UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended DECEMBER 31, 1998
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OR
[ ] 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
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(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) Identification 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 (570) 785-3181
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Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on
which registered
NONE
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Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, PAR VALUE $0.33 PER SHARE
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(Title of class)
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
12 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 [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K
is
not contained herein, and will not be contained, to the best of registrant's
knowledge, in
definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any
amendment to this Form 10-K. [X]
The aggregate market value of the voting stock held by nonaffiliates of the
registrant based on
the
closing sale price: $45,063,918 AT FEBRUARY 3, 1999.
Indicate the number of shares outstanding of the registrant's common stock,
as of the latest
practicable date: 2,208,634 AT FEBRUARY 3, 1999.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's Annual Report to Stockholders for the year ended
December 31, 1998,
are
incorporated by reference in Part II of this Annual Report. Portions of the
registrant's 1999
Proxy
Statement are incorporated by reference in Part III of this Annual Report.
Page 1 of 223
Exhibit Index on Page 37
COMM BANCORP, INC.
FORM 10-K INDEX
PART I PAGE
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Item 1. Business................................................. 3
Item 2. Properties............................................... 20
Item 3. Legal Proceedings........................................ 21
Item 4. Submission of Matters to a Vote of Security Holders...... *
PART II
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Item 5. Market for the Registrant's Common Equity and Related
Stockholder Matters...................................... 22
Item 6. Selected Financial Data.................................. 22
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations...................... 23
Item 7A. Quantitative and Qualitative Disclosures about Market
Risk..................................................... 23
Item 8. Financial Statements and Supplementary Data.............. 23
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure...................... *
PART III
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Item 10. Directors and Executive Officers of the Registrant....... 24
Item 11. Executive Compensation................................... 26
Item 12. Security Ownership of Certain Beneficial Owners and
Management............................................... 31
Item 13. Certain Relationships and Related Transactions........... 33
PART IV
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Item 14. Exhibits, Financial Statement Schedules and Reports on
Form 8-K................................................. 33
Signatures........................................................ 35
Exhibit Index..................................................... 37
*Not Applicable
COMM BANCORP, INC.
FORM 10-K
PART I
ITEM 1. BUSINESS
GENERAL
Comm Bancorp, Inc. ("Company") is a Pennsylvania business corporation,
incorporated on May 20, 1983, and is a bank holding company, registered
with and supervised by the Board of Governors of the Federal Reserve System
("Federal Reserve Board"). The Company has one wholly-owned subsidiary,
Community Bank and Trust Company ("Community Bank"). The Company's
business has consisted of managing and supervising Community Bank and its
principal source of income has been dividends paid by Community Bank. At
December 31, 1998, the Company had approximately total consolidated assets
of $388.3 million, deposits of $344.3 million and stockholders' equity of
$39.7 million. During 1998, the Company and Community Bank employed
approximately 161 persons on a full-time equivalent basis.
Community Bank is a Pennsylvania state-chartered commercial bank and a
member of the Federal Reserve System. The deposits of Community Bank are
insured by the Federal Deposit Insurance Corporation ("FDIC") under the
Bank Insurance Fund ("BIF"). As of December 31, 1998, Community Bank
operated twelve branch banking offices which were similar with respect to
economic characteristics, products and services, operating processes,
delivery system, customer bases and regulatory oversight. As a result of
these similarities and their similar long-term financial performance
characteristics, the Company has aggregated these offices into a single
operating segment consistent with the aggregation criteria for segment
reporting. Neither the Company nor Community Bank had any other reportable
operating segments during the three years ended December 31, 1998.
Community Bank's branch banking offices are located in the Northeastern
Pennsylvania counties of Lackawanna, Susquehanna, Wayne and Wyoming. The
main office of Community Bank is located in Forest City, Susquehanna
County, Pennsylvania.
SUPERVISION AND REGULATION - COMPANY
The Company is subject to the jurisdiction of the Securities and Exchange
Commission ("SEC") for matters relating to the offering and sale of its
securities. The Company is currently subject to the SEC's rules and
regulations relating to periodic reporting, insider trading reports and
proxy solicitation materials in accordance with the Securities Exchange Act
of 1934.
The Company is also subject to the provisions of the Bank Holding Company
Act of 1956 ("Bank Holding Company Act") as amended, and to supervision by
the Federal Reserve Board. The Bank Holding Company Act will require the
Company to secure the prior approval of the Federal Reserve Board before it
owns or controls, directly or indirectly, more than 5.0 percent of the
voting shares or substantially all of the assets of any institution,
including another bank.
A bank holding company is prohibited from engaging in, or acquiring direct
or indirect control of, more than 5.0 percent of the voting shares of any
company engaged in nonbanking activities unless the Federal Reserve Board,
by order or regulation, has found such activities to be so closely related
to banking or managing or controlling banks as to be a proper incident
thereto. In making this determination, the Federal Reserve Board considers
whether the performance of these activities by a bank holding company would
offer benefits to the public that outweigh possible adverse effects.
The Bank Holding Company Act also prohibits acquisition of control of a
bank holding company, such as the Company, without prior notice to the
Federal Reserve Board. Control is defined for this purpose as the power,
directly or indirectly, to influence the management or policies of a bank
holding company or to vote 25.0 percent, or 10.0 percent if no other person
or persons acting in concert holds a greater percentage, of a bank holding
Company's common stock.
The Company is required to file an annual report with the Federal Reserve
Board and any additional information that the Federal Reserve Board may
require pursuant to the Bank Holding Company Act. The Federal Reserve
Board may also make examinations of the Company and Community Bank.
Subject to certain exceptions, a bank holding company and its subsidiaries
are generally prohibited from engaging in certain tie-in arrangements in
connection with any extension of credit or provision of credit or provision
of any property or service. The so-called "Anti-tie-in" provisions state
generally that a bank may not extend credit, lease, sell property or
furnish any service to a customer on the condition that the customer
provide additional credit or service to the bank, to its bank holding
company, or to any other subsidiary of its bank holding company or on the
condition that the customer not obtain other credit or service from a
competitor of the bank, its bank holding company or any subsidiary of its
bank holding company. Subsidiary banks of a bank holding company are
subject to certain restrictions imposed by the Federal Reserve Act on any
extensions of credit to the bank holding company or any of its
subsidiaries, on investments in the stock or other securities of the bank
holding company, and on taking of such stock or securities as collateral
for loans to any borrower.
PERMITTED NONBANKING ACTIVITIES
The Federal Reserve Board permits bank holding companies or their
subsidiaries to engage in nonbanking activities so closely related to
banking or managing or controlling banks as to be a proper incident
thereto. While the types of permissible activities are subject to change
by the Federal Reserve Board, the principal nonbanking activities that
presently may be conducted by a bank holding company or its subsidiary
without prior approval of the Federal Reserve Board are:
1. EXTENDING CREDIT AND SERVICING LOANS: Making, acquiring, brokering or
servicing loans or other extensions of credit (including factoring, issuing
letters of credit and accepting drafts) for the company's account or for
the account of others.
2. ACTIVITIES RELATED TO EXTENDING CREDIT: Any activity usual in
connection with making, acquiring, brokering or servicing loans or other
extensions of credit as determined by the Federal Reserve Board. The
Federal Reserve Board has determined that the following activities are
usual in connection with making, acquiring, brokering or servicing loans or
other extensions of credit: (i) performing appraisals of real estate and
tangible and intangible personal property, including securities; (ii)
acting as intermediary for the financing of commercial or industrial
income-producing real estate by arranging for the transfer of the title,
control and risk of such a real estate project to one or more investors, if
the bank holding company and its affiliates do not have an interest in, or
participate in managing or developing, a real estate project for which it
arranges equity financing, and do not promote or sponsor the development of
the property; (iii) authorizing a subscribing merchant to accept personal
checks tendered by the merchant's customers in payment for goods and
services, and purchasing from the merchant validly authorized checks that
are subsequently dishonored; (iv) collecting overdue accounts receivable,
either retail or commercial; (v) maintaining information related to the
credit history of consumers and providing the information to a credit
grantor who is considering a borrower's application for credit or who has
extended credit to the borrower; (vi) engaging under contract with a third
party in asset management, servicing and collection of assets of a type
that an insured depository institution may originate and own, if the
company does not engage in real property management or real estate
brokerage services as part of these services; (vii) acquiring debt that is
in default at the time of acquisition under certain conditions; and (viii)
providing real estate settlement services.
3. LEASING PERSONAL OR REAL PROPERTY: Leasing personal or real property or
acting as agent, broker or adviser in leasing such property under certain
conditions.
4. OPERATING NONBANK DEPOSITORY INSTITUTIONS: (i) Owning, controlling or
operating an industrial bank, Morris Plan bank or industrial loan company,
so long as the institution is not a bank; and (ii) owning, controlling or
operating a savings association, if the savings association engages only in
deposit-taking activities, lending and other activities that are
permissible for bank holding companies.
5. TRUST COMPANY FUNCTIONS: Performing functions or activities that may be
performed by a trust company, including activities of a fiduciary, agency
or custodial nature, in the manner authorized by federal or state law, so
long as the company is not a bank for purposes of the Bank Holding Company
Act.
6. FINANCIAL AND INVESTMENT ADVISORY ACTIVITIES: Acting as investment or
financial advisor to any person including, without in any way limiting, the
foregoing: (i) serving as investment advisor as defined in section 2(a)(20)
of the Investment Company Act of 1940, 15 U.S.C. 80a-2(a)(20), to an
investment company registered under that act, including sponsoring,
organizing and managing a closed-end investment company; (ii) furnishing
general economic information and advice, general economic statistical
forecasting services and industry studies; (iii) providing advice in
connection with mergers, acquisitions, divestitures, investments, joint
ventures, leveraged buyouts, recapitalizations, capital structurings,
financing transactions and similar transactions, and conducting financial
feasibility studies; (iv) providing information, statistical forecasting
and advice with respect to any transaction in foreign exchange, swaps and
similar transactions, commodities, forward contracts, options, futures,
options on futures and similar instruments; (v) providing educational
courses and instructional materials to consumers on individual financial
management matters; and (vi) providing tax-planning and tax-preparation
services to any person.
7. AGENCY TRANSACTIONAL SERVICES FOR CUSTOMER INVESTMENTS: (i)
Providing securities brokerage services including securities clearing and/or
securities execution services on an exchange, whether alone or in
combination with investment advisory services, and incidental activities
including related securities credit activities and custodial services, if
the securities brokerage services are restricted to buying and selling
securities solely as agent for the account of customers and do not include
securities underwriting or dealing; (ii) buying and selling in the
secondary market all types of securities on the order of customers as a
"riskless principal" to the extent of engaging in a transaction in which
the company, after receiving an order to buy or sell a security from a
customer, purchases or sells the security for its own account to offset a
contemporaneous sale to or purchase from the customer. This does not
include: (a) selling bank-ineligible securities at the order of a customer
that is the issuer of the securities, or selling bank-ineligible securities
in any transaction where the company has a contractual agreement to place
the securities as agent of the issuer; or (b) acting as a riskless
principal in any transaction involving a bank-ineligible security for which
the company or any of its affiliates acts as underwriter (during the period
of the underwriting or for 30 days thereafter) or dealer; (iii) acting as
agent for the private placement of securities in accordance with the
requirements of the Securities Act of 1933 and the rules of the SEC, if the
company engaged in the activity does not purchase or repurchase for its own
account the securities being placed, or hold in inventory unsold portions
of issues of these securities; (iv) acting as a futures commission merchant
for unaffiliated persons in the execution, clearance, or execution and
clearance of any futures contract and option on a futures contract traded
on an exchange in the United States or abroad under certain conditions; and
(v) providing to customers, as agent, transactional services with respect
to swaps and similar transactions.
8. INVESTMENT TRANSACTIONS AS PRINCIPAL: (i) Underwriting and dealing in
obligations of the United States, general obligations of states and their
political subdivisions, and other obligations that state member banks of
the Federal Reserve System may be authorized to underwrite and deal in
under 12 U.S.C. 24 and 335, including banker's acceptances and certificates
of deposit, under the same limitations as would be applicable if the
activity were performed by the bank holding company's subsidiary member
banks or its subsidiary nonmember banks as if they were member banks; (ii)
engaging as principal in: (a) foreign exchange; (b) forward contracts,
options, futures, options on futures, swaps and similar contracts, whether
traded on exchanges or not, based on any rate, price, financial asset
including gold, silver, platinum, palladium, copper or any other metal
approved by the Federal Reserve Board, nonfinancial asset or group of
assets, other than a bank-ineligible security under certain conditions; or
(c) forward contracts, options, futures, options on futures, swaps and
similar contracts, whether traded on exchanges or not, based on an index of
a rate, a price or the value of any financial asset, nonfinancial asset or
group of assets, if the contract requires such settlement; and (iii)
buying, selling and storing bars, rounds, bullion and coins of gold,
silver, platinum, palladium, copper and any other metal approved by the
Federal Reserve Board, for the company's own account and the account of
others and providing incidental services such as arranging for storage,
safe custody, assaying and shipment.
9. MANAGEMENT CONSULTING AND COUNSELING ACTIVITIES: (i) Providing
management consulting advice under certain conditions; (ii) providing
consulting services to employee benefit, compensation and insurance plans,
including designing plans, assisting in the implementation of plans,
providing administrative services to plans and developing employee
communication programs for plans; and (iii) providing career counseling
services to: (a) financial organizations and individuals currently employed
by, or recently displaced from, a financial organization; (b) individuals
who are seeking employment at a financial organization; and (c) individuals
who are currently employed in or who seek positions in the finance,
accounting and audit departments of any company.
10. SUPPORT SERVICES: (i) Providing courier services for: (a) checks,
commercial papers, documents and written instruments excluding currency or
bearer-type negotiable instruments that are exchanged among banks and
financial institutions; and (b) audit and accounting media of a banking or
financial nature and other business records and documents used in
processing such media; and (ii) printing and selling checks and related
documents, including corporate image checks, cash tickets, voucher checks,
deposit slips, savings withdrawal packages and other forms that require
MICR-encoding.
11. INSURANCE AGENCY AND UNDERWRITING: (i) Acting as principal, agent or
broker for insurance including home mortgage redemption insurance that is:
(a) directly related to an extension of credit by the bank holding company
or any of its subsidiaries; and (b) limited to ensuring the repayment of
the outstanding balance due on the extension of credit in the event of the
death, disability or involuntary unemployment of the debtor; (ii) acting as
agent or broker for insurance directly related to an extension of credit by
a finance company that is a subsidiary of a bank holding company under
certain conditions; (iii) engaging in any insurance agency activity in a
place where the bank holding company or a subsidiary of the bank holding
company has a lending office and that: (a) has a population not exceeding
5,000 as shown in the preceding decennial census; or (b) has inadequate
insurance agency facilities, as determined by the Federal Reserve Board,
after notice and opportunity for hearing; (iv) under certain restrictions,
engaging in any specific insurance-agency activity if the bank holding
company, or subsidiary conducting the specific activity, conducted such
activity on May 1, 1982, or received the Federal Reserve Board approval to
conduct such activity on or before May 1, 1982; (v) supervising on behalf
of insurance underwriters the activities of retail insurance agents who
sell: (a) fidelity insurance and property and casualty insurance on the
real and personal property used in the operations of the bank holding
company or its subsidiaries; and (b) group insurance that protects the
employees of the bank holding company or its subsidiaries; (vi) engaging in
any insurance-agency activity if the bank holding company has total
consolidated assets of $50.0 million or less; and (vii) engaging in any
insurance-agency activity performed directly or indirectly at any location
in the United States by a bank holding company that was engaged in
insurance-agency activities prior to January 1, 1971, as a consequence of
approval by the Federal Reserve Board prior to January 1, 1971.
12. COMMUNITY DEVELOPMENT ACTIVITIES: (i) Making equity and debt
investments in corporations or projects primarily designed to promote
community welfare, such as the economic rehabilitation and development of
low-income areas by providing housing, services or jobs for residents; (ii)
providing advisory and related services for programs primarily designed to
promote community welfare.
13. MONEY ORDERS, SAVINGS BONDS AND TRAVELERS' CHECKS: The issuance and
sale at retail of money orders and similar consumer-type payment
instruments, the sale of U.S. savings bonds and the issuance and sale of
travelers' checks.
14. DATA PROCESSING: Providing data processing and data transmission
services, facilities (including data processing and data transmission
hardware, software, documentation or operating personnel), data bases,
advice and access to such services, facilities or data bases by any
technological means under certain conditions.
INTERSTATE BANKING
The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994
("Interstate Banking Law"), amended various federal banking laws to provide
for nationwide interstate banking, interstate bank mergers and interstate
branching. The interstate banking provisions allow for the acquisition by
a bank holding company of a bank located in another state.
Interstate bank mergers and branch purchase and assumption transactions
were allowed effective June 1, 1997, however, a state may "opt-out" of the
merger and purchase and assumption provisions by enacting a law which
specifically prohibits such interstate transactions. States could, in the
alternative, enact legislation to allow interstate merger and purchase and
assumption transactions prior to June 1, 1997. States could also enact
legislation to allow for de novo interstate branching by out-of-state
banks. In July 1995, Pennsylvania adopted "opt-in" legislation which
allows such transactions.
LEGISLATION AND REGULATORY CHANGES
From time to time, legislation is enacted that has the effect of increasing
the cost of doing business, limiting or expanding permissible activities or
affecting the competitive balance between banks and other financial
institutions. Proposals to change the laws and regulations governing the
operations and taxation of banks, bank holding companies and other
financial institutions are frequently made in Congress and before various
bank regulatory agencies. No prediction can be made as to the likelihood
of any major changes or the impact such changes might have on the Company
and Community Bank. Certain changes of potential significance to the
Company that have been enacted or promulgated, as the case may be, by
Congress or various regulatory agencies, respectively, are discussed below.
FINANCIAL INSTITUTIONS REFORM, RECOVERY AND ENFORCEMENT ACT OF 1989
("FIRREA")
On August 9, 1989, major reform and financing legislation, i.e., FIRREA,
was enacted into law in order to restructure the regulation of the thrift
industry, to address the financial condition of the Federal Savings and
Loan Insurance Corporation and to enhance the supervisory and enforcement
powers of the federal bank and thrift regulatory agencies. The Federal
Reserve Board, as the primary federal regulator of Community Bank, is
responsible for the supervision of Community Bank. The Federal Reserve
Board and FDIC have far greater flexibility to impose supervisory
agreements on an institution that fails to comply with its regulatory
requirements, particularly with respect to capital requirements. Possible
enforcement actions include the imposition of a capital plan, termination
of deposit insurance and removal or temporary suspension of an officer,
director or other institution-affiliated party.
Under FIRREA, civil penalties are classified into three levels, with
amounts increasing with the severity of the violation. The first tier
provides for civil penalties of up to $5.0 thousand per day for any
violation of law or regulation. A civil penalty of up to $25.0 thousand
per day may be assessed if more than a minimal loss or a pattern of
misconduct is involved. Finally, a civil penalty of up to $1.0 million per
day may be assessed for knowingly or recklessly causing a substantial loss
to an institution or taking action that results in a substantial pecuniary
gain or other benefit. Criminal penalties are increased to $1.0 million
per violation, up to $5.0 million for continuing violations or for the
actual amount of gain or loss. These monetary penalties may be combined
with prison sentences of up to five years.
FEDERAL DEPOSIT INSURANCE CORPORATION IMPROVEMENT ACT OF 1991
("FDICIA")
GENERAL
The FDICIA reformed a variety of bank regulatory laws. Certain of these
provisions are discussed below.
EXAMINATIONS AND AUDITS
Annual full-scope, on-site examinations are required for all FDIC-insured
institutions with assets of $500.0 million or more. For bank holding
companies with $500.0 million or more in assets, the independent
accountants of such companies shall attest to the accuracy of management's
report. Such accountants shall also monitor management's compliance with
governing laws and regulations. Such companies are also required to select
an independent audit committee, composed of outside directors who are
independent of management, to review with management and the independent
accountants the reports that must be submitted to the appropriate bank
regulatory agencies. If the independent accountants resign or are
dismissed, written notification must be given to the FDIC and to the
appropriate federal and state bank regulatory agencies.
CAPITAL ADEQUACY
The Federal Reserve Board adopted risk-based capital guidelines for bank
holding companies, such as the Company. The required minimum ratio of
total capital to risk-weighted assets (including off-balance sheet
activities, such as standby letters of credit) is 8.0 percent. At least
half of the total capital is required to be "Tier I capital," consisting
principally of common stockholders' equity, noncumulative perpetual
preferred stock and minority interests in the equity accounts of
consolidated subsidiaries, less intangible assets. The remainder ("Tier II
capital") may consist of a limited amount of subordinated debt and
intermediate-term preferred stock, certain hybrid capital instruments and
other debt securities, perpetual preferred stock and a limited amount of
the general loan loss allowance.
In addition to the risk-based capital guidelines, the Federal Reserve Board
established minimum Leverage ratio (Tier I capital to total average assets
less intangible assets) guidelines for bank holding companies. These
guidelines provide for a minimum Leverage ratio of 3.0 percent for those
bank holding companies which have the highest regulatory examination
ratings and are not contemplating or experiencing significant growth or
expansion. All other bank holding companies are required to maintain a
Leverage ratio of at least 1.0 percent to 2.0 percent above the 3.0 percent
stated minimum. The Company is in compliance with these guidelines.
Community Bank is subject to similar capital requirements also adopted by
the Federal Reserve Board.
The risk-based capital standards are required to take adequate account of
interest rate risk, concentration of credit risk and the risks of non-
traditional activities.
FDIC INSURANCE ASSESSMENTS
The FDIC has implemented a risk-related premium schedule for all insured
depository institutions that results in the assessment of premiums based on
capital and supervisory measures.
Under the risk-related premium schedule, the FDIC, on a semiannual basis,
assigns each institution to one of three capital groups (well capitalized,
adequately capitalized or under capitalized) and further assigns such
institution to one of three subgroups within a capital group corresponding
to the FDIC's judgement of the institution's strength based on supervisory
evaluations, including examination reports, statistical analysis and other
information relevant to gauging the risk posed by the institution. Only
institutions with a total capital to risk-adjusted assets ratio of 10.0
percent or greater, a Tier I capital to risk-adjusted assets ratio of 6.0
percent or greater and a Tier I Leverage ratio of 5.0 percent or greater,
are assigned to the well capitalized group.
Furthermore, for 1997 through 1999, the banking industry will help pay the
Financing Corporation ("FICO") interest payments at an assessment rate that
is 1/5 the rate paid by thrifts. The FICO assessment on the BIF insured
deposits is 1.29 cents per $100 in deposits; for Savings Association
Insurance Fund ("SAIF") insured deposits it is 6.44 cents per $100 in
deposits. Beginning January 1, 2000, the FICO interest payments will be
paid pro-rata by banks and thrifts based on deposits. At December 31,
1998, the Company estimated the FICO interest assessment to be
approximately $40.7 thousand for 1999. For the year ended December 31,
1998, the Company paid FICO expenses of approximately $39.5 thousand.
Community Bank has not been required to pay any FDIC insurance assessments
since the fourth quarter of 1996 because the BIF has met its statutorily
required ratios and Community Bank is categorized as "well capitalized."
REAL ESTATE LENDING STANDARDS
Pursuant to the FDICIA, the Federal Reserve Board and other federal banking
agencies adopted real estate lending guidelines that would set loan-to-
value ("LTV") ratios for different types of real estate loans. An LTV
ratio is generally defined as the total loan amount divided by the
appraised value of the property at the time the loan is originated or the
purchase price, whichever is lower. If the institution does not hold a
first lien position, the total loan amount would be combined with the
amount of all senior liens when calculating the ratio. In addition to
establishing the LTV ratios, the guidelines require all real estate loans
to be based upon proper loan documentation and a recent appraisal of the
property.
BANK ENTERPRISE ACT OF 1991 ("ACT")
Within the overall FDICIA is the Act. The purpose of the Act is to
encourage banking institutions to establish "basic transaction services for
consumers," or so-called "lifeline depository accounts." The FDIC
assessment rate is reduced for all lifeline depository accounts. The Act
establishes ten factors that are the minimum requirements to qualify as a
lifeline depository account. Some of these factors relate to minimum
opening and balance amounts, minimum number of monthly withdrawals, the
absence of discriminatory practices against low-income individuals and
minimum service charges and fees. Moreover, the Housing and Community
Development Act of 1972 requires that the FDIC's risk-based assessment
system include provisions regarding lifeline depository accounts.
Assessment rates applicable to lifeline depository accounts are to be
established by FDIC rule.
TRUTH IN SAVINGS ACT ("TSA")
FDICIA also contains the TSA. The Federal Reserve Board has adopted
Regulation DD under the TSA, the purpose of which is to require the clear
and uniform disclosure of interest rates that are payable on deposit
accounts by depository institutions and the fees that are assessable
against deposit accounts, so that consumers can make a meaningful
comparison between the competing claims of banks with regard to deposit
accounts and products. In addition to disclosures to be provided when a
customer establishes a deposit account, the TSA requires the depository
institution to include, in a clear and conspicuous manner, the following
information with each periodic statement: (i) the annual percentage yield;
(ii) the amount of interest earned; (iii) the amount of any fees and
charges imposed; and (iv) the number of days in the reporting period. The
TSA allows for civil lawsuits to be initiated by customers if the
depository institution violates any provision or regulation under the TSA.
<TABLE>
<CAPTION>
REGULATORY CAPITAL REQUIREMENTS
The following table presents the Company's consolidated capital ratios at
December 31, 1998:
(In Thousands)
<S> <C>
Tier I capital............................................................... $ 35,444
Tier II capital.............................................................. $ 2,524
Total capital................................................................ $ 37,968
Average assets for the Leverage ratio........................................ $374,526
Total risk-adjusted assets(1)................................................ $200,417
Tier I risk-based capital ratio(2)........................................... 17.69%
Required Tier I risk-based capital ratio..................................... 4.00
Excess Tier I risk-based capital ratio....................................... 13.69%
Total risk-based capital ratio(3)............................................ 18.94%
Required total risk-based capital ratio...................................... 8.00
Excess total risk-based capital ratio........................................ 10.94%
Tier I Leverage ratio(4)..................................................... 9.46%
Required Tier I Leverage ratio............................................... 4.00
Excess Tier I Leverage ratio................................................. 5.46%
<FN>
(1) Includes off-balance sheet items at credit-equivalent values less intangible assets.
(2) Tier I risk-based capital ratio is defined as the ratio of Tier I capital to total
risk-adjusted assets.
(3) Total risk-based capital ratio is defined as the ratio of Tier I and Tier II capital
to total risk-adjusted assets.
(4) Tier I Leverage ratio is defined as the ratio of Tier I capital to total average
assets less intangible assets.
</FN>
</TABLE>
The Company's ability to maintain the required levels of capital is
substantially dependent upon the success of its capital and business plans,
the impact of future economic events on loan customers, the ability to
manage its interest rate risk and investment portfolio and control its
growth and other operating expenses.
EFFECT OF GOVERNMENT MONETARY POLICIES
The earnings of the Company are, and will be, affected by domestic economic
conditions and the monetary and fiscal policies of the United States
government and its agencies. The monetary policies of the Federal Reserve
Board have had, and will likely continue to have, an important impact on
the operating results of commercial banks through their power to implement
national monetary policy in order to, among other things, curb inflation or
combat a recession. The Federal Reserve Board has a major effect upon the
levels of bank loans, investments and deposits through its open market
operations in United States government securities and through its
regulations of, among other things, the discount rate on borrowings of
member banks and the reserve requirements against member bank deposits. It
is not possible to predict the nature and impact of future changes in
monetary and fiscal policies.
HISTORY AND BUSINESS - COMMUNITY BANK
Community Bank's legal headquarters is located at 521 Main Street, Forest
City, Pennsylvania 18421. As of December 31, 1998, Community Bank had
approximately total assets of $385.6 million, total deposits of $344.5
million and total stockholders' equity of $37.4 million.
Community Bank is a community bank that seeks to provide personal attention
and professional financial assistance to its customers. Community Bank is
a locally managed and oriented financial institution established to serve
the needs of individuals and small- and medium-sized businesses. Community
Bank's business philosophy includes offering direct access to its President
and other officers and providing friendly, informed and courteous service,
local and timely decision making, flexible and reasonable operating
procedures and consistently-applied credit policies.
Community Bank is a full-service commercial bank offering a range of
commercial and retail banking services to its customers. These include
personal and business checking and savings accounts, certificates of
deposit and mortgage, home equity and commercial loans. In addition,
Community Bank provides safe deposit boxes, travelers' checks, wire
transfers of funds and certain corporate and personal trust services.
Community Bank is a member of the MAC system and provides customers with
access to this automated teller machine network. Community Bank also makes
credit cards available to its customers.
Community Bank solicits small- and medium-sized businesses located
primarily within its market area that typically borrow less than $100.0
thousand. In the event that certain loan requests exceed Community Bank's
lending limit to any one customer, Community Bank seeks to arrange such
loans on a participation basis with other financial institutions.
MARKET AREA
Community Bank's primary market area comprises the Lackawanna, Susquehanna,
Wayne and Wyoming counties located in the Northeast corner of the
Commonwealth of Pennsylvania. The largest municipality in this market area
is the City of Scranton with a population of approximately 82.0 thousand
based upon 1990 census data. There are no Community Bank branches located
within the City of Scranton. All of the branches are located outside of
Scranton in rural or small-town settings. See Item 2 hereof for a
description of the location of each branch office.
Community Bank competes with 18 commercial banks, three thrift institutions
and 21 credit unions, many of which are substantially larger in terms of
assets and liabilities. In addition, Community Bank experiences
competition for deposits from mutual funds and security brokers. Consumer,
mortgage and insurance companies compete for various types of loans.
Principal methods of competing for banking and permitted nonbanking
services include price, nature of product, quality of service and
convenience of location.
SUPERVISION AND REGULATION - COMMUNITY BANK
The operations of Community Bank are subject to federal and state statutes
applicable to banks chartered under the banking laws of the United States,
to members of the Federal Reserve System and to banks whose deposits are
insured by the FDIC. Bank operations are also subject to regulations of
the Pennsylvania Department of Banking ("Department"), the Federal Reserve
Board and the FDIC.
The primary federal supervisory authority that regularly examines Community
Bank is the Federal Reserve Board. The Federal Reserve Board has the
authority under the Financial Institutions Supervisory Act to prevent a
state member bank from engaging in unsafe or unsound practices in
conducting its business.
Federal and state banking laws and regulations govern, among other things,
(i) the scope of a bank's business; (ii) the investments a bank may make;
(iii) the reserves against deposits a bank must maintain; (iv) loans a bank
makes and the collateral it takes; (v) the activities of a bank with
respect to mergers and consolidations; and (vi) the establishment of
branches. All banks in Pennsylvania are permitted to maintain branch
offices in any county of the state. Branches of state-chartered banks may
be established only after approval by the Department. The Department is
required to grant approval only if it finds that there is a need for
banking services or facilities such as those contemplated by the proposed
branch. The Department may disapprove the application if the bank does not
have the capital and surplus deemed necessary.
Multi-bank holding companies are permitted in Pennsylvania. See section
entitled "Interstate Banking."
A subsidiary bank of a bank holding company is subject to certain
restrictions imposed by the Federal Reserve Act on any extensions of credit
to the bank holding company or its subsidiaries, on investments in the
stock or other securities of the bank holding company or its subsidiaries,
and on taking such stock or securities as collateral for loans. The
Federal Reserve Act and Federal Reserve Board regulations also place
certain limitations and reporting requirements on extensions of credit by
a bank to principal stockholders of its parent holding company, among
others, and to related interests of such principal stockholders. In
addition, such legislation and regulations may affect the terms upon which
any person becoming a principal stockholder of a holding company may obtain
credit from banks with which the subsidiary bank maintains a correspondent
relationship.
From time to time, various types of federal and state legislation have been
proposed that could result in additional regulations of, and restrictions
on, the business of Community Bank. It cannot be predicted whether any
such legislation will be adopted or how such legislation would affect the
business of Community Bank. As a consequence of the extensive regulation
of commercial banking activities in the United States, Community Bank's
business is particularly susceptible to the effects of federal legislation
and regulations that may increase the costs of doing business.
Under the Federal Deposit Insurance Act, the Federal Reserve Board
possesses the power to prohibit institutions regulated by it, such as
Community Bank, from engaging in any activity that would be an unsafe and
unsound banking practice and in violation of the law. Moreover, the
Financial Institutions and Interest Rate Control Act of 1987 ("FIRA")
generally: (i) expands the circumstances under which officers or directors
of a bank may be removed by the institution's federal regulator; (ii)
restricts lending by a bank to its executive officers, directors, principal
stockholders or related interests thereof; (iii) restricts management
personnel of a bank from serving as directors or holding other management
positions with certain depository institutions whose assets exceed a
specified amount or that have an office within a specified geographic area;
and (iv) restricts management personnel from borrowing from another
institution that has a correspondent relationship with their bank.
Additionally, FIRA requires that no person may acquire control of a bank
unless the appropriate federal regulator has been given 60 days prior
written notice and within that time has not disapproved the acquisition or
extended the period for disapproval.
Under the Bank Secrecy Act ("BSA"), Community Bank is required to report to
the Internal Revenue Service currency transactions of more than $10.0
thousand or multiple transactions of which it is aware in any one day that
aggregate in excess of $10.0 thousand. Civil and criminal penalties are
provided under the BSA for failure to file a required report, failure to
supply information required by the BSA or filing a false or fraudulent
report.
COMMUNITY REINVESTMENT ACT
The Community Reinvestment Act of 1977 ("CRA"), as amended, and the
regulations promulgated to implement the CRA, are designed to create a
system for bank regulatory agencies to evaluate a depository institution's
record in meeting the credit needs of its community. Until May of 1995, a
depository institution was evaluated for CRA compliance based upon twelve
assessment factors.
The CRA regulations were completely revised as of May 4, 1995, to establish
new performance-based standards for use in examining a depository
institution's compliance with the CRA. The revised CRA regulations
establish new tests for evaluating both small and large depository
institutions' investments in the community. A small bank is defined as a
depository institution that has total assets of less than $250.0 million
and is independent or is an affiliate of a holding company with less than
$1.0 billion in assets. Pursuant to the revised CRA regulations, a
depository institution that qualifies as a small bank will be examined
under streamlined procedures that emphasizes lending activities. The
streamlined examination procedures for a small bank became effective on
January 1, 1996.
A large depository institution is one that does not meet the small bank
definition above. A large depository institution can be evaluated under
one of two tests: (i) a three-part test evaluating the institution's
lending, service and investment performance; or (ii) a "strategic plan"
designed by the institution with community involvement and approved by the
appropriate federal bank regulator. A large depository institution was
required to choose one of these options prior to July of 1997, but had the
option to be examined under one of these two options prior to that time.
Effective January 1, 1996, a large depository institution that opts to be
examined pursuant to a strategic plan may submit its strategic plan to the
bank regulators for approval. In addition, the revised CRA regulations
include separate rules regarding the manner in which "wholesale banks" and
"limited purpose banks" will be evaluated for compliance. The new CRA
regulations were phased in over a two-year period, beginning July 1, 1995,
with a final effective date of July 1, 1997.
For the purposes of the CRA regulations, Community Bank is a large bank,
based upon financial information as of December 31, 1998, and is evaluated
for CRA compliance using the procedures for a large bank. Community Bank
received a final CRA compliance report from the Federal Reserve Bank of
Philadelphia on February 24, 1997. This report included notification that
Community Bank received an "outstanding" CRA rating as of December 31,
1996. There are no conditions or events since that notification that
management believes have changed Community Bank's rating.
CONCENTRATION
The Company and Community Bank are not dependent for deposits nor exposed
by loan concentrations to a single customer or to a group of customers, the
loss of any one or more of which would have a material adverse effect on
the financial position of the Company or Community Bank.
YEAR 2000 ("Y2K") COMPLIANCE: MANAGEMENT INFORMATION SYSTEMS
For information with respect to Y2K compliance, refer to Management's
Discussion and Analysis in the Annual Report to Stockholders filed at
Exhibit 13 hereto and incorporated in its entirety by reference.
ITEM 2. PROPERTIES
The Company owns no property other than through Community Bank as follows:
Type of Approximate
Property Location Ownership Square Footage Use
1 125 N. State St. Owned 24,000 Corporate Center.
Clarks Summit, PA Banking services.
2 521 Main Street Owned 7,100 Banking services.
Forest City, PA
3 347 Main Street Owned 5,500 Banking services.
Simpson, PA
4 37 Dundaff Street Owned 4,300 Banking services.
Carbondale, PA
5 Lake Como Road Leased 900 Banking services.
Lakewood, PA
6 57 Main Street Owned 6,000 Banking services.
Nicholson, PA
7 Route 6 West Owned 3,500 Banking services.
Tunkhannock, PA
8 Route 106 Owned 1,300 Banking services.
Clifford, PA
9 61 Church Street Owned 3,500 Banking services.
Montrose, PA
10 Route 29 Leased 2,175 Banking services.
Eaton Township, PA
11 Route 307 Leased 1,250 Banking services.
Lake Winola, PA
12 Route 6 Leased 1,850 Banking services.
Eynon, PA
13 97 College Avenue Owned 1,850 Banking services.
Factoryville, PA
The Lakewood property lease expires in 2001 and contains an option to renew
the lease for an additional term of five years. The Route 29 Eaton
Township and Lake Winola property leases expire in 2009. The Eynon property
lease expires in 2004. For information with respect to obligations for
lease rentals, refer to Note 6 of the Notes to Consolidated Financial
Statements in the Company's Annual Report to Stockholders filed at Exhibit
13 hereto and incorporated in its entirety by reference.
It is management's opinion that the facilities currently utilized are
suitable and adequate for current and immediate future purposes.
ITEM 3. LEGAL PROCEEDINGS
GENERAL
The nature of the Company's and Community Bank's business generates a
certain amount of litigation involving matters arising in the ordinary
course of business. However, in the opinion of management of the Company
and Community Bank, there are no proceedings pending to which the Company
and/or Community Bank are a party or to which their property is subject,
which if determined adversely, would be material in relation to the
Company's and Community Bank's undivided profits or financial position.
There are no proceedings pending other than ordinary routine litigation
incident to the business of the Company and Community Bank. In addition,
no material proceedings are pending or are known to be threatened or
contemplated against the Company and Community Bank by government
authorities or others.
ENVIRONMENTAL ISSUES
There are several federal and state statutes that govern the obligations of
financial institutions with respect to environmental issues. Besides being
responsible for its own conduct under such statutes, a bank may also be
held liable, under certain circumstances, for actions of borrowers or other
third parties on properties that collateralize loans held by the bank.
Such potential liability may far exceed the original amount of the loan
made by the bank. Currently, Community Bank is not a party to any pending
legal proceedings under any environmental statute nor is Community Bank
aware of any circumstances that may give rise to liability of Community
Bank under any such statute.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The Company had 1,149 stockholders of record including individual
participants in security position listings and 2,208,634 shares of common
stock, par value of $0.33 per share, the only authorized class of common
stock outstanding as of February 3, 1999. The Company's common stock
trades on The NASDAQ Stock Market ("NASDAQ") as CommBcp under the symbol
"CCBP." The high and low closing sale prices and dividends per share of
the Company's common stock for the four quarters of 1998 and 1997 are
summarized as follows:
<TABLE>
<CAPTION>
Dividends
High Low Declared
------- ------- ---------
<S> <C> <C> <C>
1998:
First quarter..................................... $38 3/4 $35 $.07
Second quarter.................................... 36 1/2 32 1/4 .07
Third quarter..................................... 35 3/8 27 1/2 .10
Fourth quarter.................................... $28 3/4 $25 $.13
1997:
First quarter..................................... $28 $25 $.06
Second quarter.................................... 31 1/4 26 1/2 .06
Third quarter..................................... 31 3/4 28 1/4 .06
Fourth quarter.................................... $37 $29 1/2 $.12
</TABLE>
The Company has paid cash dividends since its incorporation in 1983. It is
the present intention of the Company's Board of Directors to continue the
dividend payment policy, although the payment of future dividends must
necessarily depend upon earnings, financial position, appropriate
restrictions under applicable law and other factors relevant at the time
the Board of Directors considers any declaration of dividends. Cash
available for the payment of dividends must initially come from dividends
paid by Community Bank to the Company. Therefore, the restrictions on
Community Bank's dividend payments are directly applicable to the Company.
For information with respect to dividend restrictions of the Company and
Community Bank, refer to Note 16 of the Notes to Consolidated Financial
Statements in the Company's Annual Report to Stockholders filed at Exhibit
13 hereto and incorporated in its entirety by reference.
ITEM 6. SELECTED FINANCIAL DATA
The information called for by this item is filed at Exhibit 13 hereto and
is incorporated in its entirety by reference under this Item 6.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The information called for by this item is filed at Exhibit 13 hereto and
is incorporated in its entirety by reference under this Item 7.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information called for by this item is filed at Exhibit 13 hereto and
is incorporated in its entirety by reference under this Item 7A.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's consolidated financial statements and notes thereto are filed
at Exhibit 13 hereto and are incorporated in their entirety by reference
under this Item 8.
The Company's supplementary data is filed at Exhibit 13 hereto and is
incorporated in its entirety by reference under this Item 8.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Each director of the Company is elected for a one-year term and until his
successor is duly elected and qualified. Current directors were elected at
the 1998 Annual Meeting of Stockholders, which was held on June 12, 1998.
The following table contains certain information with respect to the
directors and executive officers of the Company:
<TABLE>
<CAPTION>
PRINCIPAL OCCUPATION
FOR PAST FIVE YEARS
AGE AS OF AND POSITION HELD DIRECTOR OF
FEBRUARY 3, WITH THE COMPANY AND COMPANY/COMMUNITY
NAME 1999 COMMUNITY BANK BANK SINCE
- ---- ----------- -------------------- -----------------
<S> <C> <C> <C>
David L. Baker 53 President and Chief 1988/1993
Executive Officer ("CEO")
of the Company and
Community Bank (as of
April 26, 1995); Senior
Vice President of
Community Bank (as of
January 20, 1993)
William F. Farber, Sr. 61 Retired President, Farber's 1983/1970
Restaurants; Chairman of the
Boards of Directors of the
Company and Community Bank
Judd B. Fitze 46 Partner, Farr, Davis & Fitze 1995/1993
(attorney-at-law)
John P. Kameen 57 Publisher, Forest City News; 1983/1979
Secretary of the Company
Erwin T. Kost 55 President, Kost Tire & Muffler 1997/1993
William B. Lopatofsky 66 Retired 1983/1982
J. Robert McDonnell 63 Owner, McDonnell's Restaurant; 1983/1979
Vice President of the Company
Joseph P. Moore, Jr. 72 President, Elk Mountain Ski 1988/1992
Resort, Inc.; Retired President,
Moore Motors Inc. (automobile
dealership)
Theodore W. Porosky 51 Owner, Porosky Lumber Company 1997/1989
Eric Stephens 47 Auto Dealer, H.L. Stephens 1988/1993
and Son (automobile dealership)
</TABLE>
PRINCIPAL OFFICERS OF THE COMPANY
The following table sets forth selected information about the principal
officers of the Company, each of whom is elected by the Board of Directors
and each of whom holds office at the discretion of the Board of Directors:
<TABLE>
<CAPTION>
COMPANY
HELD EMPLOYEE NUMBER OF SHARES AGE AS OF
NAME AND POSITION SINCE SINCE BENEFICIALLY OWNED FEBRUARY 3, 1999
- ----------------- ----- -------- ------------------ ----------------
<S> <C> <C> <C> <C>
David L. Baker 1995 1995(1) 11,980(3) 53
President and CEO
William F. Farber, Sr. 1983 (2) 186,420 61
Chairman of the Board
John P. Kameen 1996 (2) 20,339(4) 57
Secretary
J. Robert McDonnell 1983 (2) 33,563(5) 63
Vice President
Scott A. Seasock 1989 1989 3,366(6) 41
Senior Vice President and
Chief Financial Officer
("CFO")
Thomas E. Sheridan 1989 1985 6,286(7) 42
Senior Vice President and
Chief Operations Officer
("COO")
<FN>
(1) Prior to his appointment as President and CEO of the Company, Mr. Baker was
employed by Community Bank from 1993 to 1995 as a Senior Vice President.
(2) Messrs. Farber, Kameen and McDonnell are not employees of the Company.
(3) Includes 5,064 shares held individually; 5,424 shares held jointly with his spouse;
746 shares held under his individual retirement account ("IRA"); and 746 shares held
under his spouse's IRA.
(4) Includes 17,280 shares held in trust for various relatives; and 3,059 shares held
jointly with other individuals.
(5) Includes 16,272 shares held individually; 16,272 shares held individually by his
spouse; and 1,019 shares held individually by his son.
(6) Includes 1,041 shares held jointly with his spouse; 1,550 shares held jointly with
his spouse and sons; 102 shares held as custodian for his sons under the Uniform
Gift to Minors Act; and 673 shares held under his IRA.
(7) Includes 1,799 shares held jointly with his spouse; 4,080 shares held jointly with
his father; 213 shares held under his IRA; and 194 shares held under his spouse's
IRA.
</FN>
</TABLE>
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934, as amended, requires
the Company's officers and directors, and persons who own more than 10.0
percent of the registered class of the Company's equity securities, to file
reports of ownership and changes in ownership with the SEC. Officers,
directors and persons who own more than 10.0 percent of the Company's stock
are required by the SEC regulation to furnish the Company with copies of
all Section 16(a) forms they file.
Based solely on its review of the copies of such forms received by it, or
written representations from certain reporting persons that no Form 5 was
required for any of those persons, the Company believes that during the
period January 1, 1998, through December 31, 1998, its officers and
directors were in compliance with all filing requirements applicable to
them.
ITEM 11. EXECUTIVE COMPENSATION
Shown below is information concerning the annual compensation for services
in all capacities to the Company and Community Bank for the fiscal years
ended December 31, 1998, 1997 and 1996, to David L. Baker, President and
CEO of the Company and Community Bank and Scott A. Seasock, Senior Vice
President and CFO of the Company and Community Bank. No other officer's
total annual salary and bonus exceeded $100.0 thousand during the fiscal
years reported.
<TABLE>
<CAPTION>
SUMMARY COMPENSATION TABLE
LONG-TERM COMPENSATION
ANNUAL COMPENSATION AWARDS PAYOUTS
- -------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Other
Name and Annual Restricted All Other
Principal Compensa- Stock Option LTIP Compensa-
Position Year Salary($) Bonus($) tion($)(1) Award(s) /SARs Payouts tion($)(2)
David L. Baker 1998 116,151 19,400 3,245 -0- -0- -0- -0-
President and 1997 111,401 18,700 3,346 -0- -0- -0- -0-
CEO 1996 101,029 10,000 3,012 -0- -0- -0- 27,958
Scott A. Seasock 1998 92,486 11,400 2,453 -0- -0- -0- -0-
Senior Vice 1997 88,953 10,700 2,281 -0- -0- -0- -0-
President & CFO 1996 86,784 6,500 2,139 -0- -0- -0- 9,934
<FN>
(1) Represents the contribution Community Bank made on behalf of Mr. Baker and Mr.
Seasock pursuant to the profit sharing plan. Aggregate perquisites and other
personal benefits were less than 10.0 percent of
the salary and bonus reported, and therefore, need not be presented.
(2) Represents the payout from the discontinuance of the Company's deferred compensation
plan for certain senior management employees.
</FN>
</TABLE>
PENSION PLAN
Community Bank has a profit sharing plan ("Plan"), which covers all
employees who have completed 1.0 thousand hours of service, attained 21
years of age and have been employed by Community Bank for at least one
year. The entry date of an employee into the Plan is January 1 of the year
following the satisfaction of the eligibility requirements. Normal
retirement age is 65. The normal retirement benefit is the accumulated
account balance of annual contributions, investment income and forfeitures.
The annual contribution is determined by the Board of Directors each year.
Contributions are allocated to each participant based on a pro-rata share
of compensation covered under the Plan. Investment income is allocated to
each participant based on a pro-rata share of the account balances
accumulated at the beginning of the year. Forfeitures are allocated to
each participant based on a pro-rata share of compensation covered under
the Plan. If a participant separates from service prior to retirement, the
participant will be entitled to a portion of the profit sharing account
based on years of service according to the following schedule:
Years of Service Vested Interest
---------------- ---------------
Less than 1 0%
1 10
2 20
3 30
4 40
5 60
6 80
7 or more 100%
A participant is always 100.0 percent vested in pension plan transferred
balances.
During 1998, $64,092 was allocated among the participants' accounts for the
Plan. The amounts contributed by Community Bank in 1998 to the Plan for
Mr. Baker and Mr. Seasock were $3,245 and $2,453, respectively. Both Mr.
Baker and Mr. Seasock have twelve years of service credited under the Plan.
COMPENSATION OF DIRECTORS
During 1998, Mr. Baker, an officer of the Company and Community Bank, sat
on the Company's and Community Bank's Board of Directors and various
committees of Community Bank. Mr. Baker received no fees for his services
on such committees or for his services on the Company's or Community Bank's
Board of Directors.
All members of the Company's Board of Directors, including Mr. Farber, the
Chairman of the Company, received a fee of $500 per month for 1998.
Aggregate fees paid by the Company in 1998 totaled $54,000. Except for Mr.
Farber, members of Community Bank's Board of Directors received a fee of
$1,000 per month for 1998. Mr. Farber, as Chairman of Community Bank,
received a fee of $3,500 per month for 1998. In addition, all members of
Community Bank's Board of Directors, including Mr. Farber, received a year-
end bonus of $1,500. Aggregate directors' fees paid by Community Bank in
1998 were $192,000.
BOARD COMPENSATION COMMITTEE REPORT ON EXECUTIVE COMPENSATION
The Board of Directors of the Company is responsible for the governance of
the Company and its subsidiary, Community Bank. In fulfilling its
fiduciary duties, the Board of Directors acts in the best interests of the
Company's stockholders, customers and the communities served by the Company
and Community Bank. To accomplish the strategic goals and objectives of
the Company, the Board of Directors engages competent persons who undertake
to accomplish these objectives with integrity and in a cost-effective
manner. The compensation of these individuals is part of the Board of
Directors' fulfillment of its duties to accomplish the Company's strategic
mission. Community Bank provides compensation to the employees of the
Company and Community Bank.
The fundamental philosophy of the Company's and Community Bank's
compensation program is to offer competitive compensation opportunities for
all employees based on each individual's contribution and personal
performance. The compensation program is administered by the Executive
Compensation Committee ("Committee") comprised of two outside directors and
three members of the Company's Board of Directors listed in the section
"Principal Officers," thereto. The objective of the Committee is to
establish a fair compensation policy to govern executive officers' base
salaries and incentive plans to attract and motivate competent, dedicated
and ambitious managers whose efforts will enhance the products and services
of the Company, the results of which should be improved profitability,
increased dividends to our stockholders and subsequent appreciation in the
market value of our stock.
The compensation of the Company's and Community Bank's top executives is
reviewed and approved annually by the Board of Directors. The top
executives whose compensation is determined by the Committee include the
CEO and all other executive management. As guidance for review in
determining base salaries, the Committee uses information composed from a
Pennsylvania bank peer group. This bank peer group is different than the
peer group utilized for the performance chart. Pennsylvania peer group
banks have been utilized because of common industry issues and competition
for the same executive talent group.
EXECUTIVE COMPENSATION
The Board of Directors has determined that the 1998 compensation for the
President and CEO of $135,551 and the Senior Vice President and CFO of
$103,886 were appropriate in light of the Company's 1998 performance
accomplishments. There is no direct correlation, however, between the
compensation of the executive officers and the Company's performance, nor
is there any weight given by the Committee to any specific individual
criteria. Such 1998 compensation was based on the Committee's subjective
determination after review of all information that it deemed relevant.
EXECUTIVE OFFICERS
Compensation for the Company's and Community Bank's executive officers is
determined by the Committee based on its subjective analysis of the
individual's contribution to the Company's strategic goals and objectives.
In determining whether strategic goals have been achieved, the Board of
Directors considers the Company's performance as measured by, among
numerous other factors, the following: (i) earnings; (ii) revenues; (iii)
return on assets; (iv) return on equity; (v) market share; (vi) total
assets; and (vii) nonperforming loans. Although the performance and
increases in compensation are measured in light of these factors, there is
no direct correlation between any specific criterion and the employee's
compensation, nor is there any specific weight provided to any such
criteria in the Committee's analysis. The determination by the Committee
is subjective after review of all information, including the above, it
deems relevant.
Total compensation opportunities available to the employees of the Company
and Community Bank are influenced by general labor market conditions, the
specific responsibilities of the individual and the individual's
contributions to the Company's success. Individuals are reviewed annually
on a calendar year basis. The Company strives to offer compensation that
is competitive with that offered by employers of comparable size in the
banking industry. Through these compensation policies, the Company strives
to meet its strategic goals and objectives to its constituents and provide
compensation that is fair and meaningful to its employees.
Submitted by the Executive Compensation Committee
-------------------------------------------------
William F. Farber, Sr.
Judd B. Fitze
John P. Kameen
J. Robert McDonnell
Joseph P. Moore, Jr.
STOCK PERFORMANCE GRAPH AND TABLE
Set forth below is a line graph comparing the cumulative total stockholder
return on the Company's common stock, based on the market price change and
assuming reinvestment of dividends, with the cumulative total return of the
index for The NASDAQ Stock Market (US Companies) and the index for Mid-
Atlantic Bank Stocks (Delaware, Maryland, New Jersey, New York,
Pennsylvania and Washington D.C. Companies) during the five-year period
ended December 31, 1998. The stockholder return shown on the graph and
table below is not necessarily indicative of future performance. The
Company's common stock began trading on NASDAQ under the symbol "CCBP" on
June 17, 1996. Prior to June 17, 1996, the Company's common stock was
quoted on the Over-the-Counter Electronic Bulletin Board Interdealer
System.
<TABLE>
<CAPTION>
1993 1994 1995 1996 1997 1998
----- ----- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C> <C>
_________ Comm Bancorp, Inc............................. 100.0 135.5 144.5 274.4 379.9 307.1
Total Returns Index for
The NASDAQ Stock Market
(US Companies)................................ 100.0 97.8 138.3 170.0 208.6 293.2
Total Returns Index for
Mid-Atlantic Bank Stocks...................... 100.0 97.2 155.6 223.3 317.3 351.2
<FN>
NOTES:
A. The lines represent monthly index levels derived from compounded daily returns that include
all dividends.
B. The indices are reweighed daily, using the market capitalization on the previous trading day.
C. If the monthly interval, based on the fiscal year-end, is not a trading day, the preceding trading
day is used.
D. The index level for all series was set to $100.0 on 12/31/93.
</FN>
</TABLE>
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
PRINCIPAL OWNERS
The following table sets forth information, as of February 3, 1999, related
to each person of record who owns or who is known by the Board of Directors
to be the beneficial owner of more than 5.0 percent of the outstanding
common stock. Included are the name, address, number of shares
beneficially owned by such person and the percentage of the outstanding
common stock so owned.
<TABLE>
<CAPTION>
PERCENT OF OUTSTANDING
SHARES BENEFICIALLY COMMON STOCK
NAME AND ADDRESS OWNED(1) BENEFICIALLY OWNED
- ---------------- ------------------- ----------------------
<S> <C> <C>
Joseph P. Moore, Jr. 220,035(2) 9.96%
400 Williamson Road
Gladwyne, PA 19035
William F. Farber, Sr. 186,420 8.44%
Crystal Lake Road
R.R. 1, Box 1281
Carbondale, PA 18407
Gerald B. Franceski 114,227(3) 5.17%
Lewis Lake, P.O. Box 88
Union Dale, PA 18470
<FN>
(1) The shares "beneficially owned" by an individual are determined in accordance with
the definitions of "beneficial ownership" set forth in the General Rules and
Regulations of the SEC. Included may be shares owned by or for the individual's
spouse and minor children and any other relative who has the same home, as well as
shares to which the individual has or shares voting or investment power, or has the
right to acquire beneficial ownership within 60 days after February 3, 1999.
Beneficial ownership may be disclaimed as to certain of the shares.
(2) Includes 30,628 shares held individually; 6,379 shares held in the Moore Motors,
Inc. Profit Sharing Plan, an automobile dealership of which he was President; and
183,028 shares held by Moore & Company, which are held in trust for his various
relatives.
(3) Includes 64,387 shares held jointly with his spouse; 5,340 shares held jointly with
his son; 9,120 shares held jointly in various combinations with relatives; 19,140
shares held individually by his spouse; and 16,240 shares held as trustee for his
sons.
</FN>
</TABLE>
<TABLE>
<CAPTION>
BENEFICIAL OWNERSHIP BY EXECUTIVE OFFICERS AND DIRECTORS
The following table sets forth as of February 3, 1999, the amount and
percentage of the common stock beneficially owned by each director and all
officers and directors of the Company as a group:
NAME OF INDIVIDUAL AMOUNT AND NATURE OF PERCENT
OR IDENTITY OF GROUP BENEFICIAL OWNERSHIP(1)(2)(3) OF CLASS(4)
- -------------------- ----------------------------- -----------
<S> <C> <C>
David L. Baker 11,980(5) ----
William F. Farber, Sr. 186,420 8.44%
Judd B. Fitze 12,231(6) ----
John P. Kameen 20,339(7) ----
Erwin T. Kost 9,025(8) ----
William B. Lopatofsky 25,410(9) 1.15%
J. Robert McDonnell 33,563(10) 1.52%
Joseph P. Moore, Jr. 220,035(11) 9.96%
Theodore W. Porosky 3,630(12) ----
Scott A. Seasock 3,366(13) ----
Thomas E. Sheridan 6,286(14) ----
Eric Stephens 7,315(15) ----
All Executive Officers and Directors
of the Company as a Group
(10 Directors, 6 Officers,
12 Persons in Total) 539,600 24.43%
<FN>
(1) See footnote (1) under the above caption entitled "Principal Owners."
(2) Does not include any common stock held in fiduciary accounts under the control of
the Trust Department of Community Bank.
(3) Information furnished by the Executive Officers, Directors and the Company.
(4) Less than 1.0 percent unless otherwise indicated.
(5) See footnote (3) under the above caption entitled "Principal Officers of the
Company."
(6) Includes 9,177 shares held jointly with his spouse; and 3,054 shares held under his
IRA.
(7) See footnote (4) under the above caption entitled "Principal Officers of the
Company."
(8) Includes 4,518 shares held individually; and 4,507 shares held jointly with his
spouse.
(9) Includes 22,860 shares held individually; and 2,550 shares held jointly with his
spouse.
(10) See footnote (5) under the above caption entitled "Principal Officers of the
Company."
(11) See footnote (2) under the above caption entitled "Principal Owners."
(12) Held jointly with his spouse.
(13) See footnote (6) under the above caption entitled "Principal Officers of the
Company."
(14) See footnote (7) under the above caption entitled "Principal Officers of the
Company."
(15) Includes 5,495 shares held individually; 950 shares held individually by his spouse;
and 870 shares held individually by his children.
</FN>
</TABLE>
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Except as described in the paragraph below, there have been no material
transactions, or proposed transactions, between the Company and Community
Bank and any director or executive officer of the Company and/or Community
Bank or any associate of the foregoing persons. The Company and Community
Bank have had financial transactions in the ordinary course of business
with directors and officers of the Company and Community Bank. The Company
and Community Bank intend to continue to have banking and financial
transactions in the ordinary course of business with directors and officers
of the Company and Community Bank and their associates on substantially the
same terms, including interest rates and collateral, as those prevailing,
from time to time, for comparable transactions with other persons. Total
loans outstanding from Community Bank as of December 31, 1998, to the
Company's and Community Bank's executive officers and directors as a group,
members of their immediate families and companies in which they had an
ownership interest of 10.0 percent or more was $3,696,312, or approximately
9.3 percent of the total equity capital of the Company. Loans to such
persons were made in the ordinary course of business and were made on
substantially the same terms, including interest rates and collateral, as
those prevailing at the time for comparable transactions with other
persons, and did not involve more than the normal risk of collectibility or
present other unfavorable circumstances.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) 1. The Company's consolidated financial statements and notes thereto
as well as the applicable reports of the independent certified public
accountants are filed at Exhibit 13 hereto and are incorporated in their
entirety by reference under this Item 14(a)1.
2. All schedules are omitted because they are not applicable or the
required information is shown in the financial statements or notes thereto.
3. The exhibits required by Item 601 of Regulation S-K are included under
Item 14(c) hereto.
(b) Reports on Form 8-K
The Company filed no current reports on Form 8-K during the quarter ended
December 31, 1998.
(c) Exhibits required by Item 601 of Regulation S-K:
Exhibit Number Referred to
Item 601 of Regulation S-K Description of Exhibit
- -------------------------- ----------------------
2 None.
3(ii) Bylaws, amended as of March 17,
1999, incorporated by reference at
Exhibit 3(ii) to the Form 10-K for
the year ended December 31, 1998.
4 None.
9 None.
10 None.
11 None.
12 None.
13 Portions of the Annual Report to
Stockholders for Fiscal Year Ended
December 31, 1998.
16 None.
18 None.
21 List of Subsidiaries of the
Company.
22 None.
23 None.
24 None.
27 Financial Data Schedule.
99 None.
SIGNATURES
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.
COMM BANCORP, INC.
(REGISTRANT)
BY:/s/ David L. Baker March 10, 1999
----------------------------- ---
David L. Baker, President and
Chief Executive Officer
(Principal Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Signature and Capacity Date
/s/ David L. Baker March 10, 1999
- ------------------------------------- ---
David L. Baker, President and
Chief Executive Officer/Director
(Principal Executive Officer)
/s/ William F. Farber, Sr. March 10, 1999
- ------------------------------------- ---
William F. Farber, Sr.,
Chairman of the Board/Director
/s/ Judd B. Fitze March 10, 1999
- ------------------------------------- ---
Judd B. Fitze, Director
/s/ Stephanie A. Ganz March 10, 1999
- ------------------------------------- ---
Stephanie A. Ganz, VP of Finance
(Principal Accounting Officer)
/s/ John P. Kameen March 10, 1999
- ------------------------------------- ---
John P. Kameen, Secretary/Director
/s/ Erwin T. Kost March 10, 1999
- ------------------------------------- ---
Erwin T. Kost, Director
/s/ William B. Lopatofsky March 10, 1999
- ------------------------------------- ---
William B. Lopatofsky, Director
/s/ J. Robert McDonnell March 10, 1999
- ------------------------------------- ---
J. Robert McDonnell,
Vice President/Director
/s/ Joseph P. Moore, Jr. March 10, 1999
- ------------------------------------- ---
Joseph P. Moore, Jr., Director
/s/ Theodore W. Porosky March 10, 1999
- ------------------------------------- ---
Theodore W. Porosky, Director
/s/ Scott A. Seasock March 10, 1999
- ------------------------------------- ---
Scott A. Seasock, Chief Financial
Officer (Principal Financial Officer)
/s/ Eric Stephens March 10, 1999
- ------------------------------------- ---
Eric Stephens, Director
EXHIBIT INDEX
ITEM NUMBER DESCRIPTION PAGE
- ----------- ----------- ----
3(ii) Bylaws 38
13 Portions of the Annual Report to
Stockholders for Fiscal Year Ended
December 31, 1998 54
21 List of Subsidiaries of the Company 221
27 Financial Data Schedule 222
COMM BANCORP, INC.
CONTENTS
------------------------------------------------------------------
INTRODUCTION
56 Consolidated Financial Highlights
57 President's Message to Stockholders
60 Consolidated Selected Financial Data
MANAGEMENT'S DISCUSSION AND ANALYSIS
61 Forward-Looking Discussion
62 Operating Environment
72 Review of Financial Position
127 Review of Financial Performance
CONSOLIDATED FINANCIAL STATEMENTS
147 Independent Auditors' Report
148 Consolidated Statements of Income and
Comprehensive Income
149 Consolidated Balance Sheets
150 Consolidated Statements of Changes in
Stockholders' Equity
151 Consolidated Statements of Cash Flows
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS
152 Summary of significant accounting policies
166 Cash and due from banks
167 Investment securities
170 Loans, nonperforming assets and allowance for
loan losses
173 Commitments, concentrations and contingent
liabilities
174 Premises and equipment, net
176 Other assets
177 Deposits
178 Short-term borrowings
179 Long-term debt
180 Fair value of financial instruments
180 Litigation recovery
180 Employee benefit plans
181 Income taxes
183 Parent Company financial statements
184 Regulatory matters
187 Summary of quarterly financial information
(unaudited)
MANAGEMENT'S DISCUSSION AND ANALYSIS
1997 VERSUS 1996
188 Operating Environment
192 Review of Financial Position
208 Review of Financial Performance
DIRECTORS AND OFFICERS
213 Boards of Directors and Corporate Officers
214 Advisory Boards
215 Officers
216 Locations
217 Glossary of Terms
220 Stockholder Information
<TABLE>
<CAPTION>
COMM BANCORP, INC.
CONSOLIDATED FINANCIAL HIGHLIGHTS
-----------------------------------------------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
YEAR ENDED DECEMBER 31 1998 1997 1996
- --------------------------------------------------------------------------------------
<S> <C> <C> <C>
FINANCIAL POSITION:
Assets................................................... $388,251 $381,811 $354,812
Investment securities.................................... 109,626 105,666 101,994
Net loans................................................ 244,090 246,429 231,859
Deposits................................................. 344,253 332,381 320,456
Stockholders' equity..................................... $ 39,734 $ 36,102 $ 31,256
FINANCIAL PERFORMANCE:
Interest income.......................................... $ 27,224 $ 26,142 $ 25,059
Interest expense......................................... 13,960 14,068 13,550
Net interest income...................................... 13,264 12,074 11,509
Net income............................................... 4,500 4,400 4,200
Dividends declared....................................... $ 816 $ 659 $ 623
FINANCIAL RATIOS:
Return on average total assets........................... 1.19% 1.22% 1.21%
Return on average stockholders' equity................... 11.71 13.40 14.57
Tier I capital ratio..................................... 17.69 15.95 15.72
Total capital ratio...................................... 18.94 17.20 16.98
Leverage ratio........................................... 9.46 8.74 8.46
Allowance for loan losses to loans, net.................. 1.63% 1.52% 1.67%
PER SHARE DATA:
Net income............................................... $ 2.04 $ 2.00 $ 1.91
Cash dividends declared.................................. 0.37 0.30 0.28
Stockholders' equity..................................... $ 18.00 $ 16.39 $ 14.21
Comm Bancorp, Inc. is a bank holding company
incorporated under the laws of Pennsylvania.
Headquartered in Forest City, Pennsylvania, Comm
Bancorp, Inc. serves four counties through twelve
community banking offices. Each office, interdependent
with the community, offers a comprehensive array of
financial products and services to individuals,
businesses, not-for-profit organizations and government
entities.
Comm Bancorp, Inc. is an equal opportunity employer.
All employees and applicants for employment are treated
without regard to age, race, color, sex, religion,
national origin, disability or veteran status.
</TABLE>
COMM BANCORP, INC.
PRESIDENT'S MESSAGE TO STOCKHOLDERS
----------------------------------------
It is my pleasure to report on the accomplishments of your Company in 1998.
We experienced continued growth and overall financial improvement. As you
may be aware, the Clarks Summit facility is open and fully functional with
operations, administrative and trust personnel on site. The expected
opening of the branch is the end of the first quarter. Construction began
in the first quarter of 1999 on the future site of our fourteenth branch in
Dickson City. We expect these expansions to enhance stockholder value by
serving our current and future customers in the same manner which has been
so successful in the past.
Once again we are pleased to report increased earnings. For the year, net
income totaled $4.5 million or $2.04 per share, an increase over the $4.4
million or $2.00 per share in 1997. Our continued growth is directly
related to increases during 1998 in average assets of 5.0%, average loans
of 2.5% and average deposits of 4.1% over the same period in 1997.
Stockholders' equity per share rose from $16.39 per share in 1997 to $18.00
per share in 1998. As you are aware, the new dividend policy which
systematically increases the dividend payout ratio has been in effect for
more than two quarters. As a result, dividends declared increased 23.8%
comparing 1998 to 1997. Feedback from stockholders indicates that this new
policy was well received.
Also during the third quarter of 1998, the program to sell conforming one-
to-four family residential mortgage loans in the secondary market became
fully operational. Our portfolio of serviced loans continues to grow,
increasing liquidity and keeping our bank competitive in the marketplace
while creating additional fee income.
In my letter to you last year, I mentioned some alternative investment
products that we were introducing through our Trust and Financial Services
Division. In 1998, we introduced fixed-rate annuity products and mutual
funds on a no-load basis to all of our bank customers, both of which were
well received. Our newly licensed bank representatives and trust personnel
sold approximately $750 thousand of these new products. The utilization of
the Discount Brokerage program has increased over the past year. Customers
have found this to be a savings of both time and money while providing
additional fee income for the bank. Personal trust assets in our Trust
Division grew by over 24% and fee income from these services increased over
38% from the previous year.
We are confident that our Trust and Financial Services Division will
continue to grow as we become established in the Clarks Summit and Dickson
City areas. This will be accomplished as existing, new and potential
customers become aware of the availability of the products and services we
COMM BANCORP, INC.
PRESIDENT'S MESSAGE TO STOCKHOLDERS (CONTINUED)
----------------------------
offer. Our initial market research indicates a strong interest from both
individuals and commercial clients in the aforementioned areas. I urge all
stockholders to utilize our Trust and Financial Services Division for your
investment and estate planning needs. I am confident that you will find
our staff knowledgeable and our services both convenient and cost
effective.
The Year 2000 continues to be of great concern to all. In May of 1997, we
brought our computer hardware systems into Year 2000 compliance and in
August of 1998, we upgraded our core processing software and installed new
ancillary software for Year 2000 compliance. Another major technological
accomplishment in 1998 was the installation of a Wide Area Network (WAN) in
all branches. The WAN will provide improved communications, allow for
imaging of loan and deposit documents, support voice-over-data
communication and generate greater efficiency relating to the overall
processing of the Bank's daily workload. We also held several meetings
with our commercial customers informing them of the Bank's progress in
regard to Year 2000 compliance and offering some advise in avoiding
potential Year 2000 problems for their businesses.
In January of 1998, our internet web site, http//www.combk.com, on the
World Wide Web became operational. We estimate over 1,500 visits were made
to the site in 1998. Stockholders and potential investors alike can get
vital information about the Bank. We have utilized our web site to inform
the general public of the progress on the Clarks Summit project through
pictures and updates.
Through our employees' commitment to the communities we serve, charitable
donations throughout our area were once again quite generous in 1998.
Recipients included: Special Olympics, various school programs and sports
teams, local fire companies, United Way and anti-drug programs, to name a
few. The bank also donated a property to Habitat for Humanity, who will
make the necessary repairs to the property and help a low income or first
time home buyer finally realize the dream of owning their own home.
Our Save for America program, which teaches the valuable life lesson of
saving to students in the local elementary schools, also went on-line with
regard to the Internet in 1998. Instead of each school processing on a
stand-alone program and supplying the bank with a disk to update students'
accounts, the entire process is done on-line with the deposit data wired
directly into the Bank via the Federal Reserve Bank. This allows timely
and accurate updates to the student accounts.
COMM BANCORP, INC.
PRESIDENT'S MESSAGE TO STOCKHOLDERS (CONTINUED)
--------------------------
Stock prices varied dramatically in 1998. This volatility was also
evidenced in the market value of your Company's stock as it traded in a
range from a high of $38 to a low of $25. We feel the drop in price was
tied to the overall national stock market conditions and was not based on
earnings or performance of the Bank. Unfortunately, as money center and
international bank stocks adjust in market value, this also has had a
negative effect on nearly all bank stocks traded on the open market. Over
the past five years, the total return of your bank stock has been
substantial. A $100.00 investment in Comm Bancorp, Inc. stock at December
31, 1993, rose to a cumulative value of $307.08 at December 31, 1998.
Comparatively, the same $100.00 investment in NASDAQ bank stocks would have
yielded a cumulative value of $293.20 over the same period.
I would like to take this opportunity to thank our employees for their
continued efforts on behalf of the bank. Their commitment to excellence
has had a dramatic effect upon our success in past years and is vital to
our continued growth.
Thank you for your continued trust in us. As we enter 1999, your
management team and Board of Directors are committed to strengthening your
investment while making every attempt to expand our services and customer
base in a prudent, yet successful manner. As always, if you have any
questions, comments or concerns do not hesitate to contact me.
Sincerely,
/s/ David L. Baker
- -------------------------------------
David L. Baker
President and Chief Executive Officer
<TABLE>
<CAPTION>
COMM BANCORP, INC.
CONSOLIDATED SELECTED FINANCIAL DATA
------------------------------------------------------------------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
YEAR ENDED DECEMBER 31 1998 1997 1996 1995 1994
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
CONDENSED STATEMENTS OF FINANCIAL PERFORMANCE:
Interest income......................................... $ 27,224 $ 26,142 $ 25,059 $ 26,467 $ 24,991
Interest expense........................................ 13,960 14,068 13,550 14,994 12,942
-------- -------- -------- -------- --------
Net interest income................................... 13,264 12,074 11,509 11,473 12,049
Provision for loan losses............................... 855 360 300 435 800
-------- -------- -------- -------- --------
Net interest income after provision for loan losses... 12,409 11,714 11,209 11,038 11,249
Noninterest income...................................... 2,673 1,776 1,387 (3,196) 1,005
Noninterest expense..................................... 9,364 7,956 7,383 8,194 7,949
-------- -------- -------- -------- --------
Income before income taxes............................ 5,718 5,534 5,213 (352) 4,305
Provision for income taxes.............................. 1,218 1,134 1,013 (552) 980
-------- -------- -------- -------- --------
Net income............................................ $ 4,500 $ 4,400 $ 4,200 $ 200 $ 3,325
======== ======== ======== ======== ========
CONDENSED STATEMENTS OF FINANCIAL POSITION:
Investment securities................................... $109,626 $105,666 $101,994 $108,706 $152,566
Net loans............................................... 244,090 246,429 231,859 209,932 190,909
Other assets............................................ 34,535 29,716 20,959 32,310 18,988
-------- -------- -------- -------- --------
Total assets.......................................... $388,251 $381,811 $354,812 $350,948 $362,463
======== ======== ======== ======== ========
Deposits................................................ $344,253 $332,381 $320,456 $317,099 $316,169
Short-term borrowings................................... 9,575 15,956
Long-term debt.......................................... 41 44 46 3,048 5,050
Other liabilities....................................... 4,223 3,709 3,054 2,906 2,599
Stockholders' equity.................................... 39,734 36,102 31,256 27,895 22,689
-------- -------- -------- -------- --------
Total liabilities and stockholders' equity............ $388,251 $381,811 $354,812 $350,948 $362,463
======== ======== ======== ======== ========
PER SHARE DATA:
Net income.............................................. $ 2.04 $ 2.00 $ 1.91 $ 0.09 $ 1.51
Cash dividends declared................................. 0.37 0.30 0.28 0.21 0.21
Stockholders' equity.................................... $ 18.00 $ 16.39 $ 14.21 $ 12.68 $ 10.31
Cash dividends declared as a percentage of net income... 18.14% 14.98% 14.83% 231.00% 13.68%
Average common shares outstanding....................... 2,205,545 2,200,960 2,200,080 2,200,080 2,200,071
SELECTED RATIOS (BASED ON AVERAGE BALANCES):
Net income as a percentage of total assets.............. 1.19% 1.22% 1.21% 0.06% 0.95%
Net income as a percentage of stockholders' equity...... 11.71 13.40 14.57 0.77 14.26
Stockholders' equity as a percentage of total assets.... 10.18 9.14 8.30 7.25 6.65
Tier I capital as a percentage of adjusted total assets. 9.46 8.74 8.46 7.12 7.32
Net interest income as a percentage of earning assets... 4.06 3.87 3.79 3.48 3.68
Loans, net, as a percentage of deposits................. 73.88% 75.02% 69.83% 62.81% 61.01%
SELECTED RATIOS AND DATA (BASED ON PERIOD END BALANCES):
Tier I capital as a percentage of risk-adjusted assets.. 17.69% 15.95% 15.72% 14.58% 14.19%
Total capital as a percentage of risk-adjusted assets... 18.94 17.20 16.98 15.84 16.05
Allowance for loan losses as a percentage of loans, net. 1.63% 1.52% 1.67% 1.83% 1.84%
Full-time equivalent employees.......................... 161 161 149 147 153
Locations............................................... 12 12 10 10 10
Note: Per share information reflects the retroactive effects of a three-for-one stock split effective
April of
1996 and a four-for-one stock split effective February of 1994. Average balances were calculated
using average
daily balances. Average balances for loans include nonaccrual loans. Tax-equivalent
adjustments were calculated
using the prevailing statutory rate of 34.0 percent.
Management's Discussion and Analysis appearing on the following pages
should be read in conjunction with the Consolidated Financial Statements
beginning on page 147 and Management's Discussion and Analysis 1997 versus
1996 beginning on page 188.
</TABLE>
FORWARD-LOOKING DISCUSSION:
Certain statements in this Form 10-K 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") 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 currently 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 that it serves. Although the
Company expects economic conditions in its market area to remain favorable,
assurance cannot be given that the 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 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:
During 1998, the United States sustained exceptional economic growth as a
result of strong household and business spending brought on by greater
confidence and offset partially by a slowdown in foreign demand. The
strength of economic growth is particularly important to the financial
success of the banking industry as its main function, lending, is directly
related to the velocity of economic activity. The gross domestic product
("GDP"), the total output of goods and services produced within United
States borders, increased 3.9 percent for 1998. This rate was twice the
anticipated growth and equals the annual performance of last year. Most
economists expected growth to subside during 1998 based on the strong
growth experienced during the past two years. GDP grew 3.9 percent in 1997
and 3.4 percent in 1996. A three-year consecutive growth rate above 3.0
percent has not been seen since the mid-1980s. Moreover, the domestic
economy completed 1998 by posting a torrid 6.1 percent growth rate during
the final quarter, the best in 15 years.
Many foreign countries are experiencing prolonged recessionary conditions,
including high unemployment and falling consumption, which continues to
reduce the demand for goods and services from the United States. In
addition, these countries have devalued their currencies, making goods from
the United States more expensive relative to their own. As a result, the
depressed demand for American exports had an adverse effect on domestic GDP
in 1998. Imports increased 10.8 percent in 1998 while exports rose a modest
1.5 percent. Despite reducing the rate of exports, the global financial
crisis has caused some beneficial effects on GDP as the Federal Reserve
Board's Open Market Committee ("FOMC") has refused to raise interest rates
despite the high level of economic growth for fear of triggering further
foreign currency devaluations. Accordingly, lower interest rates have
become an incentive for consumer and business confidence. In addition, the
global problems have helped to restrain inflation from surfacing despite
the strong growth and tight labor conditions. Recessionary conditions in
foreign countries have caused a reduction in their demand for commodities,
which has lead to an overabundance of certain goods, such as gasoline,
computers and automobiles, causing prices to decline. Moreover, the
reduced price of imported goods has caused domestic producers to compete by
retaining or lowering prices by either increasing productivity or improving
technology of their products.
Higher consumer and business confidence fueled greater domestic
expenditures in 1998, which more than counteracted the effects of the
slowdown in demand for goods and services from foreign countries. This
improvement was evidenced by increases in both the University of Michigan's
Sentiment Index, rising from 103.2 in 1997 to 104.6 in 1998, and the
Conference Board Confidence Level, rising from 125.4 in 1997 to 131.7 in
1998. Household confidence was spurred by an improved employment picture
with respect to both number of available opportunities and pay scales for
existing positions. The other major influence which strengthened consumer
confidence was the increased level of wealth caused by the continued rise
in stock values. Household net worth increased 10.0 percent in 1998 from
1997. Ideal employment conditions, improved wealth, slower inflation,
lower interest rates and higher credit availability were the primary causes
for the improved confidence.
Employment conditions were premier in 1998, as huge job gains in the
construction and retail sectors more than offset losses in manufacturing.
Approximately 2.9 million new jobs were created during 1998. Despite the
1.0 percent rise in the civilian work force, the unemployment rate declined
from 4.7 percent to 4.3 percent at December 31, 1997 and 1998,
respectively. The unemployment rate averaged 4.5 percent in 1998, the
lowest rate since 1969. Average hourly earnings rose 4.4 percent from
$12.43 at year-end 1997 to $12.98 at year-end 1998. Average weekly earnings
recorded an annualized increase of 4.1 percent to $449.11 at December 31,
1998. As a result of increased productivity, the average workweek fell from
34.7 hours in 1997 to 34.6 hours in 1998. Moreover, employees deemed the
current and foreseeable future of labor conditions favorably as evidenced
by the most recent survey of the Consumer Conference Board. According to
the survey, the percentage of respondents stating that jobs are hard to get
fell to an all-time low of 11.7 percent. Moreover, 48.2 percent of those
surveyed believed jobs are plentiful.
United States stock market prices surged during 1998, as the FOMC eased
monetary policy in an attempt to offset the impact of reduced demand for
goods from foreign countries. The FOMC decreased its target rate for
federal funds by one-quarter of one percent on September 29, October 15 and
November 17. These three cuts within seven weeks would have been viewed as
highly unusual if not for the global turmoil given the 3.9 percent economic
growth and the 4.5 percent unemployment rate. Most equity indices responded
to these cuts and higher corporate profits by experiencing strong growth in
1998. Specifically, the NASDAQ Composite increased nearly 40.0 percent, the
Standard and Poor's 500 Composite rose 25.0 percent and the Dow Jones
Industrial Average and New York Stock Exchange Composites were both up 16.0
percent. Consumer confidence and underlying consumption levels have become
heavily dependent on movements of the stock market as individuals are eager
to spend more as equity values increase. As aforementioned, the net worth
of households increased more than 10.0 percent during 1998. Moreover, the
rise in consumer confidence as a result of the improvements in equity
markets can be further evidenced by the reduced rate of savings in 1998.
The personal savings rate, savings as a percentage of disposable personal
income, declined from 2.1 percent in 1997 to 0.5 percent in 1998.
Households increase their savings from current income when they feel the
need to increase wealth to meet long-term goals. However, the rise in the
value of equity holdings has allowed consumers to feel more confident about
their financial futures and to forego allocating a higher percentage of
their salaries to savings.
Confidence was also enforced by subdued inflation in 1998, despite stronger
economic growth and tighter labor markets. An inflation measurement tied to
domestic economic activity was up only 1.0 percent for 1998, the smallest
increase in over 49 years. With respect to consumer inflation, the Consumer
Price Index ("CPI") increased by 1.6 percent, the lowest level since 1986.
Slowing medical costs and falling oil prices were primarily responsible for
the reduction. The slight increase of 1.6 percent in 1998 follows a similar
increase of 1.7 percent in 1997. The Producer Price Index ("PPI") was
deflationary for the second consecutive year. The PPI was negative 0.1
percent for 1998 as compared to negative 1.2 percent for 1997. Low
inflation was a result of rising productivity, falling commodity and energy
prices and relatively stable labor costs. The Employment Cost Index, which
measures changes in total compensation costs including salaries and
employee benefits, was 139.8 in December 1998, representing only a 3.4
percent increase over the same period last year. This increase was
mitigated by increased productivity of American workers in 1998 as the
Labor Department announced that its measure of productivity, the amount of
output produced per hour of work, increased 2.5 percent. This increase was
the greatest since 1992. Productivity measures how efficiently the economy
is turning workers' labor into goods and services. If workers produce more
for each hour of work, employers can afford to raise wages and benefits
without raising prices or lowering profits. Also assisting in keeping
inflation in check for 1998 was the devaluation of foreign currencies which
resulted in lowering the cost of imported goods. This competition against
imports, coupled with the fear that if domestic businesses raise prices
their competitors will not follow also assisted in keeping inflation to a
minimum in 1998.
A final factor for the rise in confidence was low-costing and readily-
available credit. The average interest rate on a 30-year mortgage declined
from 7.57 percent in 1997 to 6.91 percent in 1998. To a lesser extent, the
average interest rate on a 15-year mortgage also declined from 6.61 percent
in 1997 to 6.58 percent in 1998. An indication of increased availability of
credit was the strong growth in aggregate borrowings of 6.9 percent in
1998. Competition to extend credit was great as financial institutions
lowered rates, relaxed terms or softened credit standards to counteract
declining net interest margins.
The rise in confidence was the most important influence on the favorable
economic activity in 1998 as it caused exceptional strength in consumer and
business expenditures, which more than offset the adverse effects of
reductions in exports from foreign countries. During 1998, consumer
spending, as measured by personal consumption expenditures, rose 4.8
percent, the highest level in 14 years. All of the major categories of
personal consumption expenditures, durables, nondurables and services
recorded gains in 1998. Durable goods had the greatest increase of all
categories rising 12.0 percent in 1998. Increases in income and wealth led
households to boost consumption expenditures and invest in housing. All
sectors of the housing industry flourished in 1998, as evidenced by
increases of 10.4 percent in new home sales, 14.3 percent in existing home
sales and 10.2 percent in housing starts. Declines in mortgage rates and
mild weather helped promote the housing market. Total outlays for
residential investment, including home improvements, increased about 12.5
percent in 1998. Similar to consumer expenditures, business outlays also
experienced strong growth increasing 12.5 percent during 1998. The most
significant rise in such outlays was investment in new equipment increasing
16.7 percent, driven by a 62.0 percent increase in computer sales. The
strength of the economy and optimism about its long-run prospects,
efficiencies of new technologies and low-costing credit availability were
the primary reasons for the increase. As a result of the significant
increase in business investment, aggregate borrowings increased 10.7
percent from the end of 1997.
National economic expectations for 1999 are similar to the predictions made
for 1998. Economic growth is expected to decline while unemployment and
inflation are expected to increase slightly. Real GDP is expected to grow
at a slower pace of 2.5 percent during 1999 as the rates of unemployment
and CPI are expected to quicken to 4.8 percent and 2.5 percent,
respectively. Although there have been recent reports of improving economic
conditions in foreign countries, there remains a significant amount of risk
that they may relapse into financial difficulties causing further declines
in demands for United States goods and services. Should this occur, it is
expected to be offset again by higher expenditures and quite possibly,
further easement of monetary policy. Higher levels of household income and
overall wealth will be responsible for increased consumer spending.
Similarly, businesses are expected to mitigate the effects of higher
employment costs through increased productivity as a result of greater
investments in high-tech equipment. However, capital expenditures may
decline if corporate profit margins narrow. Profit reductions would also
curtail consumer spending as a result of lost wealth from declining stock
values. Adding to the risk of a downturn in economic activity is the fact
that consumers are more overextended than ever before with debt servicing
costs as a percentage of income at its highest level since 1974. The
ramifications to financial institutions of an economic downturn would
include reduced loan demand and higher asset quality problems, leading to
lower profitability.
Economic activity in the Company's four-county market area appears to have
finally caught up with that of the nation and Commonwealth as indicated by
unemployment reductions and wage gains. Unemployment rates for Lackawanna
and Susquehanna counties declined to levels similar to those of the United
States and Pennsylvania, while Wayne and Wyoming counties, recorded
significant unemployment rate reductions for 1998 of 1.4 percent and 2.2
percent, respectively, from year-end 1997. Construction generated the
largest gains in local employment as a result of improvements in the
housing industry and unseasonably mild weather. Service producing
industries also assisted in reducing unemployment levels during 1998.
National, Pennsylvania and market area unemployment rates at December 31,
1998 and 1997, are summarized as follows:
<TABLE>
<CAPTION>
December 31 1998 1997
- --------------------------------------------------------------------------------------
<S> <C> <C>
National................................................................. 4.3% 4.7%
Pennsylvania............................................................. 4.4 4.8
Lackawanna County........................................................ 4.3 5.4
Susquehanna County....................................................... 4.4 6.3
Wayne County............................................................. 6.7 8.1
Wyoming County........................................................... 6.0% 8.2%
</TABLE>
In addition, employees within the Company's market area recorded wage gains
superior to those of the Commonwealth. During 1998, the average hourly
earnings of a local manufacturing employee rose 16 cents as compared to 9
cents for all Pennsylvania workers. The average hourly earnings of a United
States manufacturing worker increased 48 cents in 1998. Despite the gain,
employees in the four-county market area still lag National and
Pennsylvania employees with respect to their hourly rate. The average
hourly rates paid to a manufacturing employee at December 31, 1998,
throughout the nation, Commonwealth and market area were $12.98, $14.07 and
$12.69, respectively. Despite tight labor markets, employers were able to
build efficiencies in 1998 without harming productivity as evidenced by a
reduction in the average weekly hours worked. As aforementioned, the
average weekly hours worked for the nation declined from 34.7 to 34.6 at
year-end 1997 and 1998, respectively. Similarly, average hours worked for
the Commonwealth reduced from 42.8 to 41.9, respectively, and for the
market area from 41.6 to 40.9, respectively. Such efficiencies have become
increasingly important as the pool of available workers has continually
declined. The civilian labor force, defined as the total number of
individuals employed and those actively seeking employment, declined by
1,500 workers from year-end 1997 to year-end 1998 for the Company's market
area. Similar to the market area, the Commonwealth recorded a 1.0 percent
decrease in the amount of available workers. In contrast to the labor force
reductions for the market area and the Commonwealth, the nation reported a
1.3 percent increase as more individuals made themselves available for
employment. Although assisting the retail business of local financial
institutions by increasing loans and lowering delinquencies of individuals,
a continuation of tight labor conditions may raise compensation costs of
area businesses. Such an event would restrict business profitability
leading to a slowdown in commercial lending and a deterioration in asset
quality. These occurrences would cause businesses to cut the number of
workers, which would most likely have an adverse effect on consumer lending
to, and the asset quality of, these individuals.
A recent Northeast Pennsylvania Economic Development Council Report
outlined optimistic future prospects for economic activity in the Company's
market area. The Council's latest "State of the Region" report outlines a
number of initiatives aimed at generating growth. These initiatives include
a Capital Redevelopment Assistance Program, Regional Education Task Force,
Northeast Pennsylvania Conservancy Plan and Passenger Rail Service
Restoration Project. Recent legislative approval of the Capital
Redevelopment Assistance Program may help the region capture new funding
for various area restoration and improvement projects. These projects would
benefit the region by generating employment and increasing spending from
within and outside the area. The Regional Education Task Force is a project
designed to combine the resources of area colleges and universities in
order to build a regional database. Such information can help local
private-sector businesses and organizations make market decisions and may
attract businesses from outside the area to relocate within the region. The
Northeast Pennsylvania Conservancy Plan continues to develop and enhance
the quality of life within the region through environmental improvements.
The restoration of passenger rail service from the local area to New York
City is expected to increase the regions attractiveness as a bedroom
community for individuals wishing to live outside the City but still work
in the metropolitan area. In addition to these initiatives, the Lackawanna
Valley Industrial Highway Project aimed at improving the region's
infrastructure is near completion. This project will open new lands for
economic development in Lackawanna and Wayne Counties. Wayne County has
already benefitted by the recent efforts as 350 new jobs will be generated
by the location of a federal prison in Waymart.
With the exception of large banks, the nation's financial institutions
continued to perform well during 1998. Banks' earnings would have increased
further if not for reductions in net interest margins, increased levels of
loan loss provisions and higher noninterest expenses. The pressure on net
interest margins was a direct reflection of lower interest rates, flat
yield curve and rapid mortgage prepayment activity with subsequent
reinvestments of the proceeds at lower yields. Although helpful in
reducing the ill effects of the foreign crisis, the FOMC's three rate cuts
placed additional pressure on net interest margins during 1998. As a
result of the already low interest rates offered on deposits, banks were
unable to reduce funds costs while being pressured to lower loan yields in
order to compete. Moreover, the reductions in the federal funds rate caused
a corresponding reduction in the yield on adjustable-rate loans tied to the
prime rate. The prime rate declined from 8.50 percent to 7.75 percent at
December 31, 1997 and 1998, respectively. Adding to the dilemma of reduced
earning asset yields was the flatness of the yield curve in 1998. Banks
were unable to extend maturities in order to achieve greater compensation.
Finally, rising prepayments on loans and mortgage-backed securities as a
result of declining interest rates forced banks to reinvest repayments at
lower yields, thus adding more pressure on net interest margins. Financial
institutions throughout the United States increased their provisions for
loan losses in response to higher loan volumes and greater write-offs on
foreign credits. In order to offset the margin compressions and higher
provisions, banks continued to increase noninterest income. During 1998,
fee income accounted for a greater percentage of banks' revenues than ever
before. Fee-based revenue increased through the expansion of product
offerings and by raising prices on existing products and services. With
respect to noninterest expenses, efficiency ratios remained weak in 1998 as
a result of significant investments made to improve competitiveness through
technological improvements and product line enhancements. Moreover, the
industry incurred a significant amount of one-time charges in 1998
including costs associated with merger and holding company restructurings
and Year 2000 ("Y2K") compliance.
As aforementioned, large financial institutions did not fare as well as
regional and community banks during 1998. These institutions were harmed
by losses from foreign credit exposure, recognition of one-time expenses
for merger-related charges and establishment of cost-cutting programs. This
reduction in large bank earnings is evidenced by examining the performance
of the nation's top 50 commercial banks in 1998. For 1998, this group
posted net income of $37.8 billion, a 3.3 percent decline as compared to
the $39.1 billion reported for 1997. Net interest income on a tax-
equivalent basis rose from $106.8 billion in 1997 to $108.9 billion in
1998. This increase was primarily a result of higher volumes of earning
assets as the net interest margin declined from 3.85 percent in 1997 to
3.61 percent in 1998. The 10.7 percent increase in the provision for loan
losses was directly related to replenishing the reserve for write-offs on
loans to emerging countries and hedge funds. The ratio of net loans
charged-off as a percentage of average loans rose from 0.54 percent in 1997
to 0.66 percent in 1998. This ratio was significantly greater for the top
10 commercial banks increasing from 0.57 percent in 1997 to 0.81 percent in
1998. Noninterest income rose 17.3 percent from $74.7 billion in 1997 to
$87.6 billion in 1998 as these banks attempted to mitigate the effects of
margin compressions and provision expansions. Noninterest expenses grew
from $108.3 billion in 1997 to $119.1 billion in 1998, a 10.0 percent
increase. As a result, the operating efficiency ratio deteriorated slightly
from 59.7 percent to 60.6 percent in 1997 and 1998, respectively.
During 1998, regional and community banks, which deal primarily in plain
vanilla consumer and commercial banking operations, exhibited stronger
performance than their larger competitors. This was evidenced by an
improvement in the financial performance of regional and community banks
located in the Mid-Atlantic region. Net income after tax improved from $1.4
billion to $1.7 billion in 1997 and 1998, respectively. The 21.4 percent
increase was primarily attributable to the strong growth in net interest
income. For the year, tax-equivalent net interest income increased to $5.7
million, an 11.1 percent increase over the comparable period last year. As
was evidenced by large banks, the rise in net interest income for regional
and community banks was primarily attributed to an increase in the average
volumes of earning assets in excess of interest-bearing liabilities as the
net interest margin declined in 1998. Average investments and loans
increased $4.0 billion and $15.1 billion, respectively, while interest-
bearing liabilities rose $13.7 billion. Conversely, net interest margin
declined from 4.07 percent in 1997 to 3.88 percent in 1998. The causes for
the decline were similar to those presented for the larger institutions.
The loan loss provision declined slightly from $296.1 million in 1997 to
$291.1 million in 1998. Lower volumes of nonperforming assets and net loans
charged-off were primarily responsible for the stability of the provision.
Noninterest revenues increased $660.3 million from 1997 as a result of
expansions in product and service offerings and a greater percentage of
banks charging for automated teller machine transactions. For 1998 and
1997, fee revenue as a percentage of total revenue was 14.0 percent and
16.3 percent, respectively. Efficiency ratios for regional and community
financial institutions deteriorated slightly as a result of increased
expenditures for product and service expansions and Y2K preparedness.
Noninterest expenses increased 28.6 percent from $3.5 billion in 1997 to
$4.5 billion in 1998. There is a great deal of risk for the future
performance of all financial institutions. Recent easing of lending
standards, which may result in higher levels of charge-offs and
nonperforming loans, along with the expected continuation of pressure on
net interest margins will most likely cause the greatest concerns in the
near-term.
As a result of higher stock prices of financial institutions in the first
half of the year, merger and acquisition activity in 1998 surpassed the
record pace of 1997. The increased market values of financial institutions
in the first half of 1998 played a major role in the financial viability of
such mergers. Greater stock prices allowed financial institutions to issue
fewer shares to execute mergers, which reduced the potential dilutive
effects to stockholders. While the number of deals throughout the nation
remained the same as the prior year, the aggregate deal value increased
from $259.8 billion in 1997 to $281.7 billion in 1998. The average price to
book value for financial institution mergers in 1998 was 2.6 times while
the median price to earnings was 23.1 times. For the prior year, the
comparable multiples of book and earnings were 2.2 times and 20.8 times,
respectively. The increase in the aggregate deal values was primarily
caused by a small number of large deals during the second quarter of 1998,
prior to the correction in financial institution stock values in the second
half of the year. Specifically, these mergers included Travelers and
Citicorp, Wells Fargo and Northwest, Banc One and First Chicago NBD, and
NationsBank and BankAmerica. Such deals accounted for 74.5 percent of the
aggregate deal value for all mergers during 1998. In addition to the
greater market values of stock prices in the first half of 1998, factors
such as deregulation, synergistic opportunities, globalization and
management incentives were the primary causes for these mega-mergers. With
respect to the Mid-Atlantic region, aggregate deal values increased from
$64.4 billion in 1997 to $100.2 billion in 1998. Included in the $100.2
billion is $82.5 billion for the Travelers-Citicorp merger. The average
price to book for this region was constant at 2.4 for 1997 and 1998. The
median price to earnings multiple was 23.0 times and 28.3 times for 1997
and 1998, respectively. Merger activity in 1999 is expected to decline as
a result of depressed stock prices and an inability of acquirers to address
due diligence considerations with respect to Y2K issues. However, after the
onset of the new millennium, merger activity could increase because of the
near-term threat that the pooling method of accounting for business
combinations may be eliminated. On December 15, 1998, the Financial
Accounting Standards Board ("FASB") published an invitation to comment on
"Methods of Accounting for Business Combinations." Citing the growth of
merger activity, the flow of capital among nations and the current lack of
comparability between domestic and international accounting methods, the
FASB has advocated the elimination of pooling of interests and the adoption
of purchase accounting as the only accounting method for combinations.
Approximately 95.0 percent of the aggregate deal values of all merger
transactions in 1998 were performed utilizing the pooling method of
accounting. Based on this statistic, it appears that any potential
acquirers will most likely attempt to hasten their acquisition plans in
order to utilize the pooling method prior to its elimination.
With respect to banking legislation, the most significant effort in 1998
dealt with modernization of the laws governing permissible financial
service activities. The bill, H.R. 10, "The Financial Services
Competitiveness Act of 1997," would repeal the Glass-Steagall Act that
restricts banks from affiliating with insurance and securities firms. H.R.
10 arose out of the widespread view that events in the marketplace made the
current structure of United States financial institutions obsolete. In
recent years, technological advancements and market innovations have
combined to replace traditional banking services with those offered by
noninsured financial institutions. Federal bank regulators have recently
allowed banks to enter into certain areas of insurance and securities,
resulting in several court battles to define permissible lines of
activities among financial industry groups. However, legislators feel the
need to create a more formalized legal framework for financial institutions
and other financial services companies to operate and compete in the
future. In general, H.R. 10 would allow banks' affiliates: (i) to engage in
securities underwriting and dealing and to sponsor and distribute mutual
funds; (ii) to underwrite and broker any type of insurance product; and
(iii) to underwrite municipal revenue bonds.
Although a version of H.R. 10 was passed in the House of Representatives
during 1998, and was recently adopted and sent to the full Senate by the
Banking Committee, it appears the legislation is far from being entered
into law. The Clinton Administration opposes the bill in its present form
because they feel it fails to protect consumers and would hurt consumer
lending laws. Others voicing their opposition to H.R. 10 include the
Treasury Department and certain consumer groups. Further complicating the
passage of the bill is a disagreement about which supervisory body should
regulate these new business activities. Specifically, if financial
institutions' insurance and securities businesses operate out of bank
operated subsidiaries rather than the holding company, they would be
insured under the Federal Deposit Insurance Corporation ("FDIC"). Such
action would allow banks a competitive advantage and more importantly
expose the FDIC insurance fund to potential losses from failures in those
activities. Despite these problems, it appears all interested parties
recognize the need to change and want to refurbish the current legislative
structure with respect to banking. When passed, the law should benefit the
competitive position for all banks.
REVIEW OF FINANCIAL POSITION:
The declining interest rate environment during 1998 has made it more
difficult for financial institutions to achieve acceptable returns on their
loans and investments. Taking on additional credit risk or lengthening the
average lives of investments are ways to contend against yield declines.
As an alternate strategy, management chose to be less aggressive with
respect to deposit pricing, sacrificing aggressive growth until a favorable
spread between earning assets and interest-bearing liabilities exists. In
keeping with this strategy, the Company directed its efforts on improving
its competitive position through delivery system expansions, new product
offerings and existing service enhancements during 1998. The acquisition of
the Eynon and Factoryville branches from First Union National Bank in the
fourth quarter of 1997 aided this expansion. On January 2, 1998, the
Company acquired land in Clarks Summit, Pennsylvania, to construct an
administrative center and branch facility. This facility will improve
efficiency and effectiveness by centralizing several divisions within the
Company. In addition, in October of 1998, the Company acquired land in
Dickson City, Pennsylvania, to construct a branch facility. Both
properties, located in Lackawanna County, will offer full-service banking
to customers in new market areas. The projects are being funded through
normal operations and will open for business in 1999. As a result of
focusing on these efforts rather than forcing deposit growth through
imprudent pricing practices, the Company experienced modest growth in 1998.
On January 1, 1998, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 131, "Disclosures about Segments of an Enterprise
and Related Information." This Statement establishes standards for the way
public companies report information about operating segments in annual
financial statements and requires that those enterprises report selected
information about operating segments in interim financial reports issued to
stockholders. A public business enterprise must report financial and
descriptive information about its reportable operating segments. Operating
segments are defined as components of an enterprise about which separate
financial information is available that is evaluated regularly by the chief
operating decision maker in deciding how to allocate resources and in
assessing performance. It also establishes standards for related
disclosures about products and services, geographic areas and major
customers.
SFAS No. 131 states that two or more operating segments may be aggregated
into a single segment if the segments have similar: (i) economic
characteristics; (ii) products and services; (iii) operating processes;
(iv) customer bases; (v) delivery systems; and (vi) regulatory environment.
The Company's twelve branch banking offices, all similar with respect to
these characteristics, have exhibited similar long-term financial
performance. Therefore, they were aggregated into a single operating
segment. The Company did not have any other reportable operating segments
during the three years ended December 31, 1998.
The Company's total assets increased to $388.3 million at December 31,
1998, an increase of $6.5 million over the $381.8 million reported at
December 31, 1997. The Company's total assets averaged $377.4 million in
1998, an increase of $18.0 million or 5.0 percent as compared to the $359.4
million in 1997. The composition of earning assets remained relatively
unchanged from 1997 to 1998. The ratio of average investments and federal
funds sold to average earning assets was 30.1 percent in 1997 and 30.7
percent in 1998. Similarly, the ratio of loans to average earning assets
also held constant. For 1997 and 1998, this ratio was 69.9 percent and
69.3 percent, respectively. However, the ratio of average earning assets
to total average assets declined to 94.7 percent in 1998 from 96.3 percent
in 1997 as excess funds not used to purchase investments or fund loan
demand were used to finance the planned expansion projects. The ratio of
average earning assets to total average assets for the peer group of 23
banks located in Northeastern Pennsylvania also declined from 97.3 percent
in 1997 to 94.5 percent in 1998.
The investment portfolio grew $3.9 million to $109.6 million at December
31, 1998, from $105.7 million at December 31, 1997. Average investments
increased slightly to $99.4 million in 1998 from $98.8 million in 1997.
The composition of the investment portfolio changed during 1998 as cash
flows from maturities of U.S. Treasury securities were reinvested into
short-term U.S. Government agency mortgage-backed securities to serve
future liquidity requirements. The mortgage-backed securities offered the
Company a greater total return over a given interest rate horizon with risk
characteristics similar to that of comparable U.S. Treasury securities.
The yield on taxable investments increased 37 basis points to 5.96 percent
for 1998 from 5.59 percent for 1997. Overall, the tax-equivalent yield on
the investment portfolio showed a 17 basis point increase for the year from
6.60 percent for 1997 to 6.77 percent for 1998.
Loans, net of unearned income, at December 31, 1998, were $248.1 million as
compared to $250.2 million at December 31, 1997. The Company had aggregate
short-term loans of $7.0 million to certain large Pennsylvania-based
commercial banks at December 31, 1997. Adjusting for such temporary credit
extensions, the loan portfolio rose $4.9 million from year-end 1997 to
year-end 1998. Average loans outstanding grew 2.5 percent from $241.9
million in 1997 to $247.9 million in 1998. Growth in commercial and
residential mortgages partially offset by declines in loans to municipal
authorities was primarily responsible for the change. The tax-equivalent
yield on the Company's loan portfolio increased from 8.53 percent for 1997
to 8.55 percent for 1998. This slight increase was significant given the
decline in general market rates and fierce loan competition during 1998.
The Company showed an improvement in its asset quality in 1998 as compared
to 1997. This was evidenced by decreases in the ratios of nonperforming
loans as a percentage of loans, net of unearned income and nonperforming
assets as percentage of loans, net of unearned income. The Company's ratio
of nonperforming loans as a percentage of loans, net of unearned income was
1.63 percent at December 31, 1998, as compared to 2.25 percent at December
31, 1997. Additionally, the ratio of nonperforming assets as a percentage
of loans, net of unearned income was 1.72 percent at December 31, 1998, as
compared to 2.41 percent at December 31, 1997. The Company's allowance for
loan losses as a percentage of loans, net of unearned income increased to
1.63 percent at December 31, 1998, from 1.52 percent at December 31, 1997.
The provision for loan losses exceeding net charge-offs caused the
improvement. In comparison, the Company's ratio surpassed the peer group's
ratio of 1.26 percent at December 31, 1998.
Total deposits at December 31, 1998, were $344.3 million, an increase of
$11.9 million or 3.6 percent over the $332.4 million reported at December
31, 1997. Deposits averaged $335.6 million for 1998, an increase of $13.2
million or 4.1 percent over the $322.4 million for 1997. This was well
below the peer group's deposit growth of 9.9 percent, as management
maintained its less aggressive deposit pricing strategy during 1998. The
Company's average noninterest-bearing deposits experienced the most
significant growth of all deposit types, increasing 18.6 percent from the
previous year. The aforementioned acquisition of the Eynon and
Factoryville branches and a higher commercial customer concentration
contributed to this growth. As a result of its less aggressive deposit
pricing strategy, the Company's cost of funds declined 17 basis points to
4.60 percent for 1998 from 4.77 percent for 1997.
The Company experienced slight declines in its interest sensitivity and
liquidity positions from year-end 1997 to year-end 1998. Interest
sensitivity, as measured by the ratio of cumulative one-year, rate
sensitive assets ("RSA") to rate sensitive liabilities ("RSL"), declined
from 0.86 at December 31, 1997, to 0.70 at December 31, 1998. Both ratios
were within the acceptable guidelines set forth in the Company's
Asset/Liability Management Policy. The net noncore funding dependence and
net short-term noncore funding dependence ratios best illustrate the
Company's liquidity position. The net noncore funding dependence ratio
equaled negative 4.0 percent at December 31, 1998, as compared to negative
7.5 percent at December 31, 1997. The Company's net short-term noncore
funding dependence ratio at December 31, 1998 and 1997, was negative 5.7
percent and negative 10.2 percent, respectively.
Stockholders' equity increased $3.6 million or 10.1 percent to $39.7
million at December 31, 1998, from $36.1 million at December 31, 1997.
This improvement is attributable to net income of $4.5 million offset by
dividends declared, net of reinvestments, of $662 and a reduction in the
net unrealized holding gains of $206. The Company's Leverage ratio, Tier
I capital as a percentage of total average assets less intangibles,
increased to 9.5 percent at December 31, 1998, as compared to 8.7 percent
at December 31, 1997. The Company exceeded all relevant regulatory capital
measurements and was considered well capitalized at December 31, 1998.
As part of management's efforts to improve and expand its delivery system
while continuing to enhance stockholder value, the Company accomplished a
number of significant goals in 1998. Management's actions to improve the
Company's delivery system included introducing new products and data
processing enhancements to keep pace and remain competitive in an ever-
changing financial industry. The Company's Trust and Financial Services
Division began offering mutual fund programs during the first quarter of
1998. One of today's most popular methods for investing, a mutual fund
program, through an investment company, pools and professionally manages
the funds of many investors with common financial goals and objectives.
Individual mutual funds operate according to stated policies and investment
objectives set forth in a prospectus. Mutual funds allow customers to
invest in a diversified mix of assets, without all the work associated with
choosing individual investments on their own. These mutual fund programs
are offered on a no-load basis, which means that there are no initial fees
to invest in the program.
In addition, during the second quarter of 1998, the Company 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 while at the same time
reduce its exposure to IRR. Many financial institutions relinquish
servicing of mortgages upon their sales, however, the Company has chosen to
maintain servicing the loans internally for the convenience of its
customers.
Additionally, during the fourth quarter of 1998, the Company kept pace with
technological advancements by installing a Wide Area Network ("WAN") to all
its locations, through the use of frame relay. The WAN improved
communications between locations and within the administrative center by:
(i) utilizing company-wide e-mail; (ii) sharing files and software; (iii)
facilitating more timely application backups; and (iv) tracking the use of
information. The WAN will also facilitate the following projects, which
are scheduled to be completed during 1999: (i) installation of a remote
image retrieval system; (ii) implementation of a document archival system;
and (iii) conversion to CoreDirector, a windows-based core bank processing
system.
As aforementioned, management set out to expand the Company's delivery
system in 1998. On January 2, 1998, after conducting a feasibility
analysis, the Company acquired land in Clarks Summit, Lackawanna County,
Pennsylvania, and began construction on a new community office facility and
administrative center. In addition to a 2,400 square foot community
banking office, the 24,000 square foot facility, completed in the first
quarter of 1999, accomodates eight administrative divisions comprised of 90
employees. Many of the Company's divisions are now centralized, thus
adding efficiency and effectiveness to overall operations. Additionally,
the Company, on October 24, 1998, acquired land in Dickson City, Lackawanna
County, Pennsylvania, to construct its fourteenth community office
facility. The 5,300 square foot community banking office is scheduled to
be completed by the end of the second quarter of 1999.
In addition to these improvements and expansion plans, the Company's Board
of Directors approved a new dividend policy during the third quarter of
1998. This new policy will systematically increase the dividend payout
ratio to a level consistent with its peer group.
INVESTMENT PORTFOLIO:
The bond market, typically known for its lethargic behavior, was
unpredictable and turbulent in 1998. As a result of uncertainties in
foreign countries, prices of U.S. Treasury bonds surged for most of 1998
while other riskier forms of fixed income investments declined, thus
causing a widening spread between such issues. The yield curve was flat
during the first half of 1998. This was spurred by continued low inflation
and an increased demand for safer U.S. Treasury securities sparked by
concerns of global recession and foreign currency devaluations. Investors,
placing a greater significance on the harmful effects of the weakness
abroad as compared to the growth in domestic demand, caused U.S. Treasury
yields to decline. Long-term investment yields, represented by the
benchmark 30-year U.S. Treasury bond, declined to 5.09 percent at year-end
1998 from 5.93 percent at the end of 1997. In addition to the weakness of
exports, such 84 basis point decline was exacerbated by the collapse of
giant hedge funds and subsequent dispositions of more risky bonds. Short-
term yields, indicated by the two-year U.S. Treasury note, decreased 112
basis points from 5.66 percent at year-end 1997 to 4.54 percent at year-end
1998. The spread between long-term and short-term yields was tight for the
majority of 1998 ranging from 15 to 40 basis points. However, during the
latter part of 1998, improvements in foreign market conditions caused
spreads to widen ranging from 55 to 103 basis points. Especially for long-
term investments, improvements in foreign market conditions, coupled with
a still strong domestic economy, eroded at the safe-haven allure of U.S.
Treasuries. Among other factors causing the decline in Treasury prices were
a decline in the value of the U.S. dollar, a sharp rise in foreign bond
yields and the successful introduction of the Euro, a common currency for
11 European nations. Market uncertainties also affected the spread between
U.S. Treasuries and other types of bonds in 1998. Investors, demanding to
be compensated for taking on additional credit risk, caused the spreads to
widen even for U.S. Government agencies. During 1998, short-term spreads,
represented by the difference between the average monthly yield on a two-
year U.S. Treasury and a U.S. Government agency mortgage-backed security
with a weighted-average life of two-years, ranged from 48 to 90 basis
points. Spreads on intermediate-term investments widened to a greater
degree during 1998. The spread between the average monthly yield between a
10-year U.S. Treasury and a comparable mortgage-backed security ranged from
106 to 203 basis points. In response to the increase in spreads, financial
institutions added considerably to their mortgage-backed holdings in the
second half of 1998. Yields on tax-exempt bonds also experienced a decline
in 1998, but not to the same degree as the taxable bonds. Representative
of such change was the decline in the yield on 20-year, bank-qualified,
tax-exempt municipal securities from 5.05 percent at the start of the year
to 4.70 percent at the end of 1998. Municipalities rushed to sell bonds in
1998 in order to take advantage of low rates causing a glut of tax-exempt
bonds. As a result, municipal bond prices were relatively weak causing the
spread between such investments and U.S. Treasury securities to widen. The
spread between the tax-equivalent yield on a 20-year municipal bond and a
comparable U.S. Treasury security increased from 181 basis points at year-
end 1997 to 224 basis points at the end of 1998. Moreover, the pretax yield
on the 20-year municipal was 96.3 percent of the comparable U.S. Treasury,
the highest level since 1986. The anticipated slowdown in the domestic
economy in 1999 is expected to benefit investment portfolios as it would
increase the likelihood of further FOMC rate cuts and reduce the
possibility of an increase in inflation.
The Company utilizes a total return approach, as defined by a national
investment performance ranking company, to analyze the investment
portfolio's performance with respect to risk and reward. Risk is assessed
by quantifying the average life of the investment portfolio as compared to
U.S. Treasury securities. Average life is derived from the standard
deviation or volatility of the Company's total return to that of U.S.
Treasury securities over a one-year time horizon. This risk measure
improved from 1.91 years in 1997 to 0.67 years in 1998 placing the
Company's investment portfolio in the 94th percentile with respect to risk
quality. Another assessment of riskiness is effective duration, which
measures the investment portfolio's exposure to market value volatility as
a result of interest rate fluctuations. At December 31, 1998, the Company's
investment portfolio had an effective duration of 1.4 years and primarily
consisted of government securities, obligations of states and
municipalities and mortgage-backed securities. The decrease in the
investment portfolio's effective duration from 1.8 years in 1997 reduced
the Company's exposure to future market value depreciation from rising
interest rates. During 1998, the Company's total return amounted to 7.2
percent. Such return placed the Company in the upper 20 percent of all bank
holding companies for 1998. Total return is defined as the cumulative
dollar return from an investment in a given period. Total return for bank
investment portfolios is the sum of all interest income, reinvestment
income on all proceeds from repayments and capital gains and losses,
whether realized or unrealized. In comparison, the Lehman Brothers'
aggregate-bond index, a benchmark used by most investment managers, scored
an 8.7 percent total return for 1998. For 1997, the Company's total return
was 7.9 percent, while the Lehman Brothers' Index was 9.4 percent.
On April 23, 1998, the interagencies of the Federal Financial Institutions
Examination Council ("FFIEC") approved a new "Supervisory Policy Statement
on Securities and End-User Derivatives Activities." This Statement, which
provides guidance on sound practices for managing the risks of investment
activities, supercedes the FFIEC's February 3, 1992, "Supervisory Policy
Statement on Securities Activities." The new Statement removes the binding
constraints from the 1992 Statement on depository institution investments
in high-risk mortgage securities. In accordance with the 1992 Statement,
structured mortgage-backed securities that at the time of purchase, or at
a subsequent testing date, meet any of the average life or interest
sensitivity tests were defined as high-risk securities. The FFIEC believes
it is a sound practice for institutions to understand the risks related to
all their investment holdings. They have substituted broader guidance for
the specific pass/fail requirements contained in the 1992 Statement. The
banking agencies believe that an effective risk management program, through
which an institution identifies, measures, monitors and controls the risks
of investment activities, provides a better framework. Under the new
Statement, banks must now demonstrate pre- and post-purchase tests for the
impact of interest rate changes on price volatility, cash flows and average
life. Moreover, the Statement requires examiners to perform core
examinations of banks' investment activities and, if certain conditions are
not met, to perform expanded examinations. The core examination will
require regulators to examine the investment portfolio in a broader sense.
Specifically, examiners will be required to make assessments on whether
they believe the bank has: (i) developed adequate investment policies,
procedures and risk limits; (ii) implemented effective internal control
programs; (iii) identified, measured, monitored and controlled associated
risks; (iv) assured effective oversight of the investment function from
directors and management; and (v) proved compliance with related laws,
regulations, policies and accounting standards. The new standards will
place additional emphasis on directors' oversight. Bank directors are
expected to set risk limits for: (i) the overall price sensitivity of the
investment portfolio; (ii) the characteristics of certain types of
securities prior and subsequent to purchase; (iii) the proportion of
certain types of securities to total investments; and (iv) the exposure to
issuers of non-rated bonds. Directors are also expected to review
investment activities periodically, ensure competent investment management,
require internal measurement systems and mandate independent review
programs. If examiners are dissatisfied with the results of a bank's core
examination, they will perform an expanded examination. Such examination
entails evaluation of a bank's measurement methods for accuracy,
suitability and assessment of internal control systems. If the results of
the expanded examination indicate that a bank's management is unable and
uncommitted to correct deficiencies, an impact examination will be
implemented. Such examination will assess whether any investment activity
deficiencies might impact a bank's safety and soundness and if management
is willing and able to correct the identified deficiencies.
In accordance with the Statement which was effective May 26, 1998, banks
must have procedures in place to manage various risk elements inherent in
the investment portfolio, particularly: (i) market or IRR; (ii) credit
risk; (iii) liquidity risk; (iv) operational risk; and (v) legal risk.
The Company's Investment Policy specifies approved investments and sets
limits to risk exposure on both individual securities and the overall
portfolio. Management evaluates and limits its risk exposure by using:
(i) quantitative techniques; (ii) subjective analysis; (iii) regulatory
guidance; and (iv) the investment policy.
Market or IRR relates to the inverse relationship between bond prices and
market yields. Such risk is defined as the risk that increases in general
market rates will result in market value losses. Market risk represents
the greatest risk to bond investors. Management quantifies and limits such
exposure through "stress test" modeling and by limiting the duration of
individual securities and the portfolio as a whole. Stress test modeling
measures the change in value of an investment given an immediate and
parallel shift in the yield curve or "shock." It is the Company's policy
to analyze an investment's price sensitivity utilizing stress testing prior
to purchase. In addition, management and the Board of Directors assess the
market value volatility of the existing investment portfolio at the end of
each quarter. Accordingly, stress tests conducted on the portfolio at
December 31, 1998, indicate declines in the investment portfolio's value of
approximately 0.8 percent, 1.7 percent and 2.6 percent given rising rate
shocks of 100, 200 and 300 basis points, respectively. The investment
portfolio had a greater market risk exposure at December 31, 1997, as
indicated by anticipated reductions of 1.9 percent, 3.8 percent and 5.7
percent, respectively, given the same rate shocks. Management deems this
to be an acceptable level of risk considering the Company's capital
position and overall composition of the balance sheet.
Recessionary conditions in foreign countries caused low inflation and
interest rates in the United States which had a beneficial effect on the
market value of the Company's investment portfolio in 1998. Adjusting for
the realization of net gains of $1,128 on the sale of certain equity
securities, the net unrealized holding gain would have increased $816
during 1998. The net unrealized holding gain on investment securities was
$1,394, net of deferred income taxes of $719, at December 31, 1998. This
gain was $1,600, net of deferred income taxes of $825, at December 31,
1997.
According to the stress test model, the majority of the market risk resides
in the Company's state and municipal securities portfolio. Given a 300
basis point increase in interest rates at year-end 1998, approximately 77.3
percent of the expected decline in the fair value of the investment
portfolio would be caused by market value depreciation. This market risk
resulted from the longer effective duration of approximately 2.8 years in
the state and municipal securities portfolio as compared to approximately
0.6 years in the remainder of the portfolio at year-end 1998. State and
municipals had a slightly longer effective duration of 3.4 years at the end
of 1997. Duration measures the percentage change in price per 100 basis
point change in yield levels, assuming an immediate and parallel shift in
the yield curve. The tax-exempt feature of such investments serves to
reduce their effective duration and susceptibility to fair value
depreciation relative to taxable securities. The weighted-average life of
the state and municipal securities portfolio was 9.0 years and 10.1 years
at December 31, 1998 and 1997, respectively. The weighted-average life of
the entire investment portfolio was 3.7 years at December 31, 1998.
Due to the state and municipal securities portfolio's susceptibility to
changes in interest rates, management uses a "trigger" strategy for such
investments. The portfolio is monitored for significant value
deteriorations resulting from increases in general market rates, with
appropriate action taken upon the occurrence of some predefined threshold
level of deterioration.
Credit risk, the probability that an issuer cannot meet principal and
interest payments on a timely basis, was mitigated through the portfolio's
composition. U.S. Treasury securities and U.S. Government agencies,
including mortgage-backed securities, accounted for 61.6 percent of
aggregate investments at December 31, 1998. Except for U.S. Treasury
securities and U.S. Government agencies there were no securities of any
individual issuer that exceeded 10.0 percent of the Company's stockholders'
equity at December 31, 1998 and 1997. Except for $888 of tax-exempt
obligations of local municipalities, all of the investment securities in
the Company's portfolio are considered "investment grade," receiving a
rating of "Baa" or higher from Moody's or "BBB" or higher from Standard and
Poor's rating services at December 31, 1998. The Company maintains
periodic financial statements on non-rated securities of local
municipalities. It is the Company's policy to assess the creditworthiness
of the issuer or counterparty prior to purchasing an investment. Management
considers repayment sources, municipal bond insurance, credit quality and
changes in credit ratings when dealing in the municipal bond sector. The
Company also considers settlement and pre-settlement credit risk with
respect to investment brokers. Brokers must be approved each year by the
Board of Directors prior to conducting business with the Company. As part
of its approval process, management requires financial statements, resumes,
National Association of Securities Dealers inquiries and general
information pertaining to the ability of a broker to honor commitments.
Liquidity risk refers to the ease in converting a security to cash at or
near its true value. Management and the Board of Directors review
quarterly the spread between the bid price and the ask price quoted by a
dealer in order to ensure liquidity in the investment portfolio. Management
considers its liquidity risk exposure limited because of its high
concentration of short-term U.S. Treasury and U.S. Government agency
securities, which normally offer the greatest liquidity relative to other
investments. The average bid-ask spread on the Company's mortgage-backed
securities portfolio was 6/32's representing 0.19 percent of its value at
December 31, 1998. During 1998 and 1997, the Company did not own any
securities that were not actively traded in a liquid market. Additionally,
the Company did not own any investments that had highly volatile market
values relative to small changes in interest rates, which would have caused
a material effect on operating results or liquidity.
Operational risk is the risk that deficiencies in information systems or
internal controls will result in unexpected loss. Sources of operational
risk include inadequate procedures, human error, system failure or fraud.
The Company limits its operational risk by separation of duties and
supervision of persons executing transactions from those responsible for
operational functions. The exposure to operational risk is also controlled
through procedures to ensure independent portfolio pricing and by providing
strong technical oversight and proper documentation. Moreover, the
investment function is reviewed at least annually for internal control
deficiencies from an independent internal auditing firm as well as an
external certified public accounting firm. Based on the latest reports of
these firms at December 31, 1998, management is unaware of any operational
or internal control deficiencies which would materially affect the
Company's operating results or financial position.
Legal risk is the risk that contracts are not legally enforceable or
documented correctly. The Company limits this type of risk by evaluating
investment agreements and ensuring the authority of the counterparty. In
addition, prior to acquisition, management evaluates whether a given
security will be considered unsuitable for regulatory purposes causing an
adverse impact on the securities value.
Although not mentioned specifically in the new FFIEC Statement, the
Company's exposure to timing risk is monitored closely by management and
the Board of Directors. Many bonds contain a provision that grants the
issuer an option to call all or part of the issue before the maturity date.
Other securities, such as mortgage-backed bonds, may prepay earlier or
extend longer than expected. Such options allow the issuer the flexibility
to refinance if market rates fall substantially below the investment's
coupon rate. Call, prepayment and extension risks are essentially all
timing risk. Timing risk refers to the uncertainty of the timing of cash
flows for a given investment or portfolio of investments. Timing risk
exists in the Company's holdings of U.S. Government agencies, obligations
of states and municipalities and mortgage-backed securities. Call
provisions present three disadvantages from the Company's perspective: (i)
the cash flow pattern of the investment is uncertain; (ii) the issuer may
call the bond when rates fall, thus increasing the Company's exposure to
reinvestment risk; and (iii) the capital appreciation of the bond will be
truncated since a callable bond's price will not rise much above the price
at which the issuer can call the bond.
The Company limits its cash flow timing risk through utilizing modeling
techniques to monitor its exposure. One such model uses median dealer
prepayment assumptions on mortgage-backed securities to project future
principal and interest cash flow streams under multiple interest rate
scenarios. The model measures both prepayment and extension risk. Based
on interest rate projections of plus or minus 300 basis points at December
31, 1998, the Company would expect to receive a minimum of $13.8 million or
a maximum of $33.7 million in principal payments on mortgage-backed
securities throughout the coming year.
Other sources of risk include: (i) reinvestment; (ii) yield curve; (iii)
inflation; (iv) event; (v) sector; and (vi) volatility. Most of these
risks are substantially mitigated through the previously-discussed
techniques. For example, management feels that its interest rate modeling
techniques largely reduce inflation risk. Other risks are considered by
management in a more subjective manner and are addressed in Investment
Committee or Asset/Liability Management Committee ("ALCO") meetings.
Additionally, the Company's Investment Policy promotes safety and soundness
in the investment portfolio by establishing strict limitations on the
quality, quantity and maximum maturity of each type of security. Moreover,
various operational procedures enhance controls and assure adherence to the
Investment Policy.
Generally accepted accounting principals ("GAAP") requires investments to
be classified and accounted for as either held-to-maturity, available-for-
sale or trading account securities based on management's intent at the time
of acquisition. Management is required to reassess the appropriateness of
such classifications at each reporting date.
For the years ended December 31, 1998 and 1997, the Company classified all
investment securities as available-for-sale. By classifying the portfolio
in this manner, management can use the securities to implement
asset/liability strategies in response to changes in interest rates,
prepayment risk, liquidity requirements or other circumstances identified
by management. Management does not anticipate reclassifying any of its
investments in the near term. The peer group also continued its trend
toward classifying a greater proportion of its investments as available-
for-sale, as evidenced by their increase from 90.7 percent at December 31,
1997, to 95.1 percent at December 31, 1998. Partially responsible for the
change was the FASB's issuance of SFAS No. 133, "Accounting for Derivative
and Financial Instruments and Hedging Activities," on June 16, 1998. SFAS
No. 133 is effective for fiscal years beginning after June 15, 1999, with
earlier adoption encouraged. A provision of the Statement allows entities
to transfer any held-to-maturity security into the available-for-sale or
trading account categories at the initial date of application without
calling into question their intent to hold other debt securities to
maturity in the future.
The appropriateness of the Company's accounting classifications for
investment securities became more significant as a result of the Auditing
Standards Board's issuance of Statement on Auditing Standards ("SAS") No.
81, "Auditing Investments." SAS No. 81 was effective for audits of
financial statements on or after December 15, 1997, and required external
auditors to ascertain whether a company has adopted accounting policies
that conform with GAAP. Furthermore, the auditors were required to
evaluate whether management appropriately classified investment securities
in accordance with its stated intent. The auditors had to examine evidence
such as written and approved records of investment strategies and
investment activities, instructions to portfolio managers and minutes of
meetings of the Board of Directors and the Investment Committee.
As a percentage of average assets, the Company's average investments
declined from 27.5 percent in 1997, to 26.3 percent in 1998. This reduction
was a direct reflection of the flatness of the yield curve during most of
1998, as management chose to invest excess funds in federal funds sold
until slope returned in the latter part of the year. The Company's average
investment in federal funds sold in 1998 was twice the amount reported last
year. In comparison, the peer group held 31.9 percent of its average
assets in investment securities in 1997 and 32.3 percent in 1998.
The carrying values of the major classifications of securities as they
relate to the total investment portfolio over the past five years are
summarized as follows:
<TABLE>
<CAPTION>
DISTRIBUTION OF INVESTMENT SECURITIES
1998 1997 1996 1995 1994
------------- ------------- ------------- ------------- -------------
DECEMBER 31 AMOUNT % AMOUNT % AMOUNT % AMOUNT % AMOUNT %
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Held-to-maturity:
U.S. Treasury securities........ $ 12,042 7.89%
U.S. Government agencies........ 36,993 24.25
State and municipals............ 20,616 13.51
Mortgage-backed securities...... 38,015 24.92
Equity securities...............
-------- ------
Total held-to-maturity........ 107,666 70.57
-------- ------
Available-for-sale:
U.S. Treasury securities........ $ 11,060 10.09% $ 28,583 27.05% $ 35,619 34.92% $ 43,751 40.25% 3,366 2.21
U.S. Government agencies........ 637 0.58 10,388 9.83 18,606 18.24 26,213 24.11 7,283 4.77
State and municipals............ 40,007 36.49 39,887 37.75 38,295 37.55 30,512 28.07
Mortgage-backed securities...... 55,834 50.93 23,746 22.47 7,058 6.92 6,154 5.66 29,444 19.30
Equity securities............... 2,088 1.91 3,062 2.90 2,416 2.37 2,076 1.91 4,807 3.15
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total available-for-sale...... 109,626 100.00 105,666 100.00 101,994 100.00 108,706 100.00 44,900 29.43
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total....................... $109,626 100.00% $105,666 100.00% $101,994 100.00% $108,706 100.00% $152,566 100.00%
</TABLE>
Proceeds from the sale of available-for-sale securities amounted to $1.7
million in 1998. The 1998 investment sales consisted of certain equity
securities of local financial institutions. The Investment Committee made
the decision to sell these securities in the third and fourth quarters of
1998 as a result of general declines in the values of bank stocks and the
high price multiples of these specific holdings as compared to peers. For
1998, the Company recognized net gains of $1.1 million. The effects of
these gains on the Company's 1998 net income were substantially negated by
the recognition of Y2K remediation costs and higher levels of nonperforming
asset related charges. The Company did not sell any securities in 1997.
Repayments from investment securities totaled $45.2 million in 1998 and
$31.2 million in 1997. The investment portfolio structure consists of
short-term laddered U.S. Government securities and intermediate-term state
and municipal obligations. The short-term portion of the portfolio assists
the Company in meeting its liquidity needs by structuring principal
maturities at regular intervals, whereas the intermediate-term state and
municipal obligations lower its tax liability. Based on the investment
portfolio at December 31, 1998, management expects to receive $32.4 million
of repayments in 1999 assuming no change in the current interest rate
environment.
Investment purchases amounted to $50.2 million in 1998. Specifically, the
Company purchased: (i) $3.0 million in short-term U.S. Treasury securities;
(ii) $2.4 million in intermediate-term state and municipal obligations;
(iii) $44.6 million in short-term collateralized mortgage obligations
("CMOs") and pooled mortgage-backed securities; and (iv) $150 in equity
securities, primarily common stock of the Federal Home Loan Bank of
Pittsburgh ("FHLB-Pgh"). The flat yield curve and yields on U.S. Treasuries
being subordinate to federal funds sold yields caused management to
reinvest repayments from maturing U.S. Treasuries in mortgage-backed
securities. As a result, as a percentage of total investments, U.S.
Treasuries decreased from 27.1 percent at year-end 1997 to 10.1 percent at
year-end 1998, whereas U.S. Government agency mortgage-backed securities
increased from 22.5 percent to 50.9 percent, respectively. Management
purchases and holds only CMO classes designated as Accretion Directed or
Planned Amortization Class ("PAC") II. These classes possess the highest
quality with respect to their structure and composition, which effectively
reduces their exposure to various risk elements. Accretion Directed CMOs
are designed to be completely insensitive to changes in mortgage payment
rates. PAC II CMOs have the highest cash flow priority and the most
protection from prepayment and extension risk of all other CMO classes.
Management has established internal pre-acquisition standards for CMOs
which exceed requirements set forth in the new FFIEC Statement. At a
minimum, prior to the acquisition of any CMO, management will evaluate the
following: (i) credit risk; (ii) market or IRR; (iii) timing risk; (iv)
liquidity risk; and (v) total return as compared to the comparable U.S.
Treasury security over a given interest rate horizon. With the exception
of credit risk, the CMOs acquired met or exceeded the risk and return
criteria of the U.S. Treasury security. The Company's holdings of CMOs
consist entirely of U.S. government-sponsored agencies. Although not
backed by the full faith and credit of the U.S. Government, it is general
knowledge that the government would ultimately cover any default of a
sponsored agency. Nearly two-thirds of all mortgage-backed securities
purchased in 1998 were acquired in the final four months of the year when
spreads were at their widest levels. Spreads between U.S. Treasuries and
mortgage-backed securities widened as investors required greater
compensation for taking on prepayment risk during a declining interest rate
environment. Lower interest rates typically increase principal cash flows
causing investors' returns to be reduced as they are forced to reinvest
repayments at lower yields. Mortgage-backed prepayments increased in 1998
as evidenced by examining generic prepayment speeds for Federal National
Mortgage Association ("FNMA") 30-year, 7.0 percent seasoned conventional
mortgages. The conditional prepayment rate("CPR"), which is the principal
means traders employ in quantifying prepayment activity in mortgage-backed
securities, increased from 8.0 percent in 1997 to 18.9 percent in 1998.
Contrary to this sharp increase, the average prepayment speed of the
Company's mortgage-backed securities slowed in 1998. In aggregate, the
collateral underlying the mortgage-backed securities in the Company's
portfolio prepaid at an average rate of 15.2 CPR during 1997, which
represents an annual prepayment rate on outstanding principal of 15.2
percent. The portfolio's average CPR rate declined to 12.9 percent in
1998. Management will continue to redirect excess funds to investments in
short-term U.S. Government securities in order to ensure funding for loan
demand and to meet pledging requirements of local municipalities.
At December 31, 1998 and 1997, none of the Company's CMOs met the criteria
for high-risk, nonequity CMOs as defined in Issue 2 of FASB's Emerging
Issues Task Force ("EITF") Issue No. 89-4, "Accounting for a Purchased
Investment in a Collateralized Mortgage Obligation Instrument or in a
Mortgage-Backed Interest-Only Certificate." EITF Issue No. 89-4 defines
high-risk, nonequity CMOs as those that have the potential for loss of a
significant portion of their original investments due to changes in: (i)
interest rates; (ii) prepayment rate of the assets of the CMO structure; or
(iii) earnings from temporary reinvestment of cash collected by the CMO
structure but not yet distributed to the holders of its obligations.
Contrary to the significant decline in the yields on U.S. Treasuries during
1998, the tax-equivalent yield on the Company's investment portfolio rose
from 6.60 percent in 1997 to 6.77 percent in 1998. This increase is more
significant when considering the aforementioned reduction in the riskiness
of the portfolio. Moreover, such yield improvement was opposite of the
results evidenced for the peer group which experienced a deterioration in
yield from 6.59 percent in 1997 to 6.43 percent in 1998.
At December 31, 1998, investment securities with an amortized cost of
$28,895 were pledged to secure deposits, to qualify for fiduciary powers
and for other purposes required or permitted by law. At December 31, 1997,
the amortized cost of pledged securities equaled $25,971. The fair value
of such securities equaled $28,836 at December 31, 1998, and $25,979 at
December 31, 1997.
The maturity distribution of the amortized cost, fair value and weighted-
average tax-equivalent yield of the available-for-sale portfolio at
December 31, 1998, is summarized as 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
mortgage-backed securities, CMOs and equity securities. Mortgage-backed
securities and CMOs 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 years maturity distribution. Expected maturities may differ from
contracted maturities because borrowers have the right to call or prepay
obligations with or without call or prepayment penalties.
<TABLE>
<CAPTION>
MATURITY DISTRIBUTION OF AVAILABLE-FOR-SALE PORTFOLIO
AFTER ONE AFTER FIVE
WITHIN BUT WITHIN BUT WITHIN AFTER
ONE YEAR FIVE YEARS TEN YEARS TEN YEARS TOTAL
------------- ------------- ------------- ------------- -------------
DECEMBER 31, 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.... $11,017 5.83% $ 11,017 5.83%
U.S. Government agencies.... $ 649 3.61% 649 3.61
State and municipals........ 1,990 6.12 5,569 6.78 $ 8,841 8.67% $21,592 8.17% 37,992 7.98
Mortgage-backed securities.. 19,344 6.45 35,333 6.27 1,374 6.23 56,051 6.33
Equity securities........... 1,804 6.44 1,804 6.44
------- ------- ------- ------- --------
Total..................... $32,351 6.22% $41,551 6.30% $10,215 8.34% $23,396 8.04% $107,513 6.85%
======= ======= ======= ======= ========
Fair value:
U.S. Treasury securities.... $11,060 $ 11,060
U.S. Government agencies.... $ 637 637
State and municipals........ 1,998 5,672 $ 9,391 $22,946 40,007
Mortgage-backed securities.. 19,293 35,177 1,364 55,834
Equity securities........... 2,088 2,088
------- ------- ------- ------- --------
Total..................... $32,351 $41,486 $10,755 $25,034 $109,626
======= ======= ======= ======= ========
</TABLE>
The Company did not have any holdings of structured notes at December 31,
1998. At December 31, 1997, the carrying value of the Company's structured
notes totaled $2.0 million. Specifically, such securities included a dual-
index floater and a delevered floater, each having a carrying value of
approximately $1.0 million at December 31, 1997. Both securities matured
in 1998. For information with respect to accounting considerations and
treatment of such instruments, refer to Note 3 in the Company's Notes to
Consolidated Financial Statements.
As previously mentioned, the FASB issued SFAS No. 133 on June 16, 1998.
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 foreign currency
exposures. 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. The Company had no dealings with instruments that qualify as
derivatives for the three years ended December 31, 1998. Moreover, the
Company's Investment Policy prohibits management from engaging in
derivative activities in the future.
On October 9, 1998, the FASB issued SFAS No. 134, "Accounting for Mortgage-
Backed Securities Retained after the Securitization of Mortgage Loans Held
for Sale by a Mortgage Banking Enterprise." This Statement amends SFAS No.
65, "Accounting for Certain Mortgage Banking Activities," to require that
after securitization of mortgage loans held for sale, an entity engaged in
mortgage banking activities classify the resulting mortgage-backed
securities or other retained interests as held-to-maturity, available-for-
sale or trading, based on its ability and intent to sell or hold those
investments, in accordance with the provisions of SFAS No. 115, "Accounting
for Certain Investments in Debt and Equity Securities." The Statement also
requires a mortgage banking enterprise to classify as trading any retained
mortgage-backed securities that it commits to sell before or during the
securitization process. SFAS No. 134 is effective for the first fiscal
quarter beginning after December 15, 1998. The adoption of SFAS No. 134 on
January 1, 1999, is not expected to have a material effect on the Company's
operating results or financial position, as it has no retained mortgage-
backed securities or other interests from the securitization of mortgage
loans held for sale.
LOAN PORTFOLIO:
Loans are the most significant assets of financial institutions and
generate the largest portion of revenues. There are many factors that
affect the overall lending environment. Specifically, the housing market
and the economic conditions affecting it may significantly impact lending
activities, since loans to finance one-to-four family residential
properties account for a predominant share of lending activities in most
financial institutions. For the Company, residential mortgage lending
activities account for approximately two-thirds of its total lending
activities.
The low interest rate environment, unseasonably mild weather and high
consumer demand, fueled by a booming stock market, low inflation and rising
wages, created a record-breaking year for the housing market and
residential mortgage lending in 1998. New and existing home sales reached
record levels. There were 888 thousand new homes purchased in 1998, the
highest level since the government started tracking these sales in 1963.
This marked a 10.3 percent increase over 1997 purchases of 805 thousand.
Existing home sales also hit a record rate of 4.8 million sold for 1998, a
14.3 percent increase over the 4.2 million sales recorded for 1997. In
addition to the reasons mentioned above, another cause for the boost in the
real estate market was that consumers found housing more affordable in
1998. The median selling price for both new and existing homes rose only
3.7 percent from 1997. On the construction side, 1998 marked the best year
in housing in over a decade. Nationally, homebuilders started 1.62 million
single-family homes and apartment units in 1998, an increase of 10.2
percent over the 1.47 million started in 1997. For the Northeast housing
starts in 1998 were up 8.8 percent over 1997 levels.
Overall, the housing market gains reflected favorably on real estate
lending for banks in 1998. In addition, low interest rates contributed to
an increase in mortgage lending. Interest rates on 30-year mortgages
averaged 66 basis points lower in 1998 at 6.91 percent, in comparison to
7.57 percent in 1997. As a result of these conditions, the total dollar
amount of real estate loans outstanding for all commercial banks grew to
$1.3 trillion at December 31, 1998, from $1.2 trillion at December 31,
1997.
As in the previous year, commercial and industrial lending benefitted from
the strong economy and low interest rates. The FOMC's three rate cuts in
1998 caused the prime rate to decrease 75 basis points from 8.50 percent at
December 31, 1997, to 7.75 percent at December 31, 1998. Business spending
increased 12.5 percent in 1998, as companies, optimistic about the economy
and its future prospects, took advantage of the availability of low-costing
credit. As a result, lending competition became increasingly fierce for
financial institutions. The economic conditions in recent years forced
lending institutions to ease loan pricing, credit and underwriting
standards. Total outstanding commercial and industrial loans to U.S.
commercial banks at December 31, 1998, grew $91.2 billion or 10.7 percent
to $945.1 billion, from $853.9 billion at December 31, 1997.
With regard to the Company's commercial loan practices, it was ranked
fourth in 1998 by the U.S. Small Business Administration's Office of
Advocacy among Pennsylvania banks with assets between $300.0 million and
$500.0 million for its "small business friendly" lending activities. This
marks the third consecutive year that the Company was ranked in the top
five of all banks. Four variables are used to rank the small business
lending activities: (i) the ratio of small business loans, loans less than
$250, to total assets; (ii) the ratio of small business loans to total
business loans; (iii) the dollar value of small business loans; and (iv)
the number of small business loans.
The Board of Governors of the Federal Reserve System ("Federal Reserve
Board") issued Supervisory Release ("SR") 98-18, "Lending Standards for
Commercial Loans" on June 23, 1998. SR 98-18 was issued based on the
results of a recent study by Federal Reserve Board's supervision staff,
which compared lending standards and terms of commercial loans made in late
1995 to those made in late 1997. The study concluded that intense
competition for loan customers has resulted in easing of loan pricing and
terms. SR 98-18 serves as guidance for examiners and highlights specific
areas within the credit risk management process that will be subjected to
heightened supervisory attention. Specifically, these areas include: (i)
the use of formal forward-looking analysis in the loan approval process.
Examiners will be evaluating the adequacy of a bank's forward-looking
analysis, which considers the possible events that might jeopardize the
ability of borrowers to repay their loans; (ii) appropriate pricing based
on credit risk. Examiners were advised to look for loan approval policies
that gave too much weight to attracting and retaining customers rather than
potential long-term consequences; and (iii) potential credit concentrations
arising from lending to real estate investment trusts ("REIT"), which are
typically very large unsecured loans. Examiners will be assessing the
level of REIT concentrations within an institution and the adequacy of the
risk management process relating to these concentrations. The Federal
Reserve Board also provided the following recommendations for banks to
improve their lending practices: (i) develop and implement formal written
credit policies; (ii) ensure credit approval processes are performed by
experienced personnel that are independent of the lending functions; (iii)
adopt standardized loan approval documents; (iv) use forward-looking
analysis in the approval process; (v) implement an internal risk rating
system; and (vi) ensure proper management information systems exist which
provide bank management and lenders with sufficient information to evaluate
the composition of, and the risk within, the loan portfolio.
Based on the Federal Reserve Board's January of 1999 "Senior Loan Officer
Opinion Survey on Bank Lending Practices," most banks are no longer
tightening standards for business lending. The survey cited only 7.0
percent of domestic banks were raising the standards for large-and mid-size
borrowers and 4.0 percent of these banks were raising their standards for
small companies. The previous survey, conducted three months earlier in
November of 1998, showed significant tightening of standards as banks were
receiving criticism from examiners for too lenient lending practices
following the Federal Reserve Board's release of SR 98-18. Similarly, 15.0
percent of banks surveyed reported tightened standards on commercial real
estate loans in January of 1999, down from 46.0 percent in November of
1998.
On the consumer side, low unemployment levels, rising wages and increased
wealth from a thriving stock market all kept confidence levels high
throughout 1998. High confidence resulted in a declining savings rate as
consumers were eager to spend more and save less. Banks however, did not
reap any benefits from this high confidence and spending. Outstanding
consumer loans declined from $506.5 billion at December 31, 1997, to $501.7
billion at December 31, 1998, as individuals chose to spend their
disposable income or find alternate nonbank financing sources.
A trend that is becoming more popular with financial institutions is
subprime lending. Subprime lending involves of lending to people with
tarnished credit histories, low income relative to debt levels and lending
money that far exceeds any underlying collateral. The majority of this
type of lending involves mortgage and home equity loans. Popularity for
these loans arose from fierce competition in the lending industry, as banks
vie for new customers and additional sources of revenue. These types of
loans appear attractive with higher fees and interest rates, resulting in
higher profit margins. However, these high profit margins come with a
price in the form of higher volatility and greater default rates.
The federal banking agencies have issued guidelines cautioning financial
institutions about the inherent risks involved in subprime lending. Many
institutions have discovered that they have underestimated the costs
involved in this type of lending, namely, high default rates, loss-on-
default rates and collection costs. Economic downturns tend to adversely
affect subprime borrowers earlier and more severely than standard risk
borrowers. Banks should carefully consider if this type of lending program
is prudent based on the additional risks involved. As a result of the
greater risks, the agencies may impose higher minimum capital requirements
on institutions that engage in this activity. The Company did not engage
in subprime lending during the years-ended December 31, 1998 and 1997.
Moreover, management does not anticipate entering into such activities in
the future.
The composition of the Company's loan portfolio at year-end for the past
five years is summarized as follows:
<TABLE>
<CAPTION>
Distribution of loan portfolio
1998 1997 1996 1995 1994
--------------- --------------- --------------- --------------- ---------------
DECEMBER 31 AMOUNT % AMOUNT % AMOUNT % AMOUNT % AMOUNT %
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Commercial, financial and others... $ 31,044 12.51% $ 38,996 15.58% $ 36,416 15.44% $ 45,554 21.30% $ 31,829 16.37%
Real estate:
Construction..................... 2,108 0.85 2,096 0.84 3,657 1.55 992 0.46 2,729 1.40
Mortgage......................... 186,004 74.96 180,123 71.98 165,868 70.34 144,649 67.65 134,453 69.13
Consumer, net...................... 28,984 11.68 29,012 11.60 29,862 12.67 22,640 10.59 25,474 13.10
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Loans, net of unearned income.... 248,140 100.00% 250,227 100.00% 235,803 100.00% 213,835 100.00% 194,485 100.00%
-------- ====== -------- ====== -------- ====== -------- ====== -------- ======
Less: allowance for loan losses.... 4,050 3,798 3,944 3,903 3,576
-------- -------- -------- -------- --------
Net loans...................... $244,090 $246,429 $231,859 $209,932 $190,909
======== ======== ======== ======== ========
</TABLE>
Loans, net of unearned income, totaled $248.1 million at December 31, 1998,
a slight decline of $2.1 million or 0.8 percent as compared to the $250.2
million at December 31, 1997. Included in loans, net of unearned income at
year-end 1997 were $7.0 million in short-term credit extensions to certain
large Pennsylvania-based commercial banks. Adjusting for the commercial
bank credit extensions at December 31, 1997 there would have been a $4.9
million or 2.1 percent increase in the loan portfolio. Taking into
consideration this adjustment, the growth is entirely related to commercial
mortgage lending. Commercial mortgages grew $5.2 million or 13.8 percent
from year-end 1997. One-to-four family residential mortgage loans rose
$0.7 million in 1998. Offsetting these increases, was a decline in
commercial loans of $1.0 million in 1998, adjusted for temporary credit
extensions at December 31, 1997. Outstanding consumer loans remained
relatively unchanged from year-end 1997 to year-end 1998. Total average
loan volumes increased in 1998 by $6.0 million or 2.5 percent to $247.9
million, from $241.9 million for 1997. The ratio of average loans, net of
unearned income to total average assets declined to 65.7 percent for 1998
from 67.3 percent for 1997. Increases in average federal funds sold and
other assets contributed to the decline as a result of the flat yield curve
and capital expenditures for delivery system expansions. In comparison,
during 1998, the peer group's average loans accounted for 62.2 percent of
total average assets. Management expects the openings of the Clarks Summit
and Dickson City banking offices to increase loan demand in 1999. In
anticipation of this increased demand, management hired additional lending
staff during 1998. However, indications suggest the real estate market
will stabilize in 1999 with slower job and income growth and lower consumer
confidence. Should these conditions occur or should interest rates climb,
the Company may experience a decline in loan demand.
Low mortgage rates, the decline in the prime rate and the repayment of the
credit extensions to financial institutions all contributed to the change
in the composition of the loan portfolio in 1998. Favorable mortgage
lending conditions, coupled with lower interest rates in general, led to an
increase in the percentage of real estate loans to total loans outstanding.
At December 31, 1998, residential and commercial real estate loans amounted
to $186.0 million and comprised approximately 75.0 percent of the loan
portfolio. In comparison, at December 31, 1997, these loans totaled $180.1
million, approximately 72.0 percent of total loans outstanding. Commercial
loans as a percentage of total loans decreased from 15.6 percent at
December 31, 1997, to 12.5 percent at December 31, 1998. As
aforementioned, this reduction was principally due to the repayments of
outstanding credit extensions to other Pennsylvania-based commercial banks
in 1998. Consumer loans remained relatively unchanged at year-ends 1997
and 1998.
The tax-equivalent yield on the loan portfolio increased 2 basis points
from 8.53 percent in 1997 to 8.55 percent in 1998. This slight increase is,
in fact, a significant accomplishment considering the low interest rate
environment and recent prime rate reductions. The Company experienced loan
yield declines throughout the year. The tax-equivalent yield in the first
quarter of 1998 was 8.65 percent. This dropped 15 basis points to 8.50
percent for the fourth quarter of 1998.
Fueled by consistently low mortgage rates, the volume of refinancing has
intensified as borrowers have consolidated bills, credit card balances and
regular consumer loans to reduce monthly debt payments and take advantage
of the tax deductibility of interest payments. The Company's volume of
refinanced residential mortgages increased $1.6 million in 1998 to $12.5
million from $10.9 million in 1997. The volume of refinancing in the near
term is expected to level off as interest rates are expected to remain
constant and holders of mortgages with rates of 8.0 percent or higher have
already refinanced.
During the third quarter of 1998, the Company successfully implemented a
secondary mortgage banking program. Secondary mortgage banking activities
involve originating mortgage loans for sale to secondary market investors.
The subsequent servicing of the sold loans can either be retained by the
seller or sold along with the loans. The Company has elected to retain
servicing of the loans sold under this program. This program allows the
Company to competitively price conforming one-to-four family residential
mortgage loans while, at the same time, reduce its exposure to IRR,
increase its liquidity and provide an additional source of noninterest
income. During 1998, the Company sold $2.1 million of residential mortgage
loans to one investor, the FNMA. Net gains on the sale of these loans
included in noninterest income for 1998 were $43. At December 31, 1998, the
Company had $503 of residential mortgage loans held for sale.
The Company adopted SFAS No. 125, "Accounting for Transfers and Servicing
of Financial Assets and Extinguishment of Liabilities," on January 1, 1997.
This Statement superseded SFAS No. 122, "Accounting for Mortgage Servicing
Rights," which was effective January 1, 1996. SFAS No. 125 provides
accounting and reporting standards for transfers and servicing of financial
assets and extinguishment of liabilities. SFAS No. 125 also provides
implementation guidance for: (i) assessing isolation of transferred assets
and for accounting for transfers of partial interests; (ii) servicing of
financial assets; (iii) securitizations; (iv) transfers of sales-type and
direct financing lease receivables; (v) securities lending transactions;
(vi) repurchase agreements; (vii) dollar-roll transactions; (viii) wash
sales; (ix) loan syndications and participations; (x) risk participations
in banker's acceptances; (xi) factoring arrangements; (xii) transfers of
receivables with recourse; and (xiii) extinguishment of liabilities. The
accounting and reporting standards in SFAS No. 125 are based on consistent
application of a financial-components approach that focuses on control.
Under this approach, after a transfer of financial assets, an enterprise
recognizes the financial and servicing assets it controls and the
liabilities it has incurred, derecognizes financial assets when control has
been surrendered and derecognizes liabilities when extinguished. SFAS No.
125 provides consistent standards for distinguishing transfers of financial
assets that are sales from transfers that are secured borrowings. The
Statement is effective for transfers and servicing of financial assets and
extinguishment of liabilities occurring after December 31, 1996, except as
amended in SFAS No. 127, "Deferral of the Effective Date of Certain
Provisions of FASB Statement No. 125." Specifically, the provisions
identified as being deferred under SFAS No. 127 include secured borrowings,
collateralizations and transfers of financial assets that are part of
repurchase agreements, dollar-rolls, securities lending and similar
transactions. The Company adopted SFAS No. 127 on January 1, 1998. During
1998, the Company had no transfers of financial assets nor extinguishment
of liabilities that fell under the scope of SFAS No. 127, therefore, the
adoption of the Statement had no material effect on operating results or
financial position.
In accordance with SFAS No. 125, a servicing right is determined by
allocating the total costs incurred between the loan sold and the servicing
right, based on their relative fair values at the date of the sale. The
servicing right is amortized in proportion to, and over the period of,
estimated net servicing income. In addition, a servicing right is assessed
for impairment at each reporting date based on the fair value of the right.
To determine the fair value of the servicing right, the Company estimates
the present value of future cash flows incorporating assumptions such as
cost of servicing, discount rates, prepayment speeds and default rates.
For purposes of measuring impairment, the rights are stratified by loan
type, term and interest rate. The amount of impairment recognized, through
a valuation allowance, is the amount by which the mortgage servicing rights
for a stratum exceed their fair value.
Mortgage servicing rights are included in other assets. Amortization of
the rights is included in noninterest income as a charge against mortgage
servicing fees.
At December 31, 1998, the cost of the mortgage servicing rights
approximated their fair value. The Company did not originate for sale or
service mortgage loans during 1997, therefore, there were no servicing
rights at December 31, 1997.
In the normal course of business, the Company is a party to financial
instruments with off-balance sheet risk to meet the financing needs of its
customers. These instruments involve, to varying degrees, elements of
credit and IRR in excess of the amount recognized in the financial
statements. Management does not anticipate that losses, if any, that may
occur as a result of funding off-balance sheet commitments would have a
material adverse effect on the Company's results of operations or financial
position.
The Company's involvement in, and exposure to, credit loss in the event of
nonperformance by the other party to the financial instrument for
commitments to extend credit, unused portions of home equity and credit
card lines and commercial letters of credit is represented by the
contractual amounts of those instruments. Commitments to extend credit are
agreements to lend to a customer as long as the conditions of the contract
are not violated. Commitments generally have fixed expirations dates or
other termination clauses and may require payment of a fee. Commercial
letters of credit are conditional commitments issued by the Company to
support customers in the purchase of commercial goods. The letters of
credit are automatically renewable upon their anniversary date unless
canceled prior to that date at the option of the Company.
The Company employs the same credit policies and requirements in making
off-balance sheet credit commitments as it does for on-balance sheet
instruments. Provision for loan losses, if any, is included in the
Company's allowance for loan losses. No provision was deemed necessary at
December 31, 1998 and 1997. These commitments are generally issued for one
year or less and often expire unused in whole or part by the customer. The
amount of collateral obtained is based on management's credit evaluation of
the customer. The type of collateral varies but may include property,
plant and equipment, residential properties, and to a lesser extent,
income-producing properties. The Company's exposure related to off-balance
sheet commitments was $18.1 million at December 31, 1998, and $17.8 million
at December 31, 1997.
At December 31, 1998, the Company had no loan concentrations exceeding 10.0
percent of total loans, excluding locational concentrations, to individuals
or multiple borrowers engaged in activities that would cause them to be
similarly affected by changes in economic or other conditions. The Company
limits its exposure to concentrations of credit risk by the nature of its
lending limits as approximately 58.6 percent of total loans outstanding are
secured by residential properties. The average mortgage outstanding on a
residential property was $41 at December 31, 1998. The Company maintains
a policy restricting the loan-to-value ratio at 80.0 percent. The loan
portfolio does not consist of any form of credit involving highly-leveraged
transactions, defined as financing transactions that involve the buyout,
acquisition or re-capitalization of an existing business and include
credits extended to highly-leveraged individuals.
Based on the Company's asset/liability simulation model, management feels
confident that it can facilitate loan demand through payments and
prepayments on investments and loans and increases in core deposits.
Management expects to receive approximately $83.3 million from repayments
on loans and investment securities during 1999. In the event an unforeseen
increase in loan demand arises during 1999, management could facilitate the
demand by aggressively competing for deposits or by utilizing various
credit products available through the FHLB-Pgh.
Management continually examines the maturity distribution and interest rate
sensitivity of the loan portfolio in an attempt to limit IRR and liquidity
strains. Approximately 31.1 percent of the loan portfolio is expected to
reprice within the next twelve months. This percentage declined slightly
in comparison to 33.5 percent repricing within the same time period at
December 31, 1997. Adjustable-rate loans at December 31, 1998, increased
$2.7 million or 5.9 percent from December 31, 1997. This increase was not
able to mitigate the $9.3 million decline in fixed-rate loans maturing
within twelve months. In total, fixed-rate loans declined $4.8 million or
2.4 percent, and accounted for 80.4 percent of the loan portfolio at
December 31, 1998. Adjustable-rate loans accounted for the remaining 19.6
percent. 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
adjustable-rate loans in an attempt to reduce IRR in the loan portfolio.
The maturity distribution and repricing information of the loan portfolio
by major classification at December 31, 1998, is summarized as follows:
<TABLE>
<CAPTION>
MATURITY DISTRIBUTION AND INTEREST SENSITIVITY OF LOAN PORTFOLIO
AFTER ONE
WITHIN BUT WITHIN AFTER
DECEMBER 31, 1998 ONE YEAR FIVE YEARS FIVE YEARS TOTAL
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Maturity schedule:
Commercial, financial and others........................... $15,686 $ 8,943 $ 6,415 $ 31,044
Real estate:
Construction............................................. 2,108 2,108
Mortgage................................................. 23,510 54,090 108,404 186,004
Consumer, net.............................................. 9,629 15,099 4,256 28,984
------- ------- -------- --------
Total.................................................. $50,933 $78,132 $119,075 $248,140
======= ======= ======== ========
Repricing schedule:
Predetermined interest rates............................... $28,558 $68,688 $102,263 $199,509
Floating-or-adjustable interest rates...................... 48,631 48,631
------- ------- -------- --------
Total.................................................. $77,189 $68,688 $102,263 $248,140
======= ======= ======== ========
</TABLE>
ASSET QUALITY:
Nationally, large financial institutions experienced deterioration in their
asset quality during 1998. This deterioration primarily resulted from an
increase in nonperforming assets and charge-offs related to failed loans to
foreign countries. For the nation's top 50 banks, nonperforming assets and
net charge-offs increased from year-end 1997 to year-end 1998 by 9.0
percent and 29.0 percent, respectively. In addition, the nonperforming
asset ratio, nonperforming assets as a percentage of total loans, was 0.70
percent at December 31, 1998, as compared to 0.68 percent at December 31,
1997. Furthermore, the ratio of net charge-offs to average loans rose to
0.66 percent for 1998, as compared to 0.54 percent for 1997.
Unlike large financial institutions, banks located within the Commonwealth
of Pennsylvania and those in the Company's peer group experienced
improvement in their asset quality for 1998. Higher wages and job growth,
lower unemployment levels and a dramatic slowing in the growth of personal
bankruptcies filed aided the improvement for both the Commonwealth and the
peer group. The total income level and total payroll employment for the
Commonwealth for 1998 increased 3.0 percent and 1.7 percent, respectively.
Pennsylvania's relatively tight labor market led to growth in wage and
salary income, the predominant portion of total income. In addition, state
unemployment levels declined from 4.8 percent in 1997 to 4.4 percent in
1998. Furthermore, for the previous two years the Commonwealth experienced
over 30.0 percent growth in the number of personal bankruptcies filed.
However, in 1998 the growth in number of filings slowed to 9.4 percent. For
the peer group, improvement in asset quality is evidenced by a decline in
the nonperforming asset ratio from 1.73 percent at December 31, 1997, to
1.02 percent at December 31, 1998. The ratio of net charge-offs to average
loans also declined in 1998 from 0.29 percent in 1997 to 0.27 percent.
In spite of the favorable economic conditions and improved asset quality,
the federal banking agencies are cautioning financial institutions on
trends that could lead to asset quality deterioration in the future if not
managed prudently. Specific to consumer lending, the agencies issued
"Interagency Guidelines on Subprime Lending." As aforementioned, subprime
lending activities involve lending to people with poor credit histories,
low incomes relative to debt levels or in lending money in an amount that
exceeds the value of the underlying collateral. A future slowdown in the
economy could lead to deterioration in asset quality related to subprime
lending. Subprime borrowers could be affected earlier and more severely
than standard-risk borrowers.
With respect to commercial lending, stiff competition has led to the
erosion of underwriting standards. Lenders are writing more high-risk
loans with few or no fees and insufficient interest margins to accurately
reflect such risk. In addition, loans are written with few loan covenants
attached and without guarantees. Furthermore, lenders are not conducting
proper analysis of future performance of their customers. As
aforementioned, the Federal Reserve Board issued SR 98-18, which serves as
guidance for examiners during their credit reviews and a warning to the
banking industry. Lax underwriting standards could lead to higher
nonperforming assets and charge-offs, should a downturn in the economy
occur.
The Company manages credit risk by diversifying the loan portfolio and
applying policies and procedures designed to foster sound lending
practices. These policies include certain standards that assist lenders in
making judgments regarding the character, capacity, capital structure and
collateral of the borrower. In addition, the lender must determine the
borrower's ability to repay the credit based on prevailing and expected
business conditions. Although supervised by a central loan committee, each
community office is responsible for the credit administration of its
respective loan portfolio. Specific responsibilities include analyzing
credit applications and making lending approvals within specified limits,
in order to minimize credit risk. The Board of Directors establishes the
lending authority of all credit officers and reviews this authority at
least annually. Credits beyond the scope of the branch lending officer are
forwarded to a centralized lending committee. This committee, comprised of
senior lending management and board members, attempts to assure the quality
of the loan portfolio through careful analysis of credit applications,
adherence to credit policies and examination of outstanding loans and
delinquencies. These procedures aid in the early detection and timely
follow-up of problem loans. Credits in excess of $500 are subject to
approval by the Board of Directors.
Also, the Company minimizes credit risk by conducting an annual internal
loan review of its loan portfolio. In addition, the Company contracts with
an external loan review company to perform an annual independent review of
the portfolio. The independent loan review aids management in identifying
deteriorating financial conditions of borrowers, allowing them to assist
customers in remedying these situations. The results of an independent
loan review conducted by an external reviewer at May 31, 1998 indicated no
material difference from the assets identified through the Company's loan
review program.
Under GAAP, a loan is considered impaired when, based on current
information and events, it is probable that the Company will be unable to
collect all amounts due according to the contractual terms of the loan
agreement. Impairment is measured based on the present value of expected
future cash flows discounted at a loan's effective interest rate, the
loan's observable market price or the fair value of collateral if the loan
is collateral-dependent. When the measure of an impaired loan is less than
the recorded investment in the loan, the impairment is recognized by
adjusting the allowance for loan losses with a corresponding charge to the
provision for loan losses.
Nonperforming assets consist of nonperforming loans and foreclosed assets.
Nonperforming loans include accruing loans past due 90 days or more and
impaired loans. Impaired loans consist of nonaccrual and restructured
loans. A loan is classified as nonaccrual when it is determined that the
collection of all or a portion of interest or principal is doubtful or when
a default of interest or principal has existed for 90 days or more, unless
the loan is well secured and in the process of collection. When a loan is
placed on nonaccrual, interest accruals discontinue and uncollected accrued
interest is reversed against income in the current period. Interest
collections after a loan has been placed on nonaccrual status are credited
to income when received unless the collectibility of principal is in doubt,
causing all collections to be applied as principal reductions. A nonaccrual
loan is returned to performing status when the loan is current as to
principal and interest and has performed with the contractual terms for a
minimum of six months. Restructured loans are loans with original terms,
interest rates, or both, that have been modified as a result of a
deterioration in the borrower's financial condition. Interest income on
restructured loans is recognized when earned using the interest method.
The Company had the same one restructured loan during 1998 and 1997.
Foreclosed assets are comprised of properties acquired through foreclosure
proceedings or acceptance of a deed-in-lieu of foreclosure and loans
classified as in-substance foreclosures. The Company includes such
properties in other assets. A loan is classified as in-substance
foreclosure when the Company has taken possession of the collateral
regardless of whether formal foreclosure proceedings take place.
Foreclosed assets are recorded at the lower of the related loan balance or
80.0 percent of its appraised fair value at the time of acquisition. Any
excess of the loan balance over the recorded value is charged to the
allowance for loan losses. Subsequent declines in the recorded value of
the property prior to its disposal and costs to maintain the assets are
included in other expenses. In addition, any gain or loss realized upon
disposal is included in other income or expense. The historical average
holding period for such properties is less than twelve months.
Information concerning nonperforming assets for the past five years is
summarized as follows. The table includes credits classified for regulatory
purposes and all material credits that cause management to have serious
doubts as to the borrowers' ability to comply with present loan repayment
terms.
<TABLE>
<CAPTION>
DISTRIBUTION OF NONPERFORMING ASSETS
DECEMBER 31 1998 1997 1996 1995 1994
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Nonaccrual loans:
Commercial, financial and others................................. $ 78 $ 197 $ 251 $ 167 $ 45
Real estate:
Construction...................................................
Mortgage....................................................... 2,223 2,063 1,018 1,164 1,352
Consumer, net.................................................... 7 12
------ ------ ------ ------ ------
Total nonaccrual loans....................................... 2,308 2,272 1,269 1,331 1,397
------ ------ ------ ------ ------
Restructured loans............................................... 174 189 225 262 236
------ ------ ------ ------ ------
Total impaired loans......................................... 2,482 2,461 1,494 1,593 1,633
------ ------ ------ ------ ------
Accruing loans past due 90 days or more:
Commercial, financial and others................................. 131 321 359 181 33
Real estate:
Construction...................................................
Mortgage....................................................... 1,035 2,536 1,247 1,633 1,194
Consumer, net.................................................... 387 312 291 336 197
------ ------ ------ ------ ------
Total accruing loans past due 90 days or more................ 1,553 3,169 1,897 2,150 1,424
------ ------ ------ ------ ------
Total nonperforming loans.................................... 4,035 5,630 3,391 3,743 3,057
------ ------ ------ ------ ------
Foreclosed assets................................................ 240 405 420 441 226
------ ------ ------ ------ ------
Total nonperforming assets................................... $4,275 $6,035 $3,811 $4,184 $3,283
====== ====== ====== ====== ======
Ratios:
Impaired loans as a percentage of loans, net..................... 1.00% 0.98% 0.63% 0.74% 0.84%
Nonperforming loans as a percentage of loans, net................ 1.63 2.25 1.44 1.75 1.57
Nonperforming assets as a percentage of loans, net............... 1.72% 2.41% 1.62% 1.96% 1.69%
</TABLE>
Nonperforming assets, comprised of nonperforming loans and foreclosed
assets, totaled $4.3 million at December 31, 1998, compared to $6.0 million
at December 31, 1997. Foreclosed assets decreased $165 during 1998. Eight
loans totaling $249 were transferred to foreclosed assets. Six properties
with an aggregate carrying value of $280 were sold for $275, resulting in
a realized net loss of $5. In addition, during 1998 the Company donated a
property held in other real estate to Habitat for Humanity. This property
had a carrying value of $23. Finally, the Company had all properties
included in other real estate re-appraised during 1998 which resulted in
additional write-downs of $111. The carrying values of all properties
included in other real estate at December 31, 1998, were no more than 80.0
percent of their collateral values.
Nonperforming loans, consisting of accruing loans past due 90 days or more
and impaired loans, decreased $1.6 million during 1998 from $5.6 million to
$4.0 million. The decline in nonperforming loans was entirely from a
decrease in accruing loans past due 90 days or more. The major portion of
this decline came from a $1.5 million decrease in real estate loans past
due 90 or more days. The Company's increased collection efforts relative to
real estate loans, coupled with an improvement in general economic
conditions in the Company's market area contributed to the decline. As
part of its collection strategy, management continuously monitors and
improves its internal procedures regarding delinquent credits. Such
procedures focus on early detection and timely follow-up of past due loans
in order to identify potential problem loans and attempt to correct them
before they deteriorate. The Company experienced some changes in its asset
quality ratios in 1998. Impaired loans as a percentage of loans, net of
unearned income, remained relatively unchanged from year-end 1997. This
ratio was 1.00 percent at December 31, 1998, compared to 0.98 percent at
December 31, 1997. For the Company's peer group, this ratio was 0.63
percent at year-end 1998. The ratio of nonperforming assets to loans, net
of unearned income, improved from 2.41 percent at December 31, 1997, to
1.72 percent at December 31, 1998. This ratio was also less favorable as
compared to the peer group's 0.91 percent recorded at December 31, 1998.
At December 31, 1998 and 1997, the Company had a recorded investment in
impaired loans of $2,482 and $2,461, respectively. The recorded investment
in impaired loans averaged $1,867 in 1998 and $2,368 in 1997. At December
31, 1998, the amount of recorded investment in impaired loans for which
there was a related allowance for loan losses and the amount of the
allowance was $2,308 and $642, respectively, and $2,272 and $541,
respectively, for the year-ended December 31, 1997. The amount of recorded
investment for which there was no related allowance for loan losses was
$174 and $189 at December 31, 1998 and 1997, respectively. During 1998,
activity in the allowance for loan losses account related to impaired loans
included a provision charged to operations of $342, losses charged to the
allowance of $286 and recoveries of impaired loans previously charged-off
of $45. The activity in 1997 in the allowance for loan losses account
related to impaired loans included a provision charged to operations of $4
and losses charged to the allowance of $113. There were no recoveries of
impaired loans previously charged-off in 1997. Interest income related to
impaired loans would have been $175, $174 and $143 in 1998, 1997 and 1996,
respectively, had such loan been current and the terms of the loan not been
modified. Interest recognized on impaired loans amounted to $98 in 1998,
$84 in 1997 and $30 in 1996. Included in these amounts was interest
recognized on a cash basis of $98, $84 and $30, respectively. Cash
received on impaired loans applied as a reduction of principal totaled
$650, $587 and $398 in 1998, 1997 and 1996, respectively. There were no
commitments to extend additional funds to customers with impaired loans at
December 31, 1998 and 1997.
Classified assets are those cited by bank examiners, or by the bank's
internal rating system, as having an undesirable degree of risk.
Regulators separate classified assets into three major categories based on
degree of risk: (i) substandard; (ii) doubtful; and (iii) loss.
Accordingly, as part of their routine annual examination process,
regulators classified assets of the Company at September 30, 1998. The
result of the review indicated an improvement in the ratio of classified
assets as a percentage of Tier I capital from the 1997 examination.
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 GAAP, 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. Historical loss experience serves as the
starting point for evaluating the adequacy of the Company's allowance
account. However, management also considers a number of relevant factors
that may 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 conclusion of the 1998 examination, as regulators considered the
Company's allowance for loan losses account adequate based on risk
characteristics and size of the loan portfolio. Upon its review of the
1998 regulatory report, management was not aware of any significant
recommendation with respect to the loan portfolio that would materially
affect future liquidity or capital resources.
Management utilizes the 1993 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. This
Statement provides guidance on the establishment and maintenance of an
allowance consistent with GAAP, related responsibilities of management and
examiners, loan review systems and international transfer risk matters.
According to this Statement, the allowance for loan losses should reflect
estimated credit losses for specifically identified loans, as well as
estimated credit losses inherent in the remainder of the loan portfolio at
the balance sheet date. The analytical tool for assessing the
reasonableness of the allowance for loan losses account, included in this
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 December 31, 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.
In an effort to ensure the consistent application of loan loss accounting
policy and to improve the transparency of financial statements, the
Securities and Exchange Commission ("SEC"), Office of the Comptroller of
the Currency ("OCC"), Federal Reserve Board, FDIC and Office of Thrift
Supervision ("OTS") issued a joint interagency statement on the allowance
for loan losses of depository institutions on November 30, 1998, which
reaffirms the 1993 Statement. The agencies stated that they recognize the
importance of meaningful financial statements to benefit investors and
promote safety and soundness in the banking industry. They also noted the
importance of depository institutions having prudent, conservative, but not
excessive loan loss allowances that fall within an acceptable range of
estimated losses. According to the Statement, management's process must be
based on a comprehensive, adequately documented and consistently applied
analysis of the institution's loan portfolio. Each of the agencies, in
their respective review process, will ensure that the allowance for loan
losses is appropriately determined and managed. The agencies agreed to
work together with the public accounting profession and the banking
industry in developing further guidance consistent with GAAP.
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, allocation of the reserve among the
major categories of loans is summarized as follows. 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.
<TABLE>
<CAPTION>
DISTRIBUTION OF ALLOWANCE FOR LOAN LOSSES
1998 1997 1996 1995 1994
-------------- -------------- -------------- -------------- --------------
CATEGORY CATEGORY CATEGORY CATEGORY CATEGORY
AS A AS A AS A AS A AS A
% OF % OF % OF % OF % OF
DECEMBER 31 AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Commercial, financial and others. $1,465 12.51% $1,322 15.58% $1,396 15.44% $1,358 21.30% $1,188 16.37%
Real estate:
Construction................... 0.85 0.84 1.55 0.46 1.40
Mortgage....................... 1,308 74.96 1,277 71.98 1,326 70.34 1,333 67.65 1,251 69.13
Consumer, net.................... 1,277 11.68 1,199 11.60 1,222 12.67 1,212 10.59 1,137 13.10
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Total........................ $4,050 100.00% $3,798 100.00% $3,944 100.00% $3,903 100.00% $3,576 100.00%
====== ====== ====== ====== ====== ====== ====== ====== ====== ======
</TABLE>
A reconciliation of the allowance for loan losses and illustration of
charge-offs and recoveries by major loan category for the past five years
is summarized as follows:
<TABLE>
<CAPTION>
RECONCILIATION OF ALLOWANCE FOR LOAN LOSSES
DECEMBER 31 1998 1997 1996 1995 1994
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Allowance for loan losses at beginning of period................. $3,798 $3,944 $3,903 $3,576 $3,169
Loans charged-off:
Commercial, financial and others................................. 410 271 523 136 243
Real estate:
Construction...................................................
Mortgage....................................................... 119 211 88 171 176
Consumer, net.................................................... 260 175 115 86 131
------ ------ ------ ------ ------
Total........................................................ 789 657 726 393 550
------ ------ ------ ------ ------
Loans recovered:
Commercial, financial and others................................. 67 15 284 80 7
Real estate:
Construction...................................................
Mortgage....................................................... 46 40 130 144 64
Consumer, net.................................................... 73 96 53 61 86
------ ------ ------ ------ ------
Total........................................................ 186 151 467 285 157
------ ------ ------ ------ ------
Net loans charged-off............................................ 603 506 259 108 393
------ ------ ------ ------ ------
Provision for loan losses........................................ 855 360 300 435 800
------ ------ ------ ------ ------
Allowance for loan losses at end of period....................... $4,050 $3,798 $3,944 $3,903 $3,576
====== ====== ====== ====== ======
Ratios:
Net loans charged-off as a percentage of average loans
outstanding..................................................... 0.24% 0.21% 0.12% 0.05% 0.21%
Allowance for loan losses as a percentage of period end loans.... 1.63% 1.52% 1.67% 1.83% 1.84%
</TABLE>
At December 31, 1998, the allowance for loan losses, against which loans
are charged-off, equaled $4.1 million and represented 1.63 percent of
loans, net of unearned income. The allowance was $3.8 million and
represented 1.52 percent of loans, net of unearned income at December 31,
1997. The provision for loan losses exceeding net loans charged-off in
1998 caused the increase over the amount reported at December 31, 1997.
The peer group reported a 1.26 percent ratio at December 31, 1998, a slight
reduction from the 1.30 percent ratio recorded one year earlier.
As a percentage of nonperforming loans, the allowance account covered 100.4
percent at December 31, 1998. This coverage ratio at December 31, 1997,
calculated to 67.5 percent. Relative to all nonperforming assets, the
allowance covered 94.7 percent and 62.9 percent, respectively, at December
31, 1998 and 1997. Management expects to continue to make provisions to
its allowance in 1999 based on the Company's previous loan experience.
Should a deterioration of asset quality occur, management would make a
corresponding increase to its monthly provision.
As part of its Y2K remediation efforts, the Company is devising contingency
plans to address any losses it may experience due to the inadequacy of
significant third parties in addressing their own Y2K issues. The Company
has specifically allocated 18.2 percent of the allowance for loan losses to
cover any potential credit losses that may arise due to Y2K noncompliance
of significant third parties.
Past due loans not satisfied through repossession, foreclosure or related
actions, are evaluated individually to determine if all or part of the
outstanding balance should be charged against the allowance for loan
losses. Any subsequent recoveries are credited to the allowance account.
Net charge-offs were $603 or 0.24 percent of average loans outstanding in
1998 compared to $506 or 0.21 percent in 1997. These levels were below the
net charge-off ratios reported by the peer group of 0.27 percent and 0.29
percent for 1998 and 1997, respectively. The nation's top 50 banks
reported an increase in the ratio of net charge-offs to average loans from
0.54 percent for 1997 to 0.66 percent for 1998. Management is cautiously
optimistic that net charge-off levels will decline in 1999 if the local
economy continues its improvement. However, management will closely
monitor net charge-off levels in 1999 should local unemployment rates
deteriorate.
DEPOSITS:
As was the case in 1997, national growth in real wages and personal
disposable income did not increase savings in 1998. Workers realized large
increases in real wages and real hourly compensation through faster gains
in nominal pay and a continuation of lower inflation. According to the
Labor Department's employment cost index, the hourly compensation of
workers in private nonfarm industries rose 3.5 percent in nominal terms
during 1998. In addition, personal disposable income increased from $5.9
trillion to $6.1 trillion at December 31, 1997 and 1998, respectively.
However, this 3.4 percent increase in disposable income did not cause a
corresponding rise in the savings rate. Savings as a percentage of personal
disposable income declined from 2.1 percent in 1997 to 0.5 percent in 1998.
Accordingly, core deposits have experienced limited growth at many
financial institutions. The main cause of this weakness was customers'
preferences to place their money in high-yielding mutual funds and stocks.
Representative of the magnitude of the increased value of the stock market
was a 16.1 percent increase in the Dow Jones Industrial Average. This index
rose from 7,908 at December 31, 1997, to 9,181 at December 31, 1998.
Financial institutions could not compete by offering lower-yielding time
deposits. Another major competitive force affecting deposit gathering was
credit unions. On August 7, 1998, legislation was signed into law reversing
a February 1998, Supreme Court ruling that restricted credit union
membership to serve individuals joined by a single common bond. The Credit
Union Membership Access Act allows occupation-based credit unions to accept
new members from groups of fewer than 3,000 people even if the new members
have no common bond of occupation with original members. It also gives the
National Credit Union Administration the authority to allow members of a
larger group to join an existing credit union if the agency determines that
the group could not sustain its own credit union. Aside from these
competitive pressures, the Company's market area is also one of the most
competitive regions in Pennsylvania with respect to product pricing.
Northeast Pennsylvania ranks near or at the highest cost for all time
deposit maturities. For example, the cost of a one-year time deposit ranged
from 3.8 percent in the northwest to 4.5 percent in the northeast during
1998. A continuation of competitive pressure from nonbanks and other
sources could result in higher funds cost or may cause an increase in
alternative funding sources. Specifically, a recent survey of community
banks indicated that Federal Home Loan Bank advances are expected to be a
significant future source of funding.
Total deposits for all commercial banks in the Commonwealth of Pennsylvania
totaled $130.3 billion in the fourth quarter of 1998, an increase of 2.9
percent as compared to the same period last year. Contrary to this limited
growth, deposits of the local peer group grew 9.9 percent in 1998. For the
year, the Company's deposits grew at a rate similar to the Commonwealth at
3.6 percent. The declining interest rate environment made it more difficult
for the Company and all financial institutions to achieve acceptable
returns on their loans and investments. Many banks combated the yield
deterioration by either taking on additional credit risk or significantly
lengthening the average lives of financial instruments. As an alternative
strategy, management chose to be less aggressive with respect to deposit
pricing during 1998, sacrificing growth until such time when an adequate
spread between earning assets and interest-bearing liabilities returns.
Except for time deposits with maturities of greater than 36 months, the
Company's pricing was lower than its peer group during 1998. For example,
the six month, one-year and 30-month certificates averaged 30 basis points,
21 basis points and 25 basis points, respectively, below the comparable
peer group's pricings. As a result of such aggressive product pricing, the
peer group's net interest margin declined in 1998. When attractive
yielding loans can be booked and attractive priced investments purchased
without acquiring an inordinate amount of risk, product pricing strategies
will be implemented to ensure adequate liquidity to take advantage of such
opportunities. Management expects that the recent stock market volatility
may cause an increase in deposits to the extent that investors begin to
return to the safety of banks. Such an event would also have a favorable
effect on the Company's cost of funds. The Company recently began offering
fixed-rate annuity products and mutual funds on a no-load basis to
customers. These products allow the Company to compete with higher-
yielding alternative investments while improving fee revenue.
The average amount of, and the rate paid on, the major classifications of
deposits for the past five years are summarized as follows:
<TABLE>
<CAPTION>
DEPOSIT DISTRIBUTION
1998 1997 1996 1995 1994
--------------------------------------------------------------------------------------
AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE
YEAR ENDED DECEMBER 31 BALANCE RATE BALANCE RATE BALANCE RATE BALANCE RATE BALANCE RATE
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-bearing:
Money market accounts....... $ 17,643 3.13% $ 16,854 3.16% $ 18,144 2.92% $ 21,869 3.47% $ 23,955 3.31%
NOW accounts................ 21,366 2.19 18,464 2.18 16,661 2.02 15,550 1.96 15,151 1.96
Savings accounts............ 64,113 2.58 65,081 2.92 67,144 3.00 71,911 3.25 83,142 3.13
Time deposits less than $100 175,954 5.61 165,487 5.70 157,271 5.67 155,183 5.75 139,641 4.94
Time deposits $100 or more.. 23,936 5.89 29,092 6.17 27,755 5.93 29,336 6.04 25,995 5.97
-------- -------- -------- -------- --------
Total interest-bearing.... 303,012 4.60% 294,978 4.77% 286,975 4.69% 293,849 4.80% 287,884 4.22%
Noninterest-bearing......... 32,550 27,448 26,329 24,090 21,849
-------- -------- -------- --------
Total deposits............ $335,562 $322,426 $313,304 $317,939 $309,733
======== ======== ======== ========
</TABLE>
Deposit volumes increased from $332.4 million at December 31, 1997, to
$344.3 million at December 31, 1998. Total deposits averaged $322.4 million
for 1997 compared to $335.6 million for 1998, an increase of 4.1 percent.
Higher volumes of time deposits $100 or more and noninterest-bearing
deposits were primarily responsible for the 3.6 percent change in the
comparable year-end deposit volumes. Large dollar denomination time
deposits rose 30.3 percent in 1998 from $20.8 million at year-end 1997 to
$27.1 million at year-end 1998. Demand deposits increased from $30.7
million to $36.0 million at December 31, 1997 and 1998, respectively, a
17.3 percent increase. Stronger deposit relationships with local school
districts caused the increase in large time deposits while greater
involvement in commercial lending resulted in a higher concentration of
demand deposits. The majority of the Company's deposit growth occurred in
the second quarter of 1998, caused by the same reasons as were noted for
the year-end change. Deposits grew at an annualized rate of 11.5 percent
during the second quarter of 1998. Marketing decisions determining the
degree of aggressiveness for deposit gathering will continue to be based on
availability of acceptable returns. However, management expects the
delivery system expansions to aid the growth of deposits in 1999.
Although not having a significant influence on the Company in 1998, the
recently enacted Taxpayer Relief Act of 1997 could also have a positive
effect on deposit volumes. This legislation signed into law on August 5,
1997, made two new individual retirement accounts ("IRA") available
beginning January 1, 1998. These products include the Roth IRA and
Education IRA. Under the Roth IRA, qualified distributions are tax-free
rather than tax deferred if made through a traditional IRA. Contributions
to a Roth IRA are never deductible. However, if the individuals meets
certain requirements, the interest and appreciation in the account will be
tax-free upon distribution. The Educational IRA provides for tax-free
savings for higher educational expenses. Similar to the Roth IRA,
contributions are not deductible, but earnings on contributions will be
distributed tax-free. The aggregate amount of funds invested in Roth and
Educational IRA was $358 at December 31, 1998. Management expects such
deposits to become more substantial as individuals shift their preference
from spending to saving for retirement. The lack of desire to save for
retirement was not unique to the Company's market area as indicated by the
1998 National Retirement Confidence Survey. According to the survey, one-
third of Americans were not currently saving for retirement. Most people
stated they had too many current financial responsibilities to be able to
save for retirement.
Management continually pursues a deposit mix that has a higher
concentration of lower-costing funds. Transaction accounts, defined as
demand deposits, money market, NOW and savings accounts, had a weighted-
average cost to the Company of 2.0 percent in 1998. Comparatively, the
weighted-average cost of time deposits was 5.6 percent in 1998. As a
percentage of average total deposits, low cost transaction accounts
increased from 39.7 percent in 1997 to 40.4 percent in 1998. Conversely,
the Company's reliance on time deposits declined from 60.3 percent to 59.6
percent, respectively. Despite the improvement, the local peer group
continued to exhibit a more advantageous deposit composition in 1998. As a
percentage of average total deposits, transaction accounts and time
deposits accounted for 53.4 percent and 46.6 percent, respectively, in
1998. However, management outperformed the peer group with respect to the
most important means of lowering fund costs during 1998. The Company
recorded an increase in noninterest-bearing deposits as compared to a
decline experienced by the peer group. Average noninterest-bearing deposits
as a percentage of average total deposits increased from 8.5 percent in
1997 to 9.7 percent in 1998. Comparatively, the peer group reported a
decline in demand deposit percentages from 16.2 percent in 1997 to 15.7
percent in 1998. The Company's 18.6 percent improvement in average
noninterest-bearing deposits in 1998 was a result of greater commercial
customer relationships and delivery system expansions. For 1998, the
Company's cost of funds declined to 4.6 percent from 4.8 percent in 1997.
More importantly, the cost of funds continued its decline throughout 1998
as evidenced by a 7 basis point drop in the average quarterly funds cost
from the first quarter to the fourth quarter. As aforementioned, management
chose to be less aggressive in deposit product pricing in 1998 as a result
of reductions in the availability of profitable opportunities with respect
to loans and investments. Such asset driven pricing strategy was the
primary cause for the improvement. The local peer group's cost of funds
improved to a lesser extent as compared to the Company during 1998. The
weighted-average cost of funds for the peer group was 4.6 percent in 1997
and 4.5 percent in 1998. Conversely, the cost of funds for all United
States bank holding companies with assets of between $300 million and $500
million increased from 4.5 percent in 1997 to 4.6 percent in 1998.
Management considers changes in general market rates, availability of
suitable loans and investments and adequacy of the overall liquidity
position at a minimum when making decisions regarding deposit pricing for
future periods. Although management expects increased pressure on the
Company's cost of funds from the intense competitive environment, they may
be able to counter these forces through offering customers alternative
nondeposit investment products.
Volatile deposits, time deposits $100 or more, increased from $20.8 million
at December 31, 1997, to $27.1 million at December 31, 1998. As
aforementioned, this increase resulted from improved banking relationships
with local school districts. However, the Company continued to be less
reliant on this type of funding as compared to the peer group in 1998.
Average volatile deposits, as a percentage of average total deposits, was
7.1 percent in 1998 as compared to 12.8 percent for the peer group. The
Company's average cost of such funds declined 30 basis points from 6.2
percent in 1997 to 5.9 percent in 1998. Conversely, the peer group's cost
for volatile deposits rose 7 basis points during 1998.
Maturities of time deposits $100 or more for the past five years are
summarized as follows:
<TABLE>
<CAPTION>
MATURITY DISTRIBUTION OF TIME DEPOSITS $100 OR MORE
DECEMBER 31 1998 1997 1996 1995 1994
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Within three months............................................. $ 7,956 $ 3,195 $ 8,598 $ 6,466 $ 7,861
After three months but within six months........................ 4,939 2,819 9,958 6,646 4,200
After six months but within twelve months....................... 8,802 6,334 11,262 8,590 10,740
After twelve months............................................. 5,391 8,484 6,047 7,982 7,410
------- ------- ------- ------- -------
Total......................................................... $27,088 $20,832 $35,865 $29,684 $30,211
======= ======= ======= ======= =======
</TABLE>
As a result of dwindling deposits caused by the competitiveness of
alternative investment products, many banks have increased their borrowings
as a liquidity substitute. Management chose to become less aggressive with
respect to deposit product pricing during 1998 rather than follow
competitors that increased borrowings. Many of the borrowing instruments
involve an inordinate amount of optionality risk which disallow repayments
in periods of falling rates and convert to higher variable cost instruments
in times of rising rates when liquidity is lower due to the abundance of
attractive assets.
Short-term borrowings available to the Company consist of a line of credit
and advances with the FHLB-Pgh secured under terms of a blanket collateral
agreement by a pledge of FHLB-Pgh stock and certain other qualifying
collateral, such as investment and mortgage-backed securities and mortgage
loans. The line is limited to the Company's maximum borrowing capacity
("MBC"), which is based on a percentage of qualifying collateral assets.
At December 31, 1998, the Company's MBC was $141.8 million. Interest
accrues daily on the line based on the rate of FHLB-Pgh discount notes.
This rate resets each day. The line is renewable annually on its
anniversary date and carries no associated commitment fees. The FHLB-Pgh
has the right to reduce or terminate the line at any time without prior
notice and the Company may repay this line at any time without incurring
prepayment penalties. Short-term advances are issued with maturities less
than one year based on the FHLB-Pgh's current cost of funds rate. Advances
are limited to the Company's MBC and are not prepayable. There are no
commitment fees associated with the advances, except for those for forward
settlement that are based on FHLB-Pgh hedging costs.
At December 31, 1998, the Company had no short-term borrowings outstanding.
There was $9.6 million in short-term borrowings outstanding at December 31,
1997, under the line of credit agreement. The average daily balance and
weighted-average rate on aggregate short-term borrowings was $185 at 6.0
percent in 1998 and $138 at 5.8 percent in 1997. The maximum amount of all
short-term borrowings outstanding at any month-end was $695 during 1998 and
$9.6 million during 1997. Short-term borrowings during 1998 and 1997
consisted entirely of the FHLB-Pgh line of credit.
Long-term debt at December 31, 1998 and 1997, consisted entirely of a 7.5
percent fixed-rate, amortizing advance from the FHLB-Pgh Community
Investment Program. This advance matures on September 2, 2009. The
scheduled principal payments on the note total $3 for each of the five
years 1999 through 2003. The prepayment fee applicable to the advance is
equal to the present value of the difference between cash flows generated
at the advance rate from the date of the prepayment until the original
maturity date, and the cash flows that would result from the interest rate
posted by the FHLB-Pgh on the date of prepayment for an advance of
comparable maturity. The note is secured under terms of a blanket
collateral agreement by a pledge of qualifying investment and mortgage-
backed securities, certain mortgage loans and a lien on FHLB-Pgh stock.
The average daily balance on long-term debt for 1998 was $43 with a
weighted-average rate of 7.0 percent. For 1997, the average daily balance
on long-term debt was $45 with a weighted-average rate of 8.9 percent.
MARKET RISK SENSITIVITY:
Market risk is the risk to a company's financial position resulting from
adverse changes in market rates or prices, such as interest rates, foreign
exchange rates or equity prices. The Company has no exposure to foreign
currency exchange risk or any specific exposure to commodity price risk.
The major area of market risk exposure to the Company is IRR. The
Company's exposure to IRR can be explained as the potential for change in
its reported earnings and/or the market value of its net worth. Variations
in interest rates affect the Company's earnings by changing its net
interest income and its level of other interest-sensitive income and
operating expenses. Interest rate changes also affect the underlying
economic value of the Company's assets, liabilities and off-balance sheet
items. These changes arise because the present value of future cash flows,
and often the cash flows themselves, change with the interest rates. The
effects of the changes in these present values reflect the change in the
Company's underlying economic value and provide a basis for the expected
change in future earnings related to the interest rate. IRR is inherent in
the role of banks as financial intermediaries, however a bank with a high
IRR level may experience lower earnings, impaired liquidity and capital
positions, and most likely, a greater risk of insolvency. Therefore, banks
must carefully evaluate IRR to promote safety and soundness in their
activities.
The responsibility for the Company's market risk sensitivity management has
been delegated to the ALCO. Specifically, ALCO utilizes several
computerized modeling techniques to monitor and attempt to control the
influence that market changes have on the Company's RSA and RSL.
Market risk continues to be a major focal point of regulatory emphasis. In
accordance with regulation, each bank is required to develop its own IRR
management program depending on its structure, including certain
fundamental components which are mandatory to ensure sound IRR management.
These elements include appropriate board and management oversight as well
as a comprehensive risk management process that effectively identifies,
measures, monitors and controls risk. Should a bank have material
weaknesses in its risk management process or high exposure relative to its
capital, the bank regulatory agencies will take action to remedy these
shortcomings. Moreover, the level of a bank's IRR exposure and the quality
of its risk management process is a determining factor when evaluating a
bank's capital adequacy.
On January 23, 1997, the Federal Reserve Board, FDIC and OCC issued a joint
news release announcing that the Basle Committee, with the agreement of the
central bank governors of the Group of Ten countries, issued the paper
entitled, "Principles for the Management of Interest Rate Risk." This
paper describes principles for strong risk management and standards that
banking agencies should use to evaluate the adequacy and effectiveness of
a bank's IRR management process. Furthermore, this guidance emphasizes the
importance of appropriate board of director and senior management oversight
of a comprehensive risk management process that identifies, measures,
monitors and controls a bank's IRR exposure.
As aforementioned, the Company utilizes various computerized modeling
techniques for market risk management. Beginning in 1997, management
implemented an additional technique to assess the Company's market risk
exposure based on SEC guidance.
On January 28, 1997, the SEC issued, "Disclosures of Accounting Policies
for Derivative Financial Instruments and Derivative Commodity Instruments
and Disclosure of Quantitative and Qualitative Information about Market
Risk Inherent in Derivative Financial Instruments, Other Financial
Instruments and Derivative Commodity Instruments." This final rule
requires quantitative and qualitative disclosures related to market risk
inherent in derivative financial instruments, certain derivative commodity
instruments and other financial instruments outside the financial
statements. Derivative financial instruments include: (i) futures; (ii)
forwards; (iii) swaps; (iv) options; and (v) other financial instruments
with similar characteristics.
Derivative commodity instruments include: (i) commodity futures; (ii)
commodity forwards; (iii) commodity swaps; (iv) commodity options; and (v)
other commodity instruments that are not derivative financial instruments,
but may be settled in cash or with another financial instrument by contract
or business custom.
Other financial instruments means all financial instruments as defined by
GAAP for which fair value disclosures are required in accordance with SFAS
No. 107, "Disclosures about Fair Value of Financial Instruments." Examples
of other financial instruments are: (i) investments; (ii) loans; (iii)
structured notes; (iv) mortgage-backed securities; (v) indexed debt
instruments; (vi) interest-only and principal-only obligations; (vii)
deposits; and (viii) other debt obligations.
In making quantitative disclosures, companies are given three alternatives
for each type of portfolio or market risk category for which disclosures
are required. These options are: (i) a tabular presentation of fair value
information and contract terms relevant to determine the future cash flows
of market risk sensitive instruments, categorized by expected maturity
dates; (ii) a sensitivity analysis that expresses the potential loss in
future earnings, fair values or cash flows of market risk sensitive
instruments from selected hypothetical changes in market rates and prices;
or (iii) value-at-risk disclosures that express the potential loss in
future earnings, fair values or cash flows of market risk sensitive
instruments from various market movements over a selected period of time
and with a selected likelihood of occurrence.
The Company utilizes the tabular presentation alternative in complying with
quantitative and qualitative disclosure rules. Information with respect to
maturities and fair values of other financial instruments at December 31,
1998, is summarized as follows. For expected maturity distributions, other
financial assets and liabilities are presented based on their carrying
values, except for investment securities, which are based on amortized
costs. Investment securities and federal funds sold distributions and
their related weighted-average interest rates are based on contractual
maturities, with the exception of mortgage-backed securities and equity
securities. Mortgage-backed securities are presented based upon estimated
principal cash flows and related weighted-average interest rates, assuming
no change in the current interest rate environment. The amount of, and
weighted-average interest rate earned on, equity securities are included in
the "Thereafter" maturity category. Loans and their related weighted-
average interest rates are categorized based on payment due dates, assuming
no change in current interest rates. For noninterest-bearing deposits,
money market, NOW and savings accounts that have no contractual maturity,
principal cash flows and related weighted-average interest rates are
presented based on the Company's historical experience, management's
judgment and statistical analysis, as applicable, concerning their most
likely withdrawal behaviors. The table presents distributions and related
weighted-average interest rates for time deposits, short-term borrowings
and long-term debt based on contractual maturities assuming no change in
current interest rates. The weighted-average yields of tax-exempt
securities and loans have been computed on a tax-equivalent basis using the
statutory tax rate of 34.0 percent. For additional information on the
assumptions used to determine fair values, reference is made to Note 1,
"Summary of significant accounting policies," in the Company's Notes to
Consolidated Financial Statements.
<TABLE>
<CAPTION>
MARKET RISK DISCLOSURES
EXPECTED MATURITY DATE
--------------------------------------------------------------------------
THERE- FAIR
1999 2000 2001 2002 2003 AFTER TOTAL VALUE
--------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Other financial assets:
Cash and due from banks........... $ 11,464 $ 11,464 $ 11,464
Average interest rate.............
Federal funds sold................ 7,700 7,700 7,700
Average interest rate............. 4.75% 4.75%
Investment securities:
U.S. Treasuries and agencies:
Fixed-rate...................... 11,017 11,017 11,060
Average interest rate........... 5.83% 5.83%
Adjustable-rate................. $ 649 649 637
Average interest rate........... 3.61% 3.61%
State and municipals.............. 1,990 1,319 $ 1,710 $ 1,880 $ 660 $ 30,433 37,992 40,007
Average interest rate............. 6.12% 6.36% 6.73% 6.86% 7.50% 8.32% 7.98%
Mortgage-backed securities........ 19,344 15,049 8,262 6,526 5,496 1,374 56,051 55,834
Average interest rate............. 6.45% 6.27% 6.27% 6.27% 6.27% 6.23% 6.33%
Equity securities................. 1,804 1,804 2,088
Average interest rate............. 6.44% 6.44%
-------- ------- ------- ------- ------- -------- -------- --------
Total........................... 32,351 17,017 9,972 8,406 6,156 33,611 107,513 109,626
Average interest rate........... 6.22% 6.18% 6.35% 6.40% 6.40% 8.13% 6.85%
Loans held for sale............... 503 503 506
Average interest rate............. 6.88% 6.88%
Net loans:
Fixed-rate........................ 28,092 21,908 18,633 14,654 12,372 100,594 196,253 196,238
Average interest rate............. 8.22% 8.41% 8.26% 8.17% 8.03% 8.02% 8.13%
Adjustable-rate................... 22,013 2,716 2,319 2,318 1,939 16,532 47,837 47,837
Average interest rate............. 8.81% 8.20% 8.38% 8.43% 8.57% 8.85% 8.74%
-------- ------- ------- ------- ------- -------- -------- --------
Total........................... 50,105 24,624 20,952 16,972 14,311 117,126 244,090 244,075
Average interest rate........... 8.48% 8.39% 8.27% 8.21% 8.10% 8.14% 8.25%
Accrued interest receivable....... 2,297 2,297 2,297
Average interest rate.............
-------- ------- ------- ------- ------- -------- -------- --------
Total........................... $104,420 $41,641 $30,924 $25,378 $20,467 $150,737 $373,567 $375,668
======== ======= ======= ======= ======= ======== ======== ========
Other financial liabilities:
Noninterest-bearing deposits...... $ 7,565 $ 6,845 $ 6,124 $ 5,404 $ 4,682 $ 5,404 $ 36,024 $ 36,024
Average interest rate.............
Interest-bearing liabilities:
MMDA, NOW and savings............. 21,648 19,590 17,528 15,466 13,404 15,463 103,099 103,099
Average interest rate............. 2.62% 2.62% 2.62% 2.62% 2.62% 2.62% 2.62%
Time deposits..................... 128,645 33,924 10,060 21,843 10,398 260 205,130 207,153
Average interest rate............. 5.25% 6.00% 5.63% 5.97% 6.04% 5.78% 5.51%
Long-term debt.................... 3 3 3 3 3 26 41 41
Average interest rate............. 7.50% 7.50% 7.50% 7.50% 7.50% 7.50% 7.50%
-------- ------- ------- ------- ------- -------- -------- --------
Total........................... 150,296 53,517 27,591 37,312 23,805 15,749 308,270 310,293
Average interest rate........... 4.87% 4.76% 3.72% 4.58% 4.11% 2.68% 4.54%
Accrued interest payable.......... 1,740 1,740 1,740
Average interest rate.............
-------- ------- ------- ------- ------- -------- -------- --------
Total........................... $159,601 $60,362 $33,715 $42,716 $28,487 $ 21,153 $346,034 $348,057
======== ======= ======= ======= ======= ======== ======== ========
</TABLE>
At December 31, 1998, the Company had investments of $32.4 million with a
weighted-average, tax-equivalent yield of 6.22 percent scheduled to mature
within one year. Correspondingly, net loans of $50.1 million with a
weighted-average, tax-equivalent yield of 8.48 percent were scheduled to
mature within the same timeframe. Overall, interest-earning assets
scheduled to mature within one year equaled $90.7 million with a weighted-
average, tax-equivalent yield of 7.34 percent. With respect to interest-
bearing liabilities, the Company had interest-bearing transaction accounts,
defined as money market, NOW and savings accounts, of $21.6 million with a
weighted-average cost of 2.62 percent scheduled to mature within one year,
based on historical withdrawal patterns. The Company had time deposits of
$128.6 million with a weighted-average cost of 5.25 percent scheduled to
mature in the same timeframe. Total interest-bearing liabilities scheduled
to mature within one year equaled $150.3 million with a weighted-average
rate of 4.87 percent.
Limitations of the market risk disclosure model include, among others: (i)
magnitude; (ii) timing; and (iii) frequency of interest rate changes of
other financial assets and liabilities. Historical withdrawal patterns
with respect to interest-bearing and noninterest-bearing transaction
accounts are not necessarily indicative of future performance as the volume
of cash flows may increase or decrease. Loan information is presented
based on payment due dates, which may materially differ from actual results
due to prepayments caused by changes in: (i) interest rates; (ii)
sociological conditions; (iii) demographics; and (iv) economic climate.
Maturity distributions and fair values are based primarily on contractual
maturities or payment due dates and do not consider repricing frequencies
for adjustable-rate assets and liabilities. The table does not include
maturity distribution and fair value information on certain assets and
liabilities, which are not considered financial, and does not anticipate
future business activity. Actual results will, more likely than not,
differ from results presented in the table.
Additionally, the Company supplements the market risk disclosure model
through simulation analysis utilizing interest rate "shocks." The model
analyzes the effects instantaneous parallel shifts of plus or minus 100
basis points will have on the economic values of other financial
instruments. The results of the model at December 31, 1998, are summarized
as follows:
<TABLE>
<CAPTION>
FAIR VALUE
------------------------------
DECEMBER 31, 1998 +100 BPS LEVEL -100 BPS
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C>
OTHER FINANCIAL ASSETS:
Cash and due from banks................................. $ 11,464 $ 11,464 $ 11,464
Federal funds sold...................................... 7,700 7,700 7,700
Investment securities................................... 108,782 109,626 110,402
Loans held for sale..................................... 492 506 517
Net loans............................................... 236,062 244,075 252,816
Accrued interest receivable............................. 2,297 2,297 2,297
-------- -------- --------
Total................................................. $366,797 $375,668 $385,196
======== ======== ========
OTHER FINANCIAL LIABILITIES:
Noninterest-bearing deposits............................ $ 36,024 $ 36,024 $ 36,024
Money market, NOW and savings accounts.................. 103,099 103,099 103,099
Time deposits........................................... 204,799 207,153 209,515
Long-term debt.......................................... 41 41 41
Accrued interest payable................................ 1,740 1,740 1,740
-------- -------- --------
Total................................................. $345,703 $348,057 $350,419
======== ======== ========
</TABLE>
The Company also uses models that consider repricing frequencies of RSA and
RSL in addition to maturity distributions. One such technique utilizes a
static gap report, which attempts to measure the Company's interest rate
exposure by calculating the net amount of RSA and RSL that reprice within
specific time intervals. A positive gap, indicated by an 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, an 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 as follows. The
distributions in the table are based on a combination of maturities, call
provisions, repricing frequencies and prepayment patterns. Adjustable-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.
<TABLE>
<CAPTION>
INTEREST RATE SENSITIVITY
DUE AFTER DUE AFTER
THREE MONTHS ONE YEAR
DUE WITHIN BUT WITHIN BUT WITHIN DUE AFTER
DECEMBER 31, 1998 THREE MONTHS TWELVE MONTHS FIVE YEARS FIVE YEARS TOTAL
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Rate-sensitive assets:
Investment securities.............. $10,200 $ 22,151 $ 41,486 $ 35,789 $109,626
Loans held for sale................ 503 503
Loans, net of unearned income...... 55,687 21,502 68,688 102,263 248,140
Federal funds sold................. 7,700 7,700
------- -------- -------- -------- --------
Total............................ $74,090 $ 43,653 $110,174 $138,052 $365,969
======= ======== ======== ======== ========
Rate-sensitive liabilities:
Money market accounts.............. $ 17,869 $ 17,869
NOW accounts....................... 22,261 22,261
Savings accounts................... $ 62,969 62,969
Time deposits less than $100....... $28,760 78,188 70,834 $ 260 178,042
Time deposits $100 or more......... 7,956 13,741 5,391 27,088
Long-term debt..................... 1 2 12 26 41
------- -------- -------- -------- --------
Total............................ $36,717 $132,061 $139,206 $ 286 $308,270
======= ======== ======== ======== ========
Rate-sensitivity gap:
Period........................... $37,373 $(88,408) $(29,032) $137,766
Cumulative....................... $37,373 $(51,035) $(80,067) $ 57,699 $ 57,699
RSA/RSL ratio:
Period........................... 2.02 0.33 0.79 482.70
Cumulative....................... 2.02 0.70 0.74 1.19 1.19
</TABLE>
At December 31, 1998, the Company had a cumulative one-year, RSA/RSL ratio
of 0.70. Although a slight deterioration from 0.86 at December 31, 1997,
such ratio falls within the Company's asset/liability policy guidelines of
0.70 and 1.30. This reduction was principally due to an increase in the
amount of time deposits repricing within one-year, as a greater proportion
of longer-term certificates of deposit are scheduled to renew in 1999. Also
causing the decline in the ratio was a smaller amount of loans and
investments repricing within one-year as compared to those amounts at year-
end 1997. At December 31, 1998, time deposits maturing or repricing within
one-year totaled $128.6 million, up $28.0 million from one year earlier.
In an attempt to decrease the Company's exposure to rising interest rates,
management began offering special rates on long-term certificates during
1995 and 1996. Many of these certificates are scheduled to renew within the
next twelve months. Local competitive rates on similar maturities have come
down as compared to the rates which were originally offered on these
maturing deposits. Accordingly, management believes it will be able to
retain the majority of these funds through product-pricing strategies while
lowering the overall costs to the Company. At December 31, 1998, loans, net
of unearned income, and investments repricing within one-year declined by
$6.6 million and $4.7 million, respectively, from the same period last
year. The recent rise in refinancing was primarily responsible for the
decline in the amount of loans repricing within one-year. A higher
concentration of mortgage-backed securities with payment lockout caused the
decline in the amount of investments. 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.
Similar to the results of the Company's cumulative one-year ratio, its
three-month ratio declined. The three-month ratio equaled 2.02 at December
31, 1998, compared to 1.87 at December 31, 1997. The causes for the change
were due to the volume of RSA repricing within three months decreased more
than the reduction in RSL. Specifically, loans, investments and federal
funds sold repricing within three-months decreased $7.1 million, $2.5
million and $0.5 million, respectively, as compared to the static gap
position one-year ago. Moreover, the Company repaying short-term borrowings
of $9.6 million in 1998 offset partially by an increase of $1.4 million in
time deposits were the major factors in reducing the amount of rate-
sensitive liabilities within the three-month interval.
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 December 31, 1998,
contradict the results indicated by the one-year static gap position.
Specifically, instantaneous and parallel shifts in general market rates of
plus 100 basis points will cause net interest income to increase $133.4 or
1.0 percent in 1999. Conversely, a shift of the same magnitude in the
opposite direction will cause a $130.5 or 1.0 percent decline in net
interest income in 1999. Management will attempt to retain the Company's
favorable IRR position during 1999 through continued vigilance in its
product pricing.
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. As specified in the
Company's Asset/Liability Management Policy, such borrowings will only be
used on a contingency basis. The reliance on these borrowings to fund
temporary deficiencies is limited to a maximum of five consecutive business
days before management is required to take appropriate action to remedy the
shortfall through normal operations. 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
fluctuations. 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.
Management annually develops a liquidity plan for the Company. The plan's
mission is to ensure that the Company can 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 liquidity plan
assesses its current liquidity position and includes determining
appropriate standards for the volume, mix, price and maturity of loans,
investments and deposits. In addition, management ascertains the
appropriate level of short-term assets required to fund normal day-to-day
operations and to ensure the Company's ability to meet off-balance sheet
commitments and unanticipated deposit withdrawals. The plan includes
controls and monitoring procedures for evaluating the Company's daily
liquidity position. Finally, the plan introduces strategies to ensure
future liquidity. Such strategies, which the Company considers proprietary
in nature, include the maintenance of a minimum net federal funds sold
cushion, a capital contingency strategy and enhanced strategies on loan and
deposit pricing. Based on the 1999 liquidity plan, the Company's ratio of
core deposits to total assets is expected to exhibit the same strength at
81.6 percent as was evidenced at year-end 1998. Core deposits are important
in maintaining a strong liquidity position as they represent a stable and
relatively low-costing source of funds.
Although declining slightly in 1998, the Company's liquidity position
continued its superiority in comparison to the peer group. This was
exemplified by recording stronger comparable net noncore funding dependence
and net short-term noncore funding dependence ratios. The Company's net
noncore funding dependence ratio, defined as the difference between noncore
funds, time deposits $100 or more and brokered time deposits under $100 and
short-term investments to long-term assets, was negative 7.5 percent and
negative 4.0 percent at December 31, 1997 and 1998, respectively. The peer
group's ratios were 7.4 percent and 2.6 percent, respectively. The net
short-term noncore funding dependence ratio, defined as the difference
between noncore funds maturing within one year, including borrowed funds,
less short-term investments to long-term assets, weakened slightly from
negative 10.2 percent at year-end 1997 to negative 5.7 percent at year-end
1998. The peer group experienced a similar deterioration in its short-term
ratio from 2.6 percent to 3.6 percent, respectively. Management believes
that by maintaining adequate volumes of short-term investments and
implementing competitive pricing strategies on deposits, it can ensure that
the Company has adequate liquidity to support future growth.
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 and FHLB-Pgh and federal funds
sold, increased $1.9 million in 1998. Cash and cash equivalents totaled
$19.2 million and $17.3 million at December 31, 1998 and 1997,
respectively. Net cash provided by operating activities totaled $5.9
million and primarily resulted from the Company's $4.5 million in net
income.
The Company's net cash used in investing activities totaled $5.6 million
for 1998. Investment purchases of $50.2 million exceeded repayments of
$45.2 million in 1998, which caused the net cash outflow. The change in
investing activities was also affected by the expenditures for premises and
equipment totaling $3.9 million. The majority of these expenditures were
related to the land and construction costs for the administrative center
and two branch facilities.
Net cash provided by financing activities equaled $1.7 million in 1998.
Increased volumes of time deposits and, to a lesser extent, transaction
accounts offset the net outflow from the repayment of short-term
borrowings. Time deposits increased $8.0 million in 1998, as a result of
improved customer relations with local school districts. Higher volumes of
commercial loan relationships in 1998 caused the $3.9 million improvement
in transaction accounts. During 1998, the Company repaid short-term
borrowings of $9.6 million.
CAPITAL ADEQUACY:
A strong capital position provides depositors and stockholders with a
margin of safety and allows the Company to take advantage of profitable
opportunities and provide for future growth. During 1998, the Company's
stockholders' equity improved $3.6 million or 10.1 percent compared to
1997. This improvement was due primarily to net income of $4.5 million
offset by dividends, net of reinvestments, of $662 and a reduction in net
unrealized holding gains of $206. The actual change in net unrealized
holding gains on investment securities for 1998, was a positive $816, net
of applicable income taxes of $277, which was offset by a $1,128
reclassification adjustment, net of applicable income taxes of $383, for
gains realized on the sale of securities. At December 31, 1998, the
Company's net unrealized holding gains were $1,394 as compared to $1,600 at
December 31, 1997.
During the third quarter of 1998, the Company's Board of Directors ratified
an amended dividend policy that will systematically increase the dividend
payout ratio, dividends declared as a percentage of net income, to a level
consistent with its peer group. For 1998, dividends declared equaled $816
or $0.37 per share. This was a 23.8 percent increase as compared to $659
or $0.30 per share declared for 1997. The Company's dividend payout ratio
for 1998 and 1997 was 18.1 percent and 15.0 percent, respectively. In
comparison, the peer group's dividend payout ratio was 45.4 percent for
1998 and 42.0 percent for 1997. It is the intention of the Board of
Directors to continue to pay cash dividends in the future. However, these
decisions are based on operating results, financial and economic decisions,
capital and growth objectives, appropriate dividend restrictions related to
the Company and other relevant factors. The primary source of funds for
dividend payment by the Company has been dividends received from its
subsidiary, Community Bank and Trust Company ("Community Bank"). Community
Bank's ability to pay dividends is subject to federal and state
regulations. Accordingly, Community Bank, without prior regulatory
approval, may declare dividends to the Company totaling $7.9 million plus
net profits earned for the period from January 1, 1999, through the date of
declaration, less dividends previously paid in 1999.
The DRP was implemented during the year-ended December 31, 1997, to offer
stockholders the opportunity to automatically reinvest their dividends in
shares of the Company's common stock. Three hundred thousand shares were
registered with the SEC under the DRP. During the years ended December 31,
1998 and 1997, 4,617 shares and 2,325 shares, respectively, were issued
under the DRP.
Bank regulatory agencies consider capital to be a significant factor in
ensuring the safety of a depositor's accounts. These agencies, in light of
past bank failures, adopted minimum capital adequacy requirements that
include mandatory and discretionary supervisory actions for noncompliance.
These requirements, otherwise known as risk-based capital standards,
generally measure the amount of a bank's required capital in relation to
the degree of risk perceived in its assets and its off-balance sheet
exposure.
On June 4, 1998, the Federal Reserve Board issued a final rule, which
became effective June 30, 1998, that amends the Tier I Leverage capital
standard for bank holding companies. This amendment establishes a minimum
Leverage ratio, of 3.0 percent for bank holding companies that are either
rated composite "1" under the bank subsidiaries, other nonbank
subsidiaries, parent companies, earnings-consolidated and capital adequacy-
consolidated ("BOPEC") rating system or those that have implemented the
Federal Reserve Board's risk-based capital market risk measure. The
minimum Leverage ratio for all other bank holding companies is 4.0 percent.
For institutions with supervisory, financial, operational or managerial
weaknesses or those experiencing significant growth, higher-than-minimum
capital ratios are required. The Company's minimum Tier I Leverage ratio
was 4.0 percent at December 31, 1998 and 1997. Other minimum capital ratio
requirements were a Tier I capital to risk-adjusted assets ratio of 4.0
percent and a total capital, Tier I and Tier II 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
implementation of a capital restoration plan and restrictions on 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 or unsound practices or received a less
than satisfactory examination report rating.
On August 26, 1998, the Federal Reserve Board, in conjunction with the
other federal banking agencies amended their respective risk-based capital
standards for banks, bank holding companies and thrifts with regard to the
regulatory treatment of unrealized holding gains on certain available-for-
sale equity securities. Currently under GAAP, unrealized gains are
reported as a component of equity capital, however, unrealized gains have
been excluded from regulatory capital under the capital standards of the
federal banking agencies.
Under the amended rule, institutions that legally hold equity securities
are permitted, but not required, to include up to 45.0 percent of the
pretax net unrealized holding gains on certain available-for-sale equity
securities in Tier II capital. The agencies cautioned that even though
including a portion of these unrealized gains in Tier II capital may
increase the total capital to risk-adjusted assets ratio, it could reduce
the Tier I capital to risk-adjusted assets ratio. This would result
because the portion of unrealized gains included in Tier II capital would
also be added to risk-adjusted assets, the denominator for both ratios.
However, the allowable unrealized gains would not be included in Tier I
capital thus the reduction in the Tier I capital ratio. The Company has
elected not to include unrealized gains on available-for-sale equity
securities in its Tier II capital.
The Company's capital ratios at December 31, 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
Federal Deposit Insurance Corporation Improvement Act of 1991, are
summarized as follows:
<TABLE>
<CAPTION>
RISK-ADJUSTED CAPITAL
MINIMUM TO BE WELL
CAPITALIZED UNDER
MINIMUM FOR CAPITAL PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
------------------------------------------------------------------
DECEMBER 31 1998 1997 1998 1997 1998 1997
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Basis for ratios:
Tier I capital to risk-adjusted assets... $ 35,444 $ 31,120 $ 8,017 $ 7,806 $12,025 $11,709
Total capital to risk-adjusted assets.... 37,968 33,576 16,033 15,612 20,042 19,515
Tier I capital to total average assets
less intangibles........................ 35,444 31,120 $14,981 $14,239 $18,726 $17,798
Risk-adjusted assets..................... 191,611 186,410
Risk-adjusted off-balance sheet items.... 8,806 8,743
Average assets for Leverage ratio........ $374,526 $355,968
Ratios:
Tier I capital as a percentage of risk-
adjusted assets and off-balance sheet
items................................... 17.7% 15.9% 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................. 18.9 17.2 8.0 8.0 10.0 10.0
Tier I capital as a percentage of total
average assets less intangibles......... 9.5% 8.7% 4.0% 4.0% 5.0% 5.0%
</TABLE>
During 1998, the Company's capital position improved as evidenced by marked
increases in its capital adequacy ratios. The Company's Leverage ratio was
9.5 percent at December 31, 1998, as compared to 8.7 percent at December
31, 1997. The Company's Tier I capital to risk-adjusted assets ratio was
17.7 percent and total capital to risk-adjusted assets ratio was 18.9
percent at December 31, 1998. In comparison, these ratios at December 31,
1997, were 15.9 percent and 17.2 percent, respectively. Each of these
ratios, at December 31, 1998 and 1997, exceeded the minimum levels required
for adequately capitalized institutions of 4.0 percent, 4.0 percent and 8.0
percent, respectively, and the levels required for well capitalized
institutions of 5.0 percent, 6.0 percent and 10.0 percent, respectively.
The Company received a final regulatory report from the Federal Reserve
Board on January 25, 1999. This report included notification that the
Company was considered well capitalized. There are no conditions or events
since this notification that management believes have changed the Company's
category.
The ALCO continually reviews the Company's capital position. As part of
its review, the ALCO considers: (i) the current and expected capital
requirements, including the maintenance of capital ratios in excess of
minimum regulatory guidelines; (ii) the market value of the Company's
securities and the resulting effect on capital; (iii) any planned asset
growth; (iv) the anticipated level of net earnings and capital position,
taking into account the projected asset/liability position and exposure to
changes in interest rates; and (v) the source and timing of additional
funds to fulfill future capital requirements.
The Company adopted SFAS No. 129, "Disclosures of Information about Capital
Structure" in 1998. This Statement does not establish any new disclosure
standards but rather codifies certain previously required disclosures.
Specifically, it requires information regarding the pertinent rights and
privileges of the various components of an entity's capital structure such
as: (i) dividend and liquidation preferences; (ii) participation rights;
(iii) call prices and dates; (iv) conversion prices and dates; (v) unusual
voting rights; and (vi) terms of contracts to issue additional shares.
Since this Statement contains no change in disclosure requirements, the
Company's adoption had no effect on financial statement presentation.
REVIEW OF FINANCIAL PERFORMANCE:
Losses from foreign credit exposures, recognition of merger-related charges
and establishment of cost-cutting programs all hindered the earnings
performance of the nation's top 50 commercial banks for 1998. This group
posted composite net income of $37.8 billion for 1998, a 3.3 percent
decline from the $39.1 billion reported for 1997. Regional and community
banks faired better in 1998. Unaffected by the aforementioned factors,
banks in the Mid-Atlantic region posted earnings for 1998 of $1.7 billion,
a 21.4 percent increase from 1997 earnings of $1.4 billion.
The Company continued its trend of higher earning during 1998. Net income
was $4.5 million or $2.04 per share in 1998, an increase over the $4.4
million or $2.00 per share reported for the previous year. The earnings
growth was attributable to higher net interest income and gains on the sale
of investment securities partially offset by increases in the provision for
loan losses and noninterest expense.
The Company's return on average assets ratio was 1.19 percent and return on
average equity ratio was 11.71 percent in 1998. These ratios for the
Company's peer group in 1998 were 1.22 percent and 12.26 percent,
respectively. For 1997, the Company's ratios were 1.22 percent and 13.40
percent, respectively. Net interest income on a tax-equivalent basis
increased $1,142 or 8.5 percent from $13,378 in 1997 to $14,520 in 1998.
Contributing to the increase was a 4 basis point improvement in the yield
on earning assets coupled with a 17 basis point reduction in the cost of
funds. The major factor in the improved yield on earning assets resulted
from a 37 basis point increase in the yield on taxable investment
securities from 5.59 percent for 1997 to 5.96 percent for 1998. This
betterment was attributed to the composition of the investment portfolio
changing as cash flows from maturing U.S. Treasury securities were
reinvested into short-term U.S. Government agency mortgage-backed
securities which offered a greater total return for essentially the same
risk exposure. The Company's cost of funds improved from 4.77 percent for
1997 to 4.60 percent for 1998 which resulted from declines in the average
rate paid on savings accounts and time deposits. Also assisting the
improvement in net interest income was a favorable volume variance. Average
earning assets increased 43.2 percent over the growth of interest-bearing
liabilities as management remained competitive in lending while being less
aggressive in pricing deposits during 1998.
The provision for loan losses increased $495 to $855 in 1998, from $360 in
1997. This increase was primarily attributable to the replenishment of the
loan loss reserve for loans charged-off in response to changes in
regulatory classifications of certain loans during 1998.
Noninterest income for the year-ended December 31, 1998, was $2,673, an
$897 increase over the $1,776 recorded for the same period last year.
Included in noninterest income for 1998 were gains of $1,128 on the sale of
investment securities and gains of $43 on the sale of one-to-four family
residential mortgage loans. Included in noninterest income for 1997 was a
$250 litigation settlement paid by a securities broker to Community Bank.
The Company's noninterest expense increased $1,408 from $7,956 in 1997, to
$9,364 in 1998. Salaries and employee benefits expense, net occupancy and
equipment expense and other expenses increased $347, $94 and $967,
respectively, in 1998. The rise in salaries and employee benefits expense
resulted from additional staffing for the late-1997 acquisition of the
Eynon and Factoryville branches coupled with annual merit raises. The
Company's recognition of its first full year of occupancy expenses related
to these new offices was the primary cause of the $94 increase. The
primary reasons for the increase in other expenses were amortization of the
core deposit intangible which resulted from the acquisition of the above
branches, write-downs of properties included in other real estate and
losses from dispositions of equipment determined to be non-compliant with
the century date change.
The Company adopted SFAS No. 128, "Earnings Per Share" in 1998. The object
of the Statement is to simplify the earnings per share ("EPS") calculation
and to make the United States standard for computation compatible with the
EPS standards of other countries and with those of the International
Accounting Standards Committee.
SFAS No. 128 required two EPS calculations. Basic EPS is computed by
dividing net income by the weighted-average common shares outstanding, and
dilutive EPS is based on the weighted-average common shares outstanding
plus all dilutive potential common shares outstanding.
The Company had no dilutive potential common shares outstanding during the
three-year period ended December 31, 1998, therefore, the per share data
presented on the face of the Consolidated Statements of Income and
Comprehensive Income relates to basic per share amounts.
Effective in the first reporting period of 1998, the Company adopted SFAS
No. 130, "Reporting Comprehensive Income." This Statement established
standards for the reporting and display of comprehensive income and its
components in a full set of general-purpose financial statements.
Comprehensive income is defined as the change in equity of a business
enterprise during a period from transactions and other events and
circumstances from nonowner sources. Items falling under the scope of SFAS
No. 130 include foreign currency items and unrealized gains and losses on
available-for-sale debt and equity securities. According to the Statement,
all items that are required to be recognized as components of comprehensive
income are to be reported in a financial statement that is displayed with
the same prominence as other financial statements. The components of
comprehensive income and the related tax effects are reported in the
Consolidated Statements of Income and Comprehensive Income. The Company's
accumulated other comprehensive income included in the Consolidated
Statements of Changes in Stockholders' Equity relates to the unrealized
gains or losses on available-for-sale securities.
The most significant factor that can have a material effect on the
financial performance of all industries is the Y2K. The Y2K issue arose
because many existing computer programs use the last two digits rather than
four to define the applicable year. These programs may interpret a date
ending in "00" as the year 1900 instead of the year 2000. Although the Y2K
problem affects all industries, its impact on the banking industry is
extensive. Banks depend on computers to perform virtually every function
from item processing to operating automated teller machines. If not
corrected, the consequences could be far-reaching. For banks in
particular, failure could result in system malfunction or miscalculation
causing a disruption of operations, including, among other things, a
temporary inability to process transactions or engage in normal business
activities.
The FFIEC on May 13, 1998, issued a statement with industry guidance on
contingency planning in connection with Y2K readiness. The FFIEC noted
that it expects financial institutions to meet the following key dates in
the Y2K testing process: (i) development of written testing and plans by
June 30, 1998; (ii) commencement of testing internal mission-critical
systems by September 1, 1998; (iii) substantial completion of testing of
internal mission-critical systems by December 31, 1998; (iv) substantial
completion of testing of mission-critical systems provided by service
providers by March 31, 1999; (v) begin external testing of material other
third parties by March 31, 1999; and (vi) completion of testing of mission-
critical systems and substantial completion of implementation by June 30,
1999.
On June 23, 1998, Federal Reserve Board issued SR 98-17, "Year 2000
Supervisory Review Plan Phase II" ("Phase II"), to summarize its
supervisory review plan for assessing Y2K compliance efforts of financial
institutions and certain service providers and software vendors during the
second phase of its supervisory program. The Federal Reserve Board noted
that Phase II required examiners to focus attention on the specific efforts
of the above parties in the areas of testing, implementation, contingency
planning and compliance with the key dates established by the
aforementioned FFIEC guidelines. Phase II requires at least one on-site
Y2K review by March 31, 1999, of all state member banks supervised by the
Federal Reserve Board.
The SEC issued Release Nos. 33-7558 and 34-40277, ("Release") on August 4,
1998. The Release was issued because the SEC does not believe that
existing Y2K disclosures provide enough specific information for an
investor to make a meaningful determination of a company's Y2K risks. This
Release provides guidance for public companies, investment advisors,
investment companies and municipal securities issuers regarding their
disclosure obligations about Y2K issues. The SEC, in this Release,
requires the aforementioned parties to disclose the following items in the
Management's Discussion and Analysis of Financial Condition and Results of
Operations section of their disclosure documents: (i) the company's state
of readiness; (ii) the costs to address a company's Y2K issues; (iii) the
risks of the company's Y2K issues; and (iv) the company's contingency
plans.
On October 15, 1998, the Federal Reserve Board, FDIC, OCC and OTS issued
"Interagency Guidelines Establishing Year 2000 Standards for Safety and
Soundness" ("Guidelines") pursuant to Section 39 of the Federal Deposit
Insurance Act. The Guidelines, which apply only to insured depository
institutions: (i) describe certain steps that must be taken regarding
awareness, assessment, renovation, validation and implementation phases of
Y2K readiness efforts; (ii) define certain key terms to help clarify the
types of actions that are expected to be undertaken; (iii) specify that the
initial review of mission-critical systems for Y2K readiness should provide
the basis for establishing priorities and deadlines and for identifying and
allocating available resources; (iv) distinguish between and provide
deadlines for the renovation of internally controlled systems and those
controlled by a third party; (v) require contingency plans regarding the
mitigation of risks associated with system failure and, if applicable, the
failure to complete renovation of mission-critical systems; (vi) require a
due diligence process that identifies, evaluates and assesses customers
posing material Y2K risks; and (vii) provide the federal banking agencies
unlimited authority and enforcement tools to address Y2K readiness, safety
and soundness concerns.
The Company is very dependent upon information technology ("IT") systems to
perform its daily operations. Early in 1997, management initiated an
enterprise-wide program to address the Y2K issue and the effects it will
have on the Company. A formal Century Date Change Preparedness ("CDC")
Policy was devised and approved by the Board of Directors. This CDC Policy
called for a Y2K project plan to coordinate and oversee the various phases,
assessment, renovation, testing and implementation of the Company's Y2K
preparedness. The Chief Operating Officer of the Company was appointed
coordinator of the Y2K project plan and the Data Processing Steering
Committee serve as oversight for the project. The progress of the Y2K
project plan including: (i) an overview of the plan's progress; (ii) the
status of compliance for mission-critical hardware and software; (iii) the
results of hardware and software testing and implementation; (iv) the
evaluation of significant customers in addressing Y2K issues in their
business; and (v) the assessment of the need for implementation of any
contingency plan for those areas that will not be compliant, is reported to
the Board of Directors on a quarterly basis or more frequently as
significant events occur.
It has always been the Company's pro-active position to remain current in
its IT systems. In doing so, the Company's exposure to risk related to Y2K
compliance of its IT systems has been greatly reduced. The following
operations of the Company have been identified as mission-critical, vital
to the successful continuance of a core business activity: (i) system
hardware; (ii) account processing; (iii) items processing; (iv) image
statement rendering; (v) teller transaction; (vi) trust accounting; and
(vii) loan document preparation software. In addition, there are IT
systems and non-IT systems that are not considered mission-critical. The
following table provides a description of the Company's systems, how the
assessment, renovation and testing for each system is being addressed,
whether or not the system is compliant, target dates for completion and
contingency plans for non-compliant systems:
<TABLE>
<CAPTION>
Y2K ESTIMATED
COMPLIANT COMPLETION CONTINGENCY
DESCRIPTION OF SYSTEM ASSESSMENT RENOVATION TESTING (YES/NO) DATE PLAN
- -----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
MISSION-CRITICAL IT
SYSTEMS:
Hardware:
System 4300 processor Certification None Complete Yes
from responsible
vendor
Operating:
Unix operating system Non-compliant Upgrade to Complete Yes
Version 3.0.2
Account processing:
Software, Release 3.0 Certification from None Complete Yes
responsible vendor
Item processing:
Software Version 3.22 Certification from None Incomplete No 3/31/99 (1)
responsible vendor
Image statement rendering:
Software Version 1.2 Certification from None Incomplete No 3/31/99 (1)
responsible vendor
Teller transaction:
Software No certification Perform internal Complete Yes
available testing
Trust accounting:
Software Version 5.0 Certification from None Complete Yes
responsible vendor
Loan document preparation:
Software Certification from None Complete Yes
responsible vendor
- -----------------------------------------------------------------------------------------------------------------------------
NONMISSION-CRITICAL IT
SYSTEMS:
Communications
Software/Data Certification Non-compliant Incomplete No 3/31/99 (2)
requested and will systems will be
be reviewed for upgraded or
compliance converted to new
products
Hardware No certification Perform internal Complete Yes (3)
available testing on all
hardware
- -----------------------------------------------------------------------------------------------------------------------------
NONMISSION-CRITICAL
NON-IT SYSTEMS:
Imbedded technology Certification Non-compliant Complete Yes (4)
requested and will systems will be
be reviewed for upgraded or
compliance converted to new
products
Other items-date stamps, Review items for Internal testing Complete Yes (4)
forms, checks, date sensitivity will be performed
calculators, etc. if needed
Items will be
replaced as needed
- -----------------------------------------------------------------------------------------------------------------------------
<FN>
(1) Responsible vendor is developing testing plan.
(2) Options are determined on an individual product basis. A cost/benefit analysis is
performed to determine if an upgrade to a new version or a conversion to a new product would be appropriate.
(3) Hardware that is not able to handle the Y2K will be replaced.
(4) Contingency options as to alternate products and suppliers are being compiled.
</FN>
</TABLE>
The Company believes that through completion of its Y2K project plan it
will successfully mitigate any Y2K problems associated with its mission-
critical IT systems. All mission-critical IT systems are currently either
Y2K compliant or will be by the end of the first quarter of 1999.
Significant testing has been performed on all software and hardware that is
currently Y2K compliant to ensure compliance. Future testing will be
performed during the first six months of 1999, as other applications become
compliant. The Company expects to be fully compliant relative to its IT
systems and non-IT systems at March 31, 1999. Based on estimates from
third party vendors and an assessment of the Data Processing Steering
Committee, the Company expects to spend approximately $200 to become fully
compliant. Costs already expended during 1998 relative to disposition of
non-compliant hardware and software were $78 and $9, respectively, and are
included in noninterest expense in the Company's Consolidated Statements of
Income and Comprehensive Income. Any future costs relative to the
Company's Y2K efforts will be expensed as incurred. Management does not
expect these costs to have a material effect on the operating results or
financial position of the Company.
The effects of the Y2K on the Company depend not only on its efforts to
address those issues, but also on the way the issues are addressed by third
parties with whom the Company has a significant relationship. These third
parties include, but are not limited to, major loan and deposit customers,
businesses that provide products and services to the Company and
governmental agencies. Management is taking various steps to assess the
risks and mitigate the potential problems that may arise in the event a
significant third party is not Y2K compliant.
The Company recognizes that a commercial customer's profitability and
liquidity positions could be adversely affected if their systems fail to
properly handle the date change. This could lead to delinquencies on
loans, possible defaults and bankruptcy filings, in extreme cases. The
Company reviewed its commercial loan files and enumerated: (i) all
commercial customers with loan balances in excess of $125 whose business is
somewhat dependent on technology; and (ii) any commercial loan customer
whose business is totally dependent on technology. The Company contacted
these customers and informed them of the Y2K and the possible effects it
could have on their business and inquired about any efforts the customer is
taking to mitigate those effects. In addition, a questionnaire regarding
the Y2K is incorporated into the commercial loan application process and
requires all potential loan customers to attest to their compliance.
The Company also realizes that education is a key element in trying to
mitigate potential Y2K problems. During the second quarter of 1998, the
Company used several mediums to convey Y2K readiness to its current and
prospective individual and business customers. With the ever-growing
popularity of the Internet, the Company chose to discuss the Y2K in its
home page on the World Wide Web. The Company also conducted a series of
breakfast seminars for its customers. The purpose of these seminars was to
aid the customers in identifying their potential exposure to any problems
associated with the Y2K. Brochures discussing Y2K awareness were included
in customers' deposit statements in the fourth quarter of 1998. The
brochures were in a question and answer format and addressed the following
issues: (i) the effect of the Y2K date change on federal deposit insurance
coverage; (ii) steps financial institutions and regulatory agencies are
taking to minimize the effect of the Y2K date change; and (iii) steps
customers should take to prepare for the Y2K.
Regardless of the Company's efforts, there can be no assurance that
significant third parties will be successful in adequately addressing their
own Y2K issues. The Company is preparing contingency plans to address the
possibility that significant third parties will not be successful. This
involves: (i) identifying alternate vendors and sources for products and
services; (ii) determining means of internal corrective action; and (iii)
allocating a portion of the allowance for loan losses to specifically cover
any potential credit losses related to the Y2K. However, no assurance can
be made, that these plans will alleviate any risks to the Company. There
may also be certain significant third parties, such as utility and
telecommunication companies, where alternative arrangements or sources are
limited or unavailable. Y2K issues, if not adequately addressed by the
Company and third parties, could have a material effect on the Company's
business, consolidated results of operations and financial position.
The preceding Y2K discussion contains "forward-looking statements" within
the meaning of the Private Securities Litigation Reform Act of 1995. These
statements include, but are not limited to: (i) whether or not testing will
be accurate; (ii) the estimated costs associated with becoming Y2K
compliant; (iii) the date by which the Company expects to be fully
compliant; and (iv) the successfulness of any contingency plans. These
statements are made using current estimates and assumptions about future
events. There can be no assurance that these estimates will be achieved
and actual results could differ materially from those anticipated. The
factors that might lead to material differences include, among others: (i)
the ability to accurately identify all mission-critical systems; (ii)
accuracy of the testing performed; (iii) whether or not third party
certifications are accurate; (iv) whether or not material customers,
suppliers, governmental agencies and other significant third parties are
successful in their Y2K efforts; (v) the adequacy of contingency plans; and
(vi) the ability to implement contingency plans.
NET INTEREST INCOME:
The major source of operating income for the Company is net interest
income. Net interest income is defined as the difference between income,
interest and fees, on earning assets and the cost of interest-bearing
liabilities supporting those assets. The primary sources of earning assets
are loans and investment securities, while deposits, short-term borrowings
and long-term debt comprise interest-bearing liabilities. Net interest
margin is the percentage of tax-equivalent net interest income to average
earning assets. Variations in volumes and rates of earning assets and
interest-bearing liabilities, in response to changes in general market
rates, are the main factors affecting net interest income. The composition
of earning assets and interest-bearing liabilities and the volume of
nonperforming assets also influence the levels of net interest income.
During 1998, the FOMC's interest rate cuts, higher mortgage prepayment
levels and the flat yield curve all factored into reduced net interest
margins for large and regional banks. For the nation's top 50 banks,
average tax-equivalent net interest margins declined 24 basis points from
3.85 percent for 1997 to 3.61 percent for 1998. Similarly, banks in the
Mid-Atlantic region also showed lower average margins, to 3.88 percent for
1998 from 4.07 percent for 1997. Conversely, the Company's tax-equivalent
net interest margin improved 19 basis points to 4.06 percent for 1998 from
3.87 percent for 1997. Similarly, the Company's tax-equivalent net
interest spread improved from 3.16 percent in 1997 to 3.37 percent in 1998.
Maintenance of an adequate net interest margin is a primary concern for
management. A low interest rate environment is expected to continue for
1999, which could cause interest margins to tighten even further.
Management believes following prudent deposit pricing practices coupled
with careful investing, will keep the Company's net interest margin in
check. However, no assurance can be given that general market conditions
will continue. Changes in general market rates or intensified competition
could adversely effect net interest income.
Management analyzes interest income and interest expense by segregating
rate and volume components of earning assets and interest-bearing
liabilities. The impact changes in the interest rates earned and paid on
assets and liabilities, along with changes in the volumes of earning assets
and interest-bearing liabilities have on net interest income are summarized
as follows. 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.
<TABLE>
<CAPTION>
NET INTEREST INCOME CHANGES DUE TO RATE AND VOLUME
1998 VS. 1997 1997 VS. 1996
---------------------- ------------------------
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............................................ $ 671 $ 671 $1,472 $(66) $1,538
Tax-exempt......................................... (114) $ 21 (135) 247 (7) 254
Investments:
Taxable............................................ 239 230 9 (616) 288 (904)
Tax-exempt......................................... (27) (66) 39 111 (47) 158
Federal funds sold................................... 265 (3) 268 (9) 4 (13)
------ ---- ----- ------ ---- ------
Total interest income............................ 1,034 182 852 1,205 172 1,033
------ ---- ----- ------ ---- ------
Interest expense:
Money market accounts................................ 19 (5) 24 4 43 (39)
NOW accounts......................................... 64 2 62 66 28 38
Savings accounts..................................... (245) (217) (28) (117) (54) (63)
Time deposits less than $100......................... 439 (146) 585 500 46 454
Time deposits $100 or more........................... (387) (79) (308) 149 70 79
Short-term borrowings................................ 3 1 2 5 (1) 6
Long-term debt....................................... (1) (1) (89) 40 (129)
------ ---- ----- ------ ---- ------
Total interest expense........................... (108) (445) 337 518 172 346
------ ---- ----- ------ ---- ------
Net interest income.............................. $1,142 $627 $ 515 $ 687 $ $ 687
====== ==== ===== ====== ==== ======
</TABLE>
Tax-equivalent net interest income grew $1,142 or 8.5 percent from $13,378
in 1997 to $14,520 in 1998. Improvements in both the average yields
received on earning assets and the average cost paid on interest-bearing
liabilities, coupled with growth in average volumes of earning assets over
average volumes of interest-bearing liabilities, contributed to the
increase. The main factor for the net interest spread improvement was a 17
basis point reduction in the Company's cost of funds from 4.77 percent for
1997 to 4.60 percent for 1998. Reductions in the average rate paid on
savings accounts of 34 basis points, time deposits less than $100 of 9
basis points and time deposits $100 or more of 28 basis points factored
into this reduction. Specifically, these rate reductions favorably
affected net interest income by $217, $146 and $79, respectively. An
increase in the average yield on earning assets of 4 basis points also
aided the improvement. The predominant cause for the improved yield was a
37 basis point increase in the yield on taxable investments. This change
accounted for a favorable rate variance of $230. This was a direct result
of management reinvesting funds received from maturing U.S. Treasury
securities into short-term U.S. Government agency mortgage-backed
securities. The yield on tax-exempt investments declined 17 basis points in
response to acquisitions of short-term,lower-yielding obligations of local
municipalities. The yield on taxable loans was constant at 8.55 percent,
while the tax-equivalent yield on tax-exempt loans improved to 8.30 percent
in 1998 from 8.08 percent in 1997.
Net interest income was also impacted by changes in the volumes of earning
assets and interest-bearing liabilities. The Company showed increases in
average loan and federal funds sold volumes, partially mitigated by greater
time deposit volumes. The Company's average loan volumes for 1998 increased
$6.0 million or 2.5 percent over 1997. This increase accounted for a $536
positive influence on interest income. An increase in federal funds sold
volumes of $4.9 million also contributed to the favorable volume variance.
Changes in the composition of time deposits partially offset the effects
the greater loan volumes had on net interest income. For 1998, time
deposits less than $100 averaged $176.0 million, a $10.5 million or 6.3
percent increase over the $165.5 million for 1997. In contrast, average
time deposits $100 or more declined $5.2 million or 17.9 percent from $29.1
million for 1997 to $23.9 million for 1998, as management chose to be less
aggressive in pricing these types of deposits.
The average balances of assets and liabilities, corresponding interest
income and expense and resulting average yields or rates paid are
summarized as follows. Earning assets averages include nonaccrual loans.
Investment averages include available-for-sale securities at amortized
cost. Income on investment securities and loans are adjusted to a tax-
equivalent basis using a statutory tax rate of 34.0 percent.
<TABLE>
<CAPTION>
SUMMARY OF NET INTEREST INCOME
1998 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..................................... $240,658 $20,587 8.55% $233,001 $19,916 8.55%
Tax-exempt.................................. 7,267 603 8.30 8,876 717 8.08
Investments:
Taxable..................................... 61,138 3,645 5.96 60,975 3,406 5.59
Tax-exempt.................................. 38,276 3,089 8.07 37,818 3,116 8.24
Federal funds sold............................ 10,164 556 5.47 5,265 291 5.53
-------- ------- -------- -------
Total earning assets...................... 357,503 28,480 7.97% 345,935 27,446 7.93%
Less: allowance for loan losses............... 3,881 3,919
Other assets.................................. 23,797 17,334
-------- --------
Total assets.............................. $377,419 $359,350
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY:
Interest-bearing liabilities:
Money market accounts......................... $ 17,643 552 3.13% $ 16,854 533 3.16%
NOW accounts.................................. 21,366 467 2.19 18,464 403 2.18
Savings accounts.............................. 64,113 1,654 2.58 65,081 1,899 2.92
Time deposits less than $100.................. 175,954 9,864 5.61 165,487 9,425 5.70
Time deposits $100 or more.................... 23,936 1,409 5.89 29,092 1,796 6.17
Short-term borrowings......................... 185 11 5.95 138 8 5.80
Long-term debt................................ 43 3 6.98 45 4 8.89
-------- ------- -------- -------
Total interest-bearing liabilities........ 303,240 13,960 4.60% 295,161 14,068 4.77%
Noninterest-bearing deposits.................. 32,550 27,448
Other liabilities............................. 3,213 3,913
Stockholders' equity.......................... 38,416 32,828
-------- --------
Total liabilities and stockholders' equity $377,419 $359,350
======== ------- ======== -------
Net interest/income spread................ $14,520 3.37% $13,378 3.16%
======= =======
Net interest margin....................... 4.06% 3.87%
Tax-equivalent adjustments:
Loans......................................... $ 206 $ 244
Investments................................... 1,050 1,060
------- -------
Total adjustments......................... $ 1,256 $ 1,304
======= =======
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 $2,829 in 1998, $1,193 in 1997 and $337 in
1996, and an average unrealized holding loss of $1,272 in 1995 and $4,217 in 1994 included in other assets.
Tax-equivalent adjustments were calculated using the prevailing statutory tax rate of 34.0 percent.
</TABLE>
<TABLE>
<CAPTION>
SUMMARY OF NET INTEREST INCOME (CONTINUED)
1996 1995 1994
- ---------------------------- ---------------------------- ----------------------------
INTEREST AVERAGE INTEREST AVERAGE INTEREST AVERAGE
AVERAGE INCOME/ INTEREST AVERAGE INCOME/ INTEREST AVERAGE INCOME/ INTEREST
BALANCE EXPENSE RATE BALANCE EXPENSE RATE BALANCE EXPENSE RATE
- -------- -------- -------- -------- -------- --------
<C> <C> <C> <C> <C> <C> <C> <C> <C>
$213,071 $18,444 8.66% $195,047 $17,238 8.84% $185,318 $15,761 8.50%
5,724 470 8.21 4,649 364 7.83 3,657 272 7.44
74,233 4,022 5.42 113,675 6,789 5.97 136,386 7,826 5.74
35,923 3,005 8.37 20,775 1,818 8.75 20,609 1,817 8.82
5,508 300 5.45 17,070 1,000 5.86 384 26 6.77
- -------- ------- -------- ------- -------- -------
334,459 26,241 7.85% 351,216 27,209 7.75% 346,354 25,702 7.42%
4,014 3,816 3,540
16,834 11,770 7,586
- -------- -------- --------
$347,279 $359,170 $350,400
======== ======== ========
$ 18,144 529 2.92% $ 21,869 758 3.47% $ 23,955 792 3.31%
16,661 337 2.02 15,550 305 1.96 15,151 297 1.96
67,144 2,016 3.00 71,911 2,336 3.25 83,142 2,602 3.13
157,271 8,925 5.67 155,183 8,923 5.75 139,641 6,905 4.94
27,755 1,647 5.93 29,336 1,771 6.04 25,995 1,553 5.97
51 3 5.88 9,935 677 6.81 11,186 545 4.87
2,122 93 4.38 4,715 224 4.75 5,050 248 4.91
- -------- ------- -------- ------- -------- -------
289,148 13,550 4.69% 308,499 14,994 4.86% 304,120 12,942 4.26%
26,329 24,090 21,849
2,968 547 1,120
28,834 26,034 23,311
- -------- -------- --------
$347,279 $359,170 $350,400
======== ------- ======== ------- ======== -------
$12,691 3.16% $12,215 2.89% $12,760 3.16%
======= =======
3.79% 3.48% 3.68%
$ 160 $ 124 $ 93
1,022 618 618
------- ------- -------
$ 1,182 $ 742 $ 711
======= ======= =======
</TABLE>
PROVISION FOR LOAN LOSSES:
Financial institutions' actions related to the provision for loan losses
were mixed in 1998 as large banks increased their provision while regional
and community banks kept their provision at the same levels of a year ago.
Large financial institutions, as represented by the nation's top 50 banks,
increased their provision for loan losses from $11.2 billion in 1997, to
$12.4 billion in 1998, a 10.7 percent increase. This increase was a direct
result of higher levels of net loans charged-off, nonperforming loans and
riskier commercial loans. The ratio of net charge-offs as a percentage of
average loans rose from 0.54 percent in 1997 to 0.66 percent in 1998. The
increase was primarily attributable to write-offs on loans to emerging
countries and hedge funds caused by the global economic crisis. Also
causing the increase was a rise in the amount of nonperforming loans from
$10.3 billion to $11.6 billion at December 31, 1997 and 1998, respectively.
Finally, an increase in the amount of commercial loans as a percentage of
the total loan portfolio caused financial institutions to allocate a
greater amount of earnings towards a provision. The provision for loan
losses for regional and community banks were unchanged at approximately
$290.0 million for 1998 and 1997. Net charge-offs as a percentage of
average loans continued lower at 0.25 percent in 1998. Nonperforming assets
declined from $1.3 billion at year-end 1997 to $1.0 billion at year-end
1998. As a percentage of loans, nonperforming assets declined from 1.12
percent to 0.78 percent at December 31, 1997 and 1998, respectively. The
recent reductions in net interest margins may cause banks to seek higher
concentrations of riskier commercial loans thus potentially causing a
corresponding increase in the level of provisions in 1999.
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 taken into consideration when
determining the provision. Based on its most current valuation, management
believes that the allowance is adequate to absorb any known and inherent
losses in the portfolio.
The Company's provision for loan losses increased from $360 in 1997 to $855
in 1998. As aforementioned, the majority of the increase occurred in the
final quarter of 1998 as management replenished the loan loss reserve for
loans charged-off in response to changes in regulatory classifications of
certain loans. Management knows of no other credits, based on results of
the latest regulatory examination received on January 25, 1999, that should
have been charged-off in 1998. Moreover, the Company had no credit losses
that should have been recognized in the December 31, 1998, financial
statements in accordance with SFAS No. 5,"Accounting for Contingencies."
SFAS No. 5 is the primary guidance on the accounting and reporting of loss
contingencies, including credit losses. This Statement requires that an
estimated loss from a loss contingency should be accrued by a charge to
income if both of the following conditions are met: (i) information
available prior to issuance of the financial statements indicate that it is
probable that an asset has been impaired and one or more future events will
occur confirming the loss at the date of the financial statements; and (ii)
the amount of the loss can be reasonably estimated. Management believes
that maintaining a standard monthly charge to operations in the form of a
provision is warranted given the recent levels of charge-offs and a greater
concentration of commercial loans. Accordingly, management will continue to
make additions to the allowance for loan loss account in 1999.
NONINTEREST INCOME:
During 1998, noninterest income increased 17.3 percent for large banks and
29.7 percent for regional and community banks as compared to last year. The
improvement was a result of financial institutions implementing charges on
existing products and services along with introduction of new product lines
given the recent reductions in net interest margins. In addition, the
reduction in interest rates fueled activity in mortgage lending during 1998
causing a corresponding rise in mortgage banking fees. Fee revenue growth
is expected to rise as financial institutions continue to experience
earning pressure.
The Company reported noninterest income of $2,673 in 1998, an $897 increase
over the $1,776 reported for 1997. Service charges, fees and commissions
remained at $1.5 million for 1998 and 1997. Management expects fee revenue
to become a more prominent portion of noninterest income in 1999, as a
result of expansions in delivery systems, products and services. As
aforementioned, the Company began originating one-to-four family
residential mortgage loans for sale on the secondary market during 1998.
Gains on the sale of such loans totaled $43. Included in noninterest income
were net gains on the sale of investment securities of $1.1 million.
Management chose to sell certain equity securities of local financial
institutions in 1998 as a result of the investments being overvalued
relative to comparable stocks and an overall weakness in bank stocks. The
recognition of Y2K remediation costs and nonperforming asset related
charges primarily offset the impact of the securities gains on 1998 net
income. As part of its Y2K preparedness, the Company evaluated all systems
and equipment during the fourth quarter of 1998 recognizing charges for
noncompliant equipment dispositions. Nonperforming asset related charges
include losses on foreclosed property devaluations, interest income
adjustments from placing certain loans on nonaccrual status and
replenishment costs for loans charged-off. For 1997, noninterest income
included a recovery of $250 from a litigation settlement paid by a
securities broker to the Company's wholly-owned subsidiary, Community Bank.
The settlement was awarded with respect to Community Bank's business
relationship with this broker prior to 1995.
NONINTEREST EXPENSE:
In general, noninterest expense is categorized into three main groups:
employee-related expenses, occupancy and equipment expenses and other
expenses. Employee-related expenses are costs associated with providing
salaries, including payroll taxes, and benefits to the Company's employees.
Occupancy and equipment expenses, the costs related to the maintenance of
facilities and equipment, include depreciation, general maintenance and
repairs, real estate taxes, rental expense offset by any rental income, and
utility costs. Other expenses include general operating expenses such as
advertising, contractual services, insurance including FDIC assessment,
other taxes and supplies. Several of theses 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 1998, the banking industry overall experienced higher levels of
noninterest expense. On the national and regional levels, significant
technological investments, costs associated with product line enhancements
and one-time charges related to Y2K compliance all contributed to increases
in noninterest expense and weaker efficiency ratios. The efficiency ratio,
a means of measuring a company's operating efficiency, is defined as a
company's noninterest expense excluding other real estate expense, as a
percentage of net interest income and noninterest income less any
nonrecurring gains or losses. For 1998, the efficiency ratios for the
nation's top 50 banks and Mid-Atlantic region banks were 60.6 percent and
55.4 percent, respectively. These were weaker in comparison to the ratios
of 59.7 percent and 54.2 percent, respectively, for 1997.
For 1998, the Company's noninterest expense increased $1,408 or 17.7
percent to $9,364 from $7,956 for 1997. Similar to its peers, the Company
showed a weaker efficiency ratio of 61.7 percent in 1998 as compared to
58.7 percent in 1997. Another ratio used to measure efficiency is the
overhead ratio, noninterest expense as a percentage of total average
assets. The Company's overhead ratio was 2.5 percent for 1998. This ratio
was higher than the ratio of 2.2 percent recorded for 1997, however, it was
still better in comparison to the peer group's ratio of 2.6 percent for
1998.
The major components of noninterest expense for the past five years are
summarized as follows:
<TABLE>
<CAPTION>
NONINTEREST EXPENSE
YEAR ENDED DECEMBER 31 1998 1997 1996 1995 1994
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Salaries and employee benefits expense:
Salaries and payroll taxes........................................ $3,767 $3,420 $3,251 $3,429 $3,022
Employee benefits................................................. 678 678 557 599 760
------ ------ ------ ------ ------
Salaries and employee benefits expense.......................... 4,445 4,098 3,808 4,028 3,782
------ ------ ------ ------ ------
Net occupancy and equipment expense:
Net occupancy expense............................................. 532 579 602 684 784
Equipment expense................................................. 761 620 611 538 465
------ ------ ------ ------ ------
Net occupancy and equipment expense............................. 1,293 1,199 1,213 1,222 1,249
------ ------ ------ ------ ------
Other expenses:
Marketing expense................................................. 401 269 242 281 201
Other taxes....................................................... 273 255 218 200 191
Stationery and supplies........................................... 437 375 226 250 262
Contractual services.............................................. 1,006 864 871 879 727
Insurance, including FDIC assessment.............................. 93 74 84 480 717
Other............................................................. 1,416 822 721 854 820
------ ------ ------ ------ ------
Other expenses.................................................... 3,626 2,659 2,362 2,944 2,918
------ ------ ------ ------ ------
Total noninterest expense..................................... $9,364 $7,956 $7,383 $8,194 $7,949
====== ====== ====== ====== ======
</TABLE>
Americans' compensation costs, wages and benefits, increased for a fifth
consecutive year. The Employment Cost Index, the best measure of changes
in wages and benefits according to the U.S. Department of Labor, rose 3.4
percent for 1998. Compensation costs are expected to continue to increase
through 1999, due to tight labor markets, caused by consistently low
unemployment rates, and increased health-care costs.
Salaries and employee benefits expense constitute nearly half of the
Company's noninterest expense. For the year-ended December 31, 1998, these
expenses totaled $4,445 or 47.5 percent of noninterest expense. This was
an increase of $347 or 8.5 percent as compared to a year ago. Employee
additions related to the acquisition of the Eynon and Factoryville branches
caused 65.0 percent of the total increase. The remainder of the increase
was related to merit increases for employees based on their annual
performance evaluations. In spite of rising compensation costs, the
Company has effectively managed its salary and benefit costs. The
Company's compensation costs per full-time equivalent for 1998 and 1997
were $28 and $25, respectively. These costs were well below the peer
group's compensation costs per full-time equivalent of $32 for 1998 and $31
for 1997.
On January 1, 1998, the Company adopted SFAS No. 132, "Employers'
Disclosures about Pensions and Other Postretirement Benefits." The
Statement: (i) revises employers' disclosures about pension and other
postretirement benefit plans. It does not change the measurement or
recognition of pensions or other postretirement benefit plans; (ii)
standardizes the disclosure requirements for benefits of such plans to the
extent practicable; (iii) requires additional information on changes in the
benefit obligations and fair value of plan assets that will facilitate
financial analysis; (iv) eliminates certain disclosures that are no longer
useful as they were when Statements No. 87, "Employers' Accounting for
Pensions," No. 88, "Employers' Accounting for Settlement and Curtailment of
Defined Benefit Pension Plans and for Termination Benefits," and No. 106,
"Employers' Accounting for Postretirement Benefits Other Than Pensions,"
were issued. Most of the changes in the disclosure provisions of SFAS No.
132 address defined benefit plans. The adoption of this Statement did not
change the Company's disclosures nor did it have any effect on operating
results or financial position.
Net occupancy and equipment expense totaled $1,293 in 1998, an increase of
$94 or 7.8 percent over the $1,199 reported for 1997. The increase was due
entirely to additional rental and depreciation expenses associated with the
Eynon and Factoryville offices.
As aforementioned, on January 2, 1998, the Company acquired land in Clarks
Summit, Pennsylvania, for $1.2 million to construct an administrative
center and branch facility. This project, having an estimated aggregate
cost of $4.0 million, should be completed during the first quarter of 1999.
During 1998, the Company also acquired land in Dickson City, Pennsylvania,
for $625 to construct a branch facility. The estimated aggregate cost for
this project is $1.4 million and should be completed during the second
quarter of 1999. Both projects will be funded through normal operations
with approximately $2.8 million of costs remaining to be incurred at
December 31, 1998.
For the year-ended December 31, 1998, other expenses increased $967 to
$3,626 from the $2,659 recorded for the comparable period last year. The
primary factors contributing to this increase were additional expenses
associated with the operation of the two new branches, write-downs of
properties included in other real estate and dispositions of equipment
determined to be Y2K non-compliant. The Company incurred additional
amortization expense of $252 from the core deposit intangible acquired in
the aforementioned branch acquisitions. In addition to the amortization,
the Company also experienced higher levels of marketing, supply and general
operating costs associated with a full year of operation of these new
branches.
Also included in other expenses in 1998 were nonrecurring charges of $198
related to write-downs of other real estate properties and the disposition
of Y2K non-compliant equipment. It is the Company's policy to write-down
other real estate properties to the lower of the related loan balance or
80.0 percent of the fair market value based upon independent appraisals.
During 1998, the Company had the properties in other real estate re-
appraised. These reappraisals indicated a reduction in the fair market
value of these properties. As a result, the Company wrote-down other real
estate by $111 in 1998. As part of its Y2K readiness, the Company
evaluated and tested all computer hardware and software to determine Y2K
compliance. Based on this evaluation, non-compliant assets having a net
book value of $87 were disposed.
The Company expects increases in noninterest expenses for 1999. Additional
salary and benefit costs, depreciation and other expenses will be incurred
relative to the opening of the Clarks Summit and Dickson City locations.
The Company also expects additional costs associated with its continuing
Y2K remediation efforts.
On October 20, 1998, the FDIC decided to retain the existing Bank Insurance
Fund ("BIF") and Savings Association Insurance Fund ("SAIF") assessment
schedules of 0 to 27 basis points per year for the first semiannual
assessment period of 1999. According to FDIC statistics: (i) 95.1 percent
of all BIF-member institutions and 91.9 percent of SAIF-member institutions
are estimated to be listed in the lowest risk category, thus paying no
premiums; (ii) only 0.1 percent of both BIF- and SAIF-member institutions
are estimated to be in the highest risk category, paying a premium of 27
cents per 100 dollars in deposits; (iii) the average annual assessment rate
is projected to be 0.08 cents per 100 dollars and 0.25 cents per 100
dollars for BIF-member and SAIF-member institutions, respectively; (iv) the
FDIC-approved rate schedules are expected to maintain the reserve ratios
for both the BIF and SAIF above the Congressional mandated 1.25 percent
through June 30, 1999; (v) at June 30, 1998, the BIF reserve ratio was
1.40 percent and the SAIF reserve ratio was 1.38 percent; and (vi) there
will continue to be a separate levy assessed on all FDIC-insured
institutions to bear the cost of 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 required the FICO rate on BIF-
assessable deposits to be one-fifth the rate for SAIF-assessable deposits
until January 1, 2000.
The Company was in the 95.1 percent classified in the Well Capitalized
Supervisory Risk Subgroup at December 31, 1998. Accordingly, the Company
will be exempt from paying a BIF assessment for the first half of 1999.
However, the Company, along with all banks, continues to be assessed
quarterly for their assistance in interest payments on FICO bonds used to
capitalize the SAIF. The Company's assessment was $40 for the years-ended
December 31, 1998 and 1997.
INCOME TAXES:
The Company reported tax expense of $1,218 in 1998 compared to $1,134 in
1997. The effective tax rate increased from 20.5 percent in 1997 to 21.3
percent in 1998. Higher level of earnings along with lower amounts of tax-
exempt income were primarily responsible for the increase in the effective
tax rate. Tax-exempt interest income as a percentage of total interest
income declined from 9.7 percent in 1997 to 8.9 percent in 1998. Despite
this reduction, the Company continues to experience an advantageous tax
position as compared to the peer group. The peer group's effective tax rate
was 25.5 percent in 1997 and 26.0 percent in 1998. Management expects a
slight increase in the Company's tax burden in 1999 based on higher taxable
earnings offset partially by income on tax-exempt investments and loans and
by utilizing investment tax credits available through its investment in a
residential housing program for elderly and low-to moderate-income
families. The aggregate amount of tax credits available from this project
that will be recognized over ten years ending 2003 is $895.
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.
INDEPENDENT AUDITORS' REPORT
Board of Directors
and Stockholders
Comm Bancorp, Inc.
Forest City, Pennsylvania
We have audited the accompanying consolidated balance sheets of Comm
Bancorp, Inc. and subsidiary as of December 31, 1998 and 1997, and the
related consolidated statements of income and comprehensive income, changes
in stockholders' equity and cash flows for each of the years in the three-
year period ended December 31, 1998. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles
used and significant estimates made by management, as well as evaluating
the overall financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Comm
Bancorp, Inc. and subsidiary as of December 31, 1998 and 1997, and the
results of their operations and their cash flows for each of the years in
the three-year period ended December 31, 1998, in conformity with generally
accepted accounting principles.
January 30, 1999
/s/ Kronick Kalada Berdy & Co.
- --------------------------------
KRONICK KALADA BERDY & CO., P.C.
Kingston, Pennsylvania
<TABLE>
<CAPTION>
COMM BANCORP, INC.
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
--------------------------------------------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
YEAR ENDED DECEMBER 31 1998 1997 1996
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
INTEREST INCOME:
Interest and fees on loans:
Taxable................................................................... $20,587 $19,916 $18,444
Tax-exempt................................................................ 397 473 310
Interest and dividends on investment securities available-for-sale:
Taxable................................................................... 3,493 3,274 3,914
Tax-exempt................................................................ 2,039 2,056 1,983
Dividends................................................................. 152 132 108
Interest on federal funds sold.............................................. 556 291 300
------- ------- -------
Total interest income................................................... 27,224 26,142 25,059
------- ------- -------
INTEREST EXPENSE:
Interest on deposits........................................................ 13,946 14,056 13,454
Interest on short-term borrowings........................................... 11 8 3
Interest on long-term debt.................................................. 3 4 93
------- ------- -------
Total interest expense.................................................. 13,960 14,068 13,550
------- ------- -------
Net interest income..................................................... 13,264 12,074 11,509
Provision for loan losses................................................... 855 360 300
------- ------- -------
Net interest income after provision for loan losses..................... 12,409 11,714 11,209
------- ------- -------
NONINTEREST INCOME:
Service charges, fees and commissions....................................... 1,502 1,526 1,445
Litigation recovery......................................................... 250
Net gains on sale of loans.................................................. 43
Net gains (losses) on sale of investment securities......................... 1,128 (58)
------- ------- -------
Total noninterest income................................................ 2,673 1,776 1,387
------- ------- -------
NONINTEREST EXPENSE:
Salaries and employee benefits expense...................................... 4,445 4,098 3,808
Net occupancy and equipment expense......................................... 1,293 1,199 1,213
Other expenses.............................................................. 3,626 2,659 2,362
------- ------- -------
Total noninterest expense............................................... 9,364 7,956 7,383
------- ------- -------
Income before income taxes.................................................. 5,718 5,534 5,213
Provision for income tax expense............................................ 1,218 1,134 1,013
------- ------- -------
Net income.............................................................. 4,500 4,400 4,200
------- ------- -------
OTHER COMPREHENSIVE INCOME:
Unrealized gains (losses) on investment securities available-for-sale....... 816 1,570 (385)
Reclassification adjustment for (gains) losses included in net income....... (1,128) 58
Income tax expense (benefit) related to other comprehensive income.......... (106) 534 (111)
------- ------- -------
Other comprehensive income (loss), net of income taxes.................. (206) 1,036 (216)
------- ------- -------
Comprehensive income.................................................... $ 4,294 $ 5,436 $ 3,984
======= ======= =======
PER SHARE DATA:
Net income.................................................................. $ 2.04 $ 2.00 $ 1.91
Cash dividends declared..................................................... $ 0.37 $ 0.30 $ 0.28
Average common shares outstanding........................................... 2,205,545 2,200,960 2,200,080
See notes to consolidated financial statements.
</TABLE>
<TABLE>
<CAPTION>
COMM BANCORP, INC.
CONSOLIDATED BALANCE SHEETS
----------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
DECEMBER 31 1998 1997
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS:
Cash and due from banks................................................................. $ 11,464 $ 9,040
Federal funds sold...................................................................... 7,700 8,225
Investment securities available-for-sale................................................ 109,626 105,666
Loans held for sale, net................................................................ 503
Loans, net of unearned income........................................................... 248,140 250,227
Less: allowance for loan losses....................................................... 4,050 3,798
-------- --------
Net loans............................................................................... 244,090 246,429
Premises and equipment, net............................................................. 7,016 3,772
Accrued interest receivable............................................................. 2,297 2,575
Other assets............................................................................ 5,555 6,104
-------- --------
Total assets........................................................................ $388,251 $381,811
======== ========
LIABILITIES:
Deposits:
Noninterest-bearing................................................................... $ 36,024 $ 30,703
Interest-bearing...................................................................... 308,229 301,678
-------- --------
Total deposits...................................................................... 344,253 332,381
Short-term borrowings................................................................... 9,575
Long-term debt.......................................................................... 41 44
Accrued interest payable................................................................ 1,740 1,714
Other liabilities....................................................................... 2,483 1,995
-------- --------
Total liabilities................................................................... 348,517 345,709
-------- --------
STOCKHOLDERS' EQUITY:
Common stock, par value $0.33, authorized 12,000,000 shares, issued and outstanding:
1998, 2,207,022 shares; 1997, 2,202,405 shares......................................... 729 727
Capital surplus......................................................................... 6,537 6,385
Retained earnings....................................................................... 31,074 27,390
Accumulated other comprehensive income.................................................. 1,394 1,600
-------- --------
Total stockholders' equity.......................................................... 39,734 36,102
-------- --------
Total liabilities and stockholders' equity.......................................... $388,251 $381,811
======== ========
See notes to consolidated financial statements.
</TABLE>
<TABLE>
<CAPTION>
COMM BANCORP, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
-----------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
ACCUMULATED
OTHER TOTAL
COMMON CAPITAL RETAINED COMPREHENSIVE STOCKHOLDERS'
FOR THE THREE YEARS ENDED DECEMBER 31, 1998 STOCK SURPLUS EARNINGS INCOME EQUITY
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
BALANCE, DECEMBER 31, 1995............................ $733 $6,310 $20,072 $ 780 $27,895
Net income............................................ 4,200 4,200
Dividends declared: $0.28 per share................... (623) (623)
Net changes in unrealized gain on securities.......... (216) (216)
Three-for-one stock split............................. (7) 7
---- ------ ------- ------ -------
BALANCE, DECEMBER 31, 1996............................ 726 6,317 23,649 564 31,256
Net income............................................ 4,400 4,400
Dividends declared: $0.30 per share................... (659) (659)
Dividend reinvestment plan: 2,325 shares issued....... 1 68 69
Net changes in unrealized gain on securities.......... 1,036 1,036
---- ------ ------- ------ -------
BALANCE, DECEMBER 31, 1997............................ 727 6,385 27,390 1,600 36,102
Net income............................................ 4,500 4,500
Dividends declared: $0.37 per share................... (816) (816)
Dividend reinvestment plan: 4,617 shares issued....... 2 152 154
Net changes in unrealized gain on securities.......... (206) (206)
---- ------ ------- ------ -------
BALANCE, DECEMBER 31, 1998............................ $729 $6,537 $31,074 $1,394 $39,734
==== ====== ======= ====== =======
See notes to consolidated financial statements.
</TABLE>
<TABLE>
<CAPTION>
COMM BANCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
-----------------------------------------------------------------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
YEAR ENDED DECEMBER 31 1998 1997 1996
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income..................................................................... $ 4,500 $ 4,400 $ 4,200
Adjustments:
Provision for loan losses.................................................... 855 360 300
Depreciation, amortization and accretion..................................... 1,317 947 1,037
Amortization of loan fees.................................................... (186) (195) (215)
Deferred income tax expense (benefit)........................................ (95) 41 (66)
Losses (gains) on sale of investment securities available-for-sale........... (1,128) 58
Losses (gains) on other real estate.......................................... 139 (49) (35)
Losses on disposition of equipment........................................... 87
Changes in:
Loans held for sale, net................................................... (503)
Accrued interest receivable................................................ 278 96 201
Other assets............................................................... (9) (81) 61
Accrued interest payable................................................... 26 (146) (3)
Other liabilities.......................................................... 571 170 203
-------- -------- --------
Net cash provided by operating activities................................ 5,852 5,543 5,741
-------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sale of available-for-sale investment securities................. 1,659 1,472
Proceeds from repayments of available-for-sale investment securities........... 45,175 31,150 24,860
Purchases of available-for-sale investment securities.......................... (50,198) (33,392) (20,237)
Proceeds from sale of loans.................................................... 3,439
Proceeds from sale of other real estate........................................ 275 400 279
Net decreases (increases) in lending activities................................ 1,421 (17,974) (22,235)
Purchases of premises and equipment............................................ (3,940) (1,057) (518)
Proceeds from acquisition of branches, net..................................... 16,268
-------- -------- --------
Net cash used in investing activities.................................... (5,608) (1,166) (16,379)
-------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net changes in:
Money market, NOW, savings and noninterest-bearing accounts.................. 3,901 (56) (1,842)
Time deposits................................................................ 7,971 (7,093) 5,199
Short-term borrowings........................................................ (9,575) 9,575
Payments on long-term debt..................................................... (3) (2) (3,002)
Proceeds from the issuance of common shares.................................... 154 69
Cash dividends paid............................................................ (793) (637) (675)
-------- -------- --------
Net cash provided by (used in) financing activities...................... 1,655 1,856 (320)
-------- -------- --------
Net increase (decrease) in cash and cash equivalents..................... 1,899 6,233 (10,958)
-------- -------- --------
Cash and cash equivalents at beginning of year........................... 17,265 11,032 21,990
-------- -------- --------
Cash and cash equivalents at end of year................................. $ 19,164 $ 17,265 $ 11,032
======== ======== ========
SUPPLEMENTAL DISCLOSURES:
Cash paid during the period for:
Interest..................................................................... $ 13,934 $ 14,112 $ 13,553
Income taxes................................................................. 1,066 1,022 1,315
Noncash items:
Transfers of:
Loans to other real estate................................................. 249 336 223
Unrealized losses (gains) on available-for-sale securities................. $ 206 $ (1,036) $ 216
Fair value of assets acquired and liabilities assumed:
Loans, premises and equipment.............................................. $ 730
Core deposit intangible.................................................... 2,178
Cash received.............................................................. 16,268
Accrued interest payable................................................... (102)
--------
Deposit liabilities assumed................................................ $ 19,074
========
See notes to consolidated financial statements.
</TABLE>
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLOCIES:
NATURE OF OPERATIONS:
Comm Bancorp, Inc., a bank holding company incorporated under the laws of
Pennsylvania, provides a full range of banking services, including trust
services, through its one wholly-owned subsidiary, Community Bank and Trust
Company ("Community Bank"). Community Bank services its individual and
commercial customers through twelve full-service branches located within
four counties of Pennsylvania. Susquehanna and Wyoming counties account
for the predominant portion of Comm Bancorp, Inc.'s business activities,
with Lackawanna and Wayne counties contributing to a lesser degree.
Community Bank's primary product is loans to finance one-to-four family
residential properties. Other products include loans to small- and medium-
sized businesses and individuals. Community Bank primarily funds its loans
by offering certificates of deposit to commercial enterprises and
individuals. Other product offerings include various demand and savings
accounts.
Community Bank faces competition primarily from other commercial banks,
thrift institutions and credit unions within the Northeastern Pennsylvania
market, many of which are substantially larger in terms of assets and
liabilities. In addition, Community Bank experiences competition for
deposits from mutual fund and security brokers. Consumer, mortgage and
insurance companies compete for various types of loans. Principal methods
of competing for banking and permitted nonbanking services include price,
nature of product, quality of service and convenience of location.
Comm Bancorp, Inc. and Community Bank (collectively, the "Company") are
subject to regulations of certain federal and state regulatory agencies and
undergo periodic examinations.
SEGMENT DISCLOSURE:
On January 1, 1998, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 131, "Disclosures About Segments of an Enterprise
and Related Information." This Statement establishes standards for the way
public companies report information about operating segments in annual
financial statements and requires that those enterprises report selected
information about operating segments in interim financial reports issued to
stockholders. A public business enterprise must report financial and
descriptive information about its reportable operating segments. Operating
segments are defined as components of an enterprise about which separate
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLOCIES (CONTINUED):
financial information is available that is evaluated regularly by the chief
operating decision maker in deciding how to allocate resources and in
assessing performance. It also establishes standards for related
disclosures about products and services, geographic areas and major
customers.
SFAS No. 131 states that two or more operating segments may be aggregated
into a single segment if the segments have similar: (i) economic
characteristics; (ii) products and services; (iii) operating processes;
(iv) customer base; (v) delivery systems; and (vi) regulatory environment.
The Company's twelve branch banking offices, all similar with respect to
these characteristics, have exhibited similar long-term financial
performance. Therefore, they were aggregated into a single operating
segment. The Company did not have any other reportable operating segments
during the three years ended December 31, 1998.
BASIS OF PRESENTATION:
The consolidated financial statements of the Company have been prepared in
conformity with generally accepted accounting principles ("GAAP"),
Regulation S-X, Item 302 of Regulation S-K and reporting practices applied
in the banking industry. All significant intercompany balances and
transactions have been eliminated in the consolidation. The Company also
presents herein condensed parent company only financial information
regarding Comm Bancorp, Inc. ("Parent Company").
Prior period amounts are reclassified when necessary to conform with the
current year's presentation.
USE OF ESTIMATES:
The preparation of financial statements in conformity with GAAP requires
management to make certain estimates and assumptions. These estimates and
assumptions affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the
financial statements as well as the reported amounts of revenues and
expenses during the reporting periods. Significant estimates that are
particularly susceptible to material change in the next year relate to the
allowance for loan losses, fair value of financial instruments, real estate
acquired through foreclosure and intangible assets. Actual results could
differ from those estimates.
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLOCIES (CONTINUED):
Management maintains the allowance for loan losses at a level it believes
adequate to absorb estimated potential credit losses. While historical
loss experience provides a reasonable starting point for assessing the
adequacy of the allowance account, management also considers a number of
relevant factors that may cause estimated credit losses associated with the
Company's current portfolio to differ from historical loss experience.
These factors include: (i) changes in lending policies and procedures; (ii)
economic conditions; (iii) nature and volume of the portfolio; (iv) loan
review system; (v) volumes of past due and impaired loans; (vi)
concentrations; (vii) borrowers' financial status; (viii) collateral value;
and (ix) other factors deemed relevant by management. This evaluation is
inherently subjective as it requires material estimates, including the
amounts and timing of future cash flows expected to be received on impaired
loans, that may be susceptible to significant change. The Company employs
the federal banking regulatory agencies' Interagency Policy Statement on
the Allowance for Loans and Lease Losses as the primary analytical tool in
assessing the adequacy of the allowance account.
Additionally, regulatory agencies, as an integral part of their examination
process, periodically review the Company's allowance for loan losses and
foreclosed real estate. These agencies may require the Company to
recognize additions to the allowance based on information available to them
at the time of their examination. Management is unaware of any such
requirements based on the results of the Company's latest regulatory
examination at September 30, 1998.
Real estate acquired in connection with foreclosures or in satisfaction of
loans is written-down to the lower of the related loan balance or 80.0
percent of fair market value based upon estimates derived through
independent appraisals. However, proceeds realized from sales may
ultimately be higher or lower than those estimates.
Intangible assets include goodwill that resulted from the 1993 acquisition
of The First National Bank of Nicholson and a core deposit intangible that
resulted from the assumption of the deposit liabilities of two branches of
First Union National Bank ("First Union") in 1997. However, if the future
benefits are not derived, estimated amortization may increase and/or a
charge for impairment may be recognized.
INVESTMENT SECURITIES:
Investment securities are classified and accounted for as either held-to-
maturity, available-for-sale or trading based on management's intent at the
time of acquisition. Management is required to reassess the
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLOCIES (CONTINUED):
appropriateness of the classifications at each reporting date. The Company
does not buy or hold securities principally for the purpose of selling them
in the near term in order to generate profits from market appreciation.
Accordingly, there were no investment securities classified as trading at
December 31, 1998 and 1997.
The Company classifies debt securities as held-to-maturity when management
has the positive intent and ability to hold the securities to maturity.
Held-to-maturity securities are stated at cost, adjusted for amortization
of premium and accretion of discount. The Company did not have any
investment securities classified as held-to-maturity at December 31, 1998
and 1997.
Investment securities are designated as available-for-sale when they are to
be held for indefinite periods of time for the purpose of implementing
management's asset/liability strategies. The Company may also sell these
securities in response to changes in interest rates, prepayment risk,
liquidity requirements or other circumstances identified by management.
Available-for-sale securities are carried at estimated fair value with
unrealized gains and losses and their related income tax effect included in
other comprehensive income and reported as a separate component of
stockholders' equity, net of income tax. Restricted investment securities
of the Federal Home Loan Bank of Pittsburgh ("FHLB-Pgh") and Federal
Reserve Bank of Philadelphia ("FRB") are carried at cost. Estimated fair
values for investment securities are based on quoted market prices from a
national electronic pricing service. All of the Company's investments
trade actively in a liquid market.
Realized gains and losses are computed using the specific identification
method and are included in noninterest income. Premiums are amortized and
discounts are accreted over the contractual lives of investment securities
using the interest method, except for mortgage-backed securities, where
amortization and accretion are based on principal repayments.
Management periodically evaluates each investment security to determine if
a decline in fair value below its amortized cost is other than temporary.
If a decline is judged to be other than temporary, the individual security
is written-down to fair value with the amount of the write-down included in
earnings.
Transfers of securities between categories are recorded at fair value at
the date of the transfer. The accounting for the resulting unrealized gains
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLOCIES (CONTINUED):
or losses is determined by the category into which the security is
transferred.
On June 16, 1998, the Financial Accounting Standards Board ("FASB") issued
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 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 affected by the provisions for potential reclassification of
investment securities.
On October 9, 1998, the FASB issued SFAS No. 134, "Accounting for Mortgage-
Backed Securities Retained after the Securitization of Mortgage Loans Held
for Sale by a Mortgage Banking Enterprise." This Statement amends SFAS No.
65, "Accounting for Certain Mortgage Banking Activities," to require that
after securitization of mortgage loans held for sale, an entity engaged in
mortgage banking activities classify the resulting mortgage-backed
securities or other retained interests as held-to-maturity, available-for-
sale or trading, based on its ability and intent to sell or hold those
investments, in accordance with the provisions of SFAS No. 115, "Accounting
for Certain Investments in Debt and Equity Securities." The Statement also
requires a mortgage banking enterprise to classify as trading any retained
mortgage-backed securities that it commits to sell before or during the
securitization process. SFAS No. 134 is effective for the first fiscal
quarter beginning after December 15, 1998. The adoption of SFAS No. 134 on
January 1, 1999, is not expected to have a material effect on the Company's
operating results or financial position as it has no retained mortgage-
backed securities or other interests from the securitization of mortgage
loans held for sale.
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLOCIES (CONTINUED):
LOANS HELD FOR SALE, NET:
Loans held for sale consist of one-to-four family residential mortgages
originated and intended for sale in the secondary market. The loans are
carried in aggregate at the lower of cost or estimated market value, based
upon current delivery prices in the secondary mortgage market. Net
unrealized losses are recognized through a valuation allowance by
corresponding charges to income. Gains or losses on the sale of these
loans are recognized in noninterest income at the time of sale using the
specific identification method. Loan origination fees, net of certain
direct loan origination costs, are included in net gains or losses upon the
sale of the related mortgage loan. All loans are sold without recourse.
LOANS:
Loans are stated at outstanding principal balances, net of unearned
interest and net deferred loan fees. Interest income is accrued on the
principal amount outstanding. Unearned interest on installment loans is
recognized over the respective loan terms using the effective interest
method. Loan origination fees, net of certain direct loan origination
costs, are deferred and recognized over the contractual life of the related
loan as an adjustment to yield. Other credit related fees, such as
commercial letters of credit fees and fees on unused, available lines of
credit are recorded as service charges, fees and commissions in noninterest
income when earned.
NONPERFORMING ASSETS:
A loan is considered impaired when, based on current information and
events, it is probable that the Company will be unable to collect all
amounts due according to the contractual terms of the loan agreement.
Impairment is measured based on the present value of expected future cash
flows discounted at a loan's effective interest rate, the loan's observable
market price or the fair value of the collateral if the loan is collateral-
dependent. When the value of an impaired loan is less than the recorded
investment in the loan, the impairment is recognized by adjusting the
allowance for loan losses with a corresponding charge to the provision for
loan losses.
Nonperforming assets consist of nonperforming loans and foreclosed assets.
Nonperforming loans include accruing loans past due 90 days or more and
impaired loans. Impaired loans consist of nonaccrual and restructured
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLOCIES (CONTINUED):
loans. A loan is classified as nonaccrual when it is determined that the
collection of all or a portion of interest or principal is doubtful or when
a default of interest or principal has existed for 90 days or more, unless
the loan is well secured and in the process of collection. When a loan is
placed on nonaccrual, interest accruals discontinue and uncollected accrued
interest is reversed against income in the current period. Interest
collections after a loan has been placed on nonaccrual status are credited
to income when received unless the collectibility of principal is in doubt,
causing all collections to be applied as principal reductions.
A nonaccrual loan is returned to performing status when the loan is current
as to principal and interest and has performed according to the contractual
terms for a minimum of six months. Restructured loans are loans with
original terms, interest rate, or both, that have been modified as a result
of a deterioration in the borrower's financial condition. Interest income
on restructured loans is recognized when earned, using the interest method.
The Company had the same one restructured loan during 1998 and 1997.
Foreclosed assets are comprised of properties acquired through foreclosure
proceedings or acceptance of a deed-in-lieu of foreclosure and loans
classified as in-substance foreclosures. The Company includes such
properties in other assets. A loan is classified as in-substance
foreclosure when the Company has taken possession of the collateral
regardless of whether formal foreclosure proceedings take place.
Foreclosed assets are recorded at the lower of the related loan balance or
80.0 percent of its appraised fair value at the time of acquisition. Any
excess of the loan balance over the recorded value is charged to the
allowance for loan losses. Subsequent declines in the recorded value of
the property prior to its disposal and costs to maintain the assets are
included in other expenses. In addition, any gain or loss realized upon
disposal is included in other income or expense. The historical average
holding period for such properties is less than twelve months.
ALLOWANCE FOR LOAN LOSSES:
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
and subsequent recoveries, if any, are credited to the account.
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
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. 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.
OFF-BALANCE SHEET FINANCIAL INSTRUMENTS:
In the ordinary course of business, the Company has entered into
off-balance sheet financial instruments consisting of commitments to extend
credit, commitments under home equity and credit card arrangements and
commercial letters of credit. These financial instruments are recorded in
the financial statements when they are exercised.
PREMISES AND EQUIPMENT, NET:
Land is stated at cost. Premises, equipment and leasehold improvements are
stated at cost less accumulated depreciation. The cost of routine
maintenance and repairs is expensed as incurred. The costs of major
replacements, renewals and betterments are capitalized. When assets are
retired or otherwise disposed of, the cost and related accumulated
depreciation are eliminated and any resulting gain or loss is reflected in
noninterest income or noninterest expense. Depreciation is computed
principally using the straight-line method based on the following useful
lives:
Premises....................................................... 15-45 years
Equipment...................................................... 5-10 years
Leasehold improvements......................................... 15 years
MORTGAGE SERVICING RIGHTS:
The Company adopted SFAS No. 125, "Accounting for Transfers and Servicing
of Financial Assets and Extinguishment of Liabilities," on January 1, 1997.
This Statement superseded SFAS No. 122, "Accounting for Mortgage Servicing
Rights," which was effective January 1, 1996. SFAS No. 125 provides
accounting and reporting standards for transfers and servicing of financial
assets and extinguishment of liabilities. SFAS No. 125 also provides
implementation guidance for: (i) assessing isolation of transferred assets
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
and for accounting for transfers of partial interests; (ii) servicing of
financial assets; (iii) securitizations; (iv) transfers of sales-type and
direct financing lease receivables; (v) securities lending transactions;
(vi) repurchase agreements; (vii) dollar-roll transactions; (viii) wash
sales; (ix) loan syndications and participations; (x) risk participations
in banker's acceptances; (xi) factoring arrangements; (xii) transfers of
receivables with recourse; and (xiii) extinguishment of liabilities. The
accounting and reporting standards in SFAS No. 125 are based on consistent
application of a financial-components approach that focuses on control.
Under this approach, after a transfer of financial assets, an enterprise
recognizes the financial and servicing assets it controls and the
liabilities it has incurred, derecognizes financial assets when control has
been surrendered and derecognizes liabilities when extinguished. SFAS No.
125 provides consistent standards for distinguishing transfers of financial
assets that are sales from transfers that are secured borrowings. The
Statement is effective for transfers and servicing of financial assets and
extinguishment of liabilities occurring after December 31, 1996, except as
amended in SFAS No. 127, "Deferral of the Effective Date of Certain
Provisions of FASB Statement No. 125." Specifically, the provisions
identified as being deferred under SFAS No. 127 include secured borrowings,
collateralizations and transfers of financial assets that are part of
repurchase agreements, dollar-rolls, securities lending and similar
transactions. The Company adopted SFAS No. 127 on January 1, 1998. During
1998, the Company had no transfers of financial assets nor extinguishment
of liabilities that fell under the scope of SFAS No. 127, therefore, the
adoption of the Statement had no material effect on operating results or
financial position.
In accordance with SFAS No. 125, a servicing right is determined by
allocating the total costs incurred between the loan sold and the servicing
right, based on their relative fair values at the date of the sale. The
servicing right is amortized in proportion to, and over the period of,
estimated net servicing income. In addition, a servicing right is assessed
for impairment at each reporting date based on the fair value of the right.
To determine the fair value of the servicing right, the Company estimates
the present value of future cash flows incorporating assumptions such as
cost of servicing, discount rates, prepayment speeds and default rates.
For purposes of measuring impairment, the rights are stratified by loan
type, term and interest rate. The amount of impairment recognized, through
a valuation allowance, is the amount by which the mortgage servicing rights
for a stratum exceed their fair value.
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
Mortgage servicing rights are included in other assets. Amortization of
the rights is included in noninterest income as a charge against mortgage
servicing fees.
At December 31, 1998, the cost of the mortgage servicing rights
approximated their fair value. The Company did not originate for sale or
service mortgage loans during 1997, therefore, there were no servicing
rights at December 31, 1997.
LONG-LIVED AND INTANGIBLE ASSETS:
Goodwill, the excess cost over the net assets acquired in a business
combination accounted for as a purchase, is included in other assets and
amortized on a straight-line basis over 15 years. The core deposit
intangible that resulted from the purchase of the Eynon and Factoryville
branches is included in other assets and amortized on a straight-line basis
over eight years. Management, on a periodic basis, reviews goodwill and
the core deposit intangible and evaluates events or changes in
circumstances that may indicate impairment in the carrying amount of these
assets. Impairment, if any, is measured on a discounted cash flow basis.
As of December 31, 1998 and 1997, there were no events or changes in
circumstances that would lead management to believe that the carrying
amounts of these assets may not be recoverable.
EMPLOYEE BENEFIT PLANS:
On January 1, 1998, the Company adopted SFAS No. 132, "Employers'
Disclosures about Pensions and Other Postretirement Benefits." The
Statement: (i) revised employers' disclosures about pension and other
postretirement benefit plans. It did not change the measurement or
recognition of pensions or other postretirement benefit plans; (ii)
standardized the disclosure requirements for benefits of such plans to the
extent practicable; (iii) required additional information on changes in the
benefit obligations and fair value of plan assets that will facilitate
financial analysis; (iv) eliminated certain disclosures that are no longer
useful as they were when Statements No. 87, "Employers' Accounting for
Pensions," No. 88, "Employers' Accounting for Settlement and Curtailment of
Defined Benefit Pension Plans and for Termination Benefits," and No. 106,
"Employers' Accounting for Postretirement Benefits Other Than Pensions,"
were issued. Most of the changes in the disclosure provisions of SFAS No.
132 address defined benefit plans. The adoption of this Statement did not
change the Company's disclosures nor did it have any effect on operating
results or financial position.
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
The Company has a defined contribution plan covering all employees who have
completed 1,000 hours of service, attained 21 years of age and have been
employed by the Company for at least one year. Contributions to the plan
are determined by the Board of Directors and are based on a prescribed
percentage of annual net income allocated to each participant based on
their pro rata share of annual compensation. Pension costs are accrued
monthly to salaries and benefits expense with the plan being funded
annually.
In addition, the Company had a deferred compensation plan for certain
senior management employees that it discontinued during the third quarter
of 1996. Costs for the plan were accrued monthly in salaries and benefits
expense. The Company had no recognition of gain or loss from the
discontinuance of the plan.
TRUST ASSETS:
Assets held in a fiduciary or agency capacity for customers are not
included in the accompanying consolidated balance sheets since they are not
the Company's assets. Trust income is recorded on a cash basis, which is
not materially different than if reported on an accrual basis. Trust
services revenue did not meet any of the quantitative thresholds for
required segment disclosure under SFAS No. 131.
FAIR VALUE OF FINANCIAL INSTRUMENTS:
Fair value estimates are based on existing financial instruments without
attempting to estimate the value of anticipated future business and the
value of assets and liabilities that are not considered financial.
Accordingly, such assets and liabilities are excluded from disclosure
requirements. For example, no benefit is recorded for the value of low-
cost funding subsequently discussed. In addition, Community Bank's trust
department contributes fee income annually. Trust assets and liabilities
are not considered financial instruments for this disclosure, and their
values have not been incorporated into the fair value estimates. Other
significant items that are not considered financial instruments include
deferred tax assets, premises and equipment, foreclosed assets and
intangibles. Accordingly, the net aggregate fair value amounts presented
do not represent the underlying value of the Company.
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
Approximately 96.8 percent and 97.4 percent of the Company's assets and
99.3 percent and 99.4 percent of its liabilities were considered financial
instruments at December 31, 1998 and 1997, respectively. In cases where
quoted market prices are not available, fair values are based on estimates
using present value or other valuation techniques. Those techniques are
significantly affected by the assumptions used, including the discount rate
and estimates of future cash flows. In that regard, the derived fair value
estimates cannot be substantiated by comparison to independent markets. In
many cases, these values cannot be realized in immediate settlement of the
instrument.
The following methods and assumptions were used by the Company to construct
the summary table in Note 11 containing the fair values and related
carrying amounts of financial instruments:
CASH AND CASH EQUIVALENTS: The carrying values of cash and cash equivalents
as reported on the balance sheet approximate fair value.
INVESTMENT SECURITIES: The fair value of investment securities is based on
quoted market prices. The carrying values of restricted equity securities
approximate fair value.
LOANS HELD FOR SALE, NET: The fair value of loans held for sale, net are
based on quoted market prices.
NET LOANS: For adjustable-rate loans that reprice frequently and with no
significant credit risk, fair values are based on carrying values. The
fair values of all other loans are estimated using discounted cash flow
analysis, using interest rates currently offered for loans with similar
terms to borrowers of similar credit risk. Fair values for impaired loans
are estimated using discounted cash flow analysis determined by the loan
review function or underlying collateral values, where applicable.
ACCRUED INTEREST RECEIVABLE: The carrying value of accrued interest
receivable as reported on the balance sheet approximates fair value.
DEPOSITS WITHOUT STATED MATURITIES: The fair value of demand deposits,
savings accounts and certain money market accounts is the amount payable on
demand at the reporting date. The fair value estimates do not include the
benefit that results from such low-cost funding provided by the deposit
liabilities compared to the cost of borrowing funds in the market.
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
DEPOSITS WITH STATED MATURITIES: The carrying value of adjustable-rate,
fixed-term time deposits approximates their fair value at the reporting
date. The present value of future cash flows for fixed-rate time deposits
is used to estimate fair value. The discount rates used are the current
rates offered for time deposits with similar maturities.
SHORT-TERM BORROWINGS: The carrying value of short-term borrowings at a
variable interest rate approximates fair value.
LONG-TERM DEBT: The fair value of the fixed-rate, long-term debt is
estimated based on rates currently available to the Company for debt with
similar terms.
ACCRUED INTEREST PAYABLE: The carrying value of accrued interest payable as
reported on the balance sheet approximates fair value.
COMMITMENTS: The majority of the Company's commitments to extend credit,
unused portions of home equity and credit card lines and letters of credit
carry current market interest rates if converted to loans. Because such
commitments are generally unassignable by either the Company or the
borrower, they only have value to the Company and the borrower. The
estimated fair value approximates the recorded deferred fee amounts and is
included in net loans.
COMPREHENSIVE INCOME:
Effective in the first reporting period of 1998, the Company adopted SFAS
No. 130, "Reporting Comprehensive Income." This Statement established
standards for the reporting and display of comprehensive income and its
components in a full set of general purpose financial statements.
Comprehensive income is defined as the change in equity of a business
enterprise during a period from transactions and other events and
circumstances from nonowner sources. Items falling under the scope of SFAS
No. 130 include foreign currency items and unrealized gains and losses on
available-for-sale debt and equity securities. According to the Statement,
all items that are required to be recognized as components of comprehensive
income are to be reported in a financial statement that is displayed with
the same prominence as other financial statements. The components of
comprehensive income and their related tax effects are reported in the
Consolidated Statements of Income and Comprehensive Income. The Company's
accumulated other comprehensive income included in the Consolidated
Statements of Changes in Stockholders' Equity relates to the unrealized
gains or losses on available-for-sale securities.
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
STATEMENTS OF CASH FLOWS:
The Statements of Cash Flows are presented using the indirect method. For
the purpose of cash flow, cash and cash equivalents include cash on hand,
cash items in the process of collection, noninterest-bearing deposits with
other banks, balances with the FRB and FHLB-Pgh and federal funds sold.
Federal funds sold are highly-liquid investments sold for one-day periods.
ADVERTISING COSTS:
The Company expenses advertising costs as incurred. Advertising costs
totaled $281 in 1998, $217 in 1997 and $206 in 1996.
INCOME TAXES:
The Company recognizes the current and deferred tax consequences of all
transactions that have been recognized in the financial statements using
the provisions of the enacted tax laws. Deferred tax assets and
liabilities are recognized for the estimated future tax effects of
temporary differences by applying enacted statutory tax rates to
differences between the financial statement carrying amounts and the tax
bases of existing assets and liabilities. The amount of deferred tax
assets is reduced, if necessary, to the amount that, based on available
evidence, will more likely than not be realized. As changes in tax laws or
rates are enacted, deferred tax assets and liabilities are adjusted through
the provision for income taxes.
The Parent Company and its subsidiary file a consolidated federal income
tax return. The subsidiary provides for income taxes on a separate return
basis, and remits amounts determined to be currently payable to the Parent
Company.
EARNINGS PER COMMON SHARE AND CAPITAL STRUCTURE:
The Company adopted SFAS No. 128, "Earnings Per Share" in 1998. The object
of SFAS No. 128 is to simplify the earnings per share ("EPS") calculation
and to make the United States standard for computation compatible with the
EPS standards of other countries and with those of the International
Accounting Standards Committee.
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
Under SFAS No. 128, two EPS calculations are required. Basic EPS is
computed by dividing net income by the weighted-average common shares
outstanding, and dilutive EPS is based on the weighted-average common
shares outstanding plus all dilutive potential common shares outstanding.
The Company had no dilutive potential common shares outstanding during the
three-year period ended December 31, 1998, therefore, the per share data
presented on the face of the Consolidated Statements of Income and
Comprehensive Income relates to basic per share amounts.
Simultaneously with its adoption of SFAS No. 128, the Company also adopted
SFAS No. 129, "Disclosure of Information about Capital Structure." This
Statement does not establish any new disclosure standards but rather
codifies certain previously-required disclosures. Specifically, it
requires information regarding the pertinent rights and privileges of the
various components of an entity's capital structure such as: (i) dividend
and liquidation preferences; (ii) participation rights; (iii) call prices
and dates; (iv) conversion prices and dates; (v) unusual voting rights; and
(vi) terms of contracts to issue additional shares. Since this Statement
contains no change in disclosure requirements, the Company's adoption had
no effect on financial statement presentation.
The effect of a three-for-one stock split that occurred on April 1, 1996,
is presented in the financial statements. The split changed the par value
from $1.00 per share to $0.33 per share.
2. CASH AND DUE FROM BANKS:
The Federal Reserve Act, as amended by the Monetary Control Act of 1980,
imposes reserve requirements on all member depository institutions. The
Company's required reserve balances were $2,148 and $1,415 at December 31,
1998 and 1997, respectively, which were satisfied through the restriction
of vault cash. These reserve requirements averaged $1,885 in 1998 and
$1,256 in 1997.
Community Bank maintains compensating balances with the FRB and various
other correspondent banks, most of which are not required, to offset
specific charges for check clearing and other services. Balances maintained
for this purpose were $8,224 and $4,337 at December 31, 1998 and 1997,
respectively. Compensating balances with correspondent banks averaged
$5,150 in 1998 and $4,407 in 1997.
3. INVESTMENT SECURITIES:
For years ended December 31, 1998 and 1997, the Company classified all
investment securities as available-for-sale. The amortized cost and fair
value of available-for-sale securities at December 31, 1998 and 1997, are
summarized as follows:
<TABLE>
<CAPTION>
AMORTIZED UNREALIZED UNREALIZED FAIR
DECEMBER 31, 1998 COST GAINS LOSSES VALUE
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
U.S. Treasury securities.................... $ 11,017 $ 43 $ 11,060
U.S. Government agencies.................... 649 $ 12 637
State and municipals........................ 37,992 2,015 40,007
Mortgage-backed securities.................. 56,051 53 270 55,834
Equity securities........................... 1,804 284 2,088
-------- ------ ---- --------
Total..................................... $107,513 $2,395 $282 $109,626
======== ====== ==== ========
AMORTIZED UNREALIZED UNREALIZED FAIR
DECEMBER 31, 1997 COST GAINS LOSSES VALUE
- ---------------------------------------------------------------------------------------
U.S. Treasury securities.................... $ 28,534 $ 56 $ 7 $ 28,583
U.S. Government agencies.................... 10,448 60 10,388
State and municipals........................ 38,329 1,558 39,887
Mortgage-backed securities.................. 23,748 51 53 23,746
Equity securities........................... 2,182 880 3,062
-------- ------ ---- --------
Total..................................... $103,241 $2,545 $120 $105,666
======== ====== ==== ========
</TABLE>
Proceeds from the sales of available-for-sale securities amounted to $1,659
in 1998 and $1,472 in 1996. There were no sales of available-for-sale
securities during 1997. The Company realized gross gains from securities
sales of $1,128 in 1998 and $8 in 1996. There were no gross losses on
security sales realized in 1998. Gross losses on security sales were $66 in
1996. Income tax expense amounted to $383 related to net realized
investment security gains in 1998. Income tax benefits amounted to $20
related to net realized investment securities losses of $58 in 1996. The
net unrealized holding gains, included as a separate component of
stockholders' equity, amounted to $1,394, net of income taxes of $719, at
December 31, 1998, and $1,600, net of income taxes of $825, at December 31,
1997.
At its November 14, 1996, meeting, the FASB's Emerging Issues Task Force
("EITF") reached a consensus on Issue No. 96-12, "Recognition of Interest
Income and Balance Sheet Classification of Structured Notes," requiring
investors to use the retrospective interest method for recognizing income
on structured notes that are classified as held-to-maturity or available-
for-sale securities and that meet one or more of three specified
conditions. These conditions relate to the risk of the contractual
principal amount or the original investment amount of the note, the
variability of the note's return on investment and the basis of the note's
3. INVESTMENT SECURITIES (CONTINUED):
contractual maturity. EITF No. 96-12 provides guidance for purposes of
determining the effective yield at which income will be recognized under
the retrospective interest method for qualifying structured notes.
Furthermore, the EITF requires an enterprise to determine whether a
structured note has experienced a decline in value below amortized cost
that is other than temporary requiring a write-down of amortized cost, with
the amount of the write-down included in earnings.
The carrying value of structured notes totaled $2.0 million at December 31,
1997. Specifically, these securities included a dual-index floater and
delevered floater, each having a carrying value of approximately $1.0
million. The delevered floater was not within the scope of EITF Issue No.
96-12 as its coupon rate moved in the same direction as market-based
interest rates. However, the coupon rate on the dual-index floater was
determined by the spread between two different indices that did not
necessarily move in the general direction of a specific interest rate or
index causing this instrument to be within the scope of EITF Issue No.
96-12. Management considered the guidance in accounting for the interest
income of this security and determined it was not significantly different
than the method used. The Company did not have any holdings of structured
notes at December 31, 1998, as all structured notes matured during 1998.
Investment securities with an amortized cost of $28,895 at December 31,
1998, and $25,971 at December 31, 1997, were pledged to secure deposits, to
qualify for fiduciary powers and for other purposes required or permitted
by law. The fair value of such securities was $28,836 at December 31,
1998, and $25,979 at December 31, 1997.
3. INVESTMENT SECURITIES (CONTINUED):
The maturity distribution of the amortized cost, fair value and weighted-
average tax-equivalent yield of the available-for-sale portfolio at
December 31, 1998, is 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 mortgage-backed securities, collateralized mortgage
obligations ("CMOs") and equity securities. Mortgage-backed securities and
CMOs 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 years maturity
distribution. Expected maturities may differ from contracted maturities or
estimated maturities for mortgage-backed securities and CMOs because
borrowers have the right to call or prepay obligations with or without call
or prepayment penalties.
<TABLE>
<CAPTION>
AFTER ONE AFTER FIVE
WITHIN BUT WITHIN BUT WITHIN AFTER
ONE YEAR FIVE YEARS TEN YEARS TEN YEARS TOTAL
-------------------------------------------------------------------------------
DECEMBER 31, 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.... $11,017 5.83% $ 11,017 5.83%
U.S. Government agencies.... $ 649 3.61% 649 3.61
State and municipals........ 1,990 6.12 5,569 6.78 $ 8,841 8.67% $21,592 8.17% 37,992 7.98
Mortgage-backed securities.. 19,344 6.45 35,333 6.27 1,374 6.23 56,051 6.33
Equity securities........... 1,804 6.44 1,804 6.44
------- ------- ------- ------- --------
Total..................... $32,351 6.22% $41,551 6.30% $10,215 8.34% $23,396 8.04% $107,513 6.85%
======= ======= ======= ======= ========
Fair value:
U.S. Treasury securities.... $11,060 $ 11,060
U.S. Government agencies.... $ 637 637
State and municipals........ 1,998 5,672 $ 9,391 $22,946 40,007
Mortgage-backed securities.. 19,293 35,177 1,364 55,834
Equity securities........... 2,088 2,088
------- ------- ------- ------- --------
Total..................... $32,351 $41,486 $10,755 $25,034 $109,626
======= ======= ======= ======= ========
</TABLE>
Except for U.S. Treasury securities and U.S. Government agencies, including
mortgage-backed securities, there were no securities of any individual
issuer that exceeded 10.0 percent of the Company's stockholders' equity at
December 31, 1998 and 1997. Except for $888 of tax-exempt obligations of
local municipalities, all of the investment securities in the Company's
portfolio are considered "investment grade," receiving a rating of "Baa" or
higher from Moody's or "BBB" or higher from Standard and Poor's rating
services at December 31, 1998.
4. LOANS, NONPERFORMING ASSETS AND ALLOWANCE FOR LOAN LOSSES (CONINTUED):
The major classifications of loans outstanding, net of unearned interest of
$2,132 and $2,180 and loan fees of $651 and $827 at December 31, 1998 and
1997, respectively, are summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31 1998 1997
- ---------------------------------------------------------------------------------------
<S> <C> <C>
Commercial, financial and others.................................. $ 31,044 $ 38,996
Real estate:
Construction.................................................... 2,108 2,096
Mortgage........................................................ 186,004 180,123
Consumer, net..................................................... 28,984 29,012
-------- --------
Total......................................................... $248,140 $250,227
======== ========
</TABLE>
Fixed-rate loans totaled $199,509 at December 31, 1998, while loans with
adjustable interest rates totaled $48,631. At December 31, 1997, fixed-
rate loans totaled $204,314 and adjustable-rate loans totaled $45,913.
The maturity distribution of the loan portfolio by major classification at
December 31, 1998, is summarized as follows:
<TABLE>
<CAPTION>
AFTER ONE
WITHIN BUT WITHIN AFTER
DECEMBER 31, 1998 ONE YEAR FIVE YEARS FIVE YEARS TOTAL
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Maturity schedule:
Commercial, financial and others..... $15,686 $ 8,943 $ 6,415 $ 31,044
Real estate:
Construction....................... 2,108 2,108
Mortgage........................... 23,510 54,090 108,404 186,004
Consumer, net........................ 9,629 15,099 4,256 28,984
------- ------- -------- --------
Total............................ $50,933 $78,132 $119,075 $248,140
======= ======= ======== ========
</TABLE>
Loans outstanding to directors, executive officers, principal stockholders
or to their affiliates totaled $3,696 at December 31, 1998, and $3,618 at
December 31, 1997. Advances and repayments during 1998 totaled $2,206 and
$2,128, respectively. These loans are made during the ordinary course of
business at the Company's normal credit terms. There were no related party
loans that were classified as nonaccrual, past due, restructured or
considered a potential credit risk at December 31, 1998 and 1997.
At December 31, 1998, substantially all of the Company's loans consisted of
loans that are at least partially secured by real estate in Lackawanna,
Susquehanna, Wayne and Wyoming counties of Northeastern Pennsylvania.
Therefore, the Company's primary concentration of credit risk is related to
the real estate market in the Northeastern Pennsylvania area. Changes in
4. LOANS, NONPERFORMING ASSETS AND ALLOWANCE FOR LOAN LOSSES (CONTINUED):
the general economy, local economy or in the real estate market could
affect the ultimate collectibility of this portion of the Company's loan
portfolio. Management does not believe there are any other significant
concentrations of credit risk that could affect the loan portfolio.
During 1997, the Company sold student loans with a carrying value of $3,405
to its servicing agent. The Company recognized a gain of $34 on the sale.
The analysis of changes affecting the allowance for loan losses account for
the three-years ended December 31, 1998, 1997 and 1996, is summarized as
follows:
<TABLE>
<CAPTION>
1998 1997 1996
- --------------------------------------------------------------------------------------
<S> <C> <C> <C>
Balance, January 1............................................. $3,798 $3,944 $3,903
Provision for loan losses...................................... 855 360 300
Loans charged-off.............................................. (789) (657) (726)
Loans recovered................................................ 186 151 467
------ ------ ------
Balance, December 31........................................... $4,050 $3,798 $3,944
====== ====== ======
</TABLE>
Information concerning nonperforming assets at December 31, 1998 and 1997,
is summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31 1998 1997
- ---------------------------------------------------------------------------------------
<S> <C> <C>
Nonaccrual loans:
Commercial, financial and others.................................... $ 78 $ 197
Real estate:
Construction......................................................
Mortgage.......................................................... 2,223 2,063
Consumer, net....................................................... 7 12
------ ------
Total nonaccrual loans.......................................... 2,308 2,272
------ ------
Restructured loans.................................................. 174 189
------ ------
Total impaired loans............................................ 2,482 2,461
------ ------
Accruing loans past due 90 days or more:
Commercial, financial and others.................................... 131 321
Real estate:
Construction......................................................
Mortgage.......................................................... 1,035 2,536
Consumer, net....................................................... 387 312
------ ------
Total accruing loans past due 90 days or more................... 1,553 3,169
------ ------
Total nonperforming loans....................................... 4,035 5,630
------ ------
Foreclosed assets................................................... 240 405
------ ------
Total nonperforming assets...................................... $4,275 $6,035
====== ======
</TABLE>
4. LOANS, NONPERFORMING ASSETS AND ALLOWANCE FOR LOAN LOSSES (CONTINUED):
Information relating to the Company's recorded investment in impaired loans
at December 31, 1998 and 1997, is summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31 1998 1997
- ---------------------------------------------------------------------------------------
<S> <C> <C>
Impaired loans:
With a related allowance............................................ $2,308 $2,272
With no related allowance........................................... 174 189
------ ------
Total............................................................. $2,482 $2,461
====== ======
</TABLE>
The analysis of changes affecting the allowance for loan losses related to
impaired loans at December 31, 1998, 1997 and 1996, is summarized as
follows:
<TABLE>
<CAPTION>
1998 1997 1996
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C>
Balance, January 1................................................ $541 $650 $614
Provision for loan losses......................................... 342 4 3
Loans charged-off................................................. (286) (113) (92)
Loans recovered................................................... 45 125
---- ---- ----
Balance, December 31.............................................. $642 $541 $650
==== ==== ====
</TABLE>
Interest income on impaired loans that would have been recognized had the
loans been current and the terms of the loans 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-years ended December 31, 1998, is summarized as
follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31 1998 1997 1996
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C>
Gross interest due under terms.................................. $ 175 $ 174 $ 143
Interest income recognized...................................... 98 84 30
------ ------ ------
Interest income not recognized.................................. $ 77 $ 90 $ 113
====== ====== ======
Interest income recognized (cash-basis)......................... $ 98 $ 84 $ 30
Average recorded investment in impaired loans................... $1,867 $2,368 $1,528
</TABLE>
Cash received on impaired loans applied as a reduction of principal totaled
$650 in 1998, $587 in 1997 and $398 in 1996. There were no commitments to
extend additional funds to customers with impaired loans at December 31,
1998 and 1997.
5. COMMITMENTS, CONCENTRATIONS AND CONTINGENT LIABILITIES:
In the normal course of business, the Company is a party to financial
instruments with off-balance sheet risk to meet the financing needs of its
customers. These instruments involve, to varying degrees, elements of
credit and interest rate risk in excess of the amount recognized in the
financial statements. Management does not anticipate that losses, if any,
that may occur as a result of funding off-balance sheet commitments, would
have a material adverse effect on the Company's results of operations or
financial position.
The contractual amounts of off-balance sheet commitments at December 31,
1998 and 1997, are summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31 1998 1997
- ---------------------------------------------------------------------------------------
<S> <C> <C>
Commitments to extend credit.......................................... $15,288 $15,881
Unused portions of home equity and credit card lines.................. 1,999 1,366
Commercial letters of credit.......................................... 808 596
------- -------
Total............................................................... $18,095 $17,843
======= =======
</TABLE>
The Company's involvement in, and exposure to, credit loss in the event of
nonperformance by the other party to the financial instrument for
commitments to extend credit, unused portions of home equity and credit
card lines and commercial letters of credit is represented by the
contractual amounts of those instruments. Commitments to extend credit are
agreements to lend to a customer as long as there is no violation of any
condition established in the contract. Commitments generally have fixed
expiration dates or other termination clauses and may require payment of a
fee. Commercial letters of credit are conditional commitments issued by
the Company to support customers in the purchase of commercial goods.
These letters of credit are automatically renewable upon their anniversary
date unless canceled prior to such date at the option of the Company.
The Company employs the same credit policies and requirements in making
off-balance sheet credit commitments as it does for on-balance sheet
instruments. Provision for losses, if any, is included in the Company's
allowance for loan losses. No provision was deemed necessary at December
31, 1998 and 1997. Such commitments are generally issued for one year or
less and often expire unused in whole or in part by the customer.
The Company provides deposit and loan products and other financial services
to consumer and corporate customers in its four-county market area of
Lackawanna, Susquehanna, Wayne and Wyoming. There are no significant
concentrations of credit risk from any individual counterparty or groups of
5. COMMITMENTS, CONCENTRATIONS AND CONTINGENT LIABILITIES (CONTINUED):
counterparties, except for locational concentrations. The concentrations
of the credit portfolio by loan type are set forth in Note 4. The Company
requires collateral on all real estate exposure and most other loans,
including off-balance sheet commitments upon extension of credit, and
maintains loan-to-value ratios of no greater than 80.0 percent, except in
the case of loans secured by deposits or U.S. Government securities. The
amount of collateral obtained is based on management's credit evaluation of
the customer. Collateral varies but may include property, plant and
equipment, primary residential properties, and to a lesser extent, income-
producing properties. Although the credit portfolio is diversified, the
Company and its borrowers are dependent on the continued viability of the
Northeastern Pennsylvania economy. The loan portfolio does not include any
form of credit involving highly-leveraged transactions, defined as
financing transactions that involve the buyout, acquisition or
recapitalization of an existing business, including credit extended to
highly-leveraged industries.
Securities and short-term investment activities are conducted with a
diverse group of government entities, corporations and depository
institutions. The Company evaluates the counterparty's creditworthiness
and type of collateral on a case-by-case basis. At December 31, 1998 and
1997, there were no significant concentrations of credit risk from any one
issuer with the exception of U.S. Treasury securities and U.S. Government
agencies, including mortgage-backed securities.
Neither the Company or any of its property is subject to any material legal
proceedings. Management, after consultation with legal counsel, does not
anticipate that the ultimate liability, if any, arising out of pending and
threatened lawsuits will have a material effect on the Company's results of
operations or financial position.
6. PREMISES AND EQUIPMENT, NET:
Premises and equipment at December 31, 1998 and 1997, are summarized as
follows:
<TABLE>
<CAPTION>
DECEMBER 31 1998 1997
- ---------------------------------------------------------------------------------------
<S> <C> <C>
Land................................................................... $ 1,575 $ 288
Premises............................................................... 7,660 5,197
Leasehold improvements................................................. 232 221
Furniture and equipment................................................ 3,831 3,846
------- ------
Total premises and equipment......................................... 13,298 9,552
Less: accumulated depreciation......................................... 6,282 5,780
------- ------
Premises and equipment, net.......................................... $ 7,016 $3,772
======= ======
</TABLE>
6. PREMISES AND EQUIPMENT, NET (CONTINUED):
Amounts charged to noninterest expense for depreciation amounted to $609 in
1998, $571 in 1997 and $496 in 1996. Occupancy expense has been reduced by
rental income from premises leased to others in the amount of $65 in 1998,
$64 in 1997 and $61 in 1996.
Certain facilities are leased under operating lease agreements expiring at
various dates until the year 2009. Two leases contain escalation clauses
that provide for cost of living adjustments, and several contain renewal
options. The realty leases require the Company to pay real estate taxes,
insurances and repair costs. Rental expense on operating leases amounted
to $153 in 1998, $164 in 1997 and $281 in 1996.
Future minimum required annual rentals under noncancellable leases are
summarized as follows:
<TABLE>
<S> <C>
1999.................................................................... $103
2000.................................................................... 103
2001.................................................................... 99
2002.................................................................... 87
2003.................................................................... 88
2004 and thereafter..................................................... 311
----
Total................................................................. $791
====
</TABLE>
On January 2, 1998, Community Bank acquired land in Clarks Summit,
Pennsylvania, for $1.2 million to construct an administrative center and
branch facility. This project, having an estimated aggregate cost of $4.0
million, should be completed during the first quarter of 1999.
On October 30, 1998, Community Bank also acquired land in Dickson City,
Pennsylvania, for $625 to construct a branch facility. This project has an
estimated aggregate cost of $1.4 million and should be completed during the
second quarter of 1999. Both the Clarks Summit and Dickson City projects
will be funded through normal operations with approximately $2.8 million of
costs remaining to be incurred at December 31, 1998.
As part of its Year 2000 ("Y2K") readiness, the Company evaluated and
tested all computer hardware and software to determine Y2K compliance.
Based on this evaluation, noncompliant assets having a net book value of
$87 were disposed. This loss on disposition was included in noninterest
expense in 1998.
7. OTHER ASSETS:
The major components of other assets at December 31, 1998 and 1997, are
summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31 1998 1997
- ---------------------------------------------------------------------------------------
<S> <C> <C>
Goodwill................................................................ $1,004 $1,222
Core deposit intangible................................................. 1,890 2,160
Deferred income taxes................................................... 681 480
Foreclosed assets....................................................... 240 405
Mortgage servicing rights............................................... 21
Other................................................................... 1,719 1,837
------ ------
Total................................................................. $5,555 $6,104
====== ======
</TABLE>
On November 14, 1997, the Company acquired certain assets and assumed the
deposit liabilities of the Eynon and Factoryville branches of First Union
in a transaction accounted for by the purchase method. The Company assumed
the deposit liabilities in exchange for the receipt of a lesser amount of
cash, other assets and loans. The transaction was recorded based on the
fair values of the assets acquired and liabilities assumed. The Company
assumed liabilities of $19.2 million and acquired land, building, equipment
and certain loans having an aggregate value of $730 and cash of $16.3
million. The amount by which the acquisition cost exceeded the value of
assets received totaled $2.2 million and is included in other assets as a
core deposit intangible.
Amortization expense of goodwill amounted to $218 per year for 1998, 1997
and 1996. Amortization expense of the core deposit intangible amounted to
$270 in 1998 and $18 in 1997.
During 1998, the Company began originating one-to-four family residential
mortgage loans for sale on the secondary market with servicing rights
retained. Mortgage loans serviced for others are not included in the
accompanying Consolidated Balance Sheets. The unpaid principal balances of
mortgage loans serviced for others was $2,127 at December 31, 1998.
Custodial escrow balances maintained in connection with the loan servicing
and included in demand deposits, was approximately $3 at December 31, 1998.
The analysis of the changes in the balances of mortgage servicing assets
for the year-ended December 31, 1998, are summarized as follows:
<TABLE>
<CAPTION>
1998
- ---------------------------------------------------------------------------------------
<S> <C>
Balance, January 1................................................................. $ 0
Additions.......................................................................... 21
Amortization.......................................................................
---
Balance, December 31............................................................... $21
===
</TABLE>
7. OTHER ASSETS (CONTINUED):
At December 31, 1998, the fair value of the mortgage servicing assets
approximated their carrying value, therefore, no valuation allowance was
deemed necessary.
8. DEPOSITS:
The major components of interest-bearing and noninterest-bearing deposits
at December 31, 1998 and 1997, are summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31 1998 1997
- ---------------------------------------------------------------------------------------
<S> <C> <C>
Interest-bearing deposits:
Money market accounts............................................ $ 17,869 $ 18,056
NOW accounts..................................................... 22,261 21,465
Savings accounts................................................. 62,969 64,998
Time deposits less than $100..................................... 178,042 176,327
Time deposits $100 or more....................................... 27,088 20,832
-------- --------
Total interest-bearing deposits................................ 308,229 301,678
Noninterest-bearing deposits....................................... 36,024 30,703
-------- --------
Total deposits................................................. $344,253 $332,381
======== ========
</TABLE>
The Company accepts deposits of its directors, executive officers,
principal stockholders or their affiliates on the same terms and at the
prevailing interest rates offered at the time of deposit for comparable
transactions with unrelated parties. The amount of related party deposits
totaled $2,741 at December 31, 1998, and $1,969 at December 31, 1997.
The maturity distribution of time deposits $100 or more at December 31,
1998 and 1997, is summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31 1998 1997
- ---------------------------------------------------------------------------------------
<S> <C> <C>
Within three months................................................... $ 7,956 $ 3,195
After three months but within six months.............................. 4,939 2,819
After six months but within twelve months............................. 8,802 6,334
After twelve months................................................... 5,391 8,484
------- -------
Total............................................................... $27,088 $20,832
======= =======
</TABLE>
Interest expense on time deposits $100 or more amounted to $1,409 in 1998,
$1,796 in 1997 and $1,647 in 1996.
8. DEPOSITS (CONTINUED):
The aggregate amounts of maturities for all time deposits at December 31,
1998, are summarized as follows:
<TABLE>
<S> <C>
1999.......................................................................... $128,645
2000.......................................................................... 33,924
2001.......................................................................... 10,060
2002.......................................................................... 21,843
2003.......................................................................... 10,398
2004 and thereafter........................................................... 260
--------
Total....................................................................... $205,130
========
</TABLE>
The aggregate amount of deposits reclassified as loans was $231 at December
31, 1998, and $89 at December 31, 1997. Management evaluates transaction
accounts that are overdrawn for collectibility as part of its evaluation
for credit losses. At December 31, 1998 and 1997, no allowance was deemed
necessary for such accounts. During 1998 and 1997, the Company had no
deposits that were received on terms other than those available in the
normal course of business.
9. SHORT-TERM BORROWINGS:
Short-term borrowings available to the Company consist of a line of credit
and advances with the FHLB-Pgh secured under terms of a blanket collateral
agreement by a pledge of FHLB-Pgh stock and certain other qualifying
collateral, such as investment and mortgage-backed securities and mortgage
loans. The line is limited to the Company's maximum borrowing capacity
("MBC") with the FHLB-Pgh, which is based on a percentage of qualifying
collateral assets. At December 31, 1998, the Company's MBC was $141.8
million. Interest accrues daily on the line based on the rate of FHLB-Pgh
discount notes. This rate resets each day. The line is renewable annually
on its anniversary date and carries no associated commitment fees. The
FHLB-Pgh has the right to reduce or terminate the line at any time without
prior notice and the Company may repay such line at any time without
incurring prepayment penalties. Short-term advances are issued with
maturities less than one year based on the FHLB-Pgh's current cost of funds
rate. Advances are limited to the Company's MBC and are not prepayable.
There are no commitment fees associated with the advances, except for those
for forward settlement that are based on FHLB-Pgh hedging costs.
At December 31, 1998, the Company had no short-term borrowings outstanding.
There was $9,575 of short-term borrowings outstanding at December 31, 1997,
under the line of credit agreement. The average daily balance and weighted-
9. SHORT-TERM BORROWINGS (CONTINUED):
average rate on aggregate short-term borrowings was $185 at 6.0 percent in
1998 and $138 at 5.8 percent in 1997. The maximum amount of all short-term
borrowings outstanding at any month-end was $695 during 1998 and $9,575
during 1997. Short-term borrowings during 1998 and 1997 consisted entirely
of the FHLB-Pgh line of credit.
10. LONG-TERM DEBT:
Long-term debt at December 31, 1998 and 1997, consisted entirely of a 7.5
percent fixed-rate, amortizing advance from the FHLB-Pgh Community
Investment Program. This advance matures on September 2, 2009. The
scheduled principal payments on the note total $3 for each of the five
years 1999 through 2003. The prepayment fee applicable to the advance is
equal to the present value of the difference between cash flows generated
at the advance rate from the date of the prepayment until the original
maturity date, and the cash flows that would result from the interest rate
posted by the FHLB-Pgh on the date of prepayment for an advance of
comparable maturity. The note is secured under terms of a blanket
collateral agreement by a pledge of qualifying investment and mortgage-
backed securities, certain mortgage loans and a lien on FHLB-Pgh stock. The
average daily balance on long-term debt for 1998 was $43 with a weighted-
average rate of 7.0 percent. For 1997, the average daily balance on long-
term debt was $45 with a weighted-average rate of 8.9 percent.
11. FAIR VALUE OF FINANCIAL INSTRUMENTS:
The estimated fair value of the Company's financial instruments at December
31, 1998 and 1997, are summarized as follows:
<TABLE>
<CAPTION>
1998 1997
------------------- -------------------
CARRYING FAIR CARRYING FAIR
DECEMBER 31 VALUE VALUE VALUE VALUE
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Financial assets:
Cash and cash equivalents.................... $ 19,164 $ 19,164 $ 17,265 $ 17,265
Investment securities........................ 109,626 109,626 105,666 105,666
Loans held for sale, net..................... 503 506
Net loans.................................... 244,090 244,075 246,429 243,905
Accrued interest receivable.................. 2,297 2,297 2,575 2,575
-------- -------- -------- --------
Total...................................... $375,680 $375,668 $371,935 $369,411
======== ======== ======== ========
Financial liabilities:
Deposits without stated maturities........... $139,123 $139,123 $135,222 $135,222
Deposits with stated maturities.............. 205,130 207,153 197,159 197,868
Short-term borrowings........................ 9,575 9,575
Long-term debt............................... 41 41 44 44
Accrued interest payable..................... 1,740 1,740 1,714 1,714
-------- -------- -------- --------
Total...................................... $346,034 $348,057 $343,714 $344,423
======== ======== ======== ========
</TABLE>
12. LITIGATION RECOVERY:
During the second quarter of 1997, Community Bank reached a settlement with
an investment securities broker. The $250 settlement was awarded with
respect to Community Bank's business relationship with this broker prior to
1995. This one-time addition to noninterest income had a $148.5 positive
impact on earnings after applicable income taxes and legal fees.
13. EMPLOYEE BENEFIT PLANS:
The Company has a defined contribution plan covering all employees who meet
the age and service requirements. Salaries and employee benefits expense
included $64 in 1998, $68 in 1997 and $67 in 1996 for the plan.
As previously mentioned in Note 1 of these financial statements, the
Company discontinued its deferred compensation plan for certain senior
management employees in 1996. Expenses for this plan amounted to $16 in
1996. Funding for the plan was provided by life insurance contracts.
14. INCOME TAXES:
For the years ended December 31, 1998, 1997 and 1996, the current and
deferred amounts of the provision for income tax expense (benefit) are
summarized as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31 1998 1997 1996
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C>
Current........................................................ $1,313 $1,093 $1,079
Deferred....................................................... (95) 41 (66)
------ ------ ------
Total........................................................ $1,218 $1,134 $1,013
====== ====== ======
</TABLE>
A reconciliation between the effective income tax expense (benefit) and the
amount of income taxes (benefit) that would have been provided at the
federal statutory tax rate of 34.0 percent for the years ended December 31,
1998, 1997 and 1996, is summarized as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31 1998 1997 1996
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C>
Federal income tax at statutory rate........................... $1,944 $1,882 $1,773
Differences resulting from:
Tax-exempt interest, net..................................... (709) (733) (668)
Goodwill..................................................... 74 74 74
Residential housing program tax credit....................... (80) (80) (160)
Other........................................................ (11) (9) (6)
------ ------ ------
Total...................................................... $1,218 $1,134 $1,013
====== ====== ======
</TABLE>
For the years ended December 31, 1998, 1997 and 1996, sources of change in
deferred income taxes and the related tax effects are summarized as
follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31 1998 1997 1996
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C>
Allowance for loan losses....................................... $ (86) $ 49 $ (14)
Loans, net of unearned income................................... 60 33 (43)
Accrued interest receivable..................................... 27 (17) (26)
Premises and equipment, net..................................... (54) (26) (28)
Core deposit intangible......................................... (42) 2
Other, net...................................................... 45
----- ---- -----
Change in deferred income taxes affecting the statements of
income....................................................... (95) 41 (66)
Deferred income taxes on investment securities recognized in
stockholders' equity........................................... (106) 534 (111)
----- ---- -----
Total change in deferred income taxes....................... $(201) $575 $(177)
===== ==== =====
</TABLE>
14. INCOME TAXES (CONTINUED):
The temporary differences that give rise to the significant portions of
deferred tax assets and liabilities at December 31, 1998 and 1997, are
summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31 1998 1997
- ---------------------------------------------------------------------------------------
<S> <C> <C>
Deferred tax assets:
Allowance for loan losses............................................ $1,210 $1,124
Loans, net of unearned income........................................ 221 281
Accrued interest receivable.......................................... 151 178
Core deposit intangible.............................................. 44 2
------ ------
Total.............................................................. 1,626 1,585
------ ------
Deferred tax liabilities:
Investment securities................................................ 718 824
Premises and equipment, net.......................................... 227 281
------ ------
Total.............................................................. 945 1,105
------ ------
Net deferred tax assets............................................ $ 681 $ 480
====== ======
</TABLE>
The Company has determined that it is not required to establish a valuation
reserve for the deferred tax assets since it is more likely than not that
the net deferred tax 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 reviews the tax criteria related to the
recognition of deferred tax assets on a quarterly basis. Banks in
Pennsylvania are not subject to state or local income taxes, however they
pay a tax on capital. Such tax is included in other expenses.
Income tax expense (benefit) related to unrealized gains and losses and the
reclassification adjustments included in other comprehensive income for the
three years ended December 31, 1998, 1997 and 1996, were calculated using
the prevailing statutory tax rate of 34.0 percent and are summarized as
follows:
<TABLE>
<CAPTION>
DECEMBER 31 1998 1997 1996
- ------------------------------------------------------------------------------------------------
<S> <C> <C>
Unrealized gains (losses) on investment securities available-for-sale... $ 277 $534 $(131)
Reclassification adjustment for (gains) losses included in net income... (383) 20
----- ---- -----
Income tax expense (benefit) related to other comprehensive income.... $(106) $534 $(111)
===== ==== =====
</TABLE>
15. PARENT COMPANY FINANCIAL STATEMENTS:
<TABLE>
<CAPTION>
CONDENSED STATEMENTS OF INCOME
YEAR ENDED DECEMBER 31 1998 1997 1996
- ----------------------------------------------------------------------------------------
<S> <C> <C> <C>
Income:
Dividends from subsidiary...................................... $ 752 $ 602 $ 753
Management fees from subsidiary................................ 340 249 176
Other income................................................... 44 81 69
------ ------ ------
Total income................................................. 1,136 932 998
------ ------ ------
Expense:
Occupancy and equipment expenses............................... 91 91 96
Other expenses................................................. 592 509 469
------ ------ ------
Total expenses............................................... 683 600 565
------ ------ ------
Income before income taxes and undistributed income of
subsidiary.................................................... 453 332 433
Income tax benefits............................................ (118) (106) (200)
------ ------ ------
Income before undistributed income of subsidiary............... 571 438 633
Equity in undistributed income of subsidiary................... 3,929 3,962 3,567
------ ------ ------
Net income................................................... $4,500 $4,400 $4,200
====== ====== ======
CONDENSED BALANCE SHEETS
DECEMBER 31 1998 1997
- ----------------------------------------------------------------------------------------
<S> <C> <C>
Assets:
Cash................................................................... $ 279 $ 445
Investment in bank subsidiary.......................................... 38,368 33,941
Investment securities available-for-sale............................... 389 1,483
Other assets........................................................... 1,590 1,265
------- -------
Total assets......................................................... $40,626 $37,134
======= =======
Liabilities:
Dividends payable...................................................... $ 287 $ 264
Other liabilities...................................................... 605 768
------- -------
Total liabilities.................................................... 892 1,032
Stockholders' equity................................................... 39,734 36,102
------- -------
Total liabilities and stockholders' equity........................... $40,626 $37,134
======= =======
</TABLE>
15. PARENT COMPANY FINANCIAL STATEMENTS (CONTINUED):
<TABLE>
<CAPTION>
CONDENSED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31 1998 1997 1996
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income................................................... $ 4,500 $ 4,400 $ 4,200
Adjustments:
Equity in undistributed income of subsidiary............... (3,929) (3,962) (3,567)
Depreciation and amortization.............................. 294 294 294
Gains on sale of investment securities..................... (8)
Changes in:
Other assets............................................. (401) 108 (158)
Other liabilities........................................ 39 (58) 208
------- ------- -------
Net cash provided by operating activities.............. 503 782 969
------- ------- -------
Cash flows from investing activities:
Proceeds from sales of investment securities................. 25
Purchases of investment securities........................... (30) (22) (73)
------- ------- -------
Net cash used in investing activities.................. (30) (22) (48)
------- ------- -------
Cash flows from financing activities:
Issuance of common stock..................................... 154 69
Cash dividends paid.......................................... (793) (637) (675)
------- ------- -------
Net cash used in financing activities.................. (639) (568) (675)
------- ------- -------
Net increase (decrease) in cash........................ (166) 192 246
Cash at beginning of year.............................. 445 253 7
------- ------- -------
Cash at end of year.................................... $ 279 $ 445 $ 253
======= ======= =======
</TABLE>
16. REGULATORY MATTERS:
Under the Pennsylvania Business Corporation Law of 1988, as amended, the
Company may not pay a dividend if, after giving effect thereto, either the
Company could not pay its debts as they become due in the usual course of
business, or the Company's total assets would be less than its total
liabilities. The determination of total assets and liabilities may be
based upon: financial statements prepared on the basis of GAAP; financial
statements that are prepared on the basis of other accounting practices and
principles that are reasonable under the circumstances; or a fair valuation
or other method that is reasonable under the circumstances.
In addition, the Company is subject to dividend restrictions under the
Pennsylvania Banking Code of 1965, as amended, which allows cash dividends
to be declared and paid out of accumulated net earnings. More stringent
dividend restrictions apply under Federal Reserve Regulation H, which
16. REGULATORY MATTERS (CONTINUED):
restricts calendar year dividend payments of member banks to the total of
its net profits for that year combined with its retained net profits of the
preceding two calendar years, less any required transfer to surplus, unless
a bank has received prior approval from the Board of Governors of the
Federal Reserve System ("Federal Reserve Board.") Accordingly, Community
Bank, without prior approval from the Federal Reserve Board, may declare
dividends to the Parent Company in 1999 totaling $7,891 plus net profits
earned for the period from January 1, 1999, through the date of
declaration, less any dividends previously paid in 1999.
The Company has paid cash dividends since its formation as a bank holding
company in 1983. It is the present intention of the Company's Board of
Directors to continue this dividend payment policy, however, further
dividends must necessarily depend upon earnings, financial condition,
appropriate legal restrictions and other factors relevant at the time the
Company's Board of Directors considers payment of dividends.
The amount of funds available for transfer from Community Bank to the
Parent Company in the form of loans and other extensions of credit is also
limited. Under the provisions of Section 23A of the Federal Reserve Act,
transfers to any one affiliate are limited to 10.0 percent of capital and
surplus. At December 31, 1998, the maximum amount available for transfer
from Community Bank to the Parent Company in the form of loans amounted to
$11,912. At December 31, 1998 and 1997, there were no loans outstanding,
nor were any advances made during 1998 and 1997.
The Company must maintain certain capital to total risk-weighted asset
ratios as defined by Section 38 of the Federal Deposit Insurance
Corporation Improvement Act of 1991 ("FDICIA"). In the event an
institution is deemed to be undercapitalized by such standards, FDICIA
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 the significantly or critically undercapitalized institutions
including restrictions on interest payable on accounts, dismissal of
management and appointment of a receiver. For well capitalized
institutions, FDICIA 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. The Company
received a final regulatory examination report from the FRB on January 25,
1999. This report included notification that the Company was considered
well capitalized under the regulatory framework for prompt corrective
action. To be categorized as well capitalized, the Company must maintain
minimum Tier I, total and Tier I Leverage ratios as set forth in the
16. REGULATORY MATTERS (CONTINUED):
table. The Tier I Leverage ratio is defined as Tier I capital to total
average assets less intangible assets. There are no conditions or events
since that notification that management believes have changed the Company's
category.
The Company's capital ratios at December 31, 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
FDICIA, are summarized as follows:
<TABLE>
<CAPTION>
MINIMUM TO BE WELL
CAPITALIZED UNDER
MINIMUM FOR CAPITAL PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
----------------------------------------------------------
DECEMBER 31, 1998 AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Tier I capital to risk-adjusted assets............ $ 35,444 17.7% $ 8,017 4.0% $12,025 6.0%
Total capital to risk-adjusted assets............. 37,968 18.9 16,033 8.0 20,042 10.0
Tier I capital to total average assets
less intangible assets........................... $ 35,444 9.5% $14,981 4.0% $18,726 5.0%
Risk-adjusted assets.............................. $191,611
Risk-adjusted off-balance sheet items............. 8,806
Average assets for Leverage ratio................. $374,526
MINIMUM TO BE WELL
CAPITALIZED UNDER
MINIMUM FOR CAPITAL PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
---------------------------------------------------------
DECEMBER 31, 1997 AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Tier I capital to risk-adjusted assets............ $ 31,120 15.9% $ 7,806 4.0% $11,709 6.0%
Total capital to risk-adjusted assets............. 33,576 17.2 15,612 8.0 19,515 10.0
Tier I capital to total average assets
less intangible assets........................... $ 31,120 8.7% $14,239 4.0% $17,798 5.0%
Risk-adjusted assets.............................. $186,410
Risk-adjusted off-balance sheet items............. 8,743
Average assets for Leverage ratio................. $355,968
</TABLE>
On April 2, 1997, the Company filed a registration statement with the
Securities and Exchange Commission to register 300,000 shares of common
stock in establishing a Dividend Reinvestment Plan ("DRP"). The purpose of
the DRP is to provide stockholders with a simple and convenient method to
invest cash dividends in the Company's common stock without payment of any
brokerage commissions while also furnishing the Company with additional
funds for general corporate purposes. Main features of the DRP include the
following: (i) shares will be purchased from original issuances; (ii) no
optional cash payments; (iii) eligibility for all registered and street
name stockholders; (iv) no minimum or maximum number of shares
participation restrictions; and (v) availability of full or partial
dividend reinvestment. During the years ended December 31, 1998 and 1997,
4,617 shares and 2,325 shares, respectively, were issued under the DRP.
17. SUMMARY OF QUARTERLY FINANCIAL INFORMATION (UNAUDITED):
<TABLE>
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1998 1997
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QUARTER ENDED MARCH 31 JUNE 30 SEPT. 30 DEC. 31 MARCH 31 JUNE 30 SEPT. 30 DEC. 31
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INTEREST INCOME:
Interest and fees on loans:
Taxable............................ $5,094 $5,110 $5,183 $5,200 $4,795 $4,946 $5,005 $5,170
Tax-exempt......................... 98 101 100 98 109 132 123 109
Interest and dividends on investment
securities available-for-sale:
Taxable............................ 838 782 880 993 807 783 820 864
Tax-exempt......................... 517 514 506 502 525 513 507 511
Dividends.......................... 29 45 39 39 31 33 32 36
Interest on federal funds sold....... 82 202 184 88 35 113 101 42
------ ------ ------ ------ ------ ------ ------ ------
Total interest income............ 6,658 6,754 6,892 6,920 6,302 6,520 6,588 6,732
------ ------ ------ ------ ------ ------ ------ ------
INTEREST EXPENSE:
Interest on deposits................. 3,422 3,461 3,540 3,523 3,433 3,518 3,536 3,569
Interest on short-term borrowings.... 7 4 1 7
Interest on long-term debt........... 1 1 1 1 1 2
------ ------ ------ ------ ------ ------ ------ ------
Total interest expense........... 3,430 3,462 3,541 3,527 3,435 3,519 3,536 3,578
------ ------ ------ ------ ------ ------ ------ ------
Net interest income.............. 3,228 3,292 3,351 3,393 2,867 3,001 3,052 3,154
Provision for loan losses............ 105 105 105 540 75 75 105 105
------ ------ ------ ------ ------ ------ ------ ------
Net interest income after
provision for loan losses....... 3,123 3,187 3,246 2,853 2,792 2,926 2,947 3,049
------ ------ ------ ------ ------ ------ ------ ------
Noninterest income:
Service charges, fees and
commissions......................... 353 376 380 393 413 349 358 406
Litigation recovery.................. 250
Net gains on sale of loans........... 4 39
Net gains on sale of investments..... 235 893
------ ------ ------ ------ ------ ------ ------ ------
Total noninterest income ........ 353 376 619 1,325 413 599 358 406
------ ------ ------ ------ ------ ------ ------ ------
Noninterest expense:
Salaries and employee benefits
expense............................. 1,094 1,109 1,105 1,137 987 1,035 998 1,078
Net occupancy and equipment expense.. 352 305 303 333 300 300 288 311
Other expenses....................... 684 792 989 1,161 596 716 660 687
------ ------ ------ ------ ------ ------ ------ ------
Total noninterest expense........ 2,130 2,206 2,397 2,631 1,883 2,051 1,946 2,076
------ ------ ------ ------ ------ ------ ------ ------
Income before income taxes........... 1,346 1,357 1,468 1,547 1,322 1,474 1,359 1,379
Provision for income tax expense..... 276 277 318 347 264 312 279 279
------ ------ ------ ------ ------ ------ ------ ------
Net income ...................... 1,070 1,080 1,150 1,200 1,058 1,162 1,080 1,100
------ ------ ------ ------ ------ ------ ------ ------
Other comprehensive income:
Unrealized gains(losses) on
investment securities available-
for-sale............................ 314 314 742 (554) (718) 941 564 783
Reclassification adjustment for gains
included in net income.............. (235) (893)
Income tax expense (benefit) related
to other comprehensive income....... 106 107 173 (492) (244) 320 192 266
------ ------ ------ ------ ------ ------ ------ ------
Other comprehensive income (loss),
net of income tax............... 208 207 334 (955) (474) 621 372 517
------ ------ ------ ------ ------ ------ ------ ------
Comprehensive income............. $1,278 $1,287 $1,484 $ 245 $ 584 $1,783 $1,452 $1,617
====== ====== ====== ====== ====== ====== ====== ======
Per share data:
Net income........................... $ 0.49 $ 0.49 $ 0.52 $ 0.54 $ 0.48 $ 0.53 $ 0.49 $ 0.50
Cash dividends declared.............. $ 0.07 $ 0.07 $ 0.10 $ 0.13 $ 0.06 $ 0.06 $ 0.06 $ 0.12
</TABLE>
OPERATING ENVIRONMENT:
The United States economy turned in an exceptional performance for 1997.
The gross domestic product, the value of goods and services produced in
the United States, grew 3.9 percent for the year, the largest annual gain
since 1994. The national unemployment level, 4.7 percent at year-end,
was the lowest it has been in 25 years. The unemployment rate at the end
of the previous year was 5.3 percent. This marks the sixth consecutive
annual decline in unemployment rates. Tighter labor conditions came with
a price to businesses, as compensation rose 3.3 percent, the largest
change in four years. The average hourly wage earned by workers equaled
$12.43 by year-end 1997, a 43 cent increase over 1996. Despite the
tightening in labor markets and higher wages paid to employees, the
nation's Consumer Price Index was 1.7 percent in 1997, which contradicts
the increase normally expected under these conditions. The nation's
Producer Price Index ("PPI") was also held in check despite the empowered
economy. Wholesale prices actually contracted for the year as the PPI
fell by 1.2 percent. Strengthened productivity growth, flat prices
influenced by Asian economic turmoil and reduced commodity market
pressures helped to keep inflation and prices subdued in 1997.
The balance of strong economic conditions and uncertainties surrounding
the Asian crisis led the Federal Reserve Open Market Committee ("FOMC")
to take limited monetary policy action throughout 1997. In March of
1997, the FOMC made a controversial decision to raise its target rate for
federal funds to 5.50 percent, the first increase in two years. The
FOMC's decision was based on its inflationary concerns over the
significant economic growth experienced during the final quarter of 1996
and the first quarter of 1997. The economy grew 4.3 percent during the
fourth quarter of 1996 followed by a 4.9 percent increase during the
first quarter of 1997. As fears over potential inflation subsided, the
FOMC made no further moves in interest rates for the remainder of the
year.
Long- and intermediate-term interest rates tumbled nationally in 1997
while short-term rates remained relatively unchanged. The average rate
on a 30-year mortgage at the end of 1997 was 7.03 percent, down from 7.64
percent one year earlier. Average rates on 15-year, fixed-rate mortgages
fell to 6.61 percent by year-end 1997 compared to 7.16 percent for the
same period of 1996. With interest rates falling, disposable incomes
rising and consumer confidence soaring, home and business spending
heightened in 1997. For the year, mortgage loans in the United States
increased 8.5 percent over 1996, while commercial loans experienced a 9.5
percent rise over the previous year. Not all lending areas had a
positive change in 1997. Consumer loans lagged behind, declining 2.3
percent as compared to 1996.
Northeastern Pennsylvania's economic performance for 1997 lagged behind
that of the nation based on lower wage gains and higher unemployment.
The average hourly earnings of a United States manufacturing worker
increased 43 cents, or 3.6 percent, during 1997. For the Company's four-
county market area, the increase for a manufacturing worker was 24 cents,
or 2.0 percent. Unemployment figures in the Company's market area were
also less favorable than those experienced for the nation and the
Commonwealth of Pennsylvania.
As aforementioned, the United States unemployment rate declined from 5.3
percent at December 31, 1996, to 4.7 percent at December 31, 1997. The
Commonwealth's rate fell to a lesser extent from 4.9 percent at year-end
1996 to 4.8 percent at year-end 1997. Unemployment rates for Lackawanna,
Susquehanna, Wayne and Wyoming counties were 5.4 percent, 6.6 percent,
8.4 percent and 7.9 percent, respectively at December 31, 1996. At year-
end 1997, comparable rates were 5.4 percent, 6.3 percent, 8.1 percent and
8.2 percent, respectively.
Additionally, the civilian labor force, defined as the total number of
individuals employed and those actively seeking employment, increased by
1.6 percent for the nation and 1.2 percent for the Commonwealth during
1997. Such gains are a significant factor in increasing economic output
due to the limitations in resources based on the low unemployment
statistics. In contrast to the labor force gains for the nation and the
Commonwealth, Northeastern Pennsylvania reported its second consecutive
year of labor force decline, a 3.5 percent drop in civilian workers as
compared to 1996.
Legislative action was taken by Pennsylvania Governor Tom Ridge in his
efforts to make Pennsylvania "business friendly." Tax cuts for
businesses, workers' compensation reform and utility deregulations were
areas of reform in Pennsylvania during 1997. The most notable tax
reforms included: (i) the repeal of the computer services sales and use
tax; (ii) an increase in the exemption of the capital stock and franchise
tax to $125 from $100; (iii) research and development tax credits capped
at $15.0 million per year to aid high technology employers; (iv) allowing
more small businesses to qualify as Subchapter S corporations; and (v)
several state sales tax codifications and adjustments for certain
manufacturers. Due to reform laws signed in 1993 and 1996, workers'
compensation costs have fallen an average of 25.0 percent in
Pennsylvania. During the Fall of 1997, Pennsylvania instituted
deregulation in the electric industry. Under this reform, customers from
residential, commercial and industrial classes can choose from competing
electricity suppliers.
The banking industry experienced another highly successful year in 1997,
as did most industries. A good indicator of this success is the
performance of the nation's top 50 commercial banks. For 1997, this
group posted earnings of $40.5 billion, an 11.9 percent increase compared
to 1996. Growth in noninterest income to $74.7 billion for 1997 was the
main reason for the positive earnings change. The increase in
noninterest income was primarily attributed to investment securities
gains and revenue items taken by money-center banks to partially offset
weak trading results. Net interest income for these commercial banks was
$107.1 billion in 1996 and $106.8 billion in 1997. The decline was
attributable to compression in net interest margins. For 1997, the
composite net interest margin for these banks compressed 24 basis points.
Regional and community banks also exhibited a strong year in 1997. For
the year, median earnings per share ("EPS") for regional and community
banks grew 13.5 percent. While not as impressive as the 15.0 percent
growth for 1996, the gain is still solid in light of the downward trend
in net interest margins. This downward trend is primarily attributed to
competition for loan and deposit products coupled with a flattening yield
curve. During 1997, banks generated strong loan growth, increased fee
income and improved operating efficiencies to offset the negative effects
of the narrowing margins.
National, regional and community banks also experienced an improvement in
asset quality during 1997. The nation's top 50 banks had nonperforming
assets of $16.2 billion at year-end 1997, marking a 9.7 percent decline
compared to 1996. For regional and community banks, the improvement was
best evidenced by the decline in the median nonperforming assets to total
assets ratio from 0.72 percent in 1996 to 0.49 percent in 1997.
Mergers, acquisitions and branch dispositions may have provided the most
significant influence on the financial services sector in 1997. Mergers
and acquisitions of financial institutions occurred at a record pace.
The number of mergers and acquisitions announced in 1997 exceeded those
of 1996 while deal prices remained high. For the year, aggregate
announced deal values for banks amounted to $259.8 billion, the largest
dollar volume in history. The number of deals for Northeast commercial
banks mirrored 1996 but the volume of these deals increased
significantly. The aggregate number of mergers and acquisitions for Mid-
Atlantic commercial banks was 25 for 1997 and 1996, however the aggregate
dollar volume of these transactions amounted to $64.4 billion in 1997
compared to $12.8 billion in 1996. Deal prices across the nation
remained high based on the elevated market valuation of acquirors and the
scarcity of certain-sized targets. The national average price to book
value for bank mergers was 2.2 times or 20.8 times annual earnings for
1997. These ratios exceeded the 1.9 times book value and the 18.9 times
annual earnings for the 1996 deals. For the year, the Mid-Atlantic
region had the highest deal price earnings multiple at 23.0 times with
the New England region having the lowest at 13.6 times. While large
commercial bank mergers were occurring at record levels, community bank
mergers reached a six-year low in 1997. There were 256 mergers of banks
with assets under $500.0 million, a reduction from the 325 recorded in
1996. Despite the slowdown, the average deal price earnings multiple
increased to 18.8 times annual earnings compared to 16.5 times annual
earnings for 1996.
There were a number of significant regulatory and legislative changes
affecting banks in 1997. Revisions to the Riegle-Neal Interstate Banking
and Efficiency Act of 1994 went into effect on July 1, 1997. Under this
revised act, interstate bank mergers became a more feasible alternative
for franchise expansion.
On February 28, 1997, the Board of Governors of the Federal Reserve
System ("Federal Reserve Board") made nonbanking activities accessible
through its comprehensive amendments to Regulation Y, "Bank Holding
Companies and Change in Bank Control." These amendments improved the
competitiveness of bank holding companies by eliminating unnecessary
regulatory burden and operating restrictions, and by streamlining the
application/notice process. The final rule lifted restrictions in
several areas, allowing bank holding companies certain freedoms to
promote competition with securities firms, technological companies,
consulting firms, data processing units and foreign banking operations.
Effective January 1, 1997, the Federal Financial Institutions
Examinations Council ("FFIEC") Uniform Financial Institutions Rating
System ("UFIRS") was revised to address changes in the financial services
industry and supervisory policies and procedures since the system's
inception in 1979. The UFIRS, commonly referred to as the CAMEL rating
system, is an internal rating system used by federal and state
supervisory agencies to evaluate the soundness of financial institutions
on a uniform basis. Under the previous CAMEL rating system, there were
five components considered when assessing an institution's soundness: (i)
capital adequacy; (ii) asset quality; (iii) management and
administration; (iv) earnings; and (v) liquidity. The revised system,
now known as CAMELS, added an "S" component to address market-risk
sensitivity. The new component stresses better management in foreign
exchange exposure, trading risk and interest rate risk ("IRR").
REVIEW OF FINANCIAL POSITION:
In 1997, the Company focused its efforts on better serving its existing
customers and on expanding its customer base. On July 25, 1997, the
Company's wholly-owned subsidiary, Community Bank and Trust Company
("Community Bank") entered a definitive agreement to acquire two branches
of First Union National Bank ("First Union"). The branches, located in
Eynon, Lackawanna County, Pennsylvania, and Factoryville, Wyoming County,
Pennsylvania, became fully-functional Community Bank offices on
November 14, 1997. The Company also continued its strategy to build the
role of loans in its earning-assets mix while promoting safety and
soundness in its investment portfolio. As a result of its efforts, the
Company experienced moderate growth in 1997.
The Company's total assets grew $27.0 million or 7.6 percent, from $354.8
million at December 31, 1996, to $381.8 million at December 31, 1997.
Total asset growth of the peer group of 35 banks located in Northeastern
Pennsylvania averaged 9.4 percent in 1997. For the year, the Company's
total assets averaged $359.4 million as compared to $347.3 million in
1996, a $12.1 million increase. The primary source of this increase was
the growth in the Company's loan portfolio. The composition of the
balance sheet changed during the year as evidenced by a shift in the
ratios of average investments and federal funds sold to average earning
assets and average loans to average earning assets. For 1997, the ratio
of average investments and federal funds sold to average earning assets
declined to 30.1 percent from 34.6 percent in 1996. A counteractive
effect took place in the average loans to average earning assets ratio,
which was 69.9 percent in 1997, an increase over the 65.4 percent
recorded for 1996.
Although not to the extent of the loan portfolio, investments rose from
$102.0 million at December 31, 1996, to $105.7 million at December 31,
1997. The Company increased its portfolio in 1997 by purchasing short-
term U.S. Treasury securities, U.S. Government agencies and intermediate-
term obligations of states and municipalities. The short-term
investments were acquired to fund future loan demand and the tax-exempt
municipal securities were acquired to reduce the Company's tax burden.
The tax-equivalent yield on the investment portfolio increased to 6.6
percent for 1997 compared to 6.4 percent for 1996.
Loans, net of unearned income, increased $14.4 million or 6.1 percent
during 1997. The Company had aggregate loans of $7.0 million to certain
large Pennsylvania-based commercial banks at December 31, 1997. In
addition, the Company sold $3.4 million in student loans to a servicing
agent during the second quarter of the year. Adjusting for the
commercial bank credit extension and student loan sales, the loan
portfolio growth was $10.8 million or 4.6 percent. Customers took
advantage of the favorable mortgage rate environment as one-to-four
family residential mortgages and nonfarm, nonresidential real estate
loans comprised the main portion of the increase. Loan growth of the
peer group averaged 10.8 percent for 1997. For the year, the tax-
equivalent yield on the Company's loan portfolio declined slightly to 8.5
percent compared to 8.6 percent for 1996.
The placement of one large commercial loan on nonaccrual status, coupled
with a lagging effect in the local economy, led to some deterioration in
the Company's asset quality in 1997 as compared to 1996. The Company's
nonperforming loans as a percentage of loans, net of unearned income,
ratio was 2.25 percent at December 31, 1997, compared to 1.44 percent at
December 31, 1996. Additionally, the ratio of nonperforming assets to
loans, net of unearned income, equaled 2.41 percent at December 31, 1997,
compared to 1.62 percent one year earlier. The Company's allowance for
loan losses as a percentage of loans, net of unearned income, declined
from 1.67 percent at December 31, 1996, to 1.52 percent at December 31,
1997. The Company's net charge-off position, coupled with the greater
loan demand, were the primary reasons for the decline.
Total deposits increased $11.9 million, or 3.7 percent, from $320.5
million at December 31, 1996, to $332.4 million at December 31, 1997.
Deposit growth for the peer group averaged 8.5 percent for 1997. The
major cause of the deposit inflow was attributable to the addition of the
Eynon and Factoryville branches. The Company's cost of funds rose
slightly to 4.8 percent for 1997 compared to 4.7 percent for 1996. In
contrast, the peer group experienced a slight decline in its cost of
funds from 4.7 percent in 1996 to 4.6 percent in 1997.
The Company experienced improved interest sensitivity and liquidity
positions from year-end 1996 to year-end 1997. Interest sensitivity, as
measured by the ratio of cumulative one-year, rate-sensitive assets
("RSA") to rate-sensitive liabilities ("RSL"), rose from 0.73 at December
31, 1996, to 0.86 at December 31, 1997. Both ratios were within the
acceptable guidelines of 0.7 and 1.3 set forth in the Company's
Asset/Liability Management Policy. The positive change in the Company's
liquidity position is best illustrated by its net noncore funding
dependence and net short-term noncore funding dependence ratios. At
December 31, 1997, the net noncore funding dependence ratio equaled
negative 7.5 percent. The same ratio equaled 2.6 percent at December 31,
1996. The Company's net short-term noncore funding dependence ratio
totaled negative 10.2 percent at December 31, 1997, while the same ratio
totaled 0.4 percent one year earlier. These ratios well outperformed
those of the peer group for 1997, which recorded a net noncore funding
dependence ratio of 10.8 percent and a net short-term noncore funding
dependence ratio of 23.0 percent.
Stockholders' equity improved from $31.3 million at December 31, 1996, to
$36.1 million at December 31, 1997, a $4.8 million increase. This
increase primarily came from strong earnings of $4.4 million and a $1.0
million positive change in the net unrealized holding gain partially
offset by dividends declared for the year of $659.
The Leverage ratio, a key regulatory ratio, defined as Tier I capital as
a percentage of total average assets less intangible assets, increased to
8.7 percent at year-end 1997 from 8.4 percent at year-end 1996. At
December 31, 1997, the Company exceeded all relevant regulatory capital
measurements and was considered well capitalized.
In addition to improving the Company's financial position and
performance, management completed several significant undertakings in
1997. These events included: (i) the establishment of a fixed-rate
annuity product sales program; (ii) the initiation of a Dividend
Reinvestment Program ("DRP"); (iii) the introduction of incentive
programs for managers and customer service employees; (iv) the planning
of a new community office facility and administrative center; and (v) the
purchase of the previously-mentioned branch offices.
INVESTMENT PORTFOLIO:
Low inflation, moderate economic growth and the Asian economic crisis all
influenced the bond market in 1997. Bond prices rose in 1997 due to
declining investors' expectations of future inflation and increased
demand for fixed-income securities. The greater demand resulted from
uncertainty in world markets and strength of the United States dollar.
Such demand intensified by reductions in the supply of bonds. The United
States budget deficit evaporation and the earning surplus have reduced
the need for new government bond sales.
Long-term investment yields declined 72 basis points while short-term
investment yields declined, to a lesser extent, by 22 basis points during
1997. The 30-year U.S. Treasury bond opened the year with a 6.65 percent
yield and ended 1997 yielding 5.93 percent. Meanwhile, yields on the
two-year U.S. Treasury note also declined, beginning 1997 with a 5.88
percent yield and ending the year yielding 5.66 percent. The changes in
long- and short-term interest rates in 1997 had a flattening effect on
the yield curve. At the beginning of 1997, the yield curve spread of the
30-year U.S. Treasury bond over the two-year U.S. Treasury note was 77
basis points. By the end of 1997, this advantage had been trimmed to 27
basis points.
The Company's investment portfolio had an effective duration of 1.8 years
and primarily consisted of government securities, obligations of states
and municipalities and mortgage-backed securities. U.S. Treasury
securities and U.S. Government agencies, including mortgage-backed
securities, accounted for 59.4 percent of aggregate investments at
December 31, 1997. The majority of the remaining portion of the
portfolio primarily consisted of insured general obligations of states
and municipalities that received a rating of "Baa" or higher from
Moody's or "BBB" or higher from Standard and Poor's rating services.
Comparatively, the investment portfolio's effective duration was 2.0
years in 1996. The Company experienced an improvement in its bond
portfolio's total return in 1997. For the year, the Company's total
return amounted to 7.9 percent. In comparison, the Lehman Brothers'
aggregate-bond index, a benchmark used by most investment managers,
scored a 9.4 percent total return for 1997. For 1996, the Company's
total return at 4.9 percent exceeded the Lehman Brothers' Index at 3.6
percent.
Market conditions for 1997 aided the value of the Company's investment
portfolio. A strong economy and falling interest rates bolstered the net
unrealized holding gain on investment securities to $1,600, net of
deferred income taxes of $825, at December 31, 1997, from $564, net of
deferred income taxes of $291, at December 31, 1996. The unrealized
holding gain equaled 2.35 percent of amortized cost at December 31, 1997,
an improvement from the 0.85 percent reported at December 31, 1996.
For the years ended December 31, 1997 and 1996, the Company classified
all investment securities as available-for-sale. The peer group also
continued its trend toward the available-for-sale classification as it
classified 90.7 percent of their investments as available-for-sale at
December 31, 1997, compared to 90.3 percent at December 31, 1996.
The Company continued its de-emphasis on the investment portfolio in
1997. Average investments declined as a percentage of average assets
from 31.7 percent in 1996, to 27.5 percent in 1997. In comparison, the
peer group held 31.9 percent in 1997 and 33.6 percent in 1996 of its
average assets in investment securities.
The Company did not sell securities in 1997. Proceeds from securities
sales in 1996 amounted to $1.5 million. The Company recognized net
losses of $58 in 1996 related to such sales. Repayments from investment
securities totaled $31.2 million in 1997 and $24.9 million in 1996.
During 1997, the Company purchased: (i) $9.0 million in short-term U.S.
Treasury securities; (ii) $4.3 million in intermediate-term state and
municipal obligations; (iii) $19.8 million in short-term collateralized
mortgage obligations ("CMOs") and pooled mortgage-backed securities; and
(iv) $298 in equity securities, primarily common stock of the Federal
Home Loan Bank of Pittsburgh ("FHLB-Pgh"). Investment purchases amounted
to $20.2 million in 1996.
Contrary to the significant decline in the yields on U.S. Treasuries
during 1997, the tax-equivalent yield on the Company's investment
portfolio rose from 6.4 percent in 1996 to 6.7 percent in 1997. U.S.
Treasury securities and obligations of states and municipalities
comprised 64.8 percent of the investment portfolio at December 31, 1997,
versus 72.5 percent at December 31, 1996. Except for U.S. Treasury
securities and U.S. Government agencies, there were no securities of any
individual issuer that exceeded 10.0 percent of the Company's
stockholders' equity at December 31, 1997 and 1996. All of the
investment securities in the Company's portfolio are considered
"investment grade," receiving a rating of "Baa" or higher from Moody's or
"BBB" or higher from Standard and Poor's rating services at December 31,
1997, except for $1,862 of tax-exempt obligations of local
municipalities. At December 31, 1997, investment securities with an
amortized cost of $25,971 were pledged to secure deposits, to qualify for
fiduciary powers and for other purposes required or permitted by law. At
December 31, 1996, the amortized cost of pledged securities equaled
$35,099. The fair value of such securities equaled $25,979 at December
31, 1997, and $34,968 at December 31, 1996.
At December 31, 1997 and 1996, the Company's investment portfolio
contained no high-risk CMOs as defined in the Federal Reserve Board's
Supervisory Policy Statement on Securities Activities. At December 31,
1997, the carrying value of the Company's holdings of structured notes
was $2.0 million. Specifically, such securities included a dual-index
floater and a delevered floater, each having a carrying value of
approximately $1.0 million. Both securities matured in 1998. The
Company had no dealings in derivative financial instruments or derivative
commodity instruments for the three years ended December 31, 1997.
LOAN PORTFOLIO:
A strong national economy, tumbling interest rates and unseasonably mild
temperatures led to record-breaking statistics for residential lending in
1997. New home sales reached 805 thousand for the year, a 5.5 percent
increase over 1996. Sales for the Northeast region experienced a 6.8
percent rise, second only to the 7.4 percent growth in the Southern
region. Sales of previously-owned homes enjoyed their second consecutive
record-breaking year reaching 4.2 million, marking a 3.1 percent increase
over the 1996 record. The Northeast region also experienced the second-
highest increase in this category with a 3.4 percent increase over 1996.
Housing starts for 1997 approximated 1996 levels with 1.5 million new
homes and apartment units begun. Of these new starts, 1.1 million were
for new single-family dwellings, a 5.2 percent decline from the 1996
figure. For the Northeast, housing starts increased 3.5 percent compared
to 1996. The national median selling price on new homes rose to $145.5,
a slight increase compared to 1996. For existing homes, the median
selling price for 1997 reached $124.1, a 5.2 percent increase from the
$118.0 recorded for 1996. In the Northeast, the median selling price for
an existing home rose to $145.1, a 3.0 percent increase compared to 1996.
Interest rates on 30-year mortgages began 1997 at 7.6 percent and peaked
in April at 8.2 percent. During the remainder of 1997, the 30-year
mortgage interest rate tumbled to a year-end low of just under 7.0
percent. This level was the nation's lowest since it hit 6.9 percent in
October of 1993. These lower rates also led to a record number of loan
refinancings in 1997. As the year closed, refinancings accounted for
nearly 60.0 percent of all mortgage applications, which was approximately
three times the usual percentage.
Housing was not the only sector that benefitted from the nation's strong
economic position. United States business lending also experienced an
upswing in 1997. With the declining rate environment, companies began to
borrow at a furious pace to "lock-in" some of the lowest corporate
interest rates ever offered. At December 31, 1997, the nation's banks
recorded $853.9 billion in commercial and industrial loans. This marked
a $74.8 billion or 9.5 percent increase over the December 31, 1996,
amount.
While mortgage and commercial lending flourished in 1997, consumer
lending performed sluggishly. Overall, consumer lending for the nation's
banks ended the year at $506.5 billion. At December 31, 1996, this
figure equaled $525.8 billion. The 3.8 percent decline was partially
attributable to the lag in changes on consumer loan interest rates as
compared to general market rates.
Loans, net of unearned income, amounted to $250.2 million at December 31,
1997, a $14.4 million or 6.1 percent increase over the $235.8 million at
December 31, 1996. The Company had aggregate commercial loans of $7.0
million to certain large Pennsylvania-based commercial banks at December
31, 1997. The Company had no such loans at year-end 1996. Adjusting for
short-term credit extensions to other financial institutions and the sale
of $3.4 million in student loans during the second quarter of 1997, the
increase would have approximated $10.8 million in 1997. After
considering all adjustments, the increase in aggregate loan demand can be
primarily attributed to two areas. For 1997, loans issued for one-to-
four family residential properties increased $8.9 million or 6.1 percent
compared to 1996. Additionally, loans issued for nonfarm, nonresidential
properties rose $5.3 million or 17.8 percent over 1996. Partially
offsetting these increases was a decline in commercial loans, adjusted
for the extensions to large Pennsylvania-based commercial banks, of $4.4
million compared to 1996. Loans, net of unearned income, amounted to
68.7 percent of total earning assets at December 31, 1997. The same
ratio equaled 69.1 percent at December 31, 1996. During 1997, the peer
group's average loans accounted for 64.0 percent of average assets as
compared to the Company's ratio of 67.3 percent.
The tax-equivalent yield on the loan portfolio declined slightly from 8.6
percent in 1996 to 8.5 percent in 1997. This level also lagged the 9.0
percent yield of the Company's peer group. The lower yield resulted from
the Company's 1997 pricing strategies in light of the falling interest
rate environment and intensified competition for loan customers. In
contrast to the national trends, the Company's volume of refinanced
residential mortgages dropped considerably from $23.1 million in 1996 to
$10.9 million in 1997. The large level of 1996 refinancings primarily
came in the second and third quarters as customers took advantage of the
Company's "Loan Sale" marketing efforts.
Falling mortgage rates and credit extensions to financial institutions
led to a slight change in the composition of the loan portfolio during
1997. The favorable mortgage lending conditions led to real estate loans
accounting for approximately 72.8 percent of total loans outstanding at
December 31, 1997, compared to 71.9 percent for the same period of 1996.
Real estate loans amounted to $182.2 million at December 31, 1997, an
increase of $12.7 million as compared to year-end 1996. Commercial loan
volumes increased by $2.6 million at December 31, 1997, as compared to
December 31, 1996. This increase is due to $7.0 million in outstanding
credit extensions to other Pennsylvania-based commercial banks at
December 31, 1997. Had such extensions not been granted, the Company
would have experienced a $4.4 million decline in its commercial loan
portfolio. Consumer loan volumes declined in 1997, falling from $29.9
million at December 31, 1996, to $29.0 million at December 31, 1997.
Adjusting for the Company's $3.4 million sale of student loans, consumer
loans would have experienced an increase of $2.5 million.
At December 31, 1997, the Company had no loan concentrations exceeding
10.0 percent of total loans, excluding locational concentrations, to
individual or multiple borrowers engaged in activities that would cause
them to be similarly affected by changes in economic or other conditions.
The Company limits its exposure to concentrations of credit risk by the
nature of its lending activities as approximately 62.4 percent of total
loans outstanding are secured by residential properties. The average
mortgage outstanding on a residential property was $37 at December 31,
1997. The Company maintains a policy restricting the loan-to-value ratio
at 80.0 percent. During 1997 and 1996, the loan portfolio did not
consist of any form of credit involving highly-leveraged transactions,
defined as financing transactions that involve the buyout, acquisition or
recapitalization of an existing business and include credits extended to
highly-leveraged industries.
In the normal course of business, the Company is a party to financial
instruments with off-balance sheet risk to meet the financing needs of
its customers. These instruments include commitments to extend credit,
unused portions of home equity and credit card lines and commercial
letters of credit. The Company's exposure to such commitments was $17.8
million at December 31, 1997, and $10.9 million at December 31, 1996. No
provision for loan losses for these commitments was deemed necessary at
December 31, 1997 or 1996.
The Company's fixed-rate loans increased $15.8 million at December 31,
1997, while adjustable-rate loans declined $1.4 million. Fixed-rate
loans comprised 81.7 percent of the loan portfolio at December 31, 1997,
with adjustable-rate loans making up the remaining 18.3 percent. At
December 31, 1996, fixed-rate loans accounted for 79.9 percent of the
loan portfolio with adjustable-rate loans making up the remaining 20.1
percent.
ASSET QUALITY:
Personal bankruptcies in the United States continued to rise in 1997 and
bank charge-off levels remained near the recessionary levels of 1990 and
1991. Despite these occurrences, national asset quality experienced
little deterioration. In 1997, 1.4 million Americans filed for personal
bankruptcy, a 19.0 percent rise over 1996. With respect to residential
mortgage lending, the Mortgage Bankers Association of America reported
that national residential mortgage delinquencies rose to a seasonally-
adjusted rate of 4.4 percent during the fourth quarter of 1997.
Moreover, national commercial credit delinquencies did not deteriorate
despite the economic difficulties experienced world-wide.
Bankruptcies in Northeastern Pennsylvania rose 42.2 percent for 1997,
over twice the increase experienced nationally. Mounting credit card
debts, job losses, uninsured medical expenses and family breakups were
all cited as causes for the rise. Bankruptcy filing increases were seen
not only among the younger generation but also among the elderly as many
older adults got into financial difficulty from supporting their adult
children.
Unemployment rates in the Company's market area remain above the levels
reported for the United States and Pennsylvania. These inflated
unemployment figures deteriorated asset quality levels. Such
deterioration is evidenced by a rise in the peer group's ratio of
nonaccrual loans as a percentage of gross loans. At December 31, 1997,
the peer group's ratio equaled 0.71 percent, a 17 basis point rise over
the 0.54 percent recorded at December 31, 1996.
Nonperforming assets, consisting of nonperforming loans and foreclosed
assets, totaled $6.0 million at December 31, 1997, compared to $3.8
million at December 31, 1996. The Company's foreclosed assets had a net
decrease of $15 during 1997. Eight loans totaling $336 were transferred
to foreclosed assets and were offset by the sale of five properties
totaling $400, including net gains on such dispositions of $49. In 1996,
a property originally purchased by the Company to be utilized as a site
for a new branch office was included in other real estate. During 1995,
management reevaluated its intent for such property and transferred it to
other real estate at $220, which equaled 80.0 percent of its appraised
value, with the difference being recorded in other losses. In the first
quarter of 1997, such property was sold with a gain of $50 being
recognized. The carrying values of all properties included in other real
estate were no more than 80.0 percent of their collateral values at
December 31, 1997.
Nonperforming loans, consisting of accruing loans past due 90 days or
more and impaired loans, increased $2.2 million during 1997 from $3.4
million to $5.6 million. The rise in nonperforming loans was primarily
due to a $1,272 increase in accruing loans past due 90 days or more and a
$967 increase in impaired loans. The $967 change in impaired loans
included gross loans placed into this category of $1,544 and gross loans
removed as a result of charge-offs of $113, transfers to other real
estate of $233, and principal repayments of $231. Approximately 60.0
percent of the $1,544 of gross loans placed into impaired status during
1997 was attributable to one commercial customer. Accruing loans past due
90 days or more increased from $1,897 at December 31, 1996, to $3,169 at
December 31, 1997. The major portion of the increase came from a $1,289
increase in real estate loans past due 90 or more days. The Company
experienced some deterioration in its asset quality ratios in 1997. The
impaired loans as a percentage of loans, net of unearned income, ratio
was 0.98 percent at December 31, 1997, compared to 0.63 percent at
December 31, 1996. For the Company's peer group, this ratio was 0.71
percent. Additionally, the nonperforming assets to loans, net of
unearned income, ratio equaled 2.41 percent at December 31, 1997,
compared to 1.62 percent one year earlier. This ratio was also less
favorable as compared to the peer group's 1.73 percent recorded at
December 31, 1997.
At December 31, 1997 and 1996, the Company had a recorded investment in
impaired loans of $2,461 and $1,494, respectively. The recorded
investment in impaired loans averaged $2,368 in 1997 and $1,528 in 1996.
At December 31, 1997, the amount of recorded investment in impaired loans
for which there was a related allowance for loan losses and the amount of
the allowance was $2,272 and $541, respectively, and $1,269 and $650,
respectively, for the year-ended December 31, 1996. The amount of
recorded investment for which there was no related allowance for loan
losses was $189 and $225 at December 31, 1997 and 1996, respectively.
During 1997, activity in the allowance for loan losses account related to
impaired loans included a provision charged to operations of $4 and
losses charged to the allowance of $113. There were no recoveries of
impaired loans previously charged-off in 1997. The activity in 1996 in
the allowance for loan losses account related to impaired loans included
a provision charged to operations of $3, losses charged to the allowance
of $92 and recoveries of impaired loans previously charged-off of $125.
Interest income related to impaired loans would have been $90 in 1997 and
$113 in 1996 had such loans been current and the terms of the loans not
been modified. Interest recognized on impaired loans amounted to $84 in
1997 and $30 in 1996. Included in these amounts was interest recognized
on a cash basis of $84 and $30, respectively. Cash received on impaired
loans applied as a reduction of principal totaled $587 and $398 in 1996.
There were no commitments to extend additional funds to customers with
impaired loans at December 31, 1997 and 1996.
The allowance for loan losses, against which loans are charged-off,
equaled $3.8 million at December 31, 1997, and represented 1.52 percent
of loans, net of unearned income. At December 31, 1996, the allowance
was $3.9 million and represented 1.67 percent of loans, net of unearned
income. The Company's strong loan demand led to the reduced ratio.
However, such ratio continued to exceed both the peer group and
regulatory guidelines. At December 31, 1997, the peer group reported a
1.30 percent ratio, down slightly from the 1.38 percent ratio recorded
one year earlier.
As a percentage of nonperforming loans, the allowance account covered
67.5 percent at December 31, 1997. This coverage ratio at December 31,
1996, calculated to 116.3 percent. Relative to all nonperforming assets,
the allowance covered 62.9 percent at December 31, 1997. At December 31,
1996, the ratio equaled 103.5 percent.
Net charge-offs were $506 or 0.21 percent of average loans outstanding in
1997 compared to $259 or 0.12 percent in 1996. The nation's top 50 banks
reported a net charge-offs to average loans ratio of 0.54 percent for
1997 and 0.63 percent for 1996, while the peer group reported net charge-
offs as a percentage of average loans outstanding of 0.29 percent for
1997 and 0.28 percent for 1996.
DEPOSITS:
The solid economic conditions prevalent throughout the United States
during 1997 led to greater consumer confidence levels and higher
disposable income rates, but did not foster growth in personal saving
patterns. Consumer confidence ended 1997 at 136.3, the highest level
experienced since 1967. Real disposable income increased 2.9 percent
from 1996 levels, the best performance in the last three years. Despite
this increase, personal savings rates, a measure of savings as a
percentage of disposable after-tax income, dropped to 2.1 percent, the
lowest level witnessed since 1939. National unemployment continued its
downward spiral, falling from 5.3 percent at year-end 1996 to 4.7 percent
by the end of 1997. With the job market narrowing, hourly wages
continued to move upward, rising 3.7 percent for 1997. This enhanced
personal wealth led to a 5.4 percent annual spending growth rate in 1997,
the greatest increase since 1994. Any funds left from the 1997 consumer
"spending spree" did not, however, find their way into bank deposit
accounts. Consumers took advantage of the higher-yielding mutual fund
and stock markets as opposed to lower-yielding bank deposits. On
average, diversified United States stock funds returned 24.4 percent in
1997, making the cumulative return on such instruments 95.3 percent over
the past three years. Also, despite a 554 point drop on October 27,
1997, the Dow Jones rebounded and ended the year over the 7,900 mark.
Consumers young and old put more money away for their retirement.
Overall, retirement savings rose 2.0 percent in 1997.
Mutual fund and stock markets were not the only obstacles the Company
faced in deposit gathering for 1997. Local bank and thrift institutions
also competed aggressively for customer deposits. For example, the
average rate paid on a 30-month certificate of deposit for the Company's
peer group exceeded 5.4 percent for 1997. Comparatively, the average
rate on 30-month certificates paid by commercial banks in the United
States was 5.3 percent for the year.
Deposit volumes rose 3.7 percent from $320.5 million at December 31,
1996, to $332.4 million at December 31, 1997. Such increase was
primarily due to the Company's acquisition of the Eynon and Factoryville
branches from First Union. Without considering deposits from these
branches, the Company's total deposits would have been $310.7 million at
December 31, 1997. For Northeastern Pennsylvania banks, deposits
increased 8.5 percent from year-end 1996 to year-end 1997. Total
deposits averaged $322.4 million for 1997 compared to $313.3 million for
1996, an increase of 2.9 percent. For the first quarter of 1997, the
Company's total deposits declined $2.7 million primarily due to a
reduction in time deposits $100 or more held by school districts. During
the second quarter, the Company's deposits grew $5.8 million. The
primary cause of the second quarter increase was an $8.2 million increase
in time deposits less than $100 fueled by the Company's offering of a
special time deposit during the quarter. Also contributing, to a lesser
degree, was a $2.1 million rise in commercial checking accounts. These
increases were partially offset by a $7.2 million decline in time
deposits $100 or more due to the cyclical nature of local school district
deposits. The third quarter of 1997 closed with the Company's deposits
$3.2 million below the $323.6 million recorded at June 30, 1997. The
Company, in anticipation of the pending influx of deposits from the Eynon
and Factoryville branch acquisition, was less aggressive in deposit
pricing. Deposits, net of the acquired branch funds, declined $9.7
million during the final quarter of 1997, as management chose to lower
the Company's cost of funds by not actively competing for higher-costing,
short-term time deposits of commercial enterprises.
The Company's deposit composition continued to change, as evidenced by a
decline in the average volume of transaction accounts as a percentage of
average total deposits. For the year-ended December 31, 1997, this ratio
equaled 39.7 percent as compared to 40.9 percent for the same period of
1996. Customers repositioned available funds from lower-yielding
transaction accounts into higher-yielding time deposits in order to
enhance their yields. The Company's weighted-average cost of time
deposits for 1997 totaled 5.8 percent. For 1997, average time deposits
accounted for 54.1 percent of the Company's average assets. The
Company's average core deposits to average total deposits had little
change in 1997, falling slightly from 91.1 percent in 1996, to 91.0
percent. For 1997, the Company's cost of funds rose slightly to 4.8
percent from 4.7 percent in 1996. The Company's increase was primarily
due to rises in rates offered on money market accounts and time deposits
$100 or more in the latter part of the year. In contrast, the peer
group's cost fell slightly from 4.7 percent in 1996 to 4.6 percent in
1997.
In 1997, the Company's noninterest-bearing deposits grew $4.3 million
from $26.4 million at December 31, 1996, to $30.7 million at December 31,
1997. Average volumes of noninterest-bearing deposits also increased
from $26.3 million in 1996 to $27.4 million in 1997. For 1997 and 1996,
average noninterest-bearing deposits comprised 7.6 percent of total
average assets. In comparison, the peer group's average noninterest-
bearing deposits comprised 8.9 percent of total average assets for 1997
and 7.6 percent of total average assets for 1996.
Volatile deposits, time deposits in denominations $100 or more, declined
from $35.9 million at December 31, 1996, to $20.8 million at December 31,
1997. As aforementioned, this decline came as the Company chose not to
actively compete for time deposits $100 or more in an attempt to bring
its cost of funds to a more acceptable level. The Company was also less
reliant on this funding as compared to the peer group in 1997. Average
volatile deposits, as a percentage of average assets, was 8.1 percent in
1997 as compared to 10.8 percent for the peer group. The Company's
average cost of such funds rose 24 basis points during 1997.
Short-term borrowings available to the Company consist of a line of
credit and fixed-rate advances with the FHLB-Pgh secured under terms of a
blanket collateral agreement by a pledge of FHLB-Pgh stock and certain
other qualifying collateral, such as investment and mortgage-backed
securities and mortgage loans. The line is limited to the Company's
maximum borrowing capacity ("MBC") with the FHLB-Pgh, which is based on a
percentage of qualifying collateral assets. At December 31, 1997, the
Company's MBC was $137.4 million. There were $9.6 million in short-term
borrowings outstanding at December 31, 1997. At December 31, 1996, the
Company had no short-term borrowings outstanding. The average daily
balance and weighted-average rate on aggregate short-term borrowings was
$138 at 5.8 percent in 1997 and $51 at 5.9 percent in 1996. The maximum
amount of all short-term borrowings outstanding at any month end was $9.6
million during 1997 and $2.8 million during 1996. Short-term borrowings
during 1997 and 1996 consisted entirely of the FHLB-Pgh line of credit.
Long-term debt at December 31, 1997 and 1996, consisted entirely of a 7.5
percent fixed-rate, amortizing advance from the FHLB-Pgh Community
Investment Program. This advance matures on September 2, 2009. The
scheduled principal payments on the note total $3 for each of the five
years 1998 through 2002. The average daily balance on long-term debt for
1997 was $45 with a weighted-average rate of 8.9 percent. For 1996, the
average daily balance on long-term debt was $2.1 million with a weighted-
average rate of 4.4 percent. Included in the average daily balance and
weighted-average rate for 1996 was a $3.0 million, 4.3 percent fixed-rate
advance that matured September 9, 1996. The note was repaid in
accordance with its contractual terms.
MARKET RISK SENSITIVITY:
The Company utilizes various computerized modeling techniques for market
risk management. For 1997, management implemented an additional
technique to assess the Company's market risk exposure based on newly-
introduced Securities and Exchange Commission ("SEC") guidance.
On January 28, 1997, the SEC issued, "Disclosures of Accounting Policies
for Derivative Financial Instruments and Derivative Commodity Instruments
and Disclosure of Quantitative and Qualitative Information about Market
Risk Inherent in Derivative Financial Instruments, Other Financial
Instruments and Derivative Commodity Instruments." This final rule
requires quantitative and qualitative disclosures related to market risk
inherent in derivative financial instruments, certain derivative
commodity instruments and other financial instruments outside the
financial statements. Derivative financial instruments include: (i)
futures; (ii) forwards; (iii) swaps; (iv) options; and (v) other
financial instruments with similar characteristics. The Company utilizes
the tabular presentation alternative in complying with quantitative and
qualitative disclosure rules.
At December 31, 1997, the Company had investments of $37.1 million with a
weighted-average, tax-equivalent yield of 5.49 percent scheduled to
mature within one year. Correspondingly, net loans of $54.5 million with
a weighted-average, tax-equivalent yield of 8.04 percent were scheduled
to mature in the same timeframe. Overall, interest-earning assets
scheduled to mature within one year equaled $99.8 million with a
weighted-average, tax-equivalent yield of 6.88 percent. With respect to
interest-bearing liabilities, the Company had interest-bearing
transaction accounts, defined as money market, NOW and savings accounts,
of $21.9 million with a weighted-average yield of 2.73 percent scheduled
to mature within one year. The Company had time deposits of $93.7
million with a weighted-average yield of 5.12 percent scheduled to mature
in the same timeframe. Total interest-bearing liabilities scheduled to
mature within one year equaled $125.2 million with a weighted-average
rate of 4.75 percent.
Additionally, the Company supplements the market risk disclosure model
through simulation analysis utilizing interest rate "shocks." The model
analyzes the effects instantaneous parallel shifts of plus or minus 100
basis points will have on the economic values of other financial
instruments. The results of the model at December 31, 1997, indicated
declines of 3.9 percent and 1.3 percent in the fair values of other
financial assets and other financial liabilities, respectively, given a
parallel and instantaneous rise in interest rates of 100 basis points.
Conversely, a similar decline in interest rates would cause increases of
4.3 percent and 1.4 percent, respectively.
The Company also uses models that consider repricing frequencies of RSA
and RSL in addition to maturity distributions. One such technique
utilizes a static gap report, which attempts to measure the Company's
interest rate exposure by calculating the net amount of RSA and RSL that
reprice within specific time intervals.
At December 31, 1997, the Company had a cumulative one-year, RSA/RSL
ratio of 0.86. This ratio has improved from the 0.73 at December 31,
1996. The improvement over 1996 levels was partially attributable to the
Company's strategy of investing in shorter-term investments. At
December 31, 1997, 35.1 percent of the Company's investment portfolio was
scheduled to mature or reprice within one year. The same ratio equaled
30.2 percent at December 31, 1996. The improvement was also aided by an
increase in loans maturing or repricing within one year. At December 31,
1997, loans maturing or repricing within one year totaled $83.8 million,
a $2.3 million increase from one year earlier. Favorable borrowing
conditions led the Company to shift the excess funds not used for
investment purchases into shorter-term loans in order to satisfy demand.
Time deposits $100 or more also contributed to improvement in the
cumulative one-year gap as they declined $17.5 million to $12.3 million
at December 31, 1997, from $29.8 million at December 31, 1996.
While the Company's cumulative one-year ratio improved, its three-month
ratio fell. The three-month ratio equaled 1.87 at December 31, 1997,
compared to 2.44 at December 31, 1996. This change occurred primarily
due to an increase in time deposits less than $100 maturing within three
months. At December 31, 1997, time deposits less than $100 maturing or
repricing in this timeframe totaled $32.1 million compared to $22.0
million at December 31, 1996. This change occurred as customers chose
liquidity over return when investing 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.
As a final tool to assist in managing its market risk sensitivity, 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 December
31, 1997, 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, an increase in net interest
income of 0.5 percent is expected. Conversely, a 100 basis point decline
in market rates would cause a 0.4 percent decrease in net interest
income.
LIQUIDITY:
Compared to 1996, the Company's liquidity position improved in 1997. The
best illustrations of this change were the Company's net noncore funding
dependence and net short-term noncore funding dependence ratios. At
December 31, 1997, the net noncore funding dependence ratio equaled
negative 7.5 percent. The same ratio equaled 2.6 percent at December 31,
1996. The Company's net short-term noncore funding dependence ratio
totaled negative 10.2 percent at December 31, 1997, while the same ratio
totaled 0.4 percent one year earlier. These ratios also well outperformed
those of the peer group for 1997. The peer group recorded a net noncore
funding dependence ratio of 7.4 percent and a net short-term noncore
funding dependence ratio of 2.6 percent at December 31, 1997.
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 and FHLB-Pgh, and
federal funds sold, increased $6.2 million in 1997. Net cash provided by
operating activities was the primary reason for the net cash inflow for
1997. This amount totaled $5.5 million and primarily resulted from the
Company's $4.4 million in net income.
The Company's net cash used in investing activities totaled $1.1 million
for 1997. The primary components of the outflow from investing
activities were loan disbursements and investment purchases, partially
offset by inflows from investment and net branch acquisition proceeds.
The Company's net loan disbursements amounted to $17.9 million for 1997.
The Company also purchased $33.4 million in securities during 1997. Such
purchases were funded with the $31.2 million in securities repayments as
well as net proceeds of $16.3 million from the branch acquisition
occurring in the fourth quarter of 1997.
Net cash provided by financing activities equaled $1.9 million in 1997.
The rise was primarily attributable to an increase of $9.6 million in
overnight borrowings partially offset by a $7.1 million reduction in time
deposits.
CAPITAL ADEQUACY:
Stockholders' equity improved $4.8 million during 1997, or 15.5 percent
compared to 1996. The primary component of this increase was the
Company's generation of $4.4 million in net income, partially offset by
$659 in dividends declared for the year. The Company's capital position
also benefitted from a $1.0 million positive change in the net unrealized
holding adjustment. The Company reported a net unrealized holding gain
of $1.6 million at December 31, 1997, as compared to $564 at December 31,
1996.
For the year-ended December 31, 1997, the Company declared dividends of
$659 or $0.30 per share as compared to $623 or $0.28 per share for the
same period of 1996. As a percentage of net income, cash dividends
declared in 1997 equaled 15.0 percent.
On April 2, 1997, the Company filed a registration statement with the SEC
to register 300 thousand shares of common stock to be used for the DRP.
The plan went into effect beginning with the second quarter dividend and
offers stockholders the opportunity to automatically reinvest their
dividends in shares of the Company's common stock. Stockholder
participation in the plan approximated 25.4 percent of average
outstanding shares for 1997.
The Company exceeded all relevant regulatory capital measurements at
December 31, 1997 and 1996, and was considered well capitalized. The
Company improved its capital level in 1997 as evidenced by its improved
Leverage ratio. This ratio was 8.7 percent at December 31, 1997,
compared to 8.3 percent at December 31, 1996. At December 31, 1997, the
Company had a Tier I risk-based ratio of 15.9 percent and a total risk-
based ratio of 17.2 percent. The Tier I risk-based ratio was 15.4
percent and the total risk-based ratio was 16.7 percent at December 31,
1996.
REVIEW OF FINANCIAL PERFORMANCE:
As was the case in 1996, financial institutions throughout the nation
recorded an increase in profits. As previously mentioned, this is best
illustrated by the performance of the nation's top 50 banks. For 1997,
this composite group earned net income of $40.5 billion, an 11.9 percent
increase compared to 1996. Similarly, Mid-Atlantic banks recorded an
increase in net income of 18.2 percent compared to 1996.
For its second consecutive year, the Company surpassed its highest net
income in its existence earning $4,400 or $2.00 per share in 1997. This
marks a $200 increase over the $4,200 or $1.91 per share earnings of
1996. The increase was a result of improvements in net interest income
and noninterest income offset partially by a higher recorded level of
noninterest expense.
The Company's return on average total assets ratio was 1.22 percent for
1997, a slight increase over the 1.21 percent recorded one year earlier.
For the Company's peer group, the return on average total assets ratio
equaled 1.33 percent for 1997. The Company's return on average
stockholders' equity equaled 13.40 percent for 1997 as compared to 14.57
percent for 1996. This ratio, despite its decline from 1996,
outperformed the 13.01 percent recorded for the peer group in 1997. Tax-
equivalent net interest income increased $687 from $12,691 in 1996 to
$13,378 in 1997. Higher loan volumes, partially offset by lower
investment volumes and higher time deposit volumes, provided the main
influences in improving net interest income.
For the year-ended December 31, 1997, the Company's provision for loan
losses increased $60 to $360. The Company chose to increase its monthly
provision from $25 to $35 effective July 1, 1997. This decision came in
response to the Company's increased amount of credit extensions and
adverse change in nonperforming asset levels.
Noninterest income increased from $1,387 in 1996 to $1,776 in 1997, an
increase of $389 or 28.0 percent. The majority of such increase resulted
from a $250 litigation settlement paid by a securities broker to the
Company's wholly-owned subsidiary, Community Bank. The settlement was
awarded with respect to Community Bank's business relationship with this
broker prior to 1995. This nonrecurring addition had a $148.5 positive
impact on earnings after applicable income taxes and legal fees.
Noninterest income also was favorably influenced by a 5.6 percent
increase in service charges, fees and commissions.
Noninterest expense for the Company increased $573 to $7,956 for 1997
compared to $7,383 for 1996. The increase was primarily caused by higher
amounts of salaries and employee benefits expense and other expenses.
Salaries and employee benefits expense increased as a result of annual
merit raises, employee additions from the Eynon and Factoryville branch
acquisition and costs associated with implementing the customer service
training program. Higher levels of stationery and supplies costs
resulting from the centralization of the purchasing department and newly-
acquired branches were the major causes of the increase in other
expenses.
NET INTEREST INCOME:
Tax-equivalent net interest income rose to $13,378 in 1997, an increase
of $687 or 5.4 percent, compared to 1996. This increase was due entirely
to the growth in the average volume of earning assets over the volume of
average interest-bearing liabilities comparing 1997 to 1996.
Specifically, the favorable volume variance resulted from an increase in
the volumes of loans partially offset by reductions in investment volumes
and greater time deposit volumes. For 1997, the Company's average loan
volumes equaled $241.9 million, a $23.1 million or 10.5 percent increase
over 1996. This $23.1 million increase accounted for a $1,792 positive
influence on interest income. For the year-ended December 31, 1997, the
Company's average investment volumes declined $11.4 million or 10.3
percent to $98.8 million. In executing this strategic decision, the
Company experienced a negative investment volume variance of $746,
partially offsetting the favorable loan volume variance. Also mitigating
the positive influence of larger loan volumes was an increase in interest
expense related to the growth of time deposits. For 1997, time deposits
less than $100 averaged $165.5 million while time deposits $100 or more
averaged $29.1 million. In contrast, time deposits less than $100
averaged $157.3 million and time deposits $100 or more averaged $27.8
million in 1996. These volume changes accounted for a $533 increase in
interest expense for 1997 related to time deposit volumes.
Net interest income was not impacted by rate variances as the tax-
equivalent yield on earning assets rose correspondingly to the cost of
funds rate on interest-bearing liabilities. The tax-equivalent yield on
earning assets increased from 7.85 percent in 1996 to 7.93 percent in
1997. On a tax-equivalent basis, interest income on earning assets
increased $172 due to yield appreciation. The main reason for the
increase was a change in rates on taxable investments. The 17 basis
point increase in the yield on taxable investments resulted in a positive
rate variance of $288. The improvement in the yield on taxable
investments was a result of the reinvestment of cash flows from maturing
adjustable-rate U.S. Government agencies to higher-yielding investments.
Partially offsetting this increase was a $73 negative rate variance on
loans. In 1997, the Company's taxable portion of the loan portfolio
yielded 8.55 percent. For the same period of 1996, the taxable loan
yield equaled 8.66 percent. Loan yields on the tax-exempt portion of the
portfolio also declined in 1997. For the year-ended December 31, 1997,
the Company's yield on the tax-exempt portion of the portfolio equaled
8.08 percent compared to 8.21 percent from a year earlier. These
declines resulted from general reductions in market rates and increased
competition during 1997. The increase in interest expense of $172,
resulting from interest rate changes on interest-bearing liabilities, was
the same as the rate variance on earning assets. Approximately two-
thirds of the rate variance on RSL was caused by increased fund costs on
time deposits. For 1997, the average rate paid on time deposits less
than $100 equaled 5.70 percent compared to 5.67 percent paid for 1996.
The average rate paid on time deposits $100 or more was also higher than
1996. For the year-ended December 31, 1997, the average rate paid on
time deposits $100 or more equaled 6.17 percent, a 24 basis point
increase over the 5.93 percent recorded for 1996. For 1997, the
Company's net interest margin improved to 3.87 percent compared to 3.79
percent for 1996.
PROVISION FOR LOAN LOSSES:
The provision for loan losses for the nation's top 50 banks increased 6.7
percent in 1997 to $11.2 billion. This increase came in response to a
rise in net charge-offs for the year of 10.8 percent to $12.3 billion.
However, as a percentage of average loans outstanding, net charge-offs
fell to 0.54 percent in 1997 compared to 0.63 percent in 1996. The more
cautious approach allowed the provisions to outdistance charge-offs by
$300.0 million for the year. In line with the stance taken by the
banking industry, the Company increased its provision for loan losses by
$60 to $360 in 1997 from the $300 taken in 1996.
NONINTEREST INCOME:
The Company recorded noninterest income of $1,776, a $389 or 28.0 percent
increase over the $1,387 reported for 1996. As previously mentioned,
the primary cause of the increase was the settlement of a lawsuit against
an investment securities broker.
Service charges, fees and commissions increased $81 or 5.6 percent from
$1,445 for the year-ended December 31, 1996, to $1,526 for the same
period of 1997. The major contributing factor to this increase was an
increase in fees collected on insufficiently-funded customer accounts.
The net investment securities losses of $58 recorded for 1996 resulted
from the disposition of four adjustable-rate CMOs with a carrying value
of $1,487. The disposition resulted from an Investment Committee
decision based on a reassessment of the appropriateness of the securities
related to their structure, composition and characteristics in line with
future investment goals.
NONINTEREST EXPENSE:
For the year-ended December 31, 1997, noninterest expense totaled $7,956,
a $573, or 7.8 percent increase, compared to 1996. The Company had a net
overhead expense to average assets ratio of 1.8 percent, slightly higher
than the 1.7 percent recorded in 1996. However, with respect to the peer
group ratio of 2.7 percent, the Company continues to demonstrate greater
efficiency. The Company's operating efficiency ratio was less favorable
compared to 1996 as it equaled 58.3 percent in 1997, compared to 56.4
percent in 1996. The acquisition of the Eynon and Factoryville branches
increased the Company's noninterest expense levels thus causing a
corresponding adverse effect to the Company's efficiency ratio.
The majority of the Company's noninterest expense comes from salaries and
benefits. For the year-ended December 31, 1997, these expenses totaled
$4,098 and composed 51.5 percent of noninterest expense. This marked a
$290 or 7.6 percent increase compared to 1996. The cost associated with
personnel performance appraisals in the form of merit increases
approximated 50.0 percent of the $290 change. The remainder of this
increase is attributable to employee additions from the branch
acquisition and customer service employee training expenses.
Net occupancy and equipment expense aggregated $1,199 for the year-ended
December 31, 1997, slightly lower than the amount recorded for the same
period last year. Lower maintenance and lease costs related to bank
facilities and equipment used in normal banking operations were the major
causes of the decline.
Other expenses totaled $2,659 in 1997, an increase of $297 or 12.6
percent compared to the $2,362 recorded in 1996. This unfavorable
variance stemmed from a nonrecurring increase in stationery and supplies
expense during the second quarter. This nonrecurring charge was
associated with the Company's decision to centralize its purchasing
department. Also contributing to the higher stationery and supplies
expense level were expenses related to the Company's new imaging system
and those related to the Eynon and Factoryville branches. The overall
increase in 1997 compared to 1996 related to stationery and supplies
amounted to $149. To a lesser degree, increased postage costs resulted
in a higher level of noninterest expenses for 1997. These costs were a
result of numerous mailings to existing and potential customers of the
Eynon and Factoryville branches and an enhancement in the distribution of
Company information to stockholders.
INCOME TAXES:
The Company reported tax expense of $1,134 in 1997 compared to $1,013 in
1996. The effective tax rate for 1997 was 20.5 percent, up from the 19.4
percent reported for 1996. The Company's higher effective tax rate for
1997 was due to the overall improvement in income levels for the year.
Despite the rise, this rate was significantly better than the 25.5
percent effective tax rate reported by the peer group for 1997.
The Company determined that it was not required to establish a valuation
reserve for the deferred tax assets since it is more likely than not that
the net deferred tax 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.
COMM BANCORP, INC.
DIRECTORS AND OFFICERS
-----------------------------------------------
BOARD OF DIRECTORS
COMM BANCORP, INC.
- -------------------
DAVID L. BAKER
PRESIDENT AND
CHIEF EXECUTIVE OFFICER
WILLIAM F. FARBER, SR.
CHAIRMAN OF THE BOARD
Retired
JUDD B. FITZE
Attorney, Farr, Davis & Fitze
JOHN P. KAMEEN
SECRETARY
Publisher, Forest City News
ERWIN T. KOST
President, Kost Tire & Muffler
WILLIAM B. LOPATOFSKY
Retired
J. ROBERT McDONNELL
VICE PRESIDENT
Owner, McDonnell's Restaurant
JOSEPH P. MOORE, JR.
President, Elk Mountain Ski Resort, Inc.
THEODORE W. POROSKY
Owner, Porosky Lumber Company
ERIC STEPHENS
Auto Dealer, H.L. Stephens and Son
CORPORATE OFFICERS
COMM BANCORP, INC.
- ------------------
DAVID L. BAKER
President and
Chief Executive Officer
WILLIAM F. FARBER, SR.
Chairman of the Board
JOHN P. KAMEEN
Secretary
J. ROBERT McDONNELL
Vice President
SCOTT A. SEASOCK
Senior Vice President
Chief Financial Officer
THOMAS E. SHERIDAN
Senior Vice President
Chief Operations Officer
BOARD OF DIRECTORS
COMMUNITY BANK AND TRUST COMPANY
- --------------------------------
DAVID L. BAKER
PRESIDENT AND
CHIEF EXECUTIVE OFFICER
WILLIAM F. FARBER, SR.
CHAIRMAN OF THE BOARD
Retired
JUDD B. FITZE
Attorney, Farr, Davis & Fitze
MICHAEL T. GOSKOWSKI
SECRETARY
Owner, Kartri Sales Mfg.
ALLAN A. HORNBECK
President, Allan Hornbeck Chevrolet
JOHN P. KAMEEN
Publisher, Forest City News
WILLIAM A. KERL
Owner, Carbondale Concrete, Kerl Oil
and Kerl Trucking
ERWIN T. KOST
President, Kost Tire & Muffler
WILLIAM B. LOPATOFSKY
Retired
J. ROBERT McDONNELL
VICE PRESIDENT
Owner, McDonnell's Restaurant
JOSEPH P. MOORE, JR.
President, Elk Mountain Ski Resort, Inc.
THEODORE W. POROSKY
Owner, Porosky Lumber Company
ERIC STEPHENS
Auto Dealer, H.L. Stephens and Son<PAGE>
COMM BANCORP, INC.
DIRECTORS AND OFFICERS (CONTINUED)
-------------------------------------
ADVISORY BOARDS
COMMUNITY BANK AND TRUST COMPANY
- --------------------------------
CARBONDALE BRANCH
- -----------------
JOSEPH J. BRENNAN
Brennan and Brennan Funeral Home
JOHN J. CERRA
Attorney, Walsh and Cerra
ROBERT W. FARBER
R.W.F. Computer Consulting Co.
HENRY E. DEECKE
Henry E. Deecke Real Estate
CLIFFORD BRANCH
- ---------------
WILLIAM F. FARBER, JR.
Manager, Farber's Restaurants
THOMAS J. LOPATOFSKY, JR.
Lenox Propane
JOSEPH T. McGRAW
Attorney, McGraw and McGraw
ERIC STEPHENS
Auto Dealer, H.L. Stephens and Son
EATON TOWNSHIP,
LAKE WINOLA AND
TUNKHANNOCK BRANCHES
- --------------------
ROD AZAR
Azar Insurance Agency
JUDD B. FITZE
Attorney, Farr, Davis & Fitze
DOUG GAY
Gay's True Value
THOMAS KUKUCHKA
Sheldon-Kukuchka Funeral Home
GLEN LAYAOU
Eaton Hills Development Corp.
Layaou Construction Co.
HOWARD TRAUGER
Trauger's, Inc.
FOREST CITY BRANCH
- ------------------
THOMAS BAILEYS
President, Fire Risk Management
and NMEB, Inc.
RICHARD CURTIS
Owner, Rich's Auto Service and
CUBE Auto Supply
JOSEPH LUCCHESI, D.D.S.
Dentist
SCOTT MISKOVSKY
Pharmacist, Red Cross Pharmacy
LINDA RICHARDS
Sparkware Associates, Inc.
STEVEN TOURJE
NEP Telephone Company
MONTROSE BRANCH
- ---------------
EDGAR B. BAKER
Consultant
DUANE JERAULD
Montrose Beverage
TOM KERR
Tom Kerr Chevrolet
ROBERT LEE
Lee's Furniture Store
DONNA WILLIAMS
Livestock Dealer/Farmer
NICHOLSON BRANCH
- ----------------
RICHARD LOCHEN
Lochen's Market
MARK NOVITCH
Sales-Leasing Manager
Pinnacle Truck Sales
DAVID SCHMIDT, JR.
Schmidt's Valley Farm Market
SIMPSON BRANCH
- --------------
FRANCIS LAPERA
Lapera Oil Company
SUSAN MANCUSO,
Mancuso and Mancuso
GERALD SALKO, D.D.S.
Dentist
COMM BANCORP, INC.
DIRECTORS AND OFFICERS (CONTINUED)
---------------------------------------
OFFICERS
COMMUNITY BANK AND TRUST COMPANY
- --------------------------------
CAROL AMES
Lake Winola Branch Manager
DAVID L. BAKER
President and
Chief Executive Officer
WILLIAM R. BOYLE
Vice President
Branch Administrator
MARK E. CATERSON
Vice President
Senior Trust Officer
THOMAS M. CHESNICK
Vice President, Cashier
Forest City Branch Manager
STEPHANIE A. GANZ, CPA
Vice President of Finance
FRAN HEDRICK
Factoryville Branch Manager
DAVID A. JONES
Vice President
Secondary Marketing Manager
RANDOLPH LaCROIX
Clifford Branch Manager
PAMELA S. MAGNOTTI
Compliance Officer
MARY ANN MUSHO
Assistant Cashier
Human Resource Officer
IRENE Y. O'MALLEY
Senior Loan Administrator
ROBERT O'MALLEY
Eynon Branch Manager
JANICE NESKY
Nicholson Branch Manager
M. EVELYN PANTZAR
Vice President
Internal Auditor
JOHN PASH
Comptroller
CHERYL RUPP
Simpson Branch Manager
WALTER SARAFINKO
Clarks Summit Branch Manager
SCOTT A. SEASOCK
Senior Vice President
Chief Financial Officer
THOMAS W. SHEPPARD
Vice President
Senior Loan Officer
THOMAS E. SHERIDAN
Senior Vice President
Chief Operations Officer
RONALD K. SMITH
Vice President
Montrose Branch Manager
TAMI L. SNYDER
Vice President
Information Services
HAROLD STOUT
Tunkhannock Branch Manager
DEBRA TEDESCO
Lakewood Branch Manager
STEVEN URSICH
Carbondale Branch Manager
MICHELLE ZIONKOWSKI
Eaton Township Branch Manager
COMMUNITY BANK AND TRUST COMPANY
LOCATIONS
----------------------------------------------------------------
CARBONDALE BRANCH*
37 Dundaff Street
Carbondale, PA 18407
570-282-7500
CLARKS SUMMIT BRANCH*
125 North State Street
Clarks Summit, PA 18411
570-586-0377
CLIFFORD BRANCH*
Route 106
Clifford, PA 18413
570-222-3168
EATON TOWNSHIP BRANCH*
Cross County Complex
Route 29
Eaton Township, PA 18657
570-836-1008
EYNON BRANCH*
Eynon Plaza
Route 6
Eynon, PA 18403
570-876-4881
FACTORYVILLE BRANCH*
97 College Avenue
Factoryville, PA 18419
570-945-5137
FOREST CITY BRANCH*
521 Main Street
Forest City, PA 18421
570-785-3181
LAKE WINOLA BRANCH*
Winola Plaza
Lake Winola, PA 18625
570-378-3195
LAKEWOOD BRANCH
Lake Como Road
Lakewood, PA 18439
570-798-2900
MONTROSE BRANCH*
61 Church Street
Montrose, PA 18801
570-278-3824
NICHOLSON BRANCH*
57 Main Street
Nicholson, PA 18446
570-942-6135
SIMPSON BRANCH*
347 Main Street
Simpson, PA 18407
570-282-4821
TUNKHANNOCK BRANCH*
Route 6 West
Tunkhannock, PA 18657
570-836-5555
TRUST SERVICES
125 North State Street
Clarks Summit, PA 18411
800-217-3501
*MAC LOCATIONS
COMM BANCORP, INC.
GLOSSARY OF TERMS
----------------------------------------------------------
BASIS POINT - Unit of measure equal to one hundredth of one percent.
BOOK VALUE PER COMMON SHARE - Value of one share of common stock calculated
by dividing stockholders' equity by the total number of common shares
outstanding.
COMMON SHARES OUTSTANDING - The total number of common shares issued less
any shares held in the treasury.
CORE DEPOSITS - Total deposits excluding time deposits of $100,000 or more.
CORE DEPOSIT INTANGIBLE - The value given to long-term deposit
relationships resulting from the assumption of liabilities in a branch
and/or bank acquisition.
EARNING ASSETS - Assets that generate interest income and/or yield-related
fee income, such as loans, securities and short-term investments.
EARNINGS PER SHARE - Net income divided by the average number of common
shares outstanding.
INTEREST-BEARING LIABILITIES - Liabilities on which interest is paid for
the use of funds, including interest checking, savings, time deposit
accounts and borrowed funds.
INTEREST SENSITIVITY - A measurement of the effect on net interest income
due to changes in interest rates.
LIQUIDITY - A corporation's ability to meet cash requirements. Deposits,
borrowings, capital and/or asset conversions are all items used for the
raising of cash.
MORTGAGE-BACKED SECURITIES - Securities collateralized by pools of
residential mortgages having cash flows serviced by repayment activity on
the underlying mortgages.
NET CHARGE-OFFS - The amount of loans charged against the allowance for
loan loss account less any recoveries on loans previously charged-off.
NET INTEREST INCOME - Income earned on earning assets less interest expense
paid on interest-bearing liabilities.
NET INTEREST MARGIN - Net interest income on a fully tax-equivalent basis
divided by total average earning assets.
NET INTEREST SPREAD - Difference between the average tax-equivalent rate
received on earning assets and the average rate paid on interest-bearing
liabilities.
COMM BANCORP, INC.
GLOSSARY OF TERMS (CONTINUED)
--------------------------------------------
NONACCRUAL LOANS - Loans that have had interest accruals interrupted due
to the financial difficulties of the borrower.
NONPERFORMING ASSETS - Assets consisting of nonperforming loans and
foreclosed assets. Nonperforming loans are defined as accruing loans past
due 90 days or more, loans on which interest is currently not being accrued
or loans on which the rate or term has been altered due to the deteriorated
financial condition of the borrower.
OVERHEAD RATIO - Used as a measurement of the relationship between
operating expenses and revenues. It is total noninterest expenses divided
by the total of tax-equivalent net interest income and noninterest income.
PAST DUE LOANS - Loans that are still accruing interest but are past due
90 days or more with respect to the collection of principal or interest.
PROVISION FOR LOAN LOSSES - A charge against income made to estimate the
expense related to management's estimated losses with respect to the loan
portfolio.
RATE-SENSITIVE ASSETS/LIABILITIES - Interest-bearing assets and liabilities
adjustable within a specified period due to maturity or contractual
agreements. These agreements typically relate stated interest rates to the
prime rate.
RESERVE FOR LOAN LOSSES - A valuation allowance charged against the loan
portfolio representing the amount considered by management to be adequate
to cover estimated losses.
RETURN ON AVERAGE TOTAL ASSETS - Net income divided by the average total
assets for the period.
RETURN ON AVERAGE TOTAL EQUITY - Net income divided by the average total
stockholders' equity for the period.
RISK-ADJUSTED ASSETS - Assets and credit-equivalent amounts of off-balance
sheet items that have been adjusted according to regulatory guidelines into
their assigned risk weights.
RISK-BASED CAPITAL RATIOS - Guidelines set forth by regulatory agencies as
to the measurement of capital and how total assets and certain off-balance
sheet items are to be risk-adjusted to reflect levels of credit risk.
SENSITIVITY GAP - The difference between rate-sensitive assets and rate-
sensitive liabilities for a designated period. Assets exceeding
liabilities reflect a positive or net asset position. Liabilities
exceeding assets reflect a negative or a net liability position.
COMM BANCORP, INC.
GLOSSARY OF TERMS (CONTINUED)
----------------------------------------------
STOCKHOLDERS' EQUITY - Total investment by holders of common stock plus
retained earnings and net unrealized gains or losses on available-for-sale
securities.
STOCKHOLDERS' EQUITY PER COMMON SHARE - The value of a common share of
stock calculated by dividing total common stockholders' equity by the total
number of outstanding common shares at the end of the period.
TAX-EQUIVALENT BASIS - An adjustment made for tax-exempt instruments equal
to the amount of taxes that would have been paid had these instruments been
taxable at the statutory rate of 34.0 percent.
TIER I CAPITAL - Stockholders' equity less goodwill and any other
intangible items.
TOTAL RISK-BASED CAPITAL - The sum of Tier I capital and the allowance for
loan losses (restricted by certain regulatory limitations).
COMM BANCORP, INC.
STOCKHOLDER INFORMATION
---------------------------------------------------
CORPORATE HEADQUARTERS:
521 Main Street
Forest City, PA 18421
LEGAL COUNSEL:
Saul, Ewing, Remick & Saul LLP
Penn National Insurance Tower
North Second Street, 7th Floor
Harrisburg, PA 17101
INDEPENDENT AUDITORS:
Kronick Kalada Berdy & Co., P.C.
190 Lathrop Street
Kingston, PA 18704
TRANSFER AGENT:
American Stock Transfer & Trust Company
40 Wall Street
New York, NY 10005
MARKET MAKERS:
Robert W. Baird & Co., Inc.
777 E. Wisconsin Avenue
Milwaukee, WI 53202-5391
414-765-3500
Hopper Soliday & Co., Inc.
1703 Oregon Pike
Lancaster, PA 17604-4548
717-560-3015
Howe Barnes Investments, Inc.
135 S. LaSalle Street
Chicago, IL 60603-4358
312-655-2958
M.H. Meyerson & Co., Inc.
525 Washington Blvd.
Jersey City, NJ 07303-0260
201-495-9500
Ryan, Beck & Co.
80 Main Street
West Orange, NJ 07052
201-325-3000
Sandler O'Neill & Partners, L.P.
Two World Trade Center
104th Floor
New York, NY 10048
212-466-7740
SEC REPORTS AND ADDITIONAL INFORMATION: Copies of
Comm Bancorp Inc.'s Annual Report on Form 10-K and
Quarterly Reports on Form 10-Q filed with the
Securities and Exchange Commission or additional
financial information concerning Comm Bancorp, Inc.
may be obtained without charge by writing to Scott A.
Seasock, Chief Financial Officer, at corporate
headquarters.
COMMUNITY REINVESTMENT:
Copies of Community Bank and Trust Company's community
reinvestment statement may be obtained without charge by
writing to Pamela Magnotti, Compliance Officer, at
corporate headquarters.
COMMON STOCK MARKET INFORMATION:
Shares of Comm Bancorp, Inc. common stock began listing on
The NASDAQ Stock Market ("NASDAQ") as CommBcp under the
symbol "CCBP" on June 17, 1996. Prior to June 17, 1996,
the Company's common stock was quoted on the Over-the-
Counter Electronic Bulletin Board Interdealer System. As
of March 1, 1999, six firms were listed on the NASDAQ
system as market makers for the Company's common stock.
The high and low closing sale prices and dividends per
share of the Company's common stock for the four quarters
of 1998 and 1997 are summarized as follows. Retroactive
effect is given in sale price and dividend information for
a three-for-one stock split effectuated April 1, 1996.
<TABLE>
<CAPTION>
CASH DIVIDENDS
1998: HIGH LOW DECLARED
------- ------- --------------
<S> <C> <C> <C>
First Quarter... $38 3/4 $35 $.07
Second Quarter.. 36 1/2 32 1/4 .07
Third Quarter... 35 3/8 27 1/2 .10
Fourth Quarter.. $28 3/4 $25 $.13
1997:
First Quarter... $28 $25 $.06
Second Quarter.. 31 1/4 26 1/2 .06
Third Quarter... 31 3/4 28 1/4 .06
Fourth Quarter.. $37 $29 1/2 $.12
DIVIDEND REINVESTMENT:
Comm Bancorp, Inc. offers a Dividend Reinvestment Plan
whereby stockholders can increase their investment in
additional shares of common stock without incurring fees
or commissions. A prospectus and enrollment form may be
obtained by contacting American Stock Transfer & Trust
Company, Dividend Reinvestment Department, 40 Wall Street,
46th Floor, New York, NY 10005, 1-800-278-4353.
DIVIDEND DIRECT DEPOSIT:
Comm Bancorp, Inc. stockholders not participating in the
Dividend Reinvestment Plan may opt to have their dividends
deposited directly into their bank account by contacting
American Stock Transfer and Trust Company at 1-800-936-
5449.
WORLD WIDE WEB INFORMATION:
The Company's Annual Report on Form 10-K and Quarterly
Reports on Form 10-Q are filed electronically through the
Electronic Data Gathering, Analysis and Retrieval System
("EDGAR"), which performs automated collection,
validation, indexing, acceptance and forwarding of
submissions to the Securities and Exchange Commission and
is accessible by the public on the Internet at
http//www.sec.gov/edgarhp.htm.
Additional financial and nonfinancial information can be
accessed electronically using the Company's web site at
http://www.combk.com.
</TABLE>
EXHIBIT 3(ii)
BYLAWS
BYLAWS
------
OF
--
COMM BANCORP, INC.
-----------------
These Bylaws are supplemental to the Pennsylvania Business
Corporation Law and other applicable provisions of law, as the
same shall from time to time be in effect.
ARTICLE I. MEETINGS OF SHAREHOLDERS.
Section 101. Place of Meetings. All meetings of the
shareholders shall be held at such place or places, within or
without the Commonwealth of Pennsylvania, as shall be determined
by the Board of Directors from time to time.
Section 102. Annual Meetings. The annual meeting of the
shareholders for the election of directors and the transaction of
such other business as may properly come before the meeting shall
be held at such date or hour as may be fixed by the Board of
Directors. Notice of the place, date, time and purpose of the
annual meeting of shareholders shall be given not less than
thirty (30) days before such meeting to each shareholder of
record entitled to vote at such meeting.
Section 103. Special Meetings. Special meetings of the
shareholders may be called at any time by the President or the
Board of Directors. Notice of the place, date, time and purpose
of a special meeting of shareholders called by the President or
the Board of Directors, shall be given not less than thirty (30)
days before such meeting to each shareholder of record entitled
to vote at such meeting.
Section 104. Conduct of Shareholders' Meetings. The Chief
Executive Officer shall preside at all shareholders' meetings.
In the absence of the Chief Executive Officer, the Chairman of
the Board shall preside or, in his/her absence, any Officer
designated by the Board of Directors. The Officer presiding over
the shareholders' meeting may establish such rules and
regulations for the conduct of the meeting as he/she may deem to
be reasonably necessary or desirable for the orderly and
expeditious conduct of the meeting. Unless the Officer presiding
over the shareholders' meeting otherwise requires, shareholders
need not vote by ballot on any question.
Section 105. Shareholder Proposals.
(a) Any shareholder who intends to submit a proposal for
inclusion in the Corporation's proxy statement for the annual
meeting of shareholders shall submit his or her proposal to the
Secretary of the Corporation not less than 120 calendar days
before the date of the mailing of the Corporation's proxy
statement in connection with the previous year's annual meeting
of shareholders. A proposal shall be submitted and be consistent
in all other respects, including being a proper subject for
action by shareholders, with the then current rules and
regulations of the Securities and Exchange Commission.
(b) A shareholder who intends to submit a proposal at an annual
meeting of shareholders and does not intend to request inclusion
of such proposal in the Corporation's proxy statement for that
annual meeting, shall submit the proposal to the Secretary of the
Corporation not later than 45 calendar days before the date of
mailing of the Corporation's proxy statement in connection with
the previous year's annual meeting of shareholders. Such
proposal shall be a proper subject for action by shareholders
under applicable federal and state law.
ARTICLE II. DIRECTORS AND BOARD MEETINGS.
Section 201. Management by Board of Directors. The business
and affairs of the Corporation shall be managed by its Board of
Directors. The Board of Directors may exercise all such powers
of the Corporation and do all such lawful acts and things as are
not by statute, regulation, the Articles of Incorporation or
these Bylaws directed or required to be exercised or done by the
shareholders.
Section 202. Nomination for Directors. Nominations for
directors to be elected at an annual meeting of shareholders must
be submitted to the Secretary of the Corporation in writing not
later than the close of business on the sixtieth (60th) day
immediately preceding the date of the meeting. Such notification
shall contain the following information to the extent known to
the notifying shareholder: (a) name and address of each proposed
nominee; (b) the principal occupation of each proposed nominee;
(c) the number of shares owned in the name of each proposed
nominee; (d) the total number of shares of capital stock of the
Corporation that will be voted for each proposed nominee; (e) the
name and residence address of the notifying shareholder; and
(f) the number of shares of capital stock of the Corporation
owned by the notifying shareholder. Nominations not made in
accordance herewith shall be disregarded by the Presiding Officer
of the meeting, and upon his/her instruction, the vote tellers
shall disregard all votes cast for each such nominee. In the
event the same person is nominated by more than one shareholder,
the nomination shall be honored, and all shares of capital stock
of the Corporation shall be counted if at least one nomination
for that person complies herewith.
Section 203. Directors Must be Shareholders. Every Director
must be a shareholder of the Corporation and shall own in his/her
own right the number of shares (if any) required by law in order
to qualify as such Director. Any Director shall forthwith cease
to be a Director when he/she no longer holds such shares, which
fact shall be reported to the Board of Directors by the
Secretary, whereupon the Board of Directors shall declare the
seat of such Directors vacated.
Section 204. Resignations. Any Director may resign at any
time. Such resignation shall be in writing, but the acceptance
thereof shall not be necessary to make it effective.
Section 205. Compensation of Directors. No Director shall be
entitled to any salary as such; but the Board of Directors may
fix, from time to time, a reasonable annual fee for acting as a
Director and a reasonable fee to be paid each Director for
his/her services in attending meetings of the Board and meetings
of committees appointed by the Board. The Corporation may
reimburse Directors for expenses related to their duties as a
member of the Board.
Section 206. Regular Meetings. Regular meetings of the Board
of Directors shall be held on such day, at such hour, and at such
place, consistent with applicable law, as the Board shall from
time to time designate or as may be designated in any notice from
the Secretary calling the meeting. The Board of Directors shall
meet for reorganization at the first regular meeting following
the annual meeting of shareholders at which the Directors are
elected. Notice need not be given of regular meetings of the
Board of Directors which are held at the time and place
designated by the Board of Directors. If a regular meeting is
not to be held at the time and place designated by the Board of
Directors, notice of such meeting, which need not specify the
business to be transacted thereat and which may be either verbal
or in writing, shall be given by the Secretary to each member of
the Board at least twenty-four (24) hours before the time of the
meeting.
A majority of the members of the Board of Directors shall
constitute a quorum for the transaction of business. If at the
time fixed for the meeting, including the meeting to organize the
new Board following the annual meeting of shareholders, a quorum
is not present, the directors in attendance may adjourn the
meeting from time to time until a quorum is obtained.
Except as otherwise provided herein, a majority of those
directors present and voting at any meeting of the Board of
Directors, shall decide each matter considered. A director
cannot vote by proxy, or otherwise act by proxy at a meeting of
the Board of Directors.
Section 207. Special Meetings. Special meetings of the Board
of Directors may be called by the Chairman of the Board, the
President or at the request of three (3) or more members of the
Board of Directors. A special meeting of the Board of Directors
shall be deemed to be any meeting other than the regular meeting
of the Board of Directors. Notice of the time and place of every
special meeting, which need not specify the business to be
transacted thereat and which may be either verbal or in writing,
shall be given by the Secretary to each member of the Board at
least twenty-four (24) hours before the time of such meeting
excepting the Organization Meeting following the election of
Directors.
Section 208. Chairman of the Board. The Board of Directors
shall elect a Chairman of the Board at the first regular meeting
of the Board following each annual meeting of shareholders at
which Directors are elected. The Chairman of the Board shall be
a member of the Board of Directors and shall preside at the
meetings of the Board and perform such other duties as may be
prescribed by the Board of Directors.
Section 209. Vice President of the Board. The Board of
Directors may elect one (1) or more Vice Presidents of the Board
as the Board of Directors may from time to time deem advisable.
The Vice President of the Board shall have such duties as are
prescribed by the Board of Directors or the Chairman of the
Board.
Section 210. Reports and Records. The reports of Officers and
Committees and the records of the proceedings of all Committees
shall be filed with the Secretary of the Corporation and
presented to the Board of Directors, if practicable, at its next
regular meeting. The Board of Directors shall keep complete
records of its proceedings in a minute book kept for that
purpose. When a Director shall request it, the vote of such
Director upon a particular question shall be recorded in the
minutes.
ARTICLE III. COMMITTEES.
Section 301. Committees. The following two (2) Committees of
the Board of Directors shall be established by the Board of
Directors in addition to any other Committee the Board of
Directors may in its discretion establish: Executive, Discount
Committees.
Section 302. Executive Committee. The Executive Committee
shall consist of any five (5) or more Directors. A majority of
the members of the Executive Committee shall constitute a quorum,
and actions of a majority of those present at a meeting at which
a quorum is present shall be actions of the Committee. Meetings
of the Committee may be called at any time by the Chairman or
Secretary of the Committee, and shall be called whenever two (2)
or more members of the Committee so request in writing. The
Executive Committee shall have and exercise the authority of the
Board of Directors in the management of the business of the
Corporation between the dates of regular meetings of the Board.
Section 303. Appointment of Committee Members. The Board of
Directors shall elect the members of the Committees and the
Chairman and Vice Chairman of each such Committee to serve until
the next annual meeting of shareholders. The President shall
appoint or shall establish a method of appointing, subject to the
approval of the Board of Directors, the members of any other
Committees established by the Board of Directors, and the
Chairman and Vice Chairman of such Committee, to serve until the
next annual meeting of shareholders. The Board of Directors may
appoint, from time to time, other committees, for such purposes
and with such powers as the Board may determine.
Section 304. Organization and Proceedings. Each Committee of
the Board of Directors shall effect its own organization by the
appointment of a Secretary and such other Officers, except the
Chairman and Vice Chairman, as it may deem necessary. A record
of proceedings of all Committees shall be kept by the Secretary
of such Committee and filed and presented as provided in Section
210 of these Bylaws.
SECTION IV. OFFICERS.
Section 401. Officers. The Officers of the Corporation shall
be a President, one (1) or more Vice Presidents, a Secretary, a
Treasurer, and such other Officers and Assistant Officers as the
Board of Directors may from time to time deem advisable. Except
for the President, Secretary, and Treasurer, the Board may
refrain from filling any of the said offices at any time and from
time to time. The same individual may hold any two (2) or more
offices except both the offices of President and Treasurer. The
following Officers shall be elected by the Board of Directors at
the time, in the manner and for such terms as the Board of
Directors from time to time shall determine: President,
Executive Vice President, Senior Vice President, Administrative
Vice President, Secretary, and Treasurer. The President may,
subject to change by the Board of Directors, appoint such
Officers and Assistant Officers as he/she may deem advisable
provided such Officers or Assistant Officers have a title not
higher than Vice President, who shall hold office for such
periods as the President shall determine. Any Officer may be
removed at any time, with or without cause, and regardless of the
term for which such Officer was elected, but without prejudice to
any contract right of such Officer. Each Officer shall hold his
office for the current year for which he was elected or appointed
by the Board unless he shall resign, becomes disqualified, or be
removed at the pleasure of the Board of Directors.
Section 402. President. The President shall have general
supervision of all of the departments and business of the
Corporation and shall prescribe the duties of the other Officers
and Employees and see to the proper performance thereof. The
President shall be responsible for having all orders and
resolutions of the Board of Directors carried into effect. The
President shall execute on behalf of the Corporation and may
affix or cause to be affixed a seal to all authorized documents
and instruments requiring such execution, except to the extent
that signing and execution thereof shall have been delegated to
some other Officer or Agent of the Corporation by the Board of
Directors or by the President. The President shall be a member
of the Board of Directors. In the absence or disability of the
Chairman of the Board or his/her refusal to act, the President
shall preside at meetings of the Board. In general, the
President shall perform all the duties and exercise all the
powers and authorities incident to such office or as prescribed
by the Board of Directors.
Section 403. Vice Presidents. The Vice Presidents shall
perform such duties, do such acts and be subject to such
supervision as may be prescribed by the Board of Directors or the
President. In the event of the absence or disability of the
President or his/her refusal to act, the Vice Presidents, in the
order of their rank, and within the same rank in the order of
their authority, shall perform the duties and have the powers and
authorities of the President, except to the extent inconsistent
with applicable law.
Section 404. Secretary. The Secretary shall act under the
supervision of the President or such other Officers as the
President may designate. Unless a designation to the contrary is
made at a meeting, the Secretary shall attend all meetings of the
Board of Directors and all meetings of the shareholders and
record all of the proceedings of such meetings in a book to be
kept for that purpose, and shall perform like duties for the
standing Committees when required by these Bylaws or otherwise.
The Secretary shall give, or cause to be given, notice of all
meetings of the shareholders and of the Board of Directors. The
Secretary shall keep a seal of the Corporation, and, when
authorized by the Board of Directors or the President, cause it
to be affixed to any documents and instruments requiring it. The
Secretary shall perform such other duties as may be prescribed by
the Board of Directors, President, or such other Supervising
Officer as the President may designate.
Section 405. Treasurer. The Treasurer shall act under the
supervision of the President or such other Officer as the
President may designate. The Treasurer shall have custody of the
Corporation's funds and such other duties as may be prescribed by
the Board of Directors, President or such other Supervising
Officer as the President may designate.
Section 406. Assistant Officers. Unless otherwise provided by
the Board of Directors, each Assistant Officer shall perform such
duties as shall be prescribed by the Board of Directors, the
President or the Officer to whom he/she is an Assistant. In the
event of the absence or disability of an Officer or his/her
refusal to act, his/her Assistant Officer shall, in the order of
their rank, and within the same rank in the order of their
seniority, have the powers and authorities of such Officer.
Section 407. Compensation. Unless otherwise provided by the
Board of Directors, the salaries and compensation of all Officers
and Assistant Officers, except the President shall be fixed by or
in the manner designated by the President.
Section 408. General Powers. The Officers are authorized to do
and perform such corporate acts as are necessary in the carrying
on of the business of the Corporation, subject always to the
direction of the Board of Directors.
ARTICLE V. SHARES OF CAPITAL STOCK.
Section 501. Authority to Sign Share Certificates. Every share
certificate of the Corporation shall be signed by the Secretary
or Assistant Secretary and President, Chairman of the Board or
Senior Vice President-Chief Financial Officer of the Corporation.
Certificates may be signed by a facsimile signature of the
Secretary or Assistant Secretary and President, Chairman of the
Board or Senior Vice President-Chief Financial Officer of the
Corporation.
Section 502. Lost or Destroyed Certificates. Any person
claiming a share certificate to be lost, destroyed or wrongfully
taken shall receive a replacement certificate if such person
shall have: (a) requested such replacement certificate before
the Corporation has notice that the shares have been acquired by
a bona fide purchaser; (b) provided the Corporation with an
indemnity agreement satisfactory in form and substance to the
Board of Directors, or the President or the Secretary; and
(c) satisfied any other reasonable requirements (including
providing an affidavit and a surety bond) fixed by the Board of
Directors, or the President or the Secretary.
ARTICLE VI. GENERAL.
Section 601. Fiscal Year. The fiscal year of the Corporation
shall begin on the first (1st) day of January in each year and
end on the thirty-first (31st) day of December in each year.
Section 602. Record Date. The Board of Directors may fix any
time whatsoever (whether or not the same is more than fifty (50)
days) prior to the date of any meeting of shareholders, or the
date for the payment of any dividend or distribution, or the date
for the allotment of rights, or the date when any change or
conversion or exchange of shares will be made or will go into
effect, as a record date for the determination of the
shareholders entitled to notice of, or to vote at, any such
meetings, or entitled to receive payment of any such dividend or
distribution, or to receive any such allotment of rights, or to
exercise the rights in respect to any such change, conversion or
exchange of shares.
Section 603. Absentee Participation in Meetings. One (1) or
more Directors may participate in a meeting of the Board of
Directors, or of a Committee of the Board, by means of a
conference telephone or similar communications equipment, by
means of which all persons participating in the meeting can hear
each other.
Section 604. Emergency Bylaws. In the event of any emergency
resulting from a nuclear attack or similar disaster, and during
the continuance of such emergency, the following Bylaw provisions
shall be in effect, notwithstanding any other provisions of the
Bylaws:
(a) A meeting of the Board of Directors or of any Committee
thereof may be called by any Officer or Director upon one (1)
hour's notice to all persons entitled to notice whom, in the sole
judgment of the notifier, it is feasible to notify;
(b) The Director or Directors in attendance at the meeting of
the Board of Directors or of any Committee thereof shall
constitute a quorum; and
(c) These Bylaws may be amended or repealed, in whole or in
part, by a majority vote of the Directors attending any meeting
of the Board of Directors, provided such amendment or repeal
shall only be effective for the duration of such emergency.
Section 605. Severability. If any provision of these Bylaws is
illegal or unenforceable as such, such illegality or
unenforceability shall not affect any other provision of these
Bylaws and such other provisions shall continue in full force and
effect.
ARTICLE VII. INDEMNIFICATION OF OFFICERS AND EMPLOYEES.
Section 701. The Corporation shall indemnify any officer and/or
employee, or any former officer and/or employee, who was or is a
party to, or is threatened to be made a party to, or who is
called to be a witness in connection with, any threatened,
pending or completed action, suit or proceeding, whether civil,
criminal, administrative or investigative (other than an action
by or in the right of the Corporation) by reason of the fact that
such person is or was an officer and/or employee of the
Corporation, or is or was serving at the request of the
Corporation as a director, officer, employee or agent of another
corporation, partnership, joint venture, trust or other
enterprise, against expenses (including attorneys' fees),
judgments, fines and amounts paid in settlement actually and
reasonably incurred by him in connection with such action, suit
or proceeding if he acted in good faith and in a manner he
reasonably believed to be in, or not opposed to, the best
interests of the Corporation, and, with respect to any criminal
action or proceeding, had no reasonable cause to believe his
conduct was unlawful. The termination of any action, suit or
proceeding by judgment, order, settlement, conviction or upon a
plea of nolo contendere or its equivalent, shall not of itself
create a presumption that the person did not act in good faith
and in a manner which he reasonably believed to be in, or not
opposed to, the best interests of the Corporation, and, with
respect to any criminal action or proceeding, had no reasonable
cause to believe that his conduct was unlawful.
Section 702. The Corporation shall indemnify any officer and/or
employee, who was or is a party to, or is threatened to be made a
party to, or who is called as a witness in connection with, any
threatened, pending or completed action or suit by or in the
right of the Corporation to procure a judgment in its favor by
reason of the fact that such person is or was a director,
officer, and/or employee or agent of another corporation,
partnership, joint venture, trust or other enterprise against
amounts paid in settlement and expenses (including attorneys'
fees) actually and reasonably incurred by him in connection with
the defense or settlement of, or serving as a witness in, such
action or suit if he acted in good faith and in a manner he
reasonably believed to be in, or not opposed to, the best
interests of the Corporation and except that no indemnification
shall be made in respect of any such claim, issue or matter as to
which such person shall have been adjudged to be liable for
misconduct in the performance of his duty to the Corporation.
Section 703. Except as may be otherwise ordered by a court,
there shall be a presumption that any officer and/or employee is
entitled to indemnification as provided in Sections 701 and 702
of this Article unless either a majority of the directors who are
not involved in such proceedings ("disinterested directors") or,
if there are less than three disinterested directors, then the
holders of one-third of the outstanding shares of the Corporation
determine that the person is not entitled to such presumption by
certifying such determination in writing to the Secretary of the
Corporation. In such event the disinterested director(s) or, in
the event of certification by shareholders, the Secretary of the
Corporation shall request of independent counsel, who may be the
outside general counsel of the Corporation, a written opinion as
to whether or not the parties involved are entitled to
indemnification under Sections 701 and 702 of this Article.
Section 704. Expenses incurred by an officer and/or employee in
defending a civil or criminal action, suit or proceeding may be
paid by the Corporation in advance of the final disposition of
such action, suit or proceeding as authorized in the manner
provided under Section 703 of this Article upon receipt of an
undertaking by or on behalf of the officer and/or employee to
repay such amount if it shall ultimately be determined that he is
not entitled to be indemnified by the Corporation.
Section 705. The indemnification provided by this Article shall
not be deemed exclusive of any other rights to which a person
seeking indemnification may be entitled under any agreement, vote
of shareholders or disinterested directors, or otherwise, both as
to action in his official capacity while serving as an officer
and/or employee and as to action in another capacity while
holding such office, and shall continue as to a person who has
ceased to be an officer and/or employee and shall inure to the
benefit of the heirs, executors and administrators of such a
person.
Section 706. The Corporation may create a fund of any nature,
which may, but need not be, under the control of a trustee, or
otherwise secure or insure in any manner its indemnification
obligations arising under this Article.
Section 707. The Corporation shall have the power to purchase
and maintain insurance on behalf of any person who is or was an
officer and/or employee of the Corporation, or is or was serving
at the request of the Corporation as an officer and/or employee
of another corporation, partnership, joint venture, trust or
other enterprise against any liability asserted against him and
incurred by him in any such capacity, or arising out of his
status as such, whether or not the Corporation would have the
power to indemnify him against such liability under the
provisions of this Article.
Section 708. Indemnification under this Article shall not be
made in any case where the act or failure to act giving rise to
the claim for indemnification is determined by a court to have
constituted willful misconduct or recklessness.
ARTICLE VIII. INDEMNIFICATION OF DIRECTORS.
Section 801. A director of this Corporation shall stand in a
fiduciary relation to the Corporation and shall perform his
duties as a director, including his duties as a member of any
committee of the board upon which he may serve, in good faith, in
a manner he reasonably believes to be in the best interests of
the Corporation, and with such care, including reasonable
inquiry, skill and diligence, as a person of ordinary prudence
would use under similar circumstances. In performing his duties,
a director shall be entitled to rely in good faith on
information, opinions, reports or statements, including financial
statements and other financial data, in each case prepared or
presented by any of the following:
(a) One or more officers or employees of the Corporation whom
the director reasonably believes to be reliable and competent in
the matters presented.
(b) Counsel, public accountants or other persons as to matters
which the director reasonably believes to be within the
professional or expert competence of such person.
(c) A committee of the board upon which he does not serve, duly
designated in accordance with law, as to matters within its
designated authority, which committee the director reasonably
believes to merit confidence.
A director shall not be considered to be acting in good faith if
he has knowledge concerning the matter in question that would
cause his reliance to be unwarranted.
Section 802. In discharging the duties of their respective
positions, the board of directors, committees of the board, and
individual directors may, in considering the best interests of
the Corporation, consider the effects of any action upon
employees, upon suppliers and customers of the Corporation and
upon communities in which offices or other establishments of the
Corporation are located, and all other pertinent factors. The
consideration of those factors shall not constitute a violation
of Section 801.
Section 803. Absent a breach of fiduciary duty, lack of good
faith or self-dealing, actions taken as a director or any failure
to take any action shall be presumed to be in the best interests
of the Corporation.
Section 804. A director of this Corporation shall not be
personally liable for monetary damages as such for any action
taken or for any failure to take any action, unless:
(a) the director has breached or failed to perform the duties of
his office under the provisions of Sections 801 and 802, and
(b) the breach or failure to perform constitutes self-dealing,
willful misconduct or recklessness.
Section 805. The provisions of Section 804 shall not apply to:
(a) the responsibility or liability of a director pursuant to a
criminal statute, or
(b) the liability of a director for the payment of taxes
pursuant to local, state or federal law.
Section 806. The Corporation shall indemnify any director, or
any former director who was or is a party to, or is threatened to
be made a party to, or who is called to be a witness in
connection with, any threatened, pending or completed action,
suit or proceeding, whether civil, criminal, administrative or
investigative (other than an action by or in the right of the
Corporation) by reason of the fact that such person is or was a
director of the Corporation, or is or was serving at the request
of the Corporation as a director, officer, employee or agent of
another corporation, partnership, joint venture, trust or other
enterprise, against expenses (including attorneys' fees),
judgment, fines and amounts paid in settlement actually and
reasonably incurred by him in connection with such action, suit
or proceeding if he acted in good faith and in a manner he
reasonably believed to be in, or not opposed to, the best
interests of the Corporation, and, with respect to any criminal
action or proceeding, had no reasonable cause to believe his
conduct was unlawful. The termination of any action, suit or
proceeding by judgment, order, settlement, conviction or upon a
plea of nolo contendere or its equivalent, shall not of itself
create a presumption that the person did not act in good faith
and in a manner which he reasonably believed to be in, or not
opposed to, the best interests of the Corporation, and, with
respect to any criminal action or proceeding, had no reasonable
cause to believe that his conduct was unlawful.
Section 807. The Corporation shall indemnify any director who
was or is a party to, or is threatened to be made a party to, or
who is called as a witness in connection with, any threatened,
pending or completed action or suit by or in the right of the
Corporation to procure a judgment in its favor by reason of the
fact that such person is or was a director, officer and/or
employee or agent of another corporation, partnership, joint
venture, trust or other enterprise against amounts paid in
settlement and expenses (including attorneys' fees) actually and
reasonably incurred by him in connection with the defense or
settlement of, or serving as a witness in, such action or suit if
he acted in good faith and in a manner he reasonably believed to
be in, or not opposed to, the best interests of the Corporation
and except that no indemnification shall be made in respect of
any such claim, issue or matter as to which such person shall
have been adjudged to be liable for misconduct in the performance
of his duty to the Corporation.
Section 808. Except as may be otherwise ordered by a court,
there shall be a presumption that any director is entitled to
indemnification as provided in Sections 806 and 807 of this
Article unless either a majority of the directors who are not
involved in such proceedings ("disinterested directors") or, if
there are less than three disinterested directors, then the
holders of one-third of the outstanding shares of the Corporation
determine that the person is not entitled to such presumption by
certifying such determination in writing to the Secretary of the
Corporation. In such event the disinterested director(s) or, in
the event of certification by shareholders, the Secretary of the
Corporation shall request of independent counsel, who may be the
outside general counsel of the Corporation, a written opinion as
to whether or not the parties involved are entitled to
indemnification under Sections 806 and 807 of this Article.
Section 809. Expenses incurred by a director in defending a
civil or criminal action, suit or proceeding may be paid by the
Corporation in advance of the final disposition of such action,
suit or proceeding as authorized in the manner provided under
Section 808 of this Article upon receipt of an undertaking by or
on behalf of the director, officer and/or employee to repay such
amount if it shall ultimately be determined that he is not
entitled to be indemnified by the Corporation as authorized by
this Article.
Section 810. The indemnification provided by this Article shall
not be deemed exclusive of any other rights to which a person
seeking indemnification may be entitled under any agreement, vote
of shareholders or disinterested directors, or otherwise, both as
to action in his official capacity while serving as a director
and as to action in another capacity while holding such office,
and shall continue as to a person who has ceased to be a director
and shall inure to the benefit of the heirs, executors and
administrators of such a person.
Section 811. The Corporation may create a fund of any nature,
which may, but need not be, under the control of a trustee, or
otherwise secure or insure in any manner its indemnification
obligations arising under this Article.
Section 812. The Corporation shall have the power to purchase
and maintain insurance on behalf of any person who is or was a
director or is or was serving at the request of the Corporation
as a director, officer, employee or agent of another corporation,
partnership, joint venture, trust or other enterprise against any
liability asserted against him and incurred by him in any such
capacity, or arising out of his status as such, whether or not
the Corporation would have the power to indemnify him against
such liability under the provisions of this Article.
Section 813. Indemnification under this Article shall not be
made in any case where the act or failure to act giving rise to
the claim for indemnification is determined by a court to have
constituted willful misconduct or recklessness.
ARTICLE IX. AMENDMENT OR REPEAL.
Section 901. Amendment or Repeal by the Board of Directors.
These Bylaws may be amended or repealed, in whole or in part, by
a majority vote of members of the Board of Directors at any
regular or special meeting of the Board duly convened. Notice
need not be given of the purpose of the meeting of the Board of
Directors at which the amendment or repeal is to be considered.
Section 902. Recording Amendments and Repeals. The text of all
amendments and repeals to these Bylaws shall be attached to the
Bylaws with a notation of the date and vote of such amendment or
repeal.
ARTICLE X. APPROVAL OF AMENDED BYLAWS AND RECORD OF AMENDMENTS
AND REPEALS.
Section 1001. Approval and Effective Date. These Bylaws have
been approved as the Bylaws of the Corporation this 15th day of
June, 1983, and shall be effected as of said date.
Section 1002. Amendments or Repeals.
Section Involved Date Amended or Repealed Approved By
Article VII May 5, 1987 Shareholders
Article VIII May 5, 1987 Shareholders
Article IX (renumbered) May 5, 1987 Board of Directors
Article X (renumbered) May 5, 1987 Board of Directors
EXHIBIT 13
PORTIONS OF THE ANNUAL REPORT TO STOCKHOLDERS
FOR FISCAL YEAR ENDED DECEMBER 31, 1998
EXHIBIT 21
LIST OF SUBSIDIARIES OF THE COMPANY
Community Bank and Trust Company, incorporated under the laws of
the Commonwealth of Pennsylvania as a state-chartered commercial
banking institution and trust company.
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<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED STATESMENTS OF OPERATIONS AND CONSOLIDATED BALANCE SHEETS
FOUND ON PAGES 148 AND 149 OF THE COMPANY'S FORM 10-K FOR THE YEAR-TO-
DATE, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
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