for-sale
securities, are reported as a separate component of the equity section of the
balance sheet, such items, along with net income, are components of
comprehensive income. The components of other comprehensive income and related
tax effects are presented in the following table:
YEARS ENDED DECEMBER 31,
(dollars in thousands) 2002 2001 2000
- -----------------------------------------------------------------------------------
Unrealized holding gains arising during the year $ 1,621 $ 458 $ 1,012
Reclassification adjustment for gains
included in income (179) 0 (29)
- -----------------------------------------------------------------------------------
Net unrealized gains 1,442 458 983
Tax effect (489) (157) (334)
- -----------------------------------------------------------------------------------
Net of tax amount $ 953 $ 301 $ 649
===================================================================================
8
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT'D)
SEGMENT REPORTING
Management has determined that it operates in only one segment, community
banking. The Corporation's non-banking activities are insignificant to the
consolidated financial statements.
TREASURY STOCK
The acquisition of treasury stock is recorded under the cost method. The
subsequent disposition or sale of the treasury stock is recorded using the
average cost method.
RECLASSIFICATIONS
Certain amounts in the 2001 and 2000 financial statements have been reclassified
to conform to the 2002 presentation format. These reclassifications had no
impact on the Corporation's net income.
RECENTLY ISSUED FASB STATEMENTS
In April 2002, the Financial Accounting Standards Board issued Statement No.
145, "Rescission of Statements No. 4, 44 and 64, Amendment of Statement No. 13."
This statement requires that debt extinguishment no longer be classified as an
extraordinary item since debt extinguishment has become a risk management
strategy for many companies. It also eliminates the inconsistent accounting
treatment for sale-leaseback transactions and certain lease modifications that
have economic effects similar to sale-leaseback transactions. This statement
became effective May 15, 2002, and did not have any impact on the Corporation's
financial condition or results of operations.
In July 2002, the Financial Accounting Standards Board issued Statement No. 146,
"Accounting for Costs Associated with Exit or Disposal Activities", which
nullifies EITF Issue 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)." This statement delays recognition of these
costs until liabilities are incurred, rather than at the date of commitment to
the plan, and requires fair value measurement. It does not impact the
recognition of liabilities incurred in connection with a business combination or
the disposal of long-lived assets. The provisions of this statement are
effective for exit or disposal activities initiated after December 31, 2002 and
are not expected to have a significant impact on the Corporation's financial
condition or results of operations.
In October 2002, the Financial Accounting Standards Board issued Statement No.
147, "Acquisitions of Certain Financial Institutions." This statement provides
guidance on accounting for the acquisition of a financial institution, including
the acquisition of part of a financial institution. The statement defines
criteria for determining whether the acquired financial institution meets the
conditions for a "business combination". If the acquisition meets the conditions
of a "business combination", the specialized accounting guidance under Statement
No. 72, "Accounting for Certain Acquisitions of Banking or Thrift Institutions"
will not apply after September 30, 2002 and the amount of any unidentifiable
intangible asset will be reclassified to goodwill upon adoption of Statement No.
147. The transition provisions were effective on October 1, 2002, and did not
have any impact on the Corporation's financial condition or results of
operations.
NOTE 2 - RESTRICTIONS ON CASH AND DUE FROM BANKS
Cash balances reserved to meet regulatory requirements of the Federal Reserve
Bank and balances maintained at other banks for compensating balance
requirements averaged approximately $4,198,000 for 2002 and $3,740,000 for 2001.
9
Notes to Consolidated Financial Statements
NOTE 3 - SECURITIES AVAILABLE-FOR-SALE AND HELD-TO-MATURITY
A summary of available-for-sale and held-to-maturity securities at December 31
follows:
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
(dollars in thousands) COST GAINS LOSSES VALUE
- ---------------------------------------------------------------------------------------
2002
Available-for-sale
Debt securities
U.S. treasuries $ 1,004 $ 16 $ 0 $ 1,020
U.S. agencies 35,087 1,015 0 36,102
States and municipals 10,474 679 0 11,153
Mortgage-backed securities 20,207 381 0 20,588
- ---------------------------------------------------------------------------------------
Total debt securities 66,772 2,091 0 68,863
Equity securities 1,503 0 0 1,503
- ---------------------------------------------------------------------------------------
Total available-for-sale $68,275 $ 2,091 $ 0 $70,366
=======================================================================================
Held-to-maturity
Debt securities-corporate trust preferred $ 9,357 $ 445 $ (263) $ 9,539
- ---------------------------------------------------------------------------------------
Total held-to-maturity $ 9,357 $ 445 $ (263) $ 9,539
=======================================================================================
2001
Available-for-sale
Debt securities
U.S. agencies $14,114 $ 368 $ (2) $14,480
States and municipals 10,871 238 (39) 11,070
Mortgage-backed securities 11,788 71 (13) 11,846
- ---------------------------------------------------------------------------------------
Total debt securities 36,773 677 (54) 37,396
Equity securities 941 25 0 966
- ---------------------------------------------------------------------------------------
Total available-for-sale $37,714 $ 702 $ (54) $38,362
=======================================================================================
Held-to-maturity
Debt securities-corporate trust preferred $ 9,358 $ 68 $ (210) $ 9,216
- ---------------------------------------------------------------------------------------
Total held-to-maturity $ 9,358 $ 68 $ (210) $ 9,216
=======================================================================================
Equity securities at December 31, 2002 include $1,503,000 of Federal Home Loan
Bank stock and Atlantic Central Bankers Bank common stock, which are held at
cost. The comparable amount at December 31, 2001, was $926,000. The amortized
cost and estimated fair value of debt securities at December 31, 2002, by
contractual maturity, are shown below. Actual maturities may differ from
contractual maturities if call options on selected debt issues are exercised in
the future. Mortgage-backed securities are included in the maturity categories
based on average expected life.
DECEMBER 31, 2002
AMORTIZED FAIR
(dollars in thousands) COST VALUE
- ---------------------------------------------------------------
Available-for-sale
Due in one year or less $ 8,465 $ 8,613
Due after one year through five years 51,112 52,589
Due after five years through ten years 5,601 5,971
Due after ten years 1,594 1,690
- ---------------------------------------------------------------
Total debt securities, available-for-sale $66,772 $68,863
===============================================================
Held-to-maturity
Due after ten years $ 9,357 $ 9,539
===============================================================
Gross gains realized from the sale of available-for-sale securities were
$179,000, $0 and $29,000, for 2002, 2001 and 2000, respectively. Securities with
a carrying value of $21,057,000 and $16,764,000 on December 31, 2002 and 2001,
respectively, were pledged to secure certain public and trust deposits.
10
NOTE 4 - LOANS
The composition of the loan portfolio at December 31, is as follows:
(dollars in thousands) 2002 2001
- -----------------------------------------------------------------------
Commercial, industrial and agricultural $161,425 $152,112
Real estate - construction and land development 20,596 21,889
- -----------------------------------------------------------------------
Total commercial related loans 182,021 174,001
Real estate - residential mortgages 24,803 24,799
Installment 27,136 26,985
- -----------------------------------------------------------------------
Total consumer related loans 51,939 51,784
- -----------------------------------------------------------------------
Total loans $233,960 $225,785
=======================================================================
Concentrations of credit risk arise when a number of customers are engaged in
similar business activities in the same geographic region or have similar
economic features that could cause their ability to meet contractual obligations
to be similarly affected by changes in economic conditions. Most of the
Corporation's business is with customers in York County, Pennsylvania and
northern Maryland. Although this may pose a concentration risk geographically,
we believe the diverse local economy and detailed knowledge about the customer
base minimizes this risk. At year-end 2002 and 2001, the total loan portfolio
included one industry concentration that exceeded 10 percent. The commercial
leasing industry accounted for 16 and 21 percent, respectively of the total loan
portfolio. Loans to borrowers within this industry are usually collateralized by
real estate.
Loans to directors, executive officers, principal shareholders, and any
associates of such persons amounted to $3,453,000 at December 31, 2002, and
$3,151,000 at December 31, 2001. During 2002, total loan additions, as adjusted,
amounted to $4,803,000 and total payments collected, as adjusted, amounted to
$4,501,000. Related party loans are made on substantially the same terms,
including interest rates and collateral, as those prevailing at the time for
comparable transactions with unrelated persons and do not involve more than
normal risk of collection. As of year-end 2002, all loans to this group were
current and performing in accordance with contractual terms.
NOTE 5 - IMPAIRED, NONACCRUAL AND PAST DUE LOANS
Information regarding impaired commercial loans at December 31, was as follows:
(dollars in thousands) 2002 2001 2000
- -------------------------------------------------------------------------------------
Impaired loans $6,445 $2,199 $2,006
Amount of impaired loans that have a related allowance 1,359 2,199 2,006
Allowance for impaired loans 444 734 376
Average investment in impaired loans 5,869 2,650 2,528
Interest income recognized on impaired commercial loans
(Primarily accrual basis) 152 115 37
=====================================================================================
As of December 31, 2002 and 2001, the loan portfolio included total nonaccrual
loans of $5,051,000 and $1,411,000, respectively. Interest that would have been
included in income had those loans been accruing at their contractual rates in
2002 was $253,000, compared with $36,000 that was recognized in income. Loans
contractually past due 90 days or more as to principal or interest, but still
accruing interest totaled $453,000 at December 31, 2002 and $164,000 at December
31, 2001.
NOTE 6 - ANALYSIS OF ALLOWANCE FOR LOAN LOSSES
Changes in the allowance for loan losses for each of the three years ended
December 31, were as follows:
(dollars in thousands) 2002 2001 2000
- -------------------------------------------------------------------------
Balance at beginning of year $ 1,898 $ 1,967 $ 2,023
Provision charged to operating expense 515 143 119
Loans charged off (1,185) (232) (238)
Recoveries 287 20 63
- -------------------------------------------------------------------------
Balance at end of year $ 1,515 $ 1,898 $ 1,967
=========================================================================
11
Notes to Consolidated Financial Statements
NOTE 7 - PREMISES AND EQUIPMENT
A summary of premises and equipment at December 31, was as follows:
(dollars in thousands) 2002 2001
- ------------------------------------------------------
Land $ 1,149 $ 1,150
Buildings and improvements 8,481 8,220
Capitalized leased premises 672 672
Equipment 6,156 6,114
- ------------------------------------------------------
16,458 16,156
Less-accumulated depreciation (7,123) (6,707)
- ------------------------------------------------------
Net premises and equipment $ 9,335 $ 9,449
======================================================
PeoplesBank leases certain banking branches under capital and noncancellable
operating leases, which expire on various dates through 2016. The terms include
various renewal options and provide for rental increases based upon
predetermined factors. Total lease expenses under operating leases amounted to
$38,000 in 2002, $22,000 in 2001 and $17,000 in 2000. At December 31, 2002,
future minimum lease payments for these leases and a capital lease are payable
as follows:
CAPITAL OPERATING
(dollars in thousands) LEASE LEASES
- -----------------------------------------------------------------
2003 $ 81 $ 70
2004 88 66
2005 88 67
2006 94 67
2007 95 68
Thereafter 803 295
- --------------------------------------------------------------
Total future minimum lease payments 1,249 $633
Less-interest (594)
- --------------------------------------------------------------
Present value of minimum lease payments $ 655
==============================================================
NOTE 8 - DEPOSITS
The composition of deposits at December 31, was as follows:
(dollars in thousands) 2002 2001
- ----------------------------------------------------------------
Noninterest bearing demand $ 30,120 $ 26,093
NOW 34,851 29,301
Money market 73,938 62,148
Savings 13,023 13,719
Time CDs less than $100,000 114,808 117,724
Time CDs $100,000 or more 25,887 27,960
- ----------------------------------------------------------------
Total deposits $292,627 $276,945
================================================================
Scheduled maturities of time deposits as of December 31, were as follows:
(dollars in thousands) 2002
- ----------------------------------------------------
2003 $ 67,294
2004 34,550
2005 24,277
2006 4,108
2007 10,466
- ----------------------------------------------------
Total time deposits $140,695
====================================================
12
NOTE 9 - SHORT-TERM BORROWINGS AND LONG-TERM DEBT
The schedule below provides a summary of short-term borrowings that consist of
federal funds purchased and other borrowings. Federal funds purchased from
correspondent banks usually mature in one business day. Other short-term
borrowings consist of credit available through Federal Home Loan Bank of
Pittsburgh (FHLBP). Based on the most recent analysis, total credit available
from the FHLBP, for both short and long-term credit needs, is approximately $99
million. As of December 31, 2002, total unused credit with the FHLBP was
approximately $78 million. Obligations to the FHLBP are secured by FHLB stock
and qualifying collateral, principally the unpledged portion of PeoplesBank's
investment securities portfolio and qualifying mortgage loan receivables. The
interest rate for short-term borrowings reprices daily based on the federal
funds rate or the open repo market depending on the borrowing program.
A summary of aggregate short-term borrowings on December 31, is as follows:
(dollars in thousands) 2002 2001 2000
- -------------------------------------------------------------------------------------------------------
Amount outstanding at end of year $7,089 $ 0 $ 0
Weighted average interest rate at end of year 1.31% 0.00% 0.00%
Maximum amount outstanding at any month-end $7,089 $3,000 $18,100
Daily average amount outstanding $ 591 $ 101 $ 9,603
Approximate weighted average interest rate for the year 1.69% 6.93% 6.32%
=======================================================================================================
A summary of long-term debt at December 31, is as follows:
(dollars in thousands) 2002 2001
- --------------------------------------------------------------------
Obligations of PeoplesBank to FHLBP
Due 2002, 6.03% $ 0 $ 3,000
Due 2004, 5.12% 1,025 1,025
Due 2005, 5.36%, convertible quarterly after
December 2002 6,000 6,000
Due 2007, 4.69%, amortizing 1,636 1,977
Due 2014, 6.43%, convertible quarterly after
July 2009 5,000 5,000
Obligation of Codorus Valley Bancorp, Inc.
Due 2009, 7.35%, amortizing 1,848 1,899
- --------------------------------------------------------------------
15,509 18,901
Capital lease obligation 655 672
- --------------------------------------------------------------------
Total long-term debt $16,164 $19,573
====================================================================
PeoplesBank's obligations to FHLBP are fixed rate and fixed/floating
(convertible) rate instruments. The FHLBP has an option on the convertible
borrowings to convert the rate to a floating rate after the expiration of a
specified period. The floating rate is based on the LIBOR index plus a spread.
If the FHLBP elects to exercise its conversion option, PeoplesBank can repay the
converted loan without a prepayment penalty. The obligation of Codorus Valley is
secured by a mortgage on the Codorus Valley Corporate Center office building at
105 Leader Heights Road, York, Pennsylvania. Total maturities of long-term debt
over the next five years are as follows: $455,000 in 2003, $1,506,000 in 2004,
$6,506,000 in 2005, $540,000 in 2006 and $112,000 in 2007.
13
Notes to Consolidated Financial Statements
NOTE 10 - STOCKHOLDERS' EQUITY
On April 9, 2002, the board of directors declared a 5 percent common stock
dividend payable on or before June 6, 2002, to shareholders of record on April
23, 2002. On April 10, 2001, the board of directors declared a 5 percent common
stock dividend payable on or before June 7, 2001, to shareholders of record on
April 24, 2001. On April 25, 2000, the board of directors declared a 5 percent
common stock dividend payable on or before June 23, 2000, to shareholders of
record on May 9, 2000.
Codorus Valley maintains a Dividend Reinvestment and Stock Purchase Plan (Plan).
Shareholders of common stock may participate in the Plan, which allows
additional shares of common stock to be purchased with reinvested dividends at
prevailing market prices. To the extent that shares are not available in the
open market, 152,326 shares of common stock are reserved and available for
issuance at December 31, 2002. Under the Plan, 2,642 shares were issued in 2002
and no shares were issued in 2001 and 2000. Open market purchases are usually
made by an independent purchasing agent retained to act as agent for Plan
participants, and the purchase price to participants will be the actual price
paid, excluding brokerage commissions and other expenses which will be paid by
the Corporation. The Plan also permits participants to make additional voluntary
cash payments toward the purchase of shares of the Corporation's common stock.
NOTE 11 - REGULATORY MATTERS
The Corporation is subject to restrictions on the payment of dividends to its
shareholders pursuant to the Pennsylvania Business Corporation Law of 1988, as
amended (BCL). The BCL prohibits dividend payments if such payment would render
the Corporation insolvent or result in negative net worth. Payment of dividends
to the Corporation by PeoplesBank is subject to restrictions set forth in the
Pennsylvania Banking Code of 1965, as amended.
The Corporation and PeoplesBank are subject to various regulatory capital
requirements. Failure to meet minimum capital requirements can result in certain
mandatory and possible additional discretionary actions by regulators that, if
imposed, could have a material effect on the Corporation's financial statements.
Under capital adequacy guidelines and the regulatory framework for prompt
corrective action, the Corporation and PeoplesBank must meet specific capital
guidelines that involve quantitative measures of assets, liabilities, and
certain off-balance sheet items as calculated under regulatory accounting
practices. The capital amounts and classification are also subject to
qualitative judgements by the regulators.
Quantitative measures established by regulators to ensure capital adequacy
require the Corporation and PeoplesBank to maintain minimum ratios, as set forth
below, to total and tier I capital as a percentage of risk-weighted assets, and
of tier I capital to average assets (leverage ratio). Management believes that
the Corporation and PeoplesBank were well capitalized on December 31, 2002,
based on FDIC capital guidelines.
The FDIC's minimum quantitative standards for a well capitalized institution are
as follows: tier I risk-based capital ratio, 6 percent; total risk-based capital
ratio, 10 percent; and leverage ratio, 5 percent. The FDIC's minimum
quantitative standards for an adequately capitalized institution are as follows:
tier I risk-based capital ratio, 4 percent; total risk-based capital ratio, 8
percent; and leverage ratio, 4 percent. At the state level, the Pennsylvania
Department of Banking uses a leverage ratio guideline of 6 percent. The
following table shows the Corporation's and PeoplesBank's actual and required
ratios and capital amounts on December 31, 2002 and 2001.
14
NOTE 11 - REGULATORY MATTERS (CONT'D)
MINIMUM FOR WELL CAPITALIZED
CODORUS VALLEY BANCORP, INC. ACTUAL CAPITAL ADEQUACY MINIMUM*
- ------------------------------------------------------------------------------------------------------------------------------------
(dollars in thousands) AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
- ------------------------------------------------------------------------------------------------------------------------------------
at December 31, 2002
Capital ratios:
Tier 1 risk-based $30,475 11.32% > than = to $ 10,770 > than = to 4.0% N/A N/A
Total risk-based 31,990 11.88 > than = to 21,539 > than = to 8.0 N/A N/A
Leverage 30,475 8.93 > than = to 13,650 > than = to 4.0 N/A N/A
- ------------------------------------------------------------------------------------------------------------------------------------
at December 31, 2001
Capital ratios:
Tier 1 risk-based $28,932 10.88% > than = to $ 10,637 > than = to 4.0% n/a n/a
Total risk-based 30,829 11.59 > than = to 21,275 > than = to 8.0 n/a n/a
Leverage 28,932 9.27 > than = to 12,482 > than = to 4.0 n/a n/a
- ------------------------------------------------------------------------------------------------------------------------------------
MINIMUM FOR WELL CAPITALIZED
PEOPLESBANK ACTUAL CAPITAL ADEQUACY MINIMUM*
- ------------------------------------------------------------------------------------------------------------------------------------
(dollars in thousands) AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
- ------------------------------------------------------------------------------------------------------------------------------------
at December 31, 2002
Capital ratios:
Tier 1 risk-based $25,946 9.86% > than = to $ 10,521 > than = to 4.0% > than = to $15,782 > than = to 6.0%
Total risk-based 27,461 10.44 > than = to 21,042 > than = to 8.0 > than = to 26,303 > than = to 10.0
Leverage 25,946 7.75 > than = to 13,390 > than = to 4.0 > than = to 16,738 > than = to 5.0
====================================================================================================================================
at December 31, 2001
Capital ratios:
Tier 1 risk-based $23,919 9.23% > than = to $ 10,369 > than = to 4.0% > than = to $15,554 > than = to 6.0%
Total risk-based 25,816 9.96 > than = to 20,738 > than = to 8.0 > than = to 25,923 > than = to 10.0
Leverage 23,919 7.86 > than = to 12,207 > than = to 4.0 > than = to 15,259 > than = to 5.0
====================================================================================================================================
* To be well capitalized under prompt correction action provisions.
NOTE 12 - BENEFIT PLANS
DEFINED CONTRIBUTION PLAN
The Corporation maintains a 401(k) savings and investment plan covering
substantially all employees. Under the plan, employees can contribute a
percentage of their gross salary. In 2002, 2001, and 2000, the Corporation
matched 50 percent of the first 6 percent of an employee's contribution. The
Corporation's expense for the 401(k) savings and investment plan was $92,000 for
2002, $77,000 for 2001, and $67,000 for 2000.
SUPPLEMENTAL BENEFIT PLANS
PeoplesBank maintains supplemental retirement plans for selected executives and
supplemental life insurance for executive officers and directors. The
supplemental life insurance plans replaced other insurance coverage. The expense
associated with these plans was approximately $130,000 for 2002, $118,000 for
2001, and $109,000 for 2000. The accrued liability was $482,000 at December 31,
2002, and $352,000 at December 31, 2001. Investment in bank owned life insurance
policies was used to finance the supplemental benefit plans, and provide a
tax-exempt return to PeoplesBank. The cash surrender value of insurance policies
was approximately $6,725,000 at December 31, 2002, and $6,094,000 at December
31, 2001.
EMPLOYEE STOCK BONUS PLAN
In 2001, the Corporation implemented an Employee Stock Bonus Plan, administered
by nonemployee members of the Corporation's board of directors, under which the
Corporation may issue shares of its common stock to employees as performance
based compensation. As of December 31, 2002, 10,348 shares of common stock were
reserved for possible issuance under this plan, subject to future adjustment in
the event of specified changes in the Corporation's capital structure. Under the
Employee Stock Bonus Plan, 152 shares of stock were issued during 2002 and no
shares of stock were issued during 2001.
15
Notes to Consolidated Financial Statements
NOTE 13 - STOCK OPTION PLANS
The Corporation maintains three stock option plans as follows: a 2000 Stock
Incentive Plan (2000 Plan), a 1998 Independent Directors Stock Option Plan (1998
Plan) and a 1996 Stock Incentive Plan (1996 Plan).
Shares reserved and available for issuance were 110,250 for the 2000 Plan,
117,140 for the 1998 Plan, and 87,630 for the 1996 Plan at December 31, 2002.
Shares reserved for future issuance under each plan are subject to adjustment in
the event of specified changes in the Corporation's capital structure. Options
awarded under these plans to date have been granted with an exercise price equal
to the fair value of the stock on the grant date, a vesting period of six months
and an expiration period of ten years.
The 2000 Plan also allows for the granting of stock appreciation rights and
restricted stock, none of which have been granted to date at December 31, 2002.
A summary of stock options from all Plans, adjusted for stock dividends, is
presented in the following table:
YEARS ENDED DECEMBER 31,
2002 2001 2000
---------------------------------------------------------------------------------
WEIGHTED WEIGHTED WEIGHTED
AVG. EXERCISE AVG. EXERCISE AVG. EXERCISE
OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE
- ----------------------------------------------------------------------------------------------------------------------
Outstanding at beginning of year 181,952 $ 14.77 162,689 $ 15.00 145,049 $ 15.50
Granted 12,000 15.50 32,550 14.00 17,640 10.88
Exercised (2,205) 10.88 (2,205) 10.88 - -
Forfeited - - (11,082) 16.70 - -
- --------------------------------------------------------------------------------------------------------------------
Outstanding at end of year 191,747 $ 14.86 181,952 $ 14.77 162,689 $ 15.00
====================================================================================================================
Information regarding options outstanding as of December 31, 2002 is presented
in the following table:
WEIGHTED AVG.
OPTIONS WEIGHTED AVG. CONTRACTUAL OPTIONS WEIGHTED AVG.
OUTSTANDING EXERCISE PRICE LIFE EXERCISABLE EXERCISE PRICE
- --------------------------------------------------------------------------------------------------------------------------
Options with exercise prices
ranging from $9.50 to $11.50 29,308 $ 10.77 5.5 YEARS 29,308 $ 10.77
Options with exercise prices
ranging from $11.51 to $16.50 128,398 14.93 6.8 YEARS 104,899 14.96
Options with exercise prices
ranging from $16.51 to $19.00 34,041 18.14 5.5 YEARS 34,041 18.14
- -----------------------------------------------------------------------------------------------------------------------
Total options outstanding with exercise
prices ranging from $9.50 to $19.00 191,747 $ 14.86 6.4 YEARS 168,248 $ 14.87
=======================================================================================================================
The grant-date fair value of options granted, adjusted for stock dividends, was
$6.60 for 2002, $6.45 for 2001 and $2.90 for 2000. These values were calculated
using the Black-Scholes option valuation model. The following significant
assumptions were used:
2002 2001 2000
- --------------------------------------------------------
Expected life (in years) 5.25 6.21 5.25
Risk free interest rate 4.52% 4.88% 5.75%
Expected volatility 56.9% 59.1% 27.1%
Expected dividend yield 3.2% 3.2% 2.6%
========================================================
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options, which have no vesting restrictions and are fully
transferable. In addition, option valuation models require input of highly
subjective assumptions including the expected stock price volatility. The
Corporation's employee stock options have characteristics different from those
of traded options, and changes in subjective input assumptions can materially
affect the fair value estimate. Therefore, in management's opinion, the existing
models do not necessarily provide a reliable single measure of fair value of its
employee stock options.
16
NOTE 13 - STOCK OPTION PLANS (CONT'D)
In accordance with Financial Accounting Standard No.123, the Corporation has
elected to disclose the pro forma information regarding net income and net
income per share as if the stock options had been accounted for under the
recognition provisions of the Statement. For purposes of pro forma disclosures,
the estimated fair value of the options is amortized to expense over the
options' vesting period. Pro forma amounts are indicated below:
YEARS ENDED DECEMBER 31,
(dollars in thousands, except per share data) 2002 2001 2000
- --------------------------------------------------------------------------------
Reported net income $3,101 $2,854 $2,707
Deduct total stock-based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects 160 115 99
- --------------------------------------------------------------------------------
Pro forma net income $2,941 $2,739 $2,608
- --------------------------------------------------------------------------------
Reported basic and diluted earnings per share $ 1.15 $ 1.06 $ 1.02
- --------------------------------------------------------------------------------
Pro forma basic and diluted earnings per share $ 1.09 $ 1.02 $ .98
================================================================================
NOTE 14 - INCOME TAXES
Significant components of the Corporation's deferred tax assets and liabilities
at December 31, are as follows:
(dollars in thousands) 2002 2001
- --------------------------------------------------------------------------------
Deferred tax assets
Allowance for loan losses $ 351 $ 481
Deferred compensation 164 120
Partnership investment amortization 259 0
Tax credit carryforward 428 0
- --------------------------------------------------------------------------------
Total deferred tax assets 1,202 601
- --------------------------------------------------------------------------------
Deferred tax liabilities
Deferred loan fees 82 75
Depreciation 259 290
Net unrealized gains on available-for-sale securities 711 222
Other, net 107 96
- --------------------------------------------------------------------------------
Total deferred tax liabilities 1,159 683
- --------------------------------------------------------------------------------
Net deferred tax asset (liability) $ 43 $ (82)
================================================================================
Analysis of federal income taxes reflected in the income statements is as
follows:
(dollars in thousands) 2002 2001 2000
- ---------------------------------------------------------------------
Current tax provision $ 1,291 $ 940 $ 1,075
Deferred tax provision (614) (8) (21)
- ---------------------------------------------------------------------
Total tax provision $ 677 $ 932 $ 1,054
=====================================================================
The reasons for the difference between the provision for income taxes and the
amount computed by applying the statutory federal income tax rate to income
before income taxes are as follows:
(dollars in thousands) 2002 2001 2000
- -------------------------------------------------------------------------------------
Income before income taxes $ 3,778 $ 3,786 $ 3,761
=====================================================================================
Computed tax at 34% $ 1,285 $ 1,287 $ 1,279
Increase (reduction) in taxes resulting from:
Tax-exempt interest income (182) (190) (165)
Interest expense disallowance 20 27 26
Tax-exempt income from bank owned life insurance (110) (100) (92)
Tax credits (372) (99) 0
Other, net 36 7 6
- -------------------------------------------------------------------------------------
Provision for income taxes $ 677 $ 932 $ 1,054
=====================================================================================
The provision for income taxes includes $61,000, $0 and $10,000 of applicable
income tax expense related to net investment security gains in 2002, 2001 and
2000, respectively. Based on current tax law, tax credits can be carried back
one year and carried forward twenty years.
17
Notes to Consolidated Financial Statements
NOTE 15 - COMMITMENTS TO EXTEND CREDIT
In the normal course of business, the Corporation is a party to various
financial transactions that are not funded as of the balance sheet date.
Off-balance sheet financial instruments, which enable bank customers to meet
their financing needs, are comprised mainly of commitments to extend credit and
standby letters of credit. Standby letters of credit commit PeoplesBank to make
payments on behalf of customers when certain specified future events occur.
To varying degrees, these instruments contain elements of credit and market risk
similar to those involved in extending loans to customers. To manage these risks
the Corporation uses the same credit policies in making commitments and
conditional obligations as it does for on-balance sheet instruments. Normally,
commitments to extend credit and letters of credit have fixed expiration dates
or termination clauses, are at specific rates and are for specific purposes.
Many of the commitments are expected to expire without being drawn; therefore,
total commitment amounts do not necessarily represent future cash requirements.
The following is a summary of outstanding commitments:
DECEMBER 31,
(dollars in thousands) 2002 2001
- --------------------------------------------------------------------
Commitments to grant loans
Fixed rate $15,180 $12,082
Variable rate 4,840 6,522
Unfunded commitments of existing loans
Fixed rate $14,316 $ 9,914
Variable rate 28,681 25,916
Standby letters of credit $ 2,454 $ 3,504
====================================================================
NOTE 16 - CONTINGENT LIABILITIES
During the second quarter of 2001, PeoplesBank's management became aware of a
potential loss stemming from its merchant credit card business. Some individuals
who transacted business with a former PeoplesBank merchant customer are seeking
refunds claiming that service was not rendered. The merchant did not have
sufficient funds to cover reimbursement requests, and PeoplesBank terminated the
merchant's credit card account relationship. Losses of approximately $1,000 and
$41,000 were included in other expense for 2002 and 2001, respectively. These
losses represent refunds in excess of funds available in the merchant's account.
We cannot estimate the additional potential loss associated with this merchant
credit card account at this time.
NOTE 17 - FAIR VALUE OF FINANCIAL INSTRUMENTS
FASB Statement No. 107, "Disclosures About Fair Value of Financial Instruments,"
requires disclosure of fair value information about financial instruments,
whether or not recognized on the balance sheet, for which it is practicable to
estimate that value. In cases where quoted market prices are not available, fair
values are based on estimates using present value of expected future cash flows
or other valuation techniques. Those techniques are significantly affected by
the assumptions used, including the discount rate and estimates of future cash
flows. In that regard, derived fair value estimates cannot be substantiated by
comparison to independent markets and, in many cases, could not be realized in
immediate settlement of the instrument. Statement No. 107 excludes certain
financial instruments and all nonfinancial instruments from its disclosure
requirements. Accordingly, the aggregate fair value amounts presented do not
represent the underlying value of the Corporation.
The Corporation used the methods and assumptions below in estimating its fair
value disclosures for financial instruments.
Cash and equivalents - The carrying amounts reported in the balance sheet for
cash and equivalents approximate their fair value at the reporting date.
Investment securities - Fair values for investment securities are based on
quoted market prices, where available. When quoted market prices are not
available, fair values are based on quoted market prices of comparable
instruments.
Loans receivable - For variable-rate and adjustable-rate loans that reprice
frequently and show no significant change in credit risk; fair values were based
on carrying values. For fixed-rate loans, fair values were estimated using
discounted cash flow analysis using interest rates currently being offered for
loans with similar terms to borrowers of similar credit quality.
18
NOTE 17 - FAIR VALUE OF FINANCIAL INSTRUMENTS (CONT'D)
Mortgage servicing rights - The fair value of mortgage servicing rights is based
on observable market prices available or the present value of expected future
cash flows when not available.
Accrued interest receivable and payable - The carrying amounts of accrued
interest receivable and payable approximate their fair values.
Demand and savings deposits - The carrying amounts of demand and savings
deposits approximate their fair values.
Time deposits - The carrying value of time certificates of deposit (CDs) less
than $100,000 with an original term of six months or less and variable rate CDs
of less than $100,000 is assumed to approximate market value. The fair value of
all other CDs is estimated by discounting the future cash flows, using rates
offered for deposits of similar remaining maturities at the reporting date.
Short-term borrowings - The carrying amount of short-term borrowings
approximates the fair value.
Long-term debt - The fair value of long-term debt is estimated by discounting
the future cash flows, using rates available for debt of similar remaining
maturities at the reporting date.
Off-balance sheet instruments - The fair value of off-balance sheet instruments,
such as commitments to extend credit and standby letters of credit, are based on
fees currently charged to enter into similar agreements. These amounts were not
considered material at December 31, 2002 and 2001.
An analysis of financial instruments is as follows:
DECEMBER 31, 2002 DECEMBER 31, 2001
CARRYING FAIR CARRYING FAIR
(dollars in thousands) AMOUNT VALUE AMOUNT VALUE
- ------------------------------------------------------------------------------
Financial assets:
Cash and equivalents $ 11,120 $ 11,120 $ 25,035 $ 25,035
Securities, available-for-sale 70,366 70,366 38,362 38,362
Securities, held-to-maturity 9,357 9,539 9,358 9,216
Loans, held for sale 4,586 4,649 12,349 12,349
Loans, net of allowance 232,445 235,993 223,887 222,998
Mortgage servicing rights 52 52 83 83
Accrued interest receivable 1,721 1,721 1,605 1,605
Financial liabilities:
Demand and savings deposits $151,932 $151,932 $131,261 $131,261
Time deposits 140,695 145,272 145,684 151,127
Short-term borrowings 7,089 7,089 0 0
Long-term debt 16,164 17,663 19,573 20,143
Accrued interest payable 433 433 596 596
==============================================================================
19
Notes to Consolidated Financial Statements
NOTE 18 - CONDENSED FINANCIAL INFORMATION-PARENT COMPANY ONLY
CONDENSED STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31,
(dollars in thousands) 2002 2001
- -----------------------------------------------------------------------
ASSETS
Cash and due from banks $ 181 $ 82
Securities, available-for-sale 0 40
Securities, held-to-maturity 3,776 4,291
Investment in subsidiaries 27,697 24,340
Premises and equipment 4,389 4,525
Other assets 146 165
- -----------------------------------------------------------------------
Total assets $36,189 $33,443
=======================================================================
LIABILITIES
Long-term debt $ 1,848 $ 1,899
Long-term debt with subsidiary, PeoplesBank 2,092 2,149
Other liabilities 26 27
- -----------------------------------------------------------------------
Total liabilities 3,966 4,075
STOCKHOLDERS' EQUITY 32,223 29,368
- -----------------------------------------------------------------------
Total liabilities and stockholders' equity $36,189 $33,443
=======================================================================
CONDENSED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31,
(dollars in thousands) 2002 2001 2000
- ------------------------------------------------------------------------------------
INCOME
Interest from investment securities $ 371 $ 394 $ 393
Dividends from PeoplesBank,
A Codorus Valley Company 1,263 1,301 1,179
Rental income 456 445 479
Other 24 0 0
- ------------------------------------------------------------------------------------
Total income 2,114 2,140 2,051
EXPENSE
Interest expense on long-term debt 312 319 327
Other 595 656 581
- ------------------------------------------------------------------------------------
Total expense 907 975 908
- ------------------------------------------------------------------------------------
Income before applicable income tax benefit and
undistributed earnings of subsidiaries 1,207 1,165 1,143
APPLICABLE INCOME TAX BENEFIT 22 46 13
- ------------------------------------------------------------------------------------
Income before undistributed earnings of subsidiaries 1,229 1,211 1,156
Undistributed earnings of subsidiaries 1,872 1,643 1,551
- ------------------------------------------------------------------------------------
Net income $3,101 $2,854 $2,707
====================================================================================
20
NOTE 18 - CONDENSED FINANCIAL INFORMATION-PARENT COMPANY ONLY (CONT'D)
CONDENSED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31,
(dollars in thousands) 2002 2001 2000
- -----------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 3,101 $ 2,854 $ 2,707
Adjustments to reconcile net income to net cash
provided by operations:
Depreciation 171 172 169
Undistributed earnings of subsidiaries (1,872) (1,643) (1,551)
Gain on sale of premises and equipment and securities (24) 0 0
Other, net 25 (45) (23)
- -----------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 1,401 1,338 1,302
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sales of securities, available-for-sale 40 0 0
Purchase of securities, available-for-sale 0 (1) (1)
Purchases of premises and equipment (75) (52) (58)
Proceeds from sales of premises and equipment 40 0 0
- -----------------------------------------------------------------------------------------------------------
Net cash provided by (used in) investing activities 5 (53) (59)
CASH FLOWS FROM FINANCING ACTIVITIES
Repayments of long-term debt (108) (100) (91)
Dividends paid (1,262) (1,102) (1,102)
Issuance of common stock 67 27 0
Purchases of treasury stock 0 0 (231)
Cash paid in lieu of fractional shares (4) (4) (4)
- -----------------------------------------------------------------------------------------------------------
Net cash used in financing activities (1,307) (1,278) (1,428)
- -----------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 99 7 (185)
Cash and cash equivalents at beginning of year 82 75 260
- -----------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 181 $ 82 $ 75
===========================================================================================================
21
Report of Independent Auditors
[LOGO OF BEARD MILLER COMPANY]
The Stockholders and Board of Directors
Codorus Valley Bancorp, Inc.
York, Pennsylvania
We have audited the accompanying consolidated statements of financial
condition of Codorus Valley Bancorp, Inc. and subsidiaries as of December 31,
2002 and 2001, and the related consolidated statements of income, changes in
stockholders' equity, and cash flows for the years then ended. These financial
statements are the responsibility of the Corporation's management. Our
responsibility is to express an opinion on these financial statements based on
our audits. The consolidated financial statements of Codorus Valley Bancorp,
Inc. for the year ended December 31, 2000 were audited by other auditors, whose
report dated February 5, 2001, expressed an unqualified opinion on those
statements.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the 2002 and 2001 consolidated financial statements
referred to above present fairly, in all material respects, the financial
position of Codorus Valley Bancorp, Inc. at December 31, 2002 and 2001, and the
results of their operations and their cash flows for the years then ended in
conformity with accounting principles generally accepted in the United States of
America.
/s/ Beard Miller Company LLP
--------------------------
BREAD MILLER COMPANY LLP
Harrisburg, Pennsylvania
January 13, 2003
22
Management's Discussion of Consolidated Financial Condition & Results of
Operations
Management's discussion and analysis of the significant changes in financial
condition, results of operations, capital resources and liquidity presented in
the accompanying consolidated financial statements for Codorus Valley Bancorp,
Inc., (Codorus Valley or Corporation) a bank holding company, and its wholly
owned subsidiary, PeoplesBank, A Codorus Valley Company (PeoplesBank), are
provided below. Codorus Valley's consolidated financial condition and results of
operations consist almost entirely of PeoplesBank's financial condition and
results of operations. Current performance does not guarantee and may not be
indicative of similar performance in the future.
FORWARD-LOOKING STATEMENTS:
Management of the Corporation has made forward-looking statements in this Annual
Report. These forward-looking statements may be subject to risks and
uncertainties. Forward-looking statements include information concerning
possible or assumed future results of operations of the Corporation and its
subsidiaries. When words such as "believes," "expects," "anticipates" or similar
expressions occur in this Annual Report, management is making forward-looking
statements.
Shareholders should note that many factors, some of which are discussed
elsewhere in this report and in the documents that management incorporates by
reference, could affect the future financial results of the Corporation and its
subsidiaries, both individually and collectively, and could cause those results
to differ materially from those expressed in the forward-looking statements
contained or incorporated by reference in this Annual Report. These factors
include the following:
- operating, legal and regulatory risks;
- economic, political and competitive forces affecting banking,
securities, asset management and credit services businesses; and
- the risk that management's analyses of these risks and forces
could be incorrect and/or that the strategies developed to
address them could be unsuccessful.
The Corporation undertakes no obligation to publicly revise or update these
forward-looking statements to reflect events or circumstances that arise after
the date of this report. Readers should carefully review the risk factors
described in other documents that Codorus Valley files periodically with the
Securities and Exchange Commission.
CRITICAL ACCOUNTING ESTIMATES:
Disclosure of Codorus Valley's significant accounting policies is included in
Note 1 to the consolidated financial statements of this Annual Report. Some of
these policies are particularly sensitive, requiring that significant judgments,
estimates and assumptions be made by management. Additional information is
contained in Management's Discussion and Analysis for the most sensitive of
these issues, including the provision and allowance for loan losses, located on
pages 28 and 34 of this Annual Report.
Significant estimates are made by management in determining the allowance for
loan losses. Management considers a variety of factors in establishing this
estimate such as current economic conditions, diversification of the loan
portfolio, delinquency statistics, results of internal loan reviews, financial
and managerial strength of borrowers, adequacy of collateral, if collateral
dependent, or present value of future cash flows and other relevant factors.
Estimates related to the value of collateral also have a significant impact on
whether or not management continues to accrue income on delinquent loans and on
the amounts at which foreclosed real estate is recorded on the statement of
financial condition.
As permitted by SFAS No. 123, the Corporation accounts for stock-based
compensation in accordance with Accounting Principles Board Opinion (APB) No.
25. Under APB No. 25, no compensation expense is recognized in the income
statement related to any options granted under the Corporation's stock option
plans. The pro forma impact of net income and earnings per share that would
occur if compensation expense was recognized, based on the estimated fair value
of the options on the date of the grant, is disclosed in Note 13 to the
consolidated financial statements. The Corporation has no current plans to
change its method of accounting for stock-based compensation.
Overview
THE UNITED STATES ECONOMY
On November 6, 2002, the Federal Reserve Board (Fed) lowered the federal funds
rate one-half percent to 1.25 percent, its only interest rate change for 2002.
The national prime rate moved in lock step and ended the year at 4.25 percent.
Both benchmark interest rates were at 41-year lows. The year 2002 ended with
consumer confidence declining due to rising unemployment and a discouraging job
outlook. Other factors constraining economic growth throughout the year
included: the third of three consecutive years of stock market losses, an
occurrence not seen in the past 60 years; high profile accounting scandals and
bankruptcies; lackluster corporate earnings reports; and anxiety over terrorism
and possible military conflict around the world.
Comparatively, in January 2001, the Fed began a series of interest rate cuts to
stimulate an economy suffering from reduced demand. By March, the United States
economy was officially in recession. On September 11, the U.S. experienced the
worst terrorist attacks in its history, which further dampened the economy and
consumer confidence. The prime lending rate began the year at 9.5 percent. By
year-end, prime was 4.75 percent, its lowest level in 40 years. Throughout the
year, unemployment increased and for the second consecutive year stock market
indices reflected losses.
THE FINANCIAL SERVICES INDUSTRY
In the first nine months of 2002, commercial banks earned 23 percent more than
in the same period of 2001, based on the most current available information from
the FDIC. In spite of a
23
Management's Discussion of Consolidated Financial Condition & Results of
Operations
sluggish national economy, the industry is poised for a record earnings year.
The increase in earnings was due primarily to a 12 percent increase in net
interest income, which was positively impacted by an increase in earning assets
and lower funding costs. A 9 percent increase in noninterest income also
contributed to earnings growth. The increase in net interest income and
noninterest income more than offset a 26 percent increase in loan loss provision
expense. Approximately one-half of the increase in loan loss provision expense
this year came from losses associated with banks' international operations.
Credit-quality problems continued to grow in commercial and industrial loan
portfolios at large banks and the loss rate on credit cards remained high. Based
on the first three quarters of 2002 annualized, the 7,933 institutions that
comprised the commercial banking industry achieved a return on assets of 1.37
percent and a return on equity of 14.88 percent.
For the third consecutive year, bank stocks represented on the Nasdaq Bank Stock
Index outperformed the benchmark S&P 500 Index. The Nasdaq Bank Stock Index
increased 5 percent for 2002, 13 percent for 2001 and 19 percent for 2000.
Comparatively, the S&P500 Index declined 23 percent for 2002, 13 percent for
2001 and 9 percent for 2000.
Management believes that the industry will continue to consolidate, but at a
slower pace than in the past. Mergers and acquisitions will continue to be a
strategy to increase profits and market share. With an emphasis on strengthening
customer relationships and finding new ways to generate fee income, it is likely
that the industry will increase the diversity of financial products and
services. Management believes that industry consolidation and product
diversification may enhance its competitive position as a community bank.
BUSINESS STRATEGIES
Throughout 2002, management and the board of directors continued to implement a
series of initiatives, as guided by the Corporation's long-range strategic plan.
In September, PeoplesBank acquired the assets of Market Street Financial
Services, Inc. (Market Street Financial), an insurance agency. The addition of
Market Street Financial allows PeoplesBank to further its expertise in
investments and insurance, expand its product menu and increase fee income. In
December, PeoplesBank added its eleventh financial center, located at 221 West
Philadelphia Street in the Susquehanna Commerce Center in the City of York,
Pennsylvania. This marks the second banking office in the City of York.
Together, they provide the necessary presence to attract business banking
opportunities in that area. During the year, the Corporation's customer focused
culture was enhanced when management expanded its customer training program to
include support personnel. Partnered with fully trained line personnel, the
company strives to create an extraordinary experience for its customers. Looking
ahead, management plans to implement strategies to grow the banking franchise,
increase fee income and reduce operating expense.
FINANCIAL HIGHLIGHTS
The Corporation earned $3,101,000 or $1.15 per diluted share for 2002, compared
to $2,854,000 or $1.06 per diluted share for 2001, and $2,707,000 or $1.02 per
diluted share for 2000. All per share amounts were adjusted for stock dividends.
The $247,000 or 9 percent increase in current period net income was caused
primarily by an increase in noninterest income and a decrease in federal income
tax, which more than offset an increase in noninterest expense and loan loss
provision. The 42 percent increase in noninterest income was due primarily to
gains from the sale of residential mortgages and investment securities. The 27
percent decrease in federal income tax was due to tax credits received by
PeoplesBank from an investment in a real estate partnership that provides
low-income housing. The 7 percent increase in noninterest expense was caused
primarily by operating expenses attributable to corporate expansion. Expansion
during 2002 included the acquisition of an insurance agency in September and the
addition of a financial center in December. Current period expense was also
impacted by corporate expansion in 2001, and normal business growth. The 260
percent increase in the loan loss provision was the result of a higher level of
charge-offs, net of recoveries. During the fourth quarter of 2002, management
charged off as loss a group of related equipment financing contracts. Total
charge-offs relating to the equipment financing contracts amounted to $864,000
for calendar year 2002. Management believes that the loss on these contracts was
caused by external fraud and is presently seeking legal redress, including the
initiation of lawsuits with other defrauded financial institutions. A summary of
quarterly earnings for 2002 and 2001 is presented in Table 13--Summary of
Quarterly Financial Data.
Net income increased $147,000 or 5 percent in 2001, compared with 2000 due to
increases in net interest income and noninterest income, and a decrease in
federal income taxes. These favorable factors more than offset an increase in
noninterest expense. The 8 percent increase in net interest income was due to an
increase in the volume of earning assets, and a decrease in funding costs
attributable to lower market interest rates. The 15 percent increase in
noninterest income was caused primarily by an increase in fees from the sale of
investment products and real estate settlement services, and gains on the sale
of residential mortgages. The 12 percent decrease in federal income taxes was
due primarily to a $99,000 tax credit from an investment in a real estate
partnership for low-income housing. The 13 percent increase in noninterest
expense was caused primarily by the addition of two full service financial
centers, a mortgage banking operation, and a centralized call center in 2001.
Annual cash dividends per share, as adjusted, were $.47 for 2002, compared to
$.45 for 2001. Additionally, a 5 percent stock dividend was paid in 2002 and
2001. Book value per share, as adjusted, was $11.95 for year-end 2002, compared
to $10.90 for year-end 2001.
Net income as a percentage of average stockholders' equity (return
24
on equity or ROE), was 10.1 percent for 2002, compared to 10.0 percent for 2001.
Net income as a percentage of average total assets (return on assets or ROA),
was .91 percent for 2002 and 2001.
At December 31, 2002, nonperforming assets as a percentage of total loans and
net foreclosed real estate were approximately 2.55 percent, compared to 1
percent for year-end 2001. Information regarding nonperforming assets is
provided in the Risk Management section of this report, including Table
8-Nonperforming Assets. The allowance for loan losses as a percentage of total
loans was .65 percent at December 31, 2002, compared to .84 percent at December
31, 2001. Information regarding the allowance is provided in the Risk Management
section of this commentary, including Tables 9 and 10. Based on a recent
evaluation of probable loan losses and the current loan portfolio, management
believes that the allowance is adequate to support losses inherent in the
portfolio at December 31, 2002.
Throughout 2002, the Corporation maintained a capital level well above minimum
regulatory quantitative requirements. Currently, there are three federal
regulatory definitions of capital that take the form of minimum ratios. Table
7--Capital Ratios, shows that the Corporation and PeoplesBank were well
capitalized on December 31, 2002.
A more detailed analysis of the factors and trends affecting corporate earnings
follows.
Income Statement Analysis
NET INTEREST INCOME
The Corporation's principal source of revenue is net interest income, the
difference between interest income earned on loans and investment securities,
and interest expense incurred on deposits and borrowed funds. The fluctuation in
net interest income from year to year is caused by changes in interest rates,
volumes and the composition or mix of interest rate sensitive assets and
liabilities.
For analytical purposes, Table 1-Net Interest Income, Table 2-Rate/Volume
Analysis of Changes in Net Interest Income and Table 3-Average Balances and
Interest Rates, are presented on a tax equivalent basis to make it easier to
compare taxable and tax-exempt assets. Income from tax-exempt assets, primarily
loans to or securities issued by state and local governments, is increased by an
amount equivalent to the federal income taxes which would have been incurred if
the income was taxable at the statutory rate of 34 percent. Unless otherwise
noted, the discussion that follows is based on interest income and interest
expense as reported in the consolidated statements of income.
Net interest income was $11,767,000 for 2002; an increase of $36,000 or 0.3
percent above the $11,731,000 earned in 2001. In spite of a $23.7 million or 8
percent increase in average earning assets, net interest income was flat for
2002 due to abnormally low market interest rates, a reflection of the Federal
Reserve Board's accommodative monetary policy to stimulate a sluggish national
economy. For example, the federal funds rate ended the year at 1.25 percent and
the prime rate ended the year at 4.25 percent. Both benchmark interest rates
were at 41-year lows. For 2002, low market interest rates lowered yields on
earning assets to a greater degree than they lowered funding costs on interest
bearing liabilities. Interest income from loans for the current year was also
constrained by an increase in nonperforming loans. Earning assets averaged $310
million and yielded 6.75 percent (tax equivalent basis) for 2002 compared to
$287 million and 7.98 percent, respectively, for 2001. Asset growth occurred
primarily in investment securities and business loans. For the second
consecutive year, deposits experienced strong growth as investors sought safe
haven from widespread price declines in securities markets. Interest bearing
liabilities averaged $281 million at an average rate of 3.17 percent for 2002
compared to $257 million and 4.23 percent, respectively, for
TABLE 1 - NET INTEREST INCOME (TAX EQUIVALENT BASIS)
(dollars in thousands) 2002 2001 2000 1999 1998 5 YR CGR*
- --------------------------------------------------------------------------------------------------------------------------
Total interest income $ 20,674 $ 22,602 $ 21,904 $ 20,314 $ 19,978 1.2%
Tax equivalent adjustment 277 288 249 192 149 n/a
- ------------------------------------------------------------------------------------------------------------------------
Adjusted total interest income 20,951 22,890 22,153 20,506 20,127 1.3%
Total interest expense 8,907 10,871 11,064 9,534 9,265 -0.4%
- ------------------------------------------------------------------------------------------------------------------------
Net interest income $ 12,044 $ 12,019 $ 11,089 $ 10,972 $ 10,862 2.7%
Average earning assets $310,431 $286,777 $264,174 $253,800 $237,378 6.3%
Average interest bearing liabilities $281,062 $257,262 $237,537 $228,163 $211,754 6.6%
Yield on earning assets 6.75% 7.98% 8.39% 8.08% 8.48%
Rate on interest bearing liabilities 3.17% 4.23% 4.66% 4.18% 4.38%
- ------------------------------------------------------------------------------------------------------------------------
Interest rate spread 3.58% 3.75% 3.73% 3.90% 4.10%
Net yield on average earning assets 3.88% 4.19% 4.20% 4.32% 4.58%
========================================================================================================================
* Compound growth rate (CGR) is the average annual growth over the five-year
period which began in 1997.
25
Management's Discussion of Consolidated Financial Condition & Results of
Operations
TABLE 2 - RATE/VOLUME ANALYSIS OF CHANGES IN NET INTEREST INCOME (TAX EQUIVALENT
BASIS)
YEAR ENDED 2002 COMPARED TO 2001
DECEMBER 31, INCREASE CHANGE DUE TO
(dollars in thousands) 2002 2001 (DECREASE) VOLUME RATE
- ---------------------------------------------------------------------------------------------------------
Interest Income
Interest bearing deposits with banks $ 5 $ 13 $ (8) $ 0 $ (8)
Federal funds sold 224 562 (338) (108) (230)
Securities, taxable 2,693 2,468 225 1,211 (986)
Securities, tax-exempt 791 827 (36) (30) (6)
Loans, taxable 17,216 18,999 (1,783) 739 (2,522)
Loans, tax-exempt 22 21 1 13 (12)
- ---------------------------------------------------------------------------------------------------------
Total interest income 20,951 22,890 (1,939) 1,825 (3,764)
Interest Expense
Deposits
Interest bearing demand 1,201 1,801 (600) 420 (1,020)
Savings 131 219 (88) (11) (77)
Time deposits under $100,000 5,154 6,222 (1,068) 95 (1,163)
Time deposits $100,000 and above 1,212 1,462 (250) 137 (387)
Short-term borrowings 10 7 3 34 (31)
Long-term debt 1,199 1,160 39 23 16
- ---------------------------------------------------------------------------------------------------------
Total interest expense 8,907 10,871 (1,964) 698 (2,662)
- ---------------------------------------------------------------------------------------------------------
Net interest income $12,044 $12,019 $ 25 $ 1,127 $(1,102)
=========================================================================================================
YEAR ENDED 2001 COMPARED TO 2000
DECEMBER 31, INCREASE CHANGE DUE TO
(dollars in thousands) 2001 2000 (DECREASE) VOLUME RATE
- ---------------------------------------------------------------------------------------------------------
Interest Income
Interest bearing deposits with banks $ 13 $ 13 $ 0 $ 0 $ 0
Federal funds sold 562 166 396 875 (479)
Securities, taxable 2,468 2,910 (442) (469) 27
Securities, tax-exempt 827 717 110 101 9
Loans, taxable 18,999 18,331 668 1,293 (625)
Loans, tax-exempt 21 16 5 5 0
- ---------------------------------------------------------------------------------------------------------
Total interest income 22,890 22,153 737 1,805 (1,068)
Interest Expense
Deposits
Interest bearing demand 1,801 1,960 (159) 363 (522)
Savings 219 364 (145) (73) (72)
Time deposits under $100,000 6,222 6,309 (87) 209 (296)
Time deposits $100,000 and above 1,462 1,129 333 464 (131)
Short-term borrowings 7 607 (600) (601) 1
Long-term debt 1,160 695 465 555 (90)
- ---------------------------------------------------------------------------------------------------------
Total interest expense 10,871 11,064 (193) 917 (1,110)
- ---------------------------------------------------------------------------------------------------------
Net interest income $12,019 $11,089 $ 930 $ 888 $ 42
=========================================================================================================
Changes which are due to both volume and rate are allocated in proportion to
their relationship to the amount of Change attributed directly to volume or
rate. Taxable loans include loan fees of $955,000 in 2002, $639,000 in 2001, and
$526,000 in 2000.
26
2001. Funding was provided primarily by growth in interest bearing demand
deposits. The same factors that constrained net interest income also constrained
the net yield on average earning assets, which was 3.88 percent for 2002
compared to 4.19 percent for 2001.
Comparatively, net interest income was $11,731,000 for 2001; an increase of
$891,000 or 8 percent above the $10,840,000 earned in 2000. Net interest income
increased due to an increase in the volume of earning assets, and a decrease in
funding costs attributable to lower market interest rates. Market interest rates
declined sharply throughout 2001, a result of Federal Reserve Board action to
stimulate a sluggish national economy. For example, the prime lending rate was
9.5 percent at the beginning of the year. By year-end, the prime rate was 4.75
percent, its lowest level in 40 years. Declining market interest rates lowered
yields on earning assets but also lowered funding costs. Earning assets averaged
$287 million for 2001 and yielded 7.98 percent (tax equivalent basis) compared
to $264 million and 8.39 percent, respectively, for 2000. Asset growth occurred
primarily in business loans and overnight investments. Deposits experienced
strong growth as investors sought refuge from widespread price declines in
securities markets. Interest bearing liabilities averaged $257 million at an
average rate of 4.23 percent for 2001 compared to $238 million and 4.66 percent,
respectively, for 2000. Funding was provided primarily by growth in money market
and time deposits.
TABLE 3 - AVERAGE BALANCES AND INTEREST RATES (TAX EQUIVALENT BASIS)
2002 2001 2000
--------------------------------------------------------------------------------------
AVERAGE AVERAGE AVERAGE
(dollars in thousands) BALANCE INTEREST RATE BALANCE INTEREST RATE BALANCE INTEREST RATE
- ----------------------------------------------------------------------------------------------------------------------------------
Assets
Interest bearing deposits with banks $ 231 $ 5 2.16% $ 239 $ 13 5.44% $ 240 $ 13 5.42%
Federal funds sold 13,336 224 1.68 16,513 562 3.40 2,633 166 6.30
Investment securities
Taxable 56,277 2,693 4.79 37,748 2,468 6.54 45,003 2,910 6.47
Tax-exempt 10,803 791 7.32 11,204 827 7.38 9,820 717 7.30
- ----------------------------------------------------------------------------------------------------------------------------------
Total investment securities 67,080 3,484 5.19 48,952 3,295 6.73 54,823 3,627 6.62
Loans
Taxable (1) 229,479 17,216 7.50 220,885 18,999 8.60 206,332 18,331 8.88
Tax-exempt 305 22 7.21 188 21 11.17 146 16 10.96
- ----------------------------------------------------------------------------------------------------------------------------------
Total loans 229,784 17,238 7.50 221,073 19,020 8.60 206,478 18,347 8.89
- ----------------------------------------------------------------------------------------------------------------------------------
Total earning assets 310,431 20,951 6.75 286,777 22,890 7.98 264,174 22,153 8.39
Other assets (2) 31,972 25,773 24,998
- ----------------------------------------------------------------------------------------------------------------------------------
Total assets $342,403 $312,550 $289,172
==================================================================================================================================
Liabilities and Stockholders' Equity
Interest bearing deposits
Interest bearing demand $102,581 $ 1,201 1.17% $ 83,172 $ 1,801 2.17% $ 70,183 $ 1,960 2.79%
Savings 13,615 131 0.96 14,348 219 1.53 17,934 364 2.03
Time deposits under $100,000 115,773 5,154 4.45 114,026 6,222 5.46 110,368 6,309 5.72
Time deposits $100,000 and above 29,243 1,212 4.14 26,737 1,462 5.47 18,949 1,129 5.96
- ----------------------------------------------------------------------------------------------------------------------------------
Total interest bearing deposits 261,212 7,698 2.95 238,283 9,704 4.07 217,434 9,762 4.49
Short-term borrowings 591 10 1.69 101 7 6.93 9,603 607 6.32
Long-term debt 19,259 1,199 6.23 18,878 1,160 6.14 10,500 695 6.62
- ----------------------------------------------------------------------------------------------------------------------------------
Total interest bearing liabilities 281,062 8,907 3.17 257,262 10,871 4.23 237,537 11,064 4.66
Noninterest bearing deposits 27,690 25,165 24,162
Other liabilities 2,895 1,569 1,276
Stockholders' equity 30,756 28,554 26,197
- ----------------------------------------------------------------------------------------------------------------------------------
Total liabilities and
stockholders' equity $342,403 $312,550 $289,172
==================================================================================================================================
Net interest income $ 12,044 $ 12,019 $ 11,089
- ----------------------------------------------------------------------------------------------------------------------------------
Interest rate spread 3.58% 3.75% 3.73%
- ----------------------------------------------------------------------------------------------------------------------------------
Net yield on earning assets 3.88% 4.19% 4.20%
- ----------------------------------------------------------------------------------------------------------------------------------
(1) Includes loan fees of $955,000 in 2002, $639,000 in 2001 and $526,000 in
2000.
(2) Includes average nonaccrual loans of $3,825,000 in 2002, $1,759,000 in
2001, and $2,528,000 in 2000.
27
Management's Discussion of Consolidated Financial Condition & Results of
Operations
PROVISION FOR LOAN LOSSES
The provision for probable loan losses is an estimated expense charged to
earnings to address losses attributable to uncollectible loans. The provision
reflects management's judgement of an appropriate level for the allowance for
loan losses. The Risk Management section, including Tables 8, 9, and 10, of this
report, provides detailed information about the allowance, provision and credit
risk. For 2002, the provision expense for probable loan losses was $515,000,
compared to $143,000 for 2001 and $119,000 for 2000. The level of expense for
2002 reflected an increase in loan charge-offs, net of recoveries, for the year.
During the fourth quarter of 2002, management charged off, as a loss, a group of
related equipment financing contracts. Total charge-offs relating to the
equipment financing contracts amounted to $864,000 for calendar year 2002.
Management believes that the loss on these contracts was caused by external
fraud and is presently seeking legal redress, including the initiation of
lawsuits with other defrauded financial institutions. Other factors that
impacted the provision for 2002 included an increase in the nonperforming loan
portfolio and continued concern over the sluggish national and local economies.
The level of expense for 2001 was responsive to loan growth and a national and
local economic slowdown. The level of expense for 2000 was reflective of loan
growth.
NONINTEREST INCOME
Total noninterest income for 2002 was $3,534,000, an increase of $1,038,000 or
42 percent above 2001. The increase was caused primarily by increases in gains
from the sale of residential mortgages and investment securities. Gains from the
sale of mortgages were up $613,000 or 386 percent. The increase reflected a full
year of operation for the mortgage banking unit and low market interest rates,
which fueled a mortgage refinance boom. The current period also included
$179,000 in net gains from the sale of securities. Comparatively, no gains were
realized from the sale of securities in 2001. Increases in the remaining
categories of noninterest income, with the exception of other income, were due
primarily to normal business growth. The increase in other income for the
current period was due in part to fees from sales of investment and insurance
products by an insurance agency, the assets of which were acquired by
PeoplesBank in September 2002. This acquisition is described below.
Total noninterest income for 2001 was $2,496,000, an increase of $332,000 or 15
percent above 2000. The increase was caused primarily by gains from the sale of
residential mortgages and an increase in other income. Gains from the sale of
mortgages, which totaled $159,000, were generated from a mortgage banking unit
that began operation in fourth quarter 2001. The $129,000 or 24 percent increase
in other income was caused primarily by an increase in fees from the sale of
investment products and real estate settlement services sold through
PeoplesBank's subsidiaries.
Acquisition of insurance agency
In September 2002, PeoplesBank purchased the assets, principally the customer
list, of Market Street Financial Services, Inc., an insurance agency. The
acquisition cost, including contingent consideration, is not significant to the
Corporation's financial condition. Presently, the staff of six, which includes
the two former owners, is comprised of five licensed sales representatives and
one administrator. Plans call for this operation to relocate to the Codorus
Valley Corporate Center in 2003. The customer list intangible asset will be
amortized on a straight-line basis over a 15-year period, the estimated
retention period of its customers. Management believes that the acquisition
enables PeoplesBank to expand its investment and insurance product menu and
expertise, increase fee income and provide greater convenience to its clients.
NONINTEREST EXPENSE
Generally, increases in noninterest expense for 2002, 2001, and 2000 reflect the
implementation of strategic initiatives to expand, staff and equip the
organization, in addition to normal business growth. Long-term capital
investments made during this three-year period were necessary to position
Codorus Valley for future expansion and increase its service capabilities.
Total noninterest expense for 2002 was $11,008,000, an increase of $710,000 or 7
percent above 2001. The increase was caused primarily by increases in salaries
and benefits and other expense. Salaries and benefits increased $724,000 or 14
percent due primarily to planned corporate expansion. The current year included
the full year cost of prior year initiatives, including the addition of two
financial centers, a mortgage banking operation and a centralized telephone call
center. Current year salaries and benefits expense also included 2002
initiatives such as the acquisition of an insurance agency in September and the
addition of a financial center in December. Other expense increased $236,000 or
14 percent due to a $35,000 loss on a fraudulent check, increases in selected
expenses such as memberships and subscriptions, appraisals, loan expenses,
employee training, seminars and business meetings, insurance, and normal
business growth. Current year foreclosed real estate expense decreased $168,000
or 70 percent. The prior year reflected a higher level of carrying costs and
loss provisions attributable to a larger portfolio of acquired properties.
Current year professional and legal expense decreased $80,000 or 26 percent. The
prior year reflected a higher level of expense caused by increased information
technology consulting and services, legal advice for arbitration matters and
consulting advice relative to future growth strategies.
Total noninterest expense for 2001 was $10,298,000, an increase of $1,174,000 or
13 percent above 2000. The increase in noninterest expense was caused by
increases in all expense categories driven primarily by corporate expansion. The
addition of two financial centers, a mortgage banking operation and a
centralized call center in 2001 caused the following
28
expense categories to increase: salaries and benefits, up $457,000 or 9%;
furniture and equipment, up $48,000 or 5%; stationery and supplies, up $55,000
or 16%; and marketing, up $45,000 or 12%. Occupancy expense, which increased
$208,000 or 33%, was also impacted by expansion, in addition to increased
expense for maintenance, repairs and energy costs, and a decrease in rental
income. Professional and legal expenses increased $115,000 or 60% due to
increases in information technology consulting and services, legal advice for
arbitration matters and consulting advice relative to future growth strategies.
Foreclosed real estate expense increased $100,000 or 72% due primarily to
increased carrying costs associated with assets taken in satisfaction of debt.
Other expense increased $146,000 or 9% due primarily to a $64,000 prepayment
penalty associated with refinancing a Federal Home Loan Bank loan to lower
future funding costs. Other expense also included a $41,000 loss from a merchant
credit card account described in Note 16-Contingent Liabilities of this report.
Franchise expansion
In December, PeoplesBank opened its eleventh financial center. This new full
service office is located at 221 West Philadelphia Street, in the City of York,
Pennsylvania. The 2,814 square foot facility, leased under an eight-year
operating lease, with renewal options, is located within the newly constructed
Susquehanna Commerce Center. This marks the second banking office in the City of
York. Together, they provide the necessary presence to attract business banking
opportunities in that area.
Capital investment in technology
In accordance with the Corporation's strategic technology plan, PeoplesBank
accomplished a key technology goal during 2002. In September, PeoplesBank
completed automation of the teller function in all financial centers. Capital
investment in teller automation software and printers is expected to increase
productivity and quality control, and increase fee income. Management also
expects the new system to enhance sales and corporate image.
INCOME TAXES
The provision for federal income tax was $677,000 for 2002, compared to $932,000
for 2001. The $255,000 or 27 percent decrease resulted primarily from the
recognition of $372,000 in tax credits from PeoplesBank's investment, as a
limited partner, in a real estate venture that provides low-income housing. Tax
credits were maximized in 2002 because they included historic rehabilitation tax
credits, which are only available in the year in which rehabilitation
construction is complete. Future tax credits from this investment will be
limited to low-income housing credits. Details about this real estate
partnership are provided under the Other Assets subheading within the Balance
Sheet Review section of this report. Comparatively, the provision for 2001
decreased $122,000 or 12 percent below 2000. The decrease resulted primarily
from the recognition of a $99,000 tax credit from the low-income housing
investment described earlier. An increase in tax-exempt income as a percentage
of total income also contributed to the decrease in tax for 2001.
Balance Sheet Review
INVESTMENT SECURITIES
The investment securities portfolio is an interest earning asset, second in size
to the loan portfolio. Investment securities serve as an important source of
revenue, a primary source of liquidity, and as collateral for public and trust
deposits.
On December 31, 2002, securities available-for-sale were $70.4 million
reflecting a $32 million increase above December 31, 2001. Decisions to purchase
or sell securities are based on an assessment of current economic and financial
conditions, including the interest rate environment, liquidity and income
requirements. Securities available-for-sale are limited to high quality debt
instruments as depicted in Note 3--Securities Available-for-Sale and
Held-to-Maturity. Equity securities within this category are primarily stock
issued by the Federal Home Loan Bank of Pittsburgh (FHLBP), a requirement of
borrowing. Note 3 shows an increase in net unrealized gains on the
available-for-sale portfolio at year-end 2002 compared to year-end 2001. The
increase in unrealized gains was attributable to declining market interest rates
during 2002. Table 4--Analysis of Investment Securities shows that the
available-for-sale portfolio yielded 4.59 percent with an average maturity of
3.1 years on December 31, 2002, compared to 6.01 percent and 3.5 years,
respectively, on December 31, 2001. The decrease in yield during the current
period was a result of low market interest rates.
On December 31, 2002, securities held-to-maturity were $9.4 million,
approximately the same level as year-end 2001. The held-to-maturity portfolio
consisted of fixed rate, long-term preferred stock (trust preferreds) issued by
commercial bank holding companies. These trust preferreds are substantially
junior subordinated debt, pay interest semi-annually, are callable, and mature
in years 2026-2028. Table 4 shows the portfolio as having a weighted average
yield of 8.43 percent and a weighted average remaining maturity of 24 years as
of December 31, 2002. Approximately $5.6 million, held by PeoplesBank, are rated
investment grade by a national rating service. The remaining $3.8 million, held
by the Corporation, are either not rated or rated below investment grade.
Generally, investment was limited to $500,000 per issuer based on an analysis of
the issuer's financial and strategic history. The trust preferred portfolio,
part of a leverage growth strategy in a prior period, was financed primarily by
borrowing from the FHLBP and a local financial institution.
LOANS
On December 31, 2002, total loans were $234 million, an increase of
approximately $8 million or 4 percent above yearend 2001. Table 5--Loan
Portfolio Composition presents the
29
Management's Discussion of Consolidated Financial Condition & Results of
Operations
TABLE 4 - ANALYSIS OF INVESTMENT SECURITIES (AMORTIZED COST BASIS)
CORPORATE WEIGHTED
U.S. U.S. STATE & EQUITY TRUST AVERAGE
(Dollars in thousands) TREASURIES AGENCIES(1) MUNICIPALS SECURITIES PREFERRED TOTAL YIELD(2)
- ---------------------------------------------------------------------------------------------------------------------------
DECEMBER 31, 2002
Available-for-sale
Maturity
Within one year $ 1,004 $ 7,461 $ 8,465 4.50%
One to five years 47,833 3,279 51,112 4.20
Five to ten years 5,601 5,601 7.25
Over ten years 1,594 1,594 7.98
No set maturity 1,503 1,503
- ------------------------------------------------------------------------------------------------------------------------
Total $ 1,004 $55,294 $10,474 $ 1,503 $ 0 $ 68,275 4.59
========================================================================================================================
Average maturity 3.1 YEARS
Held-to-maturity
Maturity
Over ten years $ 0 $ 0 $ 0 $ 0 $ 9,357 $ 9,357 8.43%
- ------------------------------------------------------------------------------------------------------------------------
Total $ 0 $ 0 $ 0 $ 0 $ 9,357 $ 9,357 8.43
========================================================================================================================
Average maturity 24.2 YEARS
DECEMBER 31, 2001
Available-for-sale
Maturity
Within one year $10,235 $ 10,235 5.68%
One to five years 15,667 2,676 18,343 5.60
Five to ten years 4,756 4,756 6.92
Over ten years 3,439 3,439 7.89
No set maturity 941 941
- ------------------------------------------------------------------------------------------------------------------------
Total $ 0 $25,902 $10,871 $ 941 $ 0 $ 37,714 6.01
========================================================================================================================
Average maturity 3.5 years
Held-to-maturity
Maturity
Over ten years $ 0 $ 0 $ 0 $ 0 $ 9,358 $ 9,358 8.44%
- ------------------------------------------------------------------------------------------------------------------------
Total $ 0 $ 0 $ 0 $ 0 $ 9,358 $ 9,358 8.44
========================================================================================================================
Average maturity 25.2 years
DECEMBER 31, 2000
Available-for-sale
Maturity
Within one year $10,868 $ 10,868 5.69%
One to five years 13,687 2,849 16,536 6.54
Five to ten years 1,500 2,770 4,270 6.48
Over ten years 5,457 5,457 7.55
No set maturity 3,251 3,251
- ------------------------------------------------------------------------------------------------------------------------
Total $ 0 $26,055 $11,076 $ 3,251 $ 0 $ 40,382 6.42
========================================================================================================================
Average maturity 3.9 years
Held-to-maturity
Maturity
Over ten years $ 0 $ 0 $ 0 $ 0 $ 9,360 $ 9,360 8.44%
- ------------------------------------------------------------------------------------------------------------------------
Total $ 0 $ 0 $ 0 $ 0 $ 9,360 $ 9,360 8.44
========================================================================================================================
Average maturity 26.2 years
(1) U.S. agency mortgage-backed instruments are included in the maturity
categories based on average expected life.
(2) Yields on tax-exempt obligations were computed on a tax equivalent basis
using a 34% tax rate.
30
composition of total loans on a comparative basis for five yearend periods. The
table reflects the Corporation's emphasis on commercial lending. At year-end
2002, commercial loans increased approximately $8 million or 5 percent above
year-end 2001. The level of consumer loans and residential mortgages was
comparable for year-end 2002 and year-end 2001. During 2001, PeoplesBank created
a mortgage banking operation. The mortgage banking staff focuses on originating
and selling residential mortgages without retaining servicing rights. These
loans are classified on the balance sheet as loans held for sale. On December
31, 2002, loans held for sale were $4.6 million compared to $12.3 million for
year-end 2001.
Table 6--Selected Loan Maturities and Interest Rate Sensitivity shows that, at
December 31, 2002, the commercial loan portfolio was divided almost evenly
between $92 million in fixed rate loans and $90 million in floating or
adjustable rate loans. Comparatively, at December 31, 2001, the commercial loan
portfolio was comprised of $114 million, or 66 percent, in fixed rate loans and
$60 million, or 34 percent, in floating or adjustable rate loans. The increase
in floating rate loans in 2002 was due to their price being lower than fixed
rate loans, which made them attractive to business clients. Floating rate loans
reprice periodically with changes in PeoplesBank's base rate, the Prime rate or
the LIBOR as reported in the Wall Street Journal. Adjustable rate loans reprice
at annual intervals based on the US treasury yield curve. Additional loan
information can be found in Note 4--Loans, and within the Risk Management
section of this report.
OTHER ASSETS
Included in other assets at December 31, 2002, is PeoplesBank's remaining $2.2
million investment in a real estate venture whose purpose is to rehabilitate and
operate seven buildings in the City of York (Pennsylvania) as part of a
revitalization initiative. PeoplesBank, is a limited partner that holds a 99.99
percent interest in the partnership. The buildings provide low-income housing to
qualified families, and to a lesser degree, space for commercial purposes.
PeoplesBank's role in the partnership is solely as an investor, whose return is
in the form of federal tax credits which will be realized over a ten year period
ending 2012.
In the first quarter of 2003, PeoplesBank committed to invest $2.8 million in an
unrelated real estate venture whose purpose is to construct 60 new townhouses
and rent them to people who qualify for low-income housing. Actual disbursement
is scheduled to be made in installments throughout the remainder of 2003 with
project completion scheduled by the end of the year. PeoplesBank, will be a
limited partner that holds a 73 percent interest in the partnership. Its role in
the partnership will be solely as an investor, whose return is in the form of
federal tax credits which will be realized over a ten year period ending 2013.
TABLE 5 - LOAN PORTFOLIO COMPOSITION
DECEMBER 31,
(dollars in thousands) 2002 % 2001 % 2000 % 1999 % 1998 %
- ------------------------------------------------------------------------------------------------------------------------------------
Commercial, industrial and
agricultural $161,425 69.0 $152,112 67.3 $140,388 64.4 $131,395 63.4 $114,313 60.4
Real estate-construction and
land development 20,596 8.8 21,889 9.7 19,365 8.9 21,956 10.6 19,663 10.4
- -----------------------------------------------------------------------------------------------------------------------------------
Total commercial related loans 182,021 77.8 174,001 77.0 159,753 73.3 153,351 74.0 133,976 70.8
Real estate-residential mortgages 24,803 10.6 24,799 11.0 30,831 14.2 29,815 14.4 31,581 16.7
Installment 27,136 11.6 26,985 12.0 27,342 12.5 24,152 11.6 23,554 12.5
- -----------------------------------------------------------------------------------------------------------------------------------
Total consumer related loans 51,939 22.2 51,784 23.0 58,173 26.7 53,967 26.0 55,135 29.2
- -----------------------------------------------------------------------------------------------------------------------------------
Total loans $233,960 100.0 $225,789 100.0 $217,926 100.0 $207,318 100.0 $189,111 00.0
===================================================================================================================================
TABLE 6 - SELECTED LOAN MATURITIES AND INTEREST RATE SENSITIVITY
DECEMBER 31, 2002
YEARS TO MATURITY
(dollars in thousands) 1 OR LESS 1 TO 5 OVER 5 TOTAL
- -----------------------------------------------------------------------------------
Commercial, industrial and agricultural $ 12,900 $ 39,430 $109,095 $161,425
Real estate-construction and land
development 10,709 6,469 3,418 20,596
- -----------------------------------------------------------------------------------
Total commercial related $ 23,609 $ 45,899 $112,513 $182,021
===================================================================================
Fixed interest rates $ 2,714 $ 28,271 $ 60,617 $ 91,602
Floating or adjustable interest rates 20,895 17,628 51,896 90,419
- -----------------------------------------------------------------------------------
Total commercial related $ 23,609 $ 45,899 $112,513 $182,021
===================================================================================
31
Management's Discussion of Consolidated Financial Condition & Results of
Operations
Funding
DEPOSITS
Deposits are a principal source of funding for earning assets. On December 31,
2002, total deposits were $293 million, reflecting a $16 million or 6 percent
increase above year-end 2001. Most of the increase occurred in demand and money
market deposits. Management believes that bank deposits continued to provide a
safe haven to customers seeking protection from widespread price declines in
securities markets, now occurring for three consecutive years. The addition of
two financial centers in the prior year also contributed to deposit growth. The
average rate paid on interest bearing deposits was 2.95 percent for 2002
compared to 4.07 percent for 2001. The reduction in the rate for 2002 reflected
unusually low market interest rates. A comparative breakdown of deposits is
located in Note 8-Deposits.
On December 31, 2002, total certificates of deposit were $141 million, scheduled
to mature in the following years: $67 million in 2003, $35 million in 2004, $24
million in 2005, $4 million in 2006 and $11 million in 2007. At 2002 year-end,
the balance of certificates $100,000 and above was $26 million. Of this total:
$7.9 million mature within three months; $2.3 million mature after three months
but within six months; $3.8 million mature after six months but within twelve
months; and the remaining $12 million mature beyond twelve months.
SHORT-TERM BORROWINGS AND LONG-TERM DEBT
To meet day-to-day funding needs, PeoplesBank may borrow from larger
correspondent banks in the form of federal funds purchased. It also uses credit
available at the Federal Home Loan Bank of Pittsburgh (FHLBP). Interest rates
are established daily based on prevailing market conditions for overnight funds.
On December 31, 2002, PeoplesBank had $7 million in outstanding short-term
borrowings. Comparatively, on December 31, 2001, PeoplesBank had no outstanding
short-term borrowings.
Long-term debt is a primary funding source for asset growth. On December 31,
2002, long-term debt was $16.2 million, which was $3.4 million below year-end
2001. The decrease in long-term debt primarily reflected the maturity of a $3
million FHLBP note in December 2002. A listing of outstanding long-term debt
instruments is provided in Note 9--Short-term Borrowings and Long-term Debt.
Generally, funds for the payment of long-term debt come from operations and
refinancings.
PeoplesBank's maximum borrowing capacity, as established quarterly by the FHLBP,
was approximately $99 million as of September 30, 2002, the most recent
available date. On December 31, 2002, PeoplesBank had approximately $21 million
outstanding on its account with the FHLBP at an average rate of 4.17 percent.
STOCKHOLDERS' EQUITY AND CAPITAL ADEQUACY
Stockholders' equity, or capital, is a source of funds, which enables the
Corporation to maintain asset growth and absorb losses. Total stockholders'
equity was $32.2 million on December 31, 2002, compared to $29.4 million for
year-end 2001. The increase in equity was primarily attributable to an increase
in retained earnings from profitable operations and an increase in unrealized
holding gains on available-for-sale investment securities caused by declining
market interest rates.
The Corporation and PeoplesBank are subject to various regulatory capital
requirements administered by banking regulators that involve quantitative
guidelines and qualitative judgements. Quantitative measures established by
regulators pertain to minimum capital ratios, as set forth in Table 7--Capital
Ratios. Table 7 provides a comparison of the Corporation's and PeoplesBank's
risk-based capital ratios and leverage ratios to the minimum regulatory
requirement for the periods indicated.
The Corporation typically pays cash dividends on a quarterly basis. The board of
directors determines the dividend rate after considering the Corporation's
capital requirements, current and projected net income, and other factors.
Annual cash dividends on a per common share basis, were $.47 for 2002 and $.45
for 2001. All per share amounts were adjusted for stock dividends.
Periodically, the Corporation pays stock dividends as another means of enhancing
long-term shareholder value. In June of 2002 and 2001, the Corporation paid a 5
percent stock dividend. Payment of the stock dividend in 2002 resulted in the
issuance of 127,927 additional common shares. Payment of the stock dividend in
2001 resulted in the issuance of 107,238 common shares and the reissuance of
14,500 common shares from treasury. The weighted average number of shares of
common stock outstanding, restated for the stock dividend, was 2,693,361 for
2002, 2,691,242 for 2001, and 2,666,615 for 2000.
As previously disclosed in this report, the Corporation maintains various
employee, director and shareholder benefit plans that could result in the
issuance of its common stock. Information about these plans can be found in Note
10--Stockholders' Equity, Note 12--Benefit Plans, and Note 13--Stock Option
Plans of the consolidated financial statements.
Capital investments made in earlier periods, as described in previous SEC
filings, and future investments will impact current and future earnings and
capital growth. Possible future investments may be made to expand the
Corporation's banking franchise and its technological capabilities and to create
or acquire financial services companies. Management and the board believe that
capital investment, guided by a long range strategic plan, is necessary to
develop an infrastructure to grow market share and net income over the long-term
and is an important strategy for enhancing long-term shareholder value.
Risk Management
During 2002, the Corporation created a Risk Management Committee, which meets at
least quarterly and includes members
32
of senior management and an independent director. The objective of the Committee
is to identify and manage risk inherent in the operations of the Corporation and
its affiliates. The Committee's risk review is broad in scope and includes the
following risks: credit, interest rate, liquidity, price, transaction,
compliance, strategic and reputation. One of its primary responsibilities is to
develop and implement formal risk management policies and procedures, and
monitor compliance.
CREDIT RISK MANAGEMENT
The Corporation emphasizes the management of credit risk. To support this
objective a sound lending policy framework has been established. Within this
framework are six basic policies that guide the lending process and minimize
risk. First, the Corporation follows detailed written lending policies and
procedures. Second, loan approval authority is granted commensurate with dollar
amount, loan type, level of risk, and loan officer experience. Third, loan
review committees function at both the senior lending officer level and the
board level to review and authorize loans that exceed preestablished dollar
thresholds and/or meet other criteria. Fourth, the Corporation directly lends
mainly within its primary geographical market area, York County, Pennsylvania
and northern Maryland. Although this may pose a geographical concentration risk,
the diverse local economy and employee knowledge of customers minimizes this
risk. Fifth, the loan portfolio is diversified to prevent dependency upon a
single customer or small group of related customers. And sixth, the Corporation
does not lend to foreign countries or persons residing therein.
In addition to a comprehensive lending policy, numerous internal reviews of the
loan and foreclosed real estate portfolios occur throughout the year. In
addition to internal controls, PeoplesBank uses an independent loan review
specialist to review its commercial loan portfolio. Furthermore, these
portfolios are reviewed by independent auditors in connection with their annual
financial statement audit, and are examined periodically by bank regulators.
At year-end 2002, the total loan portfolio included one industry concentration
that exceeded 10 percent. The commercial leasing industry accounted for
approximately $36.8 million or 16 percent of total loans at year-end 2002,
compared to $47.3 million and 21 percent, respectively, for year-end 2001. Loans
to borrowers within this industry are collateralized by real estate.
NONPERFORMING ASSETS
Table 8-Nonperforming Assets, shows asset categories posing the greatest risk of
loss. Management generally places a loan on nonaccrual status and ceases
accruing interest income when loan payment performance is unsatisfactory and the
loan is past due 90 days or more. Loans past due 90 days or more and still
accruing interest, are contractually past due, but well collateralized and in
the process of collection. The final category, foreclosed real estate, is
acquired to satisfy debts owed to PeoplesBank. Table 8 also provides a summary
of nonperforming assets and related ratios. The paragraphs below explain the
changes within each classification on that table for December 31, 2002, compared
to December 31, 2001.
For all reporting periods, nonaccrual loans were principally comprised of
collateral dependent commercial loans. Accordingly, the Corporation recognizes
interest income on a cash basis for these loans. On December 31, 2002, the
nonaccrual loan portfolio was $5,051,000, an increase of $3,640,000 or 258
percent above
TABLE 7 - CAPITAL RATIOS
FEDERAL FEDERAL CAPITAL*
DECEMBER 31, MINIMUM WELL AT DECEMBER 31,
(dollars in thousands) 2002 2001 REQUIRED CAPITALIZED 2002 2001
- ------------------------------------------------------------------------------------------------------------------
Tier I risk-based capital 4.00% 6.00%
(as a percentage of risk weighted assets)
Codorus Valley Bancorp, Inc. consolidated 11.32% 10.88% $30,475 $28,932
PeoplesBank 9.86 9.23 25,946 23,919
Total risk-based capital 8.00% 10.00%
(as a percentage of risk weighted assets)
Codorus Valley Bancorp, Inc. consolidated 11.88% 11.59% $31,990 $30,829
PeoplesBank 10.44 9.96 27,461 25,816
Leverage 4.00% 5.00%
(Tier 1 capital as a percentage of average
total assets)
Codorus Valley Bancorp, Inc. consolidated 8.93% 9.27% $30,475 $28,932
PeoplesBank 7.75 7.86 25,946 23,919
* Net unrealized gains and losses on securities available-for-sale, net of
taxes, are disregarded for capital ratio computation purposes in accordance
with federal regulatory banking guidelines.
33
Management's Discussion of Consolidated Financial Condition & Results of
Operations
December 31, 2001. The increase was caused primarily by the addition of two
unrelated business loan accounts. At year end 2002, one account had an
outstanding principal balance of $2,647,000, and the other account had an
outstanding principal balance of $1,230,000. Management believes that both loan
accounts are adequately collateralized to recover principal. On December 31,
2002, the nonaccrual loan portfolio was comprised of fifteen unrelated accounts
ranging in size from $14,000 to $2,647,000. These loan relationships vary by
industry and are generally collateralized with real estate assets. A loss
allowance is evaluated, at least quarterly, by management and the board of
directors. Efforts to modify contractual terms for individual accounts, based on
prevailing market conditions, or liquidate collateral assets, are proceeding as
quickly as potential buyers can be located and legal constraints permit.
Accruing loans that are contractually past due 90 days or more as to principal
or interest totaled $453,000 on December 31, 2002, compared to $164,000 on
December 31, 2001. The level for both periods is considered immaterial.
Generally, loans in this past due category are adequately collateralized and in
the process of collection.
Foreclosed real estate, net of reserve, totaled $465,000 at yearend 2002, a
decrease of $227,000 or 33 percent below year-end 2001. The decrease was caused
primarily by asset liquidations. On December 31, 2002, the foreclosed real
estate portfolio was comprised of real estate assets from seven former
commercial and mortgage loan accounts ranging in size from $12,000 to $133,000.
A loss allowance, which is evaluated quarterly, has been established for
foreclosed real estate assets whose estimated fair value, less selling expenses,
is below their financial carrying costs. At December 31, 2002, the allowance was
$35,000. The provision expense for foreclosed real estate, due to declines in
the fair value of individual assets, was $30,000 for 2002, compared to $62,000
for 2001, and $56,000 for 2000. Efforts to liquidate foreclosed real estate are
proceeding as quickly as potential buyers can be located.
On December 31, 2002, there were approximately $1.3 million in potential problem
loans identified by management. Potential problem loans consist of loans for
which management has serious doubts as to the ability of the borrower to comply
with present repayment terms, and which were not disclosed in Table 8. A loss
allowance was established for those potential problem loans that in management's
judgment were inadequately collateralized. Comparatively, management was
monitoring approximately $1 million in potential problem loans on December 31,
2001.
ALLOWANCE FOR LOAN LOSSES
Although the Corporation maintains sound credit policies, certain loans
deteriorate and must be charged off as losses. The allowance for loan losses is
maintained to absorb losses inherent in the portfolio at December 31, 2002. The
allowance is increased by provisions charged to expense and is reduced by loan
charge-offs, net of recoveries. In analyzing the adequacy of the allowance,
management considers the results of internal and external credit reviews, past
loss experience, changes in the size and composition of the loan portfolio,
adequacy of collateral, general economic conditions and the local business
outlook. Determining the level of the allowance for probable loan losses at any
given period is difficult, particularly during deteriorating or uncertain
economic periods. Management must make estimates
TABLE 8 - NONPERFORMING ASSETS
DECEMBER 31,
(dollars in thousands) 2002 2001 2000 1999 1998
- -------------------------------------------------------------------------------------------------
Nonaccrual loans $5,051 $1,411 $2,006 $1,892 $1,706
Accruing loans that are contractually past due
90 days or more as to principal or interest 453 164 346 13 13
Foreclosed real estate, net of reserve 465 692 2,390 1,385 1,871
- -------------------------------------------------------------------------------------------------
Total nonperforming assets $5,969 $2,267 $4,742 $3,290 $3,590
=================================================================================================
Ratios:
Nonaccrual loans as a % of total year-end loans 2.16% 0.62% 0.92% 0.91% 0.90%
Nonperforming assets as a % of total year-end
loans and net foreclosed real estate 2.55% 1.00% 2.15% 1.58% 1.88%
Nonperforming assets as a % of total year-end
stockholders' equity 18.52% 7.72% 17.31% 12.97% 13.78%
Allowance for loan losses as a multiple of
nonaccrual loans .3x 1.3x 1.0x 1.1x 1.1x
- -------------------------------------------------------------------------------------------------
34
using assumptions and information which are often subjective and fluid. Table
9--Analysis of Allowance for Loan Losses presents an analysis of the activity in
the allowance for loan losses over a five-year period. Table 10--Allocation of
the Allowance for Loan Losses presents an allocation of the allowance for loan
losses by major loan category. The unallocated component of the allowance for
loan losses represents probable losses inherent in the portfolio that are not
fully captured in the allocated allowance analyses, such as: industry
concentrations, imprecision in the loan risk evaluation process and current
economic factors.
For 2002, the allowance was $1,515,000, representing a $383,000 or 20 percent
decrease from year-end 2001. The allowance for loan losses as a percentage of
total loans was 0.65 percent for 2002 compared to 0.84 percent for 2001. Despite
an increase in nonaccrual loans evident in Table 8, management did not believe
an increase in the overall allowance was warranted due to the collateral
position of the loans in this category. The provision expense for 2002 was
$515,000, compared to $143,000 for 2001. During the fourth quarter of 2002,
management charged off as loss a group of related equipment financing contracts
that were classified as nonaccrual. Total charge-offs relating to the equipment
financing contracts amounted to $864,000 for calendar year 2002. Management
believes that the loss on these contracts was caused by external fraud and is
presently seeking legal redress, including the initiation of lawsuits with other
defrauded financial institutions. Of the remaining $963,000 exposure on related
equipment financing contracts at year-end 2002, $521,000 was current, $380,000
was less than thirty days late and $62,000 was classified as nonaccrual. Based
on a recent evaluation of probable loan losses in the current portfolio,
management believes that the allowance is adequate to support losses inherent in
the loan portfolio on December 31, 2002.
LIQUIDITY
Maintaining adequate liquidity provides the Corporation with the ability to meet
financial obligations to depositors, loan customers, employees, and stockholders
on a timely and cost effective basis in the normal course of business.
Additionally, it provides funds for growth and business opportunities as they
arise. Liquidity is generated from transactions relating to both the
Corporation's assets and liabilities. The primary sources of asset liquidity are
scheduled investment security maturities and cash inflows, funds received from
customer loan payments, and asset sales. The primary sources of liability
liquidity are deposit growth, short-term borrowing and long-term debt. Retained
earnings from profitable operations are another source of liquidity. The
Consolidated Statements of Cash Flows present the changes in cash from
operating, investing and financing activities. For 2002, management believes
that liquidity was adequate based on its availability from many sources,
including
TABLE 9 - ANALYSIS OF ALLOWANCE FOR LOAN LOSSES
(dollars in thousands) 2002 2001 2000 1999 1998
- -----------------------------------------------------------------------------------------
Balance - beginning of year $1,898 $1,967 $2,023 $1,865 $2,098
Provision charged to operating expense 515 143 119 225 375
Loans charged off:
Commercial 1,100 121 191 23 610
Real estate-mortgage 7 0 15 0 0
Consumer 78 111 32 63 25
- -----------------------------------------------------------------------------------------
Total loans charged off 1,185 232 238 86 635
Recoveries:
Commercial 274 9 27 12 13
Real estate-mortgage 0 0 0 0 0
Consumer 13 11 36 7 14
- -----------------------------------------------------------------------------------------
Total recoveries 287 20 63 19 27
- -----------------------------------------------------------------------------------------
Net charge-offs 898 212 175 67 608
- -----------------------------------------------------------------------------------------
Balance - end of year $1,515 $1,898 $1,967 $2,023 $1,865
=========================================================================================
Ratios:
Net charge-offs to average total loans 0.39% 0.10% 0.08% 0.03% 0.32%
Allowance for loan losses to total
loans at year-end 0.65 0.84 0.90 0.98 0.99
Allowance for loan losses to nonaccrual
loans and loans past due 90 days or more 27.5 120.5 83.6 106.2 108.5
- -----------------------------------------------------------------------------------------
35
Management's Discussion of Consolidated Financial Condition & Results of
Operations
the potential liquidation of a $70 million portfolio of available-for-sale
securities valued at December 31, 2002 and unused credit with the FHLBP of $78
million. The Corporation's loan-to-deposit ratio was 80 percent for year-end
2002, compared to 82 percent for year-end 2001.
Off-Balance Sheet Arrangements
The Corporation's financial statements do not reflect various commitments that
are made in the normal course of business, which may involve some liquidity
risk. These commitments consist mainly of unfunded loans and letters of credit
made under the same standards as on-balance sheet instruments. Financial
instruments with off-balance sheet risk are disclosed in Note 15 of this report.
Normally these commitments have fixed expiration dates or termination clauses
and are for specific purposes. Accordingly, many of the commitments are expected
to expire without being drawn upon and therefore, generally do not present
significant liquidity risk to the Corporation or PeoplesBank.
Long-Term Contractual Obligations
Table 11-Long-Term Contractual Obligations, shows the amount and timing of
payments that are due under long-term contractual obligations.
MARKET RISK MANAGEMENT
In the normal course of conducting business, the Corporation is exposed to
market risk, principally interest rate risk, through the operations of its
banking subsidiary, PeoplesBank. Interest rate risk arises from market driven
fluctuations in interest rates that may affect cash flows, income, expense and
the values of financial instruments. PeoplesBank is particularly vulnerable to
changes in the short-term Prime interest rate (prime rate) and LIBOR. An
Asset-Liability Committee (committee) comprised of members of senior management
manages interest rate risk. The
TABLE 10 - ALLOCATION OF ALLOWANCE FOR LOAN LOSSES
DECEMBER 31,
2002 2001 2000 1999 1998
----------------- ----------------- ----------------- ----------------- -----------------
% TOTAL % TOTAL % TOTAL % TOTAL % TOTAL
(dollars in thousands) AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS
------ ------- ------ ------- ------ ------- ------ ------- ------ -------
Commercial, industrial
and agricultural $ 906 69.0 $1,188 67.3 $1,064 64.4 $ 972 63.4 $1,329 60.4
Real estate-construction
and land development 61 8.8 55 9.7 357 8.9 196 10.6 174 10.4
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
Total commercial
related loans 967 77.8 1,243 77.0 1,421 73.3 1,168 74.0 1,503 70.8
Real estate-residential
mortgages 16 10.6 15 11.0 100 14.2 155 14.4 74 16.7
Installment 70 11.6 69 12.0 71 12.5 50 11.6 73 12.5
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
Total consumer
related loans 86 22.2 84 23.0 171 26.7 205 26.0 147 29.2
Unallocated 462 n/a 571 n/a 375 n/a 650 n/a 215 n/a
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
Total $1,515 100.0 $1,898 100.0 $1,967 100.0 $2,023 100.0 $1,865 100.0
===========================================================================================================================
Note: The specific allocation for any particular loan category may be
reallocated in the future as risk perceptions change. Furthermore, the portion
allocated to each loan category is not the total amount available for future
losses that might occur within such categories since the total allowance is a
general allowance applicable to the entire loan portfolio.
TABLE 11 - CONTRACTUAL OBLIGATIONS
LESS THAN 1-3 3-5 MORE THAN
(dollars in thousands) TOTAL 1 YEAR YEARS YEARS 5 YEARS
- --------------------------------------------------------------------------------
Long-term debt $ 15,509 $ 438 $ 7,970 $ 586 $ 6,515
Capital lease obligations 655 17 42 66 530
Operating leases 633 70 133 135 295
Time deposits 140,695 67,294 58,827 14,574 0
- --------------------------------------------------------------------------------
Total $157,492 $ 67,819 $ 66,972 $ 15,361 $ 7,340
================================================================================
36
committee's objective is to maximize net interest income within acceptable
levels of liquidity and interest rate risk and within capital adequacy
constraints. PeoplesBank is not subject to foreign currency or commodity price
risk, nor does it own any trading assets.
The committee manages interest rate risk primarily through sensitivity analysis.
Asset-liability management simulation software (ALM model) is used to model and
measure the potential loss in future net income based on hypothetical changes in
interest rates. Interest rate forecasts are supplied by a national forecasting
service and integrated with the ALM model. The Corporation's policy limit for
the maximum negative impact on net income is 10 percent over a twelve-month
period. This policy limit is tested periodically by measuring the change in net
income from a baseline scenario where interest rates are held constant, to a
high rate scenario (gradual 200 basis point increase in prime and fed funds
rates), a low rate scenario (gradual 200 basis point decrease in prime and fed
funds rates) and a most likely scenario (defined by a forecasting service) over
the future twelve month period. Important ALM modeling assumptions include: the
use of contractual cash flows; varying levels of prepayments for loans and
mortgage-backed securities; stability of noninterest income and expense;
reinvestment of repriceable cash flows in the same type of asset or liability;
and constant product rate spreads, determined at the balance sheet date, over
the twelve-month measurement period. The ALM model also includes significant
balance sheet characteristics such as rate caps and floors.
The Corporation performed a simulation on its balance sheet for December 31,
2002 and 2001. The results of that point-in-time analysis are shown in Table
12--Interest Rate Sensitivity. On December 31, 2002, the Corporation's balance
sheet was asset sensitive in response to abnormally low market interest rates
engineered by the Federal Reserve Bank to shore up a weak US economy. Asset
sensitivity means that loan and investment assets will reprice to a greater and
faster degree than the deposits and debt that fund them. Therefore, if market
interest rates continue to decline, earnings will decline. Conversely, if market
interest rates increase, earnings will increase. Generally, the financial
services industry has experienced increased liquidity, as deposit customers
sought safe haven from depressed capital markets, loan customers refinanced,
bond issuers called bonds and mortgage-backed securities prepaid faster than
scheduled. On December 31, 2002, the hypothetical 200 basis point reduction in
market interest rates (low rate scenario) portrays a 10.8 percent decline in net
income, slightly exceeding management's 10 percent policy guideline. Compared to
December 31, 2001, when the low rate scenario portrayed a 15.4 percent decline
in net income, the Corporation's balance sheet is less asset sensitive. Asset
sensitivity decreased since year-end 2001 because overnight investments
decreased while investment securities increased, particularly in the three to
four year average
TABLE 12 - INTEREST RATE SENSITIVITY
CHANGE IN INTEREST FORECASTED CHANGE IN
RATES (BASIS POINTS) INTEREST RATE NET INCOME
OVER 12 MOS SCENARIO $000'S %
- --------------------------------------------------------------
AT DECEMBER 31, 2002
+200 HIGH 217 6.0
0 FLAT (BASELINE) 0 0.0
-200 LOW (393) (10.8)
+118 MOST LIKELY 94 2.6
AT DECEMBER 31, 2001
+200 High 304 10.2
0 Flat (baseline) 0 0.0
-200 Low (458) (15.4)
+175 Most likely 35 1.2
==============================================================
37
Management's Discussion of Consolidated Financial Condition & Results of
Operations
life category. Management believes that the Corporation's balance sheet is
positioned to benefit from an economic recovery and rising market interest
rates.
Measurement of interest rate risk requires many assumptions. These assumptions
are inherently uncertain and, as a result, the model cannot precisely estimate
net interest income or precisely predict the impact of higher or lower rates on
net income. Actual results may differ from simulated results due to many factors
including: timing of cashflows, magnitude and frequency of interest rate
changes, customer behavior, changes in market conditions, and management
strategies.
IMPACT OF INFLATION AND CHANGING PRICES
The majority of assets and liabilities of a financial institution are monetary
in nature and therefore differ greatly from most commercial and industrial
companies that have significant investments in fixed assets or inventories.
However, inflation may impact the growth of total assets in the banking industry
and the resulting need to increase equity capital at higher than normal rates in
order to maintain an appropriate equity-to-assets ratio. Inflation may also
significantly affect noninterest expenses, which tend to rise during periods of
general inflation. The level of inflation can be measured by the change in the
Consumer Price Index (CPI) for all urban consumers (December vs. December). The
change in the CPI for 2002 was 2.4 percent, compared to 1.6 percent for 2001,
and 3.4 percent for 2000.
Management believes that the most significant impact on financial results is the
Corporation's ability to react to changes in market interest rates. As discussed
previously, management strives to structure the balance sheet to increase net
interest income by managing interest rate sensitive assets and liabilities to
reprice in response to changes in market interest rates. Additionally,
management is focused on increasing fee income, an income component less
sensitive to changes in market interest rates.
OTHER RISKS
More grand acts of terrorism in the United States of America, or in other
countries, could erode consumer and business confidence and disrupt commerce,
resulting in a prolonged economic recession. A prolonged economic recession
could have a material adverse effect on liquidity, capital resources or results
of operations of Codorus Valley.
Periodically, federal and state legislation is proposed that could result in
additional regulation of, or restrictions on, the business of Codorus Valley and
its subsidiaries. Management is not aware of any current specific
recommendations by regulatory authorities or proposed legislation, which, if
implemented, would have a material adverse effect upon the liquidity, capital
resources, or results of operations. Although the general cost of compliance
with numerous and multiple federal and state laws and regulations does have, and
in the future may have, a negative impact on Codorus Valley's results of
operations.
TABLE 13 - SUMMARY OF QUARTERLY FINANCIAL DATA
2002 2001
----------------------------------------------------------------------
(dollars in thousands, FOURTH THIRD SECOND FIRST FOURTH THIRD SECOND FIRST
except per share data) QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER
- -------------------------------------------------------------------------------------------------------
Interest income $5,179 $5,227 $5,110 $5,158 $5,586 $5,753 $5,710 $5,553
Interest expense 2,009 2,140 2,342 2,416 2,522 2,757 2,764 2,828
- ------------------------------------------------------------------------------------------------------
Net interest income 3,170 3,087 2,768 2,742 3,064 2,996 2,946 2,725
Provision for loan losses 445 0 50 20 0 30 83 30
Noninterest income 733 630 611 609 606 637 565 529
Noninterest expense 2,977 2,717 2,627 2,687 2,814 2,623 2,438 2,423
- ------------------------------------------------------------------------------------------------------
Net operating income 481 1,000 702 644 856 980 990 801
Gains from sales of securities 0 107 0 72 0 0 0 0
Gains, other 312 136 82 242 79 1 12 67
- ------------------------------------------------------------------------------------------------------
Pretax income 793 1,243 784 958 935 981 1,002 868
Provision for income taxes 110 271 125 171 155 265 276 236
- ------------------------------------------------------------------------------------------------------
Net income $ 683 $ 972 $ 659 $ 787 $ 780 $ 716 $ 726 $ 632
======================================================================================================
Net income per share,
basic and diluted $ 0.25 $ 0.36 $ 0.24 $ 0.30 $ 0.29 $ 0.27 $ 0.26 $ 0.24
======================================================================================================
Note-Net income per share was adjusted for stock dividends.
38
Corporate Information
A Corporate Profile
Codorus Valley Bancorp, Inc. is a Pennsylvania business incorporated in 1986,
which became a bank holding company on March 2, 1987, under the Bank Holding
Company Act of 1956. PeoplesBank, A Codorus Valley Company, is its wholly owned
banking subsidiary and SYC Realty Co., Inc. is its wholly owned nonbank
subsidiary. Organized in 1934, PeoplesBank offers a full range of business and
consumer banking services through eleven financial centers throughout York
County, Pennsylvania. It also offers investment, insurance, trust and real
estate services. The deposits of PeoplesBank are fully insured by the Federal
Deposit Insurance Corporation (FDIC) to the maximum extent provided by law. In
1998, PeoplesBank created SYC Settlement Services, Inc., as a wholly owned
subsidiary, to provide real estate settlement services. In 1999, PeoplesBank
created SYC Insurance Services, Inc., as a wholly owned subsidiary, to sell
nondeposit investment products.
Headquarters
Codorus Valley Bancorp, Inc. is headquartered at the Codorus Valley Corporate
Center, 105 Leader Heights Road, York, PA 17403.
Stock, Dividend and Broker Information
Outstanding common stock of Codorus Valley Bancorp, Inc. is quoted under the
symbol CVLY on the Nasdaq National Market System. At December 31, 2002, there
were approximately 974 shareholders of record.
Prices presented below are based on the close price as quoted on the Nasdaq
SNational Market System. Cash dividends paid for the most recent eight quarters
are also provided in the table below. Cash dividends per share (rounded) and
market prices are adjusted for stock dividends.
2002 2001
--------------------------------- ----------------------------------
DIVIDENDS DIVIDENDS
QUARTER HIGH LOW PER SHARE HIGH LOW PER SHARE
- --------------------------------------------------------------------------------------------
First $14.95 $12.86 $0.11 $17.24 $13.61 $0.11
Second 16.00 13.00 0.11 14.76 13.33 0.11
Third 16.80 15.00 0.12 15.24 13.10 0.11
Fourth 16.25 14.10 0.12 15.00 12.90 0.11
For further information, we refer you to the following market makers in our
common stock:
F.J. Morrissey & Co., Inc. Ferris, Baker Watts, Inc.
800-842-8928 410-468-2749
Notice of Annual Meeting
The Annual Meeting of Shareholders will be held on Tuesday, May 20, 2003 at 9:00
a.m. Eastern Time, at the Codorus Valley Corporate Center, 105 Leader Heights
Road, York, Pennsylvania 17403.
Transfer Agent
Wells Fargo Bank Minnesota, N.A., P.O. Box 64854, St. Paul, MN 55164-0854
800-468-9716
Dividend Reinvestment and Stock Purchase Plan
Information regarding the Corporation's Dividend Reinvestment and Stock Purchase
Plan may be obtained by calling 800-468-9716 or by writing to: Wells Fargo Bank
Minnesota, N.A., P.O. Box 64854, St. Paul, MN 55164-0854
Form 10-K Request
The form 10-K Report filed with the Securities and Exchange Commission (SEC) may
be obtained, without charge, as follows:
Via the Internet:
www.peoplesbanknet.com, select Codorus Valley Bancorp, Inc., then select the
Securities and Exchange Commission link, or visit the SEC website at
www.sec.gov/edgarhp.htm
Write to:
Chief Financial Officer, Codorus Valley Bancorp, Inc., P.O. Box 2887, York,
PA 17405-2887.
39