Item 1. Business: -----------------
Community Banks, Inc. (the "Corporation" or "Community") is a financial holding company whose banking subsidiary is Community Banks and whose non-banking subsidiaries are Community Bank Investments, Inc. (CBII), Community Banks Life Insurance Company, Inc. (CBLIC), and CMTY Capital Trust I. The subsidiaries of Community Banks are UDNB Investments, Inc.; PSB Realty Co., Inc.; The Sentinel Agency, LLC; Community Banks Insurance Services, LLC; CB Services, LLC; and CB Financial Services, 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, continuing a philosophy of local decision-making.
Community conducts a full service commercial banking business and provides trust services in Adams County, Cumberland County, Dauphin County, southern Luzerne County, Northumberland County, western Schuylkill County, Snyder County, and York County in Pennsylvania and Carroll County in Maryland. Community currently has 44 offices. There are almost 640 offices of commercial banks and savings and loan associations within its market area with which Community competes. Deposits of Community represent approximately 5.3% of the total deposits in the market area. Community has 3 offices in Adams County, 2 offices in Cumberland County, 9 offices in Dauphin County, 3 offices in Luzerne County, 2 offices in Northumberland County, 8 offices in Schuylkill County, 1 office in Snyder County, and 15 offices in York County, Pennsylvania and 1 office in Carroll County, Maryland.
Like other depository institutions, Community has been subjected to competition from 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 a number of special purpose subsidiaries. During December 2002, Community formed CMTY Capital Trust I to execute a pooled trust preferred issuance of $15 million. During 1986, Community formed CBLIC to provide credit life insurance to its consumer credit borrowers. Total premiums earned were $862,000 for the year ended December 31, 2002. During 1985, Community formed CBII to make investments primarily in equity securities of other banks. Total assets of CBII at December 31, 2002 were $5,742,000.
Community and its subsidiaries have approximately 550 full and part-time employees and 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 forms 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."
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. Community's bank subsidiary is subject to supervision and regulation, and is examined regularly, by the Federal Reserve Board and the state banking departments in the states in which it operates. Community and its direct non-banking subsidiaries are affiliates, within the meaning of the GLB Act, of Community's subsidiary bank and its subsidiaries. As a result, the subsidiary 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 minimum standard.
Community Banks is also 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 judgements by the regulators about components risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy requires Community Banks to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined) and of Tier 1 capital (as defined) to average assets (as defined). Management believes, as of December 31, 2002, that Community Banks has met all capital adequacy requirements to which they are subject.
The following table summarizes Community's capital adequacy position:
(A) Tier 1 capital divided by year-end risk-adjusted assets, as defined by the risk-based capital guidelines. (B) Total capital divided by year-end risk-adjusted assets. (C) Tier 1 capital divided by average total assets less disallowed intangible assets.
Other Information - -----------------
Community's internet address is www.communitybanks.com. 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 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.
Statistical Data: - ----------------
The following is hereby incorporated by reference:
Pages 28, 42, and 43 of the Community Banks, Inc. Annual Report to stockholders for the year ended December 31, 2002 contain the following information concerning:
Financial Highlights, Average Balances, Effective Interest Differential, and Interest Yields for the three years ended December 31, 2002.
Rate/Volume Analysis for the two years ended December 31, 2002.
Appendix A attached to Part I contains information concerning:
Return on Equity and Assets for the five years ended December 31, 2002.
Amortized Cost and Estimated Market Values of Investment Securities as of December 31, 2002, 2001, and 2000.
Maturity Distribution of Securities as of December 31, 2002 (Market Value).
Loan Account Composition as of December 31, 2002, 2001, 2000, 1999, and 1998.
Maturities and Sensitivity to Changes in Interest Rates for Commercial, Financial, and Agricultural Loans as of December 31, 2002.
Risk Elements as of December 31, 2002, 2001, 2000, 1999, and 1998.
Loan Loss Experience for the five years ended December 31, 2002.
Loans Charged Off and Recovered for the five years ended December 31, 2002.
Allowance for Loan Losses as of December 31, 2002, 2001, 2000, 1999, and 1998.
Maturity Distribution of Time Deposits over $100,000 as of December 31, 2002.
Maturity Distribution of all Time Deposits as of December 31, 2002.
Interest Rate Sensitivity as of December 31, 2002.
Item 2.
Item 2. Properties:
The Corporation owns no real property except through its subsidiary bank. Community Banks owns the following buildings: 150 Market Street, Millersburg, Dauphin County, Pennsylvania; 13-23 South Market Street, Elizabethville, Dauphin County, Pennsylvania; 3679 Peters Mountain Road, Halifax, Dauphin County, Pennsylvania; 906 North River Road, Halifax, Dauphin County, Pennsylvania; 800 Peters Mountain Road, Dauphin, Dauphin County, Pennsylvania; Main and Market Streets, Lykens, Dauphin County, Pennsylvania; 29 East Main Street, Tower City, Porter Township, Schuylkill County, Pennsylvania; 29 East Main Street, Tremont, Schuylkill County, Pennsylvania; 2 North Second Street, St. Clair, Schuylkill County, Pennsylvania; Port Carbon Highway, St. Clair, Schuylkill County, Pennsylvania; 300 East Independence Street, Shamokin, Northumberland County, Pennsylvania; 1251 Centre Turnpike, Orwigsburg, Schuylkill County, Pennsylvania; One South Arch Street, Milton, Northumberland County, Pennsylvania; 30 S. Church Street, Hazleton, Luzerne County, Pennsylvania; 702 West Main Street, Valley View, Schuylkill County, Pennsylvania; Route 25, East Main Street, Valley View, Schuylkill County, Pennsylvania; 735 Center Street, Ashland, Schuylkill County, Pennsylvania; 9-11 N. Centre Street, Pottsville, Schuylkill County, Pennsylvania; One Westside Drive, Shamokin Dam, Snyder County, Pennsylvania; 2796 Old Post Road, Linglestown, Dauphin County, Pennsylvania; 5060 Jonestown Road, Lower Paxton, Dauphin County, Pennsylvania; 201 St. John's Church Road, Camp Hill, Hampden Township, Cumberland County, Pennsylvania; 100 E. King Street, East Berlin, Adams County, Pennsylvania; 3421 Carlisle Road, Dover, York County, Pennsylvania; 29 N. Washington Street, Gettysburg, Adams County, Pennsylvania; 57-59 Main Street, Glen Rock, York County, Pennsylvania; 234 N. Main Street, Loganville, York County, Pennsylvania; 16576 Susquehanna Trail South, New Freedom, York County, Pennsylvania; Corner of Noss Road & Route 616, York New Salem, York County, Pennsylvania; 3093 Cape Horn Road, Red Lion, York County, Pennsylvania; 55 Wetzel Drive, Hanover, York County, Pennsylvania; 2685 South Queen St., York, York County, Pennsylvania; and 4501 Hanover Pike, Manchester, Carroll County, Maryland.
In addition to the offices above, Community Banks leases offices at Main Street, Pillow, Dauphin County, Pennsylvania, pursuant to a lease which, with renewal options, will extend to the year 2008; 600 Carlisle Street, Hanover, York County, Pennsylvania, pursuant to a lease which, with renewal options, will extend to the year 2006; and 509 Greenbriar Road, York, York County, Pennsylvania, pursuant to a lease which, with renewal options, will extend to the year 2029. Also, the Bank leases offices at 390 E. Penn Drive, Enola, Cumberland County, Pennsylvania; Route 93, Conyngham, Luzerne County, Pennsylvania; 77 Airport Road, Hazleton, Luzerne County, Pennsylvania; 6700 Derry Street, Rutherford, Dauphin County, Pennsylvania; 16 N. George St., York, York County, Pennsylvania; 2146 North Second Street, Harrisburg, Dauphin County, Pennsylvania; and 750 East Park Drive, Harrisburg, Dauphin County, Pennsylvania.
Community Banks also owns real property through its subsidiary, PSB Realty, at the following locations: 1191 Eichelberger Street, Hanover, York County, Pennsylvania; 155 Glen Drive, Manchester, York County, Pennsylvania; 1345 Baltimore Street, Hanover, York County, Pennsylvania; 5625 York Road, New Oxford, Adams County, Pennsylvania; and 2508 Eastern Boulevard, York, York County, Pennsylvania.
From time to time, the subsidiary bank also acquires real estate by virtue of foreclosure proceedings, such real estate is disposed of in the usual and ordinary course of business as expeditiously as is prudently possible.
Item 3.
Item 3. Legal Proceedings: - ---------------------------
There are no material pending legal actions, other than litigation incidental to the business of the Corporation, to which the Corporation is a party.
Item 4.
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 2002.
APPENDIX A - ----------
APPENDIX A - ---------- Continued
AMORTIZED COST AND ESTIMATED VALUES OF INVESTMENT SECURITIES (dollars in thousands)
At December 31, 2002, 2001, and 2000 ------------------------------------
(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.
APPENDIX A - ---------- Continued
LOAN ACCOUNT COMPOSITION (dollars in thousands) as of December 31 -----------------
The Corporation's loan activity is principally with customers located within its local market area. The Corporation continues to maintain a diversified loan portfolio and has no significant loan concentration in any economic sector. Commercial, financial, and agricultural loans consist principally of commercial lending secured by financial assets of businesses including accounts receivable, inventories and equipment, and, in most cases, include liens on real estate. Real estate construction and mortgage loans are primarily 1 to 4 family residential loans secured by residential properties within the bank's market area. Personal-installment loans consist principally of secured loans for items such as automobiles, property improvement, household and other consumer goods. The Corporation continues to sell fixed rate mortgages in the secondary market to manage interest rate risk. Historically, relative credit risk of commercial, financial and agricultural loans has generally been greater than that of other types of loans.
APPENDIX A - ---------- Continued
MATURITIES AND SENSITIVITY TO CHANGES IN INTEREST RATES FOR COMMERCIAL, FINANCIAL AND AGRICULTURAL AND REAL-ESTATE CONSTRUCTION LOANS (dollars in thousands) as of December 31, 2002 -----------------------
APPENDIX A - ---------- Continued
(a) 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 2002 was $250,000. Interest income from these loans would have approximated $605,000 in 2001.
The change in non-performing loans is primarily a result of the impact of economic conditions upon the loan portfolio. The economic outlook remains uncertain. If the economy in the Corporation's trading area improves this could have a positive impact on delinquency trends and collectibility of loans. However, the commercial real estate market in the Corporation's trading area remains stagnant. The ability of borrowers to liquidate collateral is dependent upon the demand for commercial real estate projects and a buyer's ability to finance commercial real estate projects.
APPENDIX A - ---------- Continued
(a) Averages are a combination of monthly and daily averages.
(b) For detail, see Schedule of Loans Charged Off and Recovered.
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 at least on a quarterly basis. The provision for loan losses is adjusted quarterly based upon current review. The table on page 16 presents an allocation by loan categories of the allowance for loan losses at December 31 for the last five years. In retrospect, the specific allocation in any particular category may prove excessive or inadequate and consequently may be reallocated in the future to reflect the then current condition. Accordingly, the entire allowance is available to absorb losses in any category.
APPENDIX A - ---------- Continued
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 a committee of the board of directors. The methodology used by the Corporation in estimating the allowance has not changed during 2002.
The Corporation's allowance for loan losses is based upon management's quarterly review of the loan portfolio. 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 internally risk rated by the Corporation's loan officers and periodically reviewed by loan quality personnel. Consumer and residential real estate loans are generally analyzed in the aggregate as they are of relative small dollar size and homogeneous in nature.
In addition to economic conditions, consideration of loan portfolio diversification, delinquency and historic loss experience, consideration is also given to examinations performed by the regulatory authorities.
To determine the allowance and corresponding loan loss provision, the amount required for specific loans is first determined. For certain commercial and construction loans, this amount is based upon specific borrower data determined by reviewing individual non-performing, delinquent, or potentially troubled credits. 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. The inherent unallocated allowance includes management's subjective determination of amounts necessary for such things as economic uncertainties and the possible use of imprecise estimates in determining the allocated portion of the allowance. The unallocated portion of the allowance, when added to these allocated amounts, brings the total to the amount deemed prudent and reasonable by management at that time. This unallocated portion is available to absorb losses sustained anywhere within the loan portfolios. Management believes that the allowance for loan losses at December 31, 2002 was adequate to absorb probable credit losses in the portfolio as of that date.
The provision for loan losses totaled $3,350,000 for the year ended December 31, 2002, compared to $5,080,000, $2,863,000, $1,588,000, and $2,054,000 for the years ended December 31, 2001, 2000, 1999, and 1998, respectively. The relationship of the allowance for loan losses to loans at year-end approximated 1.36% compared to ratios ranging from 1.27% to 1.42% for the previous four years. In reviewing the adequacy of the allowance for loan losses, management considered the relationship of non-accrual loans and accruing loans contractually past due 90 days or more to total assets. This relationship approximated .62%, .84%, .51%, .55%, and .63% at year-end 2002, 2001, 2000, 1999, and 1998, respectively.
APPENDIX A - ---------- Continued
*See Schedule "Loan Account Composition" for the percent of loan classification to total loans.
APPENDIX A - ---------- Continued
MATURITY DISTRIBUTION OF TIME DEPOSITS OF $100,000 OR MORE (dollars in thousands) as of December 31, 2002 -----------------------
Remaining to Maturity: Less than three months $ 20,776 Three months to six months 13,636 Six months to twelve months 32,339 More than twelve months 45,296 --------- $ 112,047 =========
MATURITY DISTRIBUTION OF ALL TIME DEPOSITS (dollars in thousands) as of December 31, 2002 -----------------------
Remaining Maturity: One year or less $ 312,177 After one year through two years 160,595 After two years through three years 63,556 After three years through four years 17,451 After four years through five years 60,055 After five years 5,204 --------- $ 619,038 =========
APPENDIX A - ---------- Continued
INTEREST RATE SENSITIVITY
The excess of interest-earning assets over interest-bearing liabilities, which are expected to mature or reprice within a given period is commonly referred to as the "GAP" for that period. For an institution with a positive GAP, the amount of income earned on its assets fluctuates more than the cost of its liabilities in response to changes in the prevailing rates of interest during the period. Accordingly, in a period of decreasing interest rates, institutions with a positive GAP will experience a greater decrease in the yield on their assets than in the cost of their liabilities. Conversely, in a period of rising interest rates, institutions with a positive GAP face a greater increase in the yield on their assets than in the cost of their liabilities. An increasing interest rate environment is favorable to institutions with a positive GAP because more of their assets than their liabilities adjust during the period and, accordingly, the increase in the yield of their assets is greater than the increase in the cost of their liabilities.
The negative GAP between the Corporation's interest-earning assets and interest-bearing liabilities maturing or repricing within one year approximated 5% of total assets at December 31, 2002.
Significant maturity/repricing assumptions (based on internal analysis) include the presentation of all savings, Money Market, and NOW accounts as being 100% interest rate sensitive. Equity securities are reflected in the longest time interval. Assumed pay downs on mortgage-backed securities and loans have also been included in all time intervals.
The following table sets forth the scheduled repricing or maturity of the Corporation's interest-earning assets and interest-bearing liabilities at December 31, 2002.
APPENDIX A - ---------- Continued
Forward-Looking Statements: - --------------------------
Incorporated by reference is the information appearing under the heading "Forward-Looking Statements" on page 40 of the Annual Report to Stockholders for the year ended December 31, 2002 (hereafter referred to as the "Annual Report").
PART II
Item 5.
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters: - ------- ----------------------------------------------------------------------
Incorporated by reference is the information appearing under the heading "Market for the Corporation's Common Stock and Related Securities Holders Matters" on page 41 of the Annual Report.
On December 19, 2002, the Corporation, through its subsidiary CMTY Capital Trust I, issued and sold to TPref Funding III, Ltd., 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. The proceeds of the sale were used by CMTY for general corporate purposes.
Item 6.
Item 6. Selected Financial Data: - ------- ------------------------
Incorporated by reference is the information appearing under the heading "Financial Highlights" on page 28 of the Annual Report.
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results - ------- ----------------------------------------------------------------------- of Operation: -------------
Incorporated by reference is the information appearing under the headings "Rate/Volume Analysis"; "Average Balances, Effective Interest Differential and Interest Yields"; and "Management's Discussion of Financial Condition and Results of Operations' on pages 29 through 41 of the Annual Report.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk - -------- ----------------------------------------------------------
Community Banks, Inc. has only virtually no involvement with derivative financial instruments and does not use them for trading purposes. These derivatives are embedded in their host contract and are not required to be bifurcated. The business of the Corporation and the composition of its balance sheet consists of investments in interest-earning assets (primarily loans, mortgage-backed securities and investment securities), which are primarily funded by interest-bearing liabilities (deposits and borrowings). Such financial instruments have varying levels of sensitivity to changes in market interest rates resulting in market risk. Other than loans, which are originated and held for sale, all of the financial instruments of the Corporation are for other than trading purposes.
Interest rate sensitivity results when the maturity or repricing intervals of interest-earning assets, interest-bearing liabilities, and off-balance sheet financial instruments are different, creating a risk that changes in the level of market interest rates will result in disproportionate changes in the value of, and the net earnings generated from, the Corporation's interest-earning assets, interest-bearing liabilities, and off-balance sheet financial instruments. The Corporation's exposure to interest rate sensitivity is managed primarily through the Corporation's strategy of selecting the types and terms of interest-earning assets and interest-bearing liabilities which generate favorable earnings, while limiting the potential negative effects of changes in market interest rates. Since the Corporation's primary source of interest-bearing liabilities is customer deposits, its ability to manage the types and terms of such deposits may be somewhat limited by customer preferences in the market areas in which it operates. Borrowings, which include Federal Home Loan Bank (FHLB) advances and short-term loans, subordinated notes, and other short-term and long-term borrowings are generally structured with specific terms which in management's judgement, when aggregated with the terms for outstanding deposits and matched with interest-earning assets, mitigate the Corporation's exposure to interest rate sensitivity.
The rates, terms and interest rate indices of the Corporation's interest-earning assets result primarily from its strategy of investing in loans and securities (a substantial portion of which have adjustable-rate terms) which permit the Corporation to limit its exposure to interest rate sensitivity, together with credit risk, while at the same time achieving a positive interest rate spread compared to the cost of interest-bearing liabilities.
Significant Assumptions Utilized in Managing Interest Rate Sensitivity - ----------------------------------------------------------------------
Managing the Corporation's exposure to interest rate sensitivity involves significant assumptions about the exercise of embedded options and the relationship of various interest rate indices of certain financial instruments.
Embedded Options - ----------------
A substantial portion of the Corporation's loans and mortgage-backed securities and residential mortgage loans contain significant embedded options, which permit the borrower to prepay the principal balance of the loan prior to maturity ("prepayments") without penalty. A loan's propensity for prepayment is dependent upon a number of factors, including the current interest rate and interest rate index (if any) of the loan, the financial ability of the borrower to refinance, the economic benefit to be obtained from refinancing, availability of refinancing at attractive terms, as well as economic and other factors in specific geographic areas which affect the sales and price levels of residential property. In a changing interest rate environment, prepayments may increase or decrease on fixed and adjustable-rate loans pursuant to the current relative levels and expectations of future short and long-term interest rates.
Investment securities, other than mortgage-backed securities and those with early call provisions, generally do not have significant embedded options and repay pursuant to specific terms until maturity. While savings and checking deposits generally may be withdrawn upon the customer's request without prior notice, a continuing relationship with such customers is generally predictable resulting in a dependable and uninterrupted source of funds. Time deposits generally have early withdrawal penalties, while term FHLB borrowings and subordinated notes have prepayment penalties, which discourage customer withdrawal of time deposits and prepayment by the Corporation of FHLB borrowings and subordinated notes prior to maturity.
Interest Rate Indices - ---------------------
The Corporation's loans and mortgage-backed securities are primarily indexed to the national interest indices. When such loans and mortgage-backed securities are funded by interest-bearing liabilities which are determined by other indices, usually deposits and FHLB borrowings, a changing interest rate environment may result in different levels of changes in the indices leading to disproportionate changes in the value of, and net earnings generated from, the Corporation's financial instruments. Each index is unique and is influenced by different external factors, therefore, the historical relationships in various indices may not be indicative of the actual change which may result in a changing interest rate environment.
Interest Rate Sensitivity Measurement - -------------------------------------
In addition to periodic GAP reports comparing the sensitivity of interest-earning assets and interest-bearing liabilities to changes in interest rates, management also utilizes a report which measures the exposure of the Corporation's economic value of equity to interest rate risk. The model calculates the present value of assets, liabilities and equity at current interest rates, and at hypothetically higher and lower interest rates at one percent intervals. The present value of each major category of financial instruments is calculated by the model using estimated cash flows based on prepayments, early withdrawals, weighted average contractual rates and terms, and discount rates for similar financial instruments. The resulting present value of longer term fixed-rate financial instruments are more sensitive to change in a higher or lower interest rate scenario, while adjustable-rate financial instruments largely reflect only a change in present value representing the difference between the contractual and discounted rates until the next interest rate repricing date. The information provided by these analyses provides some indication of the potential for interest rate adjustment, but does not necessarily mean that the rate adjustment will occur or that it will occur in accordance with the assumptions. Despite these inherent limitations, Community believes that the tools used to manage its level of interest rate risk provide an appropriate measure of market risk exposure.
The following table reflects the estimated present value of assets, liabilities and equity using the model for Community Banks, Inc. as of December 31, 2002 at current interest rates and hypothetically, higher and lower interest rates of one and two percent.
Item 8.
Item 8. Financial Statements and Supplementary Data: - ------- --------------------------------------------
Critical Accounting Policies
The Corporation has established various accounting policies that govern the application of accounting principles generally accepted in the United States of America in the preparation of its financial statements. The significant accounting policies of the Corporation are described in the footnotes to the consolidated financial statements. Certain accounting policies involve significant judgments and assumptions by management that have a material impact on the carrying value of certain assets and liabilities; management considers such accounting policies to be critical accounting policies. The judgments and assumptions used by management are based on historical experiences and other factors, which are believed to be reasonable under the circumstances. Because of the nature of the judgments and assumptions made by management, actual results could differ from these judgments and estimates, which could have a material impact on the carrying values of assets and liabilities and the results of operations of the Corporation. The Corporation believes that the allowance for loan losses, which is discussed in the section titled "Determination of the Allowance for Loan Losses" (incorporated by reference on page 37 of the Annual Report) requires the most significant judgments and estimates used in the preparation of its consolidated financial statements. See "Footnote 2 - Summary of Significant Accounting Policies" (incorporated by reference on pages 10 and 11 of the Annual Report) for a detailed description of the Corporation's estimation process and methodology related to the allowance for loan losses.
The consolidated financial statements, together with the report thereon of PricewaterhouseCoopers LLP dated January 24, 2003, are incorporated by reference to pages 6 through 27 of the Annual Report.
Item 9.
Item 9. Changes in and Disagreements With Accountants on Accounting and - ------- ---------------------------------------------------------------- Financial Disclosure: ----------------------
None.
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant: - --------- ---------------------------------------------------
Incorporated by reference to the Corporation's definitive Proxy Statement for its 2003 Annual Meeting of Shareholders, which will be filed on or before April 30, 2003.
Item 11.
Item 11. Executive Compensation: - ------- ----------------------
Incorporated by reference to the Corporation's definitive Proxy Statement for its 2003 Annual Meeting of Shareholders, which will be filed on or before April 30, 2003.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and - -------- ------------------------------------------------------------------- Related Stockholder Matters: ----------------------------
Incorporated by reference to the Corporation's definitive Proxy Statement for its 2003 Annual Meeting of Shareholders, which will be filed on or before April 30, 2003.
Item 13.
Item 13. Certain Relationships and Related Transactions: - -------- -----------------------------------------------
Incorporated by reference to the Corporation's definitive Proxy Statement for its 2003 Annual Meeting of Shareholders, which will be filed on or before April 30, 2003.
Item 14.
Item 14. Controls and Procedures: - ------- ------------------------
Under the supervision and with the participation of the Company's management, including its Chief Executive Officer and Chief Financial Officer, the Company has evaluated the effectiveness of the design and operation of its disclosure controls and procedures within 90 days prior to the filing date of this annual report. Based upon this evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that the Company's disclosure controls and procedures are adequate and effective to ensure that material information relating to the Company and its consolidated subsidiaries is made known to them by others within those entities, particularly during the period in which this annual report was prepared. There were no significant changes in the Company's internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation.
PART IV
Item 15.
Item 15. Exhibits, Financial Statements Schedules and Reports on Form 8-K: - -------- -----------------------------------------------------------------
(a) (2) All other schedules are omitted since the required information is not applicable or is not present in amounts sufficient to require submission on the schedule.
(a) (3) Exhibits
(13) Portions of the Annual Report to Security Holders incorporated by reference within this document is filed as part of this report. (21) Subsidiaries of the Registrant (See Item 1, page 4.)
(b) The registrant filed the following reports on Form 8-K during the fourth calendar quarter of the year ending December 31, 2002:
Report Dated October 18, 2002 ----------------------------- Registrant announced its earnings for the period ended September 30, 2002.
Report Dated October 30, 2002 ----------------------------- Registrant released information pursuant to Regulation FD with respect to presentation materials, which were made available to the investment community by Community Banks, Inc.
Report Dated November 5, 2002 ----------------------------- Registrant announced a stock repurchase agreement.
Report Dated December 17, 2002 ------------------------------ Registrant announced an Agreement and Plan of Reorganization between Community Banks, Inc. and the Abstracting Company of York County.
(c) Exhibits
(3)(i) Articles of Incorporation - Incorporated by reference to Exhibit 3.1, attached to Community's registration on Form 8-A, filed on May 13, 2002 (3)(ii)By-Laws (4) Instruments defining the rights of the holders of trust capital securities and sold by the Corporation are not attached, as the amount of such securities is less than 10% of the consolidated assets of the Corporation and its subsidiaries, and the securities have not been registered. The Corporation agrees to provide copies of such instruments to the SEC upon request. (10) Material Contracts 10.1 2000 Directors' Stock Option Plan, incorporated by reference to Exhibit 4 to Community's registration on Form S-8, filed on May 17, 2000 10.2 1998 Long-Term Incentive Plan, incorporated by reference to Exhibit 4 to Community's registration on Form S-8, filed on June 18, 1998 10.3 Form of Stock Option Agreement - Directors Stock Option Plan 10.4 Form of Stock Option Agreement - Long-Term Incentive Plan 10.5 Employment Agreement of Eddie L. Dunklebarger 10.6 Employment Agreement of Donald F. Holt 10.7 Employment Agreement, and amendment thereto, of Robert W. Lawley 10.8 Employment Agreement, and amendment thereto, of Anthony N. Leo 10.9 Employment Agreement, and amendment thereto, of Jeffrey M. Seibert 10.10 Salary Continuation Agreement, and amendment thereto, of Eddie L. Dunklebarger 10.11 Salary Continuation Agreement, and amendment thereto, of Robert W. Lawley 10.12 Salary Continuation Agreement, and amendment thereto, of Anthony N. Leo 10.13 Salary Continuation Agreement, and amendment thereto, of Jeffrey M. Seibert 10.14 Rights Agreement between Community Banks, Inc. and Community Banks, dated February 28, 2002, incorporated by reference to Exhibit 1 to Community's registration on Form 8-A, filed on February 27, 2002 10.15 Community Banks, Inc. 401(k) Plan 23.1 Consent of Independent Accountants - PricewaterhouseCoopers LLP 23.2 Consent of Independent Accountants - Beard Miller Company LLP 99.1 Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 99.2 Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 99.3 Independent Auditor's Report - Beard Miller Company LLP
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Community Banks, Inc.
By: /S/ (Eddie L. Dunklebarger) ----------------------------- (Eddie L. Dunklebarger) Chairman of the Board, President and Director
Date: 3/28/03
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
/S/ (Donald F. Holt) Ex. Vice President and 3/28/03 - ---------------------------------- Chief Financial Officer (Donald F. Holt)
/S/ (Ronald E. Boyer) Director 2/11/03 - ---------------------------------- (Ronald E. Boyer)
/S/ (Samuel E. Cooper) Director 2/11/03 - ---------------------------------- (Samuel E. Cooper)
/S/ (Kenneth L. Deibler) Director 2/11/03 - ---------------------------------- (Kenneth L. Deibler)
Director - ---------------------------------- (Peter DeSoto)
/S/ (Thomas W. Long) Director 2/11/03 - ---------------------------------- (Thomas W. Long)
/S/ (Donald L. Miller) Director 2/11/03 - ---------------------------------- (Donald L. Miller)
/S/ (Thomas L. Miller) Director 2/11/03 - ---------------------------------- (Thomas L. Miller)
/S/ (Earl L. Mummert) Director 2/11/03 - ---------------------------------- (Earl L. Mummert)
Director - ---------------------------------- (Wayne H. Mummert)
/S/ (Scott J. Newkam) Director 2/11/03 - ---------------------------------- (Scott J. Newkam)
/S/ (Robert W. Rissinger) Director 2/11/03 - ---------------------------------- (Robert W. Rissinger)
/S/ (Allen Shaffer) Director 2/11/03 - ---------------------------------- (Allen Shaffer)
/S/ (John W. Taylor, Jr.) Director 2/11/03 - ---------------------------------- (John W. Taylor, Jr.)
/S/ (James A. Ulsh) Director 2/11/03 - ---------------------------------- (James A. Ulsh)
CERTIFICATION
I, Eddie L. Dunklebarger, certify that:
1. I have reviewed this annual report on Form 10-K of Community Banks, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions):
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date 3/28/03 /s/ Eddie L. Dunklebarger ---------------------------- --------------------------- Eddie L. Dunklebarger Chairman and President (Chief Executive Officer)
CERTIFICATION
I, Donald F. Holt, certify that:
1. I have reviewed this annual report on Form 10-K of Community Banks, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions):
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date 3/28/03 /s/ Donald F. Holt ---------------------------- ------------------------- Donald F. Holt Executive Vice President (Chief Financial Officer)