Exhibit 13
----------
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 our consolidated balance sheets and
statements of income. This section should be read in conjunction with our
consolidated financial statements and accompanying notes.
Executive Summary
- -----------------
Our competitive strategy utilizes a retail model, which is built on the
gathering and retention of low cost core deposits. Management believes deposit
growth continues to be the primary driver of our success and that service and a
superior retail experience, not interest rates, drives deposit growth. The
consistent growth of low cost, long-term deposit relationships allows us to
focus our investments on less risky loans and securities. In addition, our
significant cash flow allows us ongoing reinvestment opportunities as interest
rates change.
Total deposits increased $254.0 million from $906.5 million at December 31, 2003
to $1.16 billion at December 31, 2004. The growth in total deposits was due to a
combination of growth from five new stores opened in the second half of 2003 and
also from same store deposit growth of 28%. We measure same store deposit growth
as the annual percentage increase in core deposits for store offices open two
years or more. As of December 31, 2004, 16 of our 24 stores had been open for
two years or more. Our core deposits include all deposits except for public fund
time deposits.
During 2004 our total net loans (including loans held for sale) increased by
$173.7 million from $479.1 million as of December 31, 2003 to $652.8 million at
December 31, 2004. This growth was represented across all loan categories,
reflecting a continuing commitment to the credit needs of our market areas. We
have taken great strides over the past 24 months to strengthen the structure and
depth of our lending function and we believe that the growth in total loans is a
result of these efforts. In recent years, there has been significant
consolidation in financial institutions in our market areas. We believe this
consolidation has caused dislocation, and therefore has provided us with the
opportunity to gain customers and hire experienced local banking professionals.
Our loan to deposit ratio, which includes loans held for sale, at December 31,
2004 was 56.9%, as compared to 53.5% as of December 31, 2003.
During 2004 our total assets grew by $225.4 million from $1.05 billion at
December 31, 2003 to $1.28 billion as of December 31, 2004. During this same
time period, interest earning assets (primarily loans and investments) increased
by $229.5 million from $972.8 million to $1.20 billion. The growth in earning
assets was funded by the previously mentioned deposit growth of $254.0 million.
Net interest income grew by $12.7 million, or 37%, compared to 2003 almost
entirely due to the increased volume in interest earning assets. Total revenues
(net interest income plus noninterest income) increased by $14.0 million, or
32%, in 2004 compared to 2003 and net income increased by 31% from $6.6 million
to $8.6 million. Diluted net income per share increased by 22%, from $1.34 to
$1.63.
The 22% increase in diluted net income per share includes the impact of an
additional 200,000 (adjusted for the two-for-one stock split) shares issued in
September 2004 in connection with a private placement offering as well as an
additional 920,000 shares (adjusted for the two-for-one stock split) resulting
from our common stock offering during November 2004.
Per share data and other appropriate share information for all periods presented
have been restated for the two-for-one stock split in the form of a 100% stock
dividend paid on February 25, 2005.
The financial highlights for 2004 compared to 2003 are summarized below.
December 31, %
2004 2003 Change
---- ---- ------
(dollars in millions)
Total Assets $1,277.4 $ 1,052.0 21%
Total Loans (Net) 638.5 469.9 36%
Total Deposits 1,160.5 906.5 28%
December 31, %
2004 2003 Change
---- ---- ------
(dollars in millions except per share data)
Total Revenues $ 57.9 $ 43.9 32%
Net Income 8.6 6.6 31%
Net Income Per Share 1.63 1.34 22%
We expect that we will continue our pattern of expanding our footprint by
branching into contiguous areas of our existing market, and by filling gaps
between existing store locations. We are targeting to open approximately four to
six new stores in each of the next five years. We opened our second store in
Lebanon county in October, giving us a total of 24 full-service stores as of
December 31, 2004. In addition, to accommodate our growth we plan to construct a
new headquarters, operations and training center in Harrisburg, which we expect
to open in late 2005. As a result of our targeted growth, we expect that
expenses related to salaries, employee benefits, occupancy, furniture and
equipment, and advertising will increase in subsequent periods. Our long-range
plan targets a
24
Management's Discussion and Analysis
of Financial Condition and Results of Operations
total of 57 store offices by the end of 2010. We believe that the demographics
of the south central Pennsylvania market should provide significant
opportunities for us to continue to grow both deposit and lending relationships.
Application of Critical Accounting Policies
- -------------------------------------------
Our accounting policies are fundamental to understanding Management's Discussion
and Analysis of Financial Condition and Results of Operations. Our accounting
policies are more fully described in Note 1 of the Notes to Consolidated
Financial Statements for December 31, 2004 included herein. Our consolidated
financial statements are prepared in conformity with accounting principles
generally accepted in the United States of America. These principles require our
management to make estimates and assumptions about future events that affect the
amounts reported in our consolidated financial statements and accompanying
notes. Since future events and their effects cannot be determined with absolute
certainty, actual results may differ from those estimates. Management makes
adjustments to its assumptions and estimates when facts and circumstances
dictate. We evaluate our estimates and assumptions on an ongoing basis and
predicate those estimates and assumptions on historical experience and on
various other factors that are believed to be reasonable under the
circumstances. Management believes the following critical accounting policies
encompass the more significant assumptions and estimates used in preparation of
our consolidated financial statements.
Allowance for Loan Losses. The allowance for loan losses represents the amount
available for estimated probable losses existing in our lending portfolio. While
the allowance for loan losses is maintained at a level believed to be adequate
by management for estimated losses in the loan portfolio, the determination of
the allowance is inherently subjective, as it involves significant estimates by
management, all of which may be susceptible to significant change.
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
estimates and assumptions used in making the evaluations. The use of different
assumptions could materially impact the level of the allowance for loan losses
and, therefore, the provision for loan losses to be charged against earnings.
Such changes could impact future results.
We perform periodic, systematic reviews of our loan portfolio to identify
inherent losses and assess the overall probability of collection. These reviews
include an analysis of historical default and loss experience, which results in
the identification and quantification of loss factors. These loss factors are
used in determining the appropriate level of allowance to cover the estimated
probable losses existing in each lending category. Management judgment involving
the estimates of loss factors can be impacted by many variables, such as the
number of years of actual default and loss history included in the evaluation
and the volatility of forecasted net credit losses.
The methodology used to determine the appropriate level of the allowance for
loan losses and related provisions differs for commercial and consumer loans,
and involves other overall evaluations. In addition, significant estimates are
involved in the determination of the appropriate level of allowance related to
impaired loans. The portion of the allowance related to impaired loans is based
on discounted cash flows using the loan's effective interest rate, or the fair
value of the collateral for collateral-dependent loans, or the observable market
price of the impaired loan. Each of these variables involves judgment and the
use of estimates. For instance, discounted cash flows are based on estimates of
the amount and timing of expected future cash flows.
In addition to periodic estimation and testing of loss factors, we periodically
evaluate 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. Management judgment is involved at many levels of these
evaluations.
An integral aspect of our risk management process is allocating the allowance
for loan losses to various components of the lending portfolio based upon an
analysis of risk characteristics, demonstrated losses, industry and other
segmentations, and other more judgmental factors, such as recent loss
experience, industry concentrations, and the impact of current economic
conditions on historical or forecasted net credit losses.
Stock-Based Compensation. As permitted by FASB Statement No. 123, "Accounting
for Stock-Based Compensation." (FAS 123), we account for stock-based
compensation in accordance with Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees," (APB 25). As permitted under APB 25,
we do not currently recognize compensation expense in the
25
Management's Discussion and Analysis
of Financial Condition and Results of Operations
income statement related to any stock options granted under our 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 for December 31, 2004, included herein.
In December 2004, the Financial Accounting Standards Board (FASB) issued
Statement No. 123(R), "Share-Based Payment," (FAS 123R). FAS 123(R) revised FAS
123 and supersedes APB 25, and its related implementation guidance. FAS 123(R)
will require all compensation costs related to share-based payments to be
recognized in the income statement (with limited exceptions) based on their fair
values and no longer allows pro forma disclosure as an alternative to reflecting
the impact of share-based payments on net income and net income per share. The
amount of compensation cost will be measured based on the grant-date fair value
of the stock-based compensation issued. Compensation cost will be recognized
over the period that an employee provides service in exchange for the award.
This statement is effective as of the beginning of the first interim or annual
reporting period that begins after June 15, 2005 and permits public companies to
adopt its requirement using one of two methods: modified prospective or modified
retrospective. The Company plans to adopt FAS 123(R) on July 1, 2005, but has
yet to decide on a method of adoption.
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, 2004, 2003 and 2002 and presents the
daily average interest rates earned on assets and the daily average interest
rates paid on liabilities for such periods. During 2004, average
interest-earning assets were $1.09 billion, an increase of $281.7 million, or
35%, over 2003. This was the result of an increase in the average balance of
investment securities of $137.1 million, an increase in the average balance of
loans receivable of $161.7 million, offset by a decrease in the average balance
of federal funds sold of $17.0 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 $212.8
million.
The yield on total interest-earning assets decreased by 4 basis points in 2004
from 5.64% to 5.60%. The decrease was due to the overall low interest rate
environment during the first half of 2004.
The aggregate cost of interest-bearing liabilities decreased 14 basis points
from 1.69% in 2003 to 1.55% in 2004. The average rate paid on savings deposits
decreased by 1 basis point, from 1.02% in 2003 to 1.01% in 2004. The average
rate paid on interest checking accounts increased from 0.70% in 2003 to 0.85% in
2004 as did the average rate paid on money market accounts, which moved from
0.91% in 2003 to 1.25% in 2004. Our money market deposits include public fund
interest checking accounts that are swept into overnight money market accounts.
The interest rate paid on these balances is usually tied to the 90-day treasury
bill, which increased from 0.91% at December 31, 2003 to 2.22% at December 31,
2004. For time deposits, the average rate paid was 2.44%, down 100 basis points
from 2003 and public funds time deposits experienced a decrease of 19 basis
points in 2004 on the average rate paid. The majority of our public funds are
deposits of local school districts and municipalities.
Our aggregate cost of funding sources decreased 12 basis points in 2004 to 1.32%
from 1.44% in 2003. This decrease resulted primarily from lower average rates
paid on total interest bearing deposits as well as a $37.6 million increase in
average noninterest-bearing demand deposits. In Table 1, 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. Yields on tax-exempt securities and loans are
not computed on a taxable equivalent basis.
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 2004 increased $12.7 million, or 37%, over 2003 to $46.6
million. Interest income on earning assets totaled $61.0 million, an increase of
$15.4 million, or 34%, over 2003. The majority of this increase was related to
volume increases in the securities and loans receivable portfolio partially
offset by lower interest rates on interest earning assets. Interest expense for
2004
26
Management's Discussion and Analysis
of Financial Condition and Results of Operations
TABLE 1
- ------------------------------------------------------------------------------------------------------------------------------------
Years Ended December 31,
(dollars in thousands) 2004 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Average Average Average Average Average Average
Earning Assets Balance Interest Rate Balance Interest Rate Balance Interest Rate
- ------------------------------------------------------------------------------------------------------------------------------------
Securities:
Taxable $ 498,016 $24,789 4.98% $361,323 $17,108 4.73% $246,230 $14,514 5.89%
Tax-exempt 6,838 401 5.86 6,444 453 7.03 1,995 107 5.36
- ------------------------------------------------------------------------------------------------------------------------------------
Total securities 504,854 25,190 4.99 367,767 17,561 4.78 248,225 14,621 5.89
Federal funds sold 3,638 67 1.84 20,653 220 1.07 31,833 508 1.59
Loans receivable:
Mortgage and construction 337,257 21,777 6.46 263,581 18,290 6.94 241,647 18,408 7.62
Commercial loans
and lines of credit 144,127 8,534 5.92 95,469 5,937 6.22 83,971 5,670 6.75
Consumer 93,166 5,122 5.50 54,840 3,318 6.05 35,851 2,677 7.47
Tax-exempt 6,095 292 4.80 5,093 216 4.25 3,598 111 3.09
- ------------------------------------------------------------------------------------------------------------------------------------
Total loans receivable 580,645 35,725 6.15 418,983 27,761 6.63 365,067 26,866 7.36
- ------------------------------------------------------------------------------------------------------------------------------------
Total earning assets $1,089,137 $60,982 5.60% $807,403 $45,542 5.64% $645,125 $41,995 6.51%
- ------------------------------------------------------------------------------------------------------------------------------------
Sources of Funds
Interest-bearing deposits:
Regular savings $276,862 $ 2,804 1.01% $234,431 $ 2,381 1.02% $196,208 $ 3,852 1.96%
Interest checking 19,464 166 0.85 14,760 103 0.70 10,590 125 1.18
Money market 327,748 4,098 1.25 230,504 2,104 0.91 145,851 1,923 1.32
Time deposits 164,765 4,024 2.44 133,196 4,584 3.44 119,916 5,600 4.67
Public funds time 45,855 817 1.78 46,562 917 1.97 54,165 1,440 2.66
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing deposits 834,694 11,909 1.43 659,453 10,089 1.53 526,730 12,940 2.46
Short-term borrowings 79,049 1,070 1.35 16,964 207 1.22 12 0 1.46
Long-term debt 13,600 1,418 10.43 13,000 1,356 10.43 13,000 1,354 10.41
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 927,343 14,397 1.55 689,417 11,652 1.69 539,742 14,294 2.65
Noninterest-bearing funds (net) 161,794 117,986 105,383
- ------------------------------------------------------------------------------------------------------------------------------------
Total sources to fund
earning assets $1,089,137 14,397 1.32 $807,403 11,652 1.44 $645,125 14,294 2.22
- ------------------------------------------------------------------------------------------------------------------------------------
Net interest income and margin $46,585 4.28% $33,890 4.20% $27,701 4.29%
- ------------------------------------------------------------------------------------------------------------------------------------
Other Balances
Cash & due from banks $ 35,285 $ 28,390 $ 23,022
Other assets 47,161 45,369 27,190
Total assets 1,171,583 881,162 695,337
Noninterest-bearing
demand deposits 180,355 142,805 114,758
Other liabilities 5,750 2,983 2,657
Stockholders' equity 58,135 45,957 38,180
- ------------------------------------------------------------------------------------------------------------------------------------
increased $2.7 million, or 24%, from $11.7 million in 2003 to $14.4 million in
2004. This increase was primarily related to the increases in our average level
of deposits and other borrowed money partially offset by a reduction in interest
rates paid on the deposit balances.
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. Our net
interest rate spread increased to 4.05% in 2004 from 3.95% in 2003 and the net
interest margin increased 8 basis points from 4.20% to 4.28%.
27
Management's Discussion and Analysis
of Financial Condition and Results of Operations
In late June 2004, the Federal Reserve Board began a measured reversal of their
accommodative stance on monetary policy that had been in place over the past
three years. The targeted federal funds rate, which was 1.00% for the first six
months of 2004, increased by 125 basis points during the third and fourth
quarters of 2004 to end the year at 2.50%. As a result, our cost of funds
increased during the third and fourth quarters compared to the first half of the
year. The increase in short-term interest rates, while significant in direction,
had very little impact on long-term interest rates and, as a result, we did not
experience a similar increase in the yields on our interest earning assets. For
2005, we expect our continuing ability to grow core deposit balances will
produce growth in overall net interest income, despite the flattening yield
curve. However, we would not expect to see expansion in the net interest margin
until long-term interest rates increase and/or the yield curve steepens.
Table 2 below 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 us on such assets and liabilities. For purposes of this
table, nonaccrual loans have been included in the average loan balances.
TABLE 2
- ------------------------------------------------------------------------------------------------------------------------------------
2004 v. 2003 2003 v. 2002
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 $ 6,814 $ 867 $ 7,681 $5,426 $(2,832) $2,594
Tax-exempt 23 (75) (52) 313 33 346
Federal funds sold (312) 159 (153) (122) (166) (288)
Interest on loans receivable:
Mortgage and construction 4,752 (1,265) 3,487 1,525 (1,643) (118)
Commercial 2,883 (286) 2,597 712 (445) 267
Consumer 2,106 (302) 1,804 1,150 (509) 641
Tax-exempt 48 28 76 63 42 105
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest income 16,314 (874) 15,440 9,067 (5,520) 3,547
- ------------------------------------------------------------------------------------------------------------------------------------
Interest on deposits:
Regular savings 446 (23) 423 373 (1,844) (1,471)
Interest checking 41 22 63 29 (51) (22)
Money market 1,210 784 1,994 779 (598) 181
Time deposits 772 (1,332) (560) 459 (1,475) (1,016)
Public funds (12) (88) (100) (149) (374) (523)
Short-term borrowings 841 22 863 207 0 207
Long-term debt 62 0 62 0 2 2
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest expense 3,360 (615) 2,745 1,698 (4,340) (2,642)
- ------------------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) $12,954 $ (259) $12,695 $7,369 $(1,180) $6,189
- ------------------------------------------------------------------------------------------------------------------------------------
(1)Changes due to both volume and rate have been allocated to volume changes.
Provision for Loan Losses
We recorded provisions of $2.6 million to the allowance for loan losses for 2004
as compared to $1.7 million in 2003. Management undertakes a rigorous and
consistently applied process in order to evaluate the allowance for loan losses
and to determine the level of provision for loan losses. Net charge-offs during
2004 were only $806,000, or 0.14% of average loans outstanding as compared to
$834,000, or 0.20% of average loans in 2003. See the section in this
Management's Discussion and Analysis on the allowance for loan losses as well as
Note 1 in the Notes to Consolidated Financial Statements for December 31, 2004
included herein for further discussion regarding our methodology for determining
the provision for loan losses.
Noninterest Income
Noninterest income for 2004 increased by $1.3 million, or 13%, over 2003 to
$11.3 million. The increase was primarily due to increased 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 $630,000 in 2004 and $765,000 in 2003 on the sale of
28
Management's Discussion and Analysis
of Financial Condition and Results of Operations
residential and student loans. Also included in noninterest income were
securities gains of $0 for 2004 and $880,000 for 2003. Excluding securities
gains in 2003, our noninterest income increased by $2.2 million, or 24%, in 2004
over 2003.
Noninterest Expenses
Noninterest expenses totaled $42.5 million for 2004, an increase of $10.0
million, or 31%, over 2003. Staffing levels, occupancy, furniture and equipment,
and related expenses increased as a result of opening one full service store in
2004 and five full service stores during the second half of 2003. A comparison
of noninterest expense for certain categories for 2004 and 2003 is presented
below.
Salary expenses and employee benefits, which represent the largest component of
noninterest expenses, increased by $5.1 million, or 31%, in 2004 over 2003. The
increased level of these expenses includes the impact of salary and benefit
costs associated with the additional staff for the stores opened in 2003 and
2004, as well as additional lending and support staff to facilitate our growth.
Occupancy expenses totaled $4.4 million in 2004, an increase of $955,000, or
28%, over 2003 while furniture and equipment expenses increased by $659,000, or
36%, to $2.5 million. The full year impact of the five stores opened in 2003
along with the additional store opened in 2004 contributed to the increases in
occupancy and furniture and equipment expenses in 2004 over 2003.
Advertising and marketing expenses were $3.1 million for 2004, an increase of
$683,000, or 28%, over 2003. The increase was primarily the result of increased
advertising efforts in each of the our markets. Our markets include Berks,
Lebanon, Dauphin, Cumberland, and York Counties of South Central Pennsylvania.
Data processing expenses increased by $774,000, or 36%, in 2004 over 2003. 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 $1.1 million were $155,000, or 16%, higher than
the prior year. The increase was attributed to the growth in the number of
account statements mailed to customers.
Other noninterest expenses totaled $6.6 million for 2004, compared to $5.0
million for 2003. This includes increased telephone and data line expenses of
$132,000, increased loan expenses of $571,000, an increase in the provision for
losses and other differences of $240,000 and increased regulatory, audit and
investor relations expenses of $190,000.
Our current strategic plan calls for the construction of four new stores in
2005. In addition, we are currently constructing a new headquarters, operations
and training center in Harrisburg, which we plan to open in late 2005. The costs
associated with these planned facilities will continue to result in higher
levels of staff, occupancy, furniture, equipment, and related expenses in 2005
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 less
noninterest income (exclusive of gain on sales of investment securities). This
ratio equaled 2.66% for 2004, compared to 2.67% for 2003. Another productivity
measure is the operating efficiency ratio. This ratio expresses the relationship
of noninterest expenses to net interest income plus noninterest income
(excluding gain on sales of investment securities). For 2004, the operating
efficiency ratio was 73.4% compared to 75.6% for 2003. Our operating efficiency
ratio remains above our peer group primarily due to our aggressive growth
expansion activities.
Provision for Federal Income Taxes
The provision for federal income taxes was $4.2 million for 2004, compared to
$3.1 million for 2003. The effective tax rate, which is the ratio of income tax
expense to income before taxes, was 32.7% in 2004 and 32.2% in 2003. See Note 11
of the Notes to Consolidated Financial Statements for December 31, 2004 included
herein for an additional analysis of our provision for income taxes for 2004 and
2003.
In accordance with Statement of Financial Accounting Standard No. 109 (FAS 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, 2004, deferred tax assets amounted to $2.8 million and deferred
tax liabilities amounted to $2.7 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.
29
Management's Discussion and Analysis
of Financial Condition and Results of Operations
Net Income and Net Income Per Share
Net income for 2004 rose to a record $8.6 million, an increase of $2.0 million,
or 31%, over the $6.6 million recorded in 2003. This increase was due to an
increase in net interest income of $12.7 million, an increase in noninterest
income of $1.3 million, partially offset by an increase in the provision for
loan losses of $951,000, an increase in noninterest expenses of $10.0 million
and an increase of $1.1 million in the provision for income taxes.
Basic earnings per common share, after adjusting for a two-for-one stock split
declared in January 2005, were $1.75 for 2004, compared to $1.44 in 2003.
Diluted earnings per common share increased 22% to $1.63 for 2004 compared to
$1.34 for 2003 after adjusting for the two-for-one stock split. Earnings per
share figures for 2004 include the impact of an additional 920,000 shares
(adjusted for the two-for-one stock split) issued during the fourth quarter
through our public stock offering as well as an additional 200,000 shares
(adjusted for the two-for-one stock split) issued at the end of the third
quarter through a private placement of common stock. See Note 13 in the Notes to
Consolidated Financial Statements for December 31, 2004 included herein for an
analysis of earnings per share.
Return on Average Assets and Average Equity
Return on average assets, referred to as "ROA," measures our net income in
relation to our total average assets. Our ROA was 0.73% for 2004 and 0.74% for
2003. ROA has remained somewhat below the peer group level as a result of our
significant expenses incurred over the past two and a half years, during which
time we increased our number of stores from 15 to 24.
Return on average equity, referred to as "ROE," indicates how effectively we can
generate net income on the capital invested by our shareholders. ROE is
calculated by dividing net income by average stockholders' equity. ROE for 2004
was 14.78%, compared to 14.27% for 2003. We expect ROE to be slightly impacted
in 2005 due to the volume of additional equity capital raised during the fourth
quarter of 2004 through the previously mentioned private placement and stock
offering.
Results of Operations
- ---------------------
2003 versus 2002
Net income for 2003 rose to $6.6 million, an increase of $883,000, or 16%, over
the $5.7 million recorded in 2002.
Diluted earnings per common share increased by 14% to $1.34 for 2003 over $1.18
for 2002 after adjusting for the 5% common stock dividend declared in January
2004 and the 2-for-1 stock split declared in January 2005.
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. Interest expense for 2003 decreased by $2.6
million, or 18%, from $14.3 million to $11.7 million.
Our 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%.
Noninterest income for 2003 increased by $2.3 million, or 30%, over 2002 to
$10.0 million. 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.
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 stores
in 2003.
Salary expenses and employee benefits 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.
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.
Advertising and marketing expenses were $2.4 million for 2003, an increase of
$244,000, or 11%, over 2002. Data processing expenses increased by $258,000, or
14%, in 2003 over 2002. Postage and supplies expenses of $986,000 were $124,000,
or 14%, higher than the prior year.
Other noninterest expenses totaled $5.0 million for 2003, compared to $4.1
million for 2002.
Financial Condition
- -------------------
Securities
Securities are purchased and sold as part of our overall asset and liability
management strategy. 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
30
Management's Discussion and Analysis
of Financial Condition and Results of Operations
available for sale and are carried at fair value. Decisions by management to
purchase or sell these securities are based on an assessment of financial and
economic conditions, including changes in prepayment risks and interest rates,
liquidity needs, capital adequacy, collateral requirements for pledging,
alternative asset and liability management strategies, tax considerations, and
regulatory requirements.
Securities are classified as held to maturity if, at the time of purchase,
management has both the intent and ability to hold the securities until
maturity. Securities held to maturity are carried at amortized cost. Sales of
securities in this portfolio should only occur in unusual and rare situations
where significant unforeseeable changes in circumstances may cause a change in
intent. Examples of such instances would include deterioration in the issuer's
creditworthiness that is evidently supportable and significant or a change in
tax law that eliminates or reduces the tax-exempt status of interest (but not
the revision of marginal tax rates applicable to interest income). Held to
maturity securities cannot be sold based upon any of the decisions used to sell
securities available for sale as listed above. See Note 3 in the Notes to
Consolidated Financial Statements for December 31, 2004 included herein for
further analysis of our securities portfolio.
Our 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. We amortize premiums and accrete 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 our securities yields.
At December 31, 2004, the weighted average life and duration of our securities
portfolio was approximately 5.1 and 4.2 years, respectively, as compared to 6.6
years and 4.8 years, respectively, at December 31, 2003. 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 amounts,
causing a shorter weighted average life of the security. Our securities
portfolio contained no "high-risk" securities or derivatives as of December 31,
2004 or 2003.
Securities available for sale increased by $38.7 million in 2004 (excluding the
effect of changes in unrealized gains or losses) primarily as a result of
purchases of $154.1 million, offset by principal repayments and maturities of
$113.4 million. The securities available for sale portfolio is comprised of U.S.
Government Agency securities, mortgage-backed securities, AAA Whole Loan CMO
securities, and corporate debt securities. At December 31, 2004, the unrealized
loss on securities available for sale included in stockholders' equity totaled
$51,000, net of tax, compared to unrealized gains of $549,000, net of tax, at
December 31, 2003.
During 2004, securities held to maturity increased by $10.1 million primarily as
a result of purchases of $46.9 million offset by principal repayments of $37.0
million. The securities held in this portfolio include U.S. Government Agency
securities, tax-exempt municipal bonds, AAA Whole Loan CMO securities, corporate
debt securities and mortgage-backed securities.
The contractual maturity distribution and weighted average yield of our
available for sale and held to maturity portfolios at December 31, 2004 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.
31
Management's Discussion and Analysis
of Financial Condition and Results of Operations
TABLE 3
- ------------------------------------------------------------------------------------------------------------------------------------
December 31, 2004 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% $ 5,000 5.00% $ 10,000 4.52%
Mortgage-backed obligations $2,026 4.09% 12,937 4.11 287,170 4.92 302,133 4.88
Corporate debt securities 2,009 7.81 2,009 7.81
- ------------------------------------------------------------------------------------------------------------------------------------
Total available for sale $ 0 -- $2,026 4.09% $17,937 4.09% $294,179 4.94% $314,142 4.89%
- ------------------------------------------------------------------------------------------------------------------------------------
Held to Maturity:
U.S. Government
Agency obligations $31,980 4.81% $ 39,001 5.83% $ 70,981 5.37%
Municipal obligations 6,827 5.84 6,827 5.84
Mortgage-backed obligations $ 44 4.51% $1,135 5.61% 161 6.22 113,623 5.11 114,963 5.11
Corporate debt securities 101 0.81 6,513 6.50 1,975 6.69 8,557 7.55 17,146 7.01
- ------------------------------------------------------------------------------------------------------------------------------------
Total held to maturity $ 145 1.93% $7,648 6.37% $34,116 4.93% $168,008 5.43% $209,917 5.38%
- ------------------------------------------------------------------------------------------------------------------------------------
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.
Loan Portfolio
- --------------
We manage risks associated with our loan portfolio through diversification, with
what we believe are sound underwriting policies and procedures that are reviewed
and updated on at least an annual basis, and ongoing loan monitoring efforts.
Additionally, we monitor concentrations of loans or loan relationships by
industry and set target percentages for each industry. At December 31, 2004,
there was no concentration greater than 10% of our loan portfolio to any one
industry.
Our commercial mortgage and construction and land development loans are
typically made to small and medium-sized investors, builders and developers and
are secured by mortgages on real property located principally in south central
Pennsylvania (principally office buildings, multifamily residential, land
development and other commercial properties). The average loan size in this
category is approximately $350,000. Our underwriting policy has established
maximum terms for commercial mortgage and construction loans depending on the
type of loan within the commercial real estate category. A five-year call option
is standard on commercial mortgages. Our underwriting policy generally requires
a loan-to-value ratio of no more than 80% on loans in this category and
typically requires owner guarantees and other collateral depending on our total
risk assessment of the transaction.
Our commercial, industrial and other business loans and lines of credit are
typically made to small and medium-sized businesses. The average loan size in
this category is approximately $200,000. Based on our underwriting standards,
loans may be secured in whole or in part by collateral such as liquid assets,
accounts receivable, equipment, inventory, and real property. Additionally, our
underwriting policy has established maximum terms for these loans depending on
the loan type within the commercial, industrial and other business loans and
lines category. The value of the collateral in this category may vary depending
on market conditions. The Bank maintains advance rates for particular collateral
categories to mitigate the risk that the borrower defaults and the value of the
collateral is not sufficient to cover the outstanding loan balance. We also
actively manage the unused portion of commercial lines of credit and would
freeze a commitment if a borrower were in default. As of December 31, 2004,
outstandings under commercial lines of credit were $74.6 million and unused
commitments were $107.5 million.
Residential real estate mortgage loans represented approximately 12% of our
total loans at December 31, 2004. Loans in this category are collateralized by
first mortgages on residential properties located in south central Pennsylvania.
Our underwritten policy provides that all residual loans are to be written based
upon standards used by the secondary market.
Consumer loans and consumer lines of credit represented approximately 17% of our
total loans at December 31, 2004. These loans and lines are secured by first and
second mortgages, personal assets of the borrower, or may be unsecured. As of
December 31, 2004, 66% of consumer loans and consumer lines of credit were
secured by second liens. When originating consumer loans, our underwriting
policy sets limitations on the term of the loan, defines allowable collateral
and the valuation of the collateral, outlines acceptable debt to income ratios
and outlines acceptable credit scores to identify those
32
Management's Discussion and Analysis
of Financial Condition and Results of Operations
loan applicants with a proven record of credit management. We actively manage
the unused portion of our consumer lines of credit and would freeze a commitment
if a borrower becomes delinquent. As of December 31, 2004, unused commitments
under consumer lines of credit were $35.6 million.
Table 4 summarizes the composition of our loan portfolio by type as of December
31, for each of the years 2000 through 2004.
TABLE 4
- ------------------------------------------------------------------------------------------------------------------------------------
December 31,
(in thousands) 2004 2003 2002 2001 2000
- ------------------------------------------------------------------------------------------------------------------------------------
Commercial mortgage $239,576 $194,609 $144,959 $142,969 $127,931
Construction and land development 39,467 26,895 31,034 32,863 30,776
Residential real estate mortgage loans 79,672 72,713 66,190 48,415 41,314
Tax-exempt loans 6,303 5,720 5,629 2,676 2,786
Commercial, industrial and other business loans 97,198 58,894 49,226 42,399 31,490
Consumer loans 109,568 71,007 34,598 36,551 30,691
Lines of credit 74,559 46,106 37,245 36,801 25,264
- ------------------------------------------------------------------------------------------------------------------------------------
Total loans $646,343 $475,944 $368,881 $342,674 $290,252
- ------------------------------------------------------------------------------------------------------------------------------------
During 2004, total gross loans increased by $175.5 million from $485.1 million
at December 31, 2003, to $660.6 million at December 31, 2004, which includes
$14.3 million of loans held for sale on December 31, 2004 and $9.2 million of
loans held for sale on December 31, 2003. The loans held for sale represent
student loans and certain residential loans our management intends to sell and
reinvest in higher yielding loans and securities. The increase in loans
receivable in 2004 was represented across all loan categories.
During 2004, commercial mortgage loans increased by $45 million, or 23%, and
commercial, industrial and other business loans increased by $38.3 million, or
65%. The addition to our staff of experienced lenders with long-term ties to the
business communities in our markets has enhanced our lending profile and, as a
result, our access to commercial lending opportunities.
Total consumer loans increased by $38.6 million in 2004 to $109.6 million at
year-end 2004 compared to $71.0 million at year-end 2003. This increase of 54%
was a direct result of a focused effort by management to increase the size of
the consumer loan portfolio across all markets of our store footprint. Lines of
credit experienced strong growth in 2004, as well, increasing by $28.5 million,
or 62%, from $46.1 million to $74.6 million.
Total loans outstanding represented 56% of total deposits and 51% of total
assets at December 31, 2004, excluding the loans held for sale, compared to 53%
and 45%, respectively, at December 31, 2003.
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, 2004, are presented in the following table.
TABLE 5
- ------------------------------------------------------------------------------------------------------------------------------------
December 31, 2004
- ------------------------------------------------------------------------------------------------------------------------------------
Due Within Due 1-5 Due Over
(in thousands) One Year Years Five Years Total
- ------------------------------------------------------------------------------------------------------------------------------------
Real estate:
Commercial mortgage $ 10,318 $ 12,163 $217,095 $239,576
Construction and land development 20,122 11,949 7,396 39,467
Residential mortgage 882 9,829 68,961 79,672
Tax-exempt 582 106 5,615 6,303
- ------------------------------------------------------------------------------------------------------------------------------------
31,904 34,047 299,067 365,018
Commercial 12,113 44,877 40,208 97,198
Consumer 4,026 13,893 91,649 109,568
Lines of credit 58,079 15,330 1,150 74,559
- ------------------------------------------------------------------------------------------------------------------------------------
Total loans $106,122 $108,147 $432,074 $646,343
- ------------------------------------------------------------------------------------------------------------------------------------
Interest rates:
Predetermined $ 50,126 $ 37,400 $272,071 $359,597
Floating 55,996 70,747 160,003 286,746
- ------------------------------------------------------------------------------------------------------------------------------------
Total loans $106,122 $108,147 $432,074 $646,343
- ------------------------------------------------------------------------------------------------------------------------------------
33
Management's Discussion and Analysis
of Financial Condition and Results of Operations
Concentrations of Credit Risk
The largest portion of loans, 37%, on our balance sheet is for commercial
mortgage related loans. Our commercial real estate loan portfolio is principally
to borrowers throughout Cumberland, Dauphin, Lebanon, York and Berks counties of
Pennsylvania where we have full-service store locations. Commercial real estate,
construction, and land development loans aggregated $279.0 million at December
31, 2004, compared to $221.5 million at December 31, 2003. Commercial real
estate loans are collateralized by the related project (principally office
building, multi-family residential, land development, and other properties) and
we generally require 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.
Consumer loans comprised 17%, or $109.5 million, of total loans at December 31,
2004. Approximately $36.7 million of consumer loans are loans collateralized by
personal assets of the borrower with another $72.0 million of consumer loans
secured by real estate.
Commercial loans represented 15% of total loans at December 31, 2004. Collateral
for these types of loans varies depending upon managements' credit evaluations
of the respective borrowers and generally includes the following: business
assets, personal guarantees, and/or personal assets of the borrower.
On a monthly basis, the Bank's credit services personnel prepare two different
loan concentration reports; one using standardized North American Industry
Classification codes and the second report by loan product type. Management
reviews and uses these concentration reports to monitor risks. Quarterly, a Risk
Management Booklet is prepared and reviewed by both management and our board of
directors which identifies areas of risk and quantifies if any exceptions were
made to policies and procedures in the lending area during the preceding
quarter. Management and the board utilize the Risk Management Booklet as a tool
to identify and limit procedure and policy exceptions and to reduce any
unnecessary risk in the lending function.
There is no concentration greater than 10% of our loan portfolio to any one
industry and there is no concentration greater than 2% to any one borrower as of
December 31, 2004.
Non-Performing Loans and Assets
Total non-performing assets (non-performing loans, foreclosed real estate and
loans past due 90 days or more and still accruing interest) at December 31,
2004, were $1.4 million, or 0.11%, of total assets as compared to $1.4 million,
or 0.13%, of total assets at December 31, 2003. Total non-performing loans
(non-accrual loans and restructured loans) at December 31, 2004 were $857,000
compared to $1.2 million a year ago. Total delinquent loans (those loans 30 days
or more delinquent) as a percentage of total loans were 0.29% at December 31,
2004, compared to 0.37% at December 31, 2003. We generally place a loan on
nonaccrual status and cease 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. Loans past due 90 days
and still accruing interest amounted to $0 and $385,000 at December 31, 2004 and
December 31, 2003, respectively.
Foreclosed real estate totaled $507,000 as of December 31, 2004 as compared to
$236,000 as of December 31, 2003. These properties have been written down to the
lower of cost or fair value less disposition costs. We obtain 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.
Table 6 on the following page summarizes information regarding non-performing
loans and non-performing assets as of December 31, 2000 through 2004.
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.
34
Management's Discussion and Analysis
of Financial Condition and Results of Operations
TABLE 6
- ------------------------------------------------------------------------------------------------------------------------------------
December 31,
(dollars in thousands) 2004 2003 2002 2001 2000
- ------------------------------------------------------------------------------------------------------------------------------------
Nonaccrual loans:
Commercial $ 308 $ 143 $ 958 $ 127 $ 300
Consumer 11 68 42 116 162
Real estate: Construction 0 159 0 0 0
Mortgage 267 417 599 633 371
- ------------------------------------------------------------------------------------------------------------------------------------
Total nonaccrual loans 586 787 1,599 876 833
Loans past due 90 days or more and still accruing 0 385 55 0 0
Restructured loans 271 0 0 0 0
- ------------------------------------------------------------------------------------------------------------------------------------
Total non-performing loans 857 1,172 1,654 876 833
Foreclosed real estate 507 236 118 12 42
- ------------------------------------------------------------------------------------------------------------------------------------
Total non-performing assets $1,364 $1,408 $1,772 $ 888 $ 875
- ------------------------------------------------------------------------------------------------------------------------------------
Non-performing loans to total loans 0.13% 0.25% 0.45% 0.26% 0.29%
Non-performing assets to total assets 0.11% 0.13% 0.23% 0.15% 0.18%
- ------------------------------------------------------------------------------------------------------------------------------------
Interest income received on nonaccrual loans $ 30 $ 37 $ 79 $ 33 $ 52
- ------------------------------------------------------------------------------------------------------------------------------------
Interest income that would have been recorded
under the original terms of the loans $ 10 $ 45 $ 193 $ 89 $ 96
- ------------------------------------------------------------------------------------------------------------------------------------
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, a 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 our 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.
More specifically, the methodology we use to assess the adequacy of our
allowance includes:
o Identifying loans for individual review under FASB Statement of
Financial Accounting Standards No. 114, "Accounting by Creditors for
Impairment of a Loan" (Statement 114). In general, the loans identified
for individual review under Statement 114 consist of large balance
commercial loans and commercial mortgages.
o Assessing whether the loans identified for review under Statement 114
are "impaired" based on the probability that all amounts due under the
loan will not be collected according to the contractual terms of the
loan agreement.
o For loans identified as impaired, calculating the estimated fair value
of the loan, using observable market prices, discounted cash flows or
the value of the underlying collateral.
o Classifying all non-impaired, large balance loans based on credit risk
ratings and allocating an allowance for loan losses based on
appropriate factors, including recent loss history for similar loans.
o Identifying other loans for evaluation collectively under the
provisions of Statement of Financial Accounting Standards No. 5
"Accounting for Contingencies" (Statement 5). In general, these other
loans included residential mortgages, consumer loans, and installment
loans.
35
Management's Discussion and Analysis
of Financial Condition and Results of Operations
o Segmenting Statement 5 loans into groups with similar characteristics
and allocating an allowance for loan losses to each segment based on
recent loss history and other relevant information.
o Reviewing the results to determine the appropriate balance of the
allowance for loan losses. This review gives additional consideration
to factors such as the mix of loans in the portfolio, the balance of
the allowance relative to total loans and non-performing assets, trends
in the overall risk profile of the portfolio, trends in delinquencies
and nonaccrual loans and local and national economic conditions.
While the allowance for loan losses is maintained at a level believed to be
adequate by management for estimated losses in the loan portfolio, determination
of the allowance is inherently subjective, as it requires estimates, all of
which may be susceptible to significant change. Changes in these estimates may
impact the provisions charged to expense in future periods.
We recorded provisions of $2.6 million to the allowance for loan losses for 2004
compared to $1.7 million for 2003. During 2004, net charge-offs amounted to
$806,000, or 0.14%, of average loans outstanding for the year, compared to
$834,000, or 0.20%, of average loans outstanding for 2003. The allowance for
loan losses decreased slightly as a percentage of loans receivable from 1.26% of
total loans outstanding at December 31, 2003, to 1.21% of total loans
outstanding at December 31, 2004 primarily due to 36% growth in the loan
portfolio. At December 31, 2004, the allowance for loan losses provided coverage
of 916% of non-performing loans, as compared to 513% coverage at December 31,
2003.
The table below presents, for the years 2000 through 2004, information regarding
our provision and allowance for loan losses.
TABLE 7
- ------------------------------------------------------------------------------------------------------------------------------------
Years Ended December 31,
(dollars in thousands) 2004 2003 2002 2001 2000
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at beginning of year $6,007 $5,146 $4,544 $3,732 $2,841
Provisions charged to operating expenses 2,646 1,695 1,435 1,469 1,050
- ------------------------------------------------------------------------------------------------------------------------------------
8,653 6,841 5,979 5,201 3,891
- ------------------------------------------------------------------------------------------------------------------------------------
Recoveries of loans previously charged-off:
Commercial 110 66 93 3 6
Consumer 113 85 2 21 8
Real estate 8 115 21 0 0
- ------------------------------------------------------------------------------------------------------------------------------------
Total recoveries 231 266 116 24 14
- ------------------------------------------------------------------------------------------------------------------------------------
Loans charged-off:
Commercial (528) (483) (561) (475) (1)
Consumer (350) (331) (70) (85) (95)
Real estate (159) (286) (318) (121) (77)
- ------------------------------------------------------------------------------------------------------------------------------------
Total charged-off (1,037) (1,100) (949) (681) (173)
- ------------------------------------------------------------------------------------------------------------------------------------
Net charge-offs (806) (834) (833) (657) (159)
Balance at end of year $7,847 $6,007 $5,146 $4,544 $3,732
- ------------------------------------------------------------------------------------------------------------------------------------
Net charge-offs (recoveries) to average loans outstanding 0.14% 0.20% 0.23% 0.21% 0.06%
Allowance for loan losses to year-end loans 1.21% 1.26% 1.40% 1.33% 1.29%
- ------------------------------------------------------------------------------------------------------------------------------------
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. The allocations in the table were determined by a combination of the
following factors: specific allocations made on loans considered impaired as
determined by management and the loan review committee, a general allocation on
certain other impaired loans, and historical losses in each loan type category
combined with a weighting of the current loan composition.
36
Management's Discussion and Analysis
of Financial Condition and Results of Operations
TABLE 8
- ------------------------------------------------------------------------------------------------------------------------------------
Allowance for Loan Losses at December 31,
2004 2003 2002 2001 2000
- ------------------------------------------------------------------------------------------------------------------------------------
% Gross % Gross % Gross % Gross % Gross
(dollars in thousands) Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
- ------------------------------------------------------------------------------------------------------------------------------------
Commercial loans
and lines of credit $3,063 27% $2,636 21% $2,428 24% $ 986 23% $ 178 19%
Consumer 1,657 17 717 15 452 9 157 11 143 11
Real estate, construction
and land development:
Commercial 2,540 43 2,157 47 1,698 48 3,240 50 3,286 55
Residential 587 13 497 17 568 19 161 16 125 15
- ------------------------------------------------------------------------------------------------------------------------------------
Total $7,847 100% $6,007 100% $5,146 100% $4,544 100% $3,732 100%
- ------------------------------------------------------------------------------------------------------------------------------------
Bank Premises and Equipment
Premises and equipment at December 31, 2004 was $45.2 million, up $7.0 million,
or 18%, over premises and equipment of $38.2 million at December 31, 2003. This
increase is primarily due to additional capital expenditures associated with the
new store opened in 2004, renovations to existing stores, and the purchase of
land for new facilities.
Other Assets
Other assets decreased by $7.7 million from $16.5 million at December 31, 2003
to $8.8 million at December 31, 2004. The change was the result of the sale of
committed securities included in other assets at December 31, 2003, with a fair
market value of $9.2 million. The proceeds from the sale were received in the
first quarter of 2004.
Deposits
Total deposits at December 31, 2004, were $1.16 billion, up $254 million, or
28%, over total deposits of $906.5 million at December 31, 2003. We remain a
deposit-driven financial institution with emphasis on core deposit accumulation
and retention as a basis for sound growth and profitability. We regard core
deposits as all deposits other than public certificates of deposits. Deposits in
the various core categories, increased $265 million, or 31%, in 2004 over 2003.
Total deposits averaged $1.02 billion for 2004, an increase of $212.8 million,
or 27%, over the 2003 average of $802.3 million. The average balance on
noninterest-bearing demand deposits increased in 2004 by $37.6 million, or 26%,
compared to the prior year. The average balance of interest bearing demand
accounts (money market and interest checking accounts) for 2004 increased by
$101.9 million, or 42%, over the average balance for the prior year. The average
total balance of all savings accounts was $276.9 million, a $42 million, or 18%,
increase over the average balance for 2003. The average balance of all time
deposits in 2004 was $210.6 million, an increase of $30.9 million, or 17%,over
the average balance for 2003. For 2004, the cost of total deposits was 1.09% as
compared to 1.25% in 2003.
The average balances and weighted average rates paid on deposits for 2004, 2003
and 2002 are presented below.
We believe that our record of sustaining core deposit growth is reflective of
our retail approach to banking which emphasizes a combination of free checking
accounts, convenient store locations, extended hours of operation, unparalleled
quality customer service, and active marketing.
TABLE 9
- ------------------------------------------------------------------------------------------------------------------------------------
Years Ended December 31,
2004 Average 2003 Average 2002 Average
(dollars in thousands) Balance/Rate Balance/Rate Balance/Rate
- ------------------------------------------------------------------------------------------------------------------------------------
Demand deposits:
Noninterest-bearing $ 180,355 $142,805 $114,758
Interest-bearing (money market and checking) 347,212 1.23% 245,264 0.90% 156,441 1.30%
Savings 276,862 1.01 234,431 1.02 196,208 1.96
Time 210,620 2.30 179,758 3.07 174,081 4.06
- ------------------------------------------------------------------------------------------------------------------------------------
Total deposits $1,015,049 $802,258 $641,488
- ------------------------------------------------------------------------------------------------------------------------------------
37
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, 2004, 2003 and 2002 is presented in Table 10.
TABLE 10
- --------------------------------------------------------------------------------
(in thousands) 2004 2003 2002
- --------------------------------------------------------------------------------
3 months or less $ 39,270 $35,065 $31,591
3 to 6 months 15,530 21,202 20,462
6 to 12 months 13,344 18,520 16,390
Over 12 months 36,811 16,612 11,427
- --------------------------------------------------------------------------------
Total $104,955 $91,399 $79,870
- --------------------------------------------------------------------------------
Short-Term Borrowings
Short-term borrowings, which consist of securities sold under agreement to
repurchase and federal funds purchased, were used in 2004 and 2003 to meet
short-term liquidity needs. For 2004, short-term borrowings averaged $49.6
million and repurchase agreements averaged $29.5 million. The average rate paid
during 2004 on our short-term borrowings was 1.39% and the average rate paid on
repurchase agreements was 1.30%. As of December 31, 2004, there were no
short-term borrowings or repurchase agreements outstanding. 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 were $87.5 million in 2004 and $50.0 million in
2003. The maximum repurchase agreements outstanding at any month-end were $40.0
million in 2004 and 2003.
Long-Term Debt
Long-term debt totaled $13.6 million and $13.0 million at December 31, 2004 and
2003, respectively. Our long-term debt consisted of Trust Capital Securities
through Commerce Harrisburg Capital Trust I and Commerce Harrisburg Capital
Trust II, our Delaware business trust subsidiaries. At December 31, 2004, all of
the Capital Trust Securities qualified as Tier I capital for regulatory capital
purposes. Proceeds of the trust capital securities were used for general
corporate purposes, including additional capitalization of our wholly-owned
banking subsidiary. See Note 10 in the Notes to Consolidated Financial
Statements for December 31, 2004, included herein, for further analysis of our
long-term debt.
Stockholders' Equity and Capital Adequacy
At December 31, 2004, stockholders' equity totaled $85.0 million, up $35.3
million, or 71%, over stockholders' equity at December 31, 2003. This increase
was due to our net income for the year and shares issued under our common stock
offering in November, a private placement in September, the dividend
reinvestment/stock purchase plan and our stock option plans. Stockholders'
equity as a percent of total assets was 6.66% at December 31, 2004, compared to
4.73% at December 31, 2003. See Note 12 of Notes to Consolidated Financial
Statements at December 31, 2004, included herein, for additional discussion
regarding Stockholders' Equity.
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 11 provides a comparison of the Bank's risk-based capital ratios and
leverage ratios to the minimum regulatory requirements for the periods
indicated.
TABLE 11
- --------------------------------------------------------------------------------
Minimum
Actual December 31, Regulatory
2004 2003 Requirements
- --------------------------------------------------------------------------------
Tier 1 Capital 11.55% 9.49% 4.00%
Total Capital 12.48 10.42 8.00
Leverage ratio
(to average assets) 7.78 6.14 3.00 - 4.00
- --------------------------------------------------------------------------------
At December 31, 2004, the consolidated capital levels of the Company and of the
Bank 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%.
Prior to October 13, 2004, shares of Pennsylvania Commerce Bancorp, Inc. common
stock were traded on the NASDAQ Small Cap Market under the symbol COBH. The
stock currently trades on the NASDAQ National Market under the symbol COBH. The
table on page 39 sets forth the prices on the NASDAQ Small Cap Market (adjusted
38
Management's Discussion and Analysis
of Financial Condition and Results of Operations
for stock dividends and split) known to us for each full quarterly period within
the two most recent fiscal years and through October 12, 2004. The table also
includes the prices on the NASDAQ National Market known to us for the period
beginning October 13, 2004 through December 31, 2004. As of December 31, 2004,
there were approximately 700 holders of record of the Company's common stock.
Sales Price
Quarter Ended: High Low
- --------------------------------------------------------------------------------
March 31, 2004 $ 27.50 $ 23.25
June 30, 2004 25.63 23.26
September 30, 2004 25.05 21.88
December 31, 2004 31.50 22.00
- --------------------------------------------------------------------------------
March 31, 2003 $ 19.05 $ 16.19
June 30, 2003 18.92 16.75
September 30, 2003 19.69 17.56
December 31, 2003 24.29 19.75
- --------------------------------------------------------------------------------
We offer a Dividend Reinvestment and Stock Purchase Plan by which dividends on
our 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.
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.
Our 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 our asset/liability management activities is to maximize
net interest income while maintaining acceptable levels of interest rate risk.
Our 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. Our 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, referred to as "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, our GAP does not necessarily predict the impact of changes
in general levels of interest rates on net interest income. Table 12 on page 40
shows our GAP position as of December 31, 2004. The repricing assumptions used
in the table are as follows:
o Fixed rate loans receivable are scheduled according to their
contractual amortization and payment schedules specific to each loan.
o Floating rate loans receivable are scheduled in the 1-90 day category
as they are tied to a floating index such as New York Prime and
available for immediate repricing.
o Securities with pre-payment characteristics such as mortgage-backed
securities and collateralized mortgage obligations are scheduled based
upon their remaining weighted average lives as calculated utilizing a
market consensus Constant Prepayment Rate. All other securities are
assumed to reprice at their contractual maturity.
o 30% of Transaction accounts are expected to reprice within the first 90
days with the remaining 70% repricing after 5 years.
o Time deposit accounts, short-term borrowings, and trust capital
securities are scheduled based upon their contractual maturity dates.
Shortcomings are inherent in any GAP analysis since certain assets and
liabilities may not move proportionally as interest rates change. As the
interest rate environment has become more volatile, we have continued to place
greater reliance on interest income sensitivity modeling and less on GAP
reporting.
Our management understands that the preparation of GAP reports can only provide
a guide to the impact of the movement of interest rates. Modeling is the best
means to predict the movement in interest rates. This is true because even with
the achievement of a perfectly matched balance sheet (per a GAP report), we may
be subject to interest rate risk due to: differences in the timing of repricing,
basis risk, market risk, customer ability to prepay loans or withdraw funds and
yield curve risk.
Our 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
39
Management's Discussion and Analysis
of Financial Condition and Results of Operations
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.
Table 12
- ------------------------------------------------------------------------------------------------------------------------------------
December 31, 2004
1 - 90 91 - 180 181 - 365 1 - 5 Beyond 5
(in thousands) Days Days Days Years Years Total
- ------------------------------------------------------------------------------------------------------------------------------------
Interest earning assets:
Loans receivable $300,695 $ 8,745 $15,391 $172,003 $162,539 $659,373
Securities 26,531 22,592 39,481 258,029 164,363 510,996
Federal funds sold 12,000 0 0 0 0 12,000
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest earning assets 339,226 31,337 54,872 430,032 326,902 1,182,369
- ------------------------------------------------------------------------------------------------------------------------------------
Interest-bearing liabilities:
Transaction accounts 224,656 0 0 0 517,508 742,164
Time deposits 84,509 23,801 33,102 70,578 0 211,990
Long-term debt 0 0 0 0 13,600 13,600
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 309,165 23,801 33,102 70,578 531,108 967,754
- ------------------------------------------------------------------------------------------------------------------------------------
Period GAP 30,061 7,536 21,770 359,454 (204,206) $214,615
- ------------------------------------------------------------------------------------------------------------------------------------
Cumulative GAP $ 30,061 $37,597 $59,367 $418,821 $214,615
- ------------------------------------------------------------------------------------------------------------------------------------
Cumulative RSA / RSL 109.72% 111.29% 116.22% 195.92% 122.18%
- ------------------------------------------------------------------------------------------------------------------------------------
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. RSA means rate sensitive assets; RSL means rate
sensitive liabilities.
Our 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. Our management continually reviews and
refines its interest rate risk management process in response to the changing
economic climate. Currently, our 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.
Our 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 12% of net income in a flat
rate scenario in the first year and 18% using a two year planning window.
The following table illustrates the impact on projected net income at December
31, 2004 and 2003 of a plus 200 and minus 100 basis point change in interest
rates.
Basis Point Change
- --------------------------------------------------------------------------------
Plus 200 Minus 100
- --------------------------------------------------------------------------------
December 31, 2004:
Twelve Months (3.2)% 3.5%
Twenty Four Months 3.2 % 1.0%
December 31, 2003
Twelve Months (3.4)% 3.1%
Twenty Four Months (3.0)% (0.1)%
- --------------------------------------------------------------------------------
All of these forecasts are within an acceptable level of interest rate risk per
the policies established by ALCO. In the event the model indicates an
unacceptable level of risk, Management could undertake a number of actions that
would reduce this risk, including the sale of a portion of our available for
sale investment portfolio, the use of risk management strategies such as
interest rate swaps and caps, or fixing the cost of our short-term borrowings.
Many assumptions were used by us to calculate the impact of changes in interest
rates, including the proportionate shift in rates. Actual results may not be
similar to our projections due to several factors including the timing and
frequency of rate changes, market conditions and the shape of the yield curve.
In general, a flattening yield curve would result in reduced net interest income
compared to the current flat rate scenario and proportionate rate shift
assumptions. Actual results
40
Management's Discussion and Analysis
of Financial Condition and Results of Operations
may also differ due to Management's actions, if any, in response to the changing
rates.
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 our assets and liabilities, as well as any off balance sheet
items. The model calculates the market value of our 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. Our ALCO policy indicates that
the level of interest rate risk is unacceptable if the immediate change would
result in the loss of 50% or more of the excess of market value over book value
in the current rate scenario. At December 31, 2004, 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 our assets and liabilities given an
immediate 200 basis point change in interest rates. One of the key assumptions
is the market value assigned to our core deposits, or the core deposit premium.
Using an independent consultant, we completed and updated comprehensive core
deposit studies in order to assign our own core deposit premiums as permitted by
regulation. The studies have consistently confirmed management's assertion that
our 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 our loans and investment securities. Thus, these core
deposit balances provide an internal hedge to market fluctuations in our fixed
rate assets. Management believes the core deposit premiums produced by our
market value of equity model at December 31, 2004 provide an accurate assessment
of our interest rate risk.
Liquidity
The objective of liquidity management is to ensure our ability to meet our
financial obligations. These obligations include the payment of deposits on
demand at their contractual maturity; the repayment of borrowings as they
mature; the payment of lease obligations as they become due; the ability to fund
new and existing loans and other funding commitments; and the ability to take
advantage of new business opportunities. Our ALCO is responsible for
implementing the policies and guidelines of our board governing liquidity.
Liquidity sources are found on both sides of the balance sheet. Liquidity is
provided on a continuous basis through scheduled and unscheduled principal
reductions and interest payments on outstanding loans and investments. Liquidity
is also provided through the availability and maintenance of a strong base of
core customer deposits; maturing short-term assets; the ability to sell
marketable securities; short-term borrowings and access to capital markets.
Liquidity is measured and monitored daily, allowing management to better
understand and react to balance sheet trends. On a monthly basis, a
comprehensive liquidity analysis is reviewed by our board of directors. The
analysis provides a summary of the current liquidity measurements, projections
and future liquidity positions given various levels of liquidity stress.
Management also maintains a detailed liquidity contingency plan designed to
respond to an overall decline in the condition of the banking industry or a
problem specific to the Company.
The Consolidated Statements of Cash Flows provide additional information on our
sources and uses of funds. From a funding standpoint, we have been able to rely
over the years on a stable base of strong "core" deposit growth. We generated
$32.9 million in cash from operating activities during 2004 versus $3.1 million
during 2003, mainly due to a combination of higher net income, a decrease in
other assets and an increase in other liabilities. Investing activities resulted
in a net cash outflow of $231.7 million during 2004 compared to $300.5 million
in 2003. Net cash provided by financing activities totaled $202.0 million in
2004 compared to $259.7 million in 2003. For 2004, cash inflows resulted
primarily from deposit growth of $254.0 million and proceeds of $25.4 million
from the previously discussed private placement and common stock offering,
offset by a $79.0 million reduction in short-term borrowings. For 2003, cash
inflows from financing activities consisted primarily of deposit growth of
$179.6 million and short-term borrowings of $79.0 million.
At December 31, 2004, liquid assets (defined as cash and cash equivalents,
short-term investments, mortgages available for sale, securities available for
sale, and non-mortgage-backed securities held to maturity due in one year or
less) totaled $360.4 million, or 28%, of total assets. This compares to $320.8
million, or 31%, of total assets, at December 31, 2003.
Our investment portfolio consists mainly of mortgage-backed securities, which do
not have stated maturities. Cash flows from such investments are dependent upon
the performance of the underlying mortgage loans, and are generally influenced
by the level of interest rates. As rates increase, cash flows generally decrease
as
41
Management's Discussion and Analysis
of Financial Condition and Results of Operations
prepayments on the underlying mortgage loans slow. As rates decrease, cash flows
generally increase as prepayments increase.
The Company and the Bank's liquidity are managed separately. On an
unconsolidated basis, the principal source of our revenue is dividends paid to
the Company by the Bank. The Bank is subject to regulatory restrictions on its
ability to pay dividends to the Company. The Company's net cash outflows consist
principally of interest on the trust-preferred securities, dividends on the
preferred stock and unallocated corporate expenses.
We also maintain 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, 2004, our
total potential liquidity through these secondary sources was $394 million, all
of which was currently available, as compared to $270 million at December 31,
2003 of which $191 million was available.
Subject to regulatory approvals, we are targeting to open approximately four to
six new stores in each of the next five years. The cost to construct and furnish
each new store will be approximately $1.7 million, excluding the cost to lease
or purchase the land on which the store is located. To accommodate our growth
and perpetuate our culture we plan to construct a new headquarters, operations
and training center in Harrisburg, which we expect to open in late 2005. The
anticipated cost to construct and furnish our new headquarters, operations and
training center in Harrisburg will be between $15.0 and $18.0 million.
Aggregate Contractual Obligations
The following table represents our on-and-off balance sheet aggregate
contractual obligations to make future payments as of December 31, 2004:
TABLE 13
- ------------------------------------------------------------------------------------------------------------------------------------
December 31, 2004
Less than Over 5
(in thousands) 1 Year 1 to 3 Years 3 to 5 Years Years Total
- ------------------------------------------------------------------------------------------------------------------------------------
Time Deposits $141,412 $31,960 $38,618 $ 0 $211,990
Long-Term Debt 0 0 0 13,600 13,600
Operating Leases 1,956 3,198 2,690 17,204 25,048
Sponsorship Obligation 175 525 550 2,100 3,350
- ------------------------------------------------------------------------------------------------------------------------------------
Total $143,543 $35,683 $41,858 $32,904 $253,988
- ------------------------------------------------------------------------------------------------------------------------------------
For further discussion regarding our commitments and contingencies, please see
Note 18 in the Notes to Consolidated Financial Statements at December 31, 2004,
included herein.
Off-Balance Sheet Arrangements
In the conduct of ordinary business operations we routinely enter 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 our liquidity or
capital resources.
We are also party to financial instruments with off-balance sheet risk in the
normal course of business to meet the financing needs of our 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 at
December 31, 2004 contained herein for additional information.
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 the annual report on Form 10-K and
the exhibits 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
42
Management's Discussion and Analysis
of Financial Condition and Results of Operations
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; 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); the impact of the rapid growth of the
Company; the Company's dependence on Commerce Bancorp, Inc. to provide various
services to the Company; changes in the Company's allowance for loan losses;
effect of terrorists attacks and threats of actual war; 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. For further information, refer to the Company's filings
with the SEC.
Impact of Inflation and Changing Prices
Interest rates have a more significant impact on our performance than do the
effects of general levels of inflation, since most of our 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
our assets and liabilities are critical to the maintenance of acceptable
performance levels.
Quantitative and Qualitative Disclosures about Market Risk
Our exposure to market risk principally includes interest rate risk, which is
discussed previously. Our net interest margin has remained fairly stable. Our
net interest margin for the year ended December 31, 2004 was 4.28%, an increase
of 8 basis points from 4.20% for the year ended December 31, 2003.
Currently, we have 97% of our deposits in accounts which we consider core
deposits. These accounts, which have a relatively low cost of deposits, have
historically contributed significantly to the net interest margin.
43
Consolidated Balance Sheets
December 31,
(in thousands, except share amounts) 2004 2003
- ------------------------------------------------------------------------------------------------------------------------------------
Assets
- ------------------------------------------------------------------------------------------------------------------------------------
Cash and due from banks $ 28,910 $ 37,715
Federal funds sold 12,000 0
- ------------------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents 40,910 37,715
Securities, available for sale at fair value 314,065 275,400
Securities, held to maturity at cost
(fair value 2004: $210,908; 2003: $201,568) 209,917 199,863
Loans, held for sale 14,287 9,164
Loans receivable, net of allowance for loan losses
(allowance 2004: $7,847; 2003: $6,007) 638,496 469,937
Restricted investments in bank stocks 5,716 5,227
Premises and equipment, net 45,188 38,178
Other assets 8,788 16,505
- ------------------------------------------------------------------------------------------------------------------------------------
Total assets $ 1,277,367 $ 1,051,989
- ------------------------------------------------------------------------------------------------------------------------------------
Liabilities and Stockholders' Equity
- ------------------------------------------------------------------------------------------------------------------------------------
Deposits:
Noninterest-bearing $ 206,393 $ 170,414
Interest-bearing 954,154 736,113
- ------------------------------------------------------------------------------------------------------------------------------------
Total deposits 1,160,547 906,527
Short-term borrowings and repurchase agreements 0 79,000
Long-term debt 13,600 13,000
Other liabilities 18,181 3,738
- ------------------------------------------------------------------------------------------------------------------------------------
Total liabilities 1,192,328 1,002,265
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 2004: 5,869,606; 2003: 2,291,805) 5,870 2,292
Surplus 62,790 38,725
Retained earnings 16,030 7,758
Accumulated other comprehensive income (loss) (51) 549
- ------------------------------------------------------------------------------------------------------------------------------------
Total stockholders' equity 85,039 49,724
- ------------------------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $ 1,277,367 $ 1,051,989
- ------------------------------------------------------------------------------------------------------------------------------------
See accompanying notes
44
Consolidated Statements of Income
Years Ended December 31,
(in thousands, except per share amounts) 2004 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Interest Income
- ------------------------------------------------------------------------------------------------------------------------------------
Loans receivable, including fees:
Taxable $35,433 $27,545 $26,755
Tax-exempt 292 216 111
Securities:
Taxable 24,789 17,108 14,514
Tax-exempt 401 453 107
Federal funds sold 67 220 508
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest income 60,982 45,542 41,995
- ------------------------------------------------------------------------------------------------------------------------------------
Interest Expense
- ------------------------------------------------------------------------------------------------------------------------------------
Deposits 11,909 10,089 12,940
Short-term borrowings 1,070 207 0
Long-term debt 1,418 1,356 1,354
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest expense 14,397 11,652 14,294
- ------------------------------------------------------------------------------------------------------------------------------------
Net interest income 46,585 33,890 27,701
Provision for loan losses 2,646 1,695 1,435
- ------------------------------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 43,939 32,195 26,266
- ------------------------------------------------------------------------------------------------------------------------------------
Noninterest Income
- ------------------------------------------------------------------------------------------------------------------------------------
Service charges and other fees 10,252 7,968 6,766
Other operating income 414 377 448
Gains on sales of loans 630 765 493
Gains on sales of securities 0 880 0
- ------------------------------------------------------------------------------------------------------------------------------------
Total noninterest income 11,296 9,990 7,707
- ------------------------------------------------------------------------------------------------------------------------------------
Noninterest Expenses
- ------------------------------------------------------------------------------------------------------------------------------------
Salaries and employee benefits 21,824 16,702 12,491
Occupancy 4,375 3,420 2,403
Furniture and equipment 2,503 1,844 1,523
Advertising and marketing 3,108 2,425 2,181
Data processing 2,922 2,148 1,890
Postage and supplies 1,141 986 862
Other 6,593 4,985 4,078
- ------------------------------------------------------------------------------------------------------------------------------------
Total noninterest expenses 42,466 32,510 25,428
- ------------------------------------------------------------------------------------------------------------------------------------
Income before income taxes 12,769 9,675 8,545
Provision for federal income taxes 4,178 3,118 2,871
- ------------------------------------------------------------------------------------------------------------------------------------
Net income $ 8,591 $ 6,557 $ 5,674
- ------------------------------------------------------------------------------------------------------------------------------------
Net Income per Common Share
- ------------------------------------------------------------------------------------------------------------------------------------
Basic $ 1.75 $ 1.44 $ 1.29
Diluted $ 1.63 $ 1.34 $ 1.18
- ------------------------------------------------------------------------------------------------------------------------------------
Average Common and Common Equivalent Shares
Outstanding
- ------------------------------------------------------------------------------------------------------------------------------------
Basic 4,856 4,506 4,332
Diluted 5,218 4,836 4,728
- ------------------------------------------------------------------------------------------------------------------------------------
See accompanying notes
45
Consolidated Statements of Stockholder' Equity
Accumulated Other
Preferred Common Retained Comprehensive
(dollars in thousands ) Stock Stock Surplus Earnings Income (Loss) Total
- ------------------------------------------------------------------------------------------------------------------------------------
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 - - - - 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, including tax benefit of $378 - 113 2,003 - - 2,116
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, including tax benefit of $178 - 48 686 - - 734
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
- ------------------------------------------------------------------------------------------------------------------------------------
Comprehensive income:
Net income - - - 8,591 - 8,591
Change in unrealized gains (losses) on securities,
net of taxes - - - - (600) (600)
----------
Total comprehensive income 7,991
----------
Dividends declared on preferred stock - - - (80) - (80)
Common stock of 68,204 shares issued under
stock option plans, including tax benefit of $319 - 68 1,233 - - 1,301
Common stock of 590 shares issued under
employee stock purchase plan - 1 27 - - 28
Proceeds from issuance of 13,842 shares of common
stock in connection with dividend reinvestment
and stock purchase plan - 14 661 - - 675
Proceeds from issuance of 560,000 shares of common
stock in connection with stock offerings - 560 24,848 - - 25,408
Other stock transactions (362 shares issued) - - 231 (239) - (8)
2-for-1 stock split in the form of a dividend
(2,934,803 shares issued) - 2,935 (2,935) - - -
- ------------------------------------------------------------------------------------------------------------------------------------
December 31, 2004 $400 $5,870 $62,790 $16,030 $ (51) $85,039
- ------------------------------------------------------------------------------------------------------------------------------------
See accompanying notes
46
Consolidated Statements of Cash Flows
Years Ended December 31,
(in thousands) 2004 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Operating Activities
- ------------------------------------------------------------------------------------------------------------------------------------
Net income $ 8,591 $ 6,557 $ 5,674
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 2,646 1,695 1,435
Provision for depreciation and amortization 2,397 1,831 1,484
Deferred income taxes 708 285 68
Amortization of securities premiums and accretion of discounts, net 1,219 3,036 926
Gains on sales of securities 0 (880) 0
Proceeds from sales of loans 75,619 106,950 67,794
Loans originated for sale (80,112) (104,835) (70,154)
Gains on sales of loans (630) (765) (493)
(Increase) decrease in other assets 8,035 (10,724) 93
Increase (decrease) in other liabilities 14,443 (93) 1,272
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 32,916 3,057 8,099
Investing Activities
- ------------------------------------------------------------------------------------------------------------------------------------
Securities held to maturity:
Proceeds from principal repayments and maturities 36,967 45,855 34,681
Purchases (46,893) (148,228) (29,121)
Securities available for sale:
Proceeds from principal repayments and maturities 113,389 191,681 77,946
Proceeds from sales 0 8,294 0
Purchases (154,071) (273,431) (176,945)
Net (purchase) redemption of restricted investments in bank stocks (489) (3,182) 548
Net increase in loans receivable (171,205) (107,897) (27,040)
Purchases of premises and equipment (9,407) (13,600) (6,306)
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash used by investing activities (231,709) (300,508) (126,237)
Financing Activities
- ------------------------------------------------------------------------------------------------------------------------------------
Net increase in demand, interest checking,
money market, and savings deposits 224,257 166,787 159,992
Net increase in time deposits 29,763 12,785 5,225
Net increase (decrease) in short-term borrowings (79,000) 79,000 0
Proceeds from common stock options exercised 982 556 1,738
Proceeds from dividend reinvestment and common stock purchase plan 675 677 868
Proceeds from issuance of common stock in connection with
stock offerings 25,408 0 0
Cash dividends on preferred stock and cash in lieu of fractional shares (97) (89) (90)
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 201,988 259,716 167,733
- ------------------------------------------------------------------------------------------------------------------------------------
Increase (decrease) in cash and cash equivalents 3,195 (37,735) 49,595
Cash and cash equivalents at beginning of year 37,715 75,450 25,855
- ------------------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at year-end $ 40,910 $ 37,715 $ 75,450
- ------------------------------------------------------------------------------------------------------------------------------------
See accompanying notes.
47
Notes to Consolidated Financial Statements
1. Significant Accounting Policies
- ------------------------------------
Nature of Operations and Basis of Presentation
The 2004 consolidated financial statements include the accounts of Pennsylvania
Commerce Bancorp, Inc. (the Company) and its wholly-owned subsidiary Commerce
Bank/Harrisburg, N.A. (Commerce or Bank). The 2003 and 2002 consolidated
financial statements also include 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.
In 2004, as a result of applying the provisions of FASB Interpretation No. 46,
"Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51,"
which represented new accounting guidance governing when an equity interest
should be consolidated, the Company was required to deconsolidate Trust I and
Trust II from its financial statements. Prior periods have not been restated.
The deconsolidation of the net assets and results of operations of the trusts
had virtually no impact on the Company's financial statements or liquidity since
the Company continues to be obligated to repay the debentures held by the trusts
and guarantees repayment of the preferred securities issued by the trusts. The
Company's total debt obligation related to the trusts did increase, however,
from $13.0 million to $13.6 million upon deconsolidation, with the difference
representing the Company's common ownership interest in the Trusts, which is now
reported in "Other assets."
For regulatory reporting purposes, the Federal Reserve Board has an outstanding
proposal under which Trust Preferred Securities will qualify as Tier I Capital
subject to new restrictions. It is anticipated that the Company will continue to
meet its minimum capital requirements under the proposed rule.
The Company is a one-bank holding company headquartered in Camp Hill,
Pennsylvania and provides retail and commercial banking services through its
subsidiary Commerce Bank/Harrisburg, N.A. 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. Material estimates that are
particularly susceptible to significant change in the near term relate to the
determination of the allowance for loan losses, the valuation of deferred tax
assets, and the valuation of securities available for sale.
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. Declines in the fair value of held-to-maturity and
available-for-sale securities below their cost that are deemed to be other than
temporary, if any, are reflected in earnings as realized losses. In estimating
other-than-temporary impairment losses, management considers (1) the length of
time and the extent to which the fair value has been less than cost, (2) the
financial condition and
48
Notes to Consolidated Financial Statements
near-term prospects of the issuer, and (3) the intent and ability of the Company
to retain its investment in the issuer for a period of time sufficient to allow
for any anticipated recovery in fair value.
Management determines the appropriate classification of debt securities at the
time of purchase and re-evaluates such designation as of each balance sheet
date.
Loans Receivable
Loans receivable that management has the intent and ability to hold for the
foreseeable future or until maturity or payoff are stated at their outstanding
unpaid principal balances, net of an allowance for loan losses and any deferred
fees and costs. Interest income is accrued on the unpaid principal balance. Loan
origination fees and costs are deferred and recognized as an adjustment of the
yield (interest income) of the related loans. The Bank is generally amortizing
these amounts over the contractual life of the loan.
The accrual of interest is generally discontinued when the contractual payment
of principal or interest has become 90 days past due or management has serious
doubts about further collectibility of principal or interest, even though the
loan is currently performing. A loan may remain on accrual status if it is in
the process of collection and is either guaranteed or well secured. When a loan
is placed on nonaccrual status, unpaid interest credited to income in the
current year is reversed and unpaid interest accrued in prior years is charged
against the allowance for loan losses. Interest received on nonaccrual loans
generally is either applied against principal or reported as interest income,
according to management's judgment as to the collectibility of principal.
Generally, loans are restored to accrual status when the obligation is brought
current, has performed in accordance with the contractual terms for a reasonable
period of time and the ultimate collectibility of the total contractual
principal and interest is no longer in doubt.
Allowance for Loan Losses
The allowance for loan losses is established through provisions for loan losses
charged against income. Loans deemed to be uncollectible are charged against the
allowance for loan losses, and subsequent recoveries, if any, are credited to
the allowance. The evaluation is inherently subjective as it requires estimates
that are susceptible to significant revision as more information becomes
available.
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. 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.
All nonaccrual loans, including any non-homogenous portfolio residential
mortgages and home equity loans with balances greater than $25,000, are
evaluated individually to determine whether a valuation allowance is necessary
due to collateral deficiencies that may exist within the loan. Large groups of
smaller balance homogeneous loans are collectively evaluated for impairment,
unless such loans are the subject of a restructuring agreement.
49
Notes to Consolidated Financial Statements
Loans Held for Sale
Loans held for sale are comprised of residential loans and student loans that
the Bank 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 Stocks
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. When capitalizing costs for store construction,
the Company includes the costs of purchasing the land, developing the site,
constructing the building, (or leasehold improvements if the property is
leased), and furniture, fixtures and equipment necessary to operate the store.
Depreciation charges begin the month in which the store opens. All other
pre-opening and post-opening costs related to the stores are expensed as
incurred.
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.
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 and stock splits declared through January 28, 2005.
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,
50
Notes to Consolidated Financial Statements
federal funds are purchased and sold for one-day periods. Cash paid during the
years ended December 31, 2004, 2003, and 2002 for interest was $14.4 million,
$12.0 million, and $14.3 million respectively. Income taxes paid totaled $3.7
million, $2.5 million, and $2.6 million in 2004, 2003, and 2002, respectively.
Stock-Based Compensation
The Company accounts for stock-based compensation issued to directors and
employees using the intrinsic value method in accordance with Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees"
(APB25). 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 option awards because the stock options 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.
The fair value of each option grant was estimated at the date of grant using the
Black-Scholes option pricing model with the following weighted-average
assumptions for 2004, 2003, and 2002 respectively: risk-free interest rates of
3.6%, 3.4% and 4.7%; volatility factors of the expected market price of the
Company's common stock of .21, .21, and .33; weighted-average expected lives of
the options of 6.1 years, 10.0 years and 10.0 years, respectively; and no cash
dividends.
Had compensation costs for stock options granted in 2004, 2003 and 2002 been
determined based on the fair value at the grant dates for awards under the plan
consistent with the provisions of FASB Statement No. 123, "Accounting for
Stock-Based Compensation" (FAS 123), the Company's net income and earnings per
share for the years ended December 31, 2004, 2003 and 2002 would have been
reduced to the proforma amounts indicated in the following table.
- --------------------------------------------------------------------------------
Years Ended December 31,
(in thousands) 2004 2003 2002
- --------------------------------------------------------------------------------
Net income:
As reported $ 8,591 $6,557 $5,674
Total stock-based compensation
cost, net of tax, that would
have been included in the
determination of net income
if the fair value based
method had been
applied to all awards (1,121) (814) (1,434)
- --------------------------------------------------------------------------------
Pro-forma $ 7,470 $5,743 $4,240
- --------------------------------------------------------------------------------
Reported earnings per share:
Basic $ 1.75 $ 1.44 $ 1.29
- --------------------------------------------------------------------------------
Diluted 1.63 1.34 1.18
- --------------------------------------------------------------------------------
Pro-forma earnings per share:
Basic $ 1.52 $ 1.26 $ .96
Diluted 1.42 1.17 .88
- --------------------------------------------------------------------------------
For purposes of pro-forma disclosures, the estimated fair value of the options
is amortized to expense over the options' vesting period.
Recent Accounting Standards
In December 2003, the Accounting Standards Executive Committee issued Statement
of Position 03-3 (SOP 03-3), "Accounting for Certain Loans or Debt Securities
Acquired in a Transfer." SOP 03-3 addresses accounting for differences between
contractual cash flows and cash flows expected to be collected from an
investor's initial investment in loans or debt securities acquired in a
transfer, including business combinations, if those differences are
attributable, at least in part, to credit quality. SOP 03-3 is effective for
loans for debt securities acquired in fiscal years beginning after December 15,
2004. The Company intends to adopt the provisions of SOP 03-3 effective January
1, 2005, and does not expect the initial implementation to have a material
effect on the Company's consolidated financial statements.
In March 2004, the Emerging Issues Task Force (EITF) reached consensus on Issue
03-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to
Certain Investments." EITF No. 03-1 includes new guidance for evaluating and
recording impairment losses on debt and equity investments, as well as new
disclosure requirements for investments that are deemed to be temporarily
impaired. In September 2004, the FASB deferred the implementation dates of the
provisions that relate to measurement and recognition of other-than-temporary
impairments. The Company is continuing to evaluate the impact of the measurement
and recognition provisions of EITF 03-1 but does not believe
51
Notes to Consolidated Financial Statements
the adoption will have a material effect on the financial position or results of
operations of the Company.
In March 2004, the SEC released Staff Accounting Bulletin (SAB) No. 105,
"Application of Accounting Principles to Loan Commitments." SAB 105 provides
guidance about the measurements of loan commitments recognized at fair value
under FASB Statement No. 133, "Accounting for Derivative Instruments and Hedging
Activities." SAB 105 also requires companies to disclose their accounting policy
for those loan commitments including methods and assumptions used to estimate
fair value and associated hedging strategies. SAB 105 is effective for all loan
commitments accounted for as derivatives that are entered into after March 31,
2004. The adoption of SAB 105 did not have a material effect on the Company's
consolidated financial statements.
In December 2004, the Financial Accounting Standards Board (FASB) issued
Statement No. 123(R), "Share-Based Payment," (FAS 123R). FAS 123(R) revised FAS
123 and supersedes APB 25, and its related implementation guidance. FAS 123(R)
will require all compensation costs related to share-based payments to be
recognized in the income statement (with limited exceptions) based on their fair
values and no longer allows pro forma disclosure as an alternative to reflecting
the impact of share-based payments on net income and net income per share. The
amount of compensation cost will be measured based on the grant-date fair value
of the stock-based compensation issued. Compensation cost will be recognized
over the period that an employee provides service in exchange for the award.
This statement is effective as of the beginning of the first interim or annual
reporting period that begins after June 15, 2005 and permits public companies to
adopt its requirements using one of two methods: modified prospective or
modified retrospective. The Company plans to adopt FAS 123R on July 1, 2005, but
has yet to decide on a method of adoption.
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 stores, 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.
Reclassifications
Certain amounts in the 2003 and 2002 financial statements have been reclassified
to conform with the 2004 presentation format. Such reclassifications had no
impact on the Company's net income.
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 2004
and 2003 was approximately $9.4 million and $6.5 million, respectively.
3. Securities
- ---------------
The amortized cost and fair value of securities at December 31, 2004 and 2003
are summarized in the following tables.
52
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------------------------------------------------------------
December 31, 2004
- ------------------------------------------------------------------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
(in thousands) Cost Gains Losses Value
- ------------------------------------------------------------------------------------------------------------------------------------
Available for Sale
U.S. Government Agency securities $ 10,000 $ 0 $ (202) $ 9,798
Mortgage-backed securities 302,133 1,614 (1,660) 302,087
Corporate debt securities 2,009 171 0 2,180
- ------------------------------------------------------------------------------------------------------------------------------------
Total $314,142 $1,785 $(1,862) $314,065
- ------------------------------------------------------------------------------------------------------------------------------------
Held to Maturity
U.S. Government Agency securities $ 70,981 $ 49 $ (663) $ 70,367
Municipal securities 6,827 36 (29) 6,834
Mortgage-backed securities 114,963 1,051 (715) 115,299
Corporate debt securities 17,146 1,262 0 18,408
- ------------------------------------------------------------------------------------------------------------------------------------
Total $209,917 $2,398 $(1,407) $210,908
- ------------------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------------------
December 31, 2003
- ------------------------------------------------------------------------------------------------------------------------------------
Gross Gross
Amortized UnrealizedUnrealized 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
- ------------------------------------------------------------------------------------------------------------------------------------
The amortized cost and fair value of debt securities at December 31, 2004 by
contractual maturity are shown in the following table. Expected maturities will
differ from contractual maturities because borrowers may have the right to call
or prepay obligations.
- ------------------------------------------------------------------------------------------------------------------------------------
Held to Maturity Available for Sale
- ------------------------------------------------------------------------------------------------------------------------------------
Amortized Fair Amortized Fair
(in thousands) Cost Value Cost Value
- ------------------------------------------------------------------------------------------------------------------------------------
Due in one year or less $ 101 $ 101 $ 0 $ 0
Due after one year through five years 6,513 6,949 0 0
Due after five years through ten years 33,955 33,788 5,000 4,903
Due after ten years 54,385 54,771 7,009 7,075
- ------------------------------------------------------------------------------------------------------------------------------------
94,954 95,609 12,009 11,978
Mortgage-backed securities 114,963 115,299 302,133 302,087
- ------------------------------------------------------------------------------------------------------------------------------------
Total $209,917 $210,908 $314,142 $314,065
- ------------------------------------------------------------------------------------------------------------------------------------
There were no sales of securities available for sale or held to maturity in
2004.
Gross gains of $640,000 and gross losses of $0 were realized on sales of
securities available for sale in 2003.
53
Notes to Consolidated Financial Statements
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 previous 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.
At December 31, 2004 and 2003 securities with a fair value of $337.8 million and
$257.1 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 $ 4,895 $ (105) $ 4,903 $ (97) $ 9,798 $ (202)
Mortgage-backed securities 152,354 (1,456) 12,408 (204) 164,762 (1,660)
- ------------------------------------------------------------------------------------------------------------------------------------
Total $ 157,249 $(1,561) $17,311 $ (301) $174,560 $(1,862)
- ------------------------------------------------------------------------------------------------------------------------------------
Held to Maturity
U.S. Government Agency securities $ 26,900 $ (80) $29,417 $ (583) $ 56,317 $ (663)
Municipal securities 4,800 (29) - - 4,800 (29)
Mortgage-backed securities 36,597 (438) 21,351 (277) 57,948 (715)
- ------------------------------------------------------------------------------------------------------------------------------------
Total $ 68,297 $ (547) $50,768 $ (860) $119,065 $(1,407)
- ------------------------------------------------------------------------------------------------------------------------------------
The table above represents 60 securities where the current fair value is less
than the related amortized cost.
At December 31, 2004, 42 debt securities, which include mortgage-backed
securities, U.S. Government Agency securities, and municipal securities, have
been in a continuous unrealized loss position for less than twelve months, and
18 debt securities have been in a continuous unrealized loss position for twelve
months or more.
In management's opinion, the unrealized losses reflect changes in general market
interest rates subsequent to the acquisition of specific securities and
represent only temporary impairment of the securities. The Company believes it
will collect all amounts contractually due on these securities as it has the
ability to hold these securities until the fair value is at least equal to the
carrying value.
4. Loans Receivable and Allowance for Loan Losses
- ---------------------------------------------------
A summary of loans receivable is as follows:
- --------------------------------------------------------------------------------
December 31,
(in thousands) 2004 2003
- --------------------------------------------------------------------------------
Real Estate:
Commercial Mortgage $239,576 $194,609
Construction and land
development 39,467 26,895
Residential Mortgage 79,672 72,713
Tax-Exempt 6,303 5,720
Commercial Business 97,198 58,894
Consumer 109,568 71,007
Lines of Credit 74,559 46,106
- --------------------------------------------------------------------------------
646,343 475,944
Less: Allowance for Loan Losses 7,847 6,007
- --------------------------------------------------------------------------------
Net Loans Receivable $638,496 $469,937
- --------------------------------------------------------------------------------
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
$14.6 million and $14.3 million at December 31, 2004 and 2003, respectively.
During 2004, $11.4 million of new advances were made and repayments totaled
$11.1 million.
54
Notes to Consolidated Financial Statements
The following is a summary of the transactions in the allowance for loan losses.
- --------------------------------------------------------------------------------
Years Ended December 31,
(in thousands) 2004 2003 2002
- --------------------------------------------------------------------------------
Balance at beginning of year $6,007 $5,146 $4,544
Provision charged to expense 2,646 1,695 1,435
Recoveries 231 266 116
Loans charged off (1,037) (1,100) (949)
- --------------------------------------------------------------------------------
Balance at end of year $7,847 $6,007 $5,146
- --------------------------------------------------------------------------------
At December 31, 2004 and 2003, the recorded investment in loans considered to be
impaired under FASB Statement No. 114 "Accounting by Creditors for Impairment of
a Loan" totaled $9.4 million and $9.8 million, respectively. At December 31,
2004, $2.3 million of impaired loans have a specific valuation allowance of $1.3
million as compared to $2.5 million of impaired loans having a specific
valuation allowance of $1.5 million at December 31, 2003. Total non-accrual
loans at December 31, 2004 and 2003 totaled $586,000 and $787,000, respectively.
Loans past due 90 days or more and still accruing totaled $0 at December 31,
2004 and $385,000 at December 31, 2003.
Impaired loans averaged approximately $8.9 million, $5.5 million and $1.5
million during 2004, 2003 and 2002, respectively. Interest income recognized on
these loans amounted to $507,000, $41,000 and $79,000 during 2004, 2003 and
2002, respectively.
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, 2004 for guarantees under standby letters of credit issued is not
material.
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) 2004 2003
- --------------------------------------------------------------------------------
Commitments to grant loans $ 3,668 $ 452
Unfunded commitments
of existing loans 188,869 109,648
Standby letters of credit 10,929 8,426
- --------------------------------------------------------------------------------
Total $203,466 $118,526
- --------------------------------------------------------------------------------
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 stores. Commercial real estate loans and loan commitments for
commercial real estate projects aggregated $307 million at December 31, 2004.
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:
55
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
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) 2004 2003
- --------------------------------------------------------------------------------
Land $10,325 $ 7,753
Buildings 30,324 26,398
Leasehold improvements 3,122 2,618
Furniture, fixtures, and equipment 13,667 11,609
- --------------------------------------------------------------------------------
57,438 48,378
Less accumulated depreciation
and amortization 12,250 10,200
- --------------------------------------------------------------------------------
$45,188 $38,178
- --------------------------------------------------------------------------------
Land, buildings, and equipment are leased under noncancelable operating lease
agreements that expire at various dates through 2025. Total rental expense for
operating leases in 2004, 2003, and 2002 was $1.7 million, $1.4 million, and
$1.1 million, respectively. At December 31, 2004, future minimum lease payments
for noncancelable operating leases are payable as follows:
- --------------------------------------------------------------------------------
(in thousands)
- --------------------------------------------------------------------------------
2005 $ 1,956
2006 1,689
2007 1,509
2008 1,437
2009 1,253
Thereafter 17,204
- --------------------------------------------------------------------------------
Total minimum lease payments $25,048
- --------------------------------------------------------------------------------
The Company has the option to extend the majority of its store land leases
beyond the original terms. If the Company exercised its options, it would incur
an additional $39.4 million in additional lease payments.
8. Deposits
- -------------
The composition of deposits is as follows:
- --------------------------------------------------------------------------------
December 31,
(in thousands) 2004 2003
- --------------------------------------------------------------------------------
Demand $ 206,393 $170,414
Interest checking and money market 435,859 312,282
Savings 306,305 241,603
Time certificates $100,000 or more 104,955 91,399
Other time certificates 107,035 90,829
- --------------------------------------------------------------------------------
$1,160,547 $906,527
- --------------------------------------------------------------------------------
At December 31, 2004, the scheduled maturities of time deposits are as follows:
- --------------------------------------------------------------------------------
(in thousands)
- --------------------------------------------------------------------------------
2004 $141,412
2005 16,263
2006 15,697
2007 9,527
2008 29,091
- --------------------------------------------------------------------------------
$211,990
- --------------------------------------------------------------------------------
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 $339 million and certain qualifying
assets of the Bank collateralize the line. At December 31, 2004 and 2003, there
was $0 and $39 million, respectively, outstanding on this line of credit at a
rate of 1.06% at December 31, 2003. The Bank has availability under two
repurchase agreements to borrow up to $45 million of which $0 and $40 million
was outstanding as of December 31, 2004 and 2003, respectively, at a rate of
1.23% at December 31, 2003. The Company has $0 and $45 million in securities
pledged at December 31, 2004 and 2003, respectively, 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, 2004.
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
56
Notes to Consolidated Financial Statements
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:
- --------------------------------------------------------------------------------
Years Ended December 31,
(in thousands) 2004 2003 2002
- --------------------------------------------------------------------------------
Provision at statutory rate
on pre-tax income $4,341 $3,289 $2,905
Tax-exempt income on
loans and investments (226) (218) (76)
Other 63 47 42
- --------------------------------------------------------------------------------
$4,178 $3,118 $2,871
- --------------------------------------------------------------------------------
The components of income tax expense are as follows:
- --------------------------------------------------------------------------------
Years Ended December 31,
(in thousands) 2004 2003 2002
- --------------------------------------------------------------------------------
Current $3,470 $2,833 $2,803
- --------------------------------------------------------------------------------
Deferred 708 285 68
- --------------------------------------------------------------------------------
$4,178 $3,118 $2,871
- --------------------------------------------------------------------------------
The components of the net deferred tax assets were as follows:
- --------------------------------------------------------------------------------
December 31,
(in thousands) 2004 2003
- --------------------------------------------------------------------------------
Deferred tax assets:
Allowance for loan losses $ 2,668 $ 2,042
Unrealized losses on securities 26 0
Other 120 59
- --------------------------------------------------------------------------------
Total deferred tax assets 2,814 2,101
- --------------------------------------------------------------------------------
Deferred tax liabilities:
Premises and equipment (1,618) (1,178)
Unrealized gains on securities 0 (283)
Prepaid expenses (167) (84)
Deferred loan fees (872) 0
- --------------------------------------------------------------------------------
Total deferred tax liabilities (2,657) (1,545)
- --------------------------------------------------------------------------------
Net deferred tax assets $ 157 $ 556
- --------------------------------------------------------------------------------
Income taxes of $299,000 were recognized on net securities gains during 2003.
During 2004, 2003 and 2002, the Company received a tax benefit on its federal
income tax return totaling $319,000, $178,000, and $378,000, respectively for
the exercise of non-qualified stock options and for disqualified dispositions of
employee stock from options exercised.
12. Stockholders' Equity
- ------------------------
At December 31, 2004, 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 287,332 shares (adjusted for common
stock dividends and splits) of the Company's common stock, exercisable at $3.48
per share (adjusted for common stock dividends and splits), 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 2004 or 2003. 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 month (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 14,432 and
17,060 common shares were issued pursuant to this plan in 2004 and 2003,
respectively. At December 31, 2004,
57
Notes to Consolidated Financial Statements
the Company had reserved approximately 416,000 common shares to be issued in
connection with the plan.
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.
On September 29, 2004, the Company entered into and consummated a Stock Purchase
Agreement with Commerce Bancorp, Inc., ("Commerce of New Jersey"). Pursuant to
the Stock Purchase Agreement, Commerce of New Jersey purchased 100,000 shares of
unregistered common stock of the Company (the "Stock") for a per share price of
$45.666 and an aggregate price of $4,566,600. Pursuant to the Stock Purchase
Agreement, the per share price was equal to the average of the closing sale
prices of the Company's common stock on the NASDAQ National Market for the five
trading day period (i.e. dates in which trades occurred) ending on September 28,
2004.
On November 2, 2004, the Company completed its offering of 460,000 shares of its
common stock at $49.00 per share. The 60,000 share underwriters' option to cover
over-allotments was fully exercised, which is included in the 460,000 share
total.
On January 28, 2005, the Board of Directors declared a 2-for-1 stock split in
the form of a 100% stock dividend payable on February 25, 2005, to stockholders
of record on February 10, 2005. Payment of the stock split resulted in the
issuance of approximately 3.0 million additional common shares.
All common stock and per share data included in these financial statements have
been restated for the stock dividends and split.
13. Earnings per Share
- ----------------------
The following table sets forth the computation of basic and diluted earnings per
share.
- ------------------------------------------------------------------------------------------------------------------------------------
For the Years Ended December 31,
2004 2003 2002
(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 $8,591 $6,557 $5,674
Preferred stock dividends (80) (80) (80)
- ------------------------------------------------------------------------------------------------------------------------------------
Income available to
common stockholders 8,511 4,856 $1.75 6,477 4,506 $1.44 5,594 4,332 $1.29
- ------------------------------------------------------------------------------------------------------------------------------------
Effect of dilutive securities:
Stock options 362 330 396
- ------------------------------------------------------------------------------------------------------------------------------------
Diluted earnings per share:
Income available to
common stockholders
plus assumed conversions $8,511 5,218 $1.63 $6,477 4,836 $1.34 $5,594 4,728 $1.18
- ------------------------------------------------------------------------------------------------------------------------------------
All options outstanding were included in the computation of diluted EPS for the
years ended December 31, 2004, 2003, and 2002, respectively because the options'
exercise price was lower than the average market price of the common shares.
14. Stock Option Plans
- ----------------------
The 1996 Employee Stock Option Plan covers 1,254,738 authorized shares of common
stock reserved for issuance upon exercise of options granted or available for
grant to officers and 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
through December 16, 2004 are exercisable one year after the date of grant,
subject to certain vesting provisions, and expire ten years after the date of
grant. As a result of a plan amendment adopted on December 17, 2004, all options
granted after this date will vest evenly over a four-year period from the date
of grant.
In 2000, the Company's shareholders approved the adoption of the 2001 Directors'
Stock Option Plan. The
58
Notes to Consolidated Financial Statements
Plan covers 243,100 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 through
December 16, 2004 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. As
a result of a plan amendment adopted on December 17, 2004, all options granted
after this date will vest evenly over a four-year period from the date of grant.
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
2004, 2003, or 2002.
Stock options transactions under the Plans were as follows:
- ------------------------------------------------------------------------------------------------------------------------------------
Years Ended December 31,
2004 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Weighted Avg. Weighted Avg. Weighted Avg.
Options Exercise Price Options Exercise Price Options Exercise Price
- ------------------------------------------------------------------------------------------------------------------------------------
Outstanding at beginning of year 948,268 $11.34 884,988 $ 9.40 1,155,474 $ 8.92
Granted 178,220 25.37 187,440 17.98 29,110 17.35
Exercised (145,634) 8.28 (106,578) 6.06 (247,964) 7.02
Forfeited (35,887) 19.42 (17,582) 16.46 (51,632) 14.57
- ------------------------------------------------------------------------------------------------------------------------------------
Outstanding at end of year 944,967 $14.12 948,268 $11.34 884,988 $ 9.40
- ------------------------------------------------------------------------------------------------------------------------------------
Exercisable at December 31 731,366 $11.37
Options available for grant at December 31 428,027
Weighted-average fair value
of options granted during the year $ 8.96 $ 6.27 $ 8.97
- ------------------------------------------------------------------------------------------------------------------------------------
Exercise prices for options outstanding as of December 31, 2004 are presented in the following table.
- ------------------------------------------------------------------------------------------------------------------------------------
As of December 31, 2004
Options Weighted Avg. Weighted Avg. Options Weighted Avg.
Outstanding Exercise Price Contractual Life Exercisable Exercise Price
- ------------------------------------------------------------------------------------------------------------------------------------
Options with exercise prices
ranging from $2.09 to $9.50 244,119 $ 6.06 2.8 Years 244,119 $ 6.06
Options with exercise prices
ranging from $9.51 to $17.00 379,518 12.83 5.5 Years 367,942 12.74
Options with exercise prices
ranging from $17.01 to $25.38 321,330 21.78 9.4 Years 119,305 17.98
- ------------------------------------------------------------------------------------------------------------------------------------
Total options outstanding with exercise
prices ranging from $2.09 to $25.38 944,967 $14.12 6.1 Years 731,366 $11.37
- ------------------------------------------------------------------------------------------------------------------------------------
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. In addition,
dividends paid by the Bank to the Corporation would be prohibited if the effect
thereof would cause the Bank's capital to be reduced below applicable minimum
capital requirements.
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.
59
Notes to Consolidated Financial Statements
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, 2004, that the Company and the Bank meet all
capital adequacy requirements to which they are subject.
As of December 31, 2004, 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.
The following table presents the risk-based and leverage capital amounts and
ratios at December 31, 2004 and 2003 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, 2004
Risked based capital ratios:
Total capital $105,936 12.49% => $67,833 => 8.0% => N/A N/A
Tier 1 capital 98,090 11.57 => 33,917 => 4.0 => N/A N/A
Leverage ratio 98,090 7.79 => 50,358 => 4.0 => N/A N/A
- ------------------------------------------------------------------------------------------------------------------------------------
Bank
As of December 31, 2004
Risked based capital ratios:
Total capital $105,708 12.48% => $67,773 => 8.0% => $84,716 =>10.0%
Tier 1 capital 97,862 11.55 => 33,886 => 4.0 => 50,829 => 6.0
Leverage ratio 97,862 7.78 => 50,326 => 4.0 => 62,907 => 5.0
- ------------------------------------------------------------------------------------------------------------------------------------
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
- ------------------------------------------------------------------------------------------------------------------------------------
16. Employee Benefit Plan
- -------------------------
The Company has established a 401(k) Retirement Savings Plan for all of its
employees who meet eligibility requirements. All eligible employees may defer up
to 15% of their income on a pretax basis through contributions to the Plan. The
Company will provide a discretionary matching contribution for up to 6% of each
employee's salary. For 2004, 2003, and 2002, the Company's matching contribution
was established at 25% of the employees' salary deferral. The amount charged to
expense was $158,000, $96,000, and $98,000 in 2004, 2003, and 2002,
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
60
Notes to Consolidated Financial Statements
the unrealized gains (losses) are presented in the table below. The
reclassification adjustments included in comprehensive income are also
presented.
- --------------------------------------------------------------------------------
Years Ended December 31,
(in thousands) 2004 2003 2002
- --------------------------------------------------------------------------------
Unrealized holding
gains(losses) arising
during the year $(909) $ (831) $2,471
Less reclassification
adjustment for gains
(losses) included in
net income 0 640 0
- --------------------------------------------------------------------------------
Net unrealized gains (losses) (909) (1,471) 2,471
Tax (expense) benefit 309 500 (840)
- --------------------------------------------------------------------------------
Net of tax amount $(600) $ (971) $1,631
- --------------------------------------------------------------------------------
18. Commitments and Contingencies
- ---------------------------------
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.
The Company has purchased the land located at the corner of Friendship Road and
TecPort Drive in Swatara Township, Dauphin County, Pennsylvania. The Company is
currently constructing a Headquarters/Operations Facility, to be called Commerce
Center, on this property to be opened in 2005. Commitments related to the
construction of the Commerce Center total $1.4 million and management expects
total construction costs to be between $15.0 to $18.0 million.
The Company has purchased the parcel of land at Linglestown and Patton Roads,
Harrisburg, Dauphin County, Pennsylvania. The Company plans to construct a
full-service branch on this property to be opened in 2006.
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 11.4% 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 maintaining the
computer wide area network, proof and encoding services, account statement
rendering, ATM/VISA card processing, data processing, advertising support, and
call center support. The Company paid approximately $2.0 million, $1.4 million,
and $1.2 million for services provided by Commerce Bancorp, Inc. during 2004,
2003, and 2002, 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, 2004 and 2003, approximately $2.1 million and $2.6 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 million, which could be drawn upon if needed. The balance at
December 31, 2004 and 2003 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 $259,000, $271,000 and $557,000, in
2004, 2003 and 2002, 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.
61
Notes to Consolidated Financial Statements
As such, the estimated fair values of these financial instruments subsequent to
the respective reporting dates may be different than the amounts reported at
each year-end.
The following information should not be interpreted as an estimate of the fair
value of the entire Company since a fair value calculation is only provided for
a limited portion of the Company's assets and liabilities. Due to a wide range
of valuation techniques and the degree of subjectivity used in making the
estimates, comparisons between the Company's disclosures and those of other
companies may not be meaningful. The Company, in estimating its fair value
disclosures for financial instruments, used the following methods and
assumptions:
Cash and cash equivalents
The carrying amounts reported approximate those assets' fair value.
Securities
Fair values of securities are based on quoted market prices, where available. If
quoted market prices are not available, fair values are based on quoted market
prices of comparable instruments.
Loans Receivable
For variable-rate loans that reprice frequently and with no significant change
in credit risk, fair values are based on carrying values. The fair values for
other loans receivable were estimated using discounted cash flow analysis, using
interest rates currently being offered for loans with similar terms to borrowers
of similar credit quality. Loans with significant collectibility concerns were
fair valued on a loan-by-loan basis utilizing a discounted cash flow method or
the fair market value of the underlying collateral.
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, 2004 and 2003 are presented in the following table.
62
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------------------------------------------------------------
2004 2003
Carrying Fair Carrying Fair
(in thousands) Amount Value Amount Value
- ------------------------------------------------------------------------------------------------------------------------------------
Financial assets:
Cash and cash equivalents $ 40,910 $ 40,910 $ 37,715 $ 37,715
Securities 523,982 524,973 475,263 476,968
Loans, net (including loans held for sale) 652,783 657,033 479,101 496,026
Restricted investments in bank stock 5,716 5,716 5,227 5,227
Accrued interest receivable 5,582 5,582 4,998 4,998
- ------------------------------------------------------------------------------------------------------------------------------------
Financial liabilities:
Deposits $1,160,547 $1,162,004 $906,527 $908,618
Long-term debt 13,600 18,008 13,000 15,610
Short-term borrowings 0 0 79,000 79,000
Accrued interest payable 509 509 470 470
- ------------------------------------------------------------------------------------------------------------------------------------
Off-balance sheet instruments:
Standby letters of credit $ 0 $ 0 $ 0 $ 0
Commitments to extend credit 0 0 0 0
- ------------------------------------------------------------------------------------------------------------------------------------
21. Quarterly Financial Data (unaudited)
- ----------------------------------------
The following represents summarized unaudited quarterly financial data of the
Company which in the opinion of management, reflects adjustments (comprising
only normal recurring accruals) necessary for fair presentation (in thousands,
except per share amounts):
- ------------------------------------------------------------------------------------------------------------------------------------
Three Months Ended
December 31 September 30 June 30 March 31
- ------------------------------------------------------------------------------------------------------------------------------------
2004
Interest income $16,632 $15,638 $14,834 $13,878
Interest expense 4,539 3,755 3,193 2,910
Net interest income 12,093 11,883 11,641 10,968
Provision for loan losses 721 675 675 575
Gains on sales of investment securities 0 0 0 0
Provision for federal income taxes 1,123 1,069 1,052 934
Net income 2,284 2,198 2,181 1,928
Net income per share:
Basic $ 0.41 $ 0.47 $ 0.47 $ 0.41
Diluted 0.38 0.43 0.43 0.38
- ------------------------------------------------------------------------------------------------------------------------------------
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 $ 0.37 $ 0.33 $ 0.36 $ 0.36
Diluted 0.34 0.31 0.34 0.34
- ------------------------------------------------------------------------------------------------------------------------------------
63
Notes to Consolidated Financial Statements
22. Condensed Financial Statements of Parent Company
- ----------------------------------------------------
Balance Sheets
December 31,
(in thousands) 2004 2003
- ------------------------------------------------------------------------------------------------------------------------------------
ASSETS
Cash $324 $518
Investment in subsidiaries:
Banking subsidiary 97,811 62,256
Non-banking subsidiaries 600 600
Other assets 706 107
- ------------------------------------------------------------------------------------------------------------------------------------
Total Assets $99,441 $63,481
- ------------------------------------------------------------------------------------------------------------------------------------
LIABILITIES
Long-term debt $13,600 $13,000
Other liabilities 802 757
- ------------------------------------------------------------------------------------------------------------------------------------
Total liabilities 14,402 13,757
- ------------------------------------------------------------------------------------------------------------------------------------
STOCKHOLDERS' EQUITY
Preferred stock 400 400
Common stock 5,870 2,292
Surplus 62,790 38,725
Retained earnings 16,030 7,758
Accumulated other comprehensive loss (51) 549
- ------------------------------------------------------------------------------------------------------------------------------------
Total stockholders' equity 85,039 49,724
- ------------------------------------------------------------------------------------------------------------------------------------
Total Liabilities & Stockholders' Equity $99,441 $63,481
- ------------------------------------------------------------------------------------------------------------------------------------
Statements of Income
Years Ended December 31,
(in thousands) 2004 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Income:
Dividends from bank subsidiary $1,044 $1,396 $ 1,226
Interest income 62 62 62
- ------------------------------------------------------------------------------------------------------------------------------------
1,106 1,458 1,288
- ------------------------------------------------------------------------------------------------------------------------------------
Expenses:
Interest expense 1,418 1,418 1,416
Other 521 349 258
- ------------------------------------------------------------------------------------------------------------------------------------
1,939 1,767 1,674
- ------------------------------------------------------------------------------------------------------------------------------------
Income (loss) before income (taxes) benefit and equity
in undistributed net income of subsidiaries (833) (309) (386)
Income (taxes) benefit 638 580 548
- ------------------------------------------------------------------------------------------------------------------------------------
(195) 271 162
Equity in undistributed net income of bank subsidiary 8,786 6,286 5,512
- ------------------------------------------------------------------------------------------------------------------------------------
Net income $8,591 $6,557 $ 5,674
- ------------------------------------------------------------------------------------------------------------------------------------
64
Notes to Consolidated Financial Statements
Statements of Cash Flows
Years Ended December 31,
(in thousands) 2004 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Operating Activities:
Net Income $ 8,591 $ 6,557 $ 5,674
Adjustments to reconcile net income to
net cash provided by operating activities:
Amortization of financing costs 6 6 6
Increase in other liabilities 45 55 30
Equity in undistributed net income of bank subsidiary (8,786) (6,286) (5,512)
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash provided (used) by operating activities (144) 332 198
- ------------------------------------------------------------------------------------------------------------------------------------
Investing Activities:
Investment in bank subsidiary (27,018) (1,210) (2,610)
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash (used) by investing activities (27,018) (1,210) (2,610)
- ------------------------------------------------------------------------------------------------------------------------------------
Financing Activities:
Proceeds from common stock options exercised 982 556 1,738
Proceeds from issuance of common stock under
stock purchase plan 675 677 868
Proceeds from issuance of common stock in connection
with stock offerings 25,408 0 0
Cash dividends on preferred stock and
cash in lieu of fractional shares (97) (89) (90)
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 26,968 1,144 2,516
- ------------------------------------------------------------------------------------------------------------------------------------
Increase (decrease) in cash and cash equivalents (194) 266 104
Cash and cash equivalents at beginning of the year 518 252 148
- ------------------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 324 $ 518 $ 252
- ------------------------------------------------------------------------------------------------------------------------------------
65
Report of Independent Registered Public Accounting Firm
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, 2004 and 2003,
and the related consolidated statements of income, stockholders' equity and cash
flows for each of the years in the three-year period ended December 31, 2004.
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 the standards of the Public Company
Accounting Oversight Board (United States). 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, 2004 and 2003,
and the results of their operations and their cash flows for each of the years
in the three-year period ended December 31, 2004 in conformity with accounting
principles generally accepted in the United States of America.
/s/ Beard Miller Company LLP
Harrisburg, Pennsylvania
January 28, 2005
66