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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, 2003
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
Commission file number 0-15786
[GRAPHIC OMITTED]COMMUNITYBANKS[GRAPHIC OMITTED]
COMMUNITY BANKS, INC.
(Exact name of registrant as specified in its charter)
Pennsylvania 23-2251762
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
750 East Park Drive, Harrisburg, PA 17111
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (717) 920-1698
Securities registered pursuant to Section 12 (b) of the Act: None
Securities registered pursuant to Section 12 (g) of the Act:
Common Stock, par value $5 per share
------------------------------------
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, 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 the Form 10-K or any amendments to this
Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
Yes X No
----- ----
Aggregate market value of the Common Stock, $5 par value, held by non-affiliates
of the registrant, computed by reference to the closing price as of the close of
business on June 30, 2003: $258,000,000
Number of shares of the Common Stock, $5 par value, outstanding as of the close
of business on March 1, 2004: 11,700,000 shares.
Documents Incorporated by Reference:
Portions of the Proxy Statement for the 2004 Annual Meeting of Shareholders of
Community Banks, Inc., have been incorporated by reference into Part III.
COMMUNITY BANKS, INC. and SUBSIDIARIES
FORM 10-K
INDEX
PART I Page
Item 1 Business 3-4
Item 2 Properties 5
Item 3 Legal Proceedings 5
Item 4 Submission of Matters to a Vote of Security Holders 5
PART II
Item 5 Market for Registrant's Common Equity and Related Stockholder Matters 6
Item 6 Selected Financial Data 7
Item 7 Management's Discussion and Analysis of Financial Condition and Results
of Operation 8-32
Item 7A Quantitative and Qualitative Disclosures About Market Risk 33-35
Item 8 Financial Statements and Supplementary Data 36-63
Item 9 Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure 64
Item 9A Controls and Procedures 64
PART III
Item 10 Directors and Executive Officers of the Registrant 65
Item 11 Executive Compensation 65
Item 12 Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters 65
Item 13 Certain Relationships and Related Transactions 65
Item 14 Principal Accounting Fees and Services 65
PART IV
Item 15 Exhibits, Financial Statement Schedules, and Reports on Form 8-K 66-68
SIGNATURES 69
2
PART I
Item 1. Business:
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Community Banks, Inc., referred to in this report as the "Corporation" or
"Community," is a financial holding company that was formed as a Pennsylvania
corporation in 1982. Community's banking subsidiary is Community Banks, referred
to in this report as the "Bank." Community's non-banking subsidiaries are
Community Bank Investments, Inc. (CBII), Community Banks Life Insurance Company,
Inc. (CBLIC), CMTY Capital Trust I, and CMTY Capital Statutory Trust II. The
subsidiaries of the Bank are UDNB Investments, Inc.; PSB Realty Co., Inc.; The
Sentinel Agency, LLC; Community Banks Insurance Services, LLC; CB Services, LLC;
and Erie Financial Group, LLC.
On January 1, 2002, Community consolidated the charters of its banking
subsidiaries under the name Community Banks, pursuant to regulatory approvals.
Prior to that time, Community's separate banking organizations operated as
Peoples State Bank (PSB), a state chartered bank with offices throughout York
and Adams Counties; and Community Banks, N.A. (CBNA), a federally chartered bank
headquartered in Dauphin County with offices in central and northeastern
Pennsylvania. The consolidation was designed to facilitate a regional
operational focus that would ease regulatory burdens while, at the same time,
maintain a philosophy of local decision-making.
Community conducts a full service commercial banking business and provides trust
services through 46 banking offices in Pennsylvania and Maryland: 3 offices in
Adams County, 2 offices in Cumberland County, 10 offices in Dauphin County, 3
offices in Luzerne County, 2 offices in Northumberland County, 7 offices in
Schuylkill County, 1 office in Snyder County, and 16 offices in York County,
Pennsylvania and 2 offices in Carroll County, Maryland. There are nearly 700
offices of commercial banks and savings and loan associations within its market
area with which Community competes. Deposits of Community represent
approximately 5% of the total deposits in the market area.
Like other banking companies, Community has been subjected to competition from
credit unions, brokerage firms, money market funds, consumer finance and credit
card companies and other companies providing financial services and credit to
consumers.
Over the years, Community has formed special purpose subsidiaries which are
included in consolidated results. In December 2003, Community formed CMTY
Statutory Capital Trust II to execute a trust preferred issuance of $15 million.
In December 2002, Community formed CMTY Capital Trust I to execute a pooled
trust preferred issuance of $15 million. In 1986, Community formed CBLIC to
provide credit life insurance to its consumer credit borrowers. Total premiums
earned were $188,000 for the year ended December 31, 2003. In 1985, Community
formed CBII to make investments primarily in equity securities of other banks.
Total assets of CBII at December 31, 2003 were $7.9 million.
Community and its subsidiaries have approximately 630 full and part-time
employees and Community considers its employee relations to be satisfactory.
Supervision and Regulation of Community
- ---------------------------------------
The banking industry is subject to extensive state and federal regulation.
Proposals to change laws and regulations governing the banking industry are
frequently raised in Congress, in state legislatures, and in various bank
regulatory agencies. The likelihood and timing that any such changes may have on
Community are difficult to determine with any certainty. Changes in laws or
regulations, or changes in the interpretation of laws or regulations, may have a
material impact on the business, operations and earnings of Community.
Community Banks, Inc. is registered as a financial holding company with the
Federal Reserve Board in accordance with the requirements of the
Gramm-Leach-Bliley Act (the "GLB Act"). The GLB Act enables broad-scale
consolidation among banks, securities firms and insurance companies for eligible
bank holding companies that have elected and maintain "financial holding
company" status. Financial holding companies can offer virtually any type of
financial service, including banking, securities underwriting, insurance (both
agency and underwriting) and merchant banking. If a bank holding company does
not become a financial holding company, it will be limited to those activities
previously determined by the Federal Reserve Board to be permissible; i.e.,
"closely related to banking" under the standard set forth in the Bank Holding
Company Act. In order to become a financial holding company, all of a bank
holding company's bank subsidiaries must be well capitalized and well managed
and have a rating under the Community Reinvestment Act (the "CRA") of at least
"satisfactory."
3
Community is subject to regulation by the Federal Reserve Board. The Federal
Reserve Board requires regular reports from Community and is authorized to make
regular examinations of Community and its subsidiaries. The Bank is subject to
supervision and regulation, and is examined regularly, by the Federal Deposit
Insurance Corporation and the state banking departments in the states in which
it operates. To the extent that the Bank's subsidiaries are licensed to engage
in the sale of insurance or the mortgage brokerage business, the subsidiaries
are subject to examination by the respective licensing authorities. Community
and its direct non-banking subsidiaries are affiliates, within the meaning of
the GLB Act, of the Bank and its subsidiaries. As a result, the Bank and its
subsidiaries are subject to restrictions on loans or extensions of credit to,
purchase of assets from, investments in, and transactions with Community and its
direct non-banking subsidiaries and on certain other transactions with them or
involving their securities.
Capital Adequacy
- ----------------
The Federal Reserve Board and the FDIC have adopted risk-based capital adequacy
guidelines for financial holding companies and banks under their supervision.
Under these guidelines, "Tier 1 capital" and "Total capital" as a percentage of
risk-weighted assets and certain off-balance sheet instruments must be at least
4% and 8%, respectively. The regulators have also imposed a leverage standard,
which focuses on the institution's ratio of Tier 1 capital to average total
assets, adjusted for goodwill and certain other items, to supplement their
risk-based ratios. This minimum leverage ratio was set at 3% and would apply
only to those banking organizations receiving a regulatory composite 1 rating.
Most banking organizations will be required to maintain a leverage ratio ranging
from 1 to 2 percentage points above the minimum standard.
Community and the Bank are subject to various regulatory capital requirements
administered by federal and state banking agencies. Failure to meet minimum
capital requirements can initiate certain mandatory and possibly additional
discretionary actions by regulators that, if undertaken, could have a direct
material effect on Community's financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, each
subsidiary bank must meet specific capital guidelines that involve quantitative
measures of assets, liabilities, and certain off-balance-sheet items as
calculated under regulatory accounting practices. The capital amounts and
classification are also subject to qualitative judgments by the regulators about
the risk weightings of components, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require Community to maintain minimum amounts and ratios of total and Tier 1
capital to risk-weighted assets and of Tier 1 capital to average assets.
Management believes, as of December 31, 2003, that Community and the Bank have
met all capital adequacy requirements to which they are subject. For tables
presenting Community's capital ratios, see "Notes to Consolidated Financial
Statements - Regulatory Matters" included in Part II, Item 8.
Sarbanes-Oxley Act of 2002
- --------------------------
The Sarbanes-Oxley Act of 2002 (Sarbanes-Oxley), which was signed into law in
July, 2002, impacts all companies with securities registered under the
Securities Exchange Act of 1934, including Community. Sarbanes-Oxley created new
requirements in the areas of corporate governance and financial disclosure
including, among other things, (i) increased responsibility for Chief Executive
Officers and Chief Financial Officers with respect to the content of filings
with the SEC; (ii) enhanced requirements for audit committees, including
independence and disclosure of expertise; (iii) enhanced requirements for
auditor independence and the types of non-audit services that auditors can
provide; (iv) accelerated filing requirements for SEC reports; (v) increased
disclosure and reporting obligations for companies, their directors and their
executive officers; and (vi) new and increased civil and criminal penalties for
violation of securities laws.
Certifications of the Chief Executive Officer and the Chief Financial Officer as
required by Sarbanes-Oxley and the resulting SEC rules can be found in the
"Exhibits" section of this document.
Other Information
- -----------------
Community's internet address is www.communitybanks.com. Electronic copies of
Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports
on Form 8-K, and amendments to those reports filed or furnished pursuant to
Section 13(a) or 15(d) of the Exchange Act, are available through the "Investor
Relations" section of Community's website as soon as reasonably practicable
after filing such material with, or furnishing it to, the Securities and
Exchange Commission. Copies of such reports are also available at no charge.
4
Item 2. Properties:
- -------------------
The following table summarizes the Bank's branch network:
PSB Total
Bank (1) Realty(2) Leased Term (3) Branches
------- -------- ------ ------- --------
In Pennsylvania:
Adams County 2 1 - - 3
Cumberland County 1 - 1 2019 2
Dauphin County 7 - 3 2018 10
Luzerne County 1 - 2 2005 3
Northumberland County 2 - - - 2
Schuylkill County 7 - - - 7
Snyder County 1 - - - 1
York County 6 4 6 2020 16
In Maryland:
Carroll County 1 - 1 2007 2
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Total 28 5 13 46
=========================================== ===========
(1) Properties are owned by the Bank, free and clear of encumbrances.
(2) Properties are owned by PSB Realty Company and are leased to the Bank.
(3) Latest lease term expiration date, excluding renewal options.
From time to time, the Bank also acquires real estate by virtue of foreclosure
proceedings, and such real estate is disposed of in the usual and ordinary
course of business as expeditiously as is prudently possible.
The following table summarizes the Corporation's other significant properties:
Owned/ Lease
User Character of Facility Location Leased Expires(1)
---- --------------------- -------- ------ ----------
Community Banks, Inc. Executive Offices Harrisburg, PA Leased 2007
Community Banks Operations Center Halifax, PA Owned
Community Banks Operations Center Hanover, PA Owned
The Sentinel Agency LLC Admin/Sales Harrisburg, PA Leased 2004
CB Insurance Services LLC Admin Mechanicsburg, PA Leased 2004
Erie Financial Group LLC Admin/Sales York, PA Owned
(1) Latest lease term expiration date, excluding renewal options.
Item 3. Legal Proceedings:
- ---------------------------
Various actions and proceedings are presently pending to which Community or one
or more of its subsidiaries is a party. These actions and proceedings arise out
of routine operations and, in management's opinion, will not have a material
adverse effect on Community's consolidated financial position.
Item 4. Submission of Matters to a Vote of Security Holders:
- -------------------------------------------------------------
No matters were submitted to a vote of security holders during the fourth
quarter of 2003.
5
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters:
- -------------------------------------------------------------------------------
Market Information
- ------------------
The shares of Community are traded on the Nasdaq National Market under the
symbol CMTY and are transferred through local and regional brokerage houses.
Community had approximately 3,346 shareholders as of December 31, 2003. The
following table sets forth dividends declared per share and the high and low
prices of Community at which the common stock has been transferred during the
periods indicated. High and low prices are based solely upon transactions known
to management of Community and represent a portion of the actual transfers of
common stock during the periods in question.
------------------------------------------------------------------------------------------------------
2003 2002
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Price Per Share Dividends Price Per Share Dividends
Low High Declared Low High Declared
First Quarter $21.83 $23.63 .16 $19.33 $22.02 .13
Second Quarter 23.22 25.00 .16 20.28 23.57 .14
Third Quarter 24.88 27.92 .17 18.97 21.98 .14
Fourth Quarter 28.00 33.75 .17 20.62 23.02 .16
Holders of the common stock of Community are entitled to such dividends as may
be declared from time to time by the Board of Directors out of funds legally
available therefore. Community currently expects that it will continue to pay
comparable dividends in the future, subject to regulatory requirements,
Community's financial condition and requirements, future prospects, business
conditions and other factors deemed relevant by the Board of Directors. As noted
in "Capital Adequacy" in Part I, Item 1, Community is subject to various
regulatory capital requirements that limit the amount of capital available for
dividends.
The market prices listed above are based on historical market quotations and
have been restated to reflect stock dividends and splits.
Equity Compensation Plan Information
- ------------------------------------
- ---------------------------------- -------------------------------- -------------------------------- -------------------------------
(a) (b) (c)
Number of securities
remaining available for
Number of securities to be future issuance under equity
issued upon exercise of Weighted average exercise compensation plans (excluding
outstanding options, warrants price of outstanding options, securities reflected in
Plan Category and rights warrants and rights column (a))
- ---------------------------------- -------------------------------- -------------------------------- -------------------------------
Equity compensation plans 978,376 $18.80 1,049,468 (1)
approved by security holders
- ---------------------------------- -------------------------------- -------------------------------- -------------------------------
Equity compensation plans not
approved by security holders (2) None n/a n/a
- ---------------------------------- -------------------------------- -------------------------------- -------------------------------
Total 978,376 $18.80 1,049,468
- ---------------------------------- -------------------------------- -------------------------------- -------------------------------
(1) Includes 80,960 shares available for future issuance under Community's
Employee Stock Purchase Plan.
(2) Community does not maintain equity compensation plans that have not
been approved by its stockholders.
Sales of Unregistered Securities
- --------------------------------
On December 16, 2003, Community, through its subsidiary CMTY Capital Statutory
Trust II, issued and sold to STI Investment Management, Inc., 15,000 trust
preferred securities for an aggregate offering price of $15 million. The trust
securities were exempt from registration under the private offering exemption in
Section 4(2) of the Securities Act of 1933 and Section 506 of Securities and
Exchange Commission Regulation D. Community used the proceeds of the sale for
general corporate purposes.
6
Item 6. Selected Financial Data:
- --------------------------------
At or for the Year Ended December 31
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2003 2002 2001 2000 1999
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(dollars in thousands except per share data)
BALANCE SHEET DATA:
At Period End:
Investment securities $ 646,961 $ 667,801 $ 543,901 $ 389,819 $ 360,540
Total loans 1,078,611 904,568 857,278 814,874 708,016
Total assets 1,860,130 1,679,898 1,509,734 1,308,713 1,151,344
Total deposits 1,230,685 1,132,913 1,003,225 919,241 826,167
Long-term debt 441,422 335,533 322,155 239,613 213,865
Stockholders' equity 143,406 129,162 111,249 103,978 86,309
Average:
Total assets 1,780,171 1,580,046 1,398,521 1,238,870 1,093,262
Total stockholders' equity 135,773 119,352 111,381 92,255 92,274
EARNINGS DATA:
Net interest income 52,536 50,488 45,935 43,795 40,248
Provision for loan losses 2,500 3,350 5,080 2,863 1,588
Net interest income after provision
for loan losses 50,036 47,138 40,855 40,932 38,660
Other income 20,441 13,975 12,141 8,148 6,388
Other expense 45,718 39,300 36,521 30,463 27,501
Provision for income taxes 4,359 3,367 2,879 4,702 4,257
Net income 20,400 18,446 13,596 13,915 13,290
PER SHARE DATA:
Basic earnings per share 1.76 1.59 1.17 1.21 1.14
Diluted earnings per share 1.71 1.55 1.15 1.19 1.12
Cash dividends .66 .57 .51 .45 .41
Book value 12.31 11.20 9.50 9.08 7.44
Average diluted shares outstanding 11,902,259 11,896,495 11,868,567 11,649,436 11,821,835
PROFITABILITY RATIOS:
Return on average assets 1.15% 1.17% .97% 1.12% 1.22%
Return on average stockholders' equity 15.03% 15.46% 12.21% 15.08% 14.40%
Net interest margin (FTE) 3.50% 3.78% 3.83% 4.01% 4.20%
Efficiency ratio 60.47% 56.81% 59.77% 55.42% 55.54%
CAPITAL AND LIQUIDITY RATIOS:
Stockholders' equity to total assets 7.71% 7.69% 7.37% 7.95% 7.50%
Average equity to average assets 7.64% 7.55% 7.96% 7.45% 8.44%
Dividend payout ratio 37.35% 36.07% 43.25% 37.48% 36.70%
Net loans to assets 57.28% 53.11% 55.98% 61.48% 60.72%
ASSET QUALITY RATIOS:
Allowance for loan losses to total loans
outstanding 1.22% 1.36% 1.42% 1.27% 1.27%
Allowance for loan losses to non-accrual
loans 162% 131% 109% 171% 152%
Non-accrual loans to total loans
outstanding .76% 1.04% 1.29% .74% .83%
Non-performing assets to total assets .70% .63% .78% .49% .57%
Net charge-offs to average loans outstanding .17% .35% .39% .20% .18%
7
Item 7. Management's Discussion and Analysis of Financial Condition and Results
- --------------------------------------------------------------------------------
of Operation:
-------------
MANAGEMENT'S DISCUSSION OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This discussion is being presented to provide a narrative explanation of the
financial statements of Community. The purpose of this presentation is to
enhance the overall financial disclosure and to provide information about
historic financial performance as a means to assess whether past performance can
be used to evaluate the prospects for future performance. Throughout this
presentation, net income and yield on earning assets have been presented on a
tax equivalent basis and balances represent average daily balances unless
otherwise indicated. All per share amounts have been restated to give effect to
the stock split, issued in the form of a 20% stock dividend, announced in the
fourth quarter of 2003. During 2003, Community completed the acquisitions of
several businesses, including: Abstracting Company of York County (ABCO), a
title, settlement, and abstracting company (April, 2003); Erie Financial Group,
Ltd. (Erie), a company providing mortgage origination services (July, 2003); and
Your Insurance Partnership, an insurance agency group specializing in personal
insurance services (October, 2003). All dollar amounts are presented in
thousands, unless otherwise indicated.
FORWARD-LOOKING STATEMENTS
Periodically, Community has made and will continue to make statements that may
include forward-looking information. The Corporation cautions that
forward-looking information disseminated through financial presentations should
not be construed as guarantees of future performance. Furthermore, actual
results may differ from expectations contained in such forward-looking
information as a result of factors that are not predictable. Financial
performance can be affected by any number of factors that are not predictable or
are out of management's direct control. Examples include: the effect of
prevailing economic conditions; unforeseen or dramatic changes in the general
interest rate environment; actions or changes in policies of the Federal Reserve
Board and other government agencies; business risk associated with the
management of the credit extension function and fiduciary activities. Each of
these factors could affect estimates, assumptions, uncertainties and risk used
to develop forward-looking information, and could cause actual results to differ
materially from management's expectations regarding future performance.
CRITICAL ACCOUNTING POLICY: ADEQUACY OF ALLOWANCE
Management believes that the application of its accounting policies and
procedures in the determination of the adequacy of the allowance for loan
losses, and the related provision for loan losses, should be considered to be a
critical accounting policy to ensure the fair presentation of the Corporation's
financial statements. Community applies a systemic methodology in order to
estimate the allowance for loan losses. These methodologies incorporate
management's judgments about the credit quality of the loan portfolio through a
disciplined process that is consistently applied. This process requires that a
detailed analysis of the loan portfolio be performed on a quarterly basis. This
analysis includes a specific individual loan review for any and all loans that
meet specific materiality criteria. Such loans are evaluated for impairment
under the provisions of Statement of Financial Accounting Standards (SF AS) No.
114, "Accounting by Creditors for Impairment of a Loan". The portfolio is
further stratified to analyze groups of homogenous loans with similar risk
characteristics. Such loans are evaluated under the provisions of SFAS No. 5
"Accounting for Contingencies". Management considers all known relevant internal
and external factors that may affect loan collectability, as well as particular
risks indigenous to specific types of lending. The process is further designed
to consolidate the aggregate loss estimates and to ensure that the allowance for
loan losses is recorded in accordance with generally accepted accounting
principles. The final results are reviewed and approved by executive management.
Results are constantly validated by a review of trends associated with loan
volume, delinquencies, potential concentrations, or other factors that may
influence the methodology used to estimate the allowance for loan losses.
2003 PERFORMANCE OVERVIEW
Community completed another year of record performance in 2003, reporting the
highest net income and earnings per share in its history. At the same time,
Community made significant progress in its continuing effort to evolve into a
"community-focused" financial services corporation, capable of delivering a
competitive menu of services to meet the expanding needs of individuals and
businesses within its marketplace. Community is committed to achieving the
highest possible return to its shareholders, constrained by the need for both
prudent management of critical risk factors and the continuing investment in
infrastructure to ensure superior customer service and growth of the franchise.
8
Net income reached $20.4 million, an 11% increase from the net income of $18.4
million reported in 2002. Similarly, diluted earnings per share reached $1.71, a
10% improvement from the $1.55 reported in 2002. Return on average assets (ROA)
and return on average equity (ROE) provide traditional benchmarks used to
compare the relative operating performance of financial service companies. At
the end of 2003, the Corporation produced an ROA of 1.15% and an ROE of 15.03%,
which were comparable to the performances of 1.17% and 15.46%, respectively, in
the prior year. Community has established long-term performance goals that are
consistent with its emergence as a growing and vibrant competitor within its
expanding footprint. The performance during 2003 was consistent with these
operating goals and generated favorable performance comparisons to
similarly-sized financial service companies operating within the northeast
region of the United States.
Performance for 2003 included double-digit growth in loan volume and steady
deposit growth that combined to yield a 5% increase in net interest income.
Non-interest income was influenced primarily by the growth in fees associated
with acquired businesses and with increases in new or existing banking products.
Mortgage origination fees expanded due to demand from the existing bank delivery
network and from the activity generated as a result of the midyear acquisition
of Erie. Title and settlement revenues grew at record levels throughout the year
and were influenced by the flurry of origination activity and by the acquisition
of ABCO. Community also recorded a $1.1 million gain from the sale of a retail
office, which is included in other income, as part of its ongoing office
reconfiguration effort. These and other factors provided a significant boost to
non-interest revenues. Aside from increases in the non-interest revenue stream,
a reduction in the provision for loan losses also contributed to improved
performance. Community continues to monitor and manage its credit quality to
minimize losses from credit activities. Finally, profitability was also
influenced by growth in expenses that occurred as a result of the additional
costs from acquired businesses, expenses associated with the expansion of the
delivery network, and from other investments in the growth of the Corporation.
Economic Climate
The year 2003 began with the predictable uncertainty that accompanies
geopolitical discord and the escalation of armed international conflict. Since
the tragedies brought on by the World Trade Center attack in September of 2001,
Americans have had to adjust to a new global reality that has made " terror
alerts" and " al Qaeda" a normal part of our national lexicon. This new reality
has had a dampening effect on economic growth. Beyond this backdrop of global
tensions lie national, regional, and local economies within the United States
that are more directly affected by international trends and events. This
vulnerability was particularly evident in the first half of 2003, with
escalation of military involvement in Iraq and increased concern over the
potential for further terrorist attacks. The economic malaise in the first half
of 2003 was even more directly affected by the overall business climate, which
was characterized by lackluster stock market returns, increased skepticism
associated with corporate scandals, and reduced capital spending within the
commercial sector.
The impact of declining interest rates during 2003 was the most influential
trend affecting the financial services industry. For the second consecutive
year, interest rates fell to the lowest levels in the last four decades. This
trend had its most significant impact on growth in net interest income, the
largest source of revenue for most financial institutions. The low rate
environment was a catalyst for borrowing activity, particularly within the
consumer sector. Since the demise of the `bubble economy' of the 1990's, steady
consumer confidence has been an important constant in sustaining the national
economy. The retail consumer's capacity and appetite for debt to accommodate the
purchase of goods and services has helped forestall a deeper, more dramatic
recessionary downturn.
The Federal Reserve Board ("Fed") maintained an accommodative stance on interest
rates throughout most of the year in order to preempt the effect of higher rates
on economic growth. The Fed's interest rate posture was also responsive to an
absence of inflationary concerns, forestalling the need to raise rates in order
to suppress the adverse consequences of unchecked inflation. These lower rates
created unprecedented challenges to achieving growth in interest spread for most
financial institutions. The rate environment provided a stimulus for credit
services, but also produced challenges associated with expanding the deposit
base. As interest rates declined, most financial institutions were forced to
become less competitive on the pricing of deposit funding products. Late in the
year, many of these products had reached practical floors, preventing meaningful
downward repricing of deposit funding. The pressure on net interest income was
exacerbated by the inability to achieve higher loan pricing or identify
favorable reinvestment opportunities within the bond markets to enhance net
interest spread.
9
While lower interest rates constrained growth in net interest income, this trend
had a positive impact on other areas of financial services industry performance.
The highest direct correlation between lower rates and higher performance
occurred in the mortgage origination markets. Nationwide, housing starts grew to
over 1.7 million while total home sales reached a record high 5.8 million in
2003. At the same time, the lower mortgage rates spurred another record level of
mortgage refinancing. This trend provided consumers with increased disposable
income and helped sustain consumer confidence during a period of rising
unemployment and stagnant economic trends. Lower interest rates also have the
tendency to reduce the volume and severity of losses from credit activities.
Affordable credit tends to mitigate the potential for borrower default, which
can be expected to increase during sustained periods of higher interest rates.
Late in the third and fourth quarters of 2003, tentative signs of a modest
economic recovery began to emerge. Unfortunately, some industry sectors continue
to be influenced adversely by conditions largely beyond their control, thus
reducing the potential for more robust improvement in near term profitability.
Specific examples include the travel, airline, and telecommunications
industries. Most industries also continued to be hamstrung by their inability to
raise prices during a period that has been almost devoid of inflationary
pressure. Many other sectors, such as the automobile and home construction
industries, remained strong during the slowdown, but are unlikely to achieve
another layer of sizeable gains in the near term, regardless of the pace of
economic improvement. As a consequence, the recovery, although welcome, is
expected to be comparatively modest in magnitude.
Community operates within a regional economy, and smaller local economies, that
traditionally have been sheltered from major aftershocks produced by volatile
swings in specific industry sectors or other subsets of the broader national
economy. Community's diverse economic underpinnings provide a solid base that is
less predisposed to broad expansions or deep slumps caused by the ebb and flow
of global or national business cycles. While the local economies are partially
cushioned from these macro-trends, they will never be totally buffered.
Consequently, while Community and the businesses and individual customers within
its markets were affected by the overall downturn in the economy, those
constituencies experienced only modest deterioration in employment and relative
economic stability.
Strategy
Community's stated operating focus is manifested in its marketing slogan, "Local
People, Local Decisions". Its operating strategy centers around three guiding
factors: growth, diversity, and profitability. During 2003, Community made
substantial progress in each of these areas.
The growth of the Community franchise was quantified several ways. The absolute
growth in loans and deposits, combined with deepening and expanding customer
relationships provided an affirmation of the potential for franchise expansion.
Community also made significant strides fortifying its presence in existing
markets in 2003. During the year, Community added three new offices, including a
presence in northern Maryland, and announced additional plans to open at least
two new offices in 2004. At the same time, management has consistently
reevaluated the viability of the delivery system, resulting in the sale of three
offices over the last two years. This ongoing evaluation of the delivery system
has allowed for redeployment of both human and financial capital in more vibrant
markets with higher potential for economic growth. During this time, the entry
of larger, less personable financial institutions into Community's core markets
via bank acquisitions has generated opportunities to gain market share and
expand customer relationships.
Diversity has been a hallmark of Community's operating strategy. Improvements
have been realized through introductions of new products and services, additions
of acquired businesses, and execution of strategic partnerships with other
financial services companies. As an example, Community has become a leading
provider of title and settlement services inside its footprint. In April, 2003,
Community added to its presence in the York, PA market by acquiring ABCO, a key
provider of title services in this vital component of Community's core banking
market. Later in 2003, the acquisition of Erie added a leading provider of
mortgage origination services in the York and northern Maryland markets. This
transaction has doubled the previous mortgage origination capacity of the
franchise and will provide efficiencies with Community's legacy origination
operations. The Corporation also added to its ability to deliver high quality
insurance services to both commercial and retail customers. The acquisition of
Your Insurance Partner, an insurance agency group with two offices in the heart
of Community's geographic footprint, adds capacity to the Corporation's growing
menu of insurance services. Improvements to fee-based revenues were also
achieved through the introduction of new, convenience-driven banking services
such as the "OverdraftHonor" program.
10
As another testimony to the commitment to meeting customer needs, the
Corporation announced an innovative revenue-sharing arrangement with Bryn Mawr
Trust Company (Bryn Mawr) in late 2003. Bryn Mawr, which is headquartered in the
affluent "Main Line" area of suburban Philadelphia, has been in the trust and
investment management services business for over 100 years. Community, which
historically has had a limited capability for delivery of these essential
services to its existing customer base, now possesses access to the expertise
and experience of a corporation that currently manages over $1.6 billion in
assets.
The net result of these growth initiatives and increased diversity of the
revenue stream has been improved profitability. This improved profitability was
achieved while simultaneously improving credit quality and making the
appropriate investment in the future growth of the franchise. Such investments
will continue to exert pressure on the overall cost structure and will present
challenges into 2004 and beyond.
Emerging Trends
For the foreseeable future, net interest income will remain the most significant
source of revenue for banks. Recent trends have resulted in pricing compression,
creating a major challenge to future revenue expansion. This convergence of
trends, combined with increasing competition from both smaller and larger
rivals, has constrained growth in this vital driver of performance. Entering
2004, management had made substantial efforts to reposition both earning asset
and funding sources to benefit from a gradual, measured rise in overall interest
rates. The Fed's stimulative monetary policy, combined with the increasing
federal budget deficit, is beginning to intensify conditions that could give
rise to inflationary pressure and higher interest rates. Most economists agree
that interest rates will begin to rise, perhaps as early as the third quarter of
2004. Management has considered options to more aggressively extend loan or
investment maturities to achieve higher asset yields, but continues to pursue a
more moderate approach. Execution of a more aggressive approach could lead to
unacceptable levels of interest rate risk to the long-term revenue stream,
particularly given the current proximity to a perceived low point in the
interest rate cycle. Consequently, the potential for reprieve from the effects
of interest rate compression remains subdued in the near term, placing increased
emphasis on garnering market share and achieving absolute earning asset growth.
Credit quality is vital to the financial performance of community-based
financial services companies. The diversity of Community's markets and the
relative granularity of its loan portfolio make it somewhat less susceptible to
adverse credit quality conditions that are systemic in nature. During 2003,
Community recognized net charge-offs that were at their lowest level since 1999.
The allowance for loan losses, the Corporation's reserve to absorb credit risk
within the existing loan portfolio, is near a five year high in terms of its
coverage of non-accrual loans. Absolute levels of non-accrual loans saw marked
reductions since the end of 2002, providing further evidence of the bank's
improving asset quality metrics.
Continuous improvement in the level of other revenue sources has served to
offset the pressure on net interest income experienced during this extended
period of declining interest rates. Community's focus on the integration of new
products and services has fueled this growth. The strategic acquisitions and
partnerships completed during 2003 have solidified existing capabilities in
title insurance and settlement services, mortgage origination, and insurance
agency services. The recently announced plan to partner with Bryn Mawr Trust
Company is expected to add new capabilities in the arena of investment
management for higher net worth customers. Growth in these areas in 2004 could
be limited, however, depending on the magnitude and velocity of market shifts.
For example, both title and mortgage origination revenues could be adversely
influenced by a sudden and substantial spike in interest rates. Similarly, the
record level of refinancing activity during the past two years is likely to
moderate as interest rates rise. Increases in revenue from delivery of asset
management services through Bryn Mawr is expected to occur gradually over a more
extended time horizon, especially given the challenges associated with garnering
market share in this segment of the financial services market.
The final major aspect of performance that will be influenced by emerging trends
is operating expenses. Community's execution of its growth strategies has driven
steady increases in operating expenses in two major areas. First, expenses
related to the new branch expansion over the last several years continued to
influence operating expenses, especially in salaries, benefits and depreciation
expense. This ongoing investment in a measured expansion plan is critical to
positioning Community in both its core markets and in contiguous markets that
are natural extensions of the franchise. Secondly, the Corporation's efforts to
expand the mix and volume of integrated services have also had the impact of
increasing operating expenses as compared to historical levels. These efforts
have been correlated with synchronous programs designed to increase the revenue
stream from both core banking and integrated services. Increases in the cost
structure have always been
11
predicated on management's assessment of market share growth potential, higher
revenues, and improvements in both profitability and return on invested capital.
NET INTEREST INCOME
Community's major source of revenue is derived from intermediation activities
and is reported as net interest income. Net interest income is defined as the
difference between interest income on earning assets and interest expense on
deposits and borrowed funds. Net interest margin is a relative measure of a
financial institution's ability to efficiently deliver net interest income from
a given level of earning assets. Both net interest income and net interest
margin are influenced by the frequency, velocity, and extent of interest rate
changes and by the composition and absolute volumes of earning assets and
funding sources.
The following table compares net interest income and net interest margin
components between 2003 and 2002 (in thousands):
2003 2002 Change
----------------------- ---------------------- --------------------
Yield/ Yield/ Yield/
Amount Rate Amount Rate Amount Rate
Interest income $ 101,217 6.02% $ 102,488 6.89% $ (1,271) (0.87)%
Interest expense 42,329 2.89% 46,212 3.60% (3,883) (0.71)%
--------- ----- ---------- ----- --------- -------
Net interest income $ 58,888 $ 56,276 $ 2,612
Interest spread 3.13% 3.29% (0.16)%
Impact of
non-interest fund s 0.37% 0.49% (0.12)%
----- ----- -------
Net interest margin 3.50% 3.78% (0.28)%
===== ===== =======
Interest Rates
Interest rates profoundly influenced net interest income and profit performance
during 2003. Since the year 2000, key interest rate indices began a steady
pattern of decline. In each of the last two years, it was assumed that rates had
declined to levels at, or near, the trough in the interest rate cycle. By 2002,
such rates had declined to levels not seen since the 1950's. Entering 2003, most
rate forecasts reflected expectations that rates would begin to increase, though
not dramatically, sometime in 2003. Instead, buoyed by Fed policy, rates
continued on a descending path throughout most of the year, reaching yet another
level of lows in most key indices. To illustrate, the following graph provides a
comparison of U.S Treasury rates for the key maturity intervals for both 2003
and the prior year: [GRAPH OMITTED]
Average U.S. Treasury Curve
---------------------------
3 Months 6 Months 1 Year 2 Year 3 Year 5 Year 10 Year
-------- -------- ------ ------ ------ ------ -------
2002 1.64% 1.72% 2.00% 2.64% 3.10% 3.82% 4.61%
2003 1.03% 1.08% 1.24% 1.65% 2.10% 2.97% 4.01%
12
The various Treasury indices, which are important interest rate barometers,
declined across the board by virtually the same extent. This ratable decline
resulted in little change to the overall slope of the yield curve. Consequently,
both earning asset yields and funding costs declined during the year. General
interest rate trends were crucial to both interest income and the interest
expense results. The incremental pricing of maturing investments, variable rate
loans, and new loan relationships was correlated with the lower prevailing
interest rates, increasing pressure on asset yields. Despite the decline in
earning asset yields, interest income was stabilized during most of the year as
earning assets were redeployed from lower-yielding, maturing investments to
comparatively higher-yielding loans. The increasing affordability of credit
created increased demand for both business and consumer credit products,
resulting in an overall increase in earning assets. At the same time, most banks
continued to benefit from an influx of deposit funding. The paucity of
competitive returns in either the equity markets or other investment yields made
bank deposits a viable short-term alternative given consumer preferences for
liquidity in anticipation of future rate increases. Most consumers were
understandably averse to commit funds into longer maturity instruments given the
expectation of higher rates. As a consequence, many banks were able to secure
increases in deposit funding, despite that fact that many of the more liquid
deposit products were priced at record low levels. The net impact was that
interest expense declined by 8% while interest income declined by only 1%,
resulting in an increase in net interest income of nearly 5%.
Interest Income /Earning Assets
Interest income was $101.2 million in 2003, only slightly below the $102.5
million recorded in 2002, despite the fact that earning asset yields declined
from 6.89% to 6.02% over the two-year period. Earning asset growth, fueled
principally by loan growth, forged a 13.0% increase from $1.487 million to
$1.680 million and helped to offset the compression that would normally
accompany lower earning asset yields. From 2002 to 2003, earning assets grew
$193 million, including $111 million in loans and $89 million in portfolio
investment securities. Growth in loans accelerated during the year and was
funded by both runoff in the investment portfolio and by an $86 million increase
in the level of deposits, most of which occurred in Community's successful Power
NOW offering. As interest rates declined, Community also sought opportunities to
"lock in" low-cost term funding. With interest rates at historic lows,
management selectively "termed out" certain short-term borrowings to secure the
benefits of the lower, longer term rates available during the year.
Interest Expense / Funding Sources
Interest expense on deposits declined dramatically during 2003 and was a major
contributor to the nearly 5% increase in net interest income. Despite increases
in loan mix and an overall increase in the level of earning assets, Community
was not able to achieve improvement in interest income due to the impact of
lower rates. Fortunately, that same rate environment permitted most banks to
reduce interest rates on deposit funding and enabled Community to reduce its
overall funding costs from $46.2 million in 2002 to $42.3 million in 2003, a
decline of almost $3.9 million or 8%. Simultaneously, most banks continued to
enjoy an influx of deposit funding as consumers opted for the security and
short-term liquidity of bank deposits. It is likely that this trend, at least in
part, could be linked to corporate and mutual fund scandals, a lackluster stock
market, low money market rates, and other developments that reduced consumer
interest in these other alternatives. Total deposits grew by nearly $86 million,
the vast majority of which occurred in savings, Power Now and other accounts
that were responsive to customer preferences for liquidity. For the first time
in several years, Community realized no growth in its time deposit categories as
consumers were reluctant to extend maturities for relatively unattractive rate
premiums.
Community also made strategic use of other forms of funding in order to meet the
consistent demand for credit extension that occurred throughout the year.
Incremental borrowing rates on federal funds, which are set by the Federal
Reserve, influenced the pricing of all short-term sources of funds and made
these borrowings far less expensive than other funding sources. Community made
strategic use of this source of liquidity within the risk parameters set forth
in its asset / liability management (ALCO) policies and procedures. At various
times during the year, Community also increased its long-term borrowings, which
are composed principally of term funding available through the Federal Home Loan
Bank programs. The Corporation experienced a 17% increase in long-term funding,
which included the first full year of $15 million in trust preferred instruments
issued under a pooled arrangement in December of 2002. Community executed an
additional $15 million in these instruments at the end of 2003, bringing its
total issuances to $30 million. The issuances were integrated with, and
responsive to, the overall capital management policy discussed later in this
presentation.
13
Interest Spread and Net Interest Margin
A financial institution's ability to effectively blend the impact of changing
rates, shifting rate indices, customer preferences, and product development
initiatives can be measured by the performance of interest spread, which is
defined as the difference between earning asset yield and the cost of funding
sources. Net interest margin combines the impact of interest spread with both
investment of non-interest bearing funding sources and management of non-earning
assets. As a result of rate trends and other dynamics specific to Community's
balance sheet, the Corporation reported a decline in net interest spread from
3.29% in 2002 to 3.13% in 2003, and a decline in net interest margin from 3.78%
to 3.50% over the same period. The decline in margin was also linked to the
impact of reduced contribution from non-interest funding sources, which declined
from 0.49% to 0.37%. During periods of declining interest rates, the
contribution from non-interest funds to net interest margin is reduced since
funds are invested at progressively lower rates. During periods of rising rates,
these funds can be expected to contribute to improvements in net interest
margin.
Quarterly Performance
The following table provides a comparison of earning asset yields, funding
costs, and other information for each of the four quarters of 2003 and 2002.
2003
-----------------------------------------------------
Fourth Third Second First
Quarter Quarter Quarter Quarter
-----------------------------------------------------
Asset yield 5.81% 5.88% 6.05% 6.38%
Funding cost 2.76% 2.80% 2.94% 3.10%
-----------------------------------------------------
Interest spread 3.05% 3.08% 3.11% 3.28%
-----------------------------------------------------
Net interest margin 3.41% 3.45% 3.49% 3.68%
-----------------------------------------------------
Net interest margin $14,795 $14,884 $14,618 $14,591
=====================================================
2002
-----------------------------------------------------
Fourth Third Second First
Quarter Quarter Quarter Quarter
-----------------------------------------------------
Asset yield 6.54% 6.80% 7.01% 7.26%
Funding cost 3.35% 3.51% 3.74% 3.82%
-----------------------------------------------------
Interest spread 3.19% 3.29% 3.27% 3.44%
-----------------------------------------------------
Net interest margin 3.65% 3.78% 3.76% 3.96%
-----------------------------------------------------
Net interest margin $14,180 $14,394 $13,757 $13,946
=====================================================
Continuing a trend which has corresponded to the general decline in interest
rates, quarterly net interest margin exhibited a steady decline throughout both
2002 and 2003. Throughout 2003, Community experienced a steady, almost
consistent decline in earning asset yields despite the benefits of a more
concentrated mix of loans, whose yields normally exceed those of portfolio
investments with comparable maturities. The increase in the mix and volume of
higher yielding loans tended to offset the overall reduction of interest income
from lower offering rates since 2002. This improved mix had the impact of
offsetting some of the adverse consequences of a lower rate environment on
interest income. Funding costs also declined during 2003, and such declines were
more directly responsible for the improvement in net interest income for the
first nine months of the year. Community's ability to improve either net
interest income or net interest margin through further reductions in incremental
pricing of deposits or other funding sources was minimized in the fourth quarter
of 2003, as a significant portion of the funding pool reached all time lows.
Pricing of both loans and deposits is also subject to competitive pressures in
the marketplace. Consequently, the short-term potential for improving net
interest margin or net interest income through further reductions in funding
costs seems less likely in the current environment.
14
PROVISION FOR CREDIT LOSSES
For the second consecutive year, Community reported a decline in the provision
for loan losses, which reflected the steady improvement in the overall asset
quality metrics of its loan portfolio. The provision declined from $3.4 million
in 2002 to $2.5 million in 2003, while the relationship of the allowance for
loan losses to loans declined from 1.36% at December 31, 2002 to 1.22% at the
end of 2003. The provision, and the level of the allowance, were responsive to
the changing credit quality conditions of both seasoned loans and the
incremental risk inherent in a growing loan portfolio. Net charge-offs during
2003 were only $1.7 million, or 0.17% of average loans, and reflected a
significant decline from charge off levels of the past two years. Non-accrual
loans aggregated $8.2 million, the lowest absolute level since the beginning of
2001. The coverage of these loans provided by the allowance reached 162%, nearly
equal to the 171% high recorded at the end of 2000. See the section addressing
the allowance for loan losses and asset quality of this discussion for
additional information.
NON-INTEREST INCOME
This increasingly vital component of the revenue stream grew substantially
during 2003 as important steps were undertaken to solidify and expand
Community's integrated businesses and complementary banking services. Excluding
the impact from sales of investment securities, non-interest revenue grew 43%,
from $12.9 million in 2002 to over $18.5 million in 2003. The income recorded
during 2003, however, included two nonrecurring gains without which Community
would still have recorded an increase of 37%, as adjusted for these items in
both years. Amounts recorded in 2003 included a gain from the curtailment of a
legacy, defined benefit plan in the third quarter and the recognition of a gain
from the sale of an office, inclusive of both loans and deposits, in the fourth
quarter. Community had recognized a similar gain from the sale of two offices
and related deposits in 2002.
The following is a summary of the various components of non-interest income for
both 2003 and 2002, including the year over year increases related thereto:
Change
2003 2002 Amount %
--------------------------------------------------------
Investment management and trust services $ 1,326 $ 993 $ 333 34%
Service charges on deposit accounts 5,128 3,440 1,688 49%
Other service charges, commissions and fees 2,958 2,471 487 20%
Insurance premium income and commissions 2,822 2,016 806 40%
Mortgage banking activities 2,532 1,221 1,311 107%
Other income 3,748 2,800 948 34%
--------------------------------------------------------
18,514 12,941 5,573 43%
Investment security gains 1,927 1,034 893 86%
--------------------------------------------------------
Total $ 20,441 $ 13,975 $ 6,466 46%
========================================================
Investment management and trust revenues include fees derived from the sale of
various retail investment products (annuities, brokerage services, mutual funds,
etc) and other fees related to Community's limited trust department activities.
Sales of investment products are facilitated under an arrangement with a
national provider of these services. Consultative sales are conducted through
the community office network. This arrangement provides convenient access to
alternative investment vehicles through licensed employees who live and work in
the communities where customers conduct their normal banking business. This
service has facilitated a more holistic approach to meeting the expanding
financial service needs of customers who live within Community's footprint.
Customers are increasingly comfortable with using trusted, competent employees
who work within their primary financial institutions for this vital service.
While traditional trust fees showed a meaningful increase in 2003, the vast
majority of the increase in this category was derived from the sale of
additional investment products to new and existing customers. Near term
increases in this category will continue to be weighted toward sales of retail
investment products. In the future, the affiliated arrangement with Bryn Mawr
Trust Company is expected to provide more competitive services to high net worth
individuals as these product offerings are made available.
15
The most substantial increase in fees occurred in the area of service charges on
deposits. In the first quarter of 2003, Community provided a new service known
as "OverdraftHonor". Under this carefully designed program, customers who so
choose now have access to a service that facilitates payment of periodic
overdraft items while simultaneously avoiding adverse credit history events.
Fees from these services, which were not provided prior to 2003, were
responsible for virtually all of the increase in this category.
Other service charges include interchange fees from Community's vast ATM network
and debit card transactions. Community continues to boast an ATM network of
nearly 100 ATMs, including those in place under a relationship with a local
convenience store chain operating within the Corporation's geographic footprint.
Fees associated with non-customer use of these convenient locations to
facilitate cash withdrawal needs grew by more than 23% since 2002. A more robust
increase of 42% was realized in the interchange fees associated with retail
transactions conducted via the use of debit or credit cards. Nearly all of the
increases in these sources of fee income resulted from increased usage and the
consumer's growing acceptance of electronic mediums as a substitute for cash or
check-based transactions.
Insurance premiums and commissions include agency-based commissions from
commercial and personal lines, fees from credit reinsurance activities related
to consumer lending, and the revenue from title insurance and settlement
activities conducted through Community's title insurance subsidiary. These fees,
which rose by a total of $806 thousand from 2002 to 2003, included an increase
of over $530 thousand related to title-based activities alone. Such increases
were related to both the overall increase in mortgage loan originations, and to
the addition of the ABCO franchise at the beginning of the second quarter of
2003. The remainder of the increase was related to the acquisitions of the
insurance agencies during the year. Community continues to explore
opportunities, through either acquisitions or strategic alliances, which will
help develop a meaningful critical mass in this important financial service.
The single largest percentage increase in revenues occurred in income from
mortgage banking activities. The increase was related both to volume increases
in purchase mortgages and refinancings, and to new volumes generated through the
midyear acquisition of the Erie subsidiary. Community has more than doubled its
capacity to originate mortgages with the acquisition of Erie and has become a
more significant and efficient competitor in its core and extended Maryland
markets.
Other income included gains from the sales of offices in both 2003 and 2002. A
gain in excess of $1 million was recorded in the fourth quarter of 2003 and
related to the sale of the loans, deposits and physical location of a single
community office. In 2002, Community had recorded a $500 thousand gain from the
sale of two smaller offices. Both sales coincided with entry into markets with
more favorable growth demographics. Other income also included a nonrecurring
gain from the curtailment of a legacy pension plan in the third quarter. With
this action, Community has made substantial progress toward uniform retirement
benefit programs for current and prospective employees while simultaneously
forestalling increased expenses from higher-cost defined benefit plans.
Security gains increased by nearly $900 thousand from 2002 as efforts were made
to identify opportunities to improve the duration or average yield of the
portfolio at various times during the year. The total gains of $1.9 million
recorded in 2003 included nearly $1.5 million of gains related to sales of bank
equity holdings.
NON-INTEREST EXPENSES
Total non-interest expenses reached $45.7 million in 2003 and reflected a 16%
increase, or $6.4 million, from the $39.3 million recorded in 2002. The growth
was influenced by two major factors. Over 25% of the increase of $6.4 million,
or $1.7 million, was directly related to increased expenses from the integrated
businesses acquired at different points during 2003. These increases included
the expenses from ABCO, Erie, and incremental insurance agency activity.
Excluding the portion of the increase related to acquired businesses, 2003
operating expenses increased $4.7 million or 12% over 2002 expenses. This second
component of the increase was more directly related to the costs associated with
expansion of the core banking franchise.
16
The following is a summary of the various components of change in operating
expenses:
Change From Total Change
-------------------- ---------------
Integrated
2003 2002 Businesses Other Amount %
---- ---- ---------- ----- ------- -
Salaries and employee benefits $ 25,397 $ 21,636 $ 1,265 $ 2,496 $ 3,761 17%
Net occupancy expense 7,200 6,051 119 1,030 1,149 19%
Marketing expense 2,018 1,090 20 908 928 85%
Telecommunications expense 1,302 995 39 268 307 31%
Other operating expenses 9,801 9,528 237 36 273 3%
-------- -------- ------- ------- ------- ---
Total $ 45,718 $ 39,300 $ 1,680 $ 4,738 $ 6,418 16%
======== ======== ======= ======= ======= ===
Excluding that portion of the increase related to the additional expenses of
businesses acquired in 2003, Community reflected significant increases in salary
and employee benefits costs (12%), occupancy expenses (17%), and other operating
expenses, including marketing and telecommunications (10%). Since the end of
2001, Community has added a total of seven new banking facilities in new or
existing markets while selling three offices in markets with less robust growth
characteristics. This selective expansion of the Community Banks franchise has
had a significant influence on the operating expense structure. At the same
time, this expansion has also been an important catalyst for the growth in loan
and deposit balances since the end of 2001.
The single largest component of costs is salary and benefits, as these expenses
represent nearly 56% of total operating costs. Excluding the impact of salaries
added from the acquired businesses, salary and benefit expenses grew nearly $2.5
million from 2002 to 2003. Of this increase, over $1 million was attributed to
the effect of the 3% average salary increase and to a heavier reliance on
employee incentives for sales of certain financial product offerings. Payroll
taxes and employee insurance costs, which increased by nearly $600 thousand,
were influenced by personnel added in both banking and acquired businesses, and
by increases in health insurance rates. The remainder of the increase, less than
$1 million, was affected by personnel added as a result of the new community
offices, the increased cost of the customer service center, and by the addition
of new lenders for certain key growth markets.
As would be expected, occupancy expenses were also influenced by increased costs
associated with community office expansion and rose by just over $1 million. The
costs for offices added since the end of 2001 grew by almost $400 thousand.
Another $250 thousand of increased costs were related to the first full year of
operation of the southern operations center and by the expansion of the customer
service center. These initiatives had been undertaken in 2002 to improve the
level of customer service to new and existing customers.
Within the overall category of other operating expenses, marketing and
promotional increased over $900 thousand. In its 2002 annual report, Community
announced its intention to increase its 2003 spending to accommodate a more
significant level of marketing and advertising costs. These costs were
undertaken in order to increase Community's market share in new markets and to
preserve and expand share in its legacy communities. Expenses were related to
expanded awareness, image and lead product advertising, especially in the first
half of 2003. Community also reflected a $300 thousand increase in its
communications and data connection expenses during the year, which included cost
for upgrades of existing systems and the increased costs for its growing office
network. Other operating expenses increased $300 thousand and were principally
related to the acquired businesses.
INCOME TAXES
Income taxes grew from $3.4 million in 2002 to $4.4 million in 2003, an increase
of nearly 30%. The increase was commensurate with the increase in pretax income
and resulted in an effective tax rate of over 17%, only slightly higher than the
15% tax rate recorded in 2002. The relative mix of tax exempt income, which grew
during 2003, influences the level of effective income tax rates and remains the
primary reason for the difference between the effective tax rate and the
statutory federal tax rate for corporations.
17
STATEMENT OF CONDITION: OVERVIEW
At December 31, 2003, Community's total assets reached almost $1.9 billion,
reflecting a change of almost 11% from the nearly $1.7 billion of assets
recorded at the end of 2002. Average assets grew to $1.8 billion for 2003 and
grew almost 13% from 2002 average assets. Average balances of earning assets,
loans and deposits grew 13%, 13% and 8%, respectively. Community benefited from
increased demand for credit in both the consumer and commercial sectors. While
consumer demand for credit was influenced by both low rates and steady consumer
confidence, growth in the commercial sector was more directly related to
Community's ability to garner market share from larger, less nimble financial
institutions. The growth trends experienced in 2003 and in previous years
continue to demonstrate Community's commitment to staying close to its core
markets and to using its local presence and responsiveness as a competitive
advantage.
INVESTMENTS
Community has established corporate investment policies that address various
aspects of portfolio management, including quality standards, liquidity and
maturity limits, investment concentrations and regulatory guidelines. The
Corporation's objective with respect to investment management includes
maintenance of appropriate asset liquidity, facilitation of asset/liability
strategy and maximization of return. Compliance with investment policy is
regularly reported to the Board of Directors.
Community actively manages its investment portfolio and, accordingly, classifies
all investment securities as "available for sale". Under current policy, if
management has the intent and the Corporation has the ability to hold securities
until maturity, securities are classified as "held-to-maturity" investments at
the time of purchase and carried at amortized historical cost. Securities to be
held for indefinite periods of time are classified as available for sale and
carried at fair value. Such securities are intended to be used as part of
Community's asset/liability management strategy, and may be sold in response to
changes in interest rates, prepayment risk and other factors affecting overall
investment strategy.
During 2003, the average balance in the investment portfolio grew from $585
million to $674 million, a growth rate of 15% that, though substantial, was far
less than the investment portfolio growth of 29% that was experienced from 2001
to 2002. During 2002, Community had experienced robust deposit growth,
particularly early in that year. Unfortunately, loan growth did not keep pace
with deposit generation growth rates, creating additional liquidity that fueled
growth in the investment portfolio throughout 2002. As Community entered 2003,
loan demand for both commercial and consumer credits increased coincident with
the demand created by steadily declining interest rates. While deposit inflow
remained significant into 2003, it was less robust growth than experienced in
2002. The combination of investment runoff and the increasing deposit base
provided more than adequate funding to keep pace with the 2003 loan growth
rates. Consequently, Community continued to experience growth in its investment
portfolio between the two years.
The pretax unrealized net gain within the investment portfolio at December 31,
2003 was $13.3 million. As required, this fair value adjustment was reflected in
other comprehensive income (adjusted for income taxes) in the stockholders'
equity section of the statement of condition. Near the end of 2003, a new
accounting pronouncement was issued that requires additional disclosures in the
footnotes to the financial statements. Such disclosures relate to declines in
the market value of specific securities that may be considered "temporarily
impaired" pursuant to newly-established criteria for identifying such
securities. Of the total of $674 million of investments included in Community's
portfolio at year end, securities aggregating over $148 million were identified
as having met the criteria necessary for disclosure. The aggregate unrealized
loss disclosed in the footnotes to the financial statements is slightly in
excess of $3.8 million, nearly all of which was related to the extraordinary
decline in interest rates on certain securities and its impact on the valuation
of those securities. Such declines were not attributed to any perceived
deterioration in an individual issuer's ability to meet the terms and
obligations of the issuance and were more than offset by gross unrealized gains
of just over $17 million. Community has the ability and intent to hold such
investments until their original maturity and fully expects that any unrealized
losses will be recovered over the term of the investments.
18
The following tables summarize amortized cost and estimated fair values at
December 31, 2003, 2002, and 2001 and maturity distribution of securities at
December 31, 2003 (in thousands).
2003 2002 2001
-----------------------------------------------------------------------------
Amortized Fair Amortized Fair Amortized Fair
Cost Value Cost Value Cost Value
-----------------------------------------------------------------------------
Mortgage-backed U.S. government agencies $ 121,853 $ 123,395 $ 206,450 $ 210,825 $ 74,403 $ 74,370
U.S. Government corporations and agencies 173,651 173,292 130,947 134,334 144,640 142,544
Obligations of states and political sub-
divisions 177,546 184,481 172,391 177,135 172,223 169,993
Corporate securities 95,461 97,987 95,022 93,094 99,561 98,405
Equity securities 65,070 67,806 50,610 52,413 57,846 58,589
--------- --------- --------- --------- --------- ---------
Total $ 633,581 $ 646,961 $ 655,420 $ 667,801 $ 548,673 $ 543,901
========= ========= ========= ========= ========= =========
MATURITY DISTRIBUTION OF SECURITIES (Fair Value)
One Five Weighted
Within Through Through After Average Average
One Year Five Years Ten Years Ten Years Total Maturity Yield(a)
---------------------------------------------------------------------------------------
U.S. Government agencies $ 18,433 $ 20,495 $ 157,165 $ 100,594 $ 296,687 10yr. 13 mos. 4.33%
Obligations of states and political
subdivisions --- 1,589 12,382 170,510 184,481 16yr. 3 mos. 7.17%
Other 5,039 23,332 27,271 110,151 165,793 15yr. 5 mos. 4.90%
-------- -------- --------- --------- ---------
Total $ 23,472 $ 45,416 $ 196,818 $ 381,255 $ 646,961 13yr. 2 mos. 5.29%
======== ======== ========= ========= =========
Percentage of total 3.63% 7.02% 30.42% 58.93% 100.0%
==== ==== ===== ===== =====
Weighted average yield (a) 2.21% 4.99% 4.80% 5.76% 5.29%
==== ==== ==== ==== ====
(a) Weighted average yields were computed on a tax equivalent basis using
a federal tax rate of 35%.
The Corporation monitors investment performance and valuation on an ongoing
basis to evaluate investment quality. An investment which has experienced a
decline in market value considered to be other than temporary is written down to
its net realizable value and the amount of the write down is accounted for as a
realized loss.
LOANS
Average loans reached $997 million at the end of 2003, a 12% increase over the
$887 million of average loans recorded in 2002. The composition of loans between
the two years was influenced by a number of factors, including the influence of
lower interest rates. The following presentation of loans at December 31 for
each of the past two years is an indication of the relative mix of loans
included in the portfolio (in thousands):
Change
2003 2002 Amount %
---- ---- ------ -
Commercial $ 367,444 $ 295,506 $ 71,938 24 %
Commercial real estate 283,662 246,533 37,129 15 %
Residential real estate 97,178 109,497 (12,319) (11)%
Consumer 330,327 253,032 77,295 31 %
---------------------------------------------------
Total $ 1,078,611 $ 904,568 $ 174,043 19 %
===================================================
19
Following a year of less robust commercial loan activity in 2002, commercial
borrowing began to increase dramatically during the second quarter of 2003, and
growth continued well into the second half of the year. After the end of the
first quarter, the steady declines in interest rate trends caused many
borrowers, including those with prior relationships with competitors of
Community, to reevaluate their existing credit arrangements in search of
improved funding terms and more responsive credit relationships. Community has
consistently made efforts to position itself in the marketplace to ensure its
ability to compete with large and small competitors alike. As a result, the
Corporation was able to increase both its commercial and commercial real estate
portfolios by nearly $109 million on an aggregate basis. Much of the growth in
the commercial sector was attributed to Community's ability to acquire existing
market share since business lending has been constrained on both a national
level and in certain segments of Community's market. A portion of this growth
also can be attributed to the addition of certain key lending personnel made
available as a result of mergers of local financial institutions by
out-of-market acquirers.
The single most significant source of loan growth occurred in consumer lending,
particularly home equity lending, which grew by $77 million between December 31,
2002 and the end of 2003. As part of Community's effort to increase its
visibility in core markets, a concerted effort was made to become a more
effective consumer lender, including substantial increases in marketing and
advertising efforts. Historically, Community has been more widely known
throughout its market as a lender to small and medium-size businesses, with an
emphasis on commercial mortgages and commercial loans secured by real estate. In
2003, Community sought to leverage its office network as a channel for expanding
consumer lending and to fulfill the consumer's appetite for convenient,
accessible retail lending services. Consumer demand for credit was also aided by
the high levels of consumer confidence and improved credit affordability
experienced in the current interest rate environment. These efforts were also
aided by the growth achieved as a result of the expansion of the office network
and sales efforts over the last several years.
Residential real estate lending, which is composed primarily of loans to
single-family creditors, has experienced a steady decline as a result of the
increasing accessibility of secondary market liquidity through mortgage banking
activities. Community-based banks continue to provide a convenient avenue for
consumers to access funding for residential lending, but most new credits
continue to be sold in the secondary market. This strategy has reduced the
interest rate risk associated with consumer preferences for long-term, fixed
rate lending, and continues to provide valuable liquidity for other forms of
relationship lending.
ALLOWANCE FOR LOAN LOSSES AND CREDIT QUALITY
The following sets forth activity within the allowance for credit losses for the
last three years.
2003 2002 2001
---- ---- ----
Balance at January 1, $ 12,343 $ 12,132 $ 10,328
Loans charged off (2,839) (4,180) (3,776)
Recoveries 1,174 1,041 500
Provision charged to operations 2,500 3,350 5,080
----------------------------------------------
Balance at December 31, $ 13,178 $ 12,343 $ 12,132
==============================================
Allowance for credit losses to loans 1.22% 1.36% 1.42%
20
The period between January 1, 2001 and December 2002 marked a period of
adjustment in the credit quality profile of Community Banks, Inc. In the last
three quarters of 2002, emerging trends suggested that the risk profile of
Corporation's loan portfolio would experience steady improvement in 2003. The
decline in both non-accrual loans and in loans "90 days or more past due"
provided indications of an improving picture of credit quality, despite dramatic
increases in the overall loan balances. During 2003, further indications of
these favorable trends continued to emerge, resulting in dramatic reductions in
both net charge-offs and additional reductions in the level of problem credits.
Net charge-offs were reduced to $1.7 million, or 0.17% of average outstanding
loans, and compared favorably to the net charge-offs of $ 3.1 million, or 0.35%,
in the prior year. Non-accrual loans, the most severe category of problem
credits, declined 13% from $9.4 million in 2002 to $8.2 million at the end of
2003 while loans 90 days or more past due declined from $961 thousand to $90
thousand over the same period. Despite a decline in the ratio of the allowance
for credit losses to loans from 1.36% at year end 2002 to 1.22% at the end of
2003, the coverage of non-accrual loans provided by the allowance increased from
131% to 162% over the two year period. As a consequence of these and other
critical factors, management was able to reduce the provision for loan losses
from $3.4 million in 2002 to $2.5 million in 2003.
The following sets forth loan loss experience for the last five years (in
thousands):
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
Loans at year-end, net of unearned income $ 1,078,611 $ 904,568 $ 857,278 $ 814,874 $ 708,016
=========== ========= ========= ========= =========
Average loans balance $ 997,190 $ 886,808 $ 838,178 $ 768,204 $ 665,422
=========== ========= ========= ========= =========
Balance, allowance for loan losses,
January 1 $ 12,343 $ 12,132 $ 10,328 $ 8,976 $ 8,608
Loans charged off:
Commercial, financial and agricultural 253 1,878 2,275 303 489
Real estate-mortgage 1,548 1,447 484 521 190
Consumer and other 1,038 855 1,017 1,101 984
----------- --------- --------- --------- ---------
Total 2,839 4,180 3,776 1,925 1,663
----------- --------- --------- --------- ----------
Loans recovered:
Commercial, financial and agricultural 240 644 120 23 140
Real estate-mortgage 689 25 108 83 43
Consumer and other 245 372 272 308 260
----------- --------- --------- --------- ---------
Total 1,174 1,041 500 414 443
----------- --------- --------- --------- ---------
Net charge-offs (1,665) (3,139) (3,276) (1,511) (1,220)
Provision for loan losses 2,500 3,350 5,080 2,863 1,588
----------- --------- --------- --------- ---------
Balance, allowance for loan losses,
December 31 $ 13,178 $ 12,343 $ 12,132 $ 10,328 $ 8,976
=========== ========= ========= ========= =========
Net charge-offs to loans at year end .15% .35% .38% .19% .17%
Net charge-offs to average loans .17% .35% .39% .20% .18%
Balance of allowance for loan losses
to loans at year end 1.22% 1.36% 1.42% 1.27% 1.27%
21
The allowance for loan losses is based upon management's continuing evaluation
of the loan portfolio. A review as to loan quality, current macro-economic
conditions and delinquency status is performed on a quarterly basis. The
provision for loan losses is adjusted quarterly based upon current review. The
following table presents an allocation by loan categories of the allowance for
loan losses at December 31 for the last five years (in thousands).
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
Loans:
Commercial, financial and agricultural $ 7,090 $ 6,305 $ 9,285 $ 5,268 $ 3,030
Real estate-construction --- --- 10 14 9
Real estate-mortgage 2,313 1,936 965 1,593 1,509
Installment 2,184 1,767 1,030 1,748 1,575
Unallocated 1,591 2,335 842 1,705 2,853
--------- --------- --------- --------- --------
Balance $ 13,178 $ 12,343 $ 12,132 $ 10,328 $ 8,976
========= ========= ========= ========= ========
The amount of the allowance assigned to each component of the loan portfolio is
derived from a combination of factors. Estimation methods and assumptions used
in the process are reviewed periodically by both management and the Board of
Directors.
The percentage of loans in each category above is included in the "Loan Account
Composition" table in Appendix A to Management's Discussion and Analysis of
Financial Condition and Results of Operation, Part II Item 7.
The Corporation's allowance for loan losses is based upon management's quarterly
review of the loan portfolio utilizing a consistent valuation methodology. The
purpose of the review is to assess loan quality, identify impaired loans,
analyze delinquencies, ascertain loan growth, evaluate potential charge-offs and
recoveries, and assess general economic conditions in the markets its affiliates
serve. Commercial and real estate loans are individually risk rated by the
Corporation's loan officers and periodically reviewed by independent loan review
personnel. Consumer and residential real estate loans are generally analyzed in
homogeneous pools utilizing historical loan charge-off information.
To determine the allowance and corresponding loan loss provision, an amount is
allocated to specific loans. For certain commercial and construction loans, this
amount is based upon specific borrower data and supporting collateral determined
by reviewing individual non-performing, delinquent, or potentially troubled
credits. For the majority of the loans that are individually reviewed for
impairment, this analysis is based on a comparison of the loan's carrying amount
to the net realizable value of the collateral. The portion of the allowance
attributable to specific impaired loans was $546 thousand at December 31, 2003.
The remaining commercial as well as consumer, and residential real estate loans
are evaluated as part of various pools. These pool reserves, generally are based
upon historic charge-offs and delinquency history, other known trends and
expected losses over the remaining lives of these loans, as well as the
condition of local, regional and national economies and other qualitative
factors.
To ensure adequacy to a higher degree of confidence, a portion of the allowance
for loan losses is considered unallocated. The unallocated portion of the
allowance is intended to provide for probable losses that are not otherwise
identifiable, for possible imprecise estimates in assessing potential losses on
commercial loans or in the calculation of pool reserves, and for the extenuating
influence of current factors, such as economic uncertainties. This unallocated
portion is available to absorb losses sustained anywhere within the loan
portfolio. The combined allocated and unallocated portions bring the total
allowance to an amount deemed prudent and reasonable by management at that time.
Risk Elements
The following sets forth information regarding various segments of the loan
portfolio, collectively referred to as risk elements. These segments include
both nonperforming assets and those loans past due for 90 days or more.
Non-performing assets include non-accrual loans, restructurings, and other real
estate. Non-accrual loans are loans for which interest income is not accrued due
to concerns about the collection of interest and/or principal. Restructured
loans may involve renegotiated interest rates, repayment terms, or both, because
of deterioration in the financial condition of the borrower. The only credits
that would have qualified as restructured loans at the end of both years were
already classified in the more severe non-accrual category. The following table
provides a comparative summary of nonperforming assets and total risk elements
at the end of each of the last five years (in thousands).
22
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
Loans on which accrual of interest has
been discontinued:
Commercial, financial and agricultural $ 3,066 $ 2,257 $ 3,783 $ 2,042 $ 2,231
Mortgages 4,054 6,609 6,952 3,445 3,203
Other 1,031 527 355 356 222
---------- ---------- ---------- ---------- ----------
8,151 9,393 11,090 5,843 5,656
---------- ---------- ---------- ---------- ----------
Loans renegotiated with borrowers --- --- --- 205 254
---------- ---------- ---------- ---------- ----------
Total non-accrual loans 8,151 9,393 11,090 6,048 5,910
Foreclosed real estate 4,865 1,183 631 416 615
---------- ---------- ---------- ---------- ----------
Total non-performing assets 13,016 10,576 11,721 6,464 6,525
Loans past due 90 days or more:
Commercial, financial and agricultural 4 97 1,002 8 146
Mortgages 40 770 405 495 147
Consumer and other 46 94 252 109 85
---------- ---------- ---------- ---------- ----------
90 961 1,659 612 378
---------- ---------- ---------- ---------- ----------
Total risk elements $ 13,106 $ 11,537 $ 13,380 $ 7,076 $ 6,903
========== ========== ========== ========== ==========
Ending allowance for loan losses $ 13,178 $ 12,343 $ 12,132 $ 10,328 $ 8,976
========== ========== ========== ========== ==========
Ending allowance to non-accrual loans 162% 131% 109% 171% 152%
Despite improvement in most categories of problem credits, there was a
substantial increase in foreclosed real estate from 2002 to 2003. The balance in
this category grew from $1.2 million at December 31, 2002 to $4.9 million at the
end of 2003. Nearly all of the increase was related to the reclassification of
two large credits that had been made to a single borrower. Pursuant to the
provisions of the original loan agreements, Community took possession of two
collateral properties in the fourth quarter of 2003, due to borrower default. A
new, unrelated borrower purchased one of the properties in January, 2004,
resulting in the return of nearly $2.6 million of loans to accrual status.
Amounts included in foreclosed real estate are stated at the lower of cost or
market and no losses are expected from the final disposition of these
properties.
The determination to discontinue the accrual of interest on non-performing loans
is made on the individual case basis. Such factors as the character and size of
the loan, quality of the collateral and the historical creditworthiness of the
borrower and/or guarantors are considered by management in assessing the
collectibility of such amounts.
The approximate amount that would have been accrued on those loans for which
interest was discontinued in 2003 was $350,000.
Overall Assessment
Community has assessed all of the above factors in the establishment of the
allowance for loan losses. The determination as to the adequacy of the allowance
reflects management's judgment, and was based upon collateral, local market
conditions, various estimates, and other information that requires subjective
analysis. These factors, which are prone to change, are monitored by management
to evaluate their potential impact on management's assessment of the adequacy of
the allowance. Based on its evaluation of loan quality, management believes that
the allowance for loan losses at December 31, 2003 was adequate to absorb
probable losses within the loan portfolio.
23
DEPOSITS
Deposit balances remain the primary source of funding for financial institutions
and Community recognized steady growth of nearly 8% in this important
core-funding source, summarized as follows (in thousands):
Change
2003 2002 Amount %
---- ---- ------ -
Demand $ 167,315 $ 163,434 $ 3,881 2%
Savings & NOW accounts 401,805 322,632 79,173 25%
Time 498,005 498,159 (154) --%
Time $100,000 or more 110,231 107,523 2,708 3%
-------------------------------------------------------------
$ 1,177,356 $ 1,091,748 $ 85,608 8%
=============================================================
Deposit growth in 2003 occurred almost exclusively in savings deposits, more
specifically Community's Power Now account. This account, which has
characteristics of both a money market and checking account, grew steadily
throughout the year. At the same time, longer term time deposit growth was flat.
Consumer preferences were clearly weighted in favor of maintaining adequate
liquidity in anticipation of a gradual rise in rates. Despite the fact that most
interest rates declined steadily throughout the period, most depositors were
reluctant to extend time deposit maturities to obtain only marginally higher
rates. The consistent downward pressure on rates, combined with lack of
confidence in other more risky investment vehicles, increased consumer
preference for the flexibility, liquidity and guaranteed return provided by
these accounts.
The following table summarizes the maturity distribution of time deposits of
$100,000 or more as of December 31, 2003 (in thousands).
Remaining to Maturity:
Less than three months $ 24,791
Three months to six months 21,735
Six mont