Management's Discussion and Analysis
of Financial Condition and Results of Operations
Management's Discussion and Analysis of Financial Condition and Results of
Operations analyzes the major elements of the Company's consolidated balance
sheets and statements of income. This section should be read in conjunction with
the Company's consolidated financial statements and accompanying notes.
Application of Critical Accounting Policies
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The reporting of the Company's financial condition and results of operations is
impacted by the application of accounting policies by management. Certain
accounting policies are particularly sensitive and require significant
judgments, estimates and assumptions to be made by management in matters that
are inherently uncertain. The Company's accounting policies are detailed in Note
1 to the financial statements. The audit committee to the board of directors has
approved these policies.
The Company's provision for loan losses and the level of the allowance for loan
losses involve significant estimates by management in evaluating the adequacy of
the allowance for loan losses. The allowance for loan losses is increased by a
charge to the provision for loan losses. Management's evaluation is based on the
Company's past loan loss experience, known and inherent risks in the portfolio,
adverse situations that may affect the borrower's ability to repay (including
the timing of future payments), the estimated value of any underlying
collateral, composition of the loan portfolio, current economic conditions and
other relevant factors. While management uses available information to make such
evaluations, future adjustments to the allowance and the provision for loan
losses may be necessary if economic conditions or loan credit quality differ
substantially from the assumptions used in making the evaluation.
As permitted by SFAS No. 123, the Company 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 Company's stock option plans. The pro forma impact
to 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
grant, is disclosed in the notes to the consolidated financial statements. The
Company intends to continue to account for stock-based compensation in this
manner unless there is more specific guidance issued by the Financial Accounting
Standards Board or unless a clear consensus develops in the financial services
industry on the application of accounting methods.
2002 Overview
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In 2002, the Company continued its strong financial performance by posting
record levels of total assets, deposits and loans. Total assets grew by $177
million, or 29%, to $787 million and total deposits increased $165 million, or
29%, to $727 million. Core deposit growth was exceptionally strong, increasing
$162 million, or 31%, from $525 million to $687 million.
Net income was up 28% in 2002 to $5.7 million from $4.4 million for 2001 and
total revenues increased by 24% to a record level of $35.4 million. Diluted net
income per common share increased 22% to $2.48 from $2.04 per share in 2001
(after adjusting for a 5% common stock dividend declared in January 2003).
In June, the Company opened a new branch at 101 North Second Street, Harrisburg,
Pennsylvania, a new branch in August at 3201 Trindle Road, Camp Hill,
Pennsylvania, and another new branch in December at 20 Knoble Boulevard,
Carlisle, Pennsylvania. This brings the Bank's total number of full-service
branches to 18. The Company plans to construct five additional branches in 2003.
Results of Operations
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Average Balances and Average Interest Rates
Table 1 on the following page sets forth balance sheet items on a daily average
basis for the years ended December 31, 2002, 2001 and 2000 and presents the
daily average interest rates earned on assets and the daily average interest
rates paid on liabilities for such periods. During 2002, average
interest-earning assets were $645.1 million, an increase of $144.0 million, or
29%, over 2001. This was the result of an increase in the average balance of
investment securities of $81.5 million, an increase in the average balance of
federal funds sold of $14.4 million, and an increase in the average balance of
loans receivable of $48.1 million. The growth in the average balance of interest
earning assets was funded primarily by an increase in the average balance of
deposits (including noninterest bearing demand deposits) of $140.4 million.
The yield on total interest-earning assets decreased by 112 basis points in 2002
from 7.63% to 6.51%. The decrease resulted primarily from decreased yields in
the loan and investment portfolios due to the overall level and timing of
changes in general market interest rates during 2002 as compared to 2001. The
Federal Reserve Board (FRB) lowered short-term market interest rates eleven
times throughout 2001 and an additional 50 basis points in 2002 for a total
decrease of 525 basis points (bps). As a result, the Company experienced lower
yields on interest-earning assets in 2002 from 2001 as well as a lower cost of
funds in 2002 versus the prior year.
1
Management's Discussion and Analysis
of Financial Condition and Results of Operations
Table 1
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Year Ended December 31,
(dollars in thousands) 2002 2001 2000
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Average Average Average Average Average Average
Earning Assets Balance Interest Rate Balance Interest Rate Balance Interest Rate
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Securities:
Taxable $246,230 $14,514 5.89% $165,013 $10,860 6.58% $121,833 $ 8,025 6.59%
Tax-exempt 1,995 107 5.36 1,743 94 5.38 795 44 5.51
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Total securities 248,225 14,621 5.89 166,756 10,954 6.57 122,628 8,069 6.58
Federal funds sold 31,833 508 1.59 17,399 641 3.68 11,707 760 6.49
Loans receivable:
Mortgage and construction 241,647 18,408 7.62 212,117 18,013 8.49 178,937 15,852 8.86
Commercial loans and
lines of credit 83,971 5,670 6.75 69,815 5,810 8.32 47,747 4,691 9.82
Consumer 35,851 2,677 7.47 32,305 2,709 8.39 26,640 2,293 8.61
Tax-exempt 3,598 111 3.09 2,711 120 4.43 1,833 109 5.94
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Total loans receivable 365,067 26,866 7.36 316,948 26,652 8.41 255,157 22,945 8.99
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Total earning assets $645,125 $41,995 6.51% $501,103 $38,247 7.63% $389,492 $31,774 8.16%
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Sources of Funds
Interest-bearing deposits:
Regular savings $197,225 $ 3,857 1.96% $141,350 $ 4,168 2.95% $108,131 $ 4,219 3.90%
Interest checking 10,590 125 1.18 7,955 165 2.07 8,696 339 3.90
Money market 145,851 1,923 1.32 100,394 2,261 2.25 71,764 2,288 3.19
Time deposits 118,899 5,595 4.71 126,389 7,133 5.64 104,983 5,422 5.17
Public funds time 54,165 1,440 2.66 33,642 1,693 5.03 25,833 1,688 6.54
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Total interest-bearing deposits 526,730 12,940 2.46 409,730 15,420 3.76 319,407 13,956 4.37
Short-term borrowings 12 0 1.46 330 13 3.94 696 42 5.91
Trust Capital Securities 13,000 1,354 10.41 7,082 760 10.73 2,708 299 11.07
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Total interest-bearing liabilities 539,742 14,294 2.65 417,142 16,193 3.88 322,811 14,297 4.43
Noninterest-bearing funds (net) 105,383 83,961 66,681
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Total sources to fund
earning assets $645,125 14,294 2.22 $501,103 16,193 3.23 $389,492 14,297 3.67
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Net interest income and margin $27,701 4.29% $22,054 4.40% $17,477 4.49%
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Other Balances
Cash & due from banks $ 23,022 $ 18,904 $ 14,806
Other assets 27,190 20,951 18,734
Total assets 695,337 540,958 423,032
Noninterest-bearing
demand deposits 114,758 91,352 72,413
Other liabilities 2,657 2,508 5,419
Stockholders' equity 38,180 29,956 22,389
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Notes: Nonaccrual loans have been included in the average loan balances.
Securities include securities available for sale and securities held to
maturity. Securities available for sale are carried at amortized cost for
purposes of calculating the average rate received on taxable securities above.
Yields on tax-exempt securities are not computed on a taxable equivalent basis.
2
Management's Discussion and Analysis
of Financial Condition and Results of Operations
The aggregate cost of interest-bearing liabilities decreased 123 basis points
from 3.88% in 2001 to 2.65% in 2002. The average rate paid on savings deposits
decreased by 99 basis points, from 2.95% in 2001 to 1.96% in 2002 and the
average rate paid on interest checking accounts decreased from 2.07% in 2001 to
1.18% in 2002. For time deposits the average rate paid was 4.71%, down 93 basis
points from 2001 and public funds experienced a decrease of 237 basis points in
2002 on the average rate paid. The majority of the Company's public funds are
deposits of local school districts and municipalities. These deposits are
repriced at maturity based upon an average of rates paid for comparable time
deposits by several financial institutions in the Central Pennsylvania market.
The Company's aggregate cost of funding sources decreased 101 basis points in
2002 from 3.23% to 2.22%. This decrease resulted primarily from lower average
rates paid on total interest bearing deposits as well as a $23.4 million
increase in the average of noninterest-bearing demand deposits.
Net Interest Income and Net Interest Margin
Net interest income is the difference between interest income earned on assets
and interest expense incurred on liabilities used to fund those assets. Interest
earning assets primarily include loans and securities. Liabilities used to fund
such assets include deposits and borrowed funds. Changes in net interest income
and margin result from the interaction between the volume and composition of
earning assets, related yields and associated funding costs.
Net interest income for 2002 increased $5.6 million, or 26%, over 2001 to $27.7
million. Interest income on earning assets totaled $42.0 million, an increase of
$3.7 million, or 10%, over 2001. The majority of this increase was related to
volume increases in the securities and loans receivable portfolios partially
offset by lower interest rates on interest earning assets. Interest expense for
2002 decreased $1.9 million, or 12% from $16.2 million in 2001 to $14.3 million
in 2002. This decrease was
Table 2
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2002 v. 2001 2001 v. 2000
Increase (Decrease) Increase (Decrease)
Due to Changes in (1) Due to Changes in (1)
(in thousands) Volume Rate Total Volume Rate Total
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Interest on securities:
Taxable $4,793 $(1,139) $3,654 $ 2,847 $ (12) $ 2,835
Tax-exempt 13 0 13 51 (1) 50
Federal funds sold 231 (364) (133) 210 (329) (119)
Interest on loans receivable:
Mortgage and construction 2,240 (1,845) 395 2,823 (662) 2,161
Commercial 956 (1,096) (140) 1,835 (716) 1,119
Consumer 265 (297) (32) 475 (59) 416
Tax-exempt 27 (36) (9) 39 (28) 11
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Total interest income 8,525 (4,777) 3,748 8,280 (1,807) 6,473
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Interest expense:
Regular savings 1,088 (1,399) (311) 976 (1,027) (51)
Interest checking 31 (71) (40) (15) (159) (174)
Money market plus 596 (934) (338) 647 (674) (27)
Time deposits (363) (1,175) (1,538) 1,218 493 1,711
Public funds 544 (797) (253) 395 (390) 5
Short-term borrowings (5) (8) (13) (15) (13) (28)
Trust Capital Securities 617 (23) 594 451 9 460
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Total interest expense 2,508 (4,407) (1,899) 3,657 (1,761) 1,896
- -------------------------------------------------------------------------------------------------------------------
Net increase (decrease) $6,017 $ (370) $5,647 $4,623 $ (46) $4,577
- -------------------------------------------------------------------------------------------------------------------
(1)Changes due to both volume and rate have been allocated to volume changes.
3
Management's Discussion and Analysis
of Financial Condition and Results of Operations
primarily related to the reduction in interest rates on the deposit products
partially offset by the increases in the Company's average level of deposits and
long-term debt.
Changes in net interest income are frequently measured by two statistics: net
interest rate spread and net interest margin. Net interest rate spread is the
difference between the average rate earned on interest-earning assets and the
average rate incurred on interest-bearing liabilities. Net interest margin
represents the difference between interest income, including net loan fees
earned, and interest expense, reflected as a percentage of average earning
assets. The Company's net interest rate spread increased to 3.86% in 2002 from
3.75% in 2001 and the net interest margin decreased 11 basis points from 4.40%
to 4.29%.
Table 2 demonstrates the relative impact on net interest income of changes in
the volume of earning assets and interest-bearing liabilities and changes in
rates earned and paid by the Company on such assets and liabilities. For
purposes of this table, nonaccrual loans have been included in the average loan
balances.
Noninterest Income
Noninterest income for 2002 increased by $1.1 million, or 17%, over 2001 to $7.7
million. The increase was due primarily to increased "core" other operating
income attributable to service charges and fees associated with servicing a
higher volume of deposit and loan accounts. Included in total noninterest income
were gains of $493,000 in 2002 and $354,000 in 2001 on the sale of residential
and student loans. Also included in noninterest income were net securities gains
of $0 for 2002 and $52,000 for 2001.
Noninterest Expenses
Noninterest expenses totaled $25.4 million for 2002, an increase of $4.9
million, or 24%, over 2001. Staffing levels, occupancy, furniture and equipment,
and related expenses increased as a result of opening three full service
branches in 2002. A comparison of noninterest expense for certain categories for
2002 and 2001 is presented below.
Salary expenses and employee benefits, which represent the largest component of
noninterest expenses, increased by $3.0 million, or 32%, in 2002 over 2001. This
increase was consistent with an increase in the level of full-time equivalent
employees from 334 at December 31, 2001 to 424 at year-end 2002. The increased
level of expenses includes the impact of salary and benefit costs associated
with the additional staff for the three new branch offices opened in June,
August and December 2002, respectively.
Occupancy expenses totaled $2.4 million in 2002, an increase of $270,000, or
13%, over 2001 while furniture and equipment expenses increased by $121,000, or
9%, to $1.5 million. The full year impact of the two branch offices opened in
2001 along with three additional branches opened in 2002, contributed to the
increases in occupancy and furniture and equipment expenses in 2002 over 2001.
Advertising and marketing expenses were $2.2 million for 2002, an increase of
$459,000, or 27%, over 2001. The increase was primarily the result of increased
advertising efforts in each of the Company's markets. The Company's markets
include Lebanon, Dauphin, Cumberland, and York Counties. With expansion into the
Berk's County area in 2003, the Company will continue to see increases in
advertising and marketing expenses. The Company will continue to have multiple
markets in which to advertise its products.
Data processing expenses increased by $577,000, or 44%, in 2002 over 2001. The
primary increase was due to costs associated with processing additional
transactions as a result of growth in the number of accounts serviced. Another
contributing factor was the Company outsourced the proof, check clearing, and
customer statement and processing functions in 2002. As a result, the Company
experienced greater costs in the data processing area but achieved offsetting
savings in postage, stationery and supplies and correspondent bank charges.
Postage and supplies expenses of $862,000 were $16,000, or 2%, higher than the
prior year. The increase in postage and supplies expenses was attributed to the
growth in the number of account statements mailed to customers offset by reduced
postage rates incurred as a direct result of converting to imaged customer
statements.
Audits, regulatory fees, and assessments for 2002 increased by $83,000, or 21%,
from 2001. This was primarily due to the increase in the yearly assessments by
the Office of the Comptroller of the Currency for examinations and the Federal
Deposit Insurance Corporation for deposit insurance coverage. Both assessment
calculations, which are based on deposit size, continue to increase as the
Company's deposit balances grow.
Other noninterest expenses totaled $3.6 million for 2002, compared to $3.2
million for 2001. The increase included increased loan expenses of $83,000,
increased legal expenses of $100,000, increased business development expenses of
$88,000 and increased provisions for non-credit-related losses of $72,000.
The Company's current strategic plan calls for the construction of five
additional new branch offices in 2003. The costs associated with these planned
offices will continue to result in higher levels of staff, facilities, and
related expenses in 2003 and in future periods.
One key measure used to monitor progress in controlling overhead expenses is the
ratio of net noninterest expenses to average assets. Net noninterest expenses
equal noninterest expenses (excluding other real estate expenses) less
noninterest income
4
Management's Discussion and Analysis
of Financial Condition and Results of Operations
(exclusive of non-recurring gains). This ratio equaled 2.55% for 2002, compared
to 2.60% for 2001. Another productivity measure is the operating efficiency
ratio. This ratio expresses the relationship of noninterest expenses (excluding
other real estate expenses) to net interest income plus noninterest income
(excluding non-recurring gains). For 2002 and 2001, the operating efficiency
ratio was 71.9%.
Provision for Income Taxes
The provision for income taxes was $2.9 million for 2002, compared to $2.2
million for 2001. The effective tax rate, which is the ratio of income tax
expense to income before taxes, was 33.6% in 2002 and 33.4% in 2001. Reference
should be made to Note 11 of the Notes to Consolidated Financial Statements for
an additional analysis of the provision for income taxes for 2002 and 2001.
In accordance with Statement of Financial Accounting Standard No. 109 (SFAS No.
109), "Accounting for Income Taxes", income taxes are accounted for under the
liability method. Under the liability method, deferred tax assets and
liabilities are recognized for future tax consequences attributable to temporary
differences between the financial statement and tax bases of existing assets and
liabilities.
At December 31, 2002, deferred tax assets amounted to $1.8 million and deferred
tax liabilities amounted to $1.4 million. Deferred tax assets are realizable
primarily through carryback of existing deductible temporary differences to
recover taxes paid in prior years, and through future reversal of existing
taxable temporary differences. Management currently anticipates future earnings
will be adequate to utilize the net deferred tax assets.
Net Income and Net Income Per Share
Net income for 2002 rose to a record $5.7 million, an increase of $1.3 million,
or 28%, over the $4.4 million recorded in 2001. This increase was due to an
increase in net interest income of $5.6 million, an increase in noninterest
income of $1.1 million, a decrease in the provision for loan losses of $34,000,
partially offset by an increase in noninterest expenses of $4.9 million and an
increase of $639,000 in the provision for income taxes.
Basic earnings per common share, after adjusting for a 5% common stock dividend
declared in January 2003, increased by 21% to $2.71 per share, compared to $2.24
in 2001. Diluted earnings per common share were $2.48 for 2002 and $2.04 for
2001 after adjusting for the 5% common stock dividend declared in January 2003.
Reference should be made to Note 13 in the Notes to Consolidated Financial
Statements for an analysis of earnings per share.
Return on Average Assets and Average Equity
Return on average assets (ROA) measures the Company's net income in relation to
its total average assets. The Company's ROA for 2002 and 2001 was 0.82%.
For purposes of calculating ROA, average assets have been adjusted to exclude
the effect of net unrealized gains (losses) on securities available for sale.
Return on average equity (ROE) indicates how effectively the Company can
generate net income on the capital invested by its stockholders. ROE is
calculated by dividing net income by average stockholders' equity. For purposes
of calculating ROE, average stockholders' equity includes the effect of
unrealized gains (losses), net of income taxes, on securities available for
sale. Reference should be made to Note 3 in the Notes to Consolidated Financial
Statements for an analysis of securities available for sale. The Company's ROE
for 2002 was 14.86%, compared to 14.85% for 2001.
Results of Operations
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2001 versus 2000
Net income for 2001 rose to a record $4.4 million, an increase of $734,000, or
20%, over the $3.7 million recorded in 2000.
Diluted earnings per common share increased by 14% to $2.04 for 2001 over $1.78
for 2000 after adjusting for the 5% common stock dividend declared in January
2002 and 2003.
Net interest income for 2001 increased $4.6 million, or 26%, over 2000 to $22.1
million. Interest income on earning assets totaled $38.2 million, an increase of
$6.5 million, or 20%, over 2000. Interest expense for 2001 increased by $1.9
million, or 13%, to $16.2 million from $14.3 million.
The Company's net interest rate spread increased to 3.75% in 2001 from 3.73% in
2000 and the net interest margin decreased 9 basis points from 4.49% to 4.40%.
Noninterest income for 2001 increased by $1.2 million, or 23%, over 2000 to $6.6
million. Included in total noninterest income were gains of $354,000 in 2001 and
$370,000 in 2000 on the sale of residential, student, and Small Business
Administration loans.
Noninterest expenses totaled $20.5 million for 2001, an increase of $4.3
million, or 27%, over 2000. Staffing levels, occupancy, furniture and equipment,
and related expenses increased as a result of opening two full service branches
in Spring and Fall 2001.
Salary expenses and employee benefits, which represent the largest component of
noninterest expenses, increased by $2.0 million, or 27%, in 2001 over 2000. This
increase was consistent with
5
Management's Discussion and Analysis
of Financial Condition and Results of Operations
an increase in the level of full-time equivalent employees from 266 at December
31, 2000 to 334 at year-end 2001.
Occupancy expenses totaled $2.1 million in 2001, an increase of $351,000, or
20%, over 2000 while furniture and equipment expenses increased by $310,000, or
28%, to $1.4 million.
Advertising and marketing expenses were $1.7 million for 2001, an increase of
$271,000, or 19%, over 2000. Data processing expenses increased by $349,000, or
36%, in 2001 over 2000. Postage and supplies expenses of $846,000 were $187,000,
or 28%, higher than the prior year.
Audits, regulatory fees, and assessments for 2001 increased by $53,000, or 15%,
from 2000. Other noninterest expenses totaled $3.2 million for 2001, compared to
$2.4 million for 2000.
Financial Condition
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Securities
Securities are purchased and sold as part of the overall asset and liability
management function at Pennsylvania Commerce Bancorp, Inc. The classification of
all securities is determined at the time of purchase. Securities expected to be
held for an indefinite period of time are classified as securities available for
sale and are carried at fair value. Decisions by management to purchase or sell
these securities are based on an assessment of financial and economic
conditions, including changes in prepayment risks and interest rates, liquidity
needs, capital adequacy, collateral requirements for pledging, alternative asset
and liability management strategies, tax considerations, and regulatory
requirements.
Securities are classified as held to maturity if, at the time of purchase,
management has both the intent and ability to hold the securities until
maturity. Securities held to maturity are carried at amortized cost. Sales of
securities in this portfolio should only occur in unusual and rare situations
where significant unforeseeable changes in circumstances may cause a change in
intent. Examples of such instances would include deterioration in the issuer's
creditworthiness that is evidently supportable and significant or a change in
tax law that eliminates or reduces the tax-exempt status of interest (but not
the revision of marginal tax rates applicable to interest income). Held to
maturity securities cannot be sold based upon any of the decisions used to sell
securities available for sale as listed above. Reference should be made to Note
3 in the Notes to Consolidated Financial Statements for further analysis of the
Company's securities portfolio.
The Company's investment securities portfolio consists primarily of U.S.
Government agency and mortgage-backed obligations. These securities have very
little, if any, credit risk because
Table 3
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December 31, 2002 Due Under 1 Year Due 1-5 Years Due 5-10 Years Due Over 10 Years Total
(dollars in thousands) Amount/Yield Amount/Yield Amount/Yield Amount/Yield Amount/Yield
- ------------------------------------------------------------------------------------------------------------------------------
Available for Sale
U.S. Government
Agency obligations -- -- -- -- $ 1,997 5.82% $ 10,310 6.48% $ 12,307 6.37%
Mortgage-backed obligations -- -- $ 647 7.64% 11,903 3.90 172,243 4.46 184,793 4.43
Corporate debt securities -- -- -- -- -- -- 6,033 7.76 6,033 7.76
- ------------------------------------------------------------------------------------------------------------------------------
Total available for sale $-- --% $ 647 7.64% $13,900 4.17% $188,586 4.68% $203,133 4.65%
- ------------------------------------------------------------------------------------------------------------------------------
Held to Maturity
U.S. Government
Agency obligations -- -- $ 999 6.30% -- -- $ 9,006 6.92% $10,005 6.86%
Municipal obligations -- -- -- -- -- -- 1,996 5.37 1,996 5.37
Mortgage-backed obligations -- -- 1,799 7.20 $ 4,833 5.11% 57,277 5.98 63,909 5.95
Corporate debt securities -- -- 2,008 6.35 11,100 6.68 8,607 7.51 21,715 6.97
- ------------------------------------------------------------------------------------------------------------------------------
Total held to maturity $-- --% $4,806 6.66% $15,933 6.19% $76,886 6.30% $97,625 6.26%
- ------------------------------------------------------------------------------------------------------------------------------
Note: Securities available for sale are carried at amortized cost in the table above for purposes of
calculating the weighted average yield received on such securities.
6
Management's Discussion and Analysis
of Financial Condition and Results of Operations
they are either backed by the full faith and credit of the U.S. Government or
their principal and interest payments are guaranteed by an agency of the U.S.
Government or are AAA rated. These investment securities carry fixed rate
coupons that do not change over the life of the securities. Since most
securities are purchased at premiums or discounts, their yield and average life
will change depending on any change in the estimated rate of prepayments. The
Company amortizes premiums and accretes discounts over the estimated average
life of the securities. Changes in the estimated average life of the securities
portfolio will lengthen or shorten the period in which the premium or discount
must be amortized or accreted, thus affecting the Company's securities yields.
At December 31, 2002, the weighted average life of the Company's securities
portfolio was 2.5 years compared to 6.7 years at December 31, 2001. The weighted
average life of the portfolio is calculated by estimating the average rate of
repayment of the underlying collateral of the security. Mortgage-backed
obligations historically experience repayment rates in excess of the scheduled
repayments, causing a shorter weighted average life of the security. The
Company's securities portfolio contained no "high-risk" securities or
derivatives as of December 31, 2002 or 2001.
Securities available for sale increased by $97.7 million in 2002 (excluding the
effect of unrealized gains or losses) primarily as a result of purchases of
$176.9 million, offset by principal repayments and maturities of $78.5 million.
The securities available for sale portfolio is comprised of U.S. Government
Agency securities, mortgage-backed securities, AAA Whole Loan CMO securities,
and corporate debt securities. At December 31, 2002, the unrealized gains on
securities available for sale included in stockholders' equity totaled $1.5
million, net of tax, compared to unrealized losses of $111,000, net of tax, at
December 31, 2001. The weighted average anticipated maturity of the securities
available for sale portfolio was 2.3 years at December 31, 2002, with a weighted
average yield of 4.65%.
During 2002, securities held to maturity decreased by $5.7 million as a result
of purchases of $29.1 million offset by principal repayments of $34.7 million.
The securities held in this portfolio include U.S. Government Agency securities,
tax-exempt municipal bonds, AAA Whole Loan CMO securities, corporate debt
securities and mortgage-backed securities. The weighted average anticipated
maturity of the securities held to maturity portfolio was 3.2 years at December
31, 2002, with a weighted average yield of 6.26%.
The contractual maturity distribution and weighted average yield of the
Company's available for sale and held to maturity portfolios at December 31,
2002 are summarized in Table 3. Weighted average yield is calculated by dividing
income within each maturity range by the outstanding amount of the related
investment and has not been tax affected on tax-exempt obligations.
Loan Portfolio
- --------------------------------------------------------------------------------
The table below summarizes the composition of the loan portfolio of the Company
by type as of December 31, for each of the years 1998 through 2002.
The Company manages risk associated with its loan portfolio through
diversification, underwriting policies and procedures that are reviewed and
updated on at least an annual basis, and ongoing loan monitoring efforts. The
commercial real estate portfolio includes owner-occupied (owner occupies greater
than 50% of the property), other commercial real estate and construction loans.
Owner-occupied and other commercial real estate loans generally have five-year
call provisions and personal guarantees of the principals involved. Construction
loans are primarily used for single-family residential properties. Financing is
provided against firm agreements of sale, with speculative construction normally
limited to one or two samples per project.
Table 4
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December 31,
(in thousands) 2002 2001 2000 1999 1998
- --------------------------------------------------------------------------------------------------------------------
Commercial real estate, construction and
land development loans $175,993 $175,832 $158,707 $120,008 $ 81,949
Residential real estate mortgage loans 66,190 48,415 41,314 34,681 31,694
Tax-exempt loans 5,629 2,676 2,786 342 395
Commercial, industrial and other business loans 49,226 42,399 31,490 21,228 19,614
Consumer loans 34,598 36,551 30,691 22,764 20,868
Lines of credit 37,245 36,801 25,264 17,082 12,601
- --------------------------------------------------------------------------------------------------------------------
Total loans $368,881 $342,674 $290,252 $216,105 $167,121
- --------------------------------------------------------------------------------------------------------------------
7
Management's Discussion and Analysis
of Financial Condition and Results of Operations
The commercial loan portfolio is comprised primarily of loans to small
businesses in the Southern Central Pennsylvania market area. Business assets,
personal guarantees, and/or personal assets of the borrower generally secure
these loans. The consumer loan portfolio is comprised primarily of loans secured
by first and second mortgage liens on residential real estate. The Company's
loan portfolio is generally nonhomogeneous in that the loans have different
interest rates, repayment options, maturities, collateral requirements, etc.
During 2002, total gross loans increased by $29.1 million from $350.3 million at
December 31, 2001, to $379.4 million at December 31, 2002, including $10.5
million of loans held for sale on December 31, 2002 and $7.7 million of loans
held for sale on December 31, 2001. The loans held for sale represent student
loans and certain residential loans that management intends to sell and reinvest
in higher yielding loans and securities. The increase in loans receivable in
2002 was primarily in residential and commercial business. Loans receivable
represented 51% of total deposits and 47% of total assets at December 31, 2002,
excluding the loans held for sale, compared to 61% and 56%, respectively, at
December 31, 2001.
The maturity ranges of the loan portfolio and the amounts of loans with
predetermined interest rates and floating interest rates in each maturity range,
as of December 31, 2002, are presented in the following table.
Concentrations of Credit Risk
The largest portion of loans, 39%, on the Company's balance sheet is for
commercial real estate related loans. The Company's commercial real estate loan
portfolio is principally to borrowers throughout Cumberland, Dauphin, Lebanon,
and York counties of Pennsylvania where it has full-service branch locations.
Commercial real estate, construction, and land development loans aggregated
$176.0 million at December 31, 2002, compared to $175.8 million at December 31,
2001. Commercial real estate loans are collateralized by the related project
(principally office building, multi-family residential, land development, and
other properties) and the Company generally requires loan-to-value ratios of no
greater than 80%. Collateral requirements on such loans are determined on a
case-by-case basis based on managements' credit evaluations of the respective
borrowers.
Non-Performing Loans and Assets
Total non-performing assets (non-performing loans and foreclosed real estate) at
December 31, 2002, were $1.8 million, or 0.23%, of total assets as compared to
$888,000, or 0.15%, of total assets at December 31, 2001. Foreclosed real estate
totaled $118,000 as of December 31, 2002, and $12,000 as of December 31, 2001.
Total non-performing loans (non-accrual loans and restructured loans) at
December 31, 2002 were $1.7 million compared to
Table 5
- --------------------------------------------------------------------------------------------------------------
December 31, 2002
- --------------------------------------------------------------------------------------------------------------
Due Under Due 1-5 Due Over
(in thousands) One Year Years Five Years Total
- --------------------------------------------------------------------------------------------------------------
Real estate:
Commercial mortgage $ 9,331 $39,949 $ 95,679 $144,959
Construction and land development 18,873 7,492 4,669 31,034
Residential mortgage 3,767 9,767 52,656 66,190
Tax-exempt 418 3,239 1,972 5,629
- --------------------------------------------------------------------------------------------------------------
32,389 60,447 154,976 247,812
Commercial 23,309 19,195 6,722 49,226
Consumer 11,173 13,156 10,269 34,598
Lines of credit 37,245 0 0 37,245
- --------------------------------------------------------------------------------------------------------------
Total loans $104,116 $92,798 $171,967 $368,881
- --------------------------------------------------------------------------------------------------------------
Interest rates:
Predetermined $ 32,546 $75,252 $158,500 $266,298
Floating 71,570 17,546 13,467 102,583
- --------------------------------------------------------------------------------------------------------------
Total loans $104,116 $92,798 $171,967 $368,881
- --------------------------------------------------------------------------------------------------------------
8
Management's Discussion and Analysis
of Financial Condition and Results of Operations
$876,000 a year ago. Total delinquent loans (those loans 30 days or more
delinquent) as a percentage of total loans were 0.68% at December 31, 2002,
compared to 0.34% at December 31, 2001. The Company generally places a loan on
nonaccrual status and ceases accruing interest when loan payment performance is
deemed unsatisfactory and the loan is past due 90 days or more, unless the loan
is both well-secured and in the process of collection. At December 31, 2002,
loans past due 90 days and still accruing interest amounted to $55,000 compared
to $0 at December 31, 2001.
Foreclosed real estate totaled $118,000 as of December 31, 2002 as compared to
$12,000 as of December 31, 2001. These properties have been written down to the
lower of cost or fair value less disposition costs. The Company obtains updated
appraisals on non-performing loans secured by real estate. In those instances
where appraisals reflect reduced collateral values, an evaluation of the
borrower's overall financial condition is made to determine the need for
possible write-downs or appropriate additions to the allowance for loan losses.
The following table summarizes information regarding non-performing loans and
non-performing assets as of December 31, 1998 through 2002.
Allowance for Loan Losses
The allowance for loan losses is a reserve established through charges to
expense in the form of a provision for loan losses and reduced by loan
charge-offs net of recoveries. Charge-offs occur when loans are deemed to be
uncollectible. Management has established an allowance for loan losses that they
believe is adequate for estimated inherent losses in the current loan portfolio.
In conjunction with an internal loan review function that operates independently
of the lending function, management monitors the loan portfolio to identify
risks on a timely basis so that an appropriate allowance can be maintained.
Based on an evaluation of the loan portfolio, management presents a quarterly
review of the allowance for loan losses to the Board of Directors, indicating
any changes in the allowance since the last review and any recommendations as to
adjustments in the allowance. In making the evaluation, management considers the
results of recent regulatory examinations, which typically include a review of
the allowance for loan losses as an important part of the examination process.
In establishing the allowance, management evaluates individual large classified
loans and nonaccrual loans, and determines an aggregate reserve for those loans
based on that review. An allowance for the remainder of the loan portfolio is
also determined based on historical loss experience within the components of the
portfolio. These allocations may be modified if current condi-
Table 6
- ---------------------------------------------------------------------------------------------------------------------
December 31,
(dollars in thousands) 2002 2001 2000 1999 1998
- ---------------------------------------------------------------------------------------------------------------------
Nonaccrual loans:
Commercial $ 958 $127 $300 $119 $227
Consumer 42 116 162 244 23
Real estate:Construction 0 0 0 0 0
Mortgage 599 633 371 321 25
- ---------------------------------------------------------------------------------------------------------------------
Total nonaccrual loans 1,599 876 833 684 275
Loans past due 90 days or more and still accruing 55 0 0 20 1
Restructured loans 0 0 0 0 0
- ---------------------------------------------------------------------------------------------------------------------
Total non-performing loans 1,654 876 833 704 276
Foreclosed real estate 118 12 42 12 11
- ---------------------------------------------------------------------------------------------------------------------
Total non-performing assets $1,772 $888 $875 $716 $287
- ---------------------------------------------------------------------------------------------------------------------
Non-performing loans to total loans 0.45% 0.26% 0.29% 0.32% 0.16%
Non-performing assets to total assets 0.23% 0.15% 0.18% 0.18% 0.09%
- ---------------------------------------------------------------------------------------------------------------------
Interest income received on nonaccrual loans $ 79 $ 33 $ 52 $ 38 $ 5
- ---------------------------------------------------------------------------------------------------------------------
Interest income that would have been recorded
under the original terms of the loans $193 $ 89 $ 96 $ 66 $ 22
9
Management's Discussion and Analysis
of Financial Condition and Results of Operations
tions indicate that loan losses may differ from historical experience, based on
factors and changes in portfolio mix and volume.
In addition, an unallocated portion of the allowance is established for losses
inherent in the loan portfolio, which have not been identified by the more
quantitative processes described above. This determination inherently involves a
higher degree of subjectivity, and considers risk factors that may not have yet
manifested themselves in the Company's historical loss experience. Those factors
include changes in levels and trends of charge-offs, delinquencies and
nonaccrual loans, trends in volume and term loans, changes in underwriting
standards and practices, portfolio mix, tenure of the loan officers and
management, changes in credit concentrations, and national and local economic
trends and conditions.
While the allowance for loan losses is maintained at a level believed to be
adequate by management for estimated losses in the loan portfolio, determination
of the allowance is inherently subjective, as it requires estimates, all of
which may be susceptible to significant change. Changes in these estimates may
impact the provisions charged to expense in future periods.
The Company recorded provisions of $1.4 million to the allowance for loan losses
for 2002 compared to $1.5 million for 2001. During 2002, net charge-offs
amounted to $833,000, or 0.23%, of average loans outstanding for the year,
compared to $657,000, or 0.21%, of average loans outstanding for 2001. The
allowance for loan losses increased as a percentage of loans receivable from
1.33% of total loans outstanding at December 31, 2001, to 1.40% of total loans
outstanding and provided coverage of 311% of non-performing loans.
The table below presents, for the years 1998 through 2002, information regarding
the Company's provision and allowance for loan losses.
Table 7
- ----------------------------------------------------------------------------------------------------------------
Year Ended December 31,
(dollars in thousands) 2002 2001 2000 1999 1998
- ----------------------------------------------------------------------------------------------------------------
Balance at beginning of year $4,544 $3,732 $2,841 $2,232 $1,699
Provisions charged to operating expenses 1,435 1,469 1,050 762 542
- ----------------------------------------------------------------------------------------------------------------
5,979 5,201 3,891 2,994 2,241
- ----------------------------------------------------------------------------------------------------------------
Recoveries of loans previously charged-off:
Commercial 93 3 6 8 4
Consumer 2 21 8 4 3
Real estate 21 0 0 1 0
- ----------------------------------------------------------------------------------------------------------------
Total recoveries 116 24 14 13 7
- ----------------------------------------------------------------------------------------------------------------
Loans charged-off:
Commercial (561) (475) (1) (150) (2)
Consumer (70) (85) (95) (10) (14)
Real estate (318) (121) (77) (6) (0)
- ----------------------------------------------------------------------------------------------------------------
Total charged-off (949) (681) (173) (166) (16)
- ----------------------------------------------------------------------------------------------------------------
Net charge-offs (833) (657) (159) (153) (9)
- ----------------------------------------------------------------------------------------------------------------
Balance at end of year $5,146 $4,544 $3,732 $2,841 $2,232
- ----------------------------------------------------------------------------------------------------------------
Net charge-offs to average loans outstanding 0.23% 0.21% 0.06% 0.08% 0.01%
Allowance for loan losses to year-end loans 1.40% 1.33% 1.29% 1.31% 1.34%
- ----------------------------------------------------------------------------------------------------------------
10
Management's Discussion and Analysis
of Financial Condition and Results of Operations
Allocation of the Allowance for Loan Losses
The following table details the allocation of the allowance for loan losses to
the various categories. The allocation is made for analytical purposes and it is
not necessarily indicative of the categories in which future credit losses may
occur. The total allowance is available to absorb losses from any segment of
loans.
Table 8
- --------------------------------------------------------------------------------------------------------------------------------
Allowance for Loan Losses at December 31,
2002 2001 2000 1999 1998
- --------------------------------------------------------------------------------------------------------------------------------
% Gross % Gross % Gross % Gross % Gross
(dollars in thousands) Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
- --------------------------------------------------------------------------------------------------------------------------------
Commercial loans
and lines of credit $2,428 23.45% $ 986 23.20% $ 178 19.20% $ 155 17.73% $ 400 19.28%
Consumer 452 9.38 157 10.67 143 10.57 224 10.53 150 12.49
Real estate, construction
and land development:
Commercial 1,698 47.84 3,240 50.38 3,286 54.61 2,335 55.69 1,582 49.27
Residential 568 19.33 161 15.75 125 15.62 127 16.05 100 18.96
- --------------------------------------------------------------------------------------------------------------------------------
Total $5,146 100.00% $4,544 100.00% $3,732 100.00% $2,841 100.00% $2,232 100.00%
- --------------------------------------------------------------------------------------------------------------------------------
Deposits
Total deposits at December 31, 2002, were $727.0 million, up $165.3 million, or
29%, over total deposits of $561.7 million at December 31, 2001. The Company
remains a deposit-driven financial institution with emphasis on core deposit
accumulation and retention as a basis for sound growth and profitability. The
Company regards core deposits as all deposits other than public certificates of
deposits. Deposits in the various core categories, increased $162.1 million, or
31%, in 2002 over 2001. Total deposits averaged $641.5 million for 2002, an
increase of $140.4 million, or 28%, over the 2001 average of $501.1 million. The
average balance on noninterest-bearing demand deposits increased in 2002 by
$23.4 million, or 26%, compared to the prior year. The average balance of
interest bearing demand accounts (money market and interest checking accounts)
for 2002 increased by $48.1 million, or 44%, over the average balance for the
prior year. The average total balance of all savings accounts was $197.2
million, a $55.9 million, or 40%, increase over the average balance for 2001.
The average balance of all time deposits in 2002 was $173.1 million, an increase
of $13.0 million, or 8%, over the average balance for 2001. For 2002, the cost
of total deposits was 2.02% as compared to 3.08% in 2001. The Company believes
that its record of sustaining core deposit growth is reflective of the Company's
retail approach to banking which emphasizes a combination of free checking
accounts, convenient branch locations, extended hours of operation, quality
service, and active marketing. The average balances and weighted average rates
paid on deposits for 2002, 2001 and 2000 are presented below.
Table 9
- -------------------------------------------------------------------------------------------------------------------------
Year Ended December 31,
2002 Average 2001 Average 2000 Average
(dollars in thousands) Balance/Rate Balance/Rate Balance/Rate
- -------------------------------------------------------------------------------------------------------------------------
Demand deposits:
Noninterest-bearing $114,758 $ 91,352 $ 72,413
Interest-bearing (money market and checking) 156,441 1.30% 108,349 2.24% 80,460 3.26%
Savings 197,225 1.96 141,350 2.95 108,131 3.90
Time 173,064 4.06 160,031 5.52 130,816 5.44
- -------------------------------------------------------------------------------------------------------------------------
Total deposits $641,488 $501,082 $391,820
- -------------------------------------------------------------------------------------------------------------------------
11
Management's Discussion and Analysis
of Financial Condition and Results of Operations
The remaining maturity for certificates of deposit of $100,000 or more as of
December 31, 2002, 2001 and 2000 is presented in Table 10.
Table 10
- -------------------------------------------------------------
(in thousands) 2002 2001 2000
- -------------------------------------------------------------
3 months or less $31,591 $32,092 $41,554
3 to 6 months 20,462 17,493 4,771
6 to 12 months 16,390 9,028 7,541
Over 12 months 11,427 16,292 13,515
- -------------------------------------------------------------
Total $79,870 $74,905 $67,381
- -------------------------------------------------------------
Interest Rate Sensitivity
The management of interest rate sensitivity seeks to avoid fluctuating net
interest margins and to provide consistent net interest income through periods
of changing interest rates. The Company's risk of loss arising from adverse
changes in the fair value of financial instruments, or market risk, is composed
primarily of interest rate risk. The primary objective of the Company's
asset/liability management activities is to maximize net interest income while
maintaining acceptable levels of interest rate risk. The Company's
Asset/Liability Committee (ALCO) is responsible for establishing policies to
limit exposure to interest rate risk, and to ensure procedures are established
to monitor compliance with those policies. The Company's Board of Directors
reviews the guidelines established by ALCO. An interest rate sensitive asset or
liability is one that, within a defined time period, either matures or
experiences an interest rate change in line with general market interest rates.
Historically, the most common method of estimating interest rate risk was to
measure the maturity and repricing relationships between interest-earning assets
and interest-bearing liabilities at specific points in time ("GAP"), typically
one year. Under this method, a company is considered liability sensitive when
the amount of its interest-bearing liabilities exceeds the amount of its
interest-earning assets within the one-year horizon. However, assets and
liabilities with similar repricing characteristics may not reprice at the same
time or to the same degree. As a result, the Company's GAP does not necessarily
predict the impact of changes in general levels of interest rates on net
interest income. Table 11 shows the GAP position for the Company as of December
31, 2002.
Table 11
- --------------------------------------------------------------------------------------------------------------------------------
December 31, 2002
- --------------------------------------------------------------------------------------------------------------------------------
1 - 90 91 - 180 181 - 365 1 - 5 Beyond 5
(in thousands) Days Days Days Years Years Total
- --------------------------------------------------------------------------------------------------------------------------------
Interest earning assets:
Loans receivable $119,955 $ 5,551 $11,978 $ 75,071 $164,383 $376,938
Securities 49,520 39,704 54,693 96,064 57,705 297,686
Federal funds sold 44,500 0 0 0 0 44,500
- --------------------------------------------------------------------------------------------------------------------------------
Total interest earning assets 213,975 45,255 66,671 171,135 222,088 719,124
- --------------------------------------------------------------------------------------------------------------------------------
Interest-bearing liabilities:
Transaction accounts 129,679 0 0 0 301,650 431,329
Time deposits 49,620 33,101 45,337 40,369 0 168,427
Trust capital securities 0 0 0 0 13,000 13,000
- --------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 179,299 33,101 45,337 40,369 314,650 612,756
- --------------------------------------------------------------------------------------------------------------------------------
Period GAP 34,676 12,154 21,334 130,766 (92,562) $106,368
- --------------------------------------------------------------------------------------------------------------------------------
Cumulative GAP $ 34,676 $46,830 $68,164 $198,930 $106,368
- --------------------------------------------------------------------------------------------------------------------------------
Notes: Nonaccrual loans, deferred fees on loans and overdrafts have been excluded in the loans receivable
balances. Securities are reported at par for purposes of this table.
12
Management's Discussion and Analysis
of Financial Condition and Results of Operations
Management believes the simulation of net interest income in different interest
rate environments provides a more meaningful measure of interest rate risk.
Income simulation analysis captures not only the potential of all assets and
liabilities to mature or reprice, but also the probability that they will do so.
Income simulation also attends to the relative interest rate sensitivities of
these items, and projects their behavior over an extended period of time.
Finally, income simulation permits management to assess the probable effects on
the balance sheet not only of changes in interest rates, but also of proposed
strategies for responding to them.
The Company's income simulation model analyzes interest rate sensitivity by
projecting net income over the next 24 months in a flat rate scenario versus net
income in alternative interest rate scenarios. Management continually reviews
and refines its interest rate risk management process in response to the
changing economic climate. Currently, the Company's model projects a 200 basis
point increase and a 100 basis point decrease during the next year, with rates
remaining constant in the second year.
Historically, the Company's Asset/Liability Committee (ALCO) policy has
established that income sensitivity will be considered acceptable if overall net
income volatility in a plus 200 or minus 200 basis point scenario is within 15%
of net income in a flat rate scenario in the first year and 30% using a two year
planning window. At December 31, 2002, the Company projected its interest rate
risk using a plus 200 and minus 100 basis point scenario. During 2002 and 2001
combined, the Federal Reserve lowered short-term interest rates by 525 basis
points, pushing the Federal Funds rate down to 1.25% at year-end 2002, the
lowest level in over 50 years. The Company's ALCO believed it was a better
measure of current risk assuming a minus 100 point scenario, as a minus 200
basis point reduction would be unlikely given that current short-term market
interest rates are already below 2.00%. At December 31, 2002, the Company's
income simulation model indicates net income would decrease 0.5%, or $39,000,
and 5.2%, or $1.0 million, in the first year and over a two-year time frame,
respectively, if rates decreased 100 basis points as compared to an increase of
4.1% and 5.5%, respectively, at December 31, 2001. The model projects that net
income would increase by 5.4%, or $414,000, and 16.8%, or $3.3 million, in the
first year and over a two-year time frame, respectively, if rates increased as
described above, as compared to an increase of 0.5% and 5.3%, respectively, at
December 31, 2001. All of these forecasts are within an acceptable level of
interest rate risk per the policies established by ALCO. The market value of
equity model reflects certain estimates and assumptions regarding the impact on
the market value of the Company's assets and liabilities given an immediate 200
basis point change in interest rates. One of the key assumptions is the market
value assigned to the Company's core deposits, or the core deposit premium. The
Company has completed and updated comprehensive core deposit studies in order to
assign its own core deposit premiums as permitted by regulation. The studies
have consistently confirmed management's assertion that the Company's core
deposits have stable balances over long periods of time, and are generally
insensitive to changes in interest rates. Thus, these core deposit balances
provide an internal hedge to market fluctuations in the Company's fixed rate
assets. Management believes the core deposit premiums produced by its market
value of equity model at December 31, 2002 provide an accurate assessment of the
Company's interest rate risk.
Management also monitors interest rate risk by utilizing a market value of
equity model. The model assesses the impact of a change in interest rates on the
market value of all the Company's assets and liabilities, as well as any off
balance sheet items. The model calculates the market value of the Company's
assets and liabilities in excess of book value in the current rate scenario, and
then compares the excess of market value over book value given an immediate 200
basis point increase in rates and a 100 basis point decrease in rates. The
Company's ALCO policy indicates that the level of interest rate risk is
unacceptable if the immediate change would result in the loss of 60% or more of
the excess of market value over book value in the current rate scenario. At
December 31, 2002, the market value of equity indicates an acceptable level of
interest rate risk.
Liquidity
Liquidity management involves the Company's ability to generate cash or
otherwise obtain funds at reasonable rates to support asset growth and reduce
assets to meet deposit withdrawals, to maintain reserve requirements, and to
otherwise operate the Company on an ongoing basis. Liquidity sources from asset
categories are provided primarily by cash, federal funds sold, and the cash flow
from the amortizing securities and loan portfolios. The primary source of
liquidity from liability categories is the generation of additional core deposit
balances. As previously mentioned, total core deposits increased by $162.1
million, or 31%, in 2002.
Additionally, the Company has established secondary sources of liquidity
consisting of federal funds lines of credit, repurchase agreements, and
borrowing capacity at the Federal Home Loan Bank, which can be drawn upon if
needed. As of December 31, 2002, the total potential liquidity for the Company
through these secondary sources was $231 million. In view of the primary and
secondary sources as previously mentioned, management believes the Company is
capable of meeting its anticipated liquidity needs.
13
Management's Discussion and Analysis
of Financial Condition and Results of Operations
Off-Balance Sheet Arrangements and Aggregate Contractual Obligations
The following table represents the Company's on-and-off balance sheet aggregate
contractual obligations to make future payments as of December 31, 2002:
Table 12
- -----------------------------------------------------------------------------------------------------
December 31, 2002
- -----------------------------------------------------------------------------------------------------
1 Year Over 1 Over 3 Over 5
(in thousands) or Less to 3 Years to 5 Years Years Total
- -----------------------------------------------------------------------------------------------------
Time Deposits $128,058 $24,038 $16,331 $ 0 $168,427
Trust Capital Securities 0 0 0 13,000 13,000
Operating Leases 1,195 2,039 1,619 6,164 11,017
- -----------------------------------------------------------------------------------------------------
Total $129,253 $26,077 $17,950 $19,164 $192,444
- -----------------------------------------------------------------------------------------------------
In addition, the Company, in the conduct of ordinary business operations
routinely enters into contracts for services. These contracts may require
payment for services to be provided in the future and may also contain penalty
clauses for the early termination of the contract. Management is not aware of
any additional commitments or contingent liabilities, which may have a material
adverse impact on the liquidity or capital resources of the Company.
The Company is also party to financial instruments with off-balance sheet risk
in the normal course of business to meet the financing needs of its customers.
These financial instruments include commitments to extend credit and standby
letters of credit.
Short-Term Borrowings
Short-term borrowings, or other borrowed money, which consists of securities
sold under agreement to repurchase and federal funds purchased, were used
occasionally in 2002 and 2001 to meet short-term liquidity needs. For 2002,
other borrowed money averaged $12,000 as compared to $330,000 in 2001. The
average rate paid on the Company's short-term borrowings was 1.46% during 2002
and 3.94% in 2001. Short-term borrowings totaled $0 at December 31, 2002 and
2001.
Long-Term Debt
Long-term debt consists of Trust Capital Securities through Commerce Harrisburg
Capital Trust I and Commerce Harrisburg Capital Trust II, Delaware business
trust subsidiaries of the Company. At December 31, 2002, all of the Capital
Trust Securities qualified as Tier I capital for regulatory capital purposes.
Proceeds of the trust capital securities are for general corporate purposes,
including additional capitalization of the Company's wholly-owned banking
subsidiary. Reference should be made to Note 10 in the Notes to the consolidated
Financial Statements for further analysis of the Company's long-term debt.
Long-term debt totaled $13.0 million at December 31, 2002 and 2001.
Stockholders' Equity and Capital Adequacy
At December 31, 2002, stockholders' equity totaled $42.8 million, up $10.2
million, or 31%, over stockholders' equity at December 31, 2001. This increase
was due to the Company's net income for the year, shares issued under stock
purchase and stock option plans, and unrealized appreciation on securities
available for sale. Stockholders' equity as a percent of total assets was 5.44%
at December 31, 2002, compared to 5.34% at December 31, 2001.
Risk-based capital provides the basis for which all banks are evaluated in terms
of capital adequacy. The risk-based capital standards require all banks to have
Tier 1 capital of at least 4% and total capital, including Tier 1 capital, of at
least 8% of risk-adjusted assets. Tier 1 capital includes common stockholders'
equity and qualifying perpetual preferred stock together with related surpluses
and retained earnings. Total capital may be comprised of total Tier 1 capital
plus limited life preferred stock, qualifying debt instruments, and the
allowance for loan losses.
Table 13 provides a comparison of the Bank's risk-based capital ratios and
leverage ratios to the minimum regulatory requirements for the periods
indicated.
At December 31, 2002, the consolidated capital levels of the Company and of the
subsidiary bank (Commerce) met the definition of a "well capitalized"
institution, i.e., a leverage capital ratio exceeding 5%, a Tier 1 risk-based
capital ratio exceeding 6%, and a total risk-based capital ratio exceeding 10%.
14
Management's Discussion and Analysis
of Financial Condition and Results of Operations
Table 13
- -----------------------------------------------------------------------------------------------------------
To Be Well-
Capitalized Under
Actual December 31, For Capital Prompt Corrective
2002 2001 Adequacy Purposes Action Provisions
- -----------------------------------------------------------------------------------------------------------
Tier 1 Capital 11.11% 10.67% 4.00% 6.00%
Total Capital 12.17 11.73 8.00 10.00
Leverage ratio (to average assets) 6.97 7.65 4.00 5.00
- -----------------------------------------------------------------------------------------------------------
The Company's common stock is listed for trading on the NASDAQ Small Cap Market
under the symbol COBH. The Company offers a Dividend Reinvestment and Stock
Purchase Plan by which dividends on the Company's Common Stock and optional cash
payments of up to $5,000 per quarter (subject to change) may be invested in
Common Stock at a 3% discount (subject to change) to the market price and
without payment of brokerage commissions.
Forward-Looking Statements
The Company may from time to time make written or oral "forward-looking
statements," including statements contained in the Company's filings with the
Securities and Exchange Commission (including this Annual Report and Form 10-K
and the exhibits hereto and thereto), in its reports to stockholders and in
other communications by the Company, which are made in good faith by the Company
pursuant to the "safe harbor" provisions of the Private Securities Litigation
Reform Act of 1995.
These forward-looking statements include statements with respect to the
Company's beliefs, plans, objectives, goals, expectations, anticipations,
estimates and intentions, that are subject to significant risks and
uncertainties and are subject to change based on various factors (some of which
are beyond the Company's control). The words "may", "could", "should", "would",
"believe", "anticipate", "estimate", "expect", "intend", "plan" and similar
expressions are intended to identify forward-looking statements. The following
factors, among others, could cause the Company's financial performance to differ
materially from that expressed in such forward-looking statements: the strength
of the United States economy in general and the strength of the local economies
in which the Company conducts operations; the effects of, and changes in, trade,
monetary and fiscal policies, including interest rate policies of the Board of
Governors of the Federal Reserve System (the "FRB"); inflation; interest rate,
market and monetary fluctuations; the timely development of competitive new
products and services by the Company and the acceptance of such products and
services by customers; the willingness of customers to substitute competitors'
products and services for the Company's products and services and vice versa;
the impact of changes in financial services' laws and regulations (including
laws concerning taxes, banking, securities and insurance); technological
changes; future acquisitions; the expense savings and revenue enhancements from
acquisitions being less than expected; the growth and profitability of the
Company's noninterest or fee income being less than expected; unanticipated
regulatory or judicial proceedings; changes in consumer spending and saving
habits; and the success of the Company at managing the risks involved in the
foregoing.
The Company cautions that the foregoing list of important factors is not
exclusive. The Company does not undertake to update any forward-looking
statements, whether written or oral, that may be made from time to time by or on
behalf of the Company.
Impact of Inflation and Changing Prices
Interest rates have a more significant impact on the Company's performance than
do the effects of general levels of inflation, since most of the Company's
assets and liabilities are monetary in nature. Interest rates do not necessarily
move in the same direction or in the same magnitude as the prices of goods and
services as measured by the Consumer Price Index. The liquidity and maturity
structure of the Company's assets and liabilities are critical to the
maintenance of acceptable performance levels.
15
Consolidated Balance Sheets
December 31,
(in thousands, except share amounts) 2002 2001
- ---------------------------------------------------------------------------------------------------------
Assets
- ---------------------------------------------------------------------------------------------------------
Cash and due from banks $ 30,950 $ 21,555
Federal funds sold 44,500 4,300
- ----------------------------------------------------------------------------------------------------------
Cash and cash equivalents 75,450 25,855
Securities, available for sale at fair value 205,436 104,722
Securities, held to maturity at cost
(fair value 2002: $101,036; 2001: $102,427 ) 97,625 103,349
Loans, held for sale 10,514 7,661
Loans receivable, net of allowance for loan losses
(allowance 2002: $5,146; 2001: $4,544) 363,735 338,130
Restricted investments in bank stock 2,045 2,593
Premises and equipment, net 26,409 21,587
Accrued interest receivable 3,675 3,542
Other assets 1,709 2,451
- ----------------------------------------------------------------------------------------------------------
Total assets $786,598 $609,890
- ----------------------------------------------------------------------------------------------------------
Liabilities and Stockholders' Equity
- ---------------------------------------------------------------------------------------------------------
Deposits:
Noninterest-bearing $127,199 $105,171
Interest-bearing 599,756 456,567
- ----------------------------------------------------------------------------------------------------------
Total deposits 726,955 561,738
Accrued interest payable 832 837
Other liabilities 2,999 1,722
Trust capital securities 13,000 13,000
- ----------------------------------------------------------------------------------------------------------
Total liabilities 743,786 577,297
- ----------------------------------------------------------------------------------------------------------
Stockholders' Equity:
Preferred stock - Series A noncumulative; $10.00 par value;
1,000,000 shares authorized; 40,000 shares issued and outstanding 400 400
Common stock - $1.00 par value; 10,000,000 shares authorized;
(issued and outstanding 2002: 2,117,089; 2001: 1,881,960) 2,117 1,882
Surplus 31,909 25,263
Retained earnings 6,866 5,159
Accumulated other comprehensive income (loss) 1,520 (111)
- ----------------------------------------------------------------------------------------------------------
Total stockholders' equity 42,812 32,593
- ----------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $786,598 $609,890
- ----------------------------------------------------------------------------------------------------------
See accompanying notes
16
Consolidated Statements of Income
Year Ended December 31,
(in thousands, except per share amounts) 2002 2001 2000
- ----------------------------------------------------------------------------------------------------------------------
Interest Income Loans receivable, including fees:
Taxable $26,755 $26,532 $22,836
Tax-exempt 111 120 109
Securities:
Taxable 14,514 10,860 8,025
Tax-exempt 107 94 44
Federal funds sold 508 641 760
- ----------------------------------------------------------------------------------------------------------------------
Total interest income 41,995 38,247 31,774
- ----------------------------------------------------------------------------------------------------------------------
Interest Expense
- ----------------------------------------------------------------------------------------------------------------------
Deposits 12,940 15,420 13,956
Other 0 13 42
Trust capital securities 1,354 760 299
- ----------------------------------------------------------------------------------------------------------------------
Total interest expense 14,294 16,193 14,297
- ----------------------------------------------------------------------------------------------------------------------
Net interest income 27,701 22,054 17,477
Provision for loan losses 1,435 1,469 1,050
- ----------------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 26,266 20,585 16,427
- ----------------------------------------------------------------------------------------------------------------------
Noninterest Income
- ----------------------------------------------------------------------------------------------------------------------
Service charges and other fees 6,766 5,660 4,564
Other 448 541 428
Gain on sales of securities available for sale 0 52 0
Gain on sales of loans 493 354 370
- ----------------------------------------------------------------------------------------------------------------------
Total noninterest income 7,707 6,607 5,362
- ----------------------------------------------------------------------------------------------------------------------
Noninterest Expenses
- ----------------------------------------------------------------------------------------------------------------------
Salaries and employee benefits 12,491 9,486 7,485
Occupancy 2,403 2,133 1,782
Furniture and equipment 1,523 1,402 1,092
Advertising and marketing 2,181 1,722 1,451
Data processing 1,890 1,313 964
Postage and supplies 862 846 659
Audits, regulatory fees and assessments 484 401 348
Other 3,594 3,209 2,408
- ----------------------------------------------------------------------------------------------------------------------
Total noninterest expenses 25,428 20,512 16,189
- ----------------------------------------------------------------------------------------------------------------------
Income before income taxes 8,545 6,680 5,600
Provision for income taxes 2,871 2,232 1,886
- ----------------------------------------------------------------------------------------------------------------------
Net income $ 5,674 $ 4,448 $ 3,714
- ----------------------------------------------------------------------------------------------------------------------
Net Income per Common Share
- ----------------------------------------------------------------------------------------------------------------------
Basic $2.71 $2.24 $1.90
Diluted 2.48 2.04 1.78
- ----------------------------------------------------------------------------------------------------------------------
See accompanying notes
17
Consolidated Statements of Stockholders' Equity
Accumulated Other
Preferred Common Retained Comprehensive
(dollars in thousands) Stock Stock Surplus Earnings Income (Loss) Total
- --------------------------------------------------------------------------------------------------------------------------------
December 31, 1999 $400 $1,644 $18,196 $3,137 $(2,999) $20,378
- --------------------------------------------------------------------------------------------------------------------------------
Comprehensive income:
Net income - - - 3,714 - 3,714
Change in unrealized gains (losses) on securities,
net of reclassification adjustment - - - - 2,323 2,323
-----
Total comprehensive income 6,037
-----
Dividends declared on preferred stock - - - (80) - (80)
Common stock of 12,693 shares issued under
stock option plans - 13 71 - - 84
Income tax benefit of stock options exercised - - 30 - - 30
Common stock of 240 shares issued under employee
stock purchase plan - - 6 - - 6
Proceeds from issuance of 8,890 shares of
common stock in connection with
dividend reinvestment and stock purchase plan - 9 210 - - 219
5% common stock dividend and cash paid in
lieu of fractional shares (82,909 shares issued) - 83 2,348 (2,437) - (6)
- --------------------------------------------------------------------------------------------------------------------------------
December 31, 2000 $400 $1,749 $20,861 $4,334 $ (676) $26,668
- --------------------------------------------------------------------------------------------------------------------------------
Comprehensive income:
Net income - - - 4,448 - 4,448
Change in unrealized gains (losses) on securities,
net of reclassification adjustment - - - - 565 565
-----
Total comprehensive income 5,013
-----
Dividends declared on preferred stock - - - (80) - (80)
Common stock of 23,231 shares issued under
stock option plans - 24 193 - - 217
Income tax benefit of stock options exercised - - 78 - - 78
Common stock of 290 shares issued under employee
stock purchase plan - - 9 - - 9
Proceeds from issuance of 20,016 shares of
common stock in connection with
dividend reinvestment and stock purchase plan - 20 678 - - 698
5% common stock dividend and cash paid in
lieu of fractional shares (89,378 shares issued) - 89 3,444 (3,543) - (10)
- --------------------------------------------------------------------------------------------------------------------------------
December 31, 2001 $400 $1,882 $25,263 $5,159 $ (111) $32,593
- --------------------------------------------------------------------------------------------------------------------------------
Comprehensive income:
Net income - - - 5,674 - 5,674
Change in unrealized gains (losses) on securities,
net of reclassification adjustment - - - - 1,631 1,631
-----
Total comprehensive income 7,305
-----
Dividends declared on preferred stock - - - (80) - (80)
Common stock of 112,379 shares issued under
stock option plans - 113 1,625 - - 1,738
Income tax benefit of stock options exercised - - 378 - - 378
Common stock of 440 shares issued under employee
stock purchase plan - - 19 - - 19
Proceeds from issuance of 21,733 shares of
common stock in connection with
dividend reinvestment and stock purchase plan - 22 846 - - 868
5% common stock dividend and cash paid in
lieu of fractional shares (100,577 shares issued) - 100 3,778 (3,887) - (9)
- -------------------------------------------------------------------------------------------------------------------------------
December 31, 2002 $400 $2,117 $31,909 $6,866 $ 1,520 $42,812
- --------------------------------------------------------------------------------------------------------------------------------
See accompanying notes
18
Consolidated Statements of Cash Flows
Year Ended December 31,
(in thousands) 2002 2001 2000
- -----------------------------------------------------------------------------------------------------------------------
Operating Activities
Net income $ 5,674 $ 4,448 $ 3,714
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 1,435 1,469 1,050
Provision for depreciation and amortization 1,484 1,403 1,202
Deferred income taxes 68 (251) (281)
Amortization of securities premiums and accretion of discounts, net 926 219 193
Gains on sale of securities available for sale 0 (52) 0
Proceeds from sales of loans 67,794 48,887 19,813
Loans originated for sale (70,154) (50,944) (19,705)
Gains on sales of loans (493) (354) (370)
Stock granted under stock purchase plan 19 9 6
(Increase) decrease in accrued interest receivable and other assets 74 (742) (1,345)
Increase in accrued interest payable and other liabilities 1,272 724 143
- -----------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 8,099 4,816 4,420
Investing Activities
- -----------------------------------------------------------------------------------------------------------------------
Securities held to maturity:
Proceeds from principal repayments and maturities 34,681 18,589 2,608
Purchases (29,121) (88,112) (7,398)
Securities available for sale:
Proceeds from principal repayments and maturities 77,946 43,922 7,501
Proceeds from sales 0 7,497 0
Purchases (176,945) (64,833) (12,268)
(Purchase) redemption of restricted investments in bank stock 548 (305) (158)
Proceeds from sales of loans receivable 0 3,255 6,449
Net increase in loans receivable (27,040) (56,254) (80,521)
Proceeds from sale of premises and equipment 0 0 743
Purchases of premises and equipment (6,306) (6,353) (4,174)
- -----------------------------------------------------------------------------------------------------------------------
Net cash used by investing activities (126,237) (142,594) (87,218)
Financing Activities
- -----------------------------------------------------------------------------------------------------------------------
Net increase in demand, interest checking,
money market, and savings deposits 159,992 102,383 68,145
Net increase in time deposits 5,225 12,772 29,892
Net decrease in other borrowed money 0 0 (8,300)
Proceeds from issuance of trust capital securities 0 8,000 5,000
Proceeds from common stock options exercised 1,738 217 84
Proceeds from common stock purchase and dividend reinvestment plan 868 698 219
Cash dividends on preferred stock and cash in lieu of fractional shares (90) (86)
(83)
- -----------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 167,733 123,984 94,957
- -----------------------------------------------------------------------------------------------------------------------
Increase (decrease) in cash and cash equivalents 49,595 (13,794) 12,159
Cash and cash equivalents at beginning of year 25,855 39,649 27,490
- -----------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at year-end $ 75,450 $ 25,855 $ 39,649
- -----------------------------------------------------------------------------------------------------------------------
See accompanying notes.
19
Notes to Consolidated Financial Statements
December 31, 2002
1. Significant Accounting Policies
- --------------------------------------------------------------------------------
Nature of Operations and Basis of Presentation
The consolidated financial statements include the accounts of Pennsylvania
Commerce Bancorp, Inc. (the Company) and its wholly-owned subsidiaries Commerce
Bank/Harrisburg, N.A. (Commerce or Bank), Commerce Harrisburg Capital Trust I
and Commerce Harrisburg Capital Trust II. All material intercompany transactions
have been eliminated. The Holding Company was formed July 1, 1999 and is subject
to regulation of the Federal Reserve Bank.
The Company is a one-bank holding company headquartered in Camp Hill,
Pennsylvania and provides full banking services through its subsidiary Commerce
Bank. Commerce operates under a national bank charter and provides full banking
services. As a national bank, Commerce is subject to regulation of the Office of
the Comptroller of the Currency and the Federal Deposit Insurance Corporation.
The area served by the Bank is principally South Central Pennsylvania.
Estimates
The financial statements are prepared in conformity with accounting principles
generally accepted in the United States of America. These principles require
management to make estimates and assumptions that affect reported amounts of
assets and liabilities and require disclosure of contingent assets and
liabilities. In the opinion of management, all adjustments considered necessary
for fair presentation have been included and are of a normal, recurring nature.
Actual results could differ from those estimates.
Securities
Securities classified as held to maturity are those debt securities that the
Company 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
average life of the securities.
Securities classified as available for sale are those debt securities that the
Company intends to hold for an indefinite period of time, but not necessarily to
maturity. 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 the maturity mix of the Company's assets and liabilities, liquidity
needs, regulatory capital considerations, and other similar factors. Securities
available for sale are carried at fair value. Unrealized gains or losses are
reported in other comprehensive income, net of the related deferred tax effect.
Realized gains or losses, determined on the basis of the cost of specific
securities sold, are included in earnings. Premiums and discounts are recognized
in interest income using the interest method over the estimated average life of
the securities.
Management determines the appropriate classification of debt securities at the
time of purchase and re-evaluates such designation as of each balance sheet
date.
Loans Receivable
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 an allowance for loan losses and any deferred
fees and costs. Interest income is accrued on the unpaid principal balance. Loan
origination fees and costs are deferred and recognized as an adjustment of the
yield (interest income) of the related loans. The Bank is generally amortizing
these amounts over the contractual life of the loan.
The accrual of interest is generally discontinued when the contractual payment
of principal or interest has become 90 days past due or management has serious
doubts about further collectibility of principal or interest, even though the
loan is currently performing. A loan may remain on accrual status if it is in
the process of collection and is either guaranteed or well secured. When a loan
is placed on nonaccrual status, unpaid interest credited to income in the
current year is reversed and unpaid interest accrued in prior years is charged
against the allowance for loan losses. Interest received on nonaccrual loans
generally is either applied against principal or reported as interest income,
according to management's judgment as to the collectibility of principal.
Generally, loans are restored to accrual status when the obligation is brought
current, has performed in accordance with the contractual terms for a reasonable
period of time and the ultimate collectibility of the total contractual
principal and interest is no longer in doubt.
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 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 the Bank's past loan
loss experience, known and inherent risks in the portfolio, adverse situations
that may affect the borrower's ability to repay, the estimated value of any
underlying collateral, composition of the loan portfolio, current economic
conditions, 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
20
Notes to Consolidated Financial Statements
on impaired loans. A loan is considered impaired when, based on current
information and events, it is probable that the Bank will be unable to collect
the scheduled payments of principal or interest when due according to the
contractual terms of the loan agreement. Factors considered by management in
determining impairment include payment status, collateral value and the
probability of collecting scheduled principal and interest payments when due.
Loans that experience insignificant payment delays and payment shortfalls
generally are not classified as impaired. Management determines the significance
of payment delays and payment shortfalls on a case-by-case basis, taking into
consideration all of the circumstances surrounding the loan and the borrower,
including the length of the delay, the reasons for the delay, the borrower's
prior payment record and the amount of the shortfall in relation to the
principal and interest owed. Impairment is measured on a loan by loan basis for
commercial and construction loans by either the present value of expected future
cash flows discounted at the loan's effective interest rate, the loan's
obtainable market price or the fair value of the collateral if the loan is
collateral dependent.
Large groups of smaller balance homogeneous loans are collectively evaluated for
impairment. Accordingly, the Bank does not separately identify individual
consumer and residential loans for impairment disclosures.
Loans Held for Sale
Loans held for sale are comprised of residential loans and student loans that
the Company originates with the intention of selling in the future. These loans
are carried at the lower of cost or estimated fair value.
Restricted Investments in Bank Stock
Restricted investments in bank stock include stock in the Federal Home Loan Bank
(FHLB) and Federal Reserve Bank. Federal law requires a member institution of
the FHLB system to hold stock of its district FHLB according to a predetermined
formula. The stock is carried at cost.
Advertising Costs
The Company follows the policy of charging the costs of advertising to expense
as 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 and liabilities are
adjusted through the provision for income taxes for the effects of changes in
tax laws and rates on the date of enactment.
Bank Premises and Equipment
Bank premises and equipment are carried at cost less accumulated depreciation
and amortization. Depreciation is charged to operations over the estimated
useful lives of the respective assets. Leasehold improvements are amortized over
the terms of the respective leases or the estimated useful lives of the
improvements, whichever is shorter. Depreciation and amortization are determined
on the straight-line method.
Per Share Data
Basic earnings per share represents income available to common stockholders
divided by the weighted-average number of common shares outstanding during the
period. Diluted earnings per share reflects 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 assumed issuance.
Potential common shares that may be issued by the Company relate solely to
outstanding stock options, and are determined using the treasury stock method.
Per share amounts have been adjusted to give retroactive effect to stock
dividends declared through January 31, 2003.
Off Balance Sheet Financial Instruments
In the ordinary course of business, the Company has entered into off balance
sheet financial instruments consisting of commitments to extend credit,
commercial letters of credit, and standby letters of credit. Such financial
instruments are recorded on the balance sheet when they become payable by the
borrower to the Company.
Cash Flow Information
For purposes of the statements of cash flows, the Company considers cash and due
from banks and federal funds sold as cash and cash equivalents. Generally,
federal funds are purchased and sold for one-day periods. Cash paid during the
years ended December 31, 2002, 2001, and 2000 for interest was $14.3 million,
$16.2 million, and $14.0 million, respectively. Income taxes paid totaled $2.6
million, $2.4 million, and $2.2 million in 2002, 2001, and 2000, respectively.
Recently Issued FASB Statements
In July of 2001, the Financial Accounting Standards Board issued Statement No.
143, "Accounting for Asset Retirement Obligations", which addresses the
financial accounting and reporting for obligations associated with the
retirement of tangible long-lived assets and the associated asset retirement
costs. This Statement requires that the fair value of a liability for an asset
retirement obligation be recognized in the period in which it is incurred if a
reasonable estimate of fair value can be made. The associated asset retirement
costs are capitalized as part of the carrying amount of the long-lived asset.
This Statement became effective for the Company on January 1, 2003.
21
Notes to Consolidated Financial Statements
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 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 after December 31, 2002.
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 classified to goodwill upon adoption of Statement
No.147. The transition provisions were effective on October 1, 2002.
Adoption of these statements did not have or is not expected to have a material
impact on the Company's financial condition or results of operations.
Segment Reporting
Commerce acts as an independent community financial services provider, and
offers traditional banking and related financial services to individual,
business and government customers. Through its branches, the Company offers a
full array of commercial and retail financial services.
Management does not separately allocate expenses, including the cost of funding
loan demand, between the commercial and retail operations of the Company. As
such, discrete financial information is not available and segment reporting
would not be meaningful.
2. Restrictions on Cash and Due From Bank Accounts
- --------------------------------------------------------------------------------
The Bank is required to maintain average reserve balances with the Federal
Reserve Bank. The average amount of those reserve balances maintained for 2002
and 2001 was approximately $4.3 million and $2.3 million, respectively.
3. Securities
- --------------------------------------------------------------------------------
The amortized cost and fair value of securities are summarized in the following
tables.
- ------------------------------------------------------------------------------------------------------------
December 31, 2002
- ------------------------------------------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
(in thousands) Cost Gains Losses Value
- ------------------------------------------------------------------------------------------------------------
Available for Sale
U.S. Government Agency securities $ 12,307 $ 204 $ 0 $ 12,511
Mortgage-backed securities 184,793 2,203 (526) 186,470
Corporate debt securities 6,033 422 0 6,455
- ------------------------------------------------------------------------------------------------------------
Total $203,133 $2,829 $(526) $205,436
- ------------------------------------------------------------------------------------------------------------
Held to Maturity
U.S. Government Agency securities $ 10,005 $ 525 $ 0 $ 10,530
Municipal securities 1,996 79 0 2,075
Mortgage-backed securities 63,909 2,284 (8) 66,185
Corporate debt securities 21,715 795 (264) 22,246
- ------------------------------------------------------------------------------------------------------------
Total $ 97,625 $3,683 $(272) $101,036
- ------------------------------------------------------------------------------------------------------------
22
Notes to Consolidated Financial Statements
- -------------------------------------------------------------------------------------------------------
December 31, 2001
- -------------------------------------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
(in thousands) Cost Gains Losses Value
- -------------------------------------------------------------------------------------------------------
Available for Sale
U.S. Treasury securities $ 1,001 $ 8 $ 0 $ 1,009
U.S. Government Agency securities 17,487 134 (4) 17,617
Mortgage-backed securities 77,269 203 (468) 77,004
Corporate debt securities 9,133 39 (80) 9,092
- -------------------------------------------------------------------------------------------------------
Total $104,890 $384 $ (552) $104,722
- -------------------------------------------------------------------------------------------------------
Held to Maturity
U.S. Government Agency securities $ 5,987 $ 73 $ (33) $ 6,027
Municipal securities 1,994 43 (15) 2,022
Mortgage-backed securities 73,611 172 (789) 72,994
Corporate debt securities 21,757 95 (468) 21,384
- -------------------------------------------------------------------------------------------------------
Total $103,349 $383 $(1,305) $102,427
- -------------------------------------------------------------------------------------------------------
The amortized cost and fair value of debt securities at December 31, 2002 by
contractual maturity are shown in the following table. Expected maturities will
differ from contractual maturities because borrowers may have the right to call
or prepay obligations.
- ----------------------------------------------------------------------------------------------------------
Held to Maturity Available for Sale
- ----------------------------------------------------------------------------------------------------------
Amortized Fair Amortized Fair
(in thousands) Cost Value Cost Value
- ----------------------------------------------------------------------------------------------------------
Due in one year or less $ 0 $ 0 $ 0 $ 0
Due after one year through five years 3,007 3,139 0 0
Due after five years through ten years 11,100 11,316 1,997 2,060
Due after ten years 19,609 20,396 16,343 16,906
- ----------------------------------------------------------------------------------------------------------
33,716 34,851 18,340 18,966
Mortgage-backed securities 63,909 66,185 184,793 186,470
- ----------------------------------------------------------------------------------------------------------
Total $97,625 $101,036 $203,133 $205,436
- ----------------------------------------------------------------------------------------------------------
There were no sales of securities available for sale in 2002. Gross gains of
$53,000 and gross losses of $1,000 were realized on sales of securities
available for sale in 2001. There were no sales of securities available for sale
in 2000.
At December 31, 2002 and 2001, securities with a fair value of $200.1 million
and $117.7 million respectively, were pledged to secure public deposits and for
other purposes as required or permitted by law.
23
Notes to Consolidated Financial Statements
4. Loans Receivable and Allowance for Loan Losses
- --------------------------------------------------------------------------------
A summary of loans receivable is as follows:
- -----------------------------------------------------------------
December 31,
(in thousands) 2002 2001
- -----------------------------------------------------------------
Real Estate:
Commercial Mortgage $144,959 $142,969
Construction and land development 31,034 32,863
Residential Mortgage 66,190 48,415
Tax-Exempt 5,629 2,676
Commercial Business 49,226 42,399
Consumer 34,598 36,551
Lines of Credit 37,245 36,801
- -----------------------------------------------------------------
368,881 342,674
Less: Allowance for Loan Losses 5,146 4,544
- -----------------------------------------------------------------
Net Loans Receivable $363,735 $338,130
- -----------------------------------------------------------------
The following is a summary of the transactions in the allowance for loan losses.
- -----------------------------------------------------------------
Year Ended December 31,
(in thousands) 2002 2001 2000
- -----------------------------------------------------------------
Balance at beginning of year $4,544 $3,732 $2,841
Provision charged to expense 1,435 1,469 1,050
Recoveries 116 24 14
Loans charged off (949) (681) (173)
- -----------------------------------------------------------------
Balance at end of year $5,146 $4,544 $3,732
- -----------------------------------------------------------------
At December 31, 2002 and 2001, the recorded investment in loans considered to be
impaired under FASB Statement No.114 "Accounting by Creditors for Impairment of
a Loan" totaled $1.5 million and $531,000, respectively, all of which are
included in nonperforming loans. As of December 31, 2002, impaired loans have a
related allowance for loan losses of $90,000. As of December 31, 2001, no
impaired loans required an allowance for loan losses. Impaired loans averaged
approximately $1.5 million, $531,000, and $267,000 during 2002, 2001, and 2000,
respectively. Actual interest income recorded on these loans amounted to
$79,000, $33,000, and $52,000 during 2002, 2001 and 2000, respectively.
At December 31, 2002 and 2001, the recorded investment in nonaccrual loans was
$1.6 million and $876,000, respectively. The recorded investment in past due
loans greater than 90 days and still accruing was $55,000 and $0 at December 31,
2002 and 2001, respectively.
Certain directors and executive officers of the Company, including their
associates and companies, have loans with the Bank. Such loans were made in the
ordinary course of business at the Bank's normal credit terms including interest
rate and collateralization, and do not represent more than a normal risk of
collection. Total loans to these persons and companies amounted to approximately
$8.5 million and $9.0 million at December 31, 2002 and 2001, respectively.
During 2002, $5.4 million of new loans were made and repayments totaled $5.9
million.
5. Loan Commitments and Standby Letters of Credit
- --------------------------------------------------------------------------------
Loan commitments are made to accommodate the financial needs of Commerce's
customers. Standby letters of credit commit the Bank to make payments on behalf
of customers when certain specified future events occur. They primarily are
issued to facilitate the customers' normal course of business transactions.
Historically, almost all of the Bank's standby letters of credit expire
unfunded.
Both types of lending arrangements have credit risk essentially the same as that
involved in extending loans to customers and are subject to the Bank's normal
credit policies. Letter of credit commitments are agreements to lend to a
customer as long as there is no violation of any condition established in the
contract. Since many of the commitments are expected to expire without being
drawn upon, the total commitment amounts do not necessarily represent future
cash requirements. Commitments generally have fixed expiration dates or other
termination clauses and may require payment of a fee.
The Bank's maximum exposure to credit loss for loan commitments (unfunded loans
and unused lines of credit, including home equity lines of credit) and standby
letters of credit outstanding were as follows:
- -----------------------------------------------------------------
December 31,
(in thousands) 2002 2001
- -----------------------------------------------------------------
Commitments to grant loans $ 1,628 $ 8,913
Unfunded commitments
of existing loans 68,105 65,302
Standby letters of credit 7,265 7,640
- -----------------------------------------------------------------
Total $76,998 $81,855
- -----------------------------------------------------------------
24
Notes to Consolidated Financial Statements
6. Concentrations of Credit Risk
- --------------------------------------------------------------------------------
The Company's loan portfolio is principally to borrowers throughout Cumberland,
Dauphin, York, and Lebanon counties of Pennsylvania where it has full-service
branch locations. Commercial real estate loans and loan commitments for
commercial real estate projects aggregated $193 million at December 31, 2002.
Commercial real estate loans are collateralized by the related project
(principally office buildings, multifamily residential, land development, and
other properties) and the Company generally requires loan-to-value ratios of no
greater than 80%. Collateral requirements on such loans are determined on a
case-by-case basis based on management's credit evaluations of the respective
borrowers.
7. Bank Premises, Equipment and Leases
- --------------------------------------------------------------------------------
A summary of premises and equipment is as follows:
- -----------------------------------------------------------------
December 31,
(in thousands) 2002 2001
- -----------------------------------------------------------------
Land $ 4,211 $ 4,211
Buildings 19,941 15,732
Leasehold improvements 1,919 1,772
Furniture, fixtures, and equipment 8,956 7,529
- -----------------------------------------------------------------
35,027 29,244
Less accumulated depreciation
and amortization 8,618 7,657
- -----------------------------------------------------------------
$26,409 $21,587
- -----------------------------------------------------------------
Land, buildings, and equipment are leased under noncancelable operating lease
agreements that expire at various dates through 2022. Total rental expense for
operating leases in 2002, 2001, and 2000 was $1,084,000, $908,000, and $739,000,
respectively. At December 31, 2002, future minimum lease payments for
noncancelable operating leases are payable as follows:
- -----------------------------------------------------------------
(in thousands)
- -----------------------------------------------------------------
2003 $1,195
2004 1,139
2005 900
2006 804
2007 815
Thereafter 6,164
- -----------------------------------------------------------------
Total minimum lease payments $11,017
- -----------------------------------------------------------------
8. Deposits
- --------------------------------------------------------------------------------
The composition of deposits is as follows:
- -----------------------------------------------------------------
December 31,
(in thousands) 2002 2001
- -----------------------------------------------------------------
Demand $127,199 $105,171
Interest checking and money market 214,293 126,851
Savings 217,036 166,514
Time certificates $100,000 or more 79,870 74,905
Other time certificates 88,557 88,297
- -----------------------------------------------------------------
$726,955 $561,738
- -----------------------------------------------------------------
At December 31, 2002, the scheduled maturities of time deposits are as follows:
- -----------------------------------------------------------------
(in thousands)
- -----------------------------------------------------------------
2003 $128,058
2004 15,407
2005 8,631
2006 5,361
2007 10,970
- -----------------------------------------------------------------
$168,427
- -----------------------------------------------------------------
9. Other Borrowed Money
- --------------------------------------------------------------------------------
The Bank has a line of credit commitment from the Federal Home Loan Bank (FHLB)
for borrowings up to $170 million. No amounts were outstanding on this line as
of December 31, 2002 and 2001. Certain qualifying assets of the Bank
collateralize the line. In addition, the Bank has a line of credit of $5.5
million and availability under two repurchase agreements to borrow up to $55.0
million, all of which were available as of December 31, 2002.
10. Long-term Debt
- --------------------------------------------------------------------------------
On June 15, 2000, the Company issued $5,000,000 of 11% Trust Capital Securities
to Commerce Bancorp, Inc. through Commerce Harrisburg Capital Trust I (the
Trust), a Delaware business trust subsidiary. The Trust Capital Securities
evidence a preferred ownership interest in the Trust, of which the Company owns
100% of the common equity. The proceeds from the issuance of the Trust Capital
Securities were invested in substantially similar Junior Subordinated Debt of
the Company. The Company unconditionally guarantees the Trust Capital
Securities. Interest on the debt is payable quarterly in arrears on March 31,
June 30, September 30, and December 31
25
Notes to Consolidated Financial Statements
of each year. The Trust Capital Securities are scheduled to mature on June 15,
2030. The Trust Capital Securities may be redeemed in whole or in part at the
option of the Company on or after June 15, 2010 at 105.50% of the principal plus
accrued interest, if any. The redemption price declines by 0.55% on June 15 of
each year from 2011 through 2020 at which time the securities may be redeemed at
100% of the principal plus accrued interest, if any, to the date fixed for
redemption, subject to certain conditions. All $5,000,000 of the Trust Capital
Securities qualified as Tier 1 capital for regulatory capital purposes.
On September 28, 2001, the Company issued $8,000,000 of 10% Trust Capital
Securities to Commerce Bancorp, Inc. through Commerce Harrisburg Capital Trust
II (the Trust II), a Delaware business trust subsidiary. The issuance of the
Trust Capital Securities has similar properties as the Trust I. The Trust
Capital Securities evidence a preferred ownership interest in the Trust II of
which the Company owns 100% of the common equity. The proceeds from the issuance
of the Trust Capital Securities were invested in substantially similar Junior
Subordinated Debt of the Company. The Company unconditionally guarantees the
Trust Capital Securities. Interest on the debt is payable quarterly with similar
terms as in the Trust I. The Trust Capital Securities are scheduled to mature on
September 28, 2031. The Trust Capital Securities may be redeemed in whole or in
part at the option of the Company on or after September 28, 2011 at 105.00% of
the principal plus accrued interest, if any. The redemption price declines by
0.50% on September 28 of each year from 2012 through 2021 at which time the
securities may be redeemed at 100% of the principal plus accrued interest, if
any, to the date fixed for redemption, subject to certain conditions. All
$8,000,000 of the Trust Capital Securities qualified as Tier 1 capital for
regulatory capital purposes.
11. Income Taxes
- --------------------------------------------------------------------------------
A reconciliation of the provision for income taxes and the amount that would
have been provided at statutory rates is as follows:
- -----------------------------------------------------------------
Year Ended December 31,
(in thousands) 2002 2001 2000
- -----------------------------------------------------------------
Provision at statutory rate
on pre-tax income $2,905 $2,271 $1,904
Tax-exempt income on
loans and investments (74) (73) (52)
Other 40 34 34
- -----------------------------------------------------------------
$2,871 $2,232 $1,886
- -----------------------------------------------------------------
The components of income tax expense are as follows:
- -----------------------------------------------------------------
Year Ended December 31,
(in thousands) 2002 2001 2000
- -----------------------------------------------------------------
Current $2,803 $2,483 $2,167
Deferred 68 (251) (281)
- -----------------------------------------------------------------
$2,871 $2,232 $1,886
- -----------------------------------------------------------------
The components of the net deferred tax assets were as follows:
- -----------------------------------------------------------------
December 31,
(in thousands) 2002 2001
- -----------------------------------------------------------------
Deferred tax assets:
Allowance for loan losses $1,749 $1,545
Unrealized losses on securities 0 57
Other 41 18
- -----------------------------------------------------------------
Total deferred tax assets 1,790 1,620
- -----------------------------------------------------------------
Deferred tax liabilities:
Unrealized gains on securities (783) 0
Premises and equipment (583) (296)
Prepaid expenses (83) (75)
- -----------------------------------------------------------------
Total deferred tax liabilities (1,449) (371)
- -----------------------------------------------------------------
Net deferred tax assets $ 341 $1,249
- -----------------------------------------------------------------
Income taxes of $0, $18,000 and $0 were recognized on net securities gains in
2002, 2001, and 2000 respectively.
12. Stockholders' Equity
- --------------------------------------------------------------------------------
At December 31, 2002, Commerce Bancorp, Inc. owned 40,000 shares of the
Company's Series A $10 par value noncumulative nonvoting preferred stock and
warrants that entitle the holder to purchase 136,825 shares (adjusted for common
stock dividends) of the Company's common stock, exercisable at $7.30 per share
(adjusted for common stock dividends), in the event of a "change in control" (as
defined in the Warrant Agreement). Such warrants are fully transferable and
expire on October 7, 2008. None of these warrants were exercised during 2002 or
2001. The preferred stock is redeemable at the option of the Company at the
price of $25 per share plus any unpaid dividends. Dividends on the preferred
stock are payable quarterly at a rate of $2 per share per annum (see Note 15).
26
Notes to Consolidated Financial Statements
The Company has implemented a dividend reinvestment and stock purchase plan.
Holders of common stock may participate in the plan in which reinvested
dividends and voluntary cash payments of up to $5,000 per quarter (subject to
change) may be reinvested in additional common shares at a 3% discount (subject
to change) from the current market price. Employees who have been continuously
employed for at least one year are also eligible to participate in the plan
under the same terms as listed above for shareholders. A total of 22,173 and
20,306 common shares were issued pursuant to this plan in 2002 and 2001,
respectively. At December 31, 2002, the Company had reserved approximately
447,000 common shares to be issued in connection with the plan.
On January 30, 2002, the Board of Directors declared a 5% common stock dividend
payable on February 25, 2002, to stockholders of record on February 11, 2002.
On January 24, 2003, the Board of Directors declared a 5% common stock dividend
payable on February 24, 2003, to stockholders of record on February 7, 2003.
All common stock and per share data included in these financial statements have
been restated for these stock dividends.
13. Earnings per Share (continued)
- --------------------------------------------------------------------------------
All options outstanding were included in the computation of diluted EPS for the
year ended December 31, 2002, because the options' exercise price was lower than
the average market price of the common shares.
Options to purchase 87,375 shares of common stock at $32.66 were outstanding
during 2001. They were not included in the computation of diluted EPS for the
year ended December 31, 2001, because the options' exercise price was greater
than the average market price of the common shares.
Options to purchase 43,788 shares of common stock at $22.38, options to purchase
49,060 shares at $22.53, options to purchase 76,259 shares at $25.49, options to
purchase 10,262 shares at $21.27, and options to purchase 10,262 shares of
common stock at $24.29 were outstanding during 2000. They were not included in
the computation of diluted EPS for the year ended December 31, 2000, because the
options' exercise price was greater than the average market price of the common
shares.
13. Earnings per Share
- --------------------------------------------------------------------------------
The following table sets forth the computation of basic and diluted earnings per
share.
For the Year Ended December 31,
(in thousands except per share amounts) 2002 2001 2000
Per Share Per Share Per Share
Income Shares Amount Income Shares Amount Income Shares Amount
- ----------------------------------------------------------------------------------------------------------------------------
Basic earnings per share:
Net income $5,674 $4,448 $3,714
Preferred stock dividends (80) (80) (80)
- ----------------------------------------------------------------------------------------------------------------------------
Income available to
common stockholders 5,594 2,063 $2.71 4,368 1,946 $2.24 3,634 1,914 $1.90
- ----------------------------------------------------------------------------------------------------------------------------
Effect of dilutive securities:
Stock options 189 194 130
- ----------------------------------------------------------------------------------------------------------------------------
Diluted earnings per share:
Income available to
common stockholders
plus assumed conversions $5,594 2,252 $2.48 $4,368 2,140 $2.04 $3,634 2,044 $1.78
- ----------------------------------------------------------------------------------------------------------------------------
27
Notes to Consolidated Financial Statements
14. Stock Option Plans
- --------------------------------------------------------------------------------
The 1996 Employee Stock Option Plan covers 502,256 authorized shares of common
stock reserved for issuance upon exercise of options granted or available for
grant to officers and key employees and will expire on December 31, 2005. The
Plan provides that the option price of qualified incentive stock options will be
fixed by the Board of Directors, but will not be less than 100% of the fair
market value of the stock at the date of grant. In addition, the Plan provides
that the option price of nonqualified stock options (NQSO's) also will be fixed
by the Board of Directors, however for NQSO's the option price may be less than
100% of the fair market value of the stock at the date of grant. Options granted
are exercisable one year after the date of grant, subject to certain vesting
provisions, and expire ten years after the date of grant.
In 2000, the Company's shareholders approved the adoption of the 2001 Directors'
Stock Option Plan. The Plan commenced January 1, 2001 and replaced the 1990
Directors' Stock Option Plan, which expired December 31, 2000. The Plan covers
115,762 authorized shares of common stock reserved for issuance upon exercise of
options granted or available for grant to directors and will expire on December
31, 2010. Under the Company's Directors' Stock Option Plan, each Director of the
Company who is not regularly employed on a salaried basis by the Company shall
be entitled to an option to acquire 1,710 shares of the Company's common stock
during each year in which the Director serves on the Board. The Plan provides
that the option price will be fixed by the Board of Directors, but will not be
less than 100% of the fair market value of the stock on the date of the grant.
Options granted are exercisable from the earlier of (1) one year after the date
of the option grant, or (2) the date of a change in control of the Bank.
The Company has adopted the disclosure-only provisions of Standards of Financial
Accounting Standards (SFAS) No. 123 "Accounting for Stock-Based Compensation."
Accordingly, no compensation costs have been recognized for options granted in
2002, 2001, and 2000.
For purposes of pro-forma disclosures, the estimated fair value of the options
is amortized to expense over the options' vesting period. The Company's
pro-forma information is presented in the following table.
- --------------------------------------------------------------------------------
Year Ended December 31,
(in thousands) 2002 2001 2000
- --------------------------------------------------------------------------------
Net income:
As reported $5,674 $4,448 $3,714
Total stock-based compensation
cost, net of tax, that would have
been included in the determination
of net income if the fair value
based method had been applied
to all awards (1,434) (952) (608)
- --------------------------------------------------------------------------------
Pro-forma $4,240 $3,496 $3,106
- --------------------------------------------------------------------------------
Reported earnings per share:
Basic $2.71 $2.24 $1.90
Diluted 2.48 2.04 1.78
- --------------------------------------------------------------------------------
Pro-forma earnings per share:
Basic $2.02 $1.75 $1.58
Diluted 1.85 1.59 1.48
- --------------------------------------------------------------------------------
The fair value of each option grant is estimated at the date of grant using the
Black-Scholes option pricing model with the following weighted-average
assumptions for 2002, 2001, and 2000 respectively: risk-free interest rates of
4.7%, 4.8% and 5.7%; volatility factors of the expected market price of the
Company's common stock of .33, .28, and .48; weighted-average expected life of
the options of 10 years; and no cash dividends.
Had compensation costs for stock options granted in 2002, 2001 and 2000 been
determined based on the fair value at the grant dates for awards under the plan
consistent with the provisions of SFAS No. 123, the Company's net income and
earnings per share for the years ended December 31, 2002, 2001 and 2000 would
have been reduced to the proforma amounts indicated.
28
Notes to Consolidated Financial Statements
Stock options transactions under the Plans were as follows:
- -----------------------------------------------------------------------------------------------------------------------------------
Year Ended December 31,
2002 2001 2000
- -----------------------------------------------------------------------------------------------------------------------------------
Weighted Avg. Weighted Avg. Weighted Avg.
Options Exercise Price Options Exercise Price Options Exercise Price
- -----------------------------------------------------------------------------------------------------------------------------------
Outstanding at beginning of year 550,225 $18.73 482,925 $15.57 424,176 $13.62
Granted 13,862 36.42 99,621 31.82 88,258 24.09
Exercised (118,078) 14.73 (25,265) 8.52 (14,811) 5.63
Forfeited (24,587) 30.59 (7,056) 24.03 (14,698) 20.45
- -----------------------------------------------------------------------------------------------------------------------------------
Outstanding at end of year 421,422 $19.75 550,225 $18.73 482,925 $15.57
- -----------------------------------------------------------------------------------------------------------------------------------
Exercisable at December 31 374,379 $18.33
Options available for grant at December 31 270,112
Weighted-average fair value
of options granted during the year $18.84 $18.53 $14.38
- -----------------------------------------------------------------------------------------------------------------------------------
Exercise prices for options outstanding as of December 31, 2002 are presented in the following table.
- -----------------------------------------------------------------------------------------------------------------------------------
As of December 31, 2002
- -----------------------------------------------------------------------------------------------------------------------------------
Options Weighted Avg. Weighted Avg. Options Weighted Avg.
Outstanding Exercise Price Contractual Life Exercisable Exercise Price
- -----------------------------------------------------------------------------------------------------------------------------------
Options with exercise prices
ranging from $4.39 to $15.00 155,490 $ 9.01 3.1 Years 155,490 $ 9.01
Options with exercise prices
ranging from $15.01 to $25.00 124,930 21.48 6.1 Years 121,465 21.55
Options with exercise prices
ranging from $25.01 to $37.86 141,002 30.05 8.7 Years 97,424 29.18
- -----------------------------------------------------------------------------------------------------------------------------------
Total options outstanding with exercise
prices ranging from $4.39 to $37.86 421,422 $19.75 5.8 Years 374,379 $18.33
- -----------------------------------------------------------------------------------------------------------------------------------
15. Regulatory Matters
- --------------------------------------------------------------------------------
Regulatory authorities restrict the amount of cash dividends the Bank can
declare without prior regulatory approval. Presently, the Bank cannot declare a
cash dividend in excess of its accumulated retained earnings.
The Company and the Bank are subject to various regulatory capital requirements
administered by federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory and possible additional
discretionary actions by regulators that, if undertaken, could have a direct
material effect on the Company's financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, the
Company and the Bank 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 judgments by the regulators
about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and the Bank to maintain minimum amounts and ratios (set
forth below) of total and Tier 1 capital (as defined in the regulations) to
risk-weighted assets, and of Tier 1 capital to average assets. Management
believes, as of December 31, 2002, that the Company and the Bank meet all
capital adequacy requirements to which they are subject.
As of December 31, 2002, the most recent notification from the Office of the
Comptroller of the Currency categorized the Bank as "well capitalized" under the
regulatory framework for prompt corrective action. To be categorized as "well
capitalized" the Bank must maintain minimum total risk-based, Tier 1 risk-based,
and Tier 1 leverage ratios as set forth in the table on the next page. There are
no conditions or events since that notification that management believes have
changed the Bank's category.
29
Notes to Consolidated Financial Statements
The following table presents the risk-based and leverage capital amounts and
ratios at December 31, 2002 and 2001 for the Company and the Bank.
- -----------------------------------------------------------------------------------------------------------------------------------
To Be Well Capitalized
For Capital Under Prompt Corrective
Actual Adequacy Purposes Action Provisions
- -----------------------------------------------------------------------------------------------------------------------------------
(dollars in thousands) Amount Ratio Amount Ratio Amount Ratio
- -----------------------------------------------------------------------------------------------------------------------------------
Company
As of December 31, 2002
Risked based capital ratios:
Total capital $59,438 12.22% => $38,907 => 8.0% N/A N/A
Tier 1 capital 54,292 11.16 => 19,454 => 4.0 N/A N/A
Leverage ratio 54,292 7.00 => 31,012 => 4.0 N/A N/A
- -----------------------------------------------------------------------------------------------------------------------------------
Bank
As of December 31, 2002
Risked based capital ratios:
Total capital $59,160 12.17% => $38,897 => 8.0% => $48,622 => 10.0%
Tier 1 capital 54,014 11.11 => 19,449 => 4.0 => 29,173 => 6.0
Leverage ratio 54,014 6.97 => 30,988 => 4.0 => 38,735 => 5.0
- -----------------------------------------------------------------------------------------------------------------------------------
Company
As of December 31, 2001
Risked based capital ratios:
Total capital $50,248 11.78% => $34,124 => 8.0% N/A N/A
Tier 1 capital 43,606 10.22 => 17,062 => 4.0 N/A N/A
Leverage ratio 43,606 7.33 => 23,796 => 4.0 N/A N/A
- ------------------------------------------------------------------------------------------------------------------------------------
Bank
As of December 31, 2001
Risked based capital ratios:
Total capital $50,045 11.73% => $34,130 => 8.0% => $42,663 => 10.0%
Tier 1 capital 45,501 10.67 => 17,065 => 4.0 => 25,598 => 6.0
Leverage ratio 45,501 7.65 => 23,786 => 4.0 => 29,733 => 5.0
- ------------------------------------------------------------------------------------------------------------------------------------
30
Notes to Consolidated Financial Statements
16. Employee Benefit Plan
- --------------------------------------------------------------------------------
The Company has established a 401(k) Retirement Savings Plan for all of its
employees who meet eligibility requirements. Employees may contribute up to 15%
of their salary to the Plan. The Company will provide a discretionary matching
contribution for up to 6% of each employee's salary. For 2002, 2001, and 2000,
the Company's matching contribution was established at 25% of the employees'
salary deferral. The amount charged to expense was $98,000, $84,000, and $42,000
in 2002, 2001, and 2000, respectively.
17. 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 only other comprehensive income item that the Company presently has is
unrealized gains (losses) on securities available for sale.
- -----------------------------------------------------------------
Year Ended December 31,
(in thousands) 2002 2001 2000
- -----------------------------------------------------------------
Unrealized holding gains (losses)
arising during the year $2,471 $ 908 $3,520
Less reclassification adjustment
for gains included in
net income 0 52 0
- -----------------------------------------------------------------
Net unrealized gains 2,471 856 3,520
Tax (expense) (840) (291) (1,197)
- -----------------------------------------------------------------
Net of tax amount $1,631 $ 565 $2,323
- -----------------------------------------------------------------
18. Commitments and Contingencies
- --------------------------------------------------------------------------------
The Company has entered into an agreement to purchase the land at 3951 Union
Deposit Road, Harrisburg, Dauphin County, Pennsylvania. The Company plans to
construct a full-service branch on this property to be opened in late Spring
2003.
The Company has entered into an agreement to purchase the land at 15 Lorane Road
in conjunction with the purchase of 5140 Perkiomen Avenue, Reading, Berks
County, Pennsylvania. The Company plans to construct a full-service branch on
these properties to be opened in Summer 2003.
In addition, the Company is also subject to certain routine legal proceedings
and claims arising in the ordinary course of business. It is management's
opinion that the ultimate resolution of these claims will not have a material
adverse effect on the Company's financial position and results of operations.
19. Related Party Transactions
- --------------------------------------------------------------------------------
Commerce Bancorp, Inc. (an 8.2% shareholder of common stock and 100%
shareholder of Series A preferred stock of the Company), through a subsidiary
(Commerce Bank, N.A., a national bank located in Cherry Hill, New Jersey),
provides various services to the Company. These services include maintenance to
the branch LAN network, proof and encoding services, deposit account statement
rendering, MAC/VISA card processing, data processing, and advertising support.
The Company paid approximately $1.3 million, $622,000, and $414,000 for services
provided by Commerce Bancorp, Inc. during 2002, 2001, and 2000, respectively.
Insurance premiums and commissions, which are paid to a subsidiary of Commerce
Bancorp, Inc., are included in the total amount paid. The Company routinely
sells loan participations to Commerce Bank, N.A. and at December 31, 2002 and
2001, approximately $8.6 million and $12.4 million, respectively, of these
participations were outstanding. A former director of the Company is Chairman of
the Board of Commerce Bank, N.A. The Company purchased certain services from a
business owned by the spouse of the former director in 2002, 2001 and 2000 in
the amounts of $267,000, $215,000, and $130,000, respectively.
A federal funds line of credit was established with Commerce Bank N.A. in the
amount of $5.5 million, which could be drawn upon if needed. The balance at
December 31, 2002 and 2001 on this line was $0.
A law firm in which a director of the Company is a partner received professional
fees totaling $290,000, $258,000, and $137,000 during 2002, 2001, and 2000,
respectively.
The Company paid commissions for real estate services to a company owned by the
Chairman of the Board of the Company of $0, $74,000, and $48,000 in 2002, 2001,
and 2000, respectively.
31
Notes to Consolidated Financial Statements
20. Fair Value of Financial Instruments
- --------------------------------------------------------------------------------
FASB Statement No. 107, "Disclosures about Fair Value of Financial Instruments"
(FAS 107), requires disclosure of fair value information about financial
instruments, whether or not recognized in the balance sheet, for which it is
practical to estimate that value. In cases where quoted market prices are not
available, fair values are based on estimates using present value or other
valuation techniques. These techniques are significantly affected by the
assumptions used, including the discount rate and estimates of future cash
flows.
Management uses its best judgment in estimating the fair value of the Company's
financial instruments; however, there are inherent weaknesses in any estimation
technique. Therefore, for substantially all financial instruments, the fair
value estimates herein are not necessarily indicative of the amounts the Company
could have realized in a sales transaction on the dates indicated. The estimated
fair value amounts have been measured as of their respective year ends, and have
not been re-evaluated or updated for purposes of these financial statements
subsequent to those respective dates. As such, the estimated fair values of
these financial instruments subsequent to the respective reporting dates may be
different than the amounts reported at each year-end.
The following information should not be interpreted as an estimate of the fair
value of the entire Company since a fair value calculation is only provided for
a limited portion of the Company's assets and liabilities. Due to a wide range
of valuation techniques and the degree of subjectivity used in making the
estimates, comparisons between the Company's disclosures and those of other
companies may not be meaningful. The Company, in estimating its fair value
disclosures for financial instruments, used the following methods and
assumptions:
Cash and cash equivalents
The carrying amounts reported approximate those assets' fair value.
Securities
Fair values of securities are based on quoted market prices, where available. If
quoted market prices are not available, fair values are based on quoted market
prices of comparable instruments.
Loans Receivable
For variable-rate loans that reprice frequently and with no significant change
in credit risk, fair values are based on carrying values. The fair values for
other loans receivable were estimated using discounted cash flow analysis, using
interest rates currently being offered for loans with similar terms to borrowers
of similar credit quality. Loans with significant collectibility concerns were
fair valued on a loan-by-loan basis utilizing a discounted cash flow method or
the fair market value of the underlying collateral.
Restricted Investments in Bank Stock
The carrying amounts reported approximate those assets' fair value.
Accrued Interest Receivable and Payable
The carrying amount of accrued interest receivable and payable approximate their
fair values.
Deposit Liabilities
The fair values disclosed for demand deposits (e.g., interest-bearing and
noninterest-bearing checking, passbook savings, and certain types of money
market accounts) are, by definition, equal to the amount payable on demand at
the reporting date (i.e., their carrying amounts). Fair values for fixed-rate
certificates of deposit are estimated using a discounted cash flow calculation
that applies interest rates currently being offered on certificates of deposit
to a schedule of aggregated expected monthly maturities on time deposits.
Long-term Debt
The fair values for long-term debt were estimated using the interest rate
currently available from the related party that holds the existing debt.
Off-balance Sheet Instruments
Fair values for the Company's off-balance sheet instruments are based on fees
currently charged to enter into similar agreements, taking into account the
remaining terms of the agreements and the counterparties' credit standing.
32
Notes to Consolidated Financial Statements
The carrying amounts and fair values of the Company's financial instruments as
of December 31 are presented in the following table.
- ---------------------------------------------------------------------------------------------------------------------------
2002 2001
- ---------------------------------------------------------------------------------------------------------------------------
Carrying Fair Carrying Fair
(in thousands) Amount Value Amount Value
- ---------------------------------------------------------------------------------------------------------------------------
Financial assets:
Cash and cash equivalents $ 75,450 $ 75,450 $ 25,855 $ 25,855
Securities 303,061 306,472 208,071 207,149
Loans, net (including loans held for sale) 374,249 393,618 345,791 346,968
Restricted invetments in bank stock 2,045 2,045 2,593 2,593
Accrued interest receivable 3,675 3,675 3,542 3,542
- ---------------------------------------------------------------------------------------------------------------------------
Financial liabilities:
Deposits $726,955 $726,070 $561,738 $562,626
Long-term debt 13,000 15,231 13,000 14,573
Accrued interest payable 832 832 837 837
- ---------------------------------------------------------------------------------------------------------------------------
Off-balance sheet instruments:
Standby letters of credit $ 0 $ 0 $ 0 $ 0
Commitments to extend credit 0 0 0 0
- ---------------------------------------------------------------------------------------------------------------------------
21. Quarterly Financial Data (unaudited)
- --------------------------------------------------------------------------------
The following represents summarized unaudited quarterly financial data of the
Company which in the opinion of management, reflects adjustments (comprising
only normal recurring accruals) necessary for fair presentation (in thousands,
except per share amounts):
- -------------------------------------------------------------------------------------------------------------
Three Months Ended
December 31 September 30 June 30 March 31
- -------------------------------------------------------------------------------------------------------------
2002
Interest income $10,992 $10,788 $10,342 $9,873
Interest expense 3,505 3,615 3,599 3,575
Net interest income 7,487 7,173 6,743 6,298
Provision for loan losses 345 375 280 435
Net securities gains 0 0 0 0
Provision for income taxes 799 741 682 649
Net income 1,570 1,467 1,347 1,290
Net income per share:
Basic $0.73 $0.69 $0.65 $0.64
Diluted 0.69 0.63 0.58 0.57
- -------------------------------------------------------------------------------------------------------------
2001
Interest income $ 9,902 $ 9,713 $ 9,489 $9,143
Interest expense 3,859 3,978 4,049 4,307
Net interest income 6,043 5,735 5,440 4,836
Provision for loan losses 464 405 315 285
Net securities gains 0 0 0 52
Provision for income taxes 646 592 533 461
Net income 1,276 1,181 1,068 923
Net income per share:
Basic $0.65 $0.60 $0.53 $0.46
Diluted 0.59 0.53 0.49 0.43
- -------------------------------------------------------------------------------------------------------------
33
Notes to Consolidated Financial Statements
22. Condensed Financial Statements of Parent Company
- --------------------------------------------------------------------------------
Balance Sheets
December 31,
(in thousands) 2002 2001
- --------------------------------------------------------------------------------
ASSETS
Cash $ 252 $ 148
Investment in subsidiaries:
Banking subsidiary 55,534 45,400
Non-banking subsidiaries 600 600
Other assets 128 117
- --------------------------------------------------------------------------------
Total Assets $56,514 $46,265
- --------------------------------------------------------------------------------
LIABILITIES
Long-term debt $13,000 $13,000
Other liabilities 702 672
- --------------------------------------------------------------------------------
Total liabilities 13,702 13,672
- --------------------------------------------------------------------------------
STOCKHOLDERS' EQUITY
Preferred stock 400 400
Common stock 2,117 1,882
Surplus 31,909 25,263
Retained earnings 6,866 5,159
Accumulated other comprehensive loss 1,520 (111)
- --------------------------------------------------------------------------------
Total stockholders' equity 42,812 32,593
- --------------------------------------------------------------------------------
Total Liabilities & Stockholders' Equity $56,514 $46,265
- --------------------------------------------------------------------------------
Statements of Income
Year Ended December 31,
(in thousands) 2002 2001 2000
- -----------------------------------------------------------------------------------------------------------------
Income:
Dividends from bank subsidiary $1,226 $ 794 $ 393
Interest income 62 32 12
- -----------------------------------------------------------------------------------------------------------------
1,288 826 405
- -----------------------------------------------------------------------------------------------------------------
Expenses:
Interest expense 1,416 793 312
Other 258 213 187
- -----------------------------------------------------------------------------------------------------------------
1,674 1,006 499
- -----------------------------------------------------------------------------------------------------------------
Loss before income (taxes) benefit and equity
in undistributed net income of subsidiaries (386) (180) (94)
Income (taxes) benefit 548 331 165
- -----------------------------------------------------------------------------------------------------------------
162 151 71
Equity in undistributed net income of bank subsidiary 5,512 4,297 3,643
- -----------------------------------------------------------------------------------------------------------------
Net income $5,674 $4,448 $3,714
- -----------------------------------------------------------------------------------------------------------------
34
Notes to Consolidated Financial Statements
Statements of Cash Flows
Year Ended December 31,
(in thousands) 2002 2001 2000
- ----------------------------------------------------------------------------------------------------------------------
Operating Activities:
Net Income $ 5,674 $ 4,448 $ 3,714
Adjustments to reconcile net income to
net cash provided by operating activities:
Amortization of financing costs 6 10 5
Increase in other liabilities 30 385 287
Equity in undistributed net income of bank subsidiary (5,512) (4,297) (3,643)
- ----------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 198 546 363
- ----------------------------------------------------------------------------------------------------------------------
Investing Activities:
Investment in bank subsidiary (2,610) (8,786) (5,303)
Investment in nonbank subsidiaries 0 (400) (200)
- ----------------------------------------------------------------------------------------------------------------------
Net cash (used) by investing activities (2,610) (9,186) (5,503)
- ----------------------------------------------------------------------------------------------------------------------
Financing Activities:
Proceeds from common stock options exercised 1,738 217 84
Proceeds from issuance of long term debt 0 8,000 5,000
Proceeds from issuance of common stock under
stock purchase plan 868 698 219
Costs of issuing long term debt 0 (53) (68)
Cash dividends on preferred stock and
cash in lieu of fractional shares (90) (86) (83)
- ----------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 2,516 8,776 5,152
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Increase in cash and cash equivalents 104 136 12
Cash and cash equivalents at beginning of the year 148 12 0
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Cash and cash equivalents at end of year $ 252 $ 148 $ 12
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35
Independent Auditor's Report
To the Board of Directors
Pennsylvania Commerce Bancorp, Inc.
Camp Hill, Pennsylvania
We have audited the accompanying consolidated balance sheets of Pennsylvania
Commerce Bancorp, Inc. and its subsidiaries as of December 31, 2002 and 2001,
and the related consolidated statements of income, stockholders' equity and cash
flows for each of the three years in the period ended December 31, 2002. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Pennsylvania
Commerce Bancorp, Inc. and its subsidiaries as of December 31, 2002 and 2001,
and the results of their operations and their cash flows for each of the three
years in the period ended December 31, 2002 in conformity with accounting
principles generally accepted in the United States of America.
/s/ Beard Miller Company LLP
Harrisburg, Pennsylvania
January 31, 2003