UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended JUNE 30, 1998
OR
[X] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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Commission file number 0-17455
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COMM BANCORP, INC.
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(Exact name of registrant as specified in its charter)
PENNSYLVANIA 23-2242292
- ------------------------------------------ ---------------------------------
(State or other jurisdiction (I.R.S. Employer Identification
of incorporation or organization) Number)
521 MAIN STREET, FOREST CITY, PA 18421
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (717) 785-3181
-----------------------------
(Former name, former address and former fiscal year, if changed since last
report.)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding twelve months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES[x] NO [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date: 2,205,844 AT JULY 24, 1998.
Page 1 of 41
COMM BANCORP, INC.
FORM 10-Q
JUNE 30, 1998
CONTENTS PAGE NO.
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PART I. FINANCIAL INFORMATION:
ITEM 1:
Consolidated Statements of Income and Comprehensive Income -
for the Three Months and Six Months Ended June 30, 1998 and
1997....................................................... 3
Consolidated Balance Sheets - June 30, 1998, and December 31,
1997....................................................... 4
Consolidated Statement of Changes in Stockholders' Equity
for the Six Months Ended June 30, 1998..................... 5
Consolidated Statements of Cash Flows for the Six Months
Ended June 30, 1998 and 1997............................... 6
Notes to Consolidated Financial Statements.................. 7
ITEM 2:
Management's Discussion and Analysis of Financial Condition
and Results of Operations.................................. 8
PART II. OTHER INFORMATION:
ITEMS 1-6:
Other Information.......................................... 40
Signature Page............................................. 41
COMM BANCORP, INC.
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
1998 1997 1998 1997
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
INTEREST INCOME:
Interest and fees on loans:
Taxable............................................................ $5,110 $4,946 $10,204 $ 9,741
Tax-exempt......................................................... 101 132 199 241
Interest and dividends on investment securities available-for-sale:
Taxable............................................................ 782 783 1,620 1,590
Tax-exempt......................................................... 514 513 1,031 1,038
Dividends.......................................................... 45 33 74 64
Interest on federal funds sold....................................... 202 113 284 148
------ ------ ------- -------
Total interest income............................................ 6,754 6,520 13,412 12,822
------ ------ ------- -------
INTEREST EXPENSE:
Interest on deposits................................................. 3,461 3,518 6,883 6,951
Interest on short-term borrowings.................................... 7 1
Interest on long-term debt........................................... 1 1 2 2
------ ------ ------- -------
Total interest expense........................................... 3,462 3,519 6,892 6,954
------ ------ ------- -------
Net interest income.............................................. 3,292 3,001 6,520 5,868
Provision for loan losses............................................ 105 75 210 150
------ ------ ------- -------
Net interest income after provision for loan losses.............. 3,187 2,926 6,310 5,718
------ ------ ------- -------
NONINTEREST INCOME:
Service charges, fees and commissions................................ 376 349 729 762
Litigation recovery.................................................. 250 250
------ ------ ------- -------
Total noninterest income......................................... 376 599 729 1,012
------ ------ ------- -------
NONINTEREST EXPENSE:
Salaries and employee benefits expense............................... 1,109 1,035 2,203 2,022
Net occupancy and equipment expense.................................. 305 300 657 600
Other expenses....................................................... 792 716 1,476 1,312
------
Total noninterest expense........................................ 2,206 2,051 4,336 3,934
------ ------ ------- -------
Income before income taxes........................................... 1,357 1,474 2,703 2,796
Provision for income tax expense..................................... 277 312 553 576
------ ------ ------- -------
Net income....................................................... 1,080 1,162 2,150 2,220
------ ------ ------- -------
OTHER COMPREHENSIVE INCOME:
Unrealized gains on investment securities available-for-sale......... 314 941 629 223
Income tax expense related to other comprehensive income............. 107 320 214 76
------ ------ ------- -------
Other comprehensive income, net of income tax.................... 207 621 415 147
------ ------ ------- -------
Comprehensive income............................................. $1,287 $1,783 $ 2,565 $ 2,367
====== ====== ======= =======
PER SHARE DATA:
Net income........................................................... $ 0.49 $ 0.53 $ 0.98 $ 1.01
Cash dividends declared.............................................. $ 0.07 $ 0.06 $ 0.14 $ 0.12
Average common shares................................................ 2,205,112 2,200,080 2,204,643 2,200,080
</TABLE>
See notes to consolidated financial statements.
COMM BANCORP, INC.
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1998 1997
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<S> <C> <C>
ASSETS:
Cash and due from banks............................................................. $ 11,433 $ 9,040
Federal funds sold.................................................................. 11,725 8,225
Investment securities available-for-sale............................................ 101,553 105,666
Loans, net of unearned income....................................................... 246,795 250,227
Less: allowance for loan losses................................................... 3,889 3,798
-------- --------
Net loans........................................................................... 242,906 246,429
Premises and equipment, net......................................................... 4,868 3,772
Accrued interest receivable......................................................... 2,310 2,575
Other assets........................................................................ 6,157 6,104
-------- --------
Total assets.................................................................... $380,952 $381,811
======== ========
LIABILITIES:
Deposits:
Noninterest-bearing............................................................... $ 31,739 $ 30,703
Interest-bearing.................................................................. 306,639 301,678
-------- --------
Total deposits.................................................................. 338,378 332,381
Short-term borrowings............................................................... 9,575
Long-term debt...................................................................... 42 44
Accrued interest payable............................................................ 1,781 1,714
Other liabilities................................................................... 2,297 1,995
-------- --------
Total liabilities............................................................... 342,498 345,709
-------- --------
STOCKHOLDERS' EQUITY:
Common stock, par value $0.33, authorized 12,000,000 shares, issued and outstanding:
June 30, 1998, 2,205,112 shares; December 31, 1997, 2,202,405 shares .............. 728 727
Capital surplus..................................................................... 6,480 6,385
Retained earnings................................................................... 29,231 27,390
Net unrealized gain on available-for-sale securities................................ 2,015 1,600
-------- --------
Total stockholders' equity...................................................... 38,454 36,102
-------- --------
Total liabilities and stockholders' equity...................................... $380,952 $381,811
======== ========
</TABLE>
See notes to consolidated financial statements.
COMM BANCORP, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
NET UNREALIZED TOTAL
COMMON CAPITAL RETAINED GAIN ON STOCKHOLDERS'
STOCK SURPLUS EARNINGS SECURITIES EQUITY
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<S> <C> <C> <C> <C> <C>
BALANCE, DECEMBER 31, 1997........................ $727 $6,385 $27,390 $1,600 $36,102
Net income........................................ 2,150 2,150
Dividends declared: $0.14 per share............... (309) (309)
Dividend reinvestment plan: 2,707 shares issued... 1 95 96
Net change in unrealized gain on securities....... 415 415
---- ------ ------- ------ -------
BALANCE, JUNE 30, 1998............................ $728 $6,480 $29,231 $2,015 $38,454
==== ====== ======= ====== =======
</TABLE>
See notes to consolidated financial statements.
COMM BANCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30 1998 1997
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<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income................................................................................ $ 2,150 $ 2,220
Adjustments:
Provision for loan losses............................................................... 210 150
Depreciation, amortization and accretion................................................ 594 435
Amortization of loan fees............................................................... (100) (102)
Deferred income tax (benefit) expense................................................... (26) 6
Losses (gains) on sales of other real estate............................................ 9 (50)
Changes in:
Interest receivable................................................................... 265 237
Other assets.......................................................................... (175) (287)
Interest payable...................................................................... 67 (38)
Other liabilities..................................................................... 197 276
------- -------
Net cash provided by operating activities........................................... 3,191 2,847
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from repayments of available-for-sale investment securities...................... 23,156 13,218
Purchases of available-for-sale investment securities..................................... (18,461) (8,799)
Proceeds from sale of other real estate................................................... 99 380
Net decreases (increases) in lending activities........................................... 3,209 (1,944)
Purchases of premises and equipment....................................................... (1,398) (715)
------- -------
Net cash provided by investing activities........................................... 6,605 2,140
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net changes in:
Money market, NOW, savings and noninterest-bearing accounts............................. 1,316 3,597
Time deposits........................................................................... 4,681 (427)
Short-term borrowings................................................................... (9,575)
Payments on long-term debt................................................................ (2) (1)
Proceeds from issuance of common shares................................................... 96
Cash dividends paid....................................................................... (419) (374)
------- -------
Net cash provided by (used in) financing activities................................. (3,903) 2,795
------- -------
Net increase in cash and cash equivalents........................................... 5,893 7,782
Cash and cash equivalents at beginning of year...................................... 17,265 11,032
------- -------
Cash and cash equivalents at end of period.......................................... $23,158 $18,814
======= =======
SUPPLEMENTAL DISCLOSURE:
Cash paid during the period for:
Interest................................................................................ $ 6,825 $ 6,992
Income taxes............................................................................ 521 272
Noncash items:
Transfer of loans to other real estate.................................................. 204 70
Change in net unrealized losses (gains) on available-for-sale securities................ (415) (147)
Cash dividends declared................................................................. $ 309 $ 264
</TABLE>
See notes to consolidated financial statements.
COMM BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
1. BASIS OF PRESENTATION:
The accompanying unaudited consolidated financial statements of Comm
Bancorp, Inc. and subsidiary, Community Bank and Trust Company
(collectively, the "Company") have been prepared in accordance with
generally accepted accounting principles ("GAAP") for interim financial
information and with the instructions to form 10-Q and Article 10-01 of
Regulation S-X. In the opinion of management, all normal recurring
adjustments necessary for a fair presentation of the financial position and
results of operations for the periods have been included. All significant
intercompany balances and transactions have been eliminated in the
consolidation. Prior-period amounts are reclassified when necessary to
conform with the current year's presentation.
The preparation of financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reported periods. Actual
results could differ from those estimates. For additional information and
disclosures required under GAAP, reference is made to the Company's Annual
Report on Form 10-K for the period ended December 31, 1997.
2. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES:
On June 16, 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standard ("SFAS") No. 133, "Accounting for
Derivative Instruments and Hedging Activities." This statement establishes
accounting and reporting standards for derivative instruments, including
certain derivative instruments embedded in other contracts, (collectively
referred to as derivatives) and for hedging activities. It requires that
an entity recognize all derivatives as either assets or liabilities in the
statement of financial position and measure those instruments at fair
value. The accounting for changes in the fair value of a derivative
depends on the intended use of the derivative and the resulting
designation. If certain conditions are met, a derivative may be
specifically designated as (i) a hedge of certain exposure to changes in
the fair value of a recognized asset or liability or an unrecognized firm
commitment, (ii) a hedge of the exposure to variable cash flows of a
forecasted transaction, or (iii) a hedge of the foreign currency exposures.
SFAS No. 133 is effective for fiscal years beginning after June 15, 1999,
with earlier adoption encouraged. The anticipated adoption of SFAS No. 133
on January 1, 2000, is not expected to have a material effect on operating
results or financial position as the Company has no instruments that
qualify as derivatives or hedges nor does it expect to be effected by the
provisions for potential reclassification of investment securities.
COMM BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
FORWARD-LOOKING DISCUSSION:
Certain statements in this Form 10-Q are forward-looking statements that
involve numerous risks and uncertainties. The following factors, among
others, may cause actual results to differ materially from projected
results:
Local, domestic and international economic and political conditions, and
government monetary and fiscal policies affect banking both directly and
indirectly. Inflation, recession, unemployment, volatile interest rates,
tight money supply, real estate values, international conflicts and other
factors beyond the control of Comm Bancorp, Inc. and its subsidiary,
Community Bank and Trust Company (collectively, the "Company") may also
adversely affect its future results of operations. Management, consisting
of the Board of Directors and executive officers, expects that no
particular factor will affect the Company's results of operations.
Downward trends in areas such as real estate, construction and consumer
spending, may adversely impact the Company's ability to maintain or
increase profitability. Therefore, the Company cannot assure that it will
continue its current rates of income and growth.
The Company's earnings depend largely upon net interest income. The
relationship between the Company's cost of funds, deposits and borrowings,
and the yield on its interest-earning assets, loans and investments all
influence net interest income levels. This relationship, defined as the
net interest spread, fluctuates and is affected by regulatory, economic and
competitive factors that influence: (i) interest rates; (ii) the volume,
rate and mix of interest-earning assets and interest-bearing liabilities;
and (iii) the level of nonperforming assets. As part of its interest rate
risk ("IRR") management strategy, management monitors the maturity and
repricing characteristics of interest-earning assets and interest-bearing
liabilities to control its exposure to interest rate changes.
In originating loans, some credit losses are likely to occur. This risk of
loss varies with, among other things: (i) general economic conditions;
(ii) loan type; (iii) creditworthiness and debt servicing capacity of the
borrower over the term of the loan; and (iv) in the case of a
collateralized loan, the value and marketability of the collateral securing
the loan. Management maintains an allowance for loan losses based on,
among other things: (i) historical loan loss experience; (ii) known
inherent risks in the loan portfolio; (iii) adverse situations that may
affect a borrower's ability to repay; (iv) the estimated value of any
underlying collateral; and (v) an evaluation of current economic conditions.
Management believes that the allowance for loan losses is adequate, but
there can be no assurance that nonperforming loans will not increase in the
future.
To a certain extent, the Company's success depends upon the general
economic conditions in the geographic market area that it serves. Although
the Company expects economic conditions in its market area to remain
favorable, assurance cannot be given that these conditions will continue.
Adverse changes to economic conditions in the Company's geographic market
area would likely impair its loan collections and may have a materially
adverse effect on the consolidated results of operations and financial
position.
The banking industry is highly competitive, with rapid changes in product
delivery systems and in consolidation of service providers. The Company
competes with many larger institutions in terms of asset size. These
competitors also have substantially greater technical, marketing and
financial resources. The larger size of these companies affords them the
opportunity to offer products and services not offered by the Company. The
Company is constantly striving to meet the convenience and needs of its
customers and to enlarge its customer base. The Company cannot assure that
these efforts will be successful in maintaining and expanding its customer
base.
OPERATING ENVIRONMENT:
At the close of the second quarter of 1998, the Federal Open Market
Committee ("FOMC") chose to maintain its target rate for federal funds at
5.50 percent as the potential inflationary effects of a strong economy were
neutralized by the Asian economic crisis. The last rate change instituted
by the FOMC occurred on March 25, 1997. For the second quarter of 1998,
the nation's gross domestic product ("GDP"), the value of goods and
services produced in the United States, grew at a modest rate of 1.4
percent annualized compared to the 5.4 percent surge experienced for the
first quarter. Additionally, although inflation was 1.7 percent for the
first half of 1998, consumer prices stabilized in June, rising an
immaterial 0.1 percent over May. The national unemployment rate for June
of 1998 equaled 4.5 percent, up slightly from the 28-year low of 4.3
percent reported for the first quarter of 1998. In contrast to the
national level, local unemployment fell during the second quarter of 1998.
Average unemployment for the Company's four-county market area of
Lackawanna, Susquehanna, Wayne and Wyoming counties declined to 5.6 percent
for the second quarter of 1998 from 8.2 percent during the first quarter.
This can be attributed to the historical lagging effect of the market
area's economy. A final indicator of the strong and stable national economy
was the Consumer Confidence Index. In June of 1998, this index was 137.6,
marking a high for the year and reaching a level not experienced since June
of 1969. In the absence of any strong indicators of inflationary pressure,
the FOMC is not expected to raise interest rates any time in the immediate
future. However, should the Asian economic situation show an improvement
and the United States economy experience continued growth, the FOMC may
invoke monetary policy and raise the overnight funds rate as a deterrent to
inflation.
With respect to the banking industry, financial results for the second
quarter of 1998 were fundamentally strong. Nonperforming assets ratios
remained strong in relation to the first quarter. This trend is expected
to continue under the current economic environment, as a strong United
States economy has mitigated any detrimental effects caused by the Asian
economic crisis. Reserves to total loans ratios experienced little change
compared to the first quarter of 1998. The relative stability of
nonperforming loans has kept coverage on nonperforming loans at high
levels. Capital ratios also experienced little change from the first
quarter of 1998 and were relatively flat compared to the second quarter of
1997. Compared to the levels reached in 1997, buyback activity has
declined in 1998. Such reduction is attributed to a combination of pooling
restrictions, slowed activity in trust preferred issuance and some scaling
back due to valuation. Although net interest margins continued to
constrict, strong gains in fee income more than offset the difference. The
contraction of net interest margins can be explained by a combination of
higher prepayments related to mortgage-backed investments and mortgage
loans, lower rates offered on the reinvested proceeds from these repayments
and the continued low lending rate environment. Attempts have been made
throughout the banking industry to counteract the reduced loan rates by
lowering deposit rates, however the flattening yield curve will hinder any
widening in margins. Efficiency ratios showed improvement in the second
quarter of 1998 after experiencing some adversity over the past few
quarters. This improvement is attributed to the high second quarter
revenue growth and continued realizations of merger-related cost savings.
Costs related to the Year 2000 will remain a factor for the remainder of
1998, however merger-related savings are expected to push these ratios
downward over the next few years.
The Company recorded net income of $2,150 or $0.98 per share for the first
half of 1998 as compared to $2,220 or $1.01 per share reported for the same
period of 1997. For the first six months of 1998, the Company's return on
average assets equaled 1.17 percent compared to 1.26 percent for the same
period of 1997. The Company's return on average equity equaled 11.65
percent for the six months ended June 30, 1998, compared to 14.00 percent
in 1997. The earnings decline was primarily due to the second quarter of
1997 realization of nonrecurring income of $148.5, net of applicable taxes
and fees, from a litigation settlement coupled with higher noninterest
expenses associated with the Eynon and Factoryville branch banking
facilities, which began operations in the fourth quarter of 1997.
Partially offsetting these factors was an improvement in the Company's net
interest income levels. For the first half of 1998, the Company reported
comprehensive income of $2,565 compared to $2,367 for the same period of
1997. The Company recorded $415 in comprehensive income, net of applicable
income taxes of $214, related to unrealized gains on investment securities
during the first six months of 1998. For the same period of 1997, the
Company recorded $147 in comprehensive income, net of applicable income
taxes of $76, related to unrealized gains on investment securities.
REVIEW OF FINANCIAL POSITION:
The Company's total assets declined $800 from $381.8 million at December
31, 1997, to $381.0 million at June 30, 1998. This decrease is due to
lower investment and loan volumes partially offset by an increase in
federal funds sold volumes. Investments at June 30, 1998, equaled $101.6
million, a $4.1 million decline compared to the $105.7 million reported at
December 31, 1997. Loans, net of unearned income decreased $3.4 million
from $250.2 million at December 31, 1997, to $246.8 million at June 30,
1998. Such reduction was due to the maturity of $7.0 million of short-term
loans to certain large Pennsylvania-based commercial banks during the first
quarter of 1998. Adjusting for these credits, loan volume grew at an
annualized rate of 3.0 percent during the first half of 1998. At June 30,
1998, the Company's investment in overnight funds equaled $11.7 million, a
$3.5 million increase over the $8.2 million recorded at December 31, 1997.
During the first half of 1998, the Company experienced improvements in
asset quality as evidenced by a reduction in the nonperforming assets to
loans, net ratio from 2.41 percent at year-end 1997 to 1.63 percent at June
30, 1998. The Company's capital position remained strong as its Leverage
ratio equaled 8.9 percent at June 30, 1998, as compared to 8.6 percent at
December 31, 1997. Stockholders' equity increased $2,352 for the first six
months of 1998 as net income of $2,150 coupled with an increase of $415 in
the net gain on available-for-sale investment securities was partially
offset by cash dividends distributed to stockholders of $213.
During the second quarter of 1998, the Company's total assets grew $10.6
million, an annualized rate of 11.5 percent. Loans grew $4.9 million while
deposits increased $9.3 million from March 31, 1998, to June 30, 1998.
Total stockholders' equity increased $1.2 million during the second quarter
of 1998, due to the Company's second quarter net income and an improvement
in the unrealized gain in the investment portfolio.
INVESTMENT PORTFOLIO:
The yield curve remained flat during the second quarter of 1998 as
evidenced by a 19 basis point difference in the yield on the one and ten
year U.S. Treasury securities. Investing continued to be treacherous for
portfolio managers as the yield on overnight funds exceeded that of the ten
year U.S. Treasury at the end of the second quarter.
The Company's investment portfolio accounted for 28.2 percent of its total
earning assets at June 30, 1998. This percentage was below the 29.0
percent at December 31, 1997, and the 28.5 percent recorded at June 30,
1997. As a result of having to operate in an interest rate environment
that does not compensate investors for extending, management chose to
continue building its short-term portion of its portfolio in conformity
with a "barbell" investment strategy approach. Such short-term investments
combined with the Company's existing portion of intermediate-term state and
municipal obligations should assist in mitigating the effects of interest
rate fluctuation on the portfolio's total return. At June 30, 1998,
intermediate-term state and municipal obligations totaled $39.9 million or
39.3 percent of total investments with short-term mortgage-backed
securities ("MBS") accounting for $33.4 million or 33.5 percent of total
investments. Excess funds not invested into short-term MBS were kept in
overnight federal funds to solidify the Company's liquidity in order to
adequately satisfy loan demand.
At June 30, 1998, the Company reported a net unrealized gain on available-
for-sale securities of $3,053, net of income taxes of $1,038. The nation's
growth rate, while remaining strong, moderated during the second quarter of
1998 in the midst of the Asian economic turmoil. This moderation prompted
the FOMC to maintain short-term interest rates at 5.50 percent. As a
result of this decision, short-term and long-term interest rates have
remained relatively unchanged from the year-end 1997 levels. This stable
interest rate environment coupled with a reduction in the portfolio's
effective duration led to a $415 positive change in the net unrealized gain
during the first half of 1998.
Should an upturn in the Asian economy occur, the United States economic
growth would probably surge during the remainder of 1998. These events
would likely cause the FOMC to invoke monetary policy, raising interest
rates and adversely effecting the market value of the investment portfolio.
The Company's Investment Committee continually monitors interest rate
changes and their effects on the value of the investment portfolio.
The carrying values of the major classifications of securities as they
relate to the total investment portfolio at June 30, 1998, and December 31,
1997, are summarized as follows:
DISTRIBUTION OF INVESTMENT SECURITIES AVAILABLE-FOR-SALE
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1998 1997
---------------- ----------------
AMOUNT % AMOUNT %
- ----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
U.S. Treasury securities........................ $ 18,570 18.29% $ 28,583 27.05%
U.S. Government agencies........................ 5,131 5.05 10,388 9.83
State and municipals............................ 39,882 39.27 39,887 37.75
Mortgage-backed securities...................... 33,993 33.47 23,746 22.47
Equity securities............................... 3,977 3.92 3,062 2.90
-------- ------ -------- ------
Total......................................... $101,553 100.00% $105,666 100.00%
======== ====== ======== ======
</TABLE>
The tax-equivalent yield on the investment portfolio was 7.0 percent during
the second quarter of 1998, an increase as compared to the 6.8 percent
yield recorded during the previous quarter. Securities repayments for the
first half of 1998 totaled $23.2 million. Of these repayments, the Company
used $3.0 million to purchase short-term U.S. Treasury securities, $1.5
million to purchase state and municipal securities, $13.8 million to
purchase short-term MBS and $134 to purchase equity securities. The
remaining $4.8 million was used to purchase overnight federal funds as well
as to satisfy loan demand. Unless interest rates change significantly
during the remainder of 1998, management expects to continue investing most
of its excess funds not used in lending into short-term U.S. Government
agencies, MBS and overnight funds.
The maturity distribution of the amortized cost, fair value and weighted-
average, tax-equivalent yield of the available-for-sale portfolio at June
30, 1998, are summarized in the table that follows. The weighted-average
yield, based on amortized cost, has been computed for state and municipals
on a tax-equivalent basis using the statutory tax rate of 34.0 percent.
The distributions are based on contractual maturity with the exception of
MBS and equity securities. MBS have been presented based upon estimated
cash flows, assuming no change in the current interest rate environment.
Equity securities with no stated contractual maturities are included in the
after ten year maturity distribution. Expected maturities may differ from
contractual maturities because borrowers have the right to call or prepay
obligations with or without call or prepayment penalties.
MATURITY DISTRIBUTION OF AVAILABLE-FOR-SALE PORTFOLIO
<TABLE>
<CAPTION>
AFTER ONE AFTER FIVE
WITHIN BUT WITHIN BUT WITHIN AFTER
ONE YEAR FIVE YEARS TEN YEARS TEN YEARS TOTAL
-----------------------------------------------------------------------------
JUNE 30, 1998 AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Amortized cost:
U.S. Treasury securities..... $15,015 5.87% $ 3,516 5.63% $18,531 5.82%
U.S. Government agencies..... 4,500 4.83 648 3.95 5,148 4.72
State and municipals......... 1,050 6.17 6,474 6.78 $6,848 8.91% $24,093 8.19% 38,465 8.02
Mortgage-backed securities... 14,466 6.47 19,335 6.17 237 6.35 34,038 6.30
Equity securities............ 2,318 6.41 2,318 6.41
------- ------- ------ ------- -------
Total...................... $35,031 5.99% $29,973 6.19% $7,085 8.82% $26,411 8.03% $98,500 6.80%
======= ======= ====== ======= =======
Fair value:
U.S. Treasury securities..... $15,050 $ 3,520 $18,570
U.S. Government agencies..... 4,496 635 5,131
State and municipals......... 1,052 6,534 $7,212 $25,084 39,882
Mortgage-backed securities... 14,440 19,315 238 33,993
Equity securities............ 3,977 3,977
------- ------- ------ ------- --------
Total...................... $35,038 $30,004 $7,450 $29,061 $101,553
======= ======= ====== ======= ========
</TABLE>
Effective May 26, 1998, the Federal Financial Institutions Examination
Council ("FFIEC") Supervisory Policy Statement on Investment Securities and
End-User Derivatives Activities went into effect replacing the Supervisory
Policy Statement on Securities Activities published February 3, 1992. This
new statement is designed to ensure that bank management and Board of
Directors know of the risk levels in investment portfolios and in new
securities purchases as well as how these risks may impact the balance
sheet. The statement also places the burden of establishing procedures to
identify, measure, monitor and control portfolio risks on the bank's
management. This means that each financial institution, while not required
to change risk profiles, must determine the level and character of risks
they will and can assume. Regulators require institutions to address two
main directives in their internal procedures. First, risk assessment must
be viewed. Under the new policy, institutions must address market, credit,
liquidity, legal and operational risk when formulating their procedures.
Each institution must also institute a risk management process to identify,
measure, monitor and control risk. Once the financial institutions have
these policies in place, regulators will evaluate each institution's
effectiveness in complying with its own procedures.
LOAN PORTFOLIO:
Other than major money center financial institutions that invest more of
their loan portfolios into commercial activities, loans to finance one-to-
four family residential properties account for the predominant portion of
bank lending activities. The housing market and the economic conditions
that affect it are particularly significant to the Company's current and
future financial viability as residential mortgage lending accounts for
approximately two-thirds of its aggregate lending activities.
After three consecutive months of decline, housing starts throughout the
United States recovered in June of 1998 as they rose by 5.6 percent
compared to May of 1998. For June, new home and apartment constructions
rose to a seasonally-adjusted annual rate of 1.6 million homes with all
regions, except for the Northeast, sharing in the gain. This increase in
housing starts for June was attributable to low mortgage interest rates,
high consumer confidence and strong job income and growth. Mortgage rates
have been favorable for consumers as the interest rate on 30-year mortgages
was 7.0 percent at June 30, 1998. This is a significant improvement over
the 7.5 percent 30-year mortgage rate at June 30, 1997. In June, the
nation's consumer confidence index reached 137.6, its highest level in 29
years. Additionally, the 4.5 percent unemployment rate and a 4.2 percent
increase in hourly wages compared to a year ago produced a favorable
environment for housing starts. The June rebound and the effects of an
unseasonably mild first quarter of 1998 accounted for a 10.3 percent
increase in housing starts for the first half of 1998 as compared to the
same period of 1997.
The composition of the Company's loan portfolio at June 30, 1998, and
December 31, 1997, is summarized as follows:
DISTRIBUTION OF LOAN PORTFOLIO
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1998 1997
AMOUNT % AMOUNT %
- ----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Commercial, financial and others.......... $ 30,489 12.35% $ 38,996 15.58%
Real estate:
Construction............................ 2,222 0.90 2,096 0.84
Mortgage................................ 184,524 74.77 180,123 71.98
Consumer, net............................. 29,560 11.98 29,012 11.60
-------- ------ -------- ------
Loans, net of unearned income........... 246,795 100.00% 250,227 100.00%
====== ======
Less: allowance for loan losses........... 3,889 3,798
-------- --------
Net loans............................. $242,906 $246,429
======== ========
</TABLE>
The Company experienced a $3.4 million, or 2.8 percent annualized, decline in
loan volumes for the six months ended June 30, 1998. The primary reason for
the decrease was an $8.5 million decline in commercial loan volumes as $7.0
million in aggregate short-term loans to certain large Pennsylvania-based
banks matured during the first quarter of 1998. As a percentage of total
loans, net of unearned income, loans secured by residential properties
accounted for 60.2 percent at June 30, 1998. Loan volumes for the Company
averaged $245.8 million during the first half of 1998 compared to $238.2
million during the same period of 1997. The loan portfolio's tax-equivalent
yield remained constant equaling 8.6 percent during the first half of 1997
and 1998. This yield, however, falls below the 8.8 percent experienced by
the Company's peer group of 35 banks in Northeastern Pennsylvania. This
variance was mainly attributed to the Company's implementation of pricing
strategies in light of increased competition and a general reduction in
lending rates. Management does not anticipate any wide fluctuations in loan
yields for the remainder of 1998 if market rates remain stable and
competition does not intensify. Management took a major step in alleviating
competitive pressures during the second quarter, as it implemented a program
to sell one-to-four family residential mortgage loans on the secondary
market. This program allows the Company to offer more competitive interest
rates on these types of loans. Many financial institutions relinquish
servicing of mortgages upon their sales, however, the Company has chosen to
maintain servicing the loan internally for customer convenience. The Company
expects to facilitate loan demand through core deposit increases and loan and
investment repayments.
Management continually examines the maturity distribution and interest rate
sensitivity of the loan portfolio in an attempt to limit IRR and liquidity
strains. Approximately 30.5 percent of the lending portfolio is expected to
reprice within the next twelve months. Management will price loan products
in the near term in order to reduce the average term of fixed-rate loans and
increase its holdings of variable-rate loans in attempting to reduce IRR in
the loan portfolio.
The maturity and repricing information of the loan portfolio by major
category at June 30, 1998, is summarized as follows:
MATURITY DISTRIBUTION AND INTEREST SENSITIVITY OF LOAN PORTFOLIO
<TABLE>
<CAPTION>
AFTER ONE
WITHIN BUT WITHIN AFTER
JUNE 30, 1998 ONE YEAR FIVE YEARS FIVE YEARS TOTAL
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Maturity schedule:
Commercial, financial and others..... $15,445 $ 9,092 $ 5,952 $ 30,489
Real estate:
Construction....................... 2,222 2,222
Mortgage........................... 22,524 54,664 107,336 184,524
Consumer, net........................ 10,205 15,206 4,149 29,560
------- ------- -------- --------
Total............................ $50,396 $78,962 $117,437 $246,795
======= ======= ======== ========
Repricing schedule:
Predetermined interest rates......... $27,536 $69,332 $102,287 $199,155
Floating or adjustable interest rates 47,640 47,640
------- ------- -------- --------
Total............................ $75,176 $69,332 $102,287 $246,795
======= ======= ======== ========
</TABLE>
ASSET QUALITY:
National, Pennsylvania and market area unemployment rates at June 30, 1998
and 1997, are summarized as follows:
<TABLE>
<CAPTION>
JUNE 30, 1998 1997
- --------------------------------------------------------------------------------------
<S> <C> <C>
United States......................................................... 4.5% 5.0%
Pennsylvania.......................................................... 4.3 5.3
Lackawanna county..................................................... 5.6 7.7
Susquehanna county.................................................... 4.1 7.3
Wayne county.......................................................... 4.9 7.4
Wyoming county........................................................ 6.3% 7.2%
</TABLE>
National unemployment at June 30, 1998, was 4.5 percent while unemployment
for the Commonwealth of Pennsylvania equaled 4.3 percent. For the
Company's market area, unemployment rates, with the exception of
Susquehanna county, remained above those experienced by the nation and the
Commonwealth. All counties in the Company's market area did, however,
follow the national and Commonwealth trends of lower unemployment rates.
These improved economic conditions are reflected in the Company's
nonperforming asset levels. At June 30, 1998, the Company's nonperforming
asset volumes equaled $4,026 or 1.6 percent of loans, net of unearned
income, a $2,009 decline from the $6,035 or 2.4 percent of loans, net of
unearned income, at December 31, 1997. The major components of this
improvement were declines in accruing loans past due 90 days or more and
nonaccrual loans.
Information concerning nonperforming assets at June 30, 1998, and December
31, 1997, is summarized in the following table. The table includes loans or
other extensions of credit classified for regulatory purposes and all
material loans or other extensions of credit that cause management to have
serious doubts as to the borrowers' ability to comply with present loan
repayment terms.
DISTRIBUTION OF NONPERFORMING ASSETS
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1998 1997
- --------------------------------------------------------------------------------------
<S> <C> <C>
Nonaccrual loans:
Commercial, financial and others............................... $ 170 $ 197
Real estate:
Construction.................................................
Mortgage..................................................... 1,171 2,063
Consumer, net.................................................. 24 12
------ ------
Total nonaccrual loans..................................... 1,365 2,272
------ ------
Restructured loans............................................. 181 189
------ ------
Total impaired loans....................................... 1,546 2,461
------ ------
Loans past due 90 days or more:
Commercial, financial and others............................... 271 321
Real estate:
Construction.................................................
Mortgage..................................................... 1,465 2,536
Consumer, net.................................................. 243 312
------ ------
Total loans past due 90 days or more....................... 1,979 3,169
------ ------
Total nonperforming loans.................................. 3,525 5,630
------ ------
Foreclosed assets.............................................. 501 405
------ ------
Total nonperforming assets................................. $4,026 $6,035
====== ======
Ratios:
Impaired loans as a percentage of loans, net................... 0.63% 0.98%
Nonperforming loans as a percentage of loans, net.............. 1.43 2.25
Nonperforming assets as a percentage of loans, net............. 1.63% 2.41%
</TABLE>
Accruing loans past due 90 days or more improved $1,190 from $3,169 at
December 31, 1997, to $1,979 at June 30, 1998. Much of this improvement is
due to the Company's increased collection efforts. There was also an
improvement in the Company's nonaccrual loan levels. At June 30, 1998, the
Company's nonaccrual loan volumes equaled $1,365, a $907 decline from the
$2,272 reported at December 31, 1997. This positive change is almost
entirely related to one commercial loan that was restored to accrual status
during the first quarter of 1998 based on the customer's efforts to bring
the loan current with respect to principal and interest as well as to
comply with the contracted loan terms.
In comparison to the $4,085 in nonperforming assets recorded at March 31,
1998, the Company's nonperforming asset levels at June 30, 1998, remain
relatively unchanged. Despite this unvarying volume, the Company's ratio
of nonperforming assets to loans, net of unearned income, experienced a
slight improvement from 1.69 percent to 1.63 percent at June 30, 1998.
The same ratio for the Company's peer group equaled 1.23 percent at June
30, 1998. Based on the improving local economy and more stringent
collection efforts, management expects additional improvement in its
nonperforming loan levels for the second half of 1998. However, should
there be a downturn in the local economic conditions, nonperforming asset
levels may deteriorate as borrowers' ability to make timely loan payments
may be hindered.
Information relating to the Company's recorded investment in impaired loans
at June 30, 1998, and December 31, 1997, is summarized as follows:
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1998 1997
- ---------------------------------------------------------------------------------------
<S> <C> <C>
Impaired loans:
With a related allowance....................................... $1,365 $2,272
With no related allowance...................................... 181 189
------ ------
Total........................................................ $1,546 $2,461
====== ======
</TABLE>
Impaired loans include a $181 restructured loan to one commercial customer.
This loan continued to perform in accordance with its modified terms during
the first half of 1998.
The analysis of changes affecting the allowance for loan losses related to
impaired loans at June 30, 1998, is summarized as follows:
<TABLE>
<CAPTION>
JUNE 30,
1998
- ---------------------------------------------------------------------------------------
<S> <C>
Balance at January 1.............................................................. $541
Provision for loan losses......................................................... 2
Loans charged-off................................................................. 52
Loans recovered................................................................... 8
----
Balance at period-end............................................................. $499
====
</TABLE>
Interest income on impaired loans that would have been recognized had the
loans been current and the terms of the loan not been modified, the
aggregate amount of interest income recognized and the amount recognized
using the cash-basis method and the average recorded investment in impaired
loans for the three-month and six-month periods ended June 30, 1998 and
1997, are summarized as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
1998 1997 1998 1997
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Gross interest due under terms................. $ 54 $ 32 $ 88 $ 66
Interest income recognized..................... 44 1 64 4
------ ------ ------ ------
Interest income not recognized................. $ 10 $ 31 $ 24 $ 62
====== ====== ====== ======
Interest income recognized (cash-basis)........ $ 44 $ 1 $ 64 $ 4
Average recorded investment in impaired loans. $2,382 $1,516 $2,365 $1,501
</TABLE>
Cash received on impaired loans applied as a reduction of principal totaled
$210 for the six months ended June 30, 1998, and $119 for the same period
of 1997. For the quarter ended June 30, 1998, cash receipts on impaired
loans equaled $167 as compared to $45 for the quarter ended June 30, 1997.
No commitments to extend additional funds to these parties existed at June
30, 1998. For the Company's peer group, the impaired loans as a percentage
of loans, net of unearned income, ratio equaled 0.76 percent while its
nonperforming loans as a percentage of loans, net of unearned income, ratio
was 1.23 percent at June 30, 1998.
The allowance for loan losses account is established through charges to
earnings as a provision for loan losses. Loans, or portions of loans,
determined to be uncollectible are charged against the allowance account
with any subsequent recoveries being credited to the account. Nonaccrual,
restructured and large delinquent commercial and real estate loans are
reviewed monthly to determine if carrying value reductions are warranted.
Consumer loans are considered losses when they are 120 days past due,
except those expected to be recovered through insurance or collateral
disposition proceeds. Under Statement of Financial Accounting Standards
("SFAS") No. 114, "Accounting by Creditors for Impairment of a Loan," the
allowance for loan losses related to impaired loans is based on discounted
cash flows using the loan's initial effective interest rate or the fair
value of the collateral for certain collateral-dependent loans. Management
uses historical loss experience as a starting point for evaluating the
adequacy of the Company's allowance account. However, it also considers a
number of relevant factors that would likely cause estimated credit losses
associated with the Company's current portfolio to differ from historical
loss experience. These factors include, among others, changes in: (i)
lending policies and procedures; (ii) economic conditions; (iii) nature and
volume of the portfolio; (iv) loan review system; (v) volumes of past due
and classified loans; (vi) concentrations; (vii) borrowers' financial
status; and (viii) collateral value.
In addition to management's assessment, various regulatory agencies, as an
integral part of their routine annual examination process, review the
Company's allowance for loan losses. These agencies may require the
Company to recognize additions to the allowance, beyond normal monthly
provisions, based on their judgments concerning information available to
them at the time of their examination. No such charge was deemed necessary
upon the conclusion of the latest examination during the third quarter of
1997, as regulators considered the Company's allowance for loan losses
account adequate based on risk characteristics and size of the loan
portfolio. Upon reviewing the 1997 report, management was unaware of any
significant recommendation with respect to the loan portfolio that would
materially affect future liquidity or capital resources.
Management utilizes the federal banking regulatory agencies' Interagency
Policy Statement on the Allowance for Loan and Lease Losses in assessing
the adequacy of its allowance for loan losses account. The policy
statement provides guidance on the nature and purpose of the allowance,
related responsibilities of management and examiners, loan review systems
and international transfer risk matters. The analytical tool for assessing
the reasonableness of the allowance for loan losses account included in
this policy statement has been used on a consistent basis by the Company
since the first quarter of 1994. The tool involves a comparison of the
reported loss allowance against the sum of specified percentages, based on
industry averages, applied to certain loan classifications. Management
considered the Company adequately reserved at June 30, 1998, based on the
results of this regulatory calculation. Management, however, will continue
to perform a thorough analysis of the Company's loan portfolio since the
calculation does not take into account differences between institutions,
their portfolios, and their underwriting, collection and credit-rating
policies.
The allowance for loan losses can generally absorb losses throughout the
loan portfolio, although in some instances allocation is made for specific
loans or groups of loans. Accordingly, the following table attempts to
allocate this reserve among the major categories. However, it should not
be interpreted as an indication that charge-offs in future periods will
occur in these amounts or proportions, or that the allocation indicates
future charge-off trends:
DISTRIBUTION OF ALLOWANCE FOR LOAN LOSSES
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1998 1997
--------------- --------------
CATEGORY CATEGORY
AS A AS A
% OF % OF
AMOUNT LOANS AMOUNT LOANS
- --------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Commercial, financial and others................... $1,360 12.35% $1,322 15.58%
Real estate:
Construction..................................... 0.90 0.84
Mortgage......................................... 1,290 74.77 1,277 71.98
Consumer, net...................................... 1,239 11.98 1,199 11.60
------ ------ ------ ------
Total.......................................... $3,889 100.00% $3,798 100.00%
====== ====== ====== ======
</TABLE>
A reconciliation of the allowance for loan losses and an illustration of
charge-offs and recoveries by major loan category for the six months ended
June 30, 1998, is summarized as follows:
RECONCILIATION OF ALLOWANCE FOR LOAN LOSSES
<TABLE>
<CAPTION>
JUNE 30,
1998
- --------------------------------------------------------------------------------------
<S> <C>
Allowance for loan losses at beginning of period............................... $3,798
Loans charged-off:
Commercial, financial and others............................................... 103
Real estate:
Construction.................................................................
Mortgage..................................................................... 51
Consumer, net.................................................................. 91
------
Total...................................................................... 245
------
Loans recovered:
Commercial, financial and others............................................... 53
Real estate:
Construction.................................................................
Mortgage..................................................................... 34
Consumer, net.................................................................. 39
------
Total...................................................................... 126
------
Net loans charged-off.......................................................... 119
------
Provision charged to operating expense......................................... 210
------
Allowance for loan losses at end of period..................................... $3,889
======
Ratios:
Net loans charged-off as a percentage of average loans outstanding............ 0.05%
Allowance for loan losses as a percentage of period end loans................. 1.58%
</TABLE>
At June 30, 1998, the allowance for loan losses account was $3,889 and
equaled 1.58 percent of loans, net of unearned income, as compared to
$3,885 and 1.61 percent of loans, net of unearned income, at March 31,
1998. The allowance remained relatively unchanged compared to the first
quarter of 1998 as a $101 increase in net chargeoffs for the quarter was
offset by the Company's continued monthly provisions to the account. With
respect to nonperforming loans, the allowance account covered 110.3 percent
at June 30, 1998, and 107.4 percent at March 31, 1998. Relative to all
nonperforming assets, the allowance account covered 96.6 percent at June
30, 1998, and 95.1 percent at March 31, 1998. For the Company's peer
group, the allowance covered 113.4 percent of all nonperforming assets.
The Company evaluates past due loans that have not been satisfied through
repossession, foreclosure or related actions, individually to determine if
all or part of the outstanding balance should be charged against the
allowance for loan losses account. Any subsequent recoveries are credited
to the allowance account. Net chargeoffs for the six months ended June 30,
1998, totaled $119 compared to net chargeoffs of $222 for the same period
of 1997.
DEPOSITS:
The average amount of, and the rate paid on, the major classifications of
deposits for the six months ended June 30, 1998, and June 30, 1997, are
summarized as follows:
DEPOSIT DISTRIBUTION
<TABLE>
<CAPTION>
JUNE 30, JUNE 30,
1998 1997
----------------- -----------------
AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE RATE BALANCE RATE
- --------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Interest-bearing:
Money market accounts....................... $ 16,773 3.03% $ 15,765 3.06%
NOW accounts................................ 20,825 2.18 18,218 2.16
Savings accounts............................ 64,237 2.61 65,583 3.03
Time less than $100......................... 174,689 5.64 161,314 5.70
Time $100 or more........................... 23,477 5.91 32,193 6.09
-------- --------
Total interest-bearing.................... 300,001 4.63% 293,073 4.78%
Noninterest-bearing......................... 30,754 26,610
-------- --------
Total deposits............................ $330,755 $319,683
======== ========
</TABLE>
The Company's deposit volumes at June 30, 1998, totaled $338.4 million, a
$9.4 million increase compared to the $329.0 million recorded at March 31,
1998. This marked a reversal from the $3.4 million decline experienced in
the first quarter of 1998. This turnaround was primarily due to increases
in commercial interest checking accounts and time deposits $100 or more
held by local school districts. The Company's deposit volumes averaged
$330.8 million for the first half of 1998, as compared to $319.7 million
for the same period of 1997. The cost of interest-bearing deposits
declined to 4.63 percent for the six months ended June 30, 1998, compared
to 4.78 percent for the same period in 1997. This improvement was a result
of the Company's continuing effort to bring funds costs to a more
acceptable level through pricing strategies. The Company may experience a
negative effect on its cost of funds for the second half of 1998 related to
competitive pressures, however these pressures may be alleviated by the
Company's fixed-rate annuity program that was implemented during the fourth
quarter of 1997.
Through building its noninterest-bearing deposit base, the Company can
reduce its funds cost. Average volumes of noninterest-bearing deposits
increased from $26.6 million for the six months ended June 30, 1997, to
$30.8 million for the comparable period of 1998. As a percentage of average
aggregate deposits, such deposits accounted for 9.3 percent during the
first half of 1998 compared to 8.3 percent for the same period in 1997.
Volatile deposits, time deposits in denominations of $100 or more,
increased from $20.8 million at December 31, 1997, to $25.6 million at June
30, 1998. The primary source of this increase is related to the
aforementioned school district deposits. The Company's average cost of
these deposits declined slightly to 5.9 percent for the first half of 1998
from 6.1 percent for the same period of 1997.
Maturities of time deposits of $100 or more for June 30, 1998, and December
31, 1997, are summarized as follows:
MATURITY DISTRIBUTION OF TIME DEPOSITS OF $100 OR MORE
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1998 1997
- ---------------------------------------------------------------------------------------
<S> <C> <C>
Within three months......................................... $ 5,343 $ 3,195
After three months but within six months.................... 6,484 2,819
After six months but within twelve months................... 6,065 6,334
After twelve months......................................... 7,673 8,484
------- -------
Total..................................................... $25,565 $20,832
======= =======
</TABLE>
INTEREST RATE SENSITIVITY:
Interest rate sensitivity management attempts to limit and, to the extent
possible, control the effects interest rate fluctuations have on net
interest income. The responsibility of this management has been delegated
to the Asset/Liability Management Committee ("ALCO"). Specifically, ALCO
utilizes a number of computerized modeling techniques to monitor and
attempt to control influences that market changes have on the Company's
rate-sensitive assets and liabilities. One such technique utilizes a
static gap report, which attempts to measure the Company's interest rate
exposure by calculating the net amount of rate-sensitive assets ("RSA") and
rate-sensitive liabilities ("RSL") that reprice within specific time
intervals. A positive gap, indicated by a RSA/RSL ratio greater than 1.0,
implies that earnings will be impacted favorably if interest rates rise and
adversely if interest rates fall during the period. A negative gap, a
RSA/RSL ratio less than 1.0, tends to indicate that earnings will be
affected inversely to interest rate changes.
The Company's interest rate sensitivity gap position, illustrating RSA and
RSL at their related carrying values, is summarized in the table that
follows. The distributions in the table are based on a combination of
maturities, call provisions, repricing frequencies and prepayment patterns.
Variable-rate assets and liabilities are distributed based on the repricing
frequency of the instrument. Mortgage instruments are distributed in
accordance with estimated cash flows, assuming there is no change in the
current interest rate environment.
INTEREST RATE SENSITIVITY
<TABLE>
<CAPTION>
DUE AFTER DUE AFTER
THREE MONTHS ONE YEAR
DUE WITHIN BUT WITHIN BUT WITHIN DUE AFTER
JUNE 30, 1998 THREE MONTHS TWELVE MONTHS FIVE YEARS FIVE YEARS TOTAL
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Rate sensitive assets:
Investment securities............... $ 8,406 $ 26,632 $ 30,004 $ 36,511 $101,553
Loans, net of unearned income....... 52,365 22,811 69,332 102,287 246,795
Federal funds sold.................. 11,725 11,725
------- -------- -------- --------- --------
Total............................. $72,496 $ 49,443 $ 99,336 $ 138,798 $360,073
======= ======== ======== ========= ========
Rate sensitive liabilities:
Money market accounts............... $ 17,383 $ 17,383
NOW accounts........................ 22,597 22,597
Savings accounts.................... $ 64,819 64,819
Time deposits less than $100........ $33,803 53,963 88,099 $ 410 176,275
Time deposits $100 or more.......... 5,343 12,549 7,673 25,565
Long-term debt...................... 1 1 8 32 42
------- -------- -------- --------- --------
Total............................. $39,147 $106,493 $160,599 $ 442 $306,681
======= ======== ======== ========= ========
Rate sensitivity gap:
Period............................ $33,349 $(57,050) $(61,263) $ 138,356
Cumulative........................ $33,349 $(23,701) $(84,964) $ 53,392 $ 53,392
RSA/RSL ratio:
Period............................ 1.85 0.46 0.62 314.02
Cumulative........................ 1.85 0.84 0.72 1.17 1.17
</TABLE>
At June 30, 1998, the Company's one year RSA/RSL ratio improved to 0.84
compared to 0.82 at March 31, 1998. Based upon the Company's
Asset/Liability Management Policy guidelines, this ratio falls within the
0.7 and 1.3 deemed by management to be acceptable. Larger volumes of
investments and loans maturing or repricing within one year partially
offset by increases in time deposits less than $100 and time deposits $100
or more maturing or repricing in the same timeframe were the major factors
influencing this improvement. The Company's investments maturing or
repricing within one year increased $11.8 million at June 30, 1998,
compared to March 31, 1998. Proceeds from maturing investments were
reinvested into short-term MBS of U.S. Government agencies in order to
better position the Company to fund future loan demand. The Company also
experienced an increase in loans maturing or repricing within one year. At
June 30, 1998, the Company had $75.2 million in loans scheduled to mature
or reprice within one year. This marks a $6.5 million increase over the
$68.7 million reported at March 31, 1998. Continued favorable borrowing
conditions led the Company to shift excess funds not used for investment
purchases into shorter-term loans in order to satisfy demand. As a partial
offset to the positive investment and loan effects, the Company experienced
increases in time deposits less than $100 and time deposits $100 or more
maturing or repricing within one year. The total increase in certificate
of deposit products at June 30, 1998, compared to March 31, 1998, equaled
$10.6 million. With the narrowing margin between long-term and short-term
interest rates, prevalent since the early part of 1997, customers began to
chose more liquidity in their investing while sacrificing little return.
The Company's three-month ratio also improved, rising to 1.85 at June 30,
1998, from 1.81 at March 31, 1998. This change is explained by increases
of $1.5 million in investment securities and $2.1 million in loans coupled
with a decrease of $1.5 million in time deposits less than $100.
According to the results of the static gap report, the Company was
liability rate-sensitive for the cumulative one-year period. This
indicates that should general market rates increase, the likelihood exists
that net interest income would be adversely affected. Conversely, a
decline in general market rates would likely have a favorable effect on net
interest income. However, these forward-looking statements are qualified
in the aforementioned section entitled "Forward-Looking Discussion" in this
Management's Discussion and Analysis.
Static gap analysis, although a credible measuring tool, does not fully
illustrate the impact of interest rate changes on future earnings. First,
market rate changes normally do not equally or simultaneously affect all
categories of assets and liabilities. Second, assets and liabilities that
can contractually reprice within the same period may not do so at the same
time or to the same magnitude. Third, the interest rate sensitivity table
presents a one-day position. Variations occur daily as the Company adjusts
its rate sensitivity throughout the year. Finally, assumptions must be
made in constructing such a table. For example, the conservative nature of
the Company's Asset/Liability Management Policy assigns money market and
NOW accounts to the due after three but within twelve months repricing
interval. In reality, these items may reprice less frequently and in
different magnitudes than changes in general interest rate levels.
As the static gap report fails to address the dynamic changes in the
balance sheet composition or prevailing interest rates, the Company
enhances its asset/liability management by using a simulation model. This
model is used to create pro forma net interest income scenarios under
various interest rate shocks. Model results at June 30, 1998, produced
results contrary to those indicated by the one-year static gap position.
Should a parallel and instantaneous rise in interest rates of 100 basis
points occur, net interest income should increase 2.3 percent. Conversely,
a 100 basis point decline in interest rates would result in a 2.3 percent
decrease in net interest income.
Financial institutions are affected differently by inflation than are
commercial and industrial companies that have significant investments in
fixed assets and inventories. Most of the Company's assets are monetary in
nature and change correspondingly with variations in the inflation rate.
It is difficult to precisely measure the impact of inflation on the
Company, however management believes that its exposure to inflation can be
mitigated through asset/liability management.
LIQUIDITY:
Liquidity is defined as a company's ability to generate cash at a
reasonable cost in order to satisfy commitments to borrowers as well as to
meet the demands of depositors and debtholders. The Company's principal
sources of liquidity are its core deposits and loan and investment payments
and prepayments. Providing a secondary source of liquidity is the
Company's available-for-sale portfolio. As a final source of liquidity,
the Company can exercise existing credit arrangements. The Company manages
liquidity daily, thus enabling management to effectively monitor
fluctuations in the Company's liquidity position and to adapt its position
according to market changes. Management believes the Company's liquidity
is adequate to meet both present and future financial obligations and
commitments on a timely basis. There are presently no known trends,
demands, commitments, events or uncertainties that have resulted or are
reasonably likely to result in material changes with respect to the
Company's liquidity.
The Company continued to improve its liquidity during the second quarter of
1998 as compared to the first quarter. The best illustrations of this
improvement are the Company's net noncore funding dependence and net short-
term noncore funding dependence ratios. The net noncore funding dependence
ratio is defined as the difference between noncore funds, time deposits
$100 or more and brokered time deposits less than $100, and short-term
investments to long-term assets. The net short-term noncore funding
dependence ratio is defined as the difference between noncore funds
maturing within one year, including borrowed funds, less short-term
investments to long-term assets. At June 30, 1998, the Company's net
noncore funding dependence ratio equaled negative 6.7 percent. This same
ratio was negative 5.2 percent at March 31, 1998. The Company's net short-
term noncore funding dependence ratio totaled negative 9.2 percent at June
30, 1998. At March 31, 1998, this ratio equaled negative 8.3 percent. At
June 30, 1998, the Company's peer group reported a net noncore funding
dependence ratio of 7.8 percent and a net short-term noncore funding
dependence ratio of 2.2 percent. Management believes that maintaining
adequate volumes of short-term investments and remaining competitive in
pricing medium-term certificates of deposit will help these ratios to
continue their improvement. Maintaining a large volume of core deposits is
important in keeping a sound liquidity position. Core deposits are
important as they represent a stable and relatively low-costing source of
funds.
The consolidated statements of cash flows present the change in cash and
cash equivalents from operating, investing and financing activities. Cash
and cash equivalents, consisting of cash on hand, cash items in the process
of collection, noninterest-bearing deposits with other banks, balances with
the Federal Reserve Bank of Philadelphia ("FRB") and Federal Home Loan Bank
of Pittsburgh ("FHLB-Pgh"), and federal funds sold, increased $5.9 million
over the first six months of 1998. Net cash provided by operating
activities totaled $3.2 million, primarily from the Company's recognition
of $2.2 million in net income for the first half of 1998.
For the six months ended June 30, 1998, net cash provided by investing
activities totaled $6.6 million and was the Company's primary source of
the net cash inflow. The major component of this increase was $23.2
million in repayments on investments with a net decrease of $3.2 million in
lending activities contributing to a lesser degree.
Partially offsetting the net cash inflows from operating and investing
activities was a $3.9 million net cash outflow from financing activities.
The primary cause of this reduction was the repayment of a short-term FHLB-
Pgh advance of $9.6 million. Partially offsetting the cash outflows
related to this loan was an increase of $6.0 million in the Company's
deposits primarily from additional school district funds.
CAPITAL ADEQUACY:
For the first six months of 1998, the Company's stockholders' equity
improved $2.4 million compared to year-end 1997. The components of this
increase were net income of $2,150 for the first half of 1998, partially
offset by cash dividends of $213 and a $415 positive change in the
unrealized gain on available-for-sale securities. Based on the its ongoing
efforts in improving the investment portfolio's quality, composition and
structure, the Company has reduced is susceptibility to market depreciation
on available-for-sale securities resulting from interest rate changes.
The Company declared a $154 or $.07 per share dividend for the second
quarter of 1998. Total dividends declared during the first half of 1998
were $309 or $0.14 per share, marking a 17.0 percent increase compared to
the first half of 1997. As a percentage of net income, dividends declared
for the six months ended June 30, 1998, equaled 14.4 percent. It is the
present intention of the Company's Board of Directors that dividends will
be paid in the future. However, the following factors, among others, may
affect these decisions: (i) operating results; (ii) financial and economic
decisions; (iii) capital needs; (iv) growth objectives; and (v) appropriate
dividend restrictions related to the Company.
Management attempts to assure capital adequacy by monitoring the current
and projected positions of the Company to support future growth, while
providing stockholders with an attractive long-term appreciation of their
investments. A recent history of bank failures prompted regulatory
agencies to adopt minimum capital adequacy requirements that include
mandatory and discretionary supervisory actions for noncompliance. On June
4, 1998, the FRB issued a final rule, which became effective June 30, 1998,
amending the Tier I leverage capital standard for bank holding companies.
Under the new regulation, bank holding companies that are either rated
composite "1" under the BOPEC rating system or those that have implemented
the FRB's risk-based capital market risk measure, must maintain a Leverage
ratio, Tier I capital to total average assets less intangibles, of at
least 3.0 percent. For all other bank holding companies, a Leverage ratio
of 4.0 percent must be maintained. For institutions with supervisory,
financial, operational or managerial weaknesses or those anticipating or
experiencing significant growth, higher-than-minimum capital ratios are
required. The Company's minimum ratio of Tier I capital to adjusted total
average assets was 4.0 percent at June 30, 1998 and 1997. Other minimum
capital ratio requirements are a Tier I capital to risk-adjusted assets
ratio of 4.0 percent and a total capital to risk-adjusted assets ratio of
8.0 percent. If an institution is deemed to be undercapitalized under
these standards, banking law prescribes an increasing amount of regulatory
intervention, including the required institution of a capital restoration
plan and restrictions on the growth of assets, branches or lines of
business. Further restrictions are applied to significantly or critically
undercapitalized institutions, including restrictions on interest payable
on accounts, dismissal of management and appointment of a receiver. For
well capitalized institutions, banking law provides authority for
regulatory intervention where the institution is deemed to be engaging in
unsafe and unsound practices or receives a less than satisfactory
examination report rating.
Under SFAS No. 115, "Accounting for Certain Investments in Debt and Equity
Securities," banks not subject to a supervisory directive will exclude
unrealized holding gains and losses, net of income taxes, on available-for-
sale debt securities when calculating Tier I capital. However, net
unrealized holding losses on available-for-sale marketable equity
securities will continue to be deducted from Tier I capital. This
regulatory accounting rule does not effect reporting for financial
statement purposes. Accordingly, for financial accounting presentations,
banks will continue to report available-for-sale and debt and equity
securities at fair value, with unrealized holding gains and losses, net of
income taxes, excluded from earnings and reported in a separate component
of stockholders' equity.
The Company's capital ratios at June 30, 1998 and 1997, as well as the
required minimum ratios for capital adequacy purposes and to be well
capitalized under the prompt corrective action provisions as defined by the
Federal Deposit Insurance Corporation Act of 1991 ("FDICIA") are summarized
as follows:
RISK-ADJUSTED CAPITAL
<TABLE>
<CAPTION>
MINIMUM TO BE WELL
CAPITALIZED UNDER
MINIMUM FOR CAPITAL PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
------------------------------------------------------------------
JUNE 30 1998 1997 1998 1997 1998 1997
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
BASIS FOR RATIOS:
Tier I capital to risk-adjusted assets... $ 32,815 $ 30,782 $ 7,749 $ 7,505 $11,624 $11,257
Total capital to risk-adjusted assets.... 35,255 33,146 15,499 15,010 19,374 18,762
Tier I capital to total average assets
less goodwill........................... 32,815 30,782 $14,700 $14,126 $18,376 $17,658
Risk-adjusted assets..................... 186,531 180,494
Risk-adjusted off-balance sheet items.... 7,204 7,129
Average assets for Leverage ratio........ $367,512 $353,161
RATIOS:
Tier I capital as a percentage of risk-
adjusted assets and off-balance sheet
items................................... 16.9% 16.4% 4.0% 4.0% 6.0% 6.0%
Total of Tier I and Tier II capital as a
percentage of risk-adjusted assets and
off-balance sheet items................. 18.2 17.7 8.0 8.0 10.0 10.0
Tier I capital as a percentage of total
average assets less goodwill............ 8.9% 8.7% 4.0% 4.0% 5.0% 5.0%
</TABLE>
The Company exceeded all relevant regulatory capital measurements at June
30, 1998, and was considered well capitalized. Regulatory agencies define
institutions not under a written directive to maintain certain capital
levels as well capitalized if they exceed the following: (i) a Tier I risk-
based ratio of at least 6.0 percent; (ii) a total risk-based ratio of at
least 10.0 percent; and (iii) a Leverage ratio of at least 5.0 percent.
The Company continues to improve its capital level as illustrated by the
positive change in its Leverage ratio. At June 30, 1998, the Company's
Leverage ratio equaled 8.9 percent as compared to 8.7 percent at March 31,
1998. This ratio also exceeds the 8.6 percent recorded at December 31,
1997.
REVIEW OF FINANCIAL PERFORMANCE:
The Company reported net income of $1,080 or $0.49 per share for the second
quarter of 1998, bringing total earnings for the year to $2,150 or $0.98
per share. This marks a $70 or 3.2 percent decline compared to the $2,220
in net income earned for the same period of 1997. For the first half of
1998, the Company's return on average assets equaled 1.17 percent while its
return on average equity equaled 11.65 percent. For the same period of
1997, the Company reported a return on average assets ratio of 1.26 percent
and a return on average equity ratio of 14.00 percent. The slight decline
in the Company's income levels is primarily attributed to a one-time
addition to noninterest income in 1997 related to a litigation settlement
awarded to the Company's wholly-owned subsidiary, Community Bank and Trust
Company ("Community Bank"), with respect to its business relationship with
a securities broker prior to 1995. This one-time addition to noninterest
income had a $148.5 positive effect on 1997 earnings after applicable legal
fees and income taxes. Another component contributing to the decline was
higher levels of noninterest expenses related to the Company's recently
acquired Eynon and Factoryville branches, which opened as Community Bank
branches during the final quarter of 1997. Improvements in net interest
income assisted the Company in lessening the impact of the aforementioned
changes.
In its preparation for the Year 2000 ("Y2K"), management is in the process
of an enterprise-wide program to address the effects of this date change on
the Company. In summary, the Y2K issue is a result of computer programs
being written using two digits rather than four to define the applicable
year. Any of the Company's computer programs that have date-sensitive
software may recognize a date using "00" as the year 1900 rather than the
year 2000. This may result in a system failure or in miscalculations
causing a disruption in operations that may include, among other things, a
temporary inability to process transactions or engage in normal business
activities. An extensive internal assessment of all operational systems,
including all date-sensitive materials, has been made to identify the
Company's exposure to the Y2K issue.
The Company, dependent on third party providers for their data processing
software, strives to remain current in software technology. This practice
has mitigated the Company's exposure to the Y2K problem. A number of the
Company's mission critical software applications are currently Y2K
compliant. The major operating systems are either currently Y2K compliant
or will be Y2K compliant by the end of 1998. Significant testing has been
completed on all software and hardware designated as Y2K compliant to
ensure that this is the case. As other applications become compliant
during 1998, future testing will be conducted. Based on its assessments,
the Company estimates that it will spend $100 to become fully compliant.
The Y2K problem is not expected to have a material adverse affect on the
Company's products, services or competitive position. Moreover, compliance
with the Y2K problem is not reasonably likely to affect the Company's
future financial results or cause the reported financial information not to
be necessarily indicative of future operating results or financial
position. Management presently believes that with modifications to the
existing software and conversions to new software, the Y2K problem can be
mitigated.
NET INTEREST INCOME:
The major source of the Company's operating income is derived from net
interest income. Net interest income is defined as the excess amount of
interest and fees on loans and other investments over interest expense
incurred on deposits and other funding sources used to support these
assets. Net interest margin is the percentage of net interest income on a
tax-equivalent basis to average earning assets. Variations in volumes and
rates of earning assets and liabilities, in response to changes in general
market rates, are the primary factors affecting net interest income. Net
interest income levels are also influenced by the composition of earning
assets and interest-bearing liabilities as well as the level of
nonperforming assets.
Management analyzes interest income and interest expense by segregating
rate and volume components of earning assets and interest-bearing
liabilities. The following table demonstrates the impact changes in the
interest rates earned and paid on assets and liabilities, along with
changes in the volume of earning assets and interest-bearing liabilities,
have on net interest income. Earning assets averages include nonaccrual
loans. Investment averages include available-for-sale securities at
amortized cost. Investment securities and loans are adjusted to a tax-
equivalent basis using a statutory tax rate of 34.0 percent. The net
change attributable to the combined impact of rate and volume has been
allocated proportionately to the change due to rate and the change due to
volume.
NET INTEREST INCOME CHANGES DUE TO RATE AND VOLUME
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
1998 VS. 1997 1998 VS. 1997
INCREASE (DECREASE) INCREASE (DECREASE)
ATTRIBUTABLE TO ATTRIBUTABLE TO
--------------------- ---------------------
TOTAL TOTAL
CHANGE RATE VOLUME CHANGE RATE VOLUME
------ ---- ------ ------ ---- ------
<S> <C> <C> <C> <C> <C> <C>
Interest income:
Loans:
Taxable............................. $ 164 $ (16) $ 180 $ 463 $ 57 $ 406
Tax-exempt.......................... (47) (47) (64) 16 (80)
Investments:
Taxable............................. 11 63 (52) 40 123 (83)
Tax-exempt.......................... 23 (23) (11) (56) 45
Federal funds sold.................... 89 (1) 90 136 2 134
----- ----- ------ ----- ----- ------
Total interest income............. 217 69 148 564 142 422
----- ----- ------ ----- ----- ------
Interest expense:
Money market accounts................. 5 11 (6) 13 (3) 16
NOW accounts.......................... 13 13 30 2 28
Savings accounts...................... (88) (80) (8) (154) (134) (20)
Time deposits less than $100.......... 127 82 45 328 (48) 376
Time deposits $100 or more............ (114) (16) (98) (285) (28) (257)
Other-term borrowings................. 1 (1) 6 (1) 7
----- ----- ------ ----- ----- ------
Total interest expense............ (57) (2) (55) (62) (212) 150
----- ----- ------ ----- ----- ------
Net interest income............... $ 274 $ 71 $ 203 $ 626 $ 354 $ 272
===== ===== ====== ===== ===== ======
</TABLE>
The Company's net interest income on a tax-equivalent basis improved $626
from $6,527 for the first half of 1997 to $7,153 for the same period of
1998. The primary cause of this increase came from the Company's improved
interest spread combined with the growth in average earning assets volumes
exceeding the growth in average interest-bearing liability volumes. For
the first six months of 1998, the Company's average, tax-equivalent
interest rate on earning assets equaled 8.05 percent, an eleven basis point
increase over the 7.94 percent recorded one year earlier. This improvement
accounted for a $142 positive rate variance related to earning asset
yields. Loan and taxable investment yields were the major contributors to
the improvement. During the six months ended June 30, 1998, the Company's
average loan yield equaled 8.62 percent, marking an improvement over the
8.56 percent reported for the same period of 1997. This accounted for a
$73 positive rate variance related to loans. The Company's yield on
investments improved 26 basis points to 6.86 percent for the first half of
1998 compared to 6.60 percent for the same period of 1997. This led to a
$67 positive change related to investment yields. During the first six
months of 1998, the Company effectively reduced its cost of funds. The
Company's overall rate paid on interest-bearing liabilities for the first
half of 1998 improved to 4.63 percent, a 15 basis point improvement
compared to the 4.78 percent rate paid for the same period of 1997. The
major contributors to this improvement were reduced rates paid on savings
accounts and on time deposits less than $100. The Company's rate paid on
savings accounts equaled 2.61 percent for the first half of 1998, a 42
basis point reduction from the 3.03 percent paid one year earlier. This
accounted for a $134 positive variance related to savings rates. An
improvement in the Company's rate paid on time deposits less than $100 also
contributed to the lower cost of funds, to a lesser degree. The Company's
interest rate paid on time deposits less than $100 for the six months ended
June 30, 1998, equaled 5.64 percent, an improvement over the 5.70 percent
rate paid for the same period of 1997, and accounted for a $48 improvement
related to interest rates paid on this type of deposit.
During the first half of 1998, the Company also experienced an improvement
in its net average earning assets to average interest-bearing liability
volumes. Overall, the Company's net interest income improved $272 related
to volumes. The Company's average earning assets grew $9.6 million to
$351.8 million for the first six months of 1998, from $342.2 million for
the same period of 1997. This increase was above the $7.1 million increase
in average interest-bearing liabilities from $293.1 million for the first
half of 1997 to $300.3 million for the same period of 1998. Greater loan
volumes and reduced volumes of time deposits $100 or more, partially offset
by larger volumes of time deposits less than $100, were the main causes of
this positive variance. For the first six months of 1998, the Company's
average loan volumes totaled $245.8 million, a $7.6 million or 3.2 percent
increase over the $238.2 million for the same period of 1997. This change
accounted for a $326 favorable variance in interest income related to loan
volumes. For the six months ended June 30, 1998, the Company's time
deposits $100 or more averaged $23.5 million, an $8.7 million decline
compared to the $32.2 million recorded one year earlier. This change came
as the Company became less aggressive in competing for this type of deposit
in its efforts to better control its overall deposit costs and accounted
for a $257 positive variance related to average volumes of time deposits
$100 or more. Partially offsetting the positive effects of the greater
loan volumes and reduced volumes of time deposits over $100, was an
increase in average volumes of time deposits less than $100. For the first
half of 1998, the Company's time deposits less than $100 averaged $174.7
million, a $13.4 million increase compared to the $161.3 million for the
same period of 1997. This had a negative effect of $376 on net interest
income related to time deposit less than $100 volumes.
For the quarter ended June 30, 1998, net interest income on a tax-
equivalent basis increased $274 compared to the same period of 1997.
Circumstances similar to those given for the six month period provide the
reasons for this favorable change. A greater net interest spread and a
growth of average earning assets occurring at a quicker pace than the
growth of average interest-bearing liabilities were the main causes of the
positive influence for the comparable second quarters of 1998 and 1997.
Management expects increased loan volumes and investment yields along with
greater controls on funds costs to positively affect net interest income.
However, should general market rates increase or competition in deposit-
gathering intensify, net interest income levels may be hindered.
Additionally, management is aware that any deterioration in local
employment conditions that may result in higher nonaccrual loan levels may
also have a dilutive effect on any positive net interest income changes.
Net interest income for major categories of earning assets and interest-
bearing liabilities for the six months ended June 30, 1998 and 1997, are
summarized as follows:
SUMMARY OF NET INTEREST INCOME
<TABLE>
<CAPTION>
JUNE 30, 1998 JUNE 30, 1997
--------------------------- ---------------------------
INTEREST AVERAGE INTEREST AVERAGE
AVERAGE INCOME/ INTEREST AVERAGE INCOME/ INTEREST
BALANCE EXPENSE RATE BALANCE EXPENSE RATE
------- -------- -------- ------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
ASSETS:
Earning assets:
Loans:
Taxable..................................... $238,503 $10,204 8.63% $228,967 $ 9,741 8.58%
Tax-exempt.................................. 7,291 301 8.33 9,197 365 8.00
Investments:
Taxable..................................... 57,006 1,694 5.99 60,737 1,654 5.49
Tax-exempt.................................. 38,717 1,562 8.14 37,886 1,573 8.37
Federal funds sold............................ 10,313 284 5.55 5,431 148 5.50
-------- ------- -------- -------
Total earning assets...................... 351,830 14,045 8.05% 342,218 13,481 7.94%
Less: allowance for loan losses.............. 3,904 3,905
Other assets.................................. 22,861 16,231
-------- --------
Total assets.............................. $370,787 $354,544
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY:
Interest-bearing liabilities:
Money market accounts......................... $ 16,773 252 3.03% $ 15,765 239 3.06%
NOW accounts.................................. 20,825 225 2.18 18,218 195 2.16
Savings accounts.............................. 64,237 832 2.61 65,583 986 3.03
Time deposits less than $100.................. 174,689 4,886 5.64 161,314 4,558 5.70
Time deposits $100 or more.................... 23,477 688 5.91 32,193 973 6.09
Short-term borrowings......................... 212 7 6.66 29 1 6.95
Long-term debt................................ 43 2 9.38 46 2 8.77
-------- ------- -------- -------
Total interest-bearing liabilities........ 300,256 6,892 4.63% 293,148 6,954 4.78%
Noninterest-bearing deposits.................. 30,754 26,610
Other liabilities............................. 2,561 2,804
Stockholders' equity.......................... 37,216 31,982
-------- ------- -------- -------
Total liabilities and stockholders' equity $370,787 6,892 $354,544 6,954
======== ------- ======== -------
Net interest/income spread................ $ 7,153 3.42% $ 6,527 3.16%
======= =======
Net interest margin....................... 4.10% 3.85%
Tax equivalent adjustments:
Loans......................................... $ 102 $ 124
Investments................................... 531 535
------- -------
Total adjustments......................... $ 633 $ 659
======= =======
</TABLE>
Note: Average balances were calculated using average daily balances.
Average balances for loans include nonaccrual loans. Available-for-
sale securities, included in investment securities, are stated at
amortized cost with the related average unrealized holding gain of
$3,047 for the first half of 1998 and $778 for the first half of 1997
included in other assets. Tax-equivalent adjustments were calculated
using the prevailing statutory rate of 34.0 percent.
PROVISION FOR LOAN LOSSES:
The Company makes provisions for loan losses based on evaluations of its
allowance for loan losses account. Factors such as previous loan
experience, overall loan portfolio characteristics, prevailing economic
conditions and other relevant factors are considered when determining the
provision. Based on its most recent evaluation, management believes that
the allowance is adequate to absorb any known and inherent losses in the
portfolio.
For the six month period ended June 30, 1998, the Company's loan loss
provision totaled $210, a $60 increase over the $150 provision for the same
period of 1997. For the second quarter of 1998, the Company's loan loss
provision equaled $105, which was $30 above the $75 recorded for the second
quarter of 1997. Despite the improvement in nonperforming assets levels
and the moderating loan demand, management believes that maintaining a
standard monthly charge to operations in the form of a provision is
warranted. Management will consider adjusting this provision during the
remainder of 1998 if loan demand intensifies or if a deterioration in
nonperforming asset levels occurs.
NONINTEREST INCOME:
For the first half of 1998, the Company recorded noninterest income of
$729, a $283 or 28.0 percent decrease compared to the same period of 1997.
The decline is a result of the Company recording nonrecurring gains in
1997. During the second quarter of 1997, the Company received $250 from the
aforementioned lawsuit against a securities broker. Another component of
this decline was related to other real estate activity in 1997. During the
first half of 1997, the Company sold four properties totaling $330 with net
gains of $50 being realized on these sales. For the same period of 1998,
the Company sold two properties totaling $58 with a net loss of $9 being
recorded on the sales. Partially offsetting the negative effects on
noninterest income related to the litigation settlement and other real
estate activity was an increase in service charges, fees and commissions.
For the six months ended June 30, 1998, the Company recorded service
charges, fees and commissions of $738, a $26 or 3.7 percent increase over
the $712 recorded for the same period one year earlier.
For the quarter ended June 30, 1998, noninterest income totaled $376 as
compared to $599 for the same period of 1997. This decrease is explained
by the 1997 proceeds of the lawsuit.
NONINTEREST EXPENSE:
The general components of noninterest expense include the costs of
providing salaries and necessary employee benefits, maintaining facilities
and general operating costs such as insurance, supplies, advertising, data
processing and other related expenses. Several of these costs and expenses
are variable while the remainder are fixed. In its efforts to control the
variable portion of these expenses, management employs budgets and other
related strategies.
For the six months ended June 30, 1998, the Company's noninterest expense
totaled $4,336, an increase of $402 or 10.2 percent as compared to the same
period last year. With respect to its operating efficiency, the Company's
net overhead to average assets ratio rose slightly to 2.0 percent for the
first half of 1998 compared to 1.8 percent for the same period of 1997.
Despite the increase, this level continues to outperform the 2.7 percent
overhead ratio experienced by the Company's peer group. A company can also
measure its efficiency with the operating efficiency ratio. This ratio is
defined as a company's noninterest expense, excluding other real estate
expense, as a percentage of net interest income and noninterest income less
nonrecurring gains and losses. The Company's operating efficiency ratio
for the first six months of 1998 was 59.4 percent compared to 59.1 percent
for the same period of 1997. The primary causes of this minimal adverse
change are the higher noninterest expense levels related to the Company's
Eynon and Factoryville offices that were acquired during the fourth quarter
of 1997.
Low unemployment and growing healthcare costs led to higher labor costs
paid by the nation's employers during the second quarter of 1998. For the
quarter, the employment cost index rose 0.9 percent after rising 0.7
percent in the first quarter. This rise is primarily due to higher
healthcare costs as the cost-saving gains related to the advent of managed
healthcare may have been realized. With the moderation in the national
economy, labor costs are not expected to fluctuate much during the second
half of 1998.
Salaries and benefits account for the primary portion of the Company's
noninterest expense. For the first half of 1998, these expenses totaled
$2,203 or 50.8 percent of all noninterest expenses. This marked an
increase over the $2,022 in salaries and benefits expenses experienced for
the same period of 1997. This increase was primarily due to personnel
performance appraisals in the form of merit increases with the remainder of
the increase being attributed to additional staffing to operate the Eynon
and Factoryville branches.
Aggregate net occupancy and equipment expenses totaled $657 for the six
months ended June 30, 1998, marking a $57 or 9.5 percent increase over the
same period of 1997. This increase is primarily due to depreciation
related to the Eynon and Factoryville branch acquisitions as well as
expenses related to meeting the Company's Y2K requirements. On January 2,
1998, the Company acquired land in Clarks Summit, Pennsylvania at a cost of
$1.2 million. This land will be used to construct a new administrative
center and branch facility for the Company. This project should be
completed during the first quarter of 1999 at an estimated aggregate cost
of $4.0 million. The Company will fund this project through normal
operations.
During the first half of 1998, the Company incurred other noninterest
expenses of $1,476, a $164 or 12.5 percent increase over the same period of
1997. The primary source of this increase comes from the amortization of
the core deposit intangible obtained in the Eynon and Factoryville branch
acquisitions. Through the six months ended June 30, 1998, the Company's
core deposit intangible expense equaled $136.
On June 19, 1998, the Federal Deposit Insurance Corporation ("FDIC") issued
a press release announcing that existing insurance premiums would be
retained for the second half of 1998. Risk-related assessment rates for
both the Bank Insurance Fund ("BIF") and the Savings Association Insurance
Fund ("SAIF") were kept in the 0 to 27 basis point range on an annual
basis. It was noted by the FDIC that: (i) over 95.0 percent of all BIF-
member institutions pay no premiums as they are in the lowest risk
category. Of these same institutions, only 0.1 percent fall into the 27
cents per 100 dollars insurance premium category. The average annual
assessment rate for all BIF-member institutions is projected at 0.08 cents
per 100 dollars. The FDIC-approved rate schedule is expected to maintain
the BIF's reserve ratio above the Congressional mandated 1.25 percent
through December 31, 1998; (ii) approximately 92.0 percent of all SAIF-
member institutions pay no premiums. The average annual assessment rate is
estimated to be 0.29 cents per 100 dollars, which is expected to maintain
SAIF reserves over the mandated 1.25 percent ratio; (iii) a separate levy
will be assessed on all FDIC-insured institutions to bear the cost of the
bonds sold by the Finance Corporation ("FICO") between 1987 and 1989 in
support of the former Federal Savings and Loan Insurance Corporation. The
1996 law requires the FICO rate on BIF-assessable deposits to equal one-
fifth the rate for SAIF-assessable deposits until January 1, 2000, or
earlier if the two funds merge.
For the quarter ended June 30, 1998, the Company experienced a $155 or 7.6
percent increase in noninterest expenses of as compared to the same period
of 1997. The reasons for the quarterly changes are similar to those
presented for the year-to-date changes.
Major components of noninterest expenses for the three months and six
months ended June 30, 1998 and 1997 are summarized as follows:
NONINTEREST EXPENSES
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
1998 1997 1998 1997
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Salaries and employee benefits expense:
Salaries and payroll taxes..................... $ 942 $ 849 $1,877 $1,673
Employee benefits.............................. 167 186 326 349
------ ------ ------ ------
Salaries and employee benefits expense....... 1,109 1,035 2,203 2,022
------ ------ ------ ------
Net occupancy and equipment expense:
Net occupancy expense.......................... 132 140 270 300
Equipment expense.............................. 173 160 387 300
------ ------ ------ ------
Net occupancy and equipment expense.......... 305 300 657 600
------ ------ ------ ------
Other noninterest expenses:
Marketing expense.............................. 78 96 129 144
Other taxes.................................... 70 59 133 130
Stationery and supplies........................ 94 80 181 178
Contractual services........................... 223 254 446 440
Insurance including FDIC assessment............ 18 21 37 41
Other.......................................... 309 206 550 379
------ ------ ------ ------
Other noninterest expenses................... 792 716 1,476 1,312
------ ------ ------ ------
Total noninterest expense.................. $2,206 $2,051 $4,336 $3,934
====== ====== ====== ======
</TABLE>
INCOME TAXES:
For the first half of 1998, the Company reported tax expense of $553 , an
effective tax rate of 20.5 percent. For the same period of 1997, the
Company reported tax expense of $576, an effective tax rate of 20.6
percent. Additionally, the Company reported tax expense of $277, a rate of
20.4 percent, for the second quarter of 1998 compared to $312, a rate of
21.2 percent, for the second quarter of 1997. The lower comparative rates
in 1998 resulted from less net income before taxes compared to 1997.
Management expects the Company's effective tax rate to remain stable for
the second half of 1998 by emphasizing income on tax-exempt investments and
loans while also using investment tax credits available through its
investment in a residential housing program for elderly and low- to
moderate-income families.
It is management's determination that a valuation reserve need not be
established for the deferred tax assets as it is more likely than not that
these assets could be principally realized through carryback to taxable
income in prior years and by future reversals of existing taxable temporary
differences or, to a lesser extent, through future taxable income. The
Company performs quarterly reviews on the tax criteria related to the
recognition of deferred tax assets.
COMM BANCORP, INC.
OTHER INFORMATION
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
NONE
Item 2. Changes in Securities
NONE
Item 3. Defaults of Senior Securities
NONE
Item 4. Submission of Matters to a Vote of Security Holders at the
Company's annual meeting of stockholders held on June 12, 1998,
for which proxies were solicited pursuant to Section 14 under the
Securities Exchange Act of 1934, the following matters were voted
upon by the stockholders.
1. To elect ten directors to serve for a one-year term and
until their successors are duly elected and qualified.
All nominees of the Board of Directors were elected. The number
of votes cast for or opposed to each of the nominees for election
to the Board of Directors were as follows:
Nominee For Against
------- ------------- ----------
David L. Baker 1,797,861.615 4,001.975
William F. Farber, Sr. 1,793,601.085 8,262.505
Judd Fitze 1,801,863.590 -------
John P. Kameen 1,801,863.590 -------
Erwin T. Kost 1,797,863.590 4,000.000
William B. Lopatofsky 1,801,863.590 -------
J. Robert McDonnell 1,801,863.590 -------
Joseph P. Moore, Jr. 1,801,263.590 600.000
Theodore W. Porosky 1,778,553.590 23,310.000
Eric Stephens 1,798,463.590 3,400.000
2. To ratify the selection of Kronick, Kalada Berdy & Co. of
Kingston, Pennsylvania, Certified Public Accountants, as the
independent auditors for the year ending December 31, 1998.
The votes cast on this matter were as follows:
For Against
------------- ----------
1,818,962.001 16,780.000
Item 5. Other Information
NONE
Item 6. Exhibits and Reports on Form 8-K
(a) NONE
(b) NONE
COMM BANCORP, INC.
FORM 10-Q
SIGNATURE PAGE
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be
signed on its behalf by the undersigned, thereunto, duly authorized.
Registrant, Comm Bancorp, Inc.
Date: August 8, 1998 /s/ David L. Baker
--------------------------------------
David L. Baker
Chief Executive Officer
Date: August 8, 1998 /s/ Scott A. Seasock
--------------------------------------
Scott A. Seasock
Chief Financial Officer
(Principal Financial Officer)
Date: August 8, 1998 /s/ John B. Errico
--------------------------------------
John B. Errico, Comptroller
Date: August 8, 1998 /s/ Stephanie A. Ganz
--------------------------------------
Stephanie A. Ganz, VP of Finance
(Principal Accounting Officer)
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLODATED INCOME STATEMENTS AND CONSOLODATED BALANCE SHEETS FOUND ON
PAGES 3 AND 4 OF THE COMPANY'S FORM 10-Q FOR THE YEAR-TO-DATE, AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> JUN-30-1998
<CASH> 11,433
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 11,725
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 101,553
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 246,795
<ALLOWANCE> 3,889
<TOTAL-ASSETS> 380,952
<DEPOSITS> 338,378
<SHORT-TERM> 0
<LIABILITIES-OTHER> 4,078
<LONG-TERM> 42
0
0
<COMMON> 728
<OTHER-SE> 37,726
<TOTAL-LIABILITIES-AND-EQUITY> 380,952
<INTEREST-LOAN> 10,403
<INTEREST-INVEST> 2,725
<INTEREST-OTHER> 284
<INTEREST-TOTAL> 13,412
<INTEREST-DEPOSIT> 6,883
<INTEREST-EXPENSE> 6,892
<INTEREST-INCOME-NET> 6,520
<LOAN-LOSSES> 210
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 4,336
<INCOME-PRETAX> 2,703
<INCOME-PRE-EXTRAORDINARY> 2,703
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,150
<EPS-PRIMARY> 0.98
<EPS-DILUTED> 0.98
<YIELD-ACTUAL> 8.05
<LOANS-NON> 1,365
<LOANS-PAST> 1,979
<LOANS-TROUBLED> 181
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 3,798
<CHARGE-OFFS> 245
<RECOVERIES> 126
<ALLOWANCE-CLOSE> 3,889
<ALLOWANCE-DOMESTIC> 3,889
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
