Item 1. Business.
History and Business Tower Bancorp, Inc. ("Tower") is a bank holding company registered under the Bank Holding Company Act of 1956, as amended. Tower was organized on October 12, 1983, under the laws of the Commonwealth of Pennsylvania for the purpose of acquiring The First National Bank of Greencastle, Greencastle, Pennsylvania ("First") and such other banks and bank related activities as are permitted by law and desirable. On June 1, 1984, Tower acquired 100% ownership of The First National Bank of Greencastle, issuing 159,753 shares of Tower's common stock to the former First shareholders.
During 1998 Tower acquired 9,807 shares of its own common stock and sold 5,005 shares of treasury stock to First's ESOP plan, and 1,504 shares to First executive officers and directors as part of a stock option plan. On July 1, 1998 Tower issued a 2 for 1 stock split of 885,600 shares, increasing the total number of shares outstanding at December 31, 1998 to 1,765,400.
During 1999 Tower acquired 9,691 shares of its own common stock and sold 5,872 shares of treasury stock to First's ESOP plan, and 1,020 shares to First executive officers as part of a stock option plan.
During 2000 Tower acquired 7,750 shares of its own common stock and sold 1,655 shares of treasury stock to First executive officers and directors as part of a stock option plan.
During 2001 Tower acquired 19,024 shares of its own common stock and sold 8,454 shares of treasury stock to First's ESOP plan, and 1,374 shares to First executive officers as part of a stock option plan.
During 2002 Tower acquired 21,127 shares of its own common stock and sold 3,080 shares of treasury stock to First's ESOP plan, 1,440 shares to First executive officers, and 2,108 shares to First directors as part of a stock option plan.
During 2003 Tower acquired 14,833 shares of its own common stock and sold 10,470 shares of treasury stock to First's ESOP plan, 1,623 shares to First executive officers, and 4,435 shares to First directors as part of a stock option plan.
Tower's primary activity consists of owning and supervising its subsidiary, The First National Bank of Greencastle, which is engaged in providing banking and bank related services in South Central Pennsylvania, principally Franklin County, where its nine branches are located in Quincy, Shady Grove, Waynesboro, Mercersburg, Chambersburg (2), and Laurich, Pennsylvania, and Hagerstown, Maryland, as well as its main office in Greencastle, Pennsylvania. During the third quarter of 2003 the ninth branch office was opened in Franklin County, Pennsylvania. The day-to-day management of First is conducted by the subsidiary's officers. Tower derives the majority of its current income from First. Tower has no employees other than its four officers who are also employees of First, its subsidiary. On December 31, 2003, First had 89 full- time and 19 part-time employees.
Tower contemplates that in the future it will evaluate and may acquire, or may cause its subsidiaries to acquire, other banks. Tower also may seek to enter businesses closely related to banking or to acquire existing companies already engaged in such activities. Any acquisition by Tower will require prior approval of the Board of Governors of the Federal Reserve System, the Pennsylvania Department of Banking, and, in some instances, other regulatory agencies and its shareholders.
Business of First
First was organized as a national bank in 1983 as part of an agreement and plan of merger between Tower and The First National Bank of Greencastle, the predecessor of First, under which First became a wholly-owned subsidiary of Tower. As indicated, First is the successor to The First National Bank of Greencastle which was originally organized in 1864.
First is engaged in commercial banking as authorized by the National Bank Act. This involves accepting demand, time and savings deposits and granting loans (consumer, commercial, real estate, business) to individuals, corporations, partnerships, associations, municipalities and other governmental bodies.
First grants agribusiness, commercial, and residential loans to customers throughout the Cumberland Valley area. It maintains a diversified loan portfolio and evaluates each customer's credit-worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary upon the extension of credit, is based on management's credit evaluation of the customer. Collateral held varies, but generally includes equipment and real estate. The concentrations of credit by type of loan are set forth on the face of the balance sheet (page 2 of the Annual Report to Shareholders).
In 2000, First entered into an affiliation agreement with Sentry Trust Company, a Pennsylvania Limited Purpose Bank, (Sentry) whereby Sentry acquired from First the right to service the trust accounts of First. Through this affiliation agreement trust and other financial services are provided to First's customers by Sentry.
As of December 31, 2003, First had total assets of approximately $ 300.7 million, total shareholders' equity of approximately $ 40 million and total deposits of approximately $ 207 million.
Regulation and Supervision
Tower Bancorp, Inc. (Tower) is a bank holding company within the meaning of the Bank Holding Company Act of 1956 (BHC Act), and is registered as such with the Board of Governors of the Federal Reserve System (FRB). As a registered bank holding company, the parent company is required to file with the FRB certain reports and information. Tower is also subject to examination by the FRB and is restricted in its acquisitions, certain of which are subject to approval by the FRB. In addition, the parent company would be required to obtain the approval of the Pennsylvania State Banking Department in order for it to acquire certain bank and nonbank subsidiaries.
Under the BHC Act, a bank holding company is, with limited exceptions, prohibited from (i) acquiring direct or indirect ownership or control of more than 5% of the voting shares of any company which is not a bank or (ii) engaging in any activity other than managing or controlling banks. With the prior approval of the FRB, however, a bank holding company may own shares of a company engaged in activities which the FRB determines to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. In addition, federal law imposes certain restrictions on transactions between Tower and its subsidiary, First National Bank of Greencastle (First). As an affiliate of First, Tower is subject, with certain exceptions, to provisions of federal law imposing limitations on, and requiring collateral for, extensions of credit by First to its affiliates.
The operations of First are subject to federal and state statutes applicable to banks chartered under the banking laws of the United States, to members of the Federal Reserve System and to banks whose deposits are insured by the Federal Deposit Insurance Corporation. Bank operations are also subject to regulations of the Office of the Comptroller of the Currency, the Federal Reserve Board and the Federal Deposit Insurance Corporation.
The primary supervisory authority of First is the Office of the Comptroller of the Currency (OCC), who regularly examines such areas as reserves, loans, investments, management practices and other aspects of bank operations. These examinations are designed primarily for the protection of the Bank depositors.
Federal and state banking laws and regulations govern, among other things, the scope of a bank's business, the investments a bank may make, the reserves against deposits a bank must maintain, the loans a bank makes and
collateral it takes, the maximum interest rates a bank may pay on deposits, the activities of a bank with respect to mergers and consolidations, and the establishment of branches, and management practices and other aspects of banking operations. See Note 20 of the Notes to Financial Statements for a discussion of the limitations on the availability of Tower's subsidiary's undistributed earnings for the payment of dividends due to such regulation and other reasons.
The Financial Institutions Reform, Recovery and Enforcement Act of 1989(FIRREA) provides among other things that a financial institution insured by the Federal Deposit Insurance Corporation(FDIC) sharing common ownership with a failed institution can be required to indemnify the FDIC for its losses resulting from the insolvency of the failed institution, even if such indemnification causes the affiliated institution also to become insolvent. Tower currently has only one subsidiary and as a result has not been significantly affected by the aforementioned provisions of FIRREA.
The OCC issued guidelines which, effective December 31, 1990, imposed upon national banks risk-based capital and leverage standards. These capital requirements of bank regulators, are discussed in Note 20 of the notes to financial statements. Failure to meet applicable capital guidelines could subject a national bank to a variety of enforcement remedies available to the federal regulatory authorities. Depending upon circumstances, the regulatory agencies may require an institution to surpass minimum capital ratios established by the OCC and the FRB.
In December 1991, the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") was enacted. FDICIA contains provisions limiting activities and business methods of depository institutions. FDICIA requires the primary federal banking regulators to promulgate regulations setting forth standards relating to, among other things, internal controls and audit systems; credit underwriting and loan documentation; interest rate exposure and other off-balance sheet assets and liabilities; and compensation of directors and officers. FDICIA also provides for expanded regulation of depository institutions and their affiliates, including parent holding companies, by such institutions' primary federal banking regulator. Each primary federal banking regulator is required to specify, by regulation, capital standards for measuring the capital adequacy of the depository institutions it supervises and, depending upon the extent to which a depository institution does not meet such capital adequacy measures, the primary federal banking regulator may prohibit such institution from paying dividends or may require such institution to take other steps to become adequately capitalized.
FDICIA establishes five capital tiers, ranging from "well capitalized", to "critically undercapitalized". A depository institution is well capitalized if it significantly exceeds the minimum level required by regulation
for each relevant capital measure. Under FDICIA, an institution that is not well capitalized is generally prohibited from accepting brokered deposits and offering interest rates on deposits higher than the prevailing rate in its market; in addition, "pass through" insurance coverage may not be available for certain employee benefit accounts. FDICIA also requires an undercapitalized depository institution to submit an acceptable capital restoration plan to the appropriate federal bank regulatory agency. One requisite element of such a plan is that the institution's parent holding company must guarantee compliance by the institution with the plan, subject to certain limitations. In the event of the parent holding company's bankruptcy, the guarantee, and any other commitments that the parent holding company has made to federal bank regulators to maintain the capital of its depository institution subsidiaries, would be assumed by the bankruptcy trustee and entitled to priority in payment.
Based on their respective regulatory capital ratios at December 31, 2003, the Bank is considered well capitalized, based on the definitions in the regulations issued by the Federal Reserve Board and the other federal bank regulatory agencies setting forth the general capital requirements mandated by FDICIA. See "Capital Funds" in management's discussion and analysis in the corporation's annual report as shown in Exhibit 13.
A federal depositor preference statute was enacted in 1993 providing that deposits and certain claims for administrative expenses and employee compensation against an insured depository institution would be afforded a priority over other general claims against such an institution, including federal funds and letters of credit, in the "liquidation or other resolution" of such an institution by any receiver.
Other Federal Laws and Regulations
Our operations are subject to additional federal laws and regulations applicable to financial institutions, including, without limitation: * Privacy provisions of the Gramm-Leach-Bliley Act and related regulations, which require us to maintain privacy policies intended to safeguard customer financial information, to disclose the policies to our customers and to allow customers to "opt out" of having their financial service providers disclose their confidential financial information to non-affiliated third parties, subject to certain exceptions; * Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records; * Consumer protection rules for the sale of insurance products by depository institutions, adopted pursuant to the requirements of the Gramm-Leach-Bliley Act; and * USA Patriot Act, which requires financial institutions to take certain actions to help prevent, detect and prosecute international money laundering and the financing of terrorism. Sarbanes-Oxley Act of 2002
On July 30, 2002, President Bush signed into law the Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act represents a comprehensive revision of laws affecting corporate governance, accounting obligations and corporate reporting. The Sarbanes-Oxley Act is applicable to all companies with equity securities registered or that file reports under the Securities Exchange Act of 1934. In particular, the Sarbanes-Oxley Act establishes: (i) new requirements for audit committees, including independence, expertise, and responsibilities; (ii) additional responsibilities regarding financial statements for the Chief Executive Officer and Chief Financial Officer of the reporting company; (iii) new standards for auditors and regulation of audits; (iv) increased disclosure and reporting obligations for the reporting company and its directors and executive officers; and (v) new and increased civil and criminal penalties for violations of the securities laws. Many of the provisions were effective immediately while other provisions become effective over a period of time and are subject to rulemaking by the SEC. Because the Corporation's common stock is registered with the SEC, it is currently subject to this Act.
The earnings of First, and therefore the earnings of Tower, are affected by general economic conditions, management policies, and the legislative and governmental actions of various regulatory authorities including the FRB, the OCC and the FDIC.
In addition to banking and securities laws, regulations and regulatory agencies, the Corporation also is subject to various other laws, regulations and regulatory agencies throughout the United States. Furthermore, various proposals, bills and regulations have been and are being considered in the United States Congress, and various other governmental regulatory and legislative bodies, which could result in changes in the profitability and governance of the Corporation. It cannot be predicted whether new legislation or regulations will be adopted and, if so, how they would affect the Corporation.
References under the caption "Supervision and Regulation" to applicable statutes, regulations and orders are brief summaries of portions thereof which do not purport to be complete and which are qualified in their entirety by reference thereto.
Important Factors Relating to Forward Looking Statements
The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for forward-looking statements to encourage companies to provide prospective information about their companies without fear of litigation so long as those statements are identified as forward-looking and are accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those projected in such statements. In
connection with certain statements made in this report and those that may be made in the future by or on behalf of the Corporation which are identified as forward-looking statements, the Corporation notes that the following important factors, among others, could cause actual results to differ materially from those set forth in any such forward-looking statements. Further, such forward- looking statements speak only as of the date on which such statement or statements are made, and the Corporation undertakes no obligation to update any forward-looking statement or statements to reflect events or circumstances after the date on which such statement is made or to reflect the occurrence of unanticipated events.
The business and profitability of a financial services organization such as the Corporation is influenced by prevailing economic conditions and governmental policies. The actions and policy directives of the Federal Reserve Board determine to a significant degree the cost and the availability of funds obtained from money market sources for lending and investing. Federal Reserve Board policies and regulations also influence, directly and indirectly, the rates of interest paid by commercial banks on their interest-bearing deposits and may also impact the value of financial instruments held by the Corporation. The nature and impact on the Corporation of future changes in economic and market conditions and monetary and fiscal policies, both foreign and domestic, are not predictable, and are beyond the Corporation's control. In addition, these conditions and policies can impact the Corporation's customers and counterparties which may increase the risk of default on their obligations to the Corporation and its affiliates. They can also affect the competitive conditions in the markets and products within which the Corporation operates, which can have an adverse impact on the Corporation's ability to maintain its revenue streams.
As part of its ongoing business, the Corporation assumes financial exposures to interest rates, currencies, equities and other financial products. In doing so, the Corporation is subject to unforeseen events which may not have been anticipated or which may have effects which exceed those assumed within its risk management processes. This risk can be accentuated by volatility and reduction in liquidity in those markets which in turn can impact the Corporation's ability to hedge and trade the positions concerned. In addition, the Corporation is dependent on its ability to access the financial markets for its funding needs.
As noted in "Supervision and Regulation", the Corporation is regulated by and subject to various regulators. The actions of these regulators can have an impact on the profitability and governance of the Corporation. Increases by regulatory authorities of minimum capital, reserve, deposit insurance and other financial viability requirements can also affect the Corporation's profitability.
The Corporation is subject to operational and control risk which is the potential for loss caused by a breakdown in communication, information, processing and settlement systems or processes or a lack of compliance with the procedures on which they rely either within the Corporation or within the broader financial systems infrastructure.
As with any financial institution, the Corporation is also subject to the risk of litigation and to an unexpected or adverse outcome in such litigation. Competitive pressures in the marketplace and unfavorable or adverse publicity and news coverage can have the effect of lessening customer demand for the Corporation's services. Ultimately, the Corporation's businesses and their success are dependent on the Corporation's ability to attract and retain high quality employees.
Competition
First's principal market area consists of the southern portion of Franklin County, Pennsylvania, the northeastern portion of Washington County, Maryland, and a portion of Fulton County, Pennsylvania. It services a substantial number of depositors in this market area, with the greatest concentration within a limited radius of Greencastle, Pennsylvania.
First, like other depository institutions, has been subjected to competition from less heavily regulated entities such as brokerage firms, money market funds, consumer finance and credit card companies and other commercial banks, many of which are larger than First. First is generally competitive with all competing financial institutions in its service area with respect to interest rates paid on time and savings deposits, service charges on deposit accounts and interest rates charged on loans.
The Corporation files periodic reports with the Securities and Exchange Commission (SEC) in the form of 10-Q's - quarterly reports; 10-K - annual report; annual proxy statements and Form 8-K for any significant events that may arise during the year. Copies of the Coporation's filings may be obtained through the SEC's internet site at www.sec.gov or may be obtained free of charge upon written request furnished to: Mr. Franklin T. Klink, III, CFO, Tower Bancorp, Inc., P. O. Box 8, Center Square, Greencastle, Pennsylvania 17225.
Item 2.
Item 2. Properties.
The First National Bank of Greencastle owns buildings at Center Square, Greencastle, Pennsylvania (its corporate headquarters); Shady Grove, Pennsylvania; 4136 Lincoln Way West, (Laurich Branch), Chambersburg, Pennsylvania; Quincy, Pennsylvania; Waynesboro, Pennsylvania; 18233 Maugans Avenue, Hagerstown, Maryland; and Lincoln Way East, Chambersburg, Pennsylvania. In addition, First leases approximately 1,500 square feet in a building located
at 11906 Buchanan Trail West, Mercersburg, Pennsylvania and 565 square feet located at 785 Fifth Avenue, Chambersburg, Pennsylvania. Offices of the bank are located in each of these buildings.
Item 3.
Item 3. Legal Proceedings.
Tower is an occasional party to legal actions arising in the ordinary course of its business. In the opinion of Tower's management, Tower has adequate legal defenses and/or insurance coverage respecting any and each of these actions and does not believe that they will materially affect Tower's operations or financial position.
Item 3a. Executive Officers of the Registrant
The following table sets forth selected information about the principal officers of the Corporation, each of whom is elected by the Board of Directors and each of whom holds office at the discretion of the Board.
Item 4.
Item 4. Submission of Matters to Vote of Security Holders.
None
Part II
Item 5.
Item 5. Market for Registrant's Common Stock and Related Security Holder Matters.
Tower's common stock is not traded on a national securities exchange, but is traded through the local and over-the-counter local markets under the symbol TOBC. At December 31, 2003, the approximate number of shareholders of record was 1,045. The price ranges for Tower common stock set forth below are the approximate bid prices obtained from brokers who make a market in the stock and don't reflect prices in actual transactions.
Item 6.
Item 6. Selected Financial Data
The selected five-year financial data on page 25 of the annual shareholders' report for the year ended December 31, 2003 is incorporated herein by reference.
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Contractural obligations of the Corporation as of December 31, 2003 are as follows:
All other information required by Item 7 is included in Management's Discussion and Analysis of Financial Condition and Results of Operations, on pages 30 through 36 of the annual shareholders report which is incorporated herein by reference.
Item 7a.
Item 7a. Quantitative and Qualitative Disclosures About Market Risk
The information set forth on pages 34 and 35 of the annual shareholders' report regarding quantitative and qualitative disclosures about market risk is incorporated herein by reference.
Item 8.
Item 8. Financial Statements and Supplementary Data
The financial statements and supplementary data, some of which is required under Guide 3 (statistical disclosures by bank holding companies) are shown on pages 2 through 29 of the annual shareholders report for the year ended December 31, 2003 and are incorporated herein by reference. Certain statistical information required in addition to those included in the annual shareholders' report are submitted herewith as follows.
Description of Statistical Information Page Loan portfolio 13 Summary of loan loss experience 14 Nonaccrual, delinquent and impaired loans 15 Allocation of allowances for loan losses 16-17 Deposits and return on equity and assets 18 Consolidated summary of operations 19
TOWER BANCORP INC. AND ITS WHOLLY-OWNED SUBSIDIARY
LOAN PORTFOLIO
The following table presents the loan portfolio at the end of each of the last five years:
TOWER BANCORP INC. AND ITS WHOLLY-OWNED SUBSIDIARY SUMMARY OF LOAN LOSS EXPERIENCE Years Ended December 31
The provision is based on an evaluation of the adequacy of the allowance for possible loan losses. The evaluation includes, but is not limited to, review of net loan losses for the year, the present and prospective financial condition of the borrowers and evaluation of current and projected economic conditions.
TOWER BANCORP INC. AND ITS WHOLLY-OWNED SUBSIDIARY
LOANS
The following table sets forth the outstanding balances of those loans on a nonaccrual status and those on accrual status which are contractually past due as to principal or interest payments for 60 days and 90 days or more at December 31.
See Note 8 of the Notes to Consolidated Financial Statements for details of income recognized and foregone revenue on nonaccrual loans for the past three years, and disclosures of any impaired loans.
Management has not identified any significant problem loans in the accrual loan categories shown above.
TOWER BANCORP INC. AND ITS WHOLLY-OWNED SUBSIDIARY
The following is 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 conditions. Accordingly, the entire allowance is available to absorb losses in any category:
TOWER BANCORP INC. AND ITS WHOLLY-OWNED SUBSIDIARY
DEPOSITS
The average amounts of deposits are summarized below:
RETURN ON EQUITY AND ASSETS (APPLYING DAILY AVERAGE BALANCES)
The following table presents a summary of significant earnings and capital ratios:
TOWER BANCORP INC. AND ITS WHOLLY-OWNED SUBSIDIARY CONSOLIDATED SUMMARY OF OPERATIONS
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures.
Not applicable.
Item 9a.
Item 9a. Controls and Procedures
The Corporation's Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of the Corporation's disclosure controls and procedures (as such term is defined in Rules 13a-14(c) under the Securities Exchange Act of 1934, as amended (the "Exchange Act")) as of December 31, 2003. Based on such evaluation, such officers have concluded that, as of December 31, 2003, the Corporation's disclosure controls and procedures are effective in alerting them on a timely basis to material information relating to the Corporation (including its consolidated subsidiary) required to be included in the Corporation's periodic filings under the Exchange Act.
CHANGES IN INTERNAL CONTROLS
There have not been any significant changes in the Corporation's internal control over financial reporting or in other factors that could significantly affect such control during the fourth quarter of 2003.
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant
The information required by Item 10 is incorporated by reference from Tower Bancorp's definitive proxy statement for the 2004 Annual Meeting of Shareholders filed pursuant to Regulation 14A.
Item 11.
Item 11. Executive Compensation
The information required by Item 11 is incorporated by reference from Tower Bancorp's definitive proxy statement for the 2004 Annual Meeting of Shareholders filed pursuant to Regulation 14A.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management
Information required by Item 12 is incorporated by reference from Tower Bancorp, Inc.'s definitive proxy statement for the 2004 Annual Meeting of Shareholders filed pursuant to Regulation 14A.
Item 13.
Item 13. Certain Relationships and Related Transactions
The information required by Item 13 is incorporated by reference from Tower Bancorp's definitive proxy statement for the 2004 Annual Meeting of Shareholders filed pursuant to Regulation 14A.
Item 14.
Item 14. Principal Accountant Fees and Services
The information required by Item 14 is incorporated by reference from Tower Bancorp's definitive proxy statement for the 2004 Annual Meeting of Shareholders filed pursuant to Regulation 14A.
PART IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules and Reports of Form 8-K.
(a) (1) - List of Financial Statements The following consolidated financial statements of Tower Bancorp and its subsidiary, included in the annual report of the registrant to its shareholders for the year ended December 31, 2003, are incorporated by reference in Item 8: Consolidated balance sheets - December 31, 2003 and 2002 Consolidated statements of income - Years ended December 31, 2003, 2002, and 2001 Consolidated statements of stockholders' equity - Years ended December 31, 2003, 2002, and 2001 Consolidated statements of cash flows - Years ended December 31, 2003, 2002, and 2001 Notes to consolidated financial statements - December 31, 2003 (2) List of Financial Statement Schedules All financial statement schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and therefore have been omitted. (3) Listing of Exhibits Exhibit (3) (i) Articles of incorporation Exhibit (3) (ii) Bylaws Exhibit (4) Instruments defining the rights of security holders including indentures Exhibit (10) Material contracts Exhibit (13) Annual report to security Holders Exhibit (14) Code of Ethics Exhibit (21) Subsidiaries of the registrant Exhibit (23) Consent of independent auditors Exhibit (31) Rule 13a - 14(a)/15d-14(a) Certifications Exhibit (32) Section 1350 Certifications All other exhibits for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and therefore have been omitted. (b) Reports on Form 8-K filed * Report filed December 11, 2003 for news release declaring dividend for fourth quarter. * Report filed January 13, 2004 for news release announcing financial results for quarter ended December 31, 2003. (c) Exhibits (3)(i) Articles of incorporation. Incorporated by reference to Form 8-K dated May 26, 1998. (ii) By-laws. Incorporated by reference to Exhibit D to the Registrant's Registration Statement on Form S-14, Registration No. 2-89573. (4) Instruments defining the rights of security holders including indentures. The rights of the holders of Registrant's common stock are contained in: (i) Articles of Incorporation of Tower Bancorp, Inc., incorporated by reference to Form 8-K dated May 26, 1998. (ii) By-laws of Tower Bancorp, Inc., filed as Exhibit D to the Registrant's Registration Statement on Form S-14 (Registration No. 2-89573). (10.1) Change of control agreements, Incorporated by reference to the registrant's Form 10Q filing dated November 12, 2002 Exhibit 99.4, and Form 10K filing dated March 15, 2002 for the year ended December 31, 2001 Exhibits 10-1 and 10-2 and Form 10-K filing dated March 22, 1999 Exhibit 10-1 and 10-2 for the year ended December 31, 1998. (10.2) Non-Qualified stock option plan; stock option plan for outside directors and amended and restated employee stock ownership plan filed as Exhibit 99.1 to the Registrant's Statement on Form S-8 (Registration No. 333-40661). (10.3) Supplemental Executive Retirement Plan Agreement incorporated by reference to the registrant's Form 10-Q filing dated November 10, 2002 Exhibit 99.3. (13) Annual report to security holders - filed herewith (14) Code of Ethics Policy for Directors and Senior Management - filed herewith (21) Subsidiaries of the registrant - filed herewith (23.1) Consent of independent auditors - filed herewith (31.1) Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 - filed herewith (31.2) Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 - filed herewith (32.1) Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 - filed herewith. (32.2) Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 - filed herewith. (d) Financial statement schedules None
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
TOWER BANCORP, INC. -------------------------- (Registrant)
By /s/ Jeff B. Shank -------------------------- Jeff B. Shank, President/CEO (Principal Executive Officer)
By /s/Franklin T. Klink, III -------------------------- Franklin T. Klink, III Treasurer (Principal Financial and Accounting Officer) Dated: March 15, 2004 --------------
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Signature Title Date
/s/ Jeff B. Shank President & - ----------------------- Director March 15, 2004 Jeff B. Shank
/s/ Kermit G. Hicks Chairman of the - ----------------------- Board & Director March 15, 2004 Kermit G. Hicks
/s/Robert L. Pensinger Vice Chairman of the - ----------------------- Board & Director March 15, 2004 Robert L. Pensinger
/s/Frederic M. Frederick Director March 15, 2004 - ----------------------- Frederic M. Frederick
/s/James H. Craig, Jr. Director March 15, 2004 - ----------------------- James H. Craig, Jr.
/s/ Lois Easton Director March 15, 2004 - ----------------------- Lois Easton
/s/ Mark E. Gayman Director March 15, 2004 - ----------------------- Mark E. Gayman Exhibit Index
Exhibit No.
13 Annual report to security holders
14 Code of Ethics Policy for Directors and Senior Management
21 Subsidiaries of the Registrant
23.1 Consent of Independent Auditors
31.1 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes- Oxley Act of 2002
32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes- Oxley Act of 2002
Exhibit 13
Tower Bancorp, Inc.
2003 Annual Financial Report
C O N T E N T S
Page
INDEPENDENT AUDITOR'S REPORT 1
CONSOLIDATED FINANCIAL STATEMENTS
Balance sheets 2 Statements of income 3 Statements of changes in stockholders' equity 4 Statements of cash flows 5 and 6 Notes to consolidated financial statements 7 - 24
SELECTED FIVE-YEAR FINANCIAL DATA 25
SUMMARY OF QUARTERLY FINANCIAL DATA 26
DISTRIBUTION OF ASSETS, LIABILITIES AND STOCKHOLDERS' EQUITY 27
CHANGES IN NET INTEREST INCOME-TAX EQUIVALENT YIELDS 28
MATURITIES OF INVESTMENT SECURITIES 29
MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION AND RESULTS OF OPERATIONS 30 - 36
INDEPENDENT AUDITOR'S REPORT
Board of Directors Tower Bancorp Inc. Greencastle, Pennsylvania
We have audited the accompanying consolidated balance sheets of Tower Bancorp Inc. and its wholly-owned subsidiary as of December 31, 2003 and 2002, and the related consolidated statements of income, changes in stockholders' equity and cash flows for each of the three years in the period ended December 31, 2003. These consolidated financial statements are the responsibility of the company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Tower Bancorp Inc. and its wholly-owned subsidiary as of December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2003 in conformity with U. S. generally accepted accounting principles.
/S/ Smith Elliott Kearns & Company, LLC --------------------------------------- SMITH ELLIOTT KEARNS & COMPANY, LLC
Chambersburg, Pennsylvania January 21, 2004
TOWER BANCORP INC. AND ITS WHOLLY-OWNED SUBSIDIARY
CONSOLIDATED BALANCE SHEETS December 31, 2003 and 2002
The Notes to Financial Statements are an integral part of these statements.
TOWER BANCORP INC. AND ITS WHOLLY-OWNED SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME Years Ended December 31, 2003, 2002, and 2001
The Notes to Financial Statements are an integral part of these statements.
TOWER BANCORP INC. AND ITS WHOLLY-OWNED SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY Years Ended December 31, 2003, 2002 and 2001
The Notes to Financial Statements are an integral part of these statements.
TOWER BANCORP INC. AND ITS WHOLLY-OWNED SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended December 31, 2003, 2002 and 2001
The Notes to Financial Statements are an integral part of these statements.
TOWER BANCORP INC. AND ITS WHOLLY-OWNED SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) Years Ended December 31, 2003, 2002, and 2001
The Notes to Financial Statements are an integral part of these statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Summary of Significant Accounting Policies
Nature of Operations
Tower Bancorp's primary activity consists of owning and supervising its subsidiary, The First National Bank of Greencastle (the Bank), which is engaged in providing banking and bank related services in South Central Pennsylvania, principally Franklin County. Its nine offices are located in Greencastle, Quincy, Shady Grove, Laurich, Waynesboro, Chambersburg (2), and Mercersburg, Pennsylvania; and Hagerstown, Maryland.
Principles of Consolidation
The consolidated financial statements include the accounts of the corporation and its wholly-owned subsidiary, The First National Bank of Greencastle. All significant intercompany transactions and accounts have been eliminated.
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for losses on loans and the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans. In connection with the determination of the allowances for losses on loans and foreclosed real estate, management obtains independent appraisals for significant properties.
While management uses available information to recognize losses on loans and foreclosed real estate, future additions to the allowances may be necessary based on changes in local economic conditions. In addition, regulatory agencies, as an integral part of their examination process, periodically review the Corporation's allowances for losses on loans and foreclosed real estate. Such agencies may require the Corporation to recognize additions to the allowances based on their judgments about information available to them at the time of their examination. Because of these factors, management's estimate of credit losses inherent in the loan portfolio and the related allowance may change in the near term.
Investment Securities
The Corporation's investments in securities are classified in three categories and accounted for as follows:
Trading Securities. Securities held principally for resale in the near term are classified as trading securities and recorded at their fair values. Unrealized gains and losses on trading securities are included in other income. Note 1. Summary of Significant Accounting Policies (Continued)
Securities to be Held to Maturity. Bonds and notes for which the Corporation has the positive intent and ability to hold to maturity are reported at cost, adjusted for amortization of premiums and accretion of discounts which are recognized in interest income using the interest method over the period to maturity.
Securities Available for Sale. Securities available for sale consist of securities not classified as trading securities nor as securities to be held to maturity. These are securities that management intends to use as a part of its asset and liability management strategy and may be sold in response to changes in interest rates, resultant prepayment risk and other related factors.
Unrealized holding gains and losses, net of tax, on securities available for sale are reported as a net amount in other comprehensive income.
Gains and losses on the sale of securities available for sale are determined using the specific-identification method.
Fair values for investment securities are based on quoted market prices.
The Corporation had no trading or held to maturity securities in 2003 or 2002.
Restricted Bank Stock
The Corporation is required to maintain minimum investment balances in The Federal Reserve Bank, Federal Home Loan Bank and Atlantic Central Banker's Bank. These investments are carried at cost because they are not actively traded and have no readily determinable market value.
Premises, Equipment, Furniture and Fixtures and Depreciation
Premises, equipment, and furniture and fixtures are carried at cost less accumulated depreciation. Depreciation has been provided generally on the straight-line method and is computed over the estimated useful lives of the various assets as follows: Years
Premises 15-40 Equipment, furniture and fixtures 3-15
Repairs and maintenance are charged to operations as incurred.
Foreclosed Property
Includes foreclosed properties for which the institution has taken physical possession in connection with loan foreclosure proceedings.
At the time of foreclosure, the real estate is recorded at the lower of the Corporation's cost (loan balance) or the asset's fair value, less estimated costs to sell, which becomes the property's new basis. Any write-downs based on the asset's fair value at date of acquisition are charged to the allowance for loan losses. Costs incurred in maintaining foreclosed real estate and subsequent write-downs to reflect declines in the fair value of the property are included in operations.
Retirement Plan
The Corporation has a money purchase pension plan which covers all full- time employees who have attained the age of twenty (20) and have completed a minimum of one year of continuous service with the Corporation. The Corporation's policy is to fund pension costs accrued.
Note 1. Summary of Significant Accounting Policies (Continued)
Loans and Allowance for Loan Losses
Loans are stated at the amount of unpaid principal, reduced by unearned discount, deferred loan origination fees, and an allowance for loan losses. Unearned discount on installment loans is recognized as income over the terms of the loans by the interest method. Interest on other loans is calculated by using the simple interest method on daily balances of the principal amount outstanding.
The allowance for loan losses is established through a provision for loan losses charged to expense. Loans are charged against the allowance for loan losses when management believes that the collectibility of the principal is unlikely. The allowance is an amount that management believes will be adequate to absorb possible losses on existing loans that may become uncollectible, based on evaluations of the collectibility of loans and prior loan loss experience. The evaluations take into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans, and current economic conditions that may affect the borrowers' ability to pay.
Loan origination fees and certain direct loan origination costs are deferred and the net amount amortized as an adjustment of the related loan's yield. The Corporation is amortizing these amounts over the contractual life of the related loans.
Nonaccrual/Impaired Loans
The accrual of interest income on loans ceases when principal or interest is past due 90 days or more and collateral is inadequate to cover principal and interest or immediately if, in the opinion of management, full collection is unlikely. Interest accrued but not collected as of the date of placement on nonaccrual status is reversed and charged against current income unless fully collateralized. Subsequent payments received are either applied to the outstanding principal balance or recorded as interest income, depending on management's assessment of the ultimate collectibility of principal. Interest income generally is not recognized on specific impaired loans unless the likelihood of further loss is remote. Interest income on such loans is recognized only to the extent of interest payments received.
Earnings per Share of Common Stock
Earnings per share of common stock were computed based on weighted average shares outstanding. For diluted earnings per share, net income is divided by the weighted average number of shares outstanding plus the incremental number of shares added as a result of converting common stock equivalents. The corporation's common stock equivalents consist of outstanding stock options. See Note 11 for further details.
A reconciliation of the weighted average shares outstanding used to calculate basic net income per share and diluted net income per share follows. There is no adjustment to net income to arrive at diluted net income per share.
Note 1. Summary of Significant Accounting Policies (Continued)
Federal Income Taxes
For financial reporting purposes, the provision for loan losses charged to operating expense is based on management's judgment, whereas for federal income tax purposes, the amount allowable under present tax law is deducted. Additionally, deferred compensation is charged to operating expense in the period the liability is incurred for financial reporting purposes, whereas, for federal income tax purposes, these expenses are deducted when paid. There are also differences between the amount of depreciation expensed for tax and financial reporting purposes, and an income tax effect caused by the adjustment to fair value for available for sale securities. As a result of these timing differences, deferred income taxes are provided in the financial statements. See Note 14 for further details.
Cash Flows
For purposes of the Statements of Cash Flows, the company has defined cash and cash equivalents as highly liquid debt instruments with maturities of three months or less. They are included in the balance sheet caption "cash and due from banks". As permitted by generally accepted accounting principles, the company has elected to present the net increase or decrease in deposits in banks, loans and deposits in the Statements of Cash Flows.
Fair Values of Financial Instruments
Generally Accepted Accounting Principles (GAAP) requires disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instruments. GAAP excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the corporation. See Note 19 for further details.
The following methods and assumptions were used by the corporation in estimating fair values of financial instruments as disclosed herein:
Cash and Cash Equivalents. The carrying amounts of cash and short- term instruments approximate their fair value.
Interest Bearing Balances with Banks. Interest bearing balances with banks having a maturity greater than one year have estimated fair values using discounted cash flows based on current market interest rates.
Securities to be Held to Maturity and Securities Available for Sale. Fair values for investment securities are based on quoted market prices.
Loans Receivable. For variable rate loans that reprice frequently and have no significant change in credit risk, fair values are based on carrying values. Fair values for fixed rate loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Fair values for impaired loans are estimated using discounted cash flow analyses or underlying collateral values, where applicable. Note 1. Summary of Significant Accounting Policies (Continued)
Deposit Liabilities. The fair values disclosed for demand deposits are, by definition, equal to the amount payable on demand at the reporting date (that is, their carrying amounts). The carrying amounts of variable rate, fixed-term money market accounts and certificates of deposit approximate their fair values at the reporting date. Fair values for fixed rate certificates of deposits and IRA's are estimated using a discounted cash flow calculation that applies interest rates currently being offered to a schedule of aggregated expected maturities on time deposits.
Federal Funds Purchased and Other Borrowed Funds. The carrying amounts of federal funds purchased, borrowings under repurchase agreements, and other short-term borrowings maturing within 90 days approximate their fair values. Fair values of other borrowings are estimated using discounted cash flow analyses based on the Corporation's current incremental borrowing rates for similar types of borrowing arrangements.
Accrued Interest. The carrying amounts of accrued interest approximate their fair values.
Off-Balance-Sheet Instruments. The Corporation generally does not charge commitment fees. Fees for standby letters of credit and their off-balance-sheet instruments are not significant.
Advertising
The Corporation expenses advertising costs as they are incurred. Advertising expense for the years ended December 31, 2003, 2002, and 2001 was $ 199,968, $ 210,196, and $ 250,101, respectively.
Comprehensive Income
The Corporation follows generally accepted accounting principles when reporting comprehensive income. Comprehensive income is defined as the change in equity from transactions and other events from nonowner sources. It includes all changes in equity except those resulting from investments by stockholders and distributions to stockholders. Comprehensive income includes net income and certain elements of "other comprehensive income" such as foreign currency transactions; accounting for futures contracts; employers accounting for pensions; and accounting for certain investments in debt and equity securities.
The Corporation has elected to report its comprehensive income in the statement of stockholders' equity. The only element of "other comprehensive income" that the Corporation has is the unrealized gains or losses on available for sale securities.
During 2003, the Corporation revised estimated calculations for unrealized holding gains (losses) on certain equity securities in its available-for- sale portfolio due to the continuing development of reliable sources for market values of securities traded in the over-the-counter market. Consequently, investments that were not marked to market in the past are recorded at market value in 2003.
The components of the change in net unrealized gains (losses) on securities are as follows:
Note 1. Summary of Significant Accounting Policies (Continued)
Stock Option Plans
The Corporation applies APB Opinion 25 and related Interpretations in accounting for its stock option plans. Accordingly, only compensation cost for the intrinsic value of options has been recognized. Had compensation cost for the Corporation's stock option plans been determined based on the fair value at the grant dates for awards under the plans consistent with the method prescribed by FASB Statement No. 123, the Corporation's net income and earnings per share would have been adjusted to the pro forma amounts indicated below:
See Note 11 for further details concerning the Corporation's Stock Options Plans.
Note 2. Investment Securities
The investment securities portfolio is comprised of securities classified as available for sale at December 31, 2003 and 2002, resulting in investment securities available for sale being carried at fair value.
The amortized cost and fair value of investment securities available for sale at December 31 were:
Note 2. Investment Securities (Continued)
The fair values of investment securities available for sale at December 31, 2003, by contractual maturity, are shown below. Contractual maturities will differ from expected maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Proceeds from sales and maturities of investment securities available for sale during 2003, 2002, and 2001, were $ 12,800,000, $ 15,820,000, and $ 22,880,000, respectively. Gross realized gains and losses on those sales and maturities were $ 3,143,000 and $ 0 for 2003, $ 1,720,000 and $ 0 for 2002, and $ 1,762,000 and $ 1,000 for 2001, respectively.
Securities carried at $ 19,589,285 and $ 22,634,739 at December 31, 2003 and 2002, respectively, were pledged to secure public funds and for other purposes as required or permitted by law.
Restricted bank stock includes:
Note 3. Allowance for Loan Losses
Activity in the allowance for loan losses is summarized as follows:
Note 4. Premises, Equipment, Furniture and Fixtures
Depreciation expense amounted to $ 385,580 in 2003, $ 429,480 in 2002, and $ 438,920 in 2001.
Note 5. Real Estate Owned Other Than Premises
Included in real estate owned other than premises are certain properties which are located adjacent to the main office. The Bank intends to hold these properties for future expansion purposes in order to protect its competitive position, and are renting certain of these properties until such time as the Bank decides they are needed. The depreciated cost of these properties was $ 476,136 and $ 350,447 at December 31, 2003 and 2002, respectively.
Note 6. Loans
Related Party Loans
The company's subsidiary has granted loans to the officers and directors of the company and its subsidiary and to their associates. Related party loans are made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated persons and do not involve more than normal risk of collectibility. The aggregate dollar amount of these loans was $ 3,289,663 and $ 2,578,347 at December 31, 2003 and 2002, respectively. During 2003, $ 1,280,783 of new loans were made and repayments totaled $ 569,467.
Outstanding loans to bank employees totaled $ 2,467,001 and $ 1,873,655 at December 31, 2003 and 2002, respectively.
Loan Maturities
The following table shows the maturities and sensitivities of loans to changes in interest rates based upon contractual maturities and terms as of December 31, 2003.
Note 7. Financial Instruments With Off-Balance-Sheet Risk
The Corporation is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financial needs of its customers and to reduce its own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheets. The contract amounts of those instruments reflect the extent of involvement the Corporation has in particular classes of financial instruments.
The Corporation's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit and financial guarantees written is represented by the contractual amount of those instruments. The Corporation uses the same credit policies in making commitments and conditional obligations as it does for on balance sheet instruments.
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Corporation evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Corporation upon extension of credit, is based on management's credit evaluation of the customer. Collateral held varies, but may include accounts receivable, inventory, real estate, equipment, and income- producing commercial properties.
Standby letters of credit and financial guarantees written are conditional commitments issued by the Corporation to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. The Corporation holds collateral supporting those commitments when deemed necessary by management.
Note 8. Nonaccrual/Impaired Loans
The following table shows the principal balances of nonaccrual loans as of December 31:
The Corporation had no impairment of loans in 2003, 2002, and 2001. Note 9. Retirement Plan
The Corporation maintains a money purchase retirement plan for those employees who meet the eligibility requirements set forth in the plan. Substantially all of the Corporation's employees are covered by the plan. The Corporation's funding policy is to contribute annually an amount, as determined under plan provisions, necessary to meet the minimum funding standards established by the plan. Contributions charged to operations were $ 82,000 for 2003, $ 47,000 for 2002, and $ 70,000 for 2001.
Note 10. Employee Benefit Plans
The Corporation maintains a profit-sharing plan for those employees who meet the eligibility requirements set forth in the plan. Contributions to the plan are based on Corporation performance and are at the discretion of the Corporation's Board of Directors. Substantially all of the Corporation's employees are covered by the plan and the contribution charged to operations was $ 120,000, $ 110,000, and $ 94,000, for 2003, 2002, and 2001, respectively.
The Corporation maintains a deferred compensation plan for certain key executives and directors, which provides supplemental retirement and life insurance benefits. The plan is partially funded by life insurance on the participants, which lists the bank as beneficiary. The estimated present value of future benefits to be paid, which are included in other liabilities, amounted to $ 781,039 and $ 791,652 at December 31, 2003 and 2002, respectively. Annual expense of $ 84,146, $ 82,680, and $ 110,000 was charged to operations for 2003, 2002, and 2001, respectively.
During 1999 a director who was a participant of the plan deceased. The present value of this participant's benefits, which will be paid out over ten years, was $ 140,287, $ 162,108, and $ 182,219, as of December 31, 2003, 2002, and 2001, respectively.
The Corporation has a supplemental group term retirement plan which covers certain officers of the Corporation. This plan is funded with single premium life insurance on the plan participants. The cash surrender value of the policies is an unrestricted asset of the Corporation. The estimated present value of the future benefits to be paid totaled $ 52,925 and $ 18,566 at December 31, 2003 and 2002, respectively. Total annual expense for this plan was $ 59,841, $ 23,989, and $ 20,165, for 2003, 2002, and 2001, respectively.
The Corporation maintains an employee stock ownership plan (ESOP) that generally covers all employees who have completed one year of service and attained the age of twenty. Contributions to the plan are determined annually by the Board of Directors as a percentage of the participants' total compensation. Compensation for the plan is defined as compensation paid including salary reduction and Sections 125 and 401(k) but excluding nontaxable fringe benefits and any compensation over $ 200,000. The payments of benefits to participants are made at death, disability, termination or retirement. Contributions to the plan for all employees charged to operations amounted to $ 120,000, $ 110,000, and $ 94,000 for 2003, 2002, and 2001, respectively. All shares held in the plan are considered issued and outstanding for earnings per share calculations and all dividends earned on ESOP shares are charged against retained earnings, the same as other outstanding shares. Total shares of the plan were 81,586 and 75,476 at December 31, 2003 and 2002, respectively.
Note 11. Stock Option Plans
In 1996 the Corporation implemented two nonqualified stock option plans, which are described below. The compensation cost that has been charged against income for those plans was $ 104,819, $ 51,353, and $ 29,555 for 2003, 2002, and 2001, respectively.
The first plan is for select key employees. This plan granted options for up to 1,623 shares at a purchase price of $ 1.00 per share. These options can be exercised only by the key employees during his/her lifetime.
The second plan is for outside directors. This plan granted options of 4,060, 3,600, and 5,154 shares for each director at $ 30.00, $ 24.250, and $ 20.125 per share for the years ended December 31, 2003, 2002, and 2001, respectively, which was based on the market value of the stock at the grant date. Options are vested one year following the grant date and expire upon the earlier of 120 months following the date of the grant or one year following the date on which a director ceases to serve in such a capacity for the corporation. At December 31, 2003 the range of exercise prices was from $ 11.91 to $ 32.13 per share. At December 31, 2003, there were 114,155 shares that can still be granted under these plans.
A summary of the status of the Corporation's two fixed stock option plans as of December 31 is as follows:
Outstanding options at December 31, 2003 consist of the following:
Note 11. Stock Option Plans (Continued)
The fair value of each option granted is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted- average assumptions.
Note 12. Deposits
Included in savings deposits at December 31 are NOW and Money Market Account balances totaling $ 90,089,000 and $ 80,839,000 for 2003 and 2002, respectively.
Time deposits of $ 100,000 and over aggregated $ 14,509,480 and $ 15,119,446 at December 31, 2003 and 2002, respectively. At December 31, 2003 and 2002 the scheduled maturities of time deposits of $ 100,000 and over are as follows:
At December 31, 2003 scheduled maturities of all time deposits are as follows:
2004 $ 31,655,519 2005 17,739,153 2006 10,193,313 2007 4,347,651 2008 8,132,991 ------------ $ 72,068,627 ============
The aggregate amount of demand deposits reclassified as loan balances were $ 506,904 and $ 184,588 at December 31, 2003 and 2002, respectively.
The Corporation accepts deposits of the officers, directors, and employees on the same terms, including interest rates, as those prevailing at the time for comparable transactions with unrelated persons. The aggregate dollar amount of deposits of officers, directors and employees totaled $ 2,422,286 and $ 1,627,189 at December 31, 2003 and 2002, respectively.
Note 13. Liabilities for Other Borrowed Funds
At December 31, 2003 and 2002, $ 3,935,000 and $ 2,800,000, respectively, of other borrowed funds represents the outstanding balance on lines of credit at other area banks. Total amount of the lines at December 31, 2003 and 2002 was $ 5,800,000. Interest on these lines ranged from 3.00% to 5.25% for 2003 and 2002. Note 13. Liabilities for Other Borrowed Funds (Continued)
In addition, $ 202,595 and $ 307,647 of the balance of liabilities for other borrowed funds at December 31, 2003 and 2002, respectively, represents the balance of the Treasury Tax and Loan Investment Program. The Corporation elected to enter into this program in accordance with federal regulations. This program permits the Corporation to borrow these Treasury Tax and Loan funds by executing an open-ended interest bearing note to the Federal Reserve Bank. Interest is payable monthly and is computed at 1/4% below the Federal Funds interest rate. The note is secured by U.S. Government obligations with a par value of $ 439,915 and $ 656,950 at December 31, 2003 and 2002, respectively.
The Corporation also had the following borrowings from the Federal Home Loan Bank:
(1) Total amount available under this line is $ 11,764,000 at December 31, 2003.
Total maximum borrowing capacity from Federal Home Loan Bank at December 31, 2003 was $ 136,241,000. Collateral for borrowings consists of certain securities and the Corporation's 1-4 family mortgage loans totaling approximately $ 136 million at December 31, 2003.
Note 14. Income Taxes
The components of income tax expense are summarized as follows:
Federal income taxes were computed after reducing pretax accounting income for non-taxable income in the amount of $ 1,810,195, $ 1,741,545, and $ 1,321,372 for 2003, 2002, and 2001, respectively. Note 14. Income Taxes (Continued)
A reconciliation of the effective applicable income tax rate to the federal statutory rate is as follows:
Deferred tax assets have been provided for deductible temporary differences related to the allowance for loan loss, deferred compensation, and interest on nonaccrual loans. Deferred tax liabilities have been provided for taxable temporary differences related to depreciation and unrealized gains on securities available for sale. The net deferred taxes included in the accompanying balance sheets at December 31 are as follows:
The company has not recorded a valuation allowance for the deferred tax assets as management feels that it is more likely than not that they will be ultimately realized.
Note 15. Tower Bancorp Inc. (Parent Company Only) Financial Information
The following are the condensed balance sheets, statements of income, and statements of cash flows for the parent company:
Note 15. Tower Bancorp Inc. (Parent Company Only) Financial Information (Continued)
Note 16. Compensating Balance Arrangements
Included in cash and due from banks are required deposit balances at the Federal Reserve of $ 615,000 at December 31, 2003 and 2002 and required deposit balances at Equifax of $ 39,391 and $ 36,641 at December 31, 2003 and 2002, respectively. These are maintained to cover processing costs and service charges.
Note 17. Concentration of Credit Risk
The Corporation grants agribusiness, commercial and residential loans to customers throughout the Cumberland Valley area. The Corporation maintains a diversified loan portfolio and evaluates each customer's credit-worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Corporation upon the extension of credit, is based on management's credit evaluation of the customer. Collateral held varies, but generally includes equipment and real estate.
The Corporation maintains deposit balances at several correspondent banks, which provide check collection and item processing services to the bank. The balances with these correspondent banks, at times, exceed federally insured limits, which management considers to be a normal business risk.
Note 18. Commitments and Contingencies
The Corporation leases its facilities in Mercersburg under a noncancellable operating lease that expires in 2006. Total rent expense charged to operations was $ 22,200 for 2003, 2002, and 2001.
The Corporation leases its facilities in Chambersburg under a noncancellable lease that expires in September 2007, with a year-to-year basis thereafter. Total rent expense charged to operations was $ 10,800, $ 9,600, and $ 3,200 for 2003, 2002, and 2001, respectively.
The Corporation also leases a site for an Automatic Teller Machine under a noncancellable operating lease that expires in 2013 with the right to negotiate an extended lease of two additional five year terms. Total rent expense charged to operations was $ 10,200 for 2003 and $ 9,000 for 2002 and 2001. The lease rental for the second five years of the initial term is subject to negotiation.
Following is a schedule, by years, of future minimum rentals under the lease agreements as of December 31, 2003:
Year Ending 2004 $ 46,200 2005 42,600 2006 42,600 2007 17,200 2008 3,600 --------- $ 152,200 =========
The Corporation is a defendant in a lawsuit that involves allegations that the Bank improperly deposited and cashed a check. Management believes it has a valid defense against this allegation. However, it is possible that the suit could result in an unfavorable outcome and management has accrued a $ 90,000 liability for this contingency.
Note 19. Fair Value of Financial Instruments
The estimated fair values of the Corporation's financial instruments were as follows at December 31:
Note 20. Regulatory Matters
Dividends paid by Tower Bancorp Inc. are generally provided from the subsidiary bank's dividends to Tower. The Federal Reserve Board, which regulates bank holding companies, establishes guidelines which indicate that cash dividends should be covered by current year earnings and the debt to equity ratio of the holding company must be below thirty percent. The Bank, as a national
Note 20. Regulatory Matters (Continued)
bank, is subject to the dividend restrictions set forth by the Comptroller of the Currency. Under such restrictions, the Bank may not, without prior approval of the Comptroller of the Currency, declare dividends in excess of the sum of the current year's earnings (as defined) plus retained earnings (as defined) from the prior two years. Dividends that the Bank could declare without approval of the Comptroller of the Currency, amounted to approximately $ 6,777,799 and $ 7,381,375 for 2003 and 2002, respectively.
The Corporation is also subject to various regulatory capital requirements administered by federal 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 the corporation's financial statements. Under capital adequacy guidelines, the corporation is required to maintain minimum capital ratios. The "leverage ratio", compares capital to adjusted total balance sheet assets while risk-based ratios compare capital to risk-weighted assets and off-balance sheet activity in order to make capital levels more sensitive to risk profiles of individual banks. A comparison of Tower Bancorp's capital ratios to regulatory minimums at December 31 is as follows:
As of December 31, 2003 the most recent notification from the Office of the Comptroller of the Currency categorized the financial institution as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the financial institution's category.
TOWER BANCORP INC. AND ITS WHOLLY-OWNED SUBSIDIARIES
SELECTED FIVE-YEAR FINANCIAL DATA
Per share amounts are based on the following weighted average shares outstanding.
2003 - 1,733,477 2001 - 1,745,847 1999 - 1,763,548 2002 - 1,737,298 2000 - 1,761,699
TOWER BANCORP INC. AND ITS WHOLLY-OWNED SUBSIDIARIES
SUMMARY OF QUARTERLY FINANCIAL DATA
The unaudited quarterly results of operations for the years ended December 31, 2003 and 2002 are as follows:
TOWER BANCORP INC. AND ITS WHOLLY-OWNED SUBSIDIARIES
DISTRIBUTION OF ASSETS, LIABILITIES AND STOCKHOLDERS' EQUITY Interest Rates and Interest Differential Tax Equivalent Yields Years Ended December 31
TOWER BANCORP INC. AND ITS WHOLLY-OWNED SUBSIDIARIES
CHANGES IN NET INTEREST INCOME TAX EQUIVALENT YIELDS
Changes which are attributed in part to volume and in part to rate are allocated in proportion to their relationships to the amounts of changes.
TOWER BANCORP INC. AND ITS WHOLLY-OWNED SUBSIDIARIES
MATURITIES OF INVESTMENT SECURITIES
December 31, 2003
The following table shows the maturities of investment securities at amortized cost as of December 31, 2003, and weighted average yields of such securities. Yields are shown on a taxable equivalent basis, assuming a 34% federal income tax rate.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with the selected supplementary financial information presented in this report.
OPERATING RESULTS
The results of operations and financial condition are explained through an analysis of fluctuations in net interest income and other noninterest income and expense items.
Net interest income is the difference between total interest income and total interest expense. Interest income is generated through earning assets which include loans, deposits with other banks and investments. The amount of interest income is dependent on many factors including the volume of earning assets, the level of and changes in interest rates, and volumes of nonperforming loans. The cost of funds varies with the volume of funds necessary to support earning assets, the rates paid to maintain deposits, rates paid on borrowed funds and the level of interest-free deposits.
Net income was $ 4,951,000 in 2003 compared to $ 4,853,000 in 2002 and $ 4,001,000 in 2001. Net income on an adjusted per share basis for 2003 was $ 2.86, up $ .07 from $ 2.79, realized during 2002.
Total interest income decreased $ 1,423,000 from 2002 to 2003 and $ 653,000 from 2001 to 2002. Decreases in 2003 and 2002 were due to reductions in rates. Average loans outstanding in 2003 increased 8.0% over 2002. However, the continuing decline in rates resulted in a 8.0% decrease in interest income from loans in 2003 as compared to a 1.3% decrease realized in 2002. Earnings on investments (excluding gains from sales) decreased 14.0% in 2003 compared to a 15.3% decrease in 2002. This decrease was primarily the result of decreased average rates of investment securities which dropped to 3.86% in 2003 from 4.6% in 2002. Total average earning assets increased 6.8% in 2003 compared to 8.9% in 2002. Increases in earning assets during 2003 and 2002 were proportionately higher in loans, which typically produce higher yields than investments.
Interest from loans accounted for 84% of total interest income for 2003, as compared to 83% and 81% for 2002 and 2001, respectively. Interest and dividends on investments amounted to $ 2,277,000 or 16.0% of interest income for 2003, as compared to $ 2,650,000 or 17% in 2002 and $ 3,130,000 or 19% in 2001.
Total interest expense was $ 4,267,000 for 2003, a decrease of $ 985,000 over the $ 5,252,000 for 2002. The increase in total average interest bearing deposits was 6.6% in 2003 compared to 3.3% in 2002. Overall growth was moderate during 2003 and 2002 with interest bearing demand deposits increasing 10.1% and time deposits and savings increasing 1.0% and 12.8%, respectively. Although overall growth was moderate during 2003, rates decreased 60 basis points which caused a decrease in interest expense on deposits of 30.4%. There were some significant changes in the level of borrowed funds resulting in an overall increase in interest expense on borrowed funds by 11.7%. This change in volume along with the decreased level of rates paid for deposits and on borrowed funds was offset somewhat by increases in average volumes in earning assets. The decrease in rates on earning assets caused the overall net interest margin to decrease by 50 basis points for 2003 compared to 2002.
The Corporation's net charge-offs have been lower than peer group performance for the past five years. Net charge-offs were $ 128,000, $ 255,000, and $ 129,000 for 2003, 2002, and 2001, respectively. Previous years' net recoveries, as well as an improving loan portfolio, have allowed the bank to have a current year provision of $ 360,000, $ 310,000, and $ 120,000 for 2003, 2002, and 2001, respectively. The provisions were based on management's evaluation of the adequacy of the reserve balance and represent amounts considered necessary to maintain the reserve at the appropriate level based on the quality of the loan portfolio and other economic conditions.
OPERATING RESULTS (Continued)
Management has significantly expanded its detailed review of the loan portfolio, which is performed quarterly, in an effort to identify and act more readily on loans with deteriorating trends. As a result, nonaccrual loans have decreased and were less than 1% of total loans over the past several years.
Management is not aware of any problem loans that are indicative of trends, events, or uncertainties that would significantly impact future operations, liquidity or capital. Management also recognizes the need to maintain an adequate reserve to meet the constant risks associated with a growing loan portfolio and an expanding customer base and intends to continue to maintain the reserve at appropriate levels based on ongoing evaluations of the loan portfolio.
Other income represents service charges on deposit accounts, commissions and fees received for the sale of travelers' checks, money orders and savings bonds, fees for trust services, fees for investment services, securities gains and losses and other income, such as safe deposit box rents. Other income increased $ 1,461,000 or 49.0% for 2003 over 2002, and increased $ 43,000 or 1.5% for 2002 over 2001. The increase in 2003 was due to income derived from increases in service fees charged and increased gains on investment security sales.
The noninterest expenses are classified into four main categories: salaries and employee benefits; occupancy expenses, which include depreciation, maintenance, utilities, taxes and insurance; equipment expenses, which include depreciation, rents and maintenance; and other operating expenses, which include all other expenses incurred in operating the Corporation.
Personnel related expenses increased $ 343,000 or 9.6% in 2003 over 2002, compared to an increase of $ 347,000 or 10.8% in 2002 over 2001. Occupancy and equipment expense increased by 1.2% from 2003 to 2002 compared to a decrease of 3.2% from 2002 to 2001. Management expected noninterest expenses to increase in 2003 and 2002 with the opening of their new branches and they expect noninterest expense to continue increasing as their plans to expand take place. Total noninterest expenses increased 12.3% in 2003, compared to a decrease of .6% in 2002.
Applicable income taxes changed between 2001, 2002, and 2003 as a result of changes in pre-tax accounting income and taxable income. As described in Note 1 of the Notes to Consolidated Financial Statements, deferred income taxes have been provided for timing differences in the recognition of certain expenses between financial reporting and tax purposes. Deferred income taxes have been provided at prevailing tax rates for such items as depreciation, provision for loan losses, deferred compensation, interest income on nonaccrual loans and unrealized gains and losses on investment securities available for sale as accounted for under SFAS 115. The marginal tax rate at which deferred taxes were provided during 2003 and 2002 is 34%. At December 31, 2003 and 2002, deferred taxes amounted to ($ 3,247,000) and ($ 804,000), respectively. This increase is due mainly to a change in the estimate of unrealized gains and losses on investment securities since information pertaining to market values of stocks traded in the over-the-counter market is now more readily available than it had been in the past. If all timing differences reversed in 2003, the actual income taxes saved by the recognition of the aforementioned expenses would not be significantly different from the deferred income taxes recognized for financial reporting purposes.
The current level of nontaxable investment and loan income is such that the Corporation is not affected by the alternative minimum tax rules.
CRITICAL ACCOUNTING POLICIES
The Bank policy related to the allowance for loan losses is considered to be a critical accounting policy because the allowance for loan losses represents a particularly sensitive accounting estimate. The amount of the allowance is based on management's evaluation of the collectibility of the loan portfolio, including the nature of the loan portfolio, credit concentrations, trends in historical loss experience, specific impaired loans, and economic conditions. CRITICAL ACCOUNTING POLICIES (Continued)
The allowance for loan losses is established through a provision for loan losses charged to expense. Loans are charged against the allowance for loan losses when management believes that the collectibility of the principal is unlikely. The allowance is an amount that management believes will be adequate to absorb possible losses on existing loans that may become uncollectible, based on evaluations of the collectibility of loans and prior loan loss experience. The evaluations take into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans, and current economic conditions that may affect the borrowers' ability to pay.
FUTURE IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
Financial Accounting Standards Board Statement 150 - Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity, was issued May of 2003 and is effective for financial instruments entered into or modified after May 31, 2003. This statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). Many of those instruments were previously classified as equity. Provisions of this statement are consistent with the Board's proposal to revise the definition of liabilities to encompass certain obligations that a reporting entity can or must settle by issuing its own equity shares, depending on the nature of the relationship established between the holder and the issuer. Management does not expect there to be a significant impact from this statement since the Corporation currently does not have any obligations requiring settlement by the issuance of its own shares of stock.
In December 2003, the Financial Accounting Standards Board released Financial Interpretation No. 46, Consolidation of Variable Interest Entities. This Interpretation of Accounting Research Bulletin No. 51, Consolidated Financial Statements, addresses consolidation by business enterprises of variable interest entities, which have one or more of the following characteristics:
1. The equity investment at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support provided by any parties, including the equity holders. 2. The equity investors lack one or more of the following essential characteristics of a controlling financial interest: a. The direct or indirect ability to make decisions about the entity's activities through voting rights or similar rights; b. The obligation to absorb the expected losses of the entity; c. The right to receive the expected residual returns of the entity. 3. The equity investors have voting rights that are not proportionate to their economic interests, and the activities of the entity involve or are conducted on behalf of an investor with a disproportionately small voting interest.
Management does not expect this interpretation to have a significant impact since the Corporation does not have any investment in any entity with the aforementioned characteristics.
Financial Accounting Standards Board (FASB) Statement 148, Accounting for Stock-Based Compensation-Transition and Disclosure, an amendment of FASB 123, amends FASB Statement No. 123, Accounting for Stock-Based Compensation, to provide alternative methods of transition for an entity that voluntarily changes to the fair value based method of accounting for stock-based employee compensation. It also amends the disclosure provisions of Statement 123 to require prominent disclosure about the effects on reported net income of an entity's accounting policy decisions with respect to stock-based employee compensation. Finally, this Statement amends APB Opinion No. 28, Interim Financial Reporting, to require disclosure about those effects in interim financial information. Management does not expect there to be a significant impact from this statement, since they have elected not to expense options under the fair value based method. LIQUIDITY RISK MANAGEMENT
Liquidity and interest rate sensitivity are related but distinctly different from one another.
Liquidity involves the Corporation's ability to meet cash withdrawal needs of customers and their credit needs in the form of loans. Liquidity is provided by cash on hand and transaction balances held at correspondent banks. Liquidity available to meet credit demands and/or adverse deposit flows is also made available from sales or maturities of short-term assets. Additional sources providing funds to meet credit needs is provided by access to the marketplace to obtain interest-bearing deposits and other borrowings. At December 31, 2003, the Corporation had off-balance sheet liabilities in the form of commitments to extend credit and letters of credit in the amount of $ 26,589,213. The Corporation also has available additional borrowing capacity of up to $ 94,870,000.
Interest Rate Sensitivity Analysis
A number of measures are used to monitor and manage interest rate risk including income simulation and interest sensitivity (gap) analysis. An income simulation model is used to assess the direction and magnitude of changes in net interest income resulting from changes in interest rates. Key assumptions in the model include prepayment, repricing and maturity of loan related assets; deposit sensitivity; market conditions and changes in other financial instruments. The Corporation's policy objective is to limit the change in annual earnings to 20% of net interest income. At December 31, 2003, based on the results of the simulation model, the Corporation would expect a change in net interest income of $ 249,844 over a 12-month period if interest rates increased from current rates by 300 basis points. If interest rates decreased from current rates by 100 basis points, the Corporation would expect a change in the net interest income of $ 57,253 over a 12-month period.
The matching of assets and liabilities may be analyzed by examining the extent to which such assets and liabilities are "interest rate sensitive" and by monitoring an institution's interest rate sensitivity "gap". An asset or liability is said to be interest rate sensitive within a specific time period if it will mature or reprice within that time period. The interest rate sensitivity gap is defined as the difference between the amount of interest- earning assets maturing or repricing within a specific time period and the amount of interest-bearing liabilities maturing or repricing within that same time period. A gap is considered positive when the amount of interest-earning assets maturing or repricing exceeds the amount of interest-bearing liabilities maturing or repricing within the same period. A gap is considered negative when the amount of interest-bearing liabilities maturing or repricing exceeds the amount of interest-earning assets maturing or repricing within the same period. Accordingly, in a rising interest rate environment, an institution with a positive gap would be in a better position to invest in higher yielding assets which would result in the yield on its assets increasing at a pace closer to the cost of its interest-bearing liabilities, than would be the case if it had a negative gap. During a period of falling interest rates, an institution with a positive gap would tend to have its assets repricing at a faster rate than one with a negative gap, which would tend to restrain the growth of its net interest income.
The Corporation closely monitors its interest rate risk as such risk relates to its operational strategies. The Corporation's Board of Directors has established an Asset/Liability Committee responsible for reviewing its asset/liability policies and interest rate risk position, which generally meets quarterly and reports to the Board on interest rate risk and trends on a quarterly basis.
The following table sets forth the amounts of interest-earning assets and interest-bearing liabilities outstanding at December 31, 2003 which are anticipated by the Corporation, based upon certain assumptions described below, to reprice or mature in each of the future time periods shown. Adjustable-rate assets and liabilities are included in the table in the period in which their interest rates can next be adjusted. LIQUIDITY RISK MANAGEMENT (Continued)
Money market, NOW and savings accounts have been included in rate sensitive liabilities of "Zero - 90 days" due to these funds being subject to immediate withdrawal.
MARKET RISK MANAGEMENT
The Corporation has risk management policies to monitor and limit exposure to market risk, and strives to take advantage of profit opportunities available in interest rate movements.
Management continuously monitors liquidity and interest rate risk through its ALCO reporting, and reprices products in order to maintain desired net interest margins. Management expects to continue to direct its marketing efforts toward attracting more low cost retail deposits while competitively pricing its time deposits in order to maintain favorable interest spreads, while minimizing structural interest rate risk.
The following table sets forth the projected maturities and average rates for all rate sensitive assets and liabilities based on the following assumptions. All fixed and variable rate loans were based on original maturity of the note since the Corporation has not experienced a significant rewriting of loans. Investments are based on maturity date. The Corporation has historically experienced very little deposit runoff and has in fact had net gains in deposits over the past MARKET RISK MANAGEMENT (Continued)
fifteen years. Based on this experience, it was estimated that maximum runoff of noninterest bearing checking would be 33% and for all other deposits except time deposits, which would be 10%. Time deposits are classified by original maturity date.
CAPITAL FUNDS
Internal capital generation has been the primary method utilized by Tower Bancorp Inc. to increase its capital. Stockholders' equity, which exceeded $ 40.4 million at December 31, 2003 has steadily increased. Regulatory authorities have established capital guidelines in the form of the "leverage ratio" and "risk-based capital ratios." The leverage ratio compares capital to total balance sheet assets, while the risk-based ratios compare capital to risk- weighted assets and off-balance-sheet activity in order to make capital levels more sensitive to risk profiles of individual banks. A comparison of Tower Bancorp's capital ratios to regulatory minimums at December 31 is as follows:
CAPITAL FUNDS (Continued)
Tower Bancorp, Inc. has traditionally been well above required levels and expects equity capital to continue to exceed regulatory guidelines. Certain ratios are useful in measuring the ability of a company to generate capital internally.
The following chart indicates the growth in equity capital for the past three years.
STOCK MARKET ANALYSIS AND DIVIDENDS
The Corporation's common stock is traded in the over-the-counter market. As of December 31, 2003 the approximate number of shareholders of record was 1,045.
EXHIBIT 14
TOWER BANCORP, INC.
DIRECTORS AND SENIOR MANAGEMENT CODE OF ETHICS
Directors and senior management, including senior financial officers, hold an important and elevated role in corporate governance at Tower Bancorp, Inc. They are vested with both the responsibility and authority to protect and preserve the interests of all of our constituents, including shareholders, employees, customers and citizens of the communities in which we conduct business. The maintenance of extremely high standards of honest, ethical and impartial conduct is essential to assure the proper performance of the company's business and the maintenance of the public's trust. This Code of Ethics prescribes the policies and procedures to be employed and enforced in the operations of Tower Bancorp, Inc. (the "Company").
* It is your responsibility to comply with the law and behave in an ethical manner. This responsibility cannot be delegated or assumed by the company.
* This code cannot anticipate every possible situation or cover every topic in detail. From time-to-time, the company may establish compliance programs to address specific subjects or you may find certain topics also covered by the First National Bank of Greencastle Code of Ethics or Employee Handbook. If you are unclear about a situation, seek guidance before taking action.
* The standards in this code do not necessarily take into account all legal requirements. Where more restrictive local laws or requirements exist, those take precedence.
* Comply with all applicable governmental rules and regulations. Failure to obey laws and regulations violates this code and may expose both you and the Company to criminal or civil prosecution. Any violation of this code or other compliance programs may result in corrective action, up to and including termination. The Company may also seek civil remedies from you and even refer criminal misconduct to law enforcement agencies.
* You are responsible for reporting suspected violations of this code, immediately to John H. McDowell Sr., our Corporate Compliance Officer.
* If you have a question about a topic covered in this code, please review the First National Bank of Greencastle Code of Ethics or Employee Handbook. If you still have a concern regarding any possible unethical or illegal conduct please contact John H. McDowell Sr., our Corporate Compliance Officer.
Conflicts of Interest
A "conflict of interest" exists any time one faces a choice between what is in his/her personal interest (financial or otherwise) and the interest of our Company. These situations are not always easy to avoid. When a conflict of interest arises, it is important to act with great care to avoid even the appearance that your actions are not in the best interest of the Company. If you find yourself in a position where your objectivity may be questioned because of individual interest or family or personal relationships, notify John H. McDowell Sr., our Corporate Compliance Officer, immediately.
Ownership Interests
Board of Directors approval is required for our Company to do business with a company in which a senior officer or family member owns - directly or indirectly - an interest. If you or a family member own or acquire an interest that is greater than 5% in any company, Board approval is needed for purchases of more than $50,000 per year.
If your ownership interest does not meet any of the above criteria, Board approval is not needed, but you remain obligated to keep our Company's interests first in mind.
Gifts, Meals, Services and Entertainment
One should not request or accept anything that might be used as a means to influence, or even appear to influence, you against the Company's best interests. Personal gifts should not be accepted other than those considered common business courtesies and for which one would reasonably expect to give something similar in return in the normal course of business. One must not accept or give any gift in excess of $100 in value without the prior approval of John H. McDowell Sr., our Compliance Officer.
Safeguarding Company Assets/Accuracy of Books and Records
We maintain internal controls to provide direction on protecting Company assets and financial accountability. The controls are based upon the following principles. Do not:
* Make personal use of Company assets that creates additional cost for the Company, interferes with work duties or violates any Company policy;
* Allow Company property to be used to help carry out illegal acts;
* Manipulate financial accounts, records or reports for personal gain;
* Maintain off-the-book accounts to facilitate questionable or illegal payments; or
* Violate any law or regulation.
Do: * Prepare project financial proposals with accurate information;
* Maintain books, accounts and records according to generally accepted accounting principles, using enough detail to reflect accurately and fairly Company transactions;
* Record transactions in a timely manner, so that no misleading financial information is created. (These transactions include, but are not limited to, income, expense, indebtedness, obligation, reserves and acquisition or disposition of assets, etc);
* Retain Company records in accordance with established policies and applicable legal and regulatory requirements; and
* Give full, fair, accurate, timely, and understandable disclosure in any and all periodic reports filed with the United States Securities and Exchange Commission.
Insider Trading
Insider trading is a crime that can carry severe penalties. If you know material, confidential information about our Company or any company with whom we have a business relationship and you trade company securities, such as stocks or bonds, while in possession of that information or tell others about it before it is made public, you may have violated the insider trading laws. Please review the Company's Insider Trading and Material Non-Public Information Policy for details on our insider trading policy.
Material information is the type of news that would affect a reasonable investor's decision on whether or not to invest in the Company's stock. Examples include plans to issue securities, sharp changes in earnings patterns, changes in dividend rates, changes in key management personnel, mergers, acquisitions, and important regulatory actions affecting the Company. This policy forbids you from trading not only in our stock, but also in those of our suppliers, customers or other companies with whom we have a business relationship while in possession of material inside information learned in the course of your employment at our Company.
We encourage you to invest in our stock. However, if you have access to any information not readily available to the public, you must be sure you do not trade while in possession of material non-public information. When you have such information:
* Do not tell anyone not authorized to have the information. A casual remark to a friend may find its way to a broker and eventually to the entire financial community thereby requiring the Company to make a premature or unplanned public announcement. This "tipping" may be illegal and damaging to the Company.
* Do not trade in our Company's stock (or that of an applicable outside company) until the next day after the news has been made public. Circumstances suggesting the possibility of insider trading may result in an investigation by governmental authorities of Company and stockbroker records of stock trading transactions. This investigation could damage the Company's reputation and result in liability or penalties, including criminal charges and fines against you.
* This policy against insider trading also covers transfers into and out of Company stock or savings plans and changes in patterns involving purchases of our stock within the plans. However, generally, regular scheduled monthly purchases of our stock within plans are not prohibited.
If you are planning to effect a transaction in our securities, you must contact John H. McDowell Sr., our Corporate Compliance Officer, in advance.
Bribery, Kickbacks And Other Improper Payments
Our Company and its officers must maintain high ethical and professional standards in all dealings.
* Do not directly or indirectly promise, offer or make payment in money or anything of value to anyone, including a government official, agent or employee of a government, political party, labor organization or business entity or a candidate of a political party, with the intent to induce favorable business treatment or to improperly affect business or governmental decisions.
* Our code does not necessarily take into account all local legal requirements. Where more restrictive local laws exist, those take precedence. In general, we do not consider ordinary and reasonable business entertainment or gifts of insubstantial value that are customary and legal in the local market to be improper.
* Document any entertainment of and gifts to customers, vendors, suppliers and potential customers, vendors and suppliers.
* Loans are not made by our Company to its senior officers. Loans are made by our banking subsidiaries and comply with all federal and state laws, statutes and regulations.
EXHIBIT 21
SUBSIDIARIES OF THE REGISTRANT
1. The First National Bank of Greencastle, Center Square, Greencastle, Pennsylvania; a National Bank organized under the National Bank Act.
Exhibit 23.1
CONSENT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders Tower Bancorp, Inc.
We consent to the incorporation by reference in the registration statements (Form S-14 No. 2-89573 and Form S-8 No. 333-40661) of our report dated January 21, 2004, with respect to the consolidated balance sheets of Tower Bancorp, Inc. and subsidiary as of December 31, 2003 and 2002 and the related consolidated statements of income, stockholders' equity and cash flows for the three year period ended December 31, 2003, which report is incorporated by reference in the December 31, 2003 annual report to stockholders on Form 10-K of Tower Bancorp, Inc.
/s/SMITH ELLIOTT KEARNS & COMPANY, LLC --------------------------------------
Chambersburg, PA March 15, 2004 Exhibit 31.1 CERTIFICATION
I, Jeffery B. Shank, President and CEO, certify, that:
1. I have reviewed this annual report on Form 10-K of Tower Bancorp, Inc.
2. Based on my knowledge, the 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 officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have:
(a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision 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 and presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this annual report based on such evaluation; and
(c) disclosed in this annual report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting.
5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):
(a) all significant deficiencies and material weaknesses in the design or operation of the internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and
(b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.
By: /s/ Jeffery B. Shank ------------------------------ Jeffery B. Shank President and CEO (Principal Executive Officer) March 15, 2004 Exhibit 31.2 CERTIFICATION
I, Franklin T. Klink, III, Treasurer, certify, that:
1. I have reviewed this annual report on Form 10-K of Tower Bancorp, Inc.
2. Based on my knowledge, the 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 officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have:
(a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision 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 and presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this annual report based on such evaluation; and
(c) disclosed in this annual report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting.
5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):
(a) all significant deficiencies and material weaknesses in the design or operation of the internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and
(b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.
By: /s/ Franklin T. Klink, III ------------------------------ Franklin T. Klink, III Treasurer (Principal Financial Officer) March 15, 2004 Exhibit 32.1
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO SECTION 906 OR THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of Tower Bancorp, Inc. (the Corporation) on Form 10-K for the period ending December 31, 2003 as filed with the Securities and Exchange Commission on the date therein specified (the "Report"), I, Jeffery B. Shank, President and Chief Executive Officer of the Corporation, certify, pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Corporation as of and for the period covered by the report.
/s/ Jeffery B. Shank ---------------------------------- Jeffery B. Shank President and Chief Executive Officer
Dated: March 15, 2004
Exhibit 32.2
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO SECTION 906 OR THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of Tower Bancorp, Inc. (the Corporation) on Form 10-K for the period ending December 31, 2003 as filed with the Securities and Exchange Commission on the date therein specified (the "Report"), I, Franklin T. Klink, III, Chief Financial Officer of the Corporation, certify, pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Corporation as of and for the period covered by the report.
/s/ Franklin T. Klink, III ---------------------------------- Franklin T. Klink, III Chief Financial Officer
Dated: March 15, 2004