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
- --------------------------------------------------------------------------------
The Company's consolidated financial statements are prepared in accordance with
accounting principles generally accepted in the United States of America and
follow general practices within the industries in which it operates. Application
of these principles requires management to make estimates, assumptions, and
judgments that affect the amounts reported in the financial statements and
accompanying notes. 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.
2003 Overview
- --------------------------------------------------------------------------------
In 2003, the Company continued its strong financial performance by posting
record levels of total assets, deposits and loans. Total assets grew by $265
million, or 34%, to $1.05 billion and total deposits increased $180 million, or
25%, to $907 million. Core deposit growth was exceptionally strong, increasing
$171 million, or 25%, from $687 million to $858 million. The Company also
experienced strong loan growth in 2003 as total loans outstanding increased by
$106 million, or 29%, to $470 million.
Total revenues (net interest income plus noninterest income) increased by 24% to
a record level of $43.9 million and net income was up 16% in 2003 to $6.6
million from $5.7 million for 2002. Diluted net income per common share
increased 13% to $2.68 from $2.37 per share in 2002 (after adjusting for a 5%
common stock dividend declared in January 2004).
In 2003, the Company opened five new branches in the Central Pennsylvania area,
bringing the total number of full-service branches to 23. Two of the new offices
opened in 2003 are located in Berks County, marking Commerce's initial entry
into this market.
Results of Operations
- --------------------------------------------------------------------------------
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, 2003, 2002 and 2001 and presents the
daily average interest rates earned on assets and the daily average interest
rates paid on liabilities for such periods. During 2003, average
interest-earning assets were $807.4 million, an increase of $162.3 million, or
25%, over 2002. This was the result of an increase in the average balance of
investment securities of $119.5 million, an increase in the average balance of
loans receivable of $53.9 million, offset by a decrease in the average balance
of fed funds sold of $11.2 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 $160.8
million.
The yield on total interest-earning assets decreased by 87 basis points in 2003
from 6.51% to 5.64%. 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 2003 as compared to 2002. As a
result, the Company experienced lower yields on most interest-earning assets in
2003 from 2002 as well as a lower cost of funds in 2003 versus the prior year.
The aggregate cost of interest-bearing liabilities decreased 96 basis points
from 2.65% in 2002 to 1.69% in 2003. The average rate paid on savings deposits
decreased by 94 basis points, from 1.96% in 2002 to 1.02% in 2003 and the
average rate paid
22
Management's Discussion and Analysis
of Financial Condition and Results of Operations
on interest checking accounts decreased from 1.18% in 2002 to 0.70% in 2003. The
average rate paid on money market accounts decreased from 1.32% in 2002 to 0.91%
in 2003. For time deposits, the average rate paid was 3.46%, down 125 basis
points from 2002 and public funds time deposits experienced a decrease of 69
basis points in 2003 on the average rate paid. The majority of the Company's
public funds are deposits of local school districts and municipalities.
The Company's aggregate cost of funding sources decreased 78 basis points in
2003 to 1.44% from 2.22% in 2002. This decrease resulted primarily from lower
average rates paid on total interest bearing deposits as well as a $28.0 million
increase in average noninterest-bearing demand deposits.
TABLE 1
- --------------------------------------------------------------------------------------------------------------------------------
Year Ended December 31,
(dollars in thousands) 2003 2002 2001
- --------------------------------------------------------------------------------------------------------------------------------
Average Average Average Average Average Average
Earning Assets Balance Interest Rate Balance Interest Rate Balance Interest Rate
- --------------------------------------------------------------------------------------------------------------------------------
Securities:
Taxable $361,323 $17,108 4.74% $246,230 $14,514 5.89% $165,013 $10,860 6.58%
Tax-exempt 6,444 453 7.02 1,995 107 5.36 1,743 94 5.38
- --------------------------------------------------------------------------------------------------------------------------------
Total securities 367,767 17,561 4.78 248,225 14,621 5.89 166,756 10,954 6.57
Federal funds sold 20,653 220 1.07 31,833 508 1.59 17,399 641 3.68
Loans receivable:
Mortgage and construction 263,581 18,290 6.94 241,647 18,408 7.62 212,117 18,013 8.49
Commercial loans and
lines of credit 95,469 5,937 6.22 83,971 5,670 6.75 69,815 5,810 8.32
Consumer 54,840 3,318 6.05 35,851 2,677 7.47 32,305 2,709 8.39
Tax-exempt 5,093 216 4.25 3,598 111 3.09 2,711 120 4.43
- --------------------------------------------------------------------------------------------------------------------------------
Total loans receivable 418,983 27,761 6.63 365,067 26,866 7.36 316,948 26,652 8.41
================================================================================================================================
Total earning assets $807,403 $45,542 5.64% $645,125 $41,995 6.51% $501,103 $38,247 7.63%
================================================================================================================================
Sources of Funds
Interest-bearing deposits:
Regular savings $235,515 $ 2,392 1.02% $197,225 $ 3,857 1.96% $141,350 $ 4,168 2.95%
Interest checking 14,760 103 0.70 10,590 125 1.18 7,955 165 2.07
Money market 230,504 2,104 0.91 145,851 1,923 1.32 100,394 2,261 2.25
Time deposits 132,112 4,573 3.46 118,899 5,595 4.71 126,389 7,133 5.64
Public funds time 46,562 917 1.97 54,165 1,440 2.66 33,642 1,693 5.03
================================================================================================================================
Total interest-bearing deposits 659,453 10,089 1.53 526,730 12,940 2.46 409,730 15,420 3.76
Short-term borrowings 16,964 207 1.22 12 0 1.46 330 13 3.94
Long-term debt 13,000 1,356 10.43 13,000 1,354 10.41 7,082 760 10.73
================================================================================================================================
Total interest-bearing liabilities 689,417 11,652 1.69 539,742 14,294 2.65 417,142 16,193 3.88
Noninterest-bearing funds (net) 117,986 105,383 83,961
- --------------------------------------------------------------------------------------------------------------------------------
Total sources to fund
earning assets $807,403 11,652 1.44 $645,125 14,294 2.22 $501,103 16,193 3.23
================================================================================================================================
Net interest income and margin $33,890 4.20% $27,701 4.29% $22,054 4.40%
- --------------------------------------------------------------------------------------------------------------------------------
Other Balances
Cash & due from banks $ 28,390 $ 23,022 $ 18,904
Other assets 45,369 27,190 20,951
Total assets 881,162 695,337 540,958
Noninterest-bearing
demand deposits 142,805 114,758 91,352
Other liabilities 2,983 2,657 2,508
Stockholders' equity 45,957 38,180 29,956
- --------------------------------------------------------------------------------------------------------------------------------
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 and loans are not computed on a taxable
equivalent basis.
23
Management's Discussion and Analysis
of Financial Condition and Results of Operations
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 2003 increased $6.2 million, or 22%, over 2002 to $33.9
million. Interest income on earning assets totaled $45.5 million, an increase of
$3.5 million, or 8%, over 2002. 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
2003 decreased $2.6 million, or 18%, from $14.3 million in 2002 to $11.7 million
in 2003. This decrease was primarily related to the reduction in interest rates
paid on the deposit products partially offset by the increases in the Company's
average level of deposits and other borrowed money.
Changes in net interest income are frequently measured by two statistics: net
interest rate spread and net interest margin. Net interest rate spread is the
difference between the average rate earned on earning assets and the average
rate incurred on interest-bearing liabilities. Net interest margin represents
the difference between interest income, including net loan fees earned, and
interest expense, reflected as a percentage of average earning assets. The
Company's net interest rate spread increased to 3.95% in 2003 from 3.86% in 2002
and the net interest margin decreased 9 basis points from 4.29% to 4.20%.
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.
TABLE 2
- -------------------------------------------------------------------------------------------------------------------------------
2003 v. 2002 2002 v. 2001
Increase (Decrease) Increase (Decrease)
Due to Changes in (1) Due to Changes in (1)
--------------------------------------------------------------------------------
(in thousands) Volume Rate Total Volume Rate Total
- -------------------------------------------------------------------------------------------------------------------------------
Interest on securities:
Taxable $5,426 $(2,832) $2,594 $4,793 $(1,139) $3,654
Tax-exempt 313 33 346 13 0 13
Federal funds sold (122) (166) (288) 231 (364) (133)
Interest on loans receivable:
Mortgage and construction 1,525 (1,643) (118) 2,240 (1,845) 395
Commercial 712 (445) 267 956 (1,096) (140)
Consumer 1,150 (509) 641 265 (297) (32)
Tax-exempt 63 42 105 27 (36) (9)
- -------------------------------------------------------------------------------------------------------------------------------
Total interest income 9,067 (5,520) 3,547 8,525 (4,777) 3,748
- -------------------------------------------------------------------------------------------------------------------------------
Interest expense:
Regular savings 389 (1,854) (1,465) 1,088 (1,399) (311)
Interest checking 29 (51) (22) 31 (71) (40)
Money market 779 (598) 181 596 (934) (338)
Time deposits 464 (1,486) (1,022) (363) (1,175) (1,538)
Public funds (149) (374) (523) 544 (797) (253)
Short-term borrowings 207 0 207 (5) (8) (13)
Long-term debt 0 2 2 617 (23) 594
- -------------------------------------------------------------------------------------------------------------------------------
Total interest expense 1,719 (4,361) (2,642) 2,508 (4,407) (1,899)
- -------------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) $7,348 $(1,159) $6,189 $6,017 $ (370) $5,647
===============================================================================================================================
(1) Changes due to both volume and rate have been allocated to volume changes.
24
Management's Discussion and Analysis
of Financial Condition and Results of Operations
Noninterest Income
Noninterest income for 2003 increased by $2.3 million, or 30%, over 2002 to
$10.0 million. The increase was primarily due 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 $765,000 in 2003 and $493,000 in 2002 on the
sale of residential and student loans. Also included in noninterest income were
securities gains of $880,000 for 2003 and $0 for 2002.
Noninterest Expenses
Noninterest expenses totaled $32.5 million for 2003, an increase of $7.1
million, or 28%, over 2002. Staffing levels, occupancy, furniture and equipment,
and related expenses increased as a result of opening five full service branches
in 2003. A comparison of noninterest expense for certain categories for 2003 and
2002 is presented below.
Salary expenses and employee benefits, which represent the largest component of
noninterest expenses, increased by $4.2 million, or 34%, in 2003 over 2002. This
increase was partially due to an increase in the level of full-time equivalent
employees from 424 at December 31, 2002 to 503 at year-end 2003. The increased
level of expenses includes the impact of salary and benefit costs associated
with the additional staff for the new branch offices opened in June, July, and
September and two in December 2003, respectively.
Occupancy expenses totaled $3.4 million in 2003, an increase of $1.0 million, or
42%, over 2002 while furniture and equipment expenses increased by $321,000, or
21%, to $1.8 million. The full year impact of the three branch offices opened in
2002 along with five additional branches opened in 2003 contributed to the
increases in occupancy and furn-iture and equipment expenses in 2003 over 2002.
Advertising and marketing expenses were $2.4 million for 2003, an increase of
$244,000, or 11%, over 2002. The increase was primarily the result of new branch
opening expenses associated with the five new branches along with increased
advertising efforts in each of the Company's markets. Two out of the five
branches opened in 2003, were opened in Berks County, a new market for the
Company. The Company's markets include Berks, Lebanon, Dauphin, Cumberland, and
York Counties of South Central Pennsylvania. The Company will continue to have
multiple markets in which to advertise its products.
Data processing expenses increased by $258,000, or 14%, in 2003 over 2002. The
primary increase was due to costs associated with processing additional
transactions as a result of growth in the number of accounts serviced.
Postage and supplies expenses of $986,000 were $124,000, or 14%, higher than the
prior year. The increase in postage and supplies expense was attributed to the
growth in the number of account statements mailed to customers.
Other noninterest expenses totaled $5.0 million for 2003, compared to $4.1
million for 2002. This includes increased loan expenses of $367,000, increased
checkbook printing expense of $92,000, increased business development expenses
of $191,000 and increased shares tax expense of $79,000.
The Company's current strategic plan calls for the construction of two or three
additional new branch offices in 2004. The costs associated with these planned
offices will continue to result in higher levels of staff, facilities, and
related expenses in 2004 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. For purposes of this
calculation, net noninterest expenses equal noninterest expenses (excluding
other real estate expenses) less noninterest income (exclusive of gains on sales
of investment securities). This ratio equaled 2.66% for 2003, compared to 2.55%
for 2002. 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 gains
on sales of investment securities). For 2003, the operating efficiency ration
was 75.7% compared to 71.9% for 2002. The Company's operating efficiency ratio
remains above its peer group primarily due to its aggressive branch expansion
activities.
Provision for Federal Income Taxes
The provision for federal income taxes was $3.1 million for 2003, compared to
$2.9 million for 2002. The effective tax rate, which is the ratio of income tax
expense to income before taxes, was 32.2% in 2003 and 33.6% in 2002. 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 2003 and 2002.
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, 2003, deferred tax assets amounted to $2.1 million and deferred
tax liabilities amounted to $1.5 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.
25
Management's Discussion and Analysis
of Financial Condition and Results of Operations
Net Income and Net Income Per Share
Net income for 2003 rose to a record $6.6 million, an increase of $883,000, or
16%, over the $5.7 million recorded in 2002. This increase was due to an
increase in net interest income of $6.2 million, an increase in noninterest
income of $2.3 million, partially offset by an increase in the provision for
loan losses of $260,000, an increase in noninterest expenses of $7.1 million and
an increase of $247,000 in the provision for income taxes.
Basic earnings per common share, after adjusting for a 5% common stock dividend
declared in January 2004, increased by 12% to $2.88 per share, compared to $2.58
in 2002. Diluted earnings per common share were $2.68 for 2003 and $2.37 for
2002 after adjusting for the 5% common stock dividend declared in January 2004.
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 was 0.74% for 2003 and 0.82% for
2002. This decrease is the result of 34% growth in total assets combined with a
16% increase in net income. Contributing to these results was the addition of 5
new branch offices in 2003 and their related costs.
For purposes of calculating ROA, average assets have been adjusted to exclude
the effect of net unrealized gains (losses) on securities available for sale.
The Company's ROE for 2003 was 14.27%, compared to 14.86% for 2002. 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.
Results of Operations
- --------------------------------------------------------------------------------
2002 versus 2001
Net income for 2002 rose to $5.7 million, an increase of $1.3 million, or 28%,
over the $4.4 million recorded in 2001.
Diluted earnings per common share increased by 22% to $2.37 for 2002 over $1.94
for 2001 after adjusting for the 5% common stock dividends declared in January
2003 and 2004.
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. Interest expense for 2002 decreased by $1.9
million, or 12%, from $16.2 million to $14.3 million.
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%.
Noninterest income for 2002 increased by $1.1 million, or 17%, over 2001 to $7.7
million. 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.
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.
Salary expenses and employee benefits 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.
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.
Advertising and marketing expenses were $2.2 million for 2002, an increase of
$459,000, or 27%, over 2001. Data processing expenses increased by $577,000, or
44%, in 2002 over 2001. Postage and supplies expenses of $862,000 were $16,000,
or 2%, higher than the prior year.
Other noninterest expenses totaled $4.1 million for 2002, compared to $3.6
million for 2001.
Financial Condition
- --------------------------------------------------------------------------------
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
26
Management's Discussion and Analysis
of Financial Condition and Results of Operations
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 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, 2003, the weighted average life and duration of the Company's
securities portfolio was approximately 6.6 and 4.8 years, respectively, as
compared to 2.5 years and 2.0 years, respectively, at December 31, 2002. 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, 2003 or 2002.
Securities available for sale increased by $71.4 million in 2003 (excluding the
effect of unrealized gains or losses) primarily as a result of purchases of
$273.4 million, offset by principal repayments and maturities of $191.7 million
and the sale of $8.3 million in securities. 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, 2003, the unrealized gains on securities available for sale
included in stockholders' equity totaled $549,000, net of tax, compared to
unrealized gains of $1.5 million, net of tax, at December 31, 2002.
During 2003, securities held to maturity increased by $102.3 million primarily
as a result of purchases of $148.2 million offset by principal repayments of
$45.9 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. As of December 31,
2003, the Company had committed securities with a carrying value of $8.6 million
and a fair market value of $9.2 million for sale. These securities are included
as other assets on the balance sheet at December 31, 2003.
TABLE 3
- -------------------------------------------------------------------------------------------------------------------------------
December 31, 2003 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 $ 5,000 4.05% $ 19,000 5.79% $ 24,000 5.43%
Mortgage-backed obligations $ 734 4.80% 20,037 3.57 227,784 4.51 248,555 4.44
Corporate debt securities 2,013 7.80 2,013 7.80
- -------------------------------------------------------------------------------------------------------------------------------
Total available for sale $ 0 -- $ 734 4.80% $25,037 3.67% $248,797 4.63% $274,568 4.55%
===============================================================================================================================
Held to Maturity
U.S. Government
Agency obligations $1,100 6.30% $14,988 4.58% $ 23,922 5.87% $ 40,010 5.40%
Municipal obligations 6,845 7.05 6,845 7.05
Mortgage-backed obligations $2,160 5.32% 243 4.75 133,522 5.15 135,925 5.15
Corporate debt securities 4,534 6.52 3,968 6.57 8,581 7.53 17,083 7.04
- -------------------------------------------------------------------------------------------------------------------------------
Total held to maturity $1,100 6.30% $6,694 6.13% $19,199 4.99% $172,870 5.44% $199,863 5.43%
===============================================================================================================================
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.
27
Management's Discussion and Analysis
of Financial Condition and Results of Operations
The contractual maturity distribution and weighted average yield of the
Company's available for sale and held to maturity portfolios at December 31,
2003 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 following table summarizes the composition of the loan portfolio of the
Company by type as of December 31, for each of the years 1999 through 2003.
The Company manages risk associated with its loan portfolio through
diversification, sound 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.
The commercial loan portfolio is comprised primarily of loans to small and
mid-sized businesses primarily in the South 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 non-homogeneous in that the loans have
different interest rates, repayment options, maturities, collateral
requirements, etc.
During 2003, total gross loans increased by $105.7 million from $379.4 million
at December 31, 2002, to $485.1 million at December 31, 2003, including $9.2
million of loans held for sale on December 31, 2003 and $10.5 million of loans
held for sale on December 31, 2002. The loans held for sale represent student
loans and certain residential loans the Company's management intends to sell and
reinvest in higher yielding loans and securities. The increase in loans
receivable in 2003 was primarily in the commercial real estate and consumer loan
portfolios. Total consumer loans increased by $36.4 million in 2003 to $71.0
million, an increase of 105%. The Company's 2003 Strategic Plan included a large
effort to increase the size of the consumer loan portfolio across all markets of
its branch footprint. Consumer loans represented 15% and 9% of total loans
outstanding as of December 31, 2003 and 2002, respectively. Total loans
outstanding represented 53% of total deposits and 45% of total assets at
December 31, 2003, excluding the loans held for sale, compared to 51% and 47%,
respectively, at December 31, 2002.
TABLE 4
- ----------------------------------------------------------------------------------------------------------------------
December 31,
(in thousands) 2003 2002 2001 2000 1999
- ----------------------------------------------------------------------------------------------------------------------
Commercial mortgage $194,609 $144,959 $142,969 $127,931 $101,550
Construction and land development 26,895 31,034 32,863 30,776 18,458
Residential real estate mortgage loans 72,713 66,190 48,415 41,314 34,681
Tax-exempt loans 5,720 5,629 2,676 2,786 342
Commercial, industrial and other business loans 58,894 49,226 42,399 31,490 21,228
Consumer loans 71,007 34,598 36,551 30,691 22,764
Lines of credit 46,106 37,245 36,801 25,264 17,082
- ----------------------------------------------------------------------------------------------------------------------
Total loans $475,944 $368,881 $342,674 $290,252 $216,105
======================================================================================================================
28
Management's Discussion and Analysis
of Financial Condition and Results of Operations
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, 2003, are presented in the following table.
TABLE 5
- ----------------------------------------------------------------------------------------------------------------
December 31, 2003
- ----------------------------------------------------------------------------------------------------------------
Due Under Due 1-5 Due Over
(in thousands) One Year Years Five Years Total
- ----------------------------------------------------------------------------------------------------------------
Real estate:
Commercial mortgage $ 16,934 $ 86,228 $ 91,447 $194,609
Construction and land development 20,309 4,630 1,956 26,895
Residential mortgage 3,407 9,780 59,526 72,713
Tax-exempt 554 1,906 3,260 5,720
- ----------------------------------------------------------------------------------------------------------------
41,204 102,544 156,189 299,937
Commercial 26,847 25,344 6,703 58,894
Consumer 14,023 19,322 37,662 71,007
Lines of credit 46,106 0 0 46,106
- ----------------------------------------------------------------------------------------------------------------
Total loans $128,180 $147,210 $200,554 $475,944
- ----------------------------------------------------------------------------------------------------------------
Interest rates:
Predetermined $ 39,775 $138,608 $161,054 $339,437
Floating 88,405 8,602 39,500 136,507
- ----------------------------------------------------------------------------------------------------------------
Total loans $128,180 $147,210 $200,554 $475,944
================================================================================================================
Concentrations of Credit Risk
The largest portion of loans, 41%, on the Company's balance sheet is for
commercial mortgage related loans. The Company's commercial real estate loan
portfolio is principally to borrowers throughout Cumberland, Dauphin, Lebanon,
York and Berks counties of Pennsylvania where it has full-service branch
locations. Commercial real estate, construction, and land development loans
aggregated $221.5 million at December 31, 2003, compared to $176.0 million at
December 31, 2002. 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, 2003, were $1.4 million, or 0.13%, of total assets as compared to
$1.8 million, or 0.23%, of total assets at December 31, 2002. Total
non-performing loans (non-accrual loans and restructured loans) at December 31,
2003 were $1.2 million compared to $1.7 million a year ago. Total delinquent
loans (those loans 30 days or more delinquent) as a percentage of total loans
were 0.38% at December 31, 2003, compared to 0.68% at December 31, 2002. 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, 2003, loans past due 90 days and still
accruing interest amounted to $385,000 compared to $55,000 at December 31, 2002.
Foreclosed real estate totaled $236,000 as of December 31, 2003 as compared to
$118,000 as of December 31, 2002. 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.
29
Management's Discussion and Analysis
of Financial Condition and Results of Operations
The following table summarizes information regarding non-performing loans and
non-performing assets as of December 31, 1999 through 2003.
TABLE 6
- ------------------------------------------------------------------------------------------------------------------------------
December 31,
(dollars in thousands) 2003 2002 2001 2000 1999
- ------------------------------------------------------------------------------------------------------------------------------
Nonaccrual loans:
Commercial $ 143 $ 958 $ 127 $ 300 $ 119
Consumer 68 42 116 162 244
Real estate: Construction 159 0 0 0 0
Mortgage 417 599 633 371 321
- ------------------------------------------------------------------------------------------------------------------------------
Total nonaccrual loans 787 1,599 876 833 684
Loans past due 90 days or more and still accruing 385 55 0 0 20
Restructured loans 0 0 0 0 0
- ------------------------------------------------------------------------------------------------------------------------------
Total non-performing loans 1,172 1,654 876 833 704
Other real estate 236 118 12 42 12
- ------------------------------------------------------------------------------------------------------------------------------
Total non-performing assets $1,408 $1,772 $ 888 $ 875 $ 716
==============================================================================================================================
Non-performing loans to total loans 0.25% 0.45% 0.26% 0.29% 0.32%
Non-performing assets to total assets 0.13% 0.23% 0.15% 0.18% 0.18%
- ------------------------------------------------------------------------------------------------------------------------------
Interest income received on nonaccrual loans $37 $ 79 $ 33 $ 52 $ 38
- ------------------------------------------------------------------------------------------------------------------------------
Interest income that would have been recorded
under the original terms of the loans $45 $ 193 $ 89 $ 96 $ 66
==============================================================================================================================
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 conditions 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
30
Management's Discussion and Analysis
of Financial Condition and Results of Operations
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 $1.7 million to the allowance for loan losses
for 2003 compared to $1.4 million for 2002. During 2003, net charge-offs
amounted to $834,000, or 0.20%, of average loans outstanding for the year,
compared to $833,000, or 0.23%, of average loans outstanding for 2002. The
allowance for loan losses decreased as a percentage of loans receivable from
1.40% of total loans outstanding at December 31, 2002, to 1.26% of total loans
outstanding at December 31, 2003 and provided coverage of 513% of non-performing
loans. Based upon a consistent application of the Company's loan loss reserve
methodology, the allowance level increased by $861,000 to $6.0 million or 1.26%
of total loans at December 31, 2003, but decreased as a percentage of total
loans due to 29% growth in the loan portfolio in 2003.
The table below presents, for the years 1999 through 2003, information regarding
the Company's provision and allowance for loan losses.
Table 7
- ------------------------------------------------------------------------------------------------------------------------------
Year Ended December 31,
(dollars in thousands) 2003 2002 2001 2000 1999
- ------------------------------------------------------------------------------------------------------------------------------
Balance at beginning of year $5,146 $4,544 $3,732 $2,841 $2,232
Provisions charged to operating expenses 1,695 1,435 1,469 1,050 762
- ------------------------------------------------------------------------------------------------------------------------------
6,841 5,979 5,201 3,891 2,994
- ------------------------------------------------------------------------------------------------------------------------------
Recoveries of loans previously charged-off:
Commercial 66 93 3 6 8
Consumer 85 2 21 8 4
Real estate 115 21 0 0 1
- ------------------------------------------------------------------------------------------------------------------------------
Total recoveries 266 116 24 14 13
- ------------------------------------------------------------------------------------------------------------------------------
Loans charged-off:
Commercial (483) (561) (475) (1) (150)
Consumer (331) (70) (85) (95) (10)
Real estate (286) (318) (121) (77) (6)
- ------------------------------------------------------------------------------------------------------------------------------
Total charged-off (1,100) (949) (681) (173) (166)
- ------------------------------------------------------------------------------------------------------------------------------
Net charge-offs (834) (833) (657) (159) (153)
- ------------------------------------------------------------------------------------------------------------------------------
Balance at end of year $6,007 $5,146 $4,544 $3,732 $2,841
- ------------------------------------------------------------------------------------------------------------------------------
Net charge-offs (recoveries) to average loans outstanding 0.20% 0.23% 0.21% 0.06% 0.08%
Allowance for loan losses to year-end loans 1.26% 1.40% 1.33% 1.29% 1.31%
==============================================================================================================================
31
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,
2003 2002 2001 2000 1999
- ----------------------------------------------------------------------------------------------------------------------------------
% Gross % Gross % Gross % Gross % Gross
(dollars in thousands) Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
- ----------------------------------------------------------------------------------------------------------------------------------
Commercial loans
and lines of credit $2,636 21% $2,428 24% $ 986 23% $ 178 19% $ 155 18%
Consumer 717 15 452 9 157 11 143 11 224 10
Real estate, construction
and land development:
Commercial 2,157 47 1,698 48 3,240 50 3,286 55 2,335 56
Residential 497 17 568 19 161 16 125 15 127 16
- ----------------------------------------------------------------------------------------------------------------------------------
Total $6,007 100% $5,146 100% $4,544 100% $3,732 100% $2,841 100%
==================================================================================================================================
Deposits
Total deposits at December 31, 2003, were $906.5 million, up $179.6 million, or
25%, over total deposits of $727.0 million at December 31, 2002. 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 $170.8 million, or
25%, in 2003 over 2002. Total deposits averaged $802.3 million for 2003, an
increase of $160.8 million, or 25%, over the 2002 average of $641.5 million. The
average balance on noninterest-bearing demand deposits increased in 2003 by
$28.0 million, or 24%, compared to the prior year. The average balance of
interest bearing demand accounts (money market and interest checking accounts)
for 2003 increased by $88.8 million, or 57%, over the average balance for the
prior year. The average total balance of all savings accounts was $235.5
million, a $38.3 million, or 19%, increase over the average balance for 2002.
The average balance of all time deposits in 2003 was $178.7 million, an increase
of $5.6 million, or 3%, over the average balance for 2002. For 2003, the cost of
total deposits was 1.26% as compared to 2.02% in 2002.
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, unparalleled quality customer service, and active marketing.
The average balances and weighted average rates paid on deposits for 2003, 2002
and 2001 are presented below.
TABLE 9
- --------------------------------------------------------------------------------------------------------------------------------
Year Ended December 31,
2003 Average 2002 Average 2001 Average
(dollars in thousands) Balance/Rate Balance/Rate Balance/Rate
- --------------------------------------------------------------------------------------------------------------------------------
Demand deposits:
Noninterest-bearing $142,805 $114,758 $ 91,352
Interest-bearing (money market and checking) 245,264 0.90% 156,441 1.30% 108,349 2.24%
Savings 235,515 1.02 197,225 1.96 141,350 2.95
Time 178,674 3.07 173,064 4.06 160,031 5.52
- --------------------------------------------------------------------------------------------------------------------------------
Total deposits $802,258 $641,488 $501,082
================================================================================================================================
32
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, 2003, 2002 and 2001 is presented in Table 10.
TABLE 10
- ----------------------------------------------------------------
(in thousands) 2003 2002 2001
- ----------------------------------------------------------------
3 months or less $35,065 $31,591 $32,092
3 to 6 months 21,202 20,462 17,493
6 to 12 months 18,520 16,390 9,028
Over 12 months 16,612 11,427 16,292
- ----------------------------------------------------------------
Total $91,399 $79,870 $74,905
- ----------------------------------------------------------------
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, 2003.
TABLE 11
- --------------------------------------------------------------------------------------------------------------------------------
December 31, 2003
- --------------------------------------------------------------------------------------------------------------------------------
1 - 90 91 - 180 181 - 365 1 - 5 Beyond 5
(in thousands) Days Days Days Years Years Total
- --------------------------------------------------------------------------------------------------------------------------------
Interest earning assets:
Loans receivable $ 152,491 $ 8,978 $ 12,711 $132,706 $176,672 $483,558
Securities 41,222 34,919 59,118 243,552 102,041 480,852
Federal funds sold 0 0 0 0 0 0
- --------------------------------------------------------------------------------------------------------------------------------
Total interest earning assets 193,713 43,897 71,829 376,258 278,713 964,410
- --------------------------------------------------------------------------------------------------------------------------------
Interest-bearing liabilities:
Transaction accounts 167,764 0 0 0 386,121 553,885
Time deposits 60,434 30,071 45,348 46,375 0 182,228
Short-term borrowings 79,000 0 0 0 0 79,000
Trust capital securities 0 0 0 0 13,000 13,000
- --------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 307,198 30,071 45,348 46,375 399,121 828,113
================================================================================================================================
Period GAP (113,485) 13,826 26,481 329,883 (120,408) $136,297
- --------------------------------------------------------------------------------------------------------------------------------
Cumulative GAP $(113,485) $(99,659) $(73,178) $256,705 $136,297
================================================================================================================================
Notes: Nonaccrual loans, deferred fees on loans and overdrafts have been excluded in the loans receivable balances. Securities are
reported at current face for purposes of this table.
33
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.
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 100 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, 2003, the Company's income simulation model
indicates net income would be higher by 3.1%, or $309,000, in the first year and
lower by 0.1%, or $33,000, over a two-year time frame, if rates decreased 100
basis points as compared to lower by 0.5% and by 5.2%, respectively, at December
31, 2002. The model projects that net income would be lower by 1.0%, or
$518,000, and lower by 3.4%, or $336,000, in the first year and over a two-year
time frame, respectively, if rates increased 200 basis points, as compared to
higher by 5.4% and 16.8%, respectively, at December 31, 2002. All of these
forecasts are within an acceptable level of interest rate risk per the policies
established by ALCO.
Management also monitors interest rate risk by utilizing a market value of
equity model. The model assesses the impact of a change in interest rates on the
market value of all 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, 2003, the market value of equity indicates an acceptable level of
interest rate risk.
The market value of equity model reflects certain estimates and assumptions
regarding the impact on the market value of 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. Using an independent consultant, 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, are relatively insensitive to changes in
interest rates and have significant longer average lives and durations than the
Company's loans and investment securities. 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, 2003 provide an accurate assessment of the
Company's 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 $170.8
million, or 25%, in 2003.
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, 2003, the total potential liquidity for the Company
through these secondary sources was $270 million of which $191 million was
available at December 31, 2003. In view of the primary and secondary sources as
previously mentioned, management believes the Company is capable of meeting its
anticipated liquidity needs.
34
Management's Discussion and Analysis
of Financial Condition and Results of Operations
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, 2003:
TABLE 12
- ---------------------------------------------------------------------------------------------------------------------
December 31, 2003
- ---------------------------------------------------------------------------------------------------------------------
1 Year Over 1 Over 3 Over 5
(in thousands) or Less to 3 Years to 5 Years Years Total
- ---------------------------------------------------------------------------------------------------------------------
Time Deposits $135,853 $23,811 $22,564 $ 0 $182,228
Long-Term Debt 0 0 0 13,000 13,000
Operating Leases 1,618 2,618 2,241 10,249 16,726
Sponsorship Obligation (1) 150 400 617 2,333 3,500
- ---------------------------------------------------------------------------------------------------------------------
Total $137,621 $26,829 $25,422 $25,582 $215,454
=====================================================================================================================
(1) Sponsorship Obligation was signed in January 2004.
Off-Balance Sheet Arrangements
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. See Note 5 in the Notes to the Consolidated Financial
Statements for additional information.
Short-Term Borrowings
Short-term borrowings, which consist of securities sold under agreement to
repurchase and federal funds purchased, were used in 2003 and 2002 to meet
short-term liquidity needs. For 2003, short-term borrowings averaged $11.7
million and repurchase agreements averaged $5.3 million. The average rate paid
during 2003 on the Company's short-term borrowings was 1.23% and the average
rate paid on repurchase agreements was 1.20%. Short-term borrowings and
repurchase agreements totaled $39.0 million and $40.0 million, respectively at
December 31, 2003. The maximum short-term borrowings outstanding at any
month-end in 2003 were $50.0 million. The maximum repurchase agreements
outstanding at any month-end in 2003 were $40.0 million. Amounts outstanding
during 2002 and 2001 were not significant.
Long-Term Debt
Long-term debt consists of Trust Capital Securities through Commerce Harrisburg
Capital Trust I and Commerce Harrisburg Capital Trust II, a Delaware business
trust subsidiaries of the Company. At December 31, 2003, 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, 2003 and 2002.
Stockholders' Equity and Capital Adequacy
At December 31, 2003, stockholders' equity totaled $49.7 million, up $6.9
million, or 16%, over stockholders' equity at December 31, 2002. This increase
was due to the Company's net income for the year, shares issued under stock
purchase and stock option plans, offset by unrealized losses on securities
available for sale. Stockholders' equity as a percent of total assets was 4.73%
at December 31, 2003, compared to 5.44% at December 31, 2002.
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.
35
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
2003 2002 Adequacy Purposes Action Provisions
- -------------------------------------------------------------------------------------------------------------------------------
Tier 1 Capital 9.49% 11.11% 4.00% 6.00%
Total Capital 10.42 12.17 8.00 10.00
Leverage ratio (to average assets) 6.14 6.97 4.00 5.00
- -------------------------------------------------------------------------------------------------------------------------------
At December 31, 2003, 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%.
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 month (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.
36
Consolidated Balance Sheets
December 31,
(in thousands, except share amounts) 2003 2002
- ----------------------------------------------------------------------------------------------------------------------
Assets
- ----------------------------------------------------------------------------------------------------------------------
Cash and due from banks $ 37,715 $ 30,950
Federal funds sold 0 44,500
- ----------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents 37,715 75,450
Securities, available for sale at fair value 275,400 205,436
Securities, held to maturity at cost
(fair value 2003: $201,568; 2002: $101,036 ) 199,863 97,625
Loans, held for sale 9,164 10,514
Loans receivable, net of allowance for loan losses
(allowance 2003: $6,007; 2002: $5,146) 469,937 363,735
Restricted investments in bank stock 5,227 2,045
Premises and equipment, net 38,178 26,409
Other assets 16,505 5,384
- ----------------------------------------------------------------------------------------------------------------------
Total assets $1,051,989 $786,598
======================================================================================================================
Liabilities and Stockholders' Equity
- ----------------------------------------------------------------------------------------------------------------------
Deposits:
Noninterest-bearing $ 170,414 $127,199
Interest-bearing 736,113 599,756
- ----------------------------------------------------------------------------------------------------------------------
Total deposits 906,527 726,955
Short-term borrowings 39,000 0
Repurchase agreements 40,000 0
Trust capital securities 13,000 13,000
Other liabilities 3,738 3,831
- ----------------------------------------------------------------------------------------------------------------------
Total liabilities 1,002,265 743,786
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 2003: 2,291,805; 2002: 2,117,089) 2,292 2,117
Surplus 38,725 31,909
Retained earnings 7,758 6,866
Accumulated other comprehensive income 549 1,520
- ----------------------------------------------------------------------------------------------------------------------
Total stockholders' equity 49,724 42,812
- ----------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $1,051,989 $786,598
======================================================================================================================
See accompanying notes
37
Consolidated Statements of Income
Year Ended December 31,
(in thousands, except per share amounts) 2003 2002 2001
- -------------------------------------------------------------------------------------------------------------------------
Interest Income
- -------------------------------------------------------------------------------------------------------------------------
Loans receivable, including fees:
Taxable $27,545 $26,755 $26,532
Tax-exempt 216 111 120
Securities:
Taxable 17,108 14,514 10,860
Tax-exempt 453 107 94
Federal funds sold 220 508 641
- -------------------------------------------------------------------------------------------------------------------------
Total interest income 45,542 41,995 38,247
=========================================================================================================================
Interest Expense
- -------------------------------------------------------------------------------------------------------------------------
Deposits 10,089 12,940 15,420
Short-term borrowings 207 0 13
Trust capital securities 1,356 1,354 760
- -------------------------------------------------------------------------------------------------------------------------
Total interest expense 11,652 14,294 16,193
- -------------------------------------------------------------------------------------------------------------------------
Net interest income 33,890 27,701 22,054
Provision for loan losses 1,695 1,435 1,469
- -------------------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 32,195 26,266 20,585
=========================================================================================================================
Noninterest Income
- -------------------------------------------------------------------------------------------------------------------------
Service charges and other fees 7,968 6,766 5,660
Other operating income 377 448 541
Gains on sales of loans 765 493 354
Gains on sales of securities 880 0 52
- -------------------------------------------------------------------------------------------------------------------------
Total noninterest income 9,990 7,707 6,607
=========================================================================================================================
Noninterest Expenses
- -------------------------------------------------------------------------------------------------------------------------
Salaries and employee benefits 16,702 12,491 9,486
Occupancy 3,420 2,403 2,133
Furniture and equipment 1,844 1,523 1,402
Advertising and marketing 2,425 2,181 1,722
Data processing 2,148 1,890 1,313
Postage and supplies 986 862 846
Other 4,985 4,078 3,610
- -------------------------------------------------------------------------------------------------------------------------
Total noninterest expenses 32,510 25,428 20,512
=========================================================================================================================
Income before income taxes 9,675 8,545 6,680
Provision for federal income taxes 3,118 2,871 2,232
- -------------------------------------------------------------------------------------------------------------------------
Net income $ 6,557 $ 5,674 $ 4,448
=========================================================================================================================
Net Income per Common Share
- -------------------------------------------------------------------------------------------------------------------------
Basic $2.88 $2.58 $2.14
Diluted $2.68 $2.37 $1.94
=========================================================================================================================
See accompanying notes
38
Consolidated Statements of Stockholders Equity
Accumulated Other
Preferred Common Retained Comprehensive
(dollars in thousands ) Stock Stock Surplus Earnings Income (Loss) Total
- ---------------------------------------------------------------------------------------------------------------------------------
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 taxes and 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 taxes and 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
=================================================================================================================================
Comprehensive income:
Net income - - - 6,557 - 6,557
Change in unrealized gains (losses) on
securities, net of taxes and reclassification
adjustment - - - - (971) (971)
----------
Total comprehensive income 5,586
----------
Dividends declared on preferred stock - - - (80) - (80)
Common stock of 48,226 shares issued under
stock option plans - 48 508 - - 556
Income tax benefit of stock options exercised - 178 - - 178
Common stock of 110 shares issued under
employee stock purchase plan - - 4 - - 4
Proceeds from issuance of 16,950 shares of
common stock in connection with dividend
reinvestment and stock purchase plan - 17 660 - - 677
5% common stock dividend and cash paid in
lieu of fractional shares (109,430 shares issued) - 110 5,466 (5,585) - (9)
- ---------------------------------------------------------------------------------------------------------------------------------
December 31, 2003 $400 $2,292 $38,725 $7,758 $549 $49,724
=================================================================================================================================
See accompanying notes
39
Consolidated Statements of Cash Flows
Year Ended December 31,
(in thousands) 2003 2002 2001
- -------------------------------------------------------------------------------------------------------------------------
Operating Activities
- -------------------------------------------------------------------------------------------------------------------------
Net income $ 6,557 $ 5,674 $ 4,448
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 1,695 1,435 1,469
Provision for depreciation and amortization 1,831 1,484 1,403
Deferred income taxes 285 68 (251)
Amortization of securities premiums and accretion of discounts, net3,036 926 219
Gains on sales of securities (880) 0 (52)
Proceeds from sales of loans 106,950 67,794 48,887
Loans originated for sale (104,835) (70,154) (50,944)
Gains on sales of loans (765) (493) (354)
(Increase) decrease in other assets (10,724) 93 (733)
Increase (decrease) in other liabilities (93) 1,272 724
- -------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 3,057 8,099 4,816
Investing Activities
- -------------------------------------------------------------------------------------------------------------------------
Securities held to maturity:
Proceeds from principal repayments and maturities 45,855 34,681 18,589
Purchases (148,228) (29,121) (88,112)
Securities available for sale:
Proceeds from principal repayments and maturities 191,681 77,946 43,922
Proceeds from sales 8,294 0 7,497
Purchases (273,431) (176,945) (64,833)
Net (purchase) redemption of restricted investments in bank stock(3,182) 548 (305)
Proceeds from sale of loans receivable 0 0 3,255
Net increase in loans receivable (107,897) (27,040) (56,254)
Purchases of premises and equipment (13,600) (6,306) (6,353)
- -------------------------------------------------------------------------------------------------------------------------
Net cash used by investing activities (300,508) (126,237) (142,594)
Financing Activities
- -------------------------------------------------------------------------------------------------------------------------
Net increase in demand, interest checking,
money market, and savings deposits 166,787 159,992 102,383
Net increase in time deposits 12,785 5,225 12,772
Net increase in short-term borrowings 79,000 0 0
Proceeds from issuance of trust capital securities 0 0 8,000
Proceeds from common stock options exercised 556 1,738 217
Proceeds from dividend reinvestment and common stock purchase plan 677 868 698
Cash dividends on preferred stock and cash in lieu of fractional shares (89) (90) (86)
- -------------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 259,716 167,733 123,984
- -------------------------------------------------------------------------------------------------------------------------
Increase (decrease) in cash and cash equivalents (37,735) 49,595 (13,794)
Cash and cash equivalents at beginning of year 75,450 25,855 39,649
- -------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at year-end $37,715 $75,450 $25,855
=========================================================================================================================
See accompanying notes.
40
Notes to Consolidated Financial Statements
December 31, 2003
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
(Trust I) and Commerce Harrisburg Capital Trust II (Trust II). All material
intercompany transactions have been eliminated. The 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. 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
Bank serves primarily the Harrisburg, York, and Reading markets of 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.
Significant Group Concentrations of Credit Risk
Most of the Company's activities are with customers located within the South
Central Pennsylvania Region. Note 3 discusses the types of securities that the
Company invests in. Notes 4 and 6 discuss the types of lending that the Company
engages in as well as loan concentrations. The Company does not have any
significant concentrations to any one industry or customer.
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.
41
Notes to Consolidated Financial Statements
The allowance consists of specific and general components. The specific
component relates to loans that are classified impaired. For such loans, an
allowance is established when the discounted cash flows (or collateral value or
observable market price) of the impaired loan is lower than the carrying value
of that loan. The general component covers non-classified loans and is based on
historical loss experience adjusted for qualitative factors. Additionally, the
general component is maintained to cover uncertainties that could affect
management's estimates of probable losses. This component reflects the margin of
imprecision inherent in the underlying assumptions used in the methodologies for
estimating losses in the portfolio.
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 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, calculated in the
aggregate.
Restricted Investments in Bank Stock
Restricted investments in bank stocks include Federal Home Loan Bank (FHLB) and
Federal Reserve Bank Stocks. 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 methods for financial reporting purposes, and accelerated
methods for income tax purposes.
Foreclosed Assets
Assets acquired through, or in lieu of, loan foreclosure are held for sale and
are initially recorded at fair value at the date of foreclosure, establishing a
new cost basis. Subsequent to foreclosure, valuations are periodically performed
by management and the assets are carried at the lower of carrying amount or fair
value less cost to sell. Revenue and expenses from operations and changes in the
valuation allowance are included in net expenses from foreclosed assets.
Foreclosed assets are included in other assets.
42
Notes to Consolidated Financial Statements
Transfers of Financial Assets
Transfers of financial assets, including sales of loans and loan participations,
are accounted for as sales, when control over the assets has been surrendered.
Control over transferred assets is deemed to be surrendered when (1) the assets
have been isolated from the Company, (2) the transferee obtains the right (free
of conditions that constrain it from taking advantage of that right) to pledge
or exchange the transferred assets, and (3) the Company does not maintain
effective control over the transferred assets through an agreement to repurchase
them before their maturity.
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 30, 2004.
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, 2003, 2002, and 2001 for interest was $12.0 million,
$14.3 million, and $16.2 million respectively. Income taxes paid totaled $2.5
million, $2.6 million, and $2.4 million in 2003, 2002, and 2001, respectively.
Stock-Based Compensation
The Company accounts for stock awards issued to directors, officers, and key
employees using the intrinsic value method in accordance with Accounting
Principles Board Opinion No. 25. This method requires that compensation expense
be recognized to the extent that the fair value of the stock exceeds the
exercise price of the stock award at the grant date. The Company generally does
not recognize compensation expense related to stock awards because the stock
awards generally have fixed terms and exercise prices that are equal to or
greater than the fair value of the Company's common stock at the grant date.
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) 2003 2002 2001
- -------------------------------------------------------------------
Net income:
As reported $6,557 $5,674 $4,448
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 (814) (1,434) (952)
- -------------------------------------------------------------------
Pro-forma 5,743 4,240 3,496
- -------------------------------------------------------------------
Reported earnings per share:
Basic $2.88 $2.58 $2.14
Diluted 2.68 2.37 1.94
- -------------------------------------------------------------------
Pro-forma earnings per share:
Basic $2.51 $1.92 $1.67
Diluted 2.34 1.76 1.51
===================================================================
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 2003, 2002, and 2001 respectively: risk-free interest rates of
3.4%, 4.7% and 4.8%; volatility factors of the expected market price of the
Company's common stock of .21, .33, and .28; weighted-average expected life of
the options of 10 years; and no cash dividends.
Had compensation costs for stock options granted in 2003, 2002 and 2001 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, 2003, 2002 and 2001 would
have been reduced to the proforma amounts indicated.
New Accounting Standards
In November 2002, the Financial Accounting Standards Board (FASB) issued FASB
Interpretation No. 45 (FIN 45), "Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others." This Interpretation expands the disclosures to
43
Notes to Consolidated Financial Statements
be made by a guarantor in its financial statements about its obligations under
certain guarantees and requires the guarantor to recognize a liability for the
fair value of an obligation assumed under certain specified guarantees. Under
FIN 45, the Company does not issue any guarantees that would require liability
recognition or disclosure, other than its standby letters of credit, as
discussed in Note 5. Adoption of FIN 45 did not have a significant impact on the
Company's financial condition or results of operations.
In January 2003, the Financial Accounting Standards Board issued FASB
Interpretation No. 46, "Consolidation of Variable Interest Entities, an
Interpretation of ARB No. 51." FIN 46 was revised in December 2003. This
Interpretation provides new guidance for the consolidation of variable interest
entities (VIEs) and requires such entities to be consolidated by their primary
beneficiaries if the entities do not effectively disperse risk among parties
involved. The Interpretation also adds disclosure requirements for investors
that are involved with unconsolidated VIEs. The disclosure requirements apply to
all financial statements issued after December 31, 2003. The consolidation
requirements apply to companies that have interests in special-purpose entities
for periods ending after December 15, 2003. Consolidation of other types of VIEs
is required in financial statements for periods ending after March 15, 2004.
In its current form, FIN 46 will require the Company to deconsolidate its
investment in Trust I and Trust II after the March 15, 2004 effective date. The
deconsolidation of subsidiary trusts of bank holding companies formed in
connection with the issuance of trust preferred securities, like Trust I and
Trust II, appears to be an unintended consequence of FIN 46. Upon adoption of
FIN 46 as of March 31, 2004, the trusts will be deconsolidated and the junior
subordinated debentures will be reported in the balance sheet as "Long-term
debt." The Company's equity interest in the trusts, which is not significant,
will be reported in "Other assets." In July 2003, the Board of Governors of the
Federal Reserve System issued a supervisory letter instructing bank holding
companies to continue to include the trust preferred securities in their Tier 1
capital for regulatory capital purposes until notice is given to the contrary.
The Federal Reserve intends to review the regulatory implications of any
accounting treatment changes and, if necessary or warranted, provide further
appropriate guidance. If the outcome is that Trust I and Trust II are no longer
included in consolidated results, the Corporation will still meet all regulatory
capital requirements to which they are subject.
In April 2003, the Financial Accounting Standards Board (FASB) issued Statement
No. 149, "Amendment of Statement No. 133, Accounting for Derivative Instruments
and Hedging Activities." This Statement clarifies the definition of a derivative
and incorporates certain decisions made by the Board as part of the Derivatives
Implementation Group process. This Statement is effective for contracts entered
into or modified and for hedging relationships designated after June 30, 2003
and should be applied prospectively. The provisions of the Statement that relate
to implementation issues addressed by the Derivatives Implementation Group that
have been effective should continue to be applied in accordance with their
respective dates. Adoption of this standard did not have an impact on the
Company's financial condition or results of operations.
In May 2003, the Financial Accounting Standards Board issued Statement No. 150,
"Accounting for Certain Financial Instruments with Characteristics of both
Liabilities and Equity." This Statement requires that an issuer classify a
financial instrument that is within its scope as a liability. Many of these
instruments were previously classified as equity. This Statement was effective
for financial instruments entered into or modified after May 31, 2003 and
otherwise was effective beginning July 1, 2003. The adoption of this standard
did not have an 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 2003
and 2002 was approximately $6.5 million and $4.3 million, respectively.
44
Notes to Consolidated Financial Statements
3. Securities
- --------------------------------------------------------------------------------
The amortized cost and fair value of securities are summarized in the following
tables.
- ------------------------------------------------------------------------------------------------------------------
December 31, 2003
- ------------------------------------------------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
(in thousands) Cost Gains Losses Value
- ------------------------------------------------------------------------------------------------------------------
Available for Sale
U.S. Government Agency securities $ 24,000 $ 10 $ (438) $ 23,572
Mortgage-backed securities 248,555 1,726 (683) 249,598
Corporate debt securities 2,013 217 0 2,230
- ------------------------------------------------------------------------------------------------------------------
Total $274,568 $1,953 $(1,121) $275,400
==================================================================================================================
Held to Maturity
U.S. Government Agency securities $ 40,010 $ 243 $ (734) $ 39,519
Municipal securities 6,845 107 (198) 6,754
Mortgage-backed securities 135,925 1,609 (1,044) 136,490
Corporate debt securities 17,083 1,722 0 18,805
- ------------------------------------------------------------------------------------------------------------------
Total $199,863 $3,681 $(1,976) $201,568
==================================================================================================================
- ------------------------------------------------------------------------------------------------------------------
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
==================================================================================================================
The amortized cost and fair value of debt securities at December 31, 2003 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.
45
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------------------------------------------
Held to Maturity Available for Sale
- ------------------------------------------------------------------------------------------------------------------
Amortized Fair Amortized Fair
(in thousands) Cost Value Cost Value
- ------------------------------------------------------------------------------------------------------------------
Due in one year or less $ 1,100 $ 1,128 $ 0 $ 0
Due after one year through five years 4,534 4,901 0 0
Due after five years through ten years 18,956 18,910 5,000 4,899
Due after ten years 39,348 40,139 21,013 20,903
- ------------------------------------------------------------------------------------------------------------------
63,938 65,078 26,013 25,802
Mortgage-backed securities 135,925 136,490 248,555 249,598
- ------------------------------------------------------------------------------------------------------------------
Total $199,863 $201,568 $274,568 $275,400
==================================================================================================================
Gross gains of $640,000 and gross losses of $0 were realized on sales of
securities available for sale in 2003. Additionally, gross gains of $240,000 and
gross losses of $0 were realized on sales of securities held to maturity. The
sale of securities held to maturity consisted of $4.5 million of corporate bonds
which were sold solely due to a continued deterioration in the issuer's
creditworthiness over the past three years. The securities were sold prior to
December 31, 2003 and settled in January 2004.
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.
At December 31, 2003 and 2002 securities with a fair value of $257.1 million and
$200.1 million respectively, were pledged to secure public deposits and for
other purposes as required or permitted by law.
The following table shows the Company's investments' gross unrealized losses and
fair value, aggregated by investment category and length of time that individual
securities have been in a continuous unrealized loss position.
- --------------------------------------------------------------------------------------------------------------------------------
Less than 12 months 12 months or more Total
Fair Unrealized Fair Unrealized Fair Unrealized
(in thousands) Value Losses Value Losses Value Losses
- --------------------------------------------------------------------------------------------------------------------------------
Available for Sale
U.S. Government Agency securities $ 13,562 $ (438) $ - $ - $ 13,562 $ (438)
Mortgage-backed securities 84,564 (639) 4,684 (44) 89,248 (683)
Corporate debt securities - - - - - -
Held to Maturity
U.S. Government Agency securities 29,272 (734) - - 29,272 (734)
Municipal securities 4,650 (198) - - 4,650 (198)
Mortgage-backed securities 53,408 (1,044) - - 53,408 (1,044)
Corporate debt securities - - - - - -
- --------------------------------------------------------------------------------------------------------------------------------
Total temporarily impaired securities $185,456 $(3,053) $4,684 $(44) $190,140 $(3,097)
================================================================================================================================
The table above represents 48 securities where the current fair value is less
than the related amortized cost.
In management's opinion, the unrealized losses reflects changes in interest
rates subsequent to the acquisition of specific securities and represent
temporary impairment of the securities.
46
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) 2003 2002
- ------------------------------------------------------------------
Real Estate:
Commercial Mortgage $194,609 $144,959
Construction and land
development 26,895 31,034
Residential Mortgage 72,713 66,190
Tax-Exempt 5,720 5,629
Commercial Business 58,894 49,226
Consumer 71,007 34,598
Lines of Credit 46,106 37,245
- ------------------------------------------------------------------
475,944 368,881
Less: Allowance for Loan Losses 6,007 5,146
- ------------------------------------------------------------------
Net Loans Receivable $469,937 $363,735
- ------------------------------------------------------------------
The following is a summary of the transactions in the allowance for loan losses.
- -----------------------------------------------------------------
Year Ended December 31,
(in thousands) 2003 2002 2001
- -----------------------------------------------------------------
Balance at beginning of year $5,146 $4,544 $3,732
Provision charged to expense 1,695 1,435 1,469
Recoveries 266 116 24
Loans charged off (1,100) (949) (681)
- -----------------------------------------------------------------
Balance at end of year $6,007 $5,146 $4,544
=================================================================
At December 31, 2003 and 2002, the recorded investment in loans considered to be
impaired under FASB Statement No. 114 "Accounting by Creditors for Impairment of
a Loan" totaled $9.8 million and $1.5 million, respectively. At December 31,
2003, $2.5 million of impaired loans have a specific valuation allowance of $1.5
million as compared to $934,000 of impaired loans having a specific valuation
allowance of $481,000 at December 31, 2002. Total non-accrual loans at December
31, 2003 and 2002 totaled $787,000 and $1.6 million, respectively. Loans past
due 90 days or more and still accruing totaled $385,000 at December 31, 2003 and
$55,000 at December 31, 2002.
Impaired loans averaged approximately $5.5 million, $1.5 million and $531,000
during 2003, 2002 and 2001, respectively. Interest income recognized on these
loans amounted to $41,000, $79,000 and $33,000 during 2003, 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
$14.0 million and $11.3 million at December 31, 2003 and 2002, respectively.
During 2003, $7.8 million of new advances were made and repayments totaled $5.1
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.
Outstanding letters of credit written are conditional commitments issued by the
Bank to guarantee the performance of a customer to a third party. The majority
of these standby letters of credit expire within the next twelve months. The
credit risk involved in issuing letters of credit is essentially the same as
that involved in extending other loan commitments. The Bank requires collateral
supporting these letters of credit as deemed necessary. Management believes that
the proceeds obtained through a liquidation of such collateral would be
sufficient to cover the maximum potential amount of future payments required
under the corresponding guarantees. The current amount of the liability as of
December 31, 2003 for guarantees under standby letters of credit issued is not
material.
47
Notes to Consolidated Financial Statements
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) 2003 2002
- --------------------------------------------------------------
Commitments to grant loans $ 452 $ 1,628
Unfunded commitments
of existing loans 109,648 68,105
Standby letters of credit 8,426 7,265
- --------------------------------------------------------------
Total $118,526 $76,998
==============================================================
6. Concentrations of Credit Risk
- --------------------------------------------------------------------------------
The Company's loan portfolio is principally to borrowers throughout Cumberland,
Dauphin, York, Lebanon and Berks counties of Pennsylvania where it has
full-service branch locations. Commercial real estate loans and loan commitments
for commercial real estate projects aggregated $238 million at December 31,
2003.
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
- --------------------------------------------------------------------------------
Bank premises and equipment are stated at cost less accumulated depreciation.
Depreciation is computed on the straight-line method over the following
estimated useful lives of the related assets:
- ---------------------------------------------------------------------
Years
- ---------------------------------------------------------------------
Buildings and leasehold improvements 2 - 39.5
Furniture, fixtures and equipment 5 - 10
Computer equipment and software 3 - 5
- ---------------------------------------------------------------------
A summary of premises and equipment is as follows:
- ---------------------------------------------------------------------
December 31,
(in thousands) 2003 2002
- ---------------------------------------------------------------------
Land $ 7,753 $ 4,211
Buildings 26,398 19,941
Leasehold improvements 2,618 1,919
Furniture, fixtures, and equipment 11,609 8,956
- ---------------------------------------------------------------------
48,378 35,027
Less accumulated depreciation
and amortization 10,200 8,618
- ---------------------------------------------------------------------
$38,178 $26,409
=====================================================================
Land, buildings, and equipment are leased under noncancelable operating lease
agreements that expire at various dates through 2023. Total rental expense for
operating leases in 2003, 2002, and 2001 was $1.4 million, $1.1 million, and
$908,000, respectively. At December 31, 2003, future minimum lease payments for
noncancelable operating leases are payable as follows:
- --------------------------------------------------------------
(in thousands)
- --------------------------------------------------------------
2004 $ 1,618
2005 1,359
2006 1,259
2007 1,215
2008 1,026
Thereafter 10,249
- --------------------------------------------------------------
Total minimum lease payments $16,726
==============================================================
8. Deposits
- --------------------------------------------------------------------------------
The composition of deposits is as follows:
- -----------------------------------------------------------------
December 31,
(in thousands) 2003 2002
- -----------------------------------------------------------------
Demand $170,414 $127,199
Interest checking and money market 312,282 214,293
Savings 241,603 216,020
Time certificates $100,000 or more 91,399 79,870
Other time certificates 90,829 89,573
- -----------------------------------------------------------------
$906,527 $726,955
=================================================================
48
Notes to Consolidated Financial Statements
At December 31, 2003, the scheduled maturities of time deposits are as follows:
- -----------------------------------------------------------------
(in thousands)
- -----------------------------------------------------------------
2003 $135,853
2004 15,635
2005 8,176
2006 14,257
2007 8,307
- -----------------------------------------------------------------
$182,228
- -----------------------------------------------------------------
9. Short-term Borrowings
- --------------------------------------------------------------------------------
Short-term borrowings consist of securities sold under agreements to repurchase
and lines of credit. The Bank has a line of credit commitment from the Federal
Home Loan Bank (FHLB) for borrowings up to $215 million and certain qualifying
assets of the Bank collateralize the line. At December 31, 2003, there was $39
million outstanding on this line of credit at a rate of 1.06%. The Bank has
availability under two repurchase agreements to borrow up to $45 million of
which $40 million was outstanding as of December 31, 2003 at a rate of 1.23%.
The Company has $45 million in securities pledged at December 31, 2003 under the
repurchase agreements. These securities are under the Company's control. In
addition, the Bank has a line of credit of $10 million from another bank all of
which was available as of December 31, 2003. There were no short-term borrowings
outstanding at December 31, 2002.
10. Long-term Debt
- --------------------------------------------------------------------------------
On June 15, 2000, the Company issued $5 million of 11% Trust Capital Securities
to Commerce Bancorp, Inc. through Trust I, 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 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 million of the Trust Capital Securities
qualified as Tier 1 capital for regulatory capital purposes.
On September 28, 2001, the Company issued $8 million of 10% Trust Capital
Securities to Commerce Bancorp, Inc. through 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 million 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) 2003 2002 2001
- ---------------------------------------------------------------
Provision at statutory rate
on pre-tax income $3,289 $2,905 $2,271
Tax-exempt income on
loans and investments (218) (76) (73)
Other 47 42 34
- ---------------------------------------------------------------
$3,118 $2,871 $2,232
===============================================================
49
Notes to Consolidated Financial Statements
The components of income tax expense are as follows:
- ---------------------------------------------------------------
Year Ended December 31,
(in thousands) 2003 2002 2001
- ---------------------------------------------------------------
Current $2,833 $2,803 $2,483
Deferred 285 68 (251)
- ---------------------------------------------------------------
$3,118 $2,871 $2,232
===============================================================
The components of the net deferred tax assets were as follows:
- ---------------------------------------------------------------
December 31,
(in thousands) 2003 2002
- ---------------------------------------------------------------
Deferred tax assets:
Allowance for loan losses $2,042 $1,749
Other 59 41
- ---------------------------------------------------------------
Total deferred tax assets $2,101 $1,790
- ---------------------------------------------------------------
Deferred tax liabilities:
Premises and equipment (1,178) (583)
Unrealized gains on securities (283) (783)
Prepaid expenses (84) (83)
- ---------------------------------------------------------------
Total deferred tax liabilities (1,545) (1,449)
- ---------------------------------------------------------------
Net deferred tax assets $ 556 $ 341
===============================================================
Income taxes of $299,000, $0 and $18,000 were recognized on net securities gains
in 2003, 2002, and 2001 respectively. During 2003, 2002 and 2001, the Company
received a deduction on its federal income tax return totalling $178,000,
$378,000, and $78,000, respectively for the exercise of non-qualified stock
options and disqualified dispositions of employee stock from options exercised.
12. Stockholders Equity
- --------------------------------------------------------------------------------
At December 31, 2003, 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 143,666 shares (adjusted for common
stock dividends) of the Company's common stock, exercisable at $6.95 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 2003 or
2002. 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.
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 17,060 and
22,173 common shares were issued pursuant to this plan in 2003 and 2002,
respectively. At December 31, 2003, the Company had reserved approximately
430,000 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.
Payment of the stock dividend resulted in the issuance of approximately 89,000
additional common shares.
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.
Payment of the stock dividend resulted in the issuance of approximately 101,000
additional common shares.
On January 23, 2004, the Board of Directors declared a 5% common stock dividend
payable on February 23, 2004, to stockholders of record on February 6, 2004.
Payment of the stock dividend resulted in the issuance of approximately 109,000
additional common shares.
All common stock and per share data included in these financial statements have
been restated for these stock dividends.
50
Notes to Consolidated Financial Statements
13. Earnings per Share
- --------------------------------------------------------------------------------
The following table sets forth the computation of basic and diluted earnings per
share.
- -----------------------------------------------------------------------------------------------------------------------------------
For the Year Ended December 31,
2003 2002 2001
(in thousands except Per Share Per Share Per Share
per share amounts) Income Shares Amount Income Shares Amount Income Shares Amount
- -----------------------------------------------------------------------------------------------------------------------------------
Basic earnings per share:
Net income $6,557 $5,674 $4,448
Preferred stock dividends (80) (80) (80)
- -----------------------------------------------------------------------------------------------------------------------------------
Income available to
common stockholders 6,477 2,253 $2.88 5,594 2,166 $2.58 4,368 2,043 $2.14
- -----------------------------------------------------------------------------------------------------------------------------------
Effect of dilutive securities:
Stock options 165 198 204
- -----------------------------------------------------------------------------------------------------------------------------------
Diluted earnings per share:
Income available to
common stockholders
plus assumed conversions $6,477 2,418 $2.68 $5,594 2,364 $2.37 $4,368 2,247 $1.94
===================================================================================================================================
All options outstanding were included in the computation of diluted EPS for the
year ended December 31, 2003, and year ended December 31, 2002 because the
options' exercise price was lower than the average market price of the common
shares.
Options to purchase 91,742 shares of common stock at $31.10, which were
outstanding during 2001, 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.
14. Stock Option Plans
- --------------------------------------------------------------------------------
The 1996 Employee Stock Option Plan covers 527,369 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
121,550 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 may be
entitled to an option to acquire shares, as determined by the Board of
Directors, 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
2003, 2002, or 2001.
51
Notes to Consolidated Financial Statements
Stock options transactions under the Plans were as follows:
- -------------------------------------------------------------------------------------------------------------------------------
Year Ended December 31,
2003 2002 2001
- -------------------------------------------------------------------------------------------------------------------------------
Weighted Avg. Weighted Avg. Weighted Avg.
Options Exercise Price Options Exercise Price Options Exercise Price
- -------------------------------------------------------------------------------------------------------------------------------
Outstanding at beginning of year 442,494 $18.81 577,737 $17.83 507,071 $14.83
Granted 93,720 35.96 14,555 34.69 104,602 30.30
Exercised (53,289) 12.13 (123,982) 14.03 (26,528) 8.11
Forfeited (8,791) 32.92 (25,816) 29.13 (7,408) 22.89
- -------------------------------------------------------------------------------------------------------------------------------
Outstanding at end of year 474,134 $22.67 442,494 $18.81 577,737 $17.83
- -------------------------------------------------------------------------------------------------------------------------------
Exercisable at December 31 367,393 $19.15
Options available for grant at December 31 185,180
Weighted-average fair value
of options granted during the year $12.54 $17.94 $17.73
- -------------------------------------------------------------------------------------------------------------------------------
Exercise prices for options outstanding as of December 31, 2003 are presented in
the following table.
- -------------------------------------------------------------------------------------------------------------------------------
As of December 31, 2003
- -------------------------------------------------------------------------------------------------------------------------------
Options Weighted Avg. Weighted Avg. Options Weighted Avg.
Outstanding Exercise Price Contractual Life Exercisable Exercise Price
- -------------------------------------------------------------------------------------------------------------------------------
Options with exercise prices
ranging from $4.18 to $15.00 128,685 $ 9.35 2.6 Years 128,685 $ 9.35
Options with exercise prices
ranging from $15.01 to $25.00 178,205 21.70 5.7 Years 172,882 21.63
Options with exercise prices
ranging from $25.01 to $36.05 167,244 33.93 9.1 Years 65,826 31.76
- -------------------------------------------------------------------------------------------------------------------------------
Total options outstanding with exercise
prices ranging from $4.18 to $36.05 474,134 $22.67 6.0 Years 367,393 $19.15
===============================================================================================================================
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, 2003, that the Company and the Bank meet all
capital adequacy requirements to which they are subject.
As of December 31, 2003, 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 below. There are no
conditions or events since that notification that management believes have
changed the Bank's category.
52
Notes to Consolidated Financial Statements
The following table presents the risk-based and leverage capital amounts and
ratios at December 31, 2003 and 2002 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, 2003
Risked based capital ratios:
Total capital $68,191 10.49% => $ 52,000 => 8.0% => N/A N/A
Tier 1 capital 62,184 9.57 => 26,000 => 4.0 => N/A N/A
Leverage ratio 62,184 6.19 => 40,198 => 4.0 => N/A N/A
- ---------------------------------------------------------------------------------------------------------------------------------
Bank
As of December 31, 2003
Risked based capital ratios:
Total capital $67,714 10.42% => $ 51,992 => 8.0% => $64,990 =>10.0%
Tier 1 capital 61,707 9.49 => 25,996 => 4.0 => 38,994 => 6.0
Leverage ratio 61,707 6.14 => 40,173 => 4.0 => 50,216 => 5.0
- ---------------------------------------------------------------------------------------------------------------------------------
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
=================================================================================================================================
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 2003, 2002, and 2001,
the Company's matching contribution was established at 25% of the employees'
salary deferral. The amount charged to expense was $96,000, $98,000, and $84,000
in 2003, 2002, and 2001, 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 comprehensive income item that the Company presently has is unrealized
gains (losses) on securities available for sale. The federal income taxes
allocated to the unrealized gains (losses) are presented in the table below. The
reclassification adjustments included in comprehensive income are also
presented.
- ----------------------------------------------------------------
Year Ended December 31,
(in thousands) 2003 2002 2001
- ----------------------------------------------------------------
Unrealized holding gains (losses)
arising during the year $ (831) $2,471 $ 908
Less reclassification adjustment
for gains (losses) included in
net income 640 0 52
- ----------------------------------------------------------------
Net unrealized gains (losses) (1,471) 2,471 856
Tax (expense) benefit 500 (840) (291)
- ----------------------------------------------------------------
Net of tax amount $ (971) $1,631 $ 565
================================================================
53
Notes to Consolidated Financial Statements
18. Commitments and Contingencies
- --------------------------------------------------------------------------------
The Company has entered into an agreement to purchase the land located at the
corner of Friendship Road and TecPort Drive in Swatara Township, Dauphin County,
Pennsylvania. The Company plans to construct a Headquarters/Operations Facility
on this property to be opened in 2005.
In January 2004, the Company entered into an agreement for naming rights to
Commerce Bank Park (formerly known as Riverside Stadium) located on Harrisburg
City Island, Harrisburg, Pennsylvania. Commerce Bank Park is home of the
Harrisburg Senators, a AA team affiliated with Major League Baseball. The term
of the naming rights agreement is 15 years with a total obligation of $3.5
million spread over the term.
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 8.4% 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, ATM/VISA card processing, data processing, and advertising support.
The Company paid approximately $1.4 million, $1.2 million, and $622,000 for
services provided by Commerce Bancorp, Inc. during 2003, 2002, and 2001,
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,
2003 and 2002, approximately $2.6 million and $8.6 million, respectively, of
these participations were outstanding.
A federal funds line of credit was established with Commerce Bank N.A. in the
amount of $10.0 million, which could be drawn upon if needed. The balance at
December 31, 2003 and 2002 on this line was $0.
The Company has engaged in certain transactions with entities, which would be
considered related parties. Payments for goods and services, including legal
services, to these related parties totaled $271,000, $557,000 and $547,000, in
2003, 2002 and 2001, respectively. Management believes disbursements made to
related parties were substantially equivalent to those that would have been paid
to unaffiliated companies for similar goods and services.
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.
54
Notes to Consolidated Financial Statements
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.
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.
Short-term Borrowings
The carrying amounts reported approximate those liabilities' fair value.
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. The
carrying amounts and fair values of the Company's financial instruments as of
December 31 are presented in the following table.
- ------------------------------------------------------------------------------------------------------------------------------
2003 2002
- ------------------------------------------------------------------------------------------------------------------------------
Carrying Fair Carrying Fair
(in thousands) Amount Value Amount Value
- ------------------------------------------------------------------------------------------------------------------------------
Financial assets:
Cash and cash equivalents $ 37,715 $ 37,715 $ 75,450 $ 75,450
Securities 475,263 476,968 303,061 306,472
Loans, net (including loans held for sale) 479,101 496,026 374,249 393,618
Restricted investments in bank stock 5,227 5,227 2,045 2,045
Accrued interest receivable 4,998 4,998 3,675 3,675
- ------------------------------------------------------------------------------------------------------------------------------
Financial liabilities:
Deposits $906,527 $908,618 $726,955 $726,070
Long-term debt 13,000 15,610 13,000 15,231
Short-term borrowings 79,000 79,000 0 0
Accrued interest payable 470 470 832 832
- ------------------------------------------------------------------------------------------------------------------------------
Off-balance sheet instruments:
Standby letters of credit $ 0 $ 0 $ 0 $ 0
Commitments to extend credit 0 0 0 0
==============================================================================================================================
55
Notes to Consolidated Financial Statements
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
- -----------------------------------------------------------------------------------------------------------------------------
2003
Interest income $12,798 $10,839 $11,127 $10,778
Interest expense 2,857 2,689 2,932 3,174
Net interest income 9,941 8,150 8,195 7,604
Provision for loan losses 495 350 525 325
Gains on sales of investment securities 592 288 0 0
Provision for federal income taxes 813 710 801 794
Net income 1,725 1,526 1,658 1,648
Net income per share:
Basic $ 0.75 $ 0.67 $ 0.73 $ 0.73
Diluted 0.69 0.62 0.68 0.68
- -----------------------------------------------------------------------------------------------------------------------------
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
Gains on sales of investment securities 0 0 0 0
Provision for federal income taxes 799 741 682 649
Net income 1,570 1,467 1,347 1,290
Net income per share:
Basic $ 0.70 $ 0.65 $ 0.62 $ 0.61
Diluted 0.65 0.60 0.55 0.54
- -----------------------------------------------------------------------------------------------------------------------------
56
Notes to Consolidated Financial Statements
22. Condensed Financial Statements of Parent Company
Balance Sheets
December 31, December 31,
(in thousands) 2003 2002
- ----------------------------------------------------------------------------------------------------
ASSETS
Cash $ 518 $ 252
Investment in subsidiaries:
Banking subsidiary 62,256 55,534
Non-banking subsidiaries 600 600
Other assets 107 128
- ----------------------------------------------------------------------------------------------------
Total Assets $63,481 $56,514
- ----------------------------------------------------------------------------------------------------
LIABILITIES
Long-term debt $13,000 $13,000
Other liabilities 757 702
- ----------------------------------------------------------------------------------------------------
Total liabilities 13,757 13,702
====================================================================================================
STOCKHOLDERS' EQUITY
Preferred stock 400 400
Common stock 2,292 2,117
Surplus 38,725 31,909
Retained earnings 7,758 6,866
Accumulated other comprehensive loss 549 1,520
- ----------------------------------------------------------------------------------------------------
Total stockholders' equity 49,724 42,812
- ----------------------------------------------------------------------------------------------------
Total Liabilities & Stockholders' Equity $63,481 $56,514
====================================================================================================
Statements of Income
Year Ended December 31,
(in thousands) 2003 2002 2001
- --------------------------------------------------------------------------------------------------------------------------
Income:
Dividends from bank subsidiary $1,396 $1,226 $ 794
Interest income 62 62 32
- --------------------------------------------------------------------------------------------------------------------------
1,458 1,288 826
- --------------------------------------------------------------------------------------------------------------------------
Expenses:
Interest expense 1,418 1,416 793
Other 349 258 213
- --------------------------------------------------------------------------------------------------------------------------
1,767 1,674 1,006
- --------------------------------------------------------------------------------------------------------------------------
Income (loss) before income (taxes) benefit and equity
in undistributed net income of subsidiaries (309) (386) (180)
Income (taxes) benefit 580 548 331
- --------------------------------------------------------------------------------------------------------------------------
271 162 151
Equity in undistributed net income of bank subsidiary 6,286 5,512 4,297
- --------------------------------------------------------------------------------------------------------------------------
Net income $6,557 $5,674 $4,448
==========================================================================================================================
57
Notes to Consolidated Financial Statements
Statements of Cash Flows
Year Ended December 31,
(in thousands) 2003 2002 2001
- -------------------------------------------------------------------------------------------------------------------------
Operating Activities:
Net Income $6,557 $5,674 $4,448
Adjustments to reconcile net income to
net cash provided by operating activities:
Amortization of financing costs 6 6 10
Increase in other liabilities 55 30 385
Equity in undistributed net income of bank subsidiary (6,286) (5,512) (4,297)
- -------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 332 198 546
- -------------------------------------------------------------------------------------------------------------------------
Investing Activities:
Investment in bank subsidiary (1,210) (2,610) (8,786)
Investment in nonbank subsidiaries 0 0 (400)
- -------------------------------------------------------------------------------------------------------------------------
Net cash (used) by investing activities (1,210) (2,610) (9,186)
- -------------------------------------------------------------------------------------------------------------------------
Financing Activities:
Proceeds from common stock options exercised 556 1,738 217
Proceeds from issuance of long term debt 0 0 8,000
Proceeds from issuance of common stock under
stock purchase plan 677 868 698
Costs of issuing long term debt 0 0 (53)
Cash dividends on preferred stock and
cash in lieu of fractional shares (89) (90) (86)
- -------------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 1,144 2,516 8,776
- -------------------------------------------------------------------------------------------------------------------------
Increase in cash and cash equivalents 266 104 136
Cash and cash equivalents at beginning of the year 252 148 12
- -------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 518 $ 252 $ 148
=========================================================================================================================
58
Independent Auditors 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, 2003 and 2002,
and the related consolidated statements of income, stockholders' equity and cash
flows for each of the three years in the period ended December 31, 2003. 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, 2003 and 2002,
and the results of their operations and their cash flows for each of the three
years in the period ended December 31, 2003 in conformity with accounting
principles generally accepted in the United States of America.
/s/ Beard Miller Company LLP
Harrisburg, Pennsylvania
January 30, 2004
59