10-K 1 codorus125093_10k.htm FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 2012

Table of Contents

 
 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549


FORM 10-K

(Mark One)
x Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the fiscal year ended December 31, 2012
or
o Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from _____________ to _____________.

Commission file Number 0-15536



 

 

 

 

CODORUS VALLEY BANCORP, INC.

 

 

(Exact name of registrant as specified in its charter)

 


 

 

 

 

 

 

 

Pennsylvania

 

 

23-2428543

 

(State or other jurisdiction of

(I.R.S. Employer

incorporation or organization)

Identification No.)


 

 

 

 

105 Leader Heights Road, P.O. Box 2887, York, Pennsylvania 17405

 

 

(Address of principal executive offices) (Zip Code)

 


 

 

 

Registrant’s telephone number, including area code: (717) 747-1519

 

Securities registered pursuant to Section 12(b) of the Act:


 

 

Title of each class

Name of each exchange on which registered

Common Stock, $2.50 par value

NASDAQ Stock Market LLC



Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
o Yes x No

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15 (d) of the Act.
o Yes x No

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. x Yes o No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes x No o

Indicate by check mark if the disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in the definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

 

 

 

Large accelerated filer o

 

Accelerated filer o

 

Non-accelerated filer o

 

Smaller Reporting Company x

Indicate by check mark whether the registrant is a shell company as defined in Rule 12b-2 of the Exchange Act.
o Yes x No

The aggregate market value of Codorus Valley Bancorp, Inc.’s voting stock held by non-affiliates was approximately $53,567,116 as of June 29, 2012.

As of March 6, 2013, Codorus Valley Bancorp, Inc. had 4,487,856 shares of common stock outstanding, par value $2.50 per share.

DOCUMENTS INCORPORATED BY REFERENCE

Part III incorporates certain information by reference to the registrant’s Proxy Statement for the Annual Meeting of Shareholders to be held May 21, 2013.

1

Codorus Valley Bancorp, Inc.
Form 10-K Index

 

 

 

 

 

 

 

Page

Part I

Item

 

 

 

1.

Business

 

3

1A.

Risk factors

 

9

1B.

Unresolved staff comments

 

9

2.

Properties

 

10

3.

Legal proceedings

 

10

4.

Mine safety disclosures

 

10

 

 

 

 

Part II

Item

 

 

 

5.

Market for registrant’s common equity, related shareholder matters and issuer purchases of equity securities

 

11

6.

Selected financial data

 

13

7.

Management’s discussion and analysis of financial condition and results of operations

 

14

7A.

Quantitative and qualitative disclosures about market risk

 

41

8.

Financial statements and supplementary data

 

43

9.

Changes in and disagreements with accountants on accounting and financial disclosure

 

87

9A.

Controls and procedures

 

87

9B.

Other information

 

87

 

 

 

 

Part III

Item

 

 

 

10.

Directors, executive officers and corporate governance

 

88

11.

Executive compensation

 

88

12.

Security ownership of certain beneficial owners and management and related shareholder matters

 

88

13.

Certain relationships and related transactions, and director independence

 

88

14.

Principal accountant fees and services

 

88

 

 

 

 

Part IV

Item

 

 

 

15.

Exhibits and financial statement schedules

 

89

 

 

 

 

 

Signatures

 

91


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PART I

Item 1: Business

Codorus Valley Bancorp, Inc. (Codorus Valley or the Corporation) is a Pennsylvania business corporation, incorporated on October 7, 1986. On March 2, 1987, Codorus Valley became a bank holding company under the Bank Holding Company Act of 1956. PeoplesBank, A Codorus Valley Company (PeoplesBank) is its wholly owned bank subsidiary. SYC Realty Co., Inc. is its wholly owned nonbank subsidiary. Codorus Valley’s business consists primarily of managing PeoplesBank, and its principal source of income is dividends received from PeoplesBank. On December 31, 2012, Codorus Valley had total consolidated assets of $1.06 billion, total deposits and other liabilities of $958.4 million, and total shareholders’ equity of $101.3 million.

Bank subsidiary

PeoplesBank, organized in 1934, is a Pennsylvania chartered bank that offers a full range of business and consumer banking services through eighteen financial centers located throughout York County, Pennsylvania and in Hunt Valley, Bel Air and Westminster, Maryland. PeoplesBank, with origins dating back to 1864, is focused on acquiring and nurturing financial relationships with small and mid-sized businesses. It also provides personal banking, mortgage banking, wealth management and real estate settlement services. The Federal Deposit Insurance Corporation insures the deposits of PeoplesBank to the maximum extent provided by law. On December 31, 2012, PeoplesBank had total gross loans of $738 million, excluding loans held for sale, and total deposits of $902 million. PeoplesBank had the second largest share of deposits in York County, PA with deposits totaling 13.1 percent of the market as of June 30, 2012, the latest available measurement date.

PeoplesBank is not dependent on deposits of, or exposed to a loan concentration to, a single customer, or a small group of customers. Therefore, the loss of a single customer, or a small customer group, would not have a material adverse effect on the financial condition of PeoplesBank. At year-end 2012, the largest indebtedness of a single PeoplesBank customer was $12,932,000, or 1.8 percent of the total loan portfolio, which was within PeoplesBank’s regulatory lending limit.

Most of the Corporation’s business is with customers in York County, Pennsylvania and northern Maryland. Although this limited market area may pose a concentration risk geographically, we believe that the diverse local economy and our detailed knowledge of the customer base lessens this risk. At year-end 2012 and 2011, the Corporation had two industry concentrations that exceeded 10 percent of the total loan portfolio: builder and developer were 13.2 percent and 14.9 percent of the portfolio at December 31, 2012 and 2011, respectively; and commercial real estate investor was 16.6 percent and 17.0 percent of the portfolio, respectively. Loans to borrowers within these industries are usually collateralized by real estate.

Nonbank subsidiaries of PeoplesBank

Codorus Valley Financial Advisors, Inc. is a wholly owned subsidiary of PeoplesBank that sells non-deposit investment products. This subsidiary began operations in January 2000 and, prior to a name change in December 2005, operated under the name SYC Insurance Services, Inc. SYC Settlement Services, Inc. is a wholly owned subsidiary of PeoplesBank that has provided real estate settlement services since January 1999. Periodically, PeoplesBank creates nonbank subsidiaries for the purpose of temporarily holding foreclosed properties pending liquidation. On December 31, 2012, only one of these subsidiaries was active. The operations of nonbank subsidiaries are consolidated for financial reporting purposes.

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Nonbank subsidiaries of Codorus Valley Bancorp, Inc.

In June 2006, Codorus Valley formed CVB Statutory Trust No. 2, a wholly-owned special purpose subsidiary whose sole purpose was to facilitate a pooled trust preferred debt issuance of $7,217,000. In November 2004, Codorus Valley formed CVB Statutory Trust No. 1 to facilitate a pooled trust preferred debt issuance of $3,093,000. The Corporation owns 100 percent of the common stock of these nonbank subsidiaries, which are not consolidated for financial reporting purposes. These obligations are reported as junior subordinated debt on the Corporation’s balance sheet.

On June 20, 1991, SYC Realty was incorporated as a wholly owned subsidiary of Codorus Valley. Codorus Valley created this nonbank subsidiary primarily for the purpose of holding foreclosed properties obtained by PeoplesBank pending liquidation of those properties. SYC Realty commenced business operations in October 1995.

Employees

At year-end 2012, PeoplesBank employed 200 full-time employees and 36 part-time employees, which equated to approximately 219 full-time equivalent employees. Employees are not covered by a collective bargaining agreement, and PeoplesBank considers its relations with employees to be satisfactory.

Segment reporting

Management has determined that it operates in only one segment, community banking. The Corporation’s non-banking activities are insignificant to the consolidated financial statements.

Competition

The banking industry in PeoplesBank’s service area, principally York County, Pennsylvania, and northern Maryland, specifically, Baltimore, Harford and Carroll counties, is extremely competitive. PeoplesBank competes through service and price and by leveraging its hometown image. It competes with commercial banks and other financial service providers, such as thrifts, credit unions, consumer finance companies, investment firms and mortgage companies. Some financial service providers operating in PeoplesBank’s service area operate on a national and regional scale and possess resources that are greater than PeoplesBank’s.

Supervision and regulation

Federal Reserve System

Codorus Valley is registered as a bank holding company, and is subject to regulation by the Board of Governors of the Federal Reserve System (Federal Reserve), under the Bank Holding Company Act of 1956, as amended. The Bank Holding Company Act requires bank holding companies to file periodic reports with, and subjects them to examination by, the Federal Reserve. The Federal Reserve has issued regulations under the Bank Holding Company Act that require a bank holding company to serve as a source of financial and managerial strength to its subsidiary banks. As a result, the Federal Reserve may require Codorus Valley to use its resources to provide adequate capital funds to PeoplesBank during periods of financial stress or adversity.

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The Bank Holding Company Act prohibits Codorus Valley from acquiring direct or indirect control of more than 5 percent of the outstanding voting stock of any bank, or substantially all of the assets of any bank, or merging with another bank holding company, without the prior approval of the Federal Reserve. The Pennsylvania Department of Banking must also approve certain similar transactions. Pennsylvania law permits Pennsylvania bank holding companies to control an unlimited number of banks.

The Bank Holding Company Act restricts Codorus Valley to activities that the Federal Reserve has found to be closely related to banking, and which are expected to produce benefits for the public that will outweigh any potentially adverse effects. Therefore, the Bank Holding Company Act prohibits Codorus Valley from engaging in most nonbanking businesses, or acquiring ownership or control of more than 5 percent of the outstanding voting stock of any company engaged in a nonbanking business, unless the Federal Reserve has determined that the nonbanking business is closely related to banking. Under the Bank Holding Company Act, the Federal Reserve may require a bank holding company to end a nonbanking business if it constitutes a serious risk to the financial soundness and stability of any bank subsidiary of the bank holding company.

The Federal Reserve Act imposes restrictions on a subsidiary bank of a bank holding company, such as PeoplesBank. The restrictions affect extensions of credit to the bank holding company and its subsidiaries, investments in the stock or other securities of the bank holding company and its subsidiaries, and taking such stock or securities as collateral for loans. The Federal Reserve Act and Federal Reserve regulations also place limitations and reporting requirements on extensions of credit by a bank to the principal shareholders of its parent holding company, among others, and to related interests of such principal shareholders. In addition, such legislation and regulation may affect the terms upon which any person becoming a principal shareholder of a holding company may obtain credit from banks with which the subsidiary bank maintains a correspondent relationship.

PeoplesBank and the banking industry, in general, are affected by the monetary and fiscal policies of the U.S. Treasury and government agencies, including the Federal Reserve. Through open market securities transactions, changes in its federal funds and discount rates and reserve requirements, the Federal Reserve exerts considerable influence over the cost and availability of funds for lending and investment.

U.S. Department of the Treasury

The U.S. Department of the Treasury (Treasury) has a capital investment in the Corporation pursuant to the Corporation’s participation in the Treasury’s Small Business Lending Funding Program (SBLF Program). In August 2011, the Corporation sold to the Treasury, for an aggregate purchase price of $25 million, 25,000 shares of non-cumulative, perpetual preferred stock, Series B, $1,000 liquidation value, $2.50 par value. Proceeds from the SBLF Program were used in part to redeem $16.5 million of outstanding Series A preferred stock previously issued to the Treasury under its Capital Purchase Program (CPP) and to repurchase a related CPP common stock warrant. These transactions were previously disclosed in filings with the SEC. The terms of the SBLF Preferred Stock Agreement impose limits on the ability of the Corporation to pay dividends and repurchase shares of common stock, as disclosed within Note 10–Shareholders’ Equity to the consolidated financial statements.

Pennsylvania Department of Banking

The operations of PeoplesBank are subject to state statutes applicable to banks chartered under the banking laws of the Commonwealth of Pennsylvania. Pennsylvania business and banking laws restrict dividend payments if such payment would render the Corporation insolvent or result in negative net worth, and the Corporation and PeoplesBank are subject to regulatory capital requirements. More information about dividend restrictions and capital requirements can be found in Note 9–Regulatory Matters in the notes to the consolidated financial statements.

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State and federal banking laws and regulations govern such things as: the scope of a bank’s business; permissible investments; the reserves against deposits a bank must maintain; the types and terms of loans a bank may make and the collateral it may take; the activities of a bank with respect to mergers and consolidations; the establishment of branches; and the sale of non-deposit investment products by the bank and its insurance subsidiary. The Pennsylvania Insurance Department, the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) control and supervise the licensing and activities of employees engaged in the sale of non-deposit investment products.

Federal Deposit Insurance Corporation (FDIC)

The FDIC is the primary federal regulator of PeoplesBank. It regularly examines banks in such areas as capital, asset quality, management, earnings, liquidity and sensitivity to market risk and other aspects of operations and requires that PeoplesBank furnish annual and quarterly reports. Examinations by the FDIC are designed for the protection of PeoplesBank’s depositors rather than Codorus Valley’s shareholders. The FDIC provides deposit insurance to banks, which covers all deposit accounts. The standard maximum insurance amount is $250,000 per depositor.

PeoplesBank pays deposit insurance premiums to the FDIC based on a risk-based assessment formula established by the FDIC for Deposit Insurance Fund (DIF) member institutions. Institutions are classified into one of four risk categories and pay premiums according to perceived risk to the FDIC’s DIF. PeoplesBank has consistently been a risk category I institution, the least risky category. Institutions in risk categories II, III and IV are assessed premiums at progressively higher rates.

As a means of funding the FDIC’s DIF, banks were required to prepay several years of deposit insurance premiums. In accordance with the FDIC’s final rule in November 2009 pertaining to prepaid assessments for the banking industry, PeoplesBank prepaid approximately $4.4 million to the FDIC on December 30, 2009. This prepaid amount represented an accumulation of regular quarterly assessments projected by the FDIC through the year 2012. Insured institutions recorded the entire prepaid assessment as a prepaid asset subject to amortization of an appropriate amount to expense each quarter to coincide with quarterly FDIC assessment notices. At December 31, 2012, the Corporation had a prepaid asset balance of approximately $1.3 million, which is expected to be returned to the Corporation by the FDIC in June 2013. Beginning in the year 2013, the Corporation will accrue the cost of FDIC premiums in anticipation of quarterly assessments by the FDIC.

In February 2011, the FDIC announced its final rule pertaining to, among other things, changes in the computation of risk-based insurance premiums as mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act. The final rule, which took effect April 1, 2011, changed the assessment base from domestic deposits to average assets minus average tangible equity, i.e., Tier 1 capital, and lowered assessment rates. For insured member institutions below $10 billion in total assets, the four risk categories framework mentioned earlier continues to apply. For the least risky category I institutions, such as PeoplesBank, the assessment rate range of 7 to 24 basis points on domestic deposits decreased to 2.5 to 9 basis points on total average assets minus average tangible equity. The final rule eliminated risk categories for large institutions with total assets of $10 billion or more. Instead, their assessment rates are now calculated using a scorecard that combines regulatory ratings and certain forward financial measures to assess the risk a large institution poses to the DIF. Generally, the change in the assessment methodology by the FDIC lowered deposit insurance premiums for community banks like PeoplesBank.

Effective January 1, 2012, PeoplesBank became subject to FDIC regulation 363.3(b), which requires depository institutions with total assets of $1 billion or more to engage an independent public accountant to examine, attest to, and report on the assertion of management concerning the institution’s internal control structure and procedures for financial reporting.

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Requirements of federal agencies that affect the Corporation and PeoplesBank

Small Business Jobs and Credit Act of 2010 In September 2010, President Obama signed into law the Small Business Jobs and Credit Act of 2010, which created the Small Business Lending Fund (SBLF). Under the SBLF the U.S. Treasury (Treasury) was authorized to make a capital investment of up to $30 billion by purchasing securities in participating community banks, principally in the form of senior preferred stock, that agree to use the funds to increase small-business lending. The SBLF limits the investment by the Treasury to 5 percent of risk-weighted assets for participating banks with total assets of $1 billion or less, and to 3 percent of risk-weighted assets for participating banks with more than $1 billion but less than $10 billion of total assets. Although the dividend rate was initially set at 5 percent, a participating community bank can decrease the dividend rate to as low as 1 percent by increasing its qualifying small business lending portfolio balance by at least 10 percent above a baseline portfolio balance. However, four and a half years after issuance, the dividend rate on SBLF securities will increase to 9 percent regardless of the level of small business lending. The SBLF provides community banks with a relatively inexpensive form of Tier 1 capital and also provides an attractive option for community banks to refinance preferred stock issued to the Treasury pursuant to its Capital Purchase Program. Accordingly, the Corporation participated in the SBLF program during the year 2011 and continues to participate in this program as discussed within the Shareholders’ Equity and Capital Adequacy section of this report.

Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) In July 2010, the Dodd-Frank Act was enacted to improve accountability and transparency in the financial system, to attempt to end “too big to fail” pertaining to large, troubled financial institutions, to protect the American taxpayer by ending governmental bailouts, to protect consumers from abusive financial services practices and for other purposes. The Dodd-Frank Act is broad and complex legislation that puts in place a sweeping new financial services regime that will have significant regulatory and legal consequences for banks now and for years to come. The effects of the Dodd-Frank Act on the financial services industry will depend, in large part, upon the extent to which regulators exercise the authority granted to them under the Dodd-Frank Act and the approaches taken in implementing regulations. Additional uncertainty regarding the effect of the Dodd-Frank Act exists due to the potential for additional legislative changes to the Dodd-Frank Act. The Corporation, as well as the broader financial services industry, is continuing to assess the potential impact of the Dodd-Frank Act on its business and operations, but at this stage, the extent of the impact cannot be determined with any degree of certainty. However, the Corporation is likely to be impacted by the Dodd-Frank Act in the areas of corporate governance, deposit insurance assessments, capital requirements, risk management, stress testing, and regulation under consumer protection laws. The Dodd-Frank Act:

 

 

 

 

Provides extensive authorities to the federal bank regulatory agencies and, in particular, the Board of Governors of the Federal Reserve, to take proactive steps to reduce or eliminate threats to the safety of the financial system, impose strict controls on large bank holding companies ($50 billion or more) and nonbank financial companies to limit their risk, and take direct control of troubled financial companies considered systemically significant;

 

 

 

 

Increases bank supervision by restructuring the supervision of holding companies and depository institutions. Establishes the equivalent of a prompt corrective action program for large bank holding companies. Requires that capital requirements for holding companies be at least as strict as capital requirements for depository institutions. Disallows new issuances of preferred securities to qualify for Tier 1 capital treatment. Directs federal bank regulators to develop specific capital requirements for holding companies and depository institutions that address activities that pose risk to the financial system, such as significant activities in higher risk areas, or concentrations in assets whose reported values are based on models;

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Establishes the Bureau of Consumer Financial Protection (Bureau) as an independent entity within the Federal Reserve System that will assume responsibility for most consumer protection laws. The Bureau will have authority to supervise, examine and take enforcement action with respect to depository institutions with more than $10 billion in assets and nonbank mortgage industry participants and other designated nonbank providers of consumer financial services;

 

 

 

 

Places certain limitations on investment and other activities by depository institutions, holding companies and their affiliates. Banks and their affiliates face strict limits on investment in, and sponsoring of, hedge funds and private equity funds. The coverage of Section 23A of the Federal Reserve Act is expanded to include the credit exposure related to additional transactions, including derivatives. New restrictions are imposed on acquisitions that would result in a financial services company controlling more than 10 percent of the consolidated aggregate liabilities of all financial companies; and

 

 

 

 

Significantly increases the regulation of mortgage lending and servicing by banks and nonbanks. Requires mortgage originators to ensure that the consumer will have the capacity to repay the loan and mandates loan related disclosures. Requires mortgage loan securitizers to retain a certain amount of risk, unless the mortgages conform to the new regulatory standards as qualified residential mortgages.

American Recovery and Reinvestment Act of 2009 (ARRA) In February 2009, the ARRA was enacted by the U.S. Congress in response to the recent financial crisis. The basic intent behind the ARRA was to preserve jobs and promote economic recovery, to assist those most impacted by the recession, to provide investments needed to increase efficiency by spurring technological advances in science and health, to invest in transportation and environmental protection and other infrastructure that will provide long-term economic benefits, and to stabilize state and local government budgets, in order to minimize and avoid reductions in essential services and counterproductive state and local taxes.

Emergency Economic Stabilization Act of 2008 (EESA) In October of 2008, the EESA, also known as the Troubled Asset Relief Act (TARP), was enacted. Under TARP, the U.S. Department of the Treasury initiated a Capital Purchase Program (CPP), which allowed qualified financial institutions to issue preferred stock to the Treasury, subject to certain limitations and terms. The EESA was developed to attract broad participation by strong financial institutions to stabilize the financial system and increase lending to benefit the national economy and U.S. citizens. As previously reported, in January 2009, the Corporation sold 16,500 shares of nonvoting Series A perpetual preferred stock and a common stock warrant to the Treasury and received $16.5 million in capital funds. Also as previously reported in August 2011 the Corporation redeemed all outstanding shares of Series A CPP preferred stock, and in September 2011 it repurchased the outstanding CPP common stock warrant. More information about this capital transaction is provided within the Shareholders’ Equity and Capital Adequacy section of this report.

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Sarbanes-Oxley Act of 2002 The Sarbanes-Oxley Act (SOA) was signed into law in July 2002 and applies to all companies, both U.S. and non-U.S, that file periodic reports under the Securities Exchange Act of 1934. The stated goals of the SOA were to increase corporate responsibility, to provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies and to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws. The SEC is responsible for establishing rules to implement various provisions of the SOA. The SOA includes specific disclosure requirements and corporate governance rules, requires the SEC and securities exchanges to adopt extensive additional disclosure, corporate governance and other related rules and mandates further studies of certain issues by the SEC. The SOA represents significant regulation of the accounting profession and corporate governance practices, such as the relationship between a board of directors and management and between a board of directors and its committees. Section 404 of the SOA became effective for the year ended December 31, 2004, for companies whose public float (i.e., the product of outstanding common shares held by non-affiliates times the share price as of the last business day of the registrant’s most recently completed second fiscal quarter) was above $75 million. For smaller companies (non-accelerated and smaller reporting company filers), including Codorus Valley, the effective date was the fiscal year ending on or after December 15, 2007. Section 404 requires publicly held companies to document, test and certify that their internal control systems over financial reporting are effective. During 2010, the Dodd-Frank Act permanently exempted public companies with common stock capitalization of less than $75 million from the independent auditor attestation requirements of the SOA. Effective December 31, 2012, PeoplesBank became subject to independent auditor attestation under FDIC regulation 363.3(b) due to its asset size, which is essentially equivalent to the SEC’s independent attestation requirement under Section 404 of the SOA.

USA Patriot Act of 2001 In October of 2001, the USA Patriot Act of 2001 was enacted to strengthen U.S. law enforcement’s and the intelligence communities’ abilities to work cohesively to combat terrorism on a variety of fronts. The Patriot Act contains sweeping anti-money laundering and financial transparency laws and imposes various regulations on financial institutions, including standards for verifying client identification at account opening, and rules to promote cooperation among financial institutions, regulators and law enforcement entities in identifying parties that may be involved in terrorism or money laundering.

Periodically, various types of federal and state legislation are proposed that could result in additional regulation of, and restrictions on, the business of Codorus Valley and PeoplesBank. It cannot be predicted whether such legislation will be adopted or, if adopted, how such legislation would affect the business of Codorus Valley and its subsidiaries. As a consequence of the extensive regulation of commercial banking activities in the United States of America, Codorus Valley and PeoplesBank’s business is particularly susceptible to being affected by federal legislation and regulations. The general cost of compliance with numerous and multiple federal and state laws and regulations does have, and in the future may have, a negative impact on Codorus Valley’s results of operations.

Other information

This Annual Report on Form 10-K is filed with the Securities and Exchange Commission (SEC). Copies of this document, the Quarterly Report on Form 10-Q, Current Reports on Form 8-K, amendments to those reports and other SEC filings by Codorus Valley Bancorp, Inc. may be obtained electronically at PeoplesBank’s website at www.peoplesbanknet.com (select Investor Relations, then select SEC filings, then select Documents), or the SEC’s website at www.sec.gov/edgarhp.htm. Copies can also be obtained without charge by writing to: Treasurer, Codorus Valley Bancorp, Inc., P.O. Box 2887, York, PA 17405-2887.

Item 1A: Risk factors

Not applicable to smaller reporting companies.

Item 1B: Unresolved staff comments

Not applicable.

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Item 2: Properties

Codorus Valley Bancorp, Inc. owns the Codorus Valley Corporate Center (Corporate Center), subject to a $1.2 million lien held by its wholly owned subsidiary, PeoplesBank. The Corporate Center is located at 105 Leader Heights Road, York Township, York, PA. This facility serves as the corporate headquarters and is approximately 40,000 square feet, a portion of which is leased to third-parties. The Corporate Center is adjacent to PeoplesBank’s Data Operations Center and the Leader Heights banking office.

PeoplesBank operates 18 branch banking offices. Of this total, 6 are owned by PeoplesBank without liens and located in York County, PA, and 12 are leased by PeoplesBank and are located in York County, PA, and in Baltimore, Carroll and Harford Counties in Maryland.

Plans call for the construction of a full-service branch office in Dover, PA on a building lot purchased by PeoplesBank in October 2012. The new office has all necessary regulatory approvals and is expected to be operational by the fall of 2013. Additionally, management is seeking regulatory approval to establish a full-service branch office in Hanover, PA. The branch will be operated out of leased office space and, subject to regulatory approval, is scheduled to be operational in May 2013.

We believe that the above properties owned and leased by the Corporation and its subsidiary are adequate for present levels of operation.

Item 3: Legal proceedings

There are no legal proceedings pending against Codorus Valley Bancorp, Inc. or any of its subsidiaries which are expected to have a material impact upon the financial position and/or operating results of the Corporation. Management is not aware of any proceedings known or contemplated by governmental authorities.

Item 4: Mine safety disclosures

Not applicable.

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PART II

Item 5: Market for registrant’s common equity, related shareholder matters and issuer purchases of equity securities

Market information

The common shares of Codorus Valley Bancorp, Inc. are traded on the NASDAQ Global Market under the symbol CVLY. Codorus Valley had approximately 1,991 holders of record as of March 6, 2013. The closing price per share of Codorus Valley’s common stock on March 6, 2013, was $16.37. The following table sets forth high and low sales prices and dividends paid per common share for Codorus Valley as reported by NASDAQ during the periods indicated. All amounts reflect the impact of the 5 percent common stock dividend distributed by the Corporation on December 11, 2012.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2012

 

2011

 

Quarter

 

High

 

Low

 

Dividends
per share

 

High

 

Low

 

Dividends
per share

 

First

 

$

10.67

 

$

7.89

 

$

0.086

 

$

10.70

 

$

8.86

 

$

0.076

 

Second

 

 

13.22

 

 

10.26

 

$

0.086

 

 

10.71

 

 

9.54

 

$

0.086

 

Third

 

 

15.39

 

 

12.62

 

$

0.105

 

 

10.48

 

 

8.33

 

$

0.086

 

Fourth

 

 

16.00

 

 

13.52

 

$

0.105

 

 

9.29

 

 

7.84

 

$

0.086

 

Dividend policy

Codorus Valley has a long history of paying quarterly cash dividends on its common stock. Codorus Valley presently expects to pay future cash dividends; however, the payment of such dividends will depend primarily upon the earnings of its subsidiary, PeoplesBank. Management anticipates that substantially all of the funds available for the payment of cash dividends by Codorus Valley will be derived from dividends paid to it by PeoplesBank. The payment of cash dividends is also subject to restrictions on dividends and capital requirements as reported in Note 9-Regulatory Matters in the notes to the consolidated financial statements.

The Corporation’s participation in the U.S. Department of the Treasury’s Small Business Lending Fund Program, previously disclosed in filings with the SEC, requires the payment of non-cumulative dividends quarterly on each January 1, April 1, July 1 and October 1 on the $25 million of Series B preferred stock issued to the Treasury on August 18, 2011, under its SBLF Program. The dividend rate can fluctuate on a quarterly basis for the first 10 quarters during which the SBLF preferred stock is outstanding, based upon changes in the level of “Qualified Small Business Lending” or “QSBL” (as defined in the Purchase Agreement under which the SBLF preferred stock was purchased by the Treasury) by the Bank. Based upon the increase in the Bank’s level of QSBL over the baseline level calculated under the terms of the Purchase Agreement, the dividend rate for the initial dividend period was set at 5 percent. For the second through ninth calendar quarters, the dividend rate may be adjusted to between one percent and five percent per annum to reflect the amount of change in the Bank’s level of QSBL. If the level of the Bank’s qualified small business loans declines so that the percentage increase in QSBL as compared to the baseline level is less than 10 percent, then the dividend rate payable on the SBLF Preferred Stock would increase. For the tenth calendar quarter through four and one-half years after issuance, the dividend rate will be fixed at between one percent and seven percent based upon the increase in QSBL as compared to the baseline. After four and one half years from issuance, the dividend rate will increase to 9 percent (including a quarterly lending incentive fee of 0.5 percent). The terms of the SBLF Preferred Stock Agreement impose limits on the ability of the Corporation to pay dividends and repurchase shares of common stock, as discussed in Note 10-Shareholders’ Equity in the notes to the consolidated financial statements.

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Prior to August 18, 2011, the Corporation paid quarterly cash dividends of 5 percent per annum on $16.5 million of Series A preferred stock that it sold to the Treasury on January 9, 2009, under Treasury’s Capital Purchase Program. The Series A preferred stock was subsequently redeemed on August 18, 2011 to coincide with the issuance of Series B preferred stock under the SBLF Program, as required by the Treasury.

Securities authorized for issuance under equity compensation plans

The following table provides information about options outstanding and securities available for future issuance under the Corporation’s 2000 Stock Incentive Plan, 2001 Employee Stock Bonus Plan, 2007 Long Term Incentive Plan and 2007 Employee Stock Purchase Plan.

 

 

 

 

 

 

 

 

 

 

 

 

 

Equity Compensation Plan Information

 

Plan Category

 

Number of securities
to be issued upon
exercise of outstanding
options, warrants and
rights

 

Weighted-average
exercise price of
outstanding options,
warrants and rights

 

Number of securities
remaining available for
future issuance under equity
compensation plans
(excluding securities
reflected in the first column)

 

Equity compensation plans approved by security holders

 

 

254,184

 

$

10.70

 

 

402,162

(1)

Equity compensation plans not approved by security holders

 

 

0

 

 

0

 

 

15,007

(2)

Total

 

 

254,184

 

$

10.70

 

 

417,169

 


 

 

(1)

Includes 172,668 shares available for issuance under the 2007 Employee Stock Purchase Plan.

(2)

Shares available for issuance under the 2001 Employee Stock Bonus Plan that provides for shares of common stock to employees as performance-based compensation.

Purchases of equity securities by the issuer and affiliated purchasers

For the years ended December 31, 2012 and 2011, the Corporation did not acquire any of its common stock under the current repurchase program.

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Item 6: Selected financial data

Codorus Valley Bancorp, Inc.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2012

 

2011

 

2010

 

2009

 

2008

 

Summary of operations (in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

$

46,512

 

$

45,411

 

$

44,027

 

$

40,310

 

$

36,732

 

Interest expense

 

 

10,527

 

 

12,359

 

 

13,154

 

 

16,358

 

 

15,809

 

Net interest income

 

 

35,985

 

 

33,052

 

 

30,873

 

 

23,952

 

 

20,923

 

Provision for loan losses

 

 

1,750

 

 

4,935

 

 

2,990

 

 

3,715

 

 

1,870

 

Noninterest income

 

 

8,190

 

 

7,358

 

 

7,574

 

 

7,497

 

 

6,665

 

Noninterest expense

 

 

29,928

 

 

27,079

 

 

28,116

 

 

24,491

 

 

20,044

 

Income before income taxes

 

 

12,497

 

 

8,396

 

 

7,341

 

 

3,243

 

 

5,674

 

Provision (benefit) for income taxes

 

 

3,103

 

 

1,617

 

 

1,133

 

 

(191

)

 

1,209

 

Net income

 

 

9,394

 

 

6,779

 

 

6,208

 

 

3,434

 

 

4,465

 

Preferred stock dividends and discount accretion

 

 

384

 

 

1,460

 

 

980

 

 

957

 

 

0

 

Net income available to common shareholders

 

$

9,010

 

$

5,319

 

$

5,228

 

$

2,477

 

$

4,465

 

 

Per common share

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(adjusted for stock dividends)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income, basic

 

$

2.03

 

$

1.22

 

$

1.22

 

$

0.58

 

$

1.07

 

Net income, diluted

 

$

2.00

 

$

1.21

 

$

1.21

 

$

0.58

 

$

1.07

 

Cash dividends paid

 

$

0.382

 

$

0.334

 

$

0.238

 

$

0.248

 

$

0.488

 

Stock dividends distributed

 

 

5

%

 

 

 

 

 

 

 

5

%

Book value

 

$

17.03

 

$

15.46

 

$

13.81

 

$

12.95

 

$

12.37

 

Tangible book value

 

$

17.03

 

$

15.42

 

$

13.75

 

$

12.87

 

$

12.29

 

Cash dividend payout ratio

 

 

18.8

%

 

27.3

%

 

19.6

%

 

42.3

%

 

45.1

%

Weighted average shares outstanding

 

 

4,441,498

 

 

4,366,478

 

 

4,297,852

 

 

4,245,056

 

 

4,164,296

 

Weighted average diluted shares outstanding

 

 

4,502,153

 

 

4,394,258

 

 

4,304,449

 

 

4,245,056

 

 

4,190,504

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Profitability ratios

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Return on average shareholders’ equity (ROE)

 

 

9.55

%

 

8.04

%

 

8.12

%

 

4.88

%

 

8.91

%

Return on average assets (ROA)

 

 

0.90

%

 

0.69

%

 

0.67

%

 

0.41

%

 

0.71

%

Net interest margin

 

 

3.81

%

 

3.73

%

 

3.72

%

 

3.18

%

 

3.63

%

Efficiency ratio

 

 

65.65

%

 

64.20

%

 

69.87

%

 

74.63

%

 

70.59

%

Net overhead ratio

 

 

2.13

%

 

2.02

%

 

2.24

%

 

2.07

%

 

2.14

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Capital ratios

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Tier 1 risk-based capital

 

 

13.59

%

 

13.35

%

 

12.51

%

 

11.83

%

 

10.03

%

Total risk-based capital

 

 

14.79

%

 

14.55

%

 

13.64

%

 

12.90

%

 

10.80

%

Average shareholders’ equity to average assets

 

 

9.45

%

 

8.56

%

 

8.29

%

 

8.43

%

 

7.94

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Summary of financial condition at year-end (in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investment securities

 

$

236,925

 

$

237,496

 

$

226,603

 

$

178,454

 

$

77,287

 

Loans

 

 

740,225

 

 

696,384

 

 

645,839

 

 

647,143

 

 

580,451

 

Assets

 

 

1,059,737

 

 

1,012,132

 

 

957,332

 

 

892,831

 

 

702,766

 

Deposits

 

 

901,307

 

 

854,399

 

 

806,110

 

 

722,957

 

 

598,129

 

Borrowings

 

 

50,171

 

 

56,885

 

 

68,805

 

 

92,748

 

 

47,779

 

Equity

 

 

101,331

 

 

93,242

 

 

76,539

 

 

72,012

 

 

52,181

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other data

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Number of bank offices

 

 

18

 

 

18

 

 

17

 

 

17

 

 

17

 

Number of employees (full-time equivalents)

 

 

219

 

 

203

 

 

198

 

 

201

 

 

200

 

Wealth Management assets, market value (in thousands)

 

$

329,626

 

$

277,505

 

$

368,985

 

$

325,482

 

$

261,153

 

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Item 7: Management’s discussion and analysis of financial condition and results of operations

Management’s discussion and analysis of the significant changes in the results of operations, capital resources and liquidity presented in the accompanying consolidated financial statements for Codorus Valley Bancorp, Inc. (Codorus Valley or the Corporation), a bank holding company, and its wholly owned subsidiary, PeoplesBank, A Codorus Valley Company (PeoplesBank), are provided below. Codorus Valley’s consolidated financial condition and results of operations consist almost entirely of PeoplesBank’s financial condition and results of operations. Current performance does not guarantee and may not be indicative of similar performance in the future.

Forward-looking statements

Management of the Corporation has made forward-looking statements in this Annual Report on Form 10-K. These forward-looking statements may be subject to risks and uncertainties. Forward-looking statements include information concerning possible or assumed future results of operations of the Corporation and its subsidiaries. When words such as “believes,” “expects,” “anticipates” or similar expressions are used in this Form 10-K, management is making forward-looking statements.

Note that many factors, some of which are discussed elsewhere in this report and in the documents that are incorporated by reference, could affect the future financial results of the Corporation and its subsidiaries, both individually and collectively, and could cause those results to differ materially from those expressed in the forward-looking statements contained or incorporated by reference in this Form 10-K. These factors include, but are not limited to, the following:

 

 

 

 

operating, legal and regulatory risks;

 

enacted financial reform legislation, e.g., Dodd-Frank Wall Street Reform and Consumer Protection Act, may have a significant impact on the Corporation’s business and results of operations;

 

a prolonged economic downturn;

 

an increase in nonperforming assets requiring loss provisions and the incurrence of carrying costs related to nonperforming assets;

 

declines in the market value of investment securities considered to be other-than-temporary;

 

the effects of and changes in the rate of FDIC premiums, including special assessments;

 

interest rate fluctuations which could increase our cost of funds or decrease our yield on earning assets and therefore reduce our net interest income;

 

future legislative or administrative changes to U.S. governmental capital programs;

 

unavailability of capital when needed or availability at less than favorable terms;

 

political and competitive forces affecting banking, securities, asset management and credit services businesses;

 

unauthorized disclosure of sensitive or confidential client or customer information, whether through a breach of our computer systems or otherwise, may adversely affect the Corporation’s operations, net income or reputation, and

 

the risk that management’s analyses of these risks and forces could be incorrect and/or that the strategies developed to address them could be unsuccessful.

The Corporation undertakes no obligation to publicly revise or update these forward-looking statements to reflect events or circumstances that arise after the date of this report.

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Critical accounting estimates

Disclosure of Codorus Valley’s significant accounting policies is included in Note 1 in the notes to the consolidated financial statements of this Form 10-K. Some of these policies require management to make significant judgments, estimates and assumptions that have a material impact on the carrying value of certain assets and liabilities.

Management makes significant estimates in determining the allowance for loan losses, valuation of foreclosed real estate, and evaluation of other-than-temporary impairment losses of securities. Management considers a variety of factors in establishing allowance for loan losses such as current economic conditions, diversification of the loan portfolio, delinquency statistics, results of internal loan reviews, financial and managerial strength of borrowers, adequacy of collateral, (if collateral dependent, or present value of future cash flows) and other relevant factors. There is also the potential for adjustment to the allowance for loan losses as a result of regulatory examinations. Foreclosed real estate is initially recorded at fair value minus estimated costs to sell at the date of foreclosure, establishing a new cost basis. Appraisals are generally used to determine fair value. After foreclosure, management reviews valuations at least quarterly and adjusts the asset to the lower of cost or fair value minus estimated costs to sell. Estimates related to the value of collateral can have a significant impact on whether or not management continues to accrue income on delinquent and impaired loans and on the amounts at which foreclosed real estate is recorded on the statement of financial condition.

The Corporation records its available-for-sale securities portfolio at fair value. Fair values for these securities are determined based on methodologies in accordance with FASB Accounting Standards Codification (ASC) Topic 820. Fair values for debt securities are volatile and may be influenced by any number of factors, including market interest rates, prepayment speeds, discount rates, credit ratings and yield curves. Fair values for debt securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on the quoted prices of similar instruments or an estimate of fair value by using a range of fair value estimates in the market place as a result of the illiquid market specific to the type of security. When the fair value of a debt security is below its amortized cost and depending on the length of time the condition exists and the extent the fair value is below amortized cost, additional analysis is performed to determine whether an other-than-temporary impairment condition exists. Debt securities are analyzed quarterly for possible other-than-temporary impairment. The analysis considers whether the Corporation has the intent to sell its debt securities prior to market recovery or maturity and whether it is more likely than not that the Corporation will be required to sell its debt securities prior to market recovery or maturity. Often, information available to conduct these assessments is limited and rapidly changing, making estimates of fair value subject to judgment. If actual information or conditions are different than estimated, the extent of the impairment of the debt security may be different than previously estimated, which could have a material effect on the Corporation’s results of operations and financial condition.

Management discussed the development and selection of critical accounting estimates and related Management Discussion and Analysis disclosure with the Audit Committee. There were no material changes made to the critical accounting estimates during the periods presented within this report. Additional information is contained in Management’s Discussion and Analysis regarding critical accounting estimates, including the provision and allowance for loan losses, located on pages 22 and 39 of this report.

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OVERVIEW

Executive summary

Net income available to common shareholders (earnings) for the year 2012 increased $3,691,000 or 69 percent above the year 2011, driven primarily by a decrease in the provision for loan losses and an increase in net interest income. The $3,185,000 or 65 percent pretax decrease in the provision for loan losses for the year 2012 reflected improved credit quality and a decrease in loan impairment charges compared to the year 2011. The $2,933,000 or 9 percent pretax increase in net interest income resulted from an increase in the average volume of earnings assets, principally commercial loans, as the Corporation leveraged its capital addition in 2011. A decrease in funding costs, resulting from the unusually low level of market interest rates and from a larger proportion of low cost core deposits to total deposits, also contributed significantly to the increase in net interest income. The level of core deposits, which for internal purposes includes repurchase agreements but excludes certificates of deposit, has trended up over the years and at December 31, 2012 comprised approximately 55 percent of total deposits. Given the low interest rate environment, the economy and the relatively high level of unemployment, our depositors have shown a preference for liquidity. A challenge for the Corporation and the financial industry will be the retention of low-cost core deposits when market interest rates eventually ramp up. According to recent pronouncements by the Federal Reserve’s Federal Open Market Committee, market interest rates could begin to rise in 2015.

Given the economy, the level of unemployment and general declines in housing prices there has been little demand for consumer loans. In contrast, residential mortgage loan refinancings increased significantly as homeowners took advantage of historically low market interest rates. Refinanced residential mortgage loans were sold to investors thereby generating a record level of income gains for the year 2012. Given the long duration of low market interest rates, refinancing activity is expected to reach a saturation level resulting in decreased residential mortgage loan production and revenue therefrom at some point in the future.

Plans call for the construction of a full-service branch office in Dover, PA on a building lot purchased by PeoplesBank in October of 2012. The new office has all necessary regulatory approvals and is expected to be operational by the fall of 2013. Additionally, management is seeking regulatory approval to establish a full-service branch office in Hanover, PA. The branch will be operated out of leased office space and, subject to regulatory approval, is scheduled to be operational in May 2013.

For 2012, the Corporation paid cash dividends totaling $0.382 per common share, an increase of $0.048 or 14 percent above the year 2011 and distributed a 5 percent common stock dividend. The market price of the Corporation’s common stock ended the year 2012 at $15.05 per share, a $7.15 increase per share over year-end 2011.

In the periods ahead, we will remain focused on profitable balance sheet growth, acquiring and nurturing client relationships, instilling a client centric culture, managing risk and expanding the banking franchise. We anticipate a continuation of economic weakness, both nationally and locally, through 2014 and possibly beyond. Risks and uncertainties include prolonged weakness in economic and business conditions, which could increase credit-related losses, possible declines in the market value of investment securities considered to be other-than-temporary, a relatively high level of unemployment, erosion of real estate values and possible adverse economic impacts caused by global events.

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Financial highlights

The Selected Financial Data schedule, located on page 13 of this report, provides a summary of operations and performance metrics for the past five years in a comparative format.

2012 vs. 2011

The Corporation earned net income available to common shareholders (earnings) totaling $9,010,000 or $2.03 per share basic, $2.00 per share diluted, compared to $5,319, 000 or $1.22 per share basic, $1.21 per share diluted for the year 2011. Per share amounts, for all periods, were adjusted for the 5 percent common stock dividend distributed in December 2012. The $3,691,000 or 69 percent increase in earnings was primarily the result of increases in interest and noninterest income and decreases in the provision for loan losses and preferred stock dividends, which more than offset increases in noninterest expense and provision for income taxes.

The $2,933,000 or 9 percent increase in net interest income for the year 2012, compared to the year 2011, resulted from an increase in the average volume of earning assets, principally commercial loans, and a decrease in funding costs. The decrease in funding costs resulted from a larger proportion of low cost core deposits to total deposits and lower rates generally paid on all deposit products, which reflected historically low market interest rates. Net interest income (tax equivalent basis) as a percentage of interest earning assets, i.e., net interest margin, was 3.81 percent for the year 2012, compared to 3.73 percent for the year 2011.

The $3,185,000 or 65 percent decrease in the provision for loan losses for the year 2012 reflected improved credit quality and a decrease in loan impairment charges compared to the year 2011.

The $832,000 or 11 percent increase in noninterest income for the year 2012, compared to the year 2011, resulted primarily from a $550,000 or 71 percent increase in gains from the sale of loans held for sale (i.e., residential mortgage loans). Market interest rates decreased to record low levels during the year 2012, leading to an increase in residential mortgage loan refinancings. A $302,000 or 29 percent increase in pretax gains from the sale of investment securities also contributed to the increase in noninterest income. U.S. agency mortgage-backed securities (MBS) were selectively sold at a gain to remove relatively low yielding instruments that were prepaying principal faster than anticipated and small odd-lot securities from the MBS portfolio.

The $2,849,000 or 11 percent increase in noninterest expense for the year 2012, compared to the year 2011, was due primarily to increases in personnel expenses and foreclosed real estate costs. The $1,564,000 or 11 percent increase in personnel expense was due to normal business growth, which included the impact of franchise expansion in September 2011, and the recognition of annual performance incentives. The $1,129,000 or 66 percent increase in foreclosed real estate costs reflected increased provisioning for impairment losses, including a $1,027,000 provision relating to a foreclosed property, as previously reported on Form 8-K filed on August 30, 2012.

The $1,486,000 or 92 percent increase in the provision for income taxes for the year 2012, compared to the year 2011, was a result of the 49 percent increase in income before income taxes.

The $1,076,000 or 74 percent decrease in preferred stock dividends and discount accretion for the year 2012, compared to the year 2011, reflected a decrease in the dividend rate and the redemption of preferred stock and a related warrant under the U.S. Treasury’s Capital Purchase Program in the third quarter of 2011.

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On December 31, 2012, total assets were approximately $1.06 billion representing a $48 million or 5 percent increase above December 31, 2011. Compared to one year ago, asset growth occurred primarily in the commercial loan portfolio and was funded primarily by an increase in core deposits.

Cash dividends on common shares for the year 2012 totaled $0.382 per share, representing an increase of $0.048 or 14 percent above 2011. Additionally, a 5% common stock dividend was distributed on December 11, 2012. Comparatively, no stock dividends on the Corporation’s common stock were distributed in the prior two years.

The Corporation has traditionally maintained a capital level well above minimum regulatory quantitative requirements. Currently, there are three federal regulatory definitions of capital that take the form of minimum ratios. Table 9—Capital Ratios, shows that the Corporation and PeoplesBank were well capitalized for all three years presented.

2011 vs. 2010

The Corporation earned net income available to common shareholders of $5,319,000 or $1.22 per share, $1.21 diluted, for the year 2011, compared to $5,228,000 or $1.22 per share, $1.21 diluted, for the year 2010. The $91,000 or 2 percent increase in annual earnings for the year 2011, compared to the year 2010 was the result of an increase in net interest income and a decrease in total noninterest expense, which more than offset a decrease in noninterest income and increases in the provision for loan losses, the provision for income taxes and preferred stock dividends and discount accretion.

The $2,179,000 or 7 percent increase in net interest income for 2011 resulted primarily from a larger volume of earning assets, principally commercial loans and investment securities, and a decrease in funding costs. The decrease in funding costs resulted from a lower volume of borrowings, a larger proportion of low cost core deposits to total deposits and lower rates generally paid on all deposit products, which reflected unusually low market interest rates. Net interest income (tax equivalent basis) as a percentage of interest earning assets, i.e., net interest margin, was 3.73 percent for the year 2011, compared to 3.72 percent for the year 2010.

The $1,945,000 or 65 percent increase in the provision for loan losses for the year 2011 reflected an increase in losses on various commercial loan relationships. During September 2011, the Corporation recorded losses totaling $3,175,000 on two unrelated commercial loan relationships which it disclosed in a Form 8-K filed on October 3, 2011, as amended by Form 8-K/A filed on November 10, 2011. The provision for the years 2011 and 2010 remained elevated in comparison to the Corporation’s historic levels (pre-2008) and was reflective of the risks and uncertainties associated with prolonged weakness in economic and business conditions, a relatively high level of unemployment and erosion of real estate values.

Total noninterest income decreased $216,000 or 3 percent for the year 2011 primarily as a result of a decrease in income from mutual fund, annuity and insurance sales due to the resignation of four registered representatives who left in February. Total noninterest expense decreased $1,037,000 or 4 percent for the year 2011 primarily as a result of a decrease in net costs and losses attributable to foreclosed real estate and impaired loans.

The provision for income tax expense for the year 2011, compared to the year 2010, increased $484,000 or 43 percent due primarily to the 14 percent increase in the level of income before income taxes.

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Table of Contents


The $480,000 or 49 percent increase in preferred stock dividends and discount accretion for the year 2011, compared to the year 2010, was primarily attributable to a non-recurring $379,000 transaction to remove unamortized discount caused by the redemption of all outstanding preferred stock issued to the U.S. Department of the Treasury (Treasury) under its Capital Purchase Program. The increase in dividends was caused by an increase in outstanding preferred stock, which reflected the Corporation’s participation in the Treasury’s Small Business Lending Fund Program (SBLF Program) commencing in August 2011, as previously reported on Form 8-K.

Total assets were approximately $1.01 billion at December 31, 2011, an increase of $55 million or 6 percent above December 31, 2010. Asset growth occurred primarily in the commercial loan portfolio and, to a lesser degree, the investment securities portfolio. Asset growth was funded by an increase in core deposits and, to a lesser degree, an $8 million addition, net of the redemption of the CPP Series A preferred stock and warrant, to capital obtained from the SBLF Program.

Annual cash dividends per common share totaled $0.334, as adjusted, for 2011, compared to $0.238, as adjusted, for 2010.

A more detailed analysis of the factors and trends affecting earnings follows.

INCOME STATEMENT ANALYSIS

Net Interest Income

The Corporation’s principal source of revenue is net interest income, which is the difference between interest income earned on loans and investment securities, and interest expense incurred on deposits and borrowed funds. Fluctuations in net interest income are caused by changes in interest rates, volumes and the composition or mix of interest rate sensitive assets and liabilities. Unless otherwise noted, the discussion that follows is based on interest income and interest expense as reported in the consolidated statements of income, not on a tax equivalent basis.

Net interest income for the year 2012 totaled $35,985,000, an increase of $2,933,000 or 9 percent above the year 2011. The increase was primarily the result of an increase in the average volume of interest earning assets and a decrease in the average rate paid on deposits. Net interest income (tax equivalent basis) as a percentage of interest earning assets, i.e., net interest margin, was 3.81 percent for the year 2012, compared to 3.73 percent for the year 2011.

The $1,101,000 or 2 percent increase in total interest income for the year 2012, compared to the year 2011, was due primarily to an increase in the average volume of interest earning assets. Interest earning assets averaged $981 million and yielded 4.89 percent (tax equivalent basis) for 2012, compared to $925 million and 5.07 percent, respectively, for the year 2011. The $56 million or 6 percent increase in the average volume of interest earning assets, which more than offset the decrease in the average yield, was due primarily to an increase in commercial loans.

The $1,832,000 or 15 percent decrease in total interest expense for the year 2012, compared to the year 2011, resulted from a larger proportion of low cost core deposits to total deposits and lower rates generally paid on all deposit products, which reflected historically low market interest rates. Total interest bearing liabilities averaged $854 million at an average rate of 1.23 percent for 2012, compared to $824 million and 1.50 percent, respectively, for the year 2011. The $30 million or 4 percent increase in the average volume of interest bearing liabilities reflected growth in core deposits, principally money market deposits. Additionally, the average volume of noninterest bearing demand deposits increased by $10 million or 15 percent for 2012, compared to the year 2011. The Corporation defines core deposits as all deposits except certificates of deposit (i.e., time deposits).

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Comparatively, for 2011, net interest income totaled $33,052,000, an increase of $2,179,000 or 7 percent above 2010. The increase was primarily the result of an increase in the average volume of interest earning assets, a decrease in the average volume of long-term debt and a decrease in the average rate paid on deposits. The net interest margin was 3.73 percent for 2011, compared to 3.72 percent for 2010.

Interest earning assets averaged $925 million and yielded 5.07 percent (tax equivalent basis) for 2011, compared to $868 million and 5.24 percent, respectively, for 2010. The $57 million or 7 percent increase in average interest earning assets was due primarily to an increase in investment securities and secondarily to an increase in commercial loans. The increase in the average volume of earning assets more than offset the decrease in the average yield, which reflected the low level of market interest rates.

Total interest bearing liabilities averaged $824 million at an average rate of 1.50 percent for 2011, compared to $779 million and 1.69 percent, respectively, for 2010. The $45 million or 6 percent increase in average interest bearing liabilities reflected growth in all deposit categories, which more than offset a decrease in long-term debt. Interest expense on deposits for 2011 was $241 million or 2 percent below 2010 as the favorable impact of low product rates and deposit mix largely offset the effect of the increase in average volume. Interest expense on long-term debt decreased for 2011, compared to 2010, due primarily to volume as maturing Federal Home Loan Bank loans, with relatively high interest rates, were selectively not refinanced.

Tables 1 and 2 are presented on a tax equivalent basis to make it easier to compare taxable and tax-exempt assets. Income from tax-exempt assets, primarily loans to or securities issued by state and local governments, is increased by the amount of federal income taxes which would have been incurred if the income was taxable at the rate of 34 percent.

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Table 1-Average Balances and Interest Rates (tax equivalent basis)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2012

 

2011

 

2010

 

(dollars in thousands)

 

Average
Balance

 

Interest

 

Yield/
Rate

 

Average
Balance

 

Interest

 

Yield/
Rate

 

Average
Balance

 

Interest

 

Yield/
Rate

 

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest bearing deposits with banks

 

$

37,101

 

$

94

 

 

0.25

%

$

27,297

 

$

66

 

 

0.24

%

$

24,452

 

$

64

 

 

0.26

%

Federal funds sold

 

 

0

 

 

0

 

 

0.00

 

 

674

 

 

2

 

 

0.30

 

 

2,935

 

 

9

 

 

0.31

 

Investment securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Taxable

 

 

145,357

 

 

3,381

 

 

2.33

 

 

150,529

 

 

3,830

 

 

2.54

 

 

117,439

 

 

3,361

 

 

2.86

 

Tax-exempt

 

 

84,357

 

 

3,587

 

 

4.25

 

 

79,577

 

 

3,581

 

 

4.50

 

 

75,217

 

 

3,590

 

 

4.77

 

Total investment securities

 

 

229,714

 

 

6,968

 

 

3.03

 

 

230,106

 

 

7,411

 

 

3.22

 

 

192,656

 

 

6,951

 

 

3.61

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Taxable (1)

 

 

700,915

 

 

40,096

 

 

5.72

 

 

651,604

 

 

38,485

 

 

5.91

 

 

633,192

 

 

37,540

 

 

5.93

 

Tax-exempt

 

 

13,150

 

 

770

 

 

5.86

 

 

14,891

 

 

887

 

 

5.96

 

 

14,647

 

 

905

 

 

6.18

 

Total loans

 

 

714,065

 

 

40,866

 

 

5.72

 

 

666,495

 

 

39,372

 

 

5.91

 

 

647,839

 

 

38,445

 

 

5.93

 

Total earning assets

 

 

980,880

 

 

47,928

 

 

4.89

 

 

924,572

 

 

46,851

 

 

5.07

 

 

867,882

 

 

45,469

 

 

5.24

 

Other assets (2)

 

 

60,431

 

 

 

 

 

 

 

 

60,143

 

 

 

 

 

 

 

 

53,870

 

 

 

 

 

 

 

Total assets

 

$

1,041,311

 

 

 

 

 

 

 

$

984,715

 

 

 

 

 

 

 

$

921,752

 

 

 

 

 

 

 

Liabilities and Shareholders’ Equity Deposits:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest bearing demand

 

$

336,077

 

 

1,335

 

 

0.40

%

$

305,982

 

 

1,937

 

 

0.63

%

$

263,381

 

 

2,015

 

 

0.77

%

Savings

 

 

33,516

 

 

84

 

 

0.25

 

 

29,442

 

 

108

 

 

0.37

 

 

26,870

 

 

107

 

 

0.40

 

Time

 

 

427,536

 

 

8,196

 

 

1.92

 

 

429,213

 

 

9,111

 

 

2.12

 

 

413,752

 

 

9,275

 

 

2.24

 

Total interest bearing deposits

 

 

797,129

 

 

9,615

 

 

1.21

 

 

764,637

 

 

11,156

 

 

1.46

 

 

704,003

 

 

11,397

 

 

1.62

 

Short-term borrowings

 

 

20,843

 

 

122

 

 

0.59

 

 

11,553

 

 

114

 

 

0.99

 

 

8,803

 

 

88

 

 

1.00

 

Long-term and junior subordinated debt

 

 

36,212

 

 

790

 

 

2.18

 

 

47,459

 

 

1,089

 

 

2.29

 

 

66,421

 

 

1,669

 

 

2.51

 

Total interest bearing liabilities

 

 

854,184

 

 

10,527

 

 

1.23

 

 

823,649

 

 

12,359

 

 

1.50

 

 

779,227

 

 

13,154

 

 

1.69

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Noninterest bearing deposits

 

 

82,008

 

 

 

 

 

 

 

 

71,621

 

 

 

 

 

 

 

 

61,372

 

 

 

 

 

 

 

Other liabilities

 

 

6,727

 

 

 

 

 

 

 

 

5,137

 

 

 

 

 

 

 

 

4,731

 

 

 

 

 

 

 

Shareholders’ equity

 

 

98,392

 

 

 

 

 

 

 

 

84,308

 

 

 

 

 

 

 

 

76,422

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total liabilities and
shareholders’ equity

 

$

1,041,311

 

 

 

 

 

 

 

$

984,715

 

 

 

 

 

 

 

$

921,752

 

 

 

 

 

 

 

Net interest income

 

 

 

 

$

37,401

 

 

 

 

 

 

 

$

34,492

 

 

 

 

 

 

 

$

32,315

 

 

 

 

Net interest margin (3)

 

 

 

 

 

 

 

 

3.81

%

 

 

 

 

 

 

 

3.73

%

 

 

 

 

 

 

 

3.72

%


 

 

(1)

Average balance includes average nonaccrual loans of $11,538,000 in 2012, $16,550,000 in 2011, and $17,242,000 in 2010. Interest includes net loan fees of $1,060,000 in 2012, $941,000 in 2011, and $1,060,000 in 2010.

(2)

Average balance includes average bank owned life insurance, foreclosed real estate and unrealized holding gains (losses) on investment securities.

(3)

Net interest income as a percentage of average earning assets.

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Table 2-Rate/Volume Analysis of Changes in Net Interest Income (tax equivalent basis)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2012 vs. 2011
Increase (decrease) due
To change in

 

2011 vs. 2010
Increase (decrease) due
To change in

 

(dollars in thousands)

 

Volume

 

Rate

 

Net

 

Volume

 

Rate

 

Net

 

 

Interest Income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest bearing deposits with banks

 

$

23

 

$

5

 

$

28

 

$

7

 

$

(5

)

$

2

 

Federal funds sold

 

 

(2

)

 

0

 

 

(2

)

 

(7

)

 

0

 

 

(7

)

Investment securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Taxable

 

 

(118

)

 

(331

)

 

(449

)

 

947

 

 

(478

)

 

469

 

Tax-exempt

 

 

215

 

 

(209

)

 

6

 

 

208

 

 

(217

)

 

(9

)

Loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Taxable

 

 

3,455

 

 

(1,844

)

 

1,611

 

 

1,092

 

 

(147

)

 

945

 

Tax-exempt

 

 

(104

)

 

(13

)

 

(117

)

 

15

 

 

(33

)

 

(18

)

Total interest income

 

 

3,469

 

 

(2,392

)

 

1,077

 

 

2,262

 

 

(880

)

 

1,382

 

Interest Expense

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deposits:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest bearing demand

 

 

188

 

 

(790

)

 

(602

)

 

326

 

 

(404

)

 

(78

)

Savings

 

 

15

 

 

(39

)

 

(24

)

 

10

 

 

(9

)

 

1

 

Time

 

 

(36

)

 

(879

)

 

(915

)

 

347

 

 

(511

)

 

(164

)

Short-term borrowings

 

 

92

 

 

(84

)

 

8

 

 

27

 

 

(1

)

 

26

 

Long-term and junior subordinated debt

 

 

(267

)

 

(32

)

 

(299

)

 

(476

)

 

(104

)

 

(580

)

Total interest expense

 

 

(8

)

 

(1,824

)

 

(1,832

)

 

234

 

 

(1,029

)

 

(795

)

Net interest income

 

$

3,477

 

$

(568

)

$

2,909

 

$

2,028

 

$

149

 

$

2,177

 

Changes which are due to both volume and rate are allocated in proportion to their relationship to the amount of change attributed directly to volume or rate.

Provision for loan losses

The provision for loan losses is an expense charged to earnings to cover estimated losses attributable to uncollectible loans. The provision reflects management’s judgment of an appropriate level for the allowance for loan and lease losses. The Risk Management section of this report, including Tables 10 – Nonperforming Assets, 11 – Analysis of Allowance for Loan and Lease Losses, and 12 – Allocation of Allowance for Loan and Lease Losses, provides detailed information about the allowance, provision and credit risk.

For 2012, the provision for loan losses was $1,750,000, compared to $4,935,000 for 2011 and $2,990,000 for 2010. The decrease in the provision for the year 2012 reflected improved credit quality and a decrease in net charge-offs on loans compared to the prior two years. The provision for the year 2011 was unusually high, the result of two unrelated partial loan charge-offs totaling $3,175,000 as reported on a Form 8-K filed October 3, 2011 and a Form 8-K/A filed on November 10, 2011. The provision for loan losses for all three periods presented remained elevated in comparison to the Corporation’s historic levels and was reflective of the risks and uncertainties associated with prolonged weakness in economic and business conditions, a relatively high level of unemployment and erosion of real estate values. These factors can adversely affect our borrowers’ ability to service their loans.

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Noninterest income

The following table presents the components of total noninterest income for each of the past three years.

Table 3-Noninterest Income

 

 

 

 

 

 

 

 

 

 

 

(dollars in thousands)

 

2012

 

2011

 

2010

 

 

Trust and investment services fees

 

$

1,702

 

$

1,510

 

$

1,420

 

Income from mutual fund, annuity and insurance sales

 

 

896

 

 

1,103

 

 

1,477

 

Service charges on deposit accounts

 

 

2,560

 

 

2,583

 

 

2,471

 

Income from bank owned life insurance including death benefits

 

 

633

 

 

647

 

 

637

 

Other income

 

 

645

 

 

613

 

 

601

 

Net gain on sales of loans held for sale

 

 

1,327

 

 

777

 

 

860

 

Net gain on sales of securities

 

 

427

 

 

125

 

 

108

 

Total noninterest income

 

$

8,190

 

$

7,358

 

$

7,574

 

For 2012, the overall $832,000 or 11 percent increase in total noninterest income, compared to 2011, was primarily the result of increases in net gain on sales of loans held for sale and trust and investment services fees. The increase in net gain on sales of securities also contributed to the increase in noninterest income. Core noninterest income, which excludes the net gain on sales of securities, increased $530,000 or 7 percent for the year 2012, compared to the year 2011. The discussion that follows addresses changes in selected categories of noninterest income.

Trust and investment services fees—Increases in this category of noninterest income for 2012 and 2011 were primarily the result of appreciation in market value of managed accounts, upon which some fees are based, and growth in traditional trust business.

Income from mutual fund, annuity and insurance sales— For 2012, the $207,000 or 19 percent decrease in income from mutual fund, annuity and insurance sales compared to 2011 was due to a decrease in sales, which reflected market uncertainty and the relative unattractiveness of variable annuities due to low rates and less favorable structures. The decrease in income for 2011, compared to 2010, was also the result of a decrease in sales which reflected the resignation of four registered representatives who left Codorus Valley Financial Advisors (CVFA), a subsidiary of PeoplesBank, in February 2011.

Service charges on deposit accounts— For 2012, service charges on deposit accounts decreased slightly compared to the year 2011 due primarily to a decrease in overdraft fees. Overdraft fee income on consumer accounts enrolled in PeoplesBank’s automated overdraft payment program, which is a significant component of service charges, decreased in response to the implementation of FDIC guidance on July 1, 2011, which effectively restricted overdraft pricing policies. The increase in service charge income for 2011, compared to 2010, was primarily the result of an increase in debit card revenue, which reflected an increase in the volume of transactions.

Income from bank owned life insurance (BOLI)—Income from BOLI for the three years presented was basically flat as low market interest rates depressed yields. This investment provides a competitive tax-free return to the Corporation while providing a life insurance benefit to the management team.

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Note: On February 6, 2013, PeoplesBank purchased $5.3 million of BOLI. Of this total $4.7 million was invested with Massachusetts Mutual Life Insurance Company and $0.6 million was invested with Midland National Life Insurance Company. The tax-exempt yield is approximately 3.77 percent or 5.71 percent on a taxable equivalent basis.

Other income— Other income, comprised of many underlying fees, increased as a result of normal business growth over the three year period presented. The increase in 2012, compared to 2011, also reflected a $53,000 increase in revenue from loan settlement services provided by SYC Settlement Services, Inc., a PeoplesBank subsidiary. The other income category includes wire transfer fees, credit card merchant fees, automated teller machine fees, safe deposit box fees and miscellaneous fees, among others.

Net gain on sales of loans held for sale— For 2012, the $550,000 or 71 percent increase in net gain on sales of loans held for sale, compared to the year 2011, was due primarily to an increase in the volume of residential mortgage loan sales. The unusually low level of market interest rates that prevailed throughout the year 2012, which were influenced by the Federal Reserve Bank to stimulate the U.S. economy, resulted in a sharp increase in residential mortgage loan refinancings. For 2011, the decrease in net gain compared to the year 2010 reflected a decrease in the volume of sales and a decrease in pricing from secondary market sources.

Net gain on sales of securities—For 2012, the net gain totaling $427,000 was primarily the result of sales of U.S. agency mortgage-backed securities (MBS) that were selectively sold to remove relatively low yielding instruments that were prepaying principal faster than anticipated and small odd-lot securities from the MBS portfolio.

Noninterest expense

The following table presents the components of total noninterest expense for each of the past three years.

Table 4-Noninterest Expense

 

 

 

 

 

 

 

 

 

 

 

(dollars in thousands)

 

2012

 

2011

 

2010

 

 

 

 

 

 

 

 

 

 

 

 

Personnel

 

$

15,312

 

$

13,748

 

$

13,276

 

Occupancy of premises, net

 

 

1,977

 

 

2,004

 

 

1,926

 

Furniture and equipment

 

 

1,896

 

 

1,730

 

 

1,670

 

Postage, stationery and supplies

 

 

508

 

 

519

 

 

516

 

Professional and legal

 

 

534

 

 

586

 

 

488

 

Marketing and advertising

 

 

907

 

 

840

 

 

700

 

FDIC insurance

 

 

733

 

 

1,004

 

 

1,297

 

Debit card processing

 

 

707

 

 

655

 

 

585

 

Charitable donations

 

 

640

 

 

396

 

 

523

 

Telephone

 

 

532

 

 

509

 

 

560

 

External data processing

 

 

560

 

 

462

 

 

431

 

Foreclosed real estate including (gains) losses on sales

 

 

2,830

 

 

1,701

 

 

3,275

 

Impaired loan carrying costs

 

 

299

 

 

620

 

 

972

 

Other

 

 

2,493

 

 

2,305

 

 

1,897

 

Total noninterest expense

 

$

29,928

 

$

27,079

 

$

28,116

 

Total noninterest expense for the year 2012 increased $2,849,000 or 11 percent above the year 2011 due primarily to increases within the personnel and foreclosed real estate expense categories.

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Planned franchise expansion—Plans call for the construction of a full-service branch office in Dover, PA on a building lot purchased by PeoplesBank in October of 2012. The new office with a planned staff size of five people has all necessary regulatory approvals and is expected to be operational by the fall of 2013. Additionally, management is seeking regulatory approval to establish a full-service branch office in Hanover, PA. The branch will be operated out of leased office space and, subject to regulatory approval, is scheduled to be operational in May 2013. Branch office expansion is expected to increase noninterest expenses such as personnel, occupancy, furniture and equipment, and marketing, among other expenses.

The discussion that follows addresses changes in selected noninterest expense categories.

Personnel—Personnel expense is comprised of wages, sales commissions, payroll taxes and employee benefits, such as medical insurance and 401K plans. The $1,564,000 or 11 percent increase in personnel expense for 2012, compared to 2011, was attributable to normal business growth, which included the full year’s impact of a branch office addition in September 2011, increased sales commissions for mortgage originators which resulted from increased production, and the accrual of annual performance incentives. Comparatively, the $472,000 or 4 percent increase in personnel expense for 2011, compared to 2010, was also attributable to normal business growth, which included a partial year’s impact for the aforementioned branch office addition. The rate of increase in personnel expense for the year 2011 was limited by the decrease in wages caused by the resignation of four registered representatives and an office manager who left PeoplesBank subsidiary CVFA in February 2011.

Effective August 1, 2010, PeoplesBank converted from a fully insured health care program to a self-insured program by joining a consortium of approximately 30 banks. Employees have customarily reimbursed the Corporation for approximately 30 percent of the cost of health insurance. For the year 2012, compared to the year 2011, the cost of the self-insured program decreased approximately $122,000 or 11 percent due to a decrease in claims expense and a decrease in the insured pool as a result of program changes.

Occupancy of premises, net— Occupancy of premises expense is comprised of rent, depreciation, maintenance, insurance, real estate taxes and utilities. The level of expense can vary annually based upon franchise expansion, repairs and maintenance, and normal business growth. Examples of franchise expansion include the addition of a branch banking office in 2011 and the relocation of an existing branch banking office during 2010 to a more favorable site.

Furniture and equipment—This category includes depreciation expense on furniture and equipment, including IT-related equipment, and the cost of computer hardware and software maintenance contracts among other expenses. The upward trend in this expense category reflects normal business growth, including price increases, IT initiatives such as CRM (described below) and the addition of a branch banking office in 2011.

During the third quarter of 2010, PeoplesBank began implementing a client relationship management (CRM) system, which, in addition to computer hardware, is comprised of two main components, sales and service software and teller software. Sales and service software, the primary component, became operational in December 2011, and began depreciation at that time over a five-year estimated useful life. The teller software component, which will be phased in by individual branch office, is expected to be fully operational by the fall of 2013. The capital outlay for this project is estimated at $625,000, which does not include staffing and other ancillary expenses. A properly managed CRM process is expected to improve the Corporation’s competitiveness and client service and retention.

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Table of Contents


Professional and legal—The level of professional and legal expense can vary annually based on the varying needs for legal, accounting and consulting services, which is driven in part by the level of routine lawsuits in the ordinary course of business, the number and complexity of corporate initiatives, and changes in regulatory compliance requirements.

Marketing and advertising—Expense for the three years presented shows an upward trend that reflects an increased operating budget to support normal business growth and increased corporate initiatives such as branding, product advertising and internal promotions.

FDIC insurance—Expense for the three years presented shows a downward trend, which reflects a decrease in the assessment rate. The decrease in the assessment rate was due to PeoplesBank’s improved financial performance and a change in the methodology for calculating insurance premiums by the FDIC. Effective April 1, 2011, the FDIC lowered assessment rates and applied them against average assets minus average tangible capital, instead of domestic deposits. More information about FDIC insurance assessments is available under the Supervision and Regulation section of this report (reference the subheading-FDIC).

Debit card processing—Expense for the three years presented shows an upward trend, which reflects increases in the number of new accounts and transaction volume. This expense category also includes the cost of operating automated teller machines.

Charitable donations— The level of charitable donations, principally educational and scholarship donations, is based, in part, upon whether or not PeoplesBank can obtain related state tax credits if available from nonprofit organizations. Accordingly, the level of charitable donations can vary from year to year. For example, the decrease in charitable donations for 2011 resulted from the denial or delay of tax credits by the state of Pennsylvania for educational donations due to budgetary constraints. PeoplesBank uses state tax credits from donations to reduce its Pennsylvania Shares Tax expense, included below in other expenses.

Foreclosed real estate including (gains) losses on sales—Net foreclosed real estate expense is comprised of impairment losses, including losses on sales, and carrying costs, net of gains from sales and income generated by the real estate. Typical carrying costs include insurance, maintenance and repairs, real estate taxes, appraisals and legal fees. Net foreclosed real estate expense remained elevated for the three years presented due to the level of carrying costs and impairment losses from deterioration of property values associated with specific properties as well as the size of the portfolio, which was reflective of prolonged weakness in economic and business conditions and the erosion of real estate values. Real estate expense for the year 2012 increased $1,129,000 or 66 percent compared to the year 2011 as a result of increased provisioning for impairment losses, including the $1,027,000 provision related to a foreclosed property, as previously reported on Form 8-K dated August 30, 2012 and filed with the SEC. For the year 2011, foreclosed real estate expense decreased $1,574,000 or 48 percent, compared to the year 2010, due in part to the recognition of rental income totaling $868,000 from a real estate project and a decrease in the provision for real estate losses. For the year 2011, the provision for real estate losses totaled $829,000, compared to $1,566,000 for 2010.

Impaired loan carrying costs— The prolonged weakness in economic and business conditions may cause fluctuations in impaired loan carrying costs. Factors such as the number and size of the loans in the impaired loan portfolio, financial capacity of the borrower or guarantor, value and liquidity of underlying collateral and the timing of when and for how long loans are classified as impaired, among other factors, contribute to the variability of this expense from period to period. Carrying costs are the same as those described for foreclosed real estate.

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Other—Other expense is comprised of many underlying expenses, including, but not limited to: Pennsylvania shares tax, memberships and subscriptions, director fees, liability insurance, third-party courier, correspondent banking expenses and miscellaneous operating losses. For the year 2012, the $188,000 or 8 percent increase in the other expense category above the year 2011 reflected a nonrecurring charge-off of the unamortized balance of an intangible asset totaling $163,000. Varying levels of Pennsylvania shares tax expense, which reflected varying levels of state tax credits that originated from charitable donations (as described earlier) can cause annual variances in the other expense category. For example, shares tax, net of credits, totaled $306,000 for 2012, compared to 392,000 for 2011 and $229,000 for 2010. The upward trend in the other expense category for the three year period presented also reflects normal business growth.

Provision for income taxes

The provision for income tax for year 2012 was $3,103,000, compared to a $1,617,000 for 2011. The increase in income tax was primarily the result of an increase in pretax income. For both periods, the Corporation’s statutory federal income tax rate was 34 percent. The Corporation’s effective income tax rate was approximately 24.8 percent for 2012, compared to 19.3 percent for 2011. The effective tax rate differs from the statutory tax rate due to the impact of low-income housing credits and tax-exempt income, including income from bank owned life insurance.

Preferred stock dividends and discount accretion

Preferred stock dividends for the year 2012 totaled $384,000, compared to preferred stock dividends and discount accretion totaling $1,460,000 for the year 2011. The $1,076,000 or 74 percent decrease was a result of a decrease in the dividend rate on preferred stock caused by the addition of loans above a predetermined baseline portfolio balance that qualified for the U.S. Treasury’s Small Business Lending Program. Also, the accretion of discount is no longer applicable in 2012 as a result of the redemption of preferred stock issued under the Treasury’s Capital Purchase Program in 2011. Information about U.S. Treasury capital programs is provided in Note 10—Shareholders’ Equity of this report.

BALANCE SHEET REVIEW

Interest bearing deposits with banks

Interest bearing deposits with banks totaled $35 million on December 31, 2012, compared to $20 million on December 31, 2011. The level of interest bearing deposits can vary significantly based on the timing and magnitude of investment opportunities and funding.

Securities, available-for-sale

The investment securities portfolio is an interest earning asset, second in size to the loan portfolio. Investment securities serve as an important source of revenue and liquidity. They also serve as collateral for public and trust deposits, securities sold under agreements to repurchase and to support borrowings. The investment securities portfolio is managed to comply with the Corporation’s Investment Securities Policy, and accounted for in accordance with FASB ASC Topic 320. Decisions to purchase or sell securities are based on an assessment of current economic and financial conditions, including the interest rate environment, the demand for loans, and liquidity and income requirements. Table 5—Investment Securities, shows the amortized cost and fair value by type of security for three year-end periods.

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Table 5-Investment Securities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2012

 

2011

 

2010

 

(dollars in thousands)

 

Amortized
Cost

 

Fair
Value

 

Amortized
Cost

 

Fair
Value

 

Amortized
Cost

 

Fair
Value

 

Available-for-sale

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Debt securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Treasury notes

 

$

5,001

 

$

5,032

 

$

10,003

 

$

10,134

 

$

8,014

 

$

8,140

 

U.S. agency

 

 

37,000

 

 

38,058

 

 

29,593

 

 

30,673

 

 

13,519

 

 

13,643

 

U.S. agency mortgage-backed, residential

 

 

84,630

 

 

88,233

 

 

103,017

 

 

106,444

 

 

108,967

 

 

110,353

 

State and municipal

 

 

98,744

 

 

102,739

 

 

82,272

 

 

86,610

 

 

88,796

 

 

90,400

 

Total

 

$

225,375

 

$

234,062

 

$

224,885

 

$

233,861

 

$

219,296

 

$

222,536

 

At December 31, 2012, the fair value of the securities, available-for-sale totaled $234 million, approximately the same level as December 31, 2011. Throughout the year 2012, cash inflows from maturities and repayments, and the proceeds from sales of securities were reinvested back into the investment securities portfolio. Approximately $17 million of U.S. agency mortgage-backed securities (MBS) were selectively sold to remove relatively low yielding instruments that were prepaying faster than anticipated and small odd-lot securities from the MBS portfolio. The sales of MBS during the year 2012 resulted in the realization of net gains totaling $427,000. During the year 2011, PeoplesBank took advantage of the low interest rate environment and sold selected securities, which generated net gains of $125,000 that were recognized in income. Included in the net gains for 2011 was an $18,000 loss associated with the sale of eleven municipal bonds totaling approximately $5 million (par value) that no longer met the Corporation’s investment standards.

Securities, available-for-sale are generally comprised of high quality debt instruments. Included in Table 5 are investments in the obligations of states and municipalities. During the fourth quarter of 2010 bonds issued by states and municipalities received negative national press because of widespread budget deficits and, by implication, the possibility of default. We believe that selected investment in municipal bonds is a sound investment practice. Municipalities have many options for meeting their debt obligations, including decreasing costs and service levels, imposing taxes and selling assets. In many cases, municipal debt issues are insured or, in the case of school districts of selected states, backed by specific reserves, which provide a layer of protection to the investor. Access to the credit market and a good credit rating are high priorities of municipal management enabling it to meet its current and future funding needs at a reasonable interest cost. For these reasons, defaults on municipal bonds are very low, well below 1 percent. With the exception of an approximately $14 million portfolio (fair value) of Texas municipal utility district bonds, which has its own criteria for investment, the remaining municipal bonds are almost all rated A or above by at least one national statistical rating organization at December 31, 2012. The majority of bonds in our portfolio are general obligation bonds, which can draw upon multiple sources of revenue, including taxes, for payment. Only a few bonds are revenue bonds, which are dependent upon a single revenue stream for payment, but they are for critical services such as water and sewer. Many of the municipal holdings are also insured or backed by specific school district loss reserves.

On January 1, 2013, provision 939(a) of the Dodd-Frank Act becomes effective, which changes the definition of investment grade by removing reliance on credit ratings by national statistical rating organizations. Investment grade under the revised definition requires an active review ( i.e., pre-purchase and post-purchase credit risk analysis) of the obligor to determine that the obligor has an adequate capacity to meet its financial commitments and more specifically that the risk of default is low and that full and timely repayment of principal and interest is expected. Obligations of the U.S. government and U.S. government sponsored enterprises are not subject to the due diligence requirement; however, municipal and corporate obligations are subject to the new requirement.

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Table of Contents


Table 6—Securities Maturity Schedule, shows that the available-for-sale portfolio had a yield of 3.14 percent on December 31, 2012. Comparatively, the portfolio yield was 3.48 percent on December 31, 2011. The decrease in portfolio yield for 2012 was the result of security additions, including the reinvestment of cash inflows from scheduled maturities and repayments of mortgage-backed bonds, during a period of unusually low market interest rates and asset yields. More information about investment securities is provided in Note 3-Securities in the notes to the consolidated financial statements.

Table 6-Securities Maturity Schedule (amortized cost basis)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2012
Maturity Distribution

 

 

 

 

 

 

 

 

 

One
through
five years

 

Five
through
ten years

 

 

 

 

 

 

 

 

 

One year
or less

 

 

 

After
ten years

 

Total

 

(dollars in thousands)

 

 

 

 

 

Amount

 

Yield(1)

 

 

Available-for-sale

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Debt securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Treasury notes

 

$

5,001

 

$

0

 

$

0

 

$

0

 

$

5,001

 

 

1.30

%

U.S. agency

 

 

2,000

 

 

32,882

 

 

2,118

 

 

0

 

 

37,000

 

 

1.58

%

U.S. agency mortgage-backed, residential (2)

 

 

0

 

 

81,793

 

 

2,837

 

 

0

 

 

84,630

 

 

2.88

%

State and municipal

 

 

10,500

 

 

63,050

 

 

21,373

 

 

3,821

 

 

98,744

 

 

4.04

%

Total

 

$

17,501

 

$

177,725

 

$

26,328

 

$

3,821

 

$

225,375

 

 

3.14

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Yield (1)

 

 

2.78

%

 

3.03

%

 

3.69

%

 

6.18

%

 

3.14

%

 

 

 

 

(1) Weighted average yields (tax equivalent basis) were calculated on the amortized cost basis.

(2) U.S. agency mortgage-backed securities are included in the maturity categories based on average expected life.

Restricted investment in bank stocks

At December 31, 2012, PeoplesBank held $2,863,000 in restricted common stock, compared to $3,635,000 at year-end 2011. Investment in restricted stock is a condition of obtaining credit from the Federal Home Loan Bank of Pittsburgh (FHLBP) and the Atlantic Central Bankers Bank (ACBB) organizations. Of the total, $2,788,000 consisted of stock issued by the FHLBP and $75,000 issued by the ACBB. Information about impairment considerations for restricted stock is provided in Note 1–Summary of Significant Accounting Policies in the notes to the consolidated financial statements.

The FHLBP resumed the payment of quarterly cash dividends in the fourth quarter of 2011 after a period of suspension since December 2008. The quarterly dividend rate is based on the average 3-month LIBOR. The annualized percentage for the fourth quarter of 2012 is 0.32 percent. The FHLBP reported that it will continue to monitor the condition of its private-label residential mortgage-back securities portfolio, its overall financial performance and retained earnings, developments in the mortgage and credit markets, and other relevant information as the basis for determining the status of dividends and excess capital stock repurchases in future quarters.

Loans held for sale

On December 31, 2012, loans held for sale were approximately $3.1 million, compared to $2.9 million at year-end 2011. For both years PeoplesBank’s mortgage banking staff remained focused on originating and selling residential mortgages without retaining servicing rights. The unusually low level of market interest rates that prevailed throughout the year 2012, which were influenced by the Federal Reserve Bank in its continuous efforts to stimulate the U.S. economy, resulted in a sharp increase in residential mortgage loan refinancings and sales. As a result, the level of net gain on sales of loans held for sale for the year 2012 increased $550,000 or 71 percent above the year 2011.

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Table of Contents


Loans

On December 31, 2012, total loans, net of deferred fees, totaled approximately $737 million, an increase of $44 million or 6 percent above year-end 2011. Most of the increase was due to a $42 million or 7 percent increase in commercial loans, which reflected increased demand, in spite of a continuation of adverse economic conditions and depressed real estate markets, and our ability to acquire business from competitors based on our reputation for client service and competitive prices. The composition of the Corporation’s loan portfolio at December 31, 2012 and 2011 is provided in Note 4–Loans in the notes to the consolidated financial statements. The average yield (tax equivalent basis) earned on total loans was 5.72 percent for 2012, compared to 5.91 percent for 2011. Table 7 presents the composition of total loans for five year-end periods.

Table 7-Loan Portfolio Composition

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31,

 

(dollars in thousands)

 

2012

 

%

 

2011

 

%

 

2010

 

%

 

2009

 

%

 

2008

 

%

 

Commercial, financial and
agricultural

 

$

510,544

 

 

69.2

 

$

462,061

 

 

66.6

 

$

419,649

 

 

65.5

 

$

415,404

 

 

64.3

 

$

348,111

 

 

60.7

 

Real estate - construction
and land development

 

 

96,936

 

 

13.2

 

 

103,514

 

 

14.9

 

 

95,735

 

 

14.9

 

 

104,986

 

 

16.3

 

 

100,088

 

 

17.5

 

Total commercial related loans

 

 

607,480

 

 

82.4

 

 

565,575

 

 

81.5

 

 

515,384

 

 

80.4

 

 

520,390

 

 

80.6

 

 

448,199

 

 

78.2

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Real estate - residential
mortgages

 

 

23,511

 

 

3.2

 

 

21,324

 

 

3.1

 

 

20,357

 

 

3.2

 

 

22,270

 

 

3.4

 

 

18,154

 

 

3.2

 

Consumer and home equity

 

 

106,143

 

 

14.4

 

 

106,616

 

 

15.4

 

 

105,108

 

 

16.4

 

 

103,217

 

 

16.0

 

 

106,725

 

 

18.6

 

Total consumer related loans

 

 

129,654

 

 

17.6

 

 

127,940

 

 

18.5

 

 

125,465

 

 

19.6

 

 

125,487

 

 

19.4

 

 

124,879

 

 

21.8

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total loans

 

$

737,134

 

 

100.0

 

$

693,515

 

 

100.0

 

$

640,849

 

 

100.0

 

$

645,877

 

 

100.0

 

$

573,078

 

 

100.0

 

Table 8 shows that, at December 31, 2012, the commercial loan portfolio was comprised of approximately $356 million or 59 percent in fixed rate loans and $252 million or 41 percent in floating rate loans, which was the same mix on December 31, 2011. Floating rate loans reprice periodically with changes in the Wall Street Journal (WSJ) prime rate or LIBOR. Additional loan information can be found in Note 4–Loans in the notes to the consolidated financial statements and within the Risk Management section of this report.

Table 8-Selected Loan Maturities and Interest Rate Sensitivity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2012
Maturity Distribution

 

 

 

 

(dollars in thousands)

 

One year
or less

 

One
through
five years

 

After
five years

 

Total

 

Commercial, financial and agricultural

 

$

86,098

 

$

119,204

 

$

305,242

 

$

510,544

 

Real estate-construction and land development

 

 

47,041

 

 

39,380

 

 

10,515

 

 

96,936

 

Total commercial related loans

 

$

133,139

 

$

158,584

 

$

315,757

 

$

607,480

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed interest rates

 

$

32,228

 

$

82,450

 

$

241,296

 

$

355,974

 

Floating interest rates

 

 

100,911

 

 

76,134

 

 

74,461

 

 

251,506

 

Total commercial related loans

 

$

133,139

 

$

158,584

 

$

315,757

 

$

607,480

 

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Other assets

On December 31, 2012, other assets totaled approximately $31 million, compared to $44 million on December 31, 2011. Other assets were primarily comprised of foreclosed real estate and investments in bank owned life insurance (BOLI). Foreclosed real estate, net of allowance, totaled $3.6 million at year-end 2012, compared to $16.2 million at year-end 2011. Foreclosed real estate is discussed in the Nonperforming Assets section of this report. Investments in life insurance relates to a select group of employees and directors whereby PeoplesBank is the owner and beneficiary of the policies. These investments, carried at the cash surrender value of the underlying policies, totaled $15.5 million at year-end 2012, compared to $14.8 million at year-end 2011. Other assets also includes lesser amounts for interest receivable on loans and investment securities, net deferred tax assets, prepaid FDIC deposit insurance and an investment in a real estate partnership that provides low cost housing to income qualified families. Additional information about these assets can be found in Note 1–Summary of Significant Accounting Policies in the notes to the consolidated financial statements under the appropriate subheadings.

Note: As a revenue raising strategy, PeoplesBank purchased $5.3 million of BOLI on February 6, 2013. Of this total, $4.7 million was invested with Massachusetts Mutual Life Insurance Company and $0.6 million was invested with Midland National Life Insurance Company. The selection of these insurers was based on their high credit rating and reputation, competitive tax-exempt yield and to accomplish diversification among insurers for the BOLI portfolio. The level of BOLI investment, including the $5.3 million addition, is estimated at 20 percent of PeoplesBank’s Tier 1 capital, excluding unrealized gains (losses) on available-for-sale securities, at December 31, 2012, which is well within PeoplesBank’s investment limitation of 25 percent of Tier 1 capital.

Funding

Deposits

Deposits are the principal source of funding for earning assets. On December 31, 2012, total deposits were $901 million, an increase of $47 million or 5 percent over year-end 2011. The increase in total deposits occurred primarily within the money market and demand categories. In contrast, total time deposits decreased $16 million or 4 percent in response to our clients’ apparent preference for liquidity. The average rate paid on interest bearing deposits was 1.21 percent for 2012, compared to 1.46 percent for 2011, which reflected the historically low level of market interest rates. The composition of the Corporation’s deposit portfolio at December 31, 2012 is provided in Note 7-Deposits in the notes to the consolidated financial statements. On December 31, 2012, the balance of certificates of deposit with a balance of $100,000 and above was $175 million. Of this total, $18 million mature within three months, $24 million mature after three months but within six months, $34 million mature after six months but within twelve months, and the remaining $99 million mature beyond twelve months.

Short-term borrowings

Short-term borrowings consist of securities sold under agreements to repurchase (repo agreements), federal funds purchased and other borrowings as described more fully in Note 8-Short-term borrowings and Long-term Debt to the consolidated financial statements. On December 31, 2012 and 2011, short-term borrowings, comprised solely of repo agreements, totaled $19.4 million and $10.3 million, respectively.

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Long-term debt

Long-term debt is a secondary funding source for asset growth. On December 31, 2012, long-term debt totaled $30.8 million, compared to $46.6 million at year-end 2011. The decrease was attributable to payments for maturing FHLBP loans throughout 2012 that were not refinanced. Generally, funds for the payment of long-term debt come from operations. On December 31, 2012, total unused credit with the FHLBP was approximately $166 million. Obligations to the FHLBP are secured by FHLBP stock and qualifying collateral, principally real estate secured loans and selected investment securities.

In June 2012, the Corporation restructured (i.e., extended) two outstanding $5 million FHLBP advances ($10 million total) to lock in low rates as a hedge against the possibility of rising market interest rates in the future. This transaction resulted in a $235,000 prepayment penalty that has been deferred and embedded in the rates on the restructured advances where it will be recognized as interest expense over their respective repayment terms. The $5 million FHLBP advance originally maturing December 2013 with a fixed rate of interest of 2.39 percent was extended to June 2019 with a fixed rate of interest of 2.10 percent. The $5 million FHLBP advance originally maturing July 2014 with a fixed rate of interest of 1.38 percent was extended to June 2018 with a fixed rate of interest of 1.87 percent. The impact of the debt restructure on current period earnings is immaterial.

A listing of outstanding long-term debt obligations is provided in Note 8-Short-term Borrowings and Long-term Debt in the notes to the consolidated financial statements.

Shareholders’ equity and capital adequacy

Shareholders’ equity or capital enables the Corporation to maintain asset growth and absorb losses. Capital adequacy can be affected by a multitude of factors, including profitability, corporate expansion, balance sheet growth, dividend policy and regulatory mandates, among others. Total shareholders’ equity was $101.3 million on December 31, 2012, compared to $93.2 million at year-end 2011. The increase in equity was the result of an increase in retained earnings from profitable operations.

Dividends on preferred stock

As previously disclosed, the Corporation participates in the U.S. Department of the Treasury’s (Treasury) Small Business Lending Fund Program (SBLF Program). Under this program, the Corporation issued $25 million, or 25,000 shares of non-cumulative, perpetual preferred stock, Series B, $1,000 liquidation value, $2.50 par value to the Treasury. The SBLF preferred stock qualifies as Tier 1 regulatory capital and requires the payment of non-cumulative cash dividends quarterly on each January 1, April 1, July 1 and October 1. The annualized dividend rate in effect on December 31, 2012 was 1 percent, compared to 5 percent on December 31, 2011. At inception of the SBLF Program (August 18, 2011) the dividend rate was initially set at 5 percent, but can vary from 1 percent to 5 percent on a quarterly basis through September 30, 2013, to reflect the amount of change in qualified small business lending compared to a baseline amount. On September 30, 2013, the dividend rate becomes fixed at the then prevailing rate for the remaining two and one half years of the initial four and one half year phase of the SBLF Program. After four and one half years from issuance the dividend rate will increase to 9 percent.

Dividends on common stock

The Corporation typically pays cash dividends on its common stock on a quarterly basis. The Board of Directors determines the dividend rate after considering the Corporation’s capital requirements, current and projected net income, and other factors. Annual cash dividends per common share totaled $0.382 for 2012, compared to $0.334 for 2011, as adjusted for the 5 percent common stock dividend described below. On January 8, 2013, the Board declared a regular cash dividend of $0.11 per common share, payable on February 12, 2013, to shareholders of record on January 22, 2013.

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Periodically, the Corporation distributes stock dividends on its common stock. On October 9, 2012, the Corporation declared a 5 percent common stock dividend distributable on December 11, 2012, to shareholders of record at the close of business on October 23, 2012. Distribution of this common stock dividend resulted in the issuance of 211,564 additional common shares.

Compensation plans

As disclosed in this report, the Corporation maintains various employee, director and shareholder benefit plans that could result in the issuance of its common stock or affect its earnings. Information regarding these plans can be found in Note 11-Benefit Plans and Note 12-Stock-Based Compensation in the notes to the consolidated financial statements.

Preferred and common stock

Information pertaining to preferred and common stock issued by the Corporation is disclosed in Note 10–Shareholders’ Equity in the notes to the consolidated financial statements.

Capital ratios

The Corporation and PeoplesBank are subject to various regulatory capital requirements administered by banking regulators that involve quantitative guidelines and qualitative judgments. Quantitative measures established by regulators pertain to minimum capital ratios, as set forth in Table 9. The table provides a comparison of the Corporation’s and PeoplesBank’s risk-based capital ratios and leverage ratios to the minimum regulatory requirement for the periods indicated.

On June 18, 2012, the federal regulatory agencies jointly issued a Notice of Proposed Rulemaking that would revise the general risk-based capital rules to incorporate certain revisions by the Basel Committee on Banking Supervision to the Basel capital framework (i.e., Basel III). Generally, the proposed rule revises the definition of regulatory capital components and related calculations, adds a new common equity tier 1 capital ratio, implements a new capital conservation buffer, increases the risk weighting for residential mortgages and past due loans, and provides a transition period for several aspects of the proposed rule. The standards set forth in the proposed rule would require bank holding companies and their bank subsidiaries to maintain substantially more capital, with a greater emphasis on common equity. Subsequent to the review and comment period on the proposal which ended October 22, 2012, the banking regulators announced that the project was being delayed. The timing for adoption of final rules to implement the Basel III capital framework is uncertain. Accordingly, final rules applicable to the Corporation and Bank may be substantially different from the Basel III framework initially proposed. The Corporation plans to monitor Basel III capital rules to ensure compliance, once finalized.

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Table of Contents


Table 9-Capital Ratios

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Ratios
at December 31,

 

Federal
Minimum
Required

 

Federal
Well
Capitalized

 

Capital *
at December 31,

 

(dollars in thousands)

 

2012

 

2011

 

 

 

2012

 

2011

 

 

Tier 1 risk-based capital

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(as a percentage of risk weighted assets)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Codorus Valley Bancorp, Inc. (consolidated)

 

 

13.59

%

 

13.35

%

 

4.00

%

 

n/a

%

$

105,597

 

$

97,128

 

PeoplesBank

 

 

13.20

 

 

12.98

 

 

4.00

 

 

6.00

 

 

102,120

 

 

94,056

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total risk-based capital

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(as a percentage of risk weighted assets)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Codorus Valley Bancorp, Inc. (consolidated)

 

 

14.79

%

 

14.55

%

 

8.00

%

 

n/a

%

$

114,899

 

$

105,830

 

PeoplesBank

 

 

14.40

 

 

14.19

 

 

8.00

 

 

10.00

 

 

111,422

 

 

102,758

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Leverage

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(Tier 1 capital as a percentage of average total assets)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Codorus Valley Bancorp, Inc. (consolidated)

 

 

10.02

%

 

9.62

%

 

4.00

%

 

n/a

%

$

105,597

 

$

97,128

 

PeoplesBank

 

 

9.72

 

 

9.35

 

 

4.00

 

 

5.00

 

 

102,120

 

 

94,056

 


 

 

*

Net unrealized gains and losses on securities available-for-sale, net of taxes, are disregarded for capital ratio computation purposes in accordance with federal regulatory banking guidelines.

Risk Management

The Corporation’s Risk Management Committee (Committee) meets at least quarterly and includes members of senior management and an independent director. The objective of the Committee is to identify and manage risk inherent in the operations of the Corporation and its affiliates. While the Committee’s risk review is broad in scope, its primary responsibility is to develop, implement and monitor compliance with formal risk management policies and procedures.

Credit risk management

Credit risk represents the possibility that a loan client, counterparty or issuer may not perform in accordance with contractual terms, posing one of the most significant risks of loss to the Corporation. Accordingly, the Corporation emphasizes the management of credit risk. To support this objective a sound lending policy framework has been established. This framework includes seven basic policies that guide the lending process and minimize risk. First, the Corporation follows detailed written lending policies and procedures. Second, lending authority is granted commensurate with dollar amount, loan type, level of risk, and loan officer experience. Third, loan review committees function at both the senior lending officer level and the Board level to review and approve loans that exceed pre-established dollar thresholds and/or meet other criteria. Fourth, the Corporation lends mainly within its primary geographical market area, York County, Pennsylvania and northern-central Maryland. Although this focus may pose a geographical concentration risk, the diverse local economy and employee knowledge of customers lessens this risk. Fifth, the loan portfolio is diversified to prevent dependency upon a single customer or small group of related customers. Sixth, the Corporation does not participate in the subprime lending market, nor does it invest in securities backed by subprime mortgages. And seventh, the Corporation does not lend to foreign countries or persons residing therein.

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The Corporation uses loan-to-value ratios (LTV ratios), establishing generally acceptable ratios of the loan amount to the value of the collateral securing the loan, to minimize the risk of loss from the loan portfolio. At December 31, 2012, the LTV ratios listed below were in effect.

 

 

 

 

Loan type

 

LTV ratio %

 

Residential, owner occupied 1-4 units, tax assessment (MD)

90

 

Residential, owner occupied 1-4 units, tax assessment (York, PA)

80

 

Residential, owner occupied 1-4 units, certified appraisal

80

 

Residential, non-owner occupied 1-4 units, certified appraisal

75

 

Residential, 5 or more units

75

 

Agricultural

75

 

Commercial

70

 

Industrial

65

 

Vacant land (depending on improvements, approvals)

60-70

 

Special/limited use properties

50

 

An acceptable valuation is required on all real estate secured loans. Generally, an appraisal performed by an independent licensed appraiser is required for real estate secured loans where the amount is above $100,000, or is non-owner occupied, or if the LTV ratio is above 70 percent for commercial property or above the limits shown in the above schedule for valuations based on tax assessments for owner occupied residential property, or if an existing appraisal is more than two years old assuming that there has been no material change in market conditions or the physical aspects of the property. Exceptions to LTV ratios and the use of a licensed appraiser are sometimes made by management or the Board of Directors when there are compensating factors.

One component of the internal credit risk review is the identification and management of industry concentrations, defined as greater than 10 percent of the total loan portfolio. The Corporation had two industry concentrations that exceeded 10 percent of the total loan portfolio: builder & developer were 13.2 percent and 14.9 of the portfolio at December 31, 2012 and 2011, respectively; and commercial real estate investor was 16.6 and 17.0 percent of the portfolio, respectively. Loans to borrowers within these industries are usually collateralized by real estate.

In addition to a comprehensive lending policy, numerous internal reviews of loan and foreclosed real estate portfolios occur throughout the year. Loan portfolios are also reviewed by independent auditors in connection with their annual financial statement audit and are examined periodically by bank regulators.

Nonperforming assets

The following table presents a five-year history of asset categories posing the greatest risk of loss and related ratios. We generally place a loan on nonaccrual status and cease accruing interest income, i.e., recognize interest income on a cash basis as long as the loan is sufficiently collateralized, when loan payment performance is unsatisfactory and the loan is past due 90 days or more. Loans past due 90 days or more and still accruing interest represent loans that are contractually past due, but are well collateralized and in the process of collection. Foreclosed real estate represents real estate acquired to satisfy debts owed to PeoplesBank. The final category, troubled debt restructurings, pertains to loans whose terms have been modified to include a concession that we would not ordinarily consider due to the debtor’s financial difficulties. Concessions granted under a troubled debt restructuring typically involve a reduction of interest rate lower than the current market rate for new debt with similar risk, the deferral of payments or extension of the stated maturity date. Troubled debt restructurings are evaluated for impairment if they have been restructured during the most recent calendar year, or if they cease to perform in accordance with the modified terms. The paragraphs below explain significant changes in the aforementioned categories for December 31, 2012, compared to December 31, 2011.

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Nonperforming assets are reviewed by management on a monthly basis. We generally rely on appraisals performed by independent licensed appraisers to determine the value of collateral for impaired collateral-dependent loans. Generally, an appraisal is performed when: an account reaches 60 days past due, unless a certified appraisal was completed within the past six months; market values have changed significantly; the condition of the property has changed significantly; or the existing appraisal is outdated. In instances where the value of the collateral is less than the net carrying amount of the loan, a specific loss allowance is established for the difference by recording a loss provision to the income statement. When it is probable that some portion or all of the loan balance will not be collected, that amount is charged off as loss against the allowance. Generally, a loan is returned to interest accruing status when we determine that circumstances have improved to the extent that all of the principal and interest amounts contractually due are current for at least six consecutive payments and future payments are reasonably assured.

Table 10-Nonperforming Assets

 

 

December 31,

 

(dollars in thousands)

 

2012

 

2011

 

2010

 

2009

 

2008

 

 

Nonaccrual loans

 

$

6,232

 

$

5,931

 

$

14,844

 

$

25,558

 

$

8,396

 

Nonaccrual loans, troubled debt restructurings

 

 

2,110

 

 

5,770

 

 

3,680

 

 

0

 

 

0

 

Accruing loans that are contractually past due 90 days or more as to principal and interest

 

 

186

 

 

0

 

 

197

 

 

40

 

 

61

 

Total nonperforming loans

 

 

8,528

 

 

11,701

 

 

18,721

 

 

25,598

 

 

8,457

 

Foreclosed real estate, net of allowance

 

 

3,633

 

 

16,243

 

 

10,572

 

 

9,314

 

 

2,052

 

Total nonperforming assets

 

$

12,161

 

$

27,944

 

$

29,293

 

$

34,912

 

$

10,509

 

Accruing troubled debt restructurings

 

$

3,550

 

$

3,272

 

$

0

 

$

0

 

$

0

 


 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Ratios:

 

Total period-end loans, net of deferred fees

 

$

737,134

 

$

693,515

 

$

640,849

 

$

645,877

 

$

573,078

 

Allowance for loan losses (ALL)

 

$

9,302

 

$

8,702

 

$

7,626

 

$

7,175

 

$

4,690

 

ALL as a % of total period-end loans

 

 

1.26

%

 

1.25

%

 

1.19

%

 

1.11

%

 

0.82

%

Annualized net charge-offs (recoveries) as a % of average total loans

 

 

0.16

%

 

0.58

%

 

0.39

%

 

0.20

%

 

0.13

%

ALL as a % of nonperforming loans

 

 

109.08

%

 

74.38

%

 

40.74

%

 

28.03

%

 

55.45

%

Nonperforming loans as a % of total period-end loans

 

 

1.16

%

 

1.69

%

 

2.92

%

 

3.96

%

 

1.48

%

Nonperforming assets as a % of total period-end loans and net foreclosed real estate

 

 

1.64

%

 

3.94

%

 

4.50

%

 

5.33

%

 

1.83

%

Nonperforming assets as a % of total period-end assets

 

 

1.15

%

 

2.76

%

 

3.06

%

 

3.91

%

 

1.50

%

Nonperforming assets as a % of total period-end shareholders’ equity

 

 

12.00

%

 

29.97

%

 

38.27

%

 

48.48

%

 

20.14

%

The level of nonperforming assets, while relatively high in comparison to the Corporation’s historic level, has trended down over the last four years. Significant progress in reducing the level of nonperforming assets was accomplished in the year 2012, compared to 2011, as a result of recoveries from borrower payments and foreclosed real estate sales, loan charge-offs and the establishment of valuation allowances for selective accounts. While progress has been made in reducing nonperforming assets, we remain concerned about prolonged weak economic conditions and the corresponding effects it has on our commercial borrowers.

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Table of Contents


Nonaccrual loans

We evaluate the adequacy of the allowance for loan losses at least quarterly and have established a loss allowance for selected loan relationships where the net realizable value of the collateral is insufficient to repay the loan. In this regard, allowances, if applicable, are noted below within the description of the loan. Collection efforts, including modification of contractual terms for individual accounts based on prevailing market conditions and liquidation of collateral assets, are being employed to maximize recovery. Further provisions for loan losses may be required for nonaccrual loans as additional information becomes available or conditions change. There is also the potential for adjustment to the allowance as a result of regulatory examinations. A loan is returned to interest accruing status when we determine that circumstances have improved to the extent that all of the principal and interest amounts contractually due are current for at least six consecutive payments and future payments are reasonably assured.

On December 31, 2012, the nonaccrual loan portfolio balance totaled $8,342,000, compared to $11,701,000 at year-end 2011. The decrease in nonaccrual loans was primarily the result of the payoff in full of two large commercial loans during 2012, which more than offset nonaccrual loan additions. On December 31, 2012, the nonaccrual loan portfolio was comprised of nineteen unrelated loan relationships, principally collateralized commercial loans, with outstanding principal balances ranging in size from $17,000 to $2,110,000. Four unrelated commercial relationships, which represent the majority of the nonaccrual loan portfolio balance, are described below.

Loan no. 1—At December 31, 2012, the outstanding principal balance of the loan relationship was $2,110,000, collateralized by commercial rental properties whose rents are assigned to PeoplesBank. Based on a recent appraisal of the primary real estate collateralizing the relationship, we believe that the loans are adequately collateralized. The borrower is presently operating under a troubled debt restructuring agreement.

Loan no. 2—At December 31, 2012, the outstanding principal balance of the loan relationship was $1,349,000, collateralized by two commercial properties. Based on an independent appraisal of the real estate collateralizing the relationship, we believe that the loans are adequately collateralized. The Bank is presently pursuing its legal remedies to recover the amount due.

Loan no. 3—At December 31, 2012, the outstanding principal balance of the loan relationship was $1,280,000, which represents three commercial loans guaranteed from 70% to 80%, depending upon the specific loan, by the U.S. Department of Agriculture. A $120,000 allowance for loan losses was established for this relationship. Several parcels of improved real estate provide collateral for the loans. The Bank is working through the process to liquidate the real estate.

Loan no. 4— PeoplesBank owns a 62.5 percent participation interest in this loan relationship. The carrying value of the Bank’s principal at December 31, 2012, was $856,000, which reflects a payment totaling $1,634,000 from the sale of collateral during January 2012. The Bank is pursuing its legal options against parties to the original loan agreement, including the liquidation of remaining collateral. As previously disclosed, PeoplesBank charged-off $2,275,000 as a loss in September 2011 due to deterioration in the value of the collateral.

For 2012, the gross interest income that would have been recorded if the nonaccrual loans had been current in accordance with their original terms and current throughout the period was approximately $838,000. The amount of interest income on those nonaccrual loans that was included in net income for 2012 was approximately $258,000. The interest income recognized on impaired loans, which includes nonaccrual loans, in Note 5–Loans in the notes to the consolidated financial statements, is a lesser amount because it includes interest income only from the time the loan was impaired.

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Table of Contents


At December 31, 2012, there were approximately $18.9 million in potential problem loans being closely monitored by management. Potential problem loans consist of loans classified as substandard where we have doubts as to the ability of the borrower to comply with present repayment terms, and which are not disclosed in Table 10. A loss allowance totaling $595,000 was established at December 31, 2012, for those potential problem commercial loans that, in our judgment, were under collateralized. Comparatively, we were monitoring approximately $3.0 million of potential problem loans at December 31, 2011.

Foreclosed real estate

On December 31, 2012, foreclosed real estate, net of allowance, totaled $3,633,000, compared to $16,243,000 at December 31, 2011. The $12,610,000 or 78 percent decrease was due primarily to the sale of real estate and secondarily to an increase in the allowance for real estate losses for selected properties. On December 31, 2012, the portfolio was comprised of five unrelated accounts ranging in size from $74,000 to $1,314,000, which in general, we are actively attempting to liquidate. If a valuation allowance for probable loss has been established for a particular property it is so noted in the property description below. Further valuation allowances may be required on any foreclosed property as additional information becomes available or conditions change. Foreclosed real estate is included in the other assets category on the Corporation’s balance sheet. Three unrelated foreclosed real estate properties, which represent the majority of the foreclosed real estate portfolio balance, are described below.

Property no. 1— The carrying amount of this property at December 31, 2012 was $1,314,000, which is net of a $1,984,000 allowance for probable loss based on an independent appraisal less estimated selling costs. This account is collateralized by 266 acres of unimproved land that is zoned for residential development. Based on information obtained in 2012, plans to obtain a formal development plan were suspended with the intent to temporarily retain the property and investigate other development, disposition or income generating options at some future date. Impairment loss for this property totaled $710,000 for the year 2012, which is reflected in the allowance.

Property no. 2— The carrying amount of this property at December 31, 2012 was $1,088,000, which is net of a $1,627,000 allowance for probable loss based on the results of an independent appraisal less estimated selling costs. During the third quarter of 2012, a $1,027,000 impairment loss and corresponding increase in the allowance were recognized as reported on Form 8-K filed on August 30, 2012. The impairment recorded in the third quarter follows a $308,000 impairment loss and corresponding increase in the allowance recorded in the second quarter of 2012. This account is collateralized by 136 approved residential building lots. Of this total, 29 lots are improved. Management is evaluating its disposition options with regard to this property.

Property no. 3—The carrying amount of this property at December 31, 2012 was $780,000, which represents the value of the borrower’s personal residence presently listed for sale less estimated selling costs. Earlier in the year 2012, the Corporation recovered $837,000 from the sale of additional real estate collateral.

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Table of Contents


Allowance for loan losses

Although the Corporation maintains sound credit policies, certain loans deteriorate and must be charged off as losses. The allowance for loan losses is maintained to absorb losses inherent in the portfolio. The allowance is increased by provisions charged to expense and is reduced by loan charge-offs, net of recoveries. The allowance is based upon management’s continuous evaluation of the loan portfolio coupled with a formal review of adequacy on a quarterly basis, which is subject to review and approval by the Board. An overview of the methodology and key factors that we use in evaluating the adequacy of the allowance and loan impairment is provided in Note 1-Summary of Significant Accounting Policies in the notes to the consolidated financial statements.

The allowance for loan losses consists primarily of three components: specific allowances for individually impaired commercial loans; allowances calculated for pools of loans; and an unallocated component, which reflects the margin of imprecision inherent in the assumptions that underlie the evaluation of the adequacy of the allowance. The Corporation uses an internal risk rating system to evaluate individual loans. Loans are segmented into industry groups or pools with similar characteristics, and an allowance for loan losses is allocated to each segment based on quantitative factors such as recent loss history (two-year rolling average of net charge-offs) and qualitative factors, such as the results of internal and external credit reviews, changes in the size and composition of the loan portfolio, adequacy of collateral, general economic conditions and the local business outlook. Determining the level of the allowance for probable loan losses at any given period is difficult, particularly during deteriorating or uncertain economic periods. We must make estimates using assumptions and information that is often subjective and fluid. There is also the potential for adjustment to the allowance as a result of regulatory examinations.

Table 11—Analysis of Allowance for Loan Losses presents an analysis of the activity in the allowance for loan losses over a five-year period. A more detailed analysis of the allowance for the current year is provided in Note 5 –Allowance for Loan Losses in the notes to the consolidated financial statements.

The allowance was $9,302,000 or 1.26 percent of total loans, on December 31, 2012, compared to $8,702,000 and 1.25 percent, respectively, on December 31, 2011. For the year 2012, net charge-offs totaled $1,150,000, which was well below the $3,859,000 for the year 2011. The level of charge-offs in 2011 were unusually high due to the inclusion of partial charge-offs for two unrelated commercial loans totaling $3,175,000. The decrease in the level of net charge-offs lowered the net charge-off ratio to 0.16 percent for the year 2012, compared to 0.58 percent for the year 2011. The risks and uncertainties associated with prolonged weakness in economic and business conditions, a relatively high level of unemployment and erosion of real estate values, which adversely affect our borrowers’ ability to service their loans, can cause significant fluctuations in the level of charge-offs and provision expense from one period to another. Based on a comprehensive analysis of the loan portfolio, we believe that the allowance for loan losses was adequate at December 31, 2012.

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Table of Contents


Table 11-Analysis of Allowance for Loan Losses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(dollars in thousands)

 

2012

 

2011

 

2010

 

2009

 

2008

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance - beginning of year

 

$

8,702

 

$

7,626

 

$

7,175

 

$

4,690

 

$

3,434

 

Provision charged to operating expense

 

 

1,750

 

 

4,935

 

 

2,990

 

 

3,715

 

 

1,870

 

Loans charged off

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial, financial and agricultural

 

 

607

 

 

3,444

 

 

1,519

 

 

750

 

 

16

 

Real estate-construction and land development

 

 

2

 

 

0

 

 

789

 

 

310

 

 

481

 

Real estate-residential mortgages

 

 

115

 

 

141

 

 

31

 

 

0

 

 

0

 

Consumer and home equity

 

 

501

 

 

371

 

 

298

 

 

244

 

 

165

 

Total loans charged off

 

 

1,225

 

 

3,956

 

 

2,637

 

 

1,304

 

 

662

 

Recoveries

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial, financial and agricultural

 

 

17

 

 

9

 

 

24

 

 

16

 

 

41

 

Real estate-residential mortgages

 

 

41

 

 

0

 

 

0

 

 

6

 

 

2

 

Consumer and home equity

 

 

17

 

 

88

 

 

74

 

 

52

 

 

5

 

Total recoveries

 

 

75

 

 

97

 

 

98

 

 

74

 

 

48

 

Net charge offs

 

 

1,150

 

 

3,859

 

 

2,539

 

 

1,230

 

 

614

 

Balance - end of year

 

$

9,302

 

$

8,702

 

$

7,626

 

$

7,175

 

$

4,690

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Ratios

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net charge offs as a % of average total loans

 

 

0.16

%

 

0.58

%

 

0.39

%

 

0.20

%

 

0.13

%

Allowance for loan losses as a % of total period-end loans

 

 

1.26

%

 

1.25

%

 

1.19

%

 

1.11

%

 

0.82

%

Allowance for loan losses as a % of nonperforming loans

 

 

109.08

%

 

74.38

%

 

40.74

%

 

28.03

%

 

55.45

%

Table 12—Allocation of Allowance for Loan Losses presents an allocation of the allowance for loan losses by major loan category. Because all identified losses are immediately charged off, no portion of the allowance for loan losses is restricted to any individual loan or groups of loans, and the entire allowance is available to absorb any and all loan losses. Generally, the unallocated component reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the loan portfolio.

Table 12-Allocation of Allowance for Loan Losses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31,

 

 

 

2012

 

2011

 

2010

 

2009

 

2008

 

(dollars in thousands)

 

Amount

 

% Total
Loans

 

Amount

 

% Total
Loans

 

Amount

 

% Total
Loans

 

Amount

 

% Total
Loans

 

Amount

 

% Total
Loans

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial, financial and agricultural

 

$

6,461

 

 

69.2

 

$

5,950

 

 

66.6

 

$

5,226

 

 

65.5

 

$

4,974

 

 

64.3

 

$

2,480

 

 

60.7

 

Real estate - construction and land development

 

 

1,571

 

 

13.2

 

 

2,170

 

 

14.9

 

 

1,561

 

 

14.9

 

 

1,837

 

 

16.3

 

 

1,016

 

 

17.5

 

Total commercial related

 

 

8,032

 

 

82.4

 

 

8,120

 

 

81.5

 

 

6,787

 

 

80.4

 

 

6,811

 

 

80.6

 

 

3,496

 

 

78.2

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Real estate - residential mortgages

 

 

124

 

 

3.2

 

 

88

 

 

3.1

 

 

30

 

 

3.2

 

 

32

 

 

3.4

 

 

31

 

 

3.2

 

Consumer and home equity

 

 

475

 

 

14.4

 

 

257

 

 

15.4

 

 

284

 

 

16.4

 

 

188

 

 

16.0

 

 

212

 

 

18.6

 

Total consumer related

 

 

599

 

 

17.6

 

 

345

 

 

18.5

 

 

314

 

 

19.6

 

 

220

 

 

19.4

 

 

243

 

 

21.8

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unallocated

 

 

671

 

 

n/a

 

 

237

 

 

n/a

 

 

525

 

 

n/a

 

 

144

 

 

n/a

 

 

951

 

 

n/a

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

9,302

 

 

100.0

 

$

8,702

 

 

100.0

 

$

7,626

 

 

100.0

 

$

7,175

 

 

100.0

 

$

4,690

 

 

100.0

 

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Liquidity

Maintaining adequate liquidity provides the Corporation with the ability to meet financial obligations to depositors, loan customers, employees, and shareholders on a timely and cost effective basis in the normal course of business. Additionally, it provides funds for growth and business opportunities as they arise. Liquidity is generated from transactions relating to both the Corporation’s assets and liabilities. The primary sources of asset liquidity are scheduled investment security maturities and cash inflows, funds received from customer loan payments, and asset sales. The primary sources of liability liquidity are deposit growth, short-term borrowings and long-term debt. The Consolidated Statements of Cash Flows, included in this report, present the changes in cash from operating, investing and financing activities. At year-end 2012, we believe that liquidity was adequate based upon the potential liquidation of unpledged available-for-sale securities with a fair value totaling approximately $96 million and available credit from the Federal Home Loan Bank of Pittsburgh totaling approximately $166 million. The Corporation’s loan-to-deposit ratio was approximately 82 percent for year-end 2012, compared to 81 percent for year-end 2011.

Off-Balance sheet arrangements

The Corporation’s financial statements do not reflect various commitments that are made in the normal course of business, which may involve some liquidity risk. These commitments consist primarily of commitments to grant new loans, unfunded commitments under existing loan facilities, and letters of credit issued under the same standards as on-balance sheet instruments. Financial instruments with off-balance sheet risk are disclosed in Note 14-Commitments to Extend Credit in the notes to the consolidated financial statements totaled $248 million at December 31, 2012, compared to $166 million at December 31, 2011. Normally these commitments have fixed expiration dates or termination clauses and are for specific purposes. Accordingly, many of the commitments are expected to expire without being drawn and therefore, generally do not present significant liquidity risk to the Corporation or PeoplesBank.

Impact of inflation and changing prices

The majority of assets and liabilities of a financial institution are monetary in nature and therefore, differ greatly from most commercial and industrial companies that have significant investments in fixed assets or inventories. However, inflation may impact the growth of total assets in the banking industry and the resulting need to increase equity capital at higher than normal rates in order to maintain an appropriate equity-to-assets ratio. Inflation may also significantly affect noninterest expenses, which tend to rise during periods of general inflation. The level of inflation can be measured by the change in the Consumer Price Index (CPI) for all urban consumers (December vs. December). The change in the CPI for 2012 was 1.7 percent, compared to 3.0 percent for 2011 and 1.5 percent for 2010.

Management believes that the most significant impact on financial results is the Corporation’s ability to react to changes in market interest rates. Management strives to structure the balance sheet to increase net interest income by managing interest rate sensitive assets and liabilities to reprice in response to changes in market interest rates. Additionally, management is focused on increasing fee income, an income component that is less sensitive to changes in market interest rates.

Item 7A: Quantitative and qualitative disclosures about market risk

Not applicable to smaller reporting companies.

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Report of Management’s Assessment of
Internal Controls Over Financial Reporting

The Corporation carried out an evaluation, under the supervision and with the participation of the Corporation’s management, including the Corporation’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of its disclosure controls and procedures, as defined in Exchange Act Rules 13a-15(e) and 15d-15(e). Based upon the evaluation, the Corporation’s Chief Executive Officer and Chief Financial Officer concluded that, as of December 31, 2012, the Corporation’s disclosure controls and procedures are effective. Disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Corporation’s reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.

The management of the Corporation is responsible for establishing and maintaining adequate internal control over financial reporting. The Corporation’s internal control system is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness of future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Management assessed the effectiveness of the Corporation’s internal control over financial reporting as of December 31, 2012, using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework, with an emphasis on Internal Control Over Financial Reporting-Guidance for Smaller Public Companies, also issued by COSO. Based on this assessment, management concluded that, as of December 31, 2012, the Corporation’s internal control over financial reporting is effective based on those criteria.

This Annual Report does not include an attestation report of the Corporation’s independent registered public accounting firm regarding internal control over financial reporting as no such report is required. Management’s report was not subject to attestation by the Corporation’s registered public accounting firm pursuant to rules of the Securities and Exchange Commission that permit the Corporation to provide only management’s report in this Annual Report.

 

 

 

 

 

/s/ Larry J. Miller

 

 

/s/ Jann A. Weaver

 

Larry J. Miller

 

Jann A. Weaver

(Principal Executive Officer)

 

(Principal Financial and Accounting

Vice-Chairman, President

 

Officer) Treasurer, and

and Chief Executive Officer

 

Assistant Secretary

 

 

 

March 26, 2013

 

March 26, 2013

42


Table of Contents


Item 8: Financial statements and supplementary data
Codorus Valley Bancorp, Inc.
Consolidated Balance Sheets

 

 

 

 

 

 

 

 

(dollars in thousands, except share and per share data)

 

December 31,
2012

 

December 31,
2011

 

Assets

 

 

 

 

 

 

 

Interest bearing deposits with banks

 

$

34,866

 

$

19,640

 

Cash and due from banks

 

 

14,891

 

 

12,555

 

Total cash and cash equivalents

 

 

49,757

 

 

32,195

 

Securities, available-for-sale

 

 

234,062

 

 

233,861

 

Restricted investment in bank stocks, at cost

 

 

2,863

 

 

3,635

 

Loans held for sale

 

 

3,091

 

 

2,869

 

Loans (net of deferred fees of $1,186 - 2012 and $692 - 2011)

 

 

737,134

 

 

693,515

 

Less-allowance for loan losses

 

 

(9,302

)

 

(8,702

)

Net loans

 

 

727,832

 

 

684,813

 

Premises and equipment, net

 

 

11,493

 

 

10,861

 

Other assets

 

 

30,639

 

 

43,898

 

Total assets

 

$

1,059,737

 

$

1,012,132

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

Deposits

 

 

 

 

 

 

 

Noninterest bearing

 

$

88,476

 

$

73,760

 

Interest bearing

 

 

812,831

 

 

780,639

 

Total deposits

 

 

901,307

 

 

854,399

 

Short-term borrowings

 

 

19,356

 

 

10,257

 

Long-term debt

 

 

30,815

 

 

46,628

 

Other liabilities

 

 

6,928

 

 

7,606

 

Total liabilities

 

 

958,406

 

 

918,890

 

 

 

 

 

 

 

 

 

Shareholders’ equity

 

 

 

 

 

 

 

Preferred stock, par value $2.50 per share; $1,000 liquidation preference, 1,000,000 shares authorized; 25,000 Series B shares issued and outstanding - 2012 and 2011

 

 

25,000

 

 

25,000

 

Common stock, par value $2.50 per share; 15,000,000 shares authorized; 4,482,319 shares issued and outstanding - 2012 and 10,000,000 shares authorized; 4,202,606 shares issued and outstanding - 2011

 

 

11,206

 

 

10,507

 

Additional paid-in capital

 

 

40,524

 

 

37,253

 

Retained earnings

 

 

18,868

 

 

14,558

 

Accumulated other comprehensive income

 

 

5,733

 

 

5,924

 

Total shareholders’ equity

 

 

101,331

 

 

93,242

 

Total liabilities and shareholders’ equity

 

$

1,059,737

 

$

1,012,132

 

See accompanying notes.

43


Table of Contents


Codorus Valley Bancorp, Inc.
Consolidated Statements of Income

 

 

 

 

 

 

 

 

 

 

 

 

 

Years ended December 31,

 

(dollars in thousands, except per share data)

 

2012

 

2011

 

2010

 

Interest income

 

 

 

 

 

 

 

 

 

 

Loans, including fees

 

$

40,613

 

$

39,083

 

$

38,151

 

Investment securities:

 

 

 

 

 

 

 

 

 

 

Taxable

 

 

3,367

 

 

3,823

 

 

3,354

 

Tax-exempt

 

 

2,424

 

 

2,430

 

 

2,442

 

Dividends

 

 

14

 

 

7

 

 

7

 

Other

 

 

94

 

 

68

 

 

73

 

Total interest income

 

 

46,512

 

 

45,411

 

 

44,027

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

 

 

 

 

 

 

 

 

 

Deposits

 

 

9,615

 

 

11,156

 

 

11,397

 

Federal funds purchased and other short-term borrowings

 

 

122

 

 

114

 

 

88

 

Long-term debt

 

 

790

 

 

1,089

 

 

1,669

 

Total interest expense

 

 

10,527

 

 

12,359

 

 

13,154

 

Net interest income

 

 

35,985

 

 

33,052

 

 

30,873

 

 

 

 

 

 

 

 

 

 

 

 

Provision for loan losses

 

 

1,750

 

 

4,935

 

 

2,990

 

Net interest income after provision for loan losses

 

 

34,235

 

 

28,117

 

 

27,883

 

 

 

 

 

 

 

 

 

 

 

 

Noninterest income

 

 

 

 

 

 

 

 

 

 

Trust and investment services fees

 

 

1,702

 

 

1,510

 

 

1,420

 

Income from mutual fund, annuity and insurance sales

 

 

896

 

 

1,103

 

 

1,477

 

Service charges on deposit accounts

 

 

2,560

 

 

2,583

 

 

2,471

 

Income from bank owned life insurance including death benefits

 

 

633

 

 

647

 

 

637

 

Other income

 

 

645

 

 

613

 

 

601

 

Net gain on sales of loans held for sale

 

 

1,327

 

 

777

 

 

860

 

Net gain on sales of securities

 

 

427

 

 

125

 

 

108

 

Total noninterest income

 

 

8,190

 

 

7,358

 

 

7,574

 

 

 

 

 

 

 

 

 

 

 

 

Noninterest expense

 

 

 

 

 

 

 

 

 

 

Personnel

 

 

15,312

 

 

13,748

 

 

13,276

 

Occupancy of premises, net

 

 

1,977

 

 

2,004

 

 

1,926

 

Furniture and equipment

 

 

1,896

 

 

1,730

 

 

1,670

 

Postage, stationery and supplies

 

 

508

 

 

519

 

 

516

 

Professional and legal

 

 

534

 

 

586

 

 

488

 

Marketing and advertising

 

 

907

 

 

840

 

 

700

 

FDIC insurance

 

 

733

 

 

1,004

 

 

1,297

 

Debit card processing

 

 

707

 

 

655

 

 

585

 

Charitable donations

 

 

640

 

 

396

 

 

523

 

Telephone

 

 

532

 

 

509

 

 

560

 

External data processing

 

 

560

 

 

462

 

 

431

 

Foreclosed real estate including (gains) losses on sales

 

 

2,830

 

 

1,701

 

 

3,275

 

Impaired loan carrying costs

 

 

299

 

 

620

 

 

972

 

Other

 

 

2,493

 

 

2,305

 

 

1,897

 

Total noninterest expense

 

 

29,928

 

 

27,079

 

 

28,116

 

Income before income taxes

 

 

12,497

 

 

8,396

 

 

7,341

 

Provision for income taxes

 

 

3,103

 

 

1,617

 

 

1,133

 

Net income

 

 

9,394

 

 

6,779

 

 

6,208

 

Preferred stock dividends and discount accretion

 

 

384

 

 

1,460

 

 

980

 

Net income available to common shareholders

 

$

9,010

 

$

5,319

 

$

5,228

 

Net income per common share, basic

 

$

2.03

 

$

1.22

 

$

1.22

 

Net income per common share, diluted

 

$

2.00

 

$

1.21

 

$

1.21

 

See accompanying notes.

44


Table of Contents


Codorus Valley Bancorp, Inc.
Consolidated Statements of Comprehensive Income

 

 

 

 

 

 

 

 

 

 

 

 

 

Years ended December 31,

 

(dollars in thousands)

 

2012

 

2011

 

2010

 

Net income

 

$

9,394

 

$

6,779

 

$

6,208

 

Other comprehensive income (loss)

 

 

 

 

 

 

 

 

 

 

Securities available for sale:

 

 

 

 

 

 

 

 

 

 

Net unrealized holding (losses) gains arising during the period (net of tax expense (benefit) of $47, $1,993, and ($99), respectively)

 

 

91

 

 

3,869

 

 

(192

)

Reclassification adjustment for gains included in net income (net of tax expense of $145, $42, and $37, respectively)

 

 

(282

)

 

(83

)

 

(71

)

Net unrealized gains (losses)

 

 

(191

)

 

3,786

 

 

(263

)

Comprehensive income

 

$

9,203

 

$

10,565

 

$

5,945

 

See accompanying notes.

45


Table of Contents


Codorus Valley Bancorp, Inc.
Consolidated Statements of Cash Flows

 

 

 

 

 

 

 

 

 

 

 

 

 

Years ended December 31,

 

(dollars in thousands)

 

2012

 

2011

 

2010

 

 

 

 

 

 

 

 

 

 

 

 

Cash flows from operating activities

 

 

 

 

 

 

 

 

 

 

Net income

 

$

9,394

 

$

6,779

 

$

6,208

 

Adjustments to reconcile net income to net cash provided by operations:

 

 

 

 

 

 

 

 

 

 

Depreciation/amortization

 

 

1,377

 

 

1,310

 

 

1,363

 

Net amortization of premiums on securities

 

 

1,438

 

 

1,449

 

 

1,181

 

Amortization of deferred loan origination fees and costs

 

 

(311

)

 

(265

)

 

(323

)

Amortization of intangible assets

 

 

190

 

 

95

 

 

40

 

Provision for loan losses

 

 

1,750

 

 

4,935

 

 

2,990

 

Provision for losses on foreclosed real estate

 

 

2,663

 

 

829

 

 

1,566

 

Deferred income tax expense (benefit)

 

 

385

 

 

(1,057

)

 

(1,144

)

Amortization of investment in real estate partnership

 

 

335

 

 

583

 

 

562

 

Increase in cash surrender value and death benefit on bank owned life insurance

 

 

(633

)

 

(647

)

 

(637

)

Originations of loans held for sale

 

 

(72,298

)

 

(47,106

)

 

(55,445

)

Proceeds from sales of loans held for sale

 

 

73,403

 

 

50,004

 

 

52,421

 

Net gain on sales of loans held for sale

 

 

(1,327

)

 

(777

)

 

(860

)

Loss (gain) on disposal of premises and equipment

 

 

9

 

 

(3

)

 

8

 

Net gain on sales of securities available-for-sale

 

 

(427

)

 

(125

)

 

(108

)

Gain on sales of held for sale assets

 

 

0

 

 

0

 

 

(35

)

Net loss (gain) on sales of foreclosed real estate

 

 

167

 

 

(154

)

 

(110

)

Stock-based compensation

 

 

295

 

 

229

 

 

157

 

Decrease (increase) in accrued interest receivable

 

 

73

 

 

(62

)

 

(163

)

Decrease in other assets

 

 

416

 

 

59

 

 

755

 

Decrease in accrued interest payable

 

 

(51

)

 

(166

)

 

(65

)

(Decrease) increase in other liabilities

 

 

(365

)

 

411

 

 

770

 

Net cash provided by operating activities

 

 

16,483

 

 

16,321

 

 

9,131

 

 

 

 

 

 

 

 

 

 

 

 

Cash flows from investing activities

 

 

 

 

 

 

 

 

 

 

Purchases of securities, available-for-sale

 

 

(63,119

)

 

(59,502

)

 

(92,829

)

Maturities, repayments and calls of securities, available-for-sale

 

 

44,178

 

 

37,937

 

 

38,153

 

Sales of securities, available-for-sale

 

 

17,440

 

 

15,715

 

 

4,845

 

Redemption of restricted investment in bank stock

 

 

772

 

 

432

 

 

210

 

Net increase in loans made to customers

 

 

(44,689

)

 

(59,274

)

 

(6,130

)

Purchases of premises and equipment

 

 

(2,018

)

 

(1,402

)

 

(914

)

Investment in bank owned life insurance

 

 

(237

)

 

(677

)

 

(7

)

Proceeds from held for sale assets

 

 

0

 

 

0

 

 

542

 

Proceeds from bank owned life insurance

 

 

206

 

 

0

 

 

0

 

Investment in foreclosed real estate

 

 

(17

)

 

(4,130

)

 

(1,640

)

Proceeds from sales of foreclosed real estate

 

 

10,028

 

 

914

 

 

8,094

 

Net cash used in investing activities

 

 

(37,456

)

 

(69,987

)

 

(49,676

)

 

 

 

 

 

 

 

 

 

 

 

Cash flows from financing activities

 

 

 

 

 

 

 

 

 

 

Net increase in demand and savings deposits

 

 

63,343

 

 

51,186

 

 

54,026

 

Net (decrease) increase in time deposits

 

 

(16,435

)

 

(2,896

)

 

29,127

 

Net increase (decrease) in short-term borrowings

 

 

9,099

 

 

3,494

 

 

(1,703

)

Proceeds from issuance of long-term debt

 

 

0

 

 

15,000

 

 

0

 

Repayment of long-term debt

 

 

(15,813

)

 

(30,414

)

 

(22,240

)

Tax benefit on vested restricted stock

 

 

44

 

 

0

 

 

0

 

Cash dividends paid to preferred shareholders

 

 

(634

)

 

(774

)

 

(825

)

Cash dividends paid to common shareholders

 

 

(1,690

)

 

(1,454

)

 

(1,022

)

Redemption of preferred stock and common stock warrant

 

 

0

 

 

(17,027

)

 

0

 

Issuance of preferred stock

 

 

0

 

 

25,000

 

 

0

 

Issuance of common stock

 

 

627

 

 

477

 

 

272

 

Cash paid in lieu of fractional shares

 

 

(6

)

 

0

 

 

0

 

Net cash provided by financing activities

 

 

38,535

 

 

42,592

 

 

57,635

 

Net increase (decrease) in cash and cash equivalents

 

 

17,562

 

 

(11,074

)

 

17,090

 

Cash and cash equivalents at beginning of year

 

 

32,195

 

 

43,269

 

 

26,179

 

Cash and cash equivalents at end of period

 

$

49,757

 

$

32,195

 

$

43,269

 

See accompanying notes.

46


Table of Contents


Codorus Valley Bancorp, Inc.
Consolidated Statements of Changes in Shareholders’ Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(dollars in thousands, except per share data)

 

Preferred
Stock

 

Common
Stock

 

Additional
Paid-in
Capital

 

Retained
Earnings

 

Accumulated
Other
Comprehensive
Income

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, January 1, 2010

 

$

15,828

 

$

10,187

 

$

37,004

 

$

6,592

 

$

2,401

 

$

72,012

 

Net income

 

 

 

 

 

 

 

 

 

 

 

6,208

 

 

 

 

 

6,208

 

Other comprehensive loss, net of tax

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(263

)

 

(263

)

Preferred stock discount accretion

 

 

155

 

 

 

 

 

 

 

 

(155

)

 

 

 

 

0

 

Common stock cash dividends ($0.238 per share, adjusted)

 

 

 

 

 

 

 

 

 

 

 

(1,022

)

 

 

 

 

(1,022

)

Preferred stock dividends

 

 

 

 

 

 

 

 

 

 

 

(825

)

 

 

 

 

(825

)

Stock-based compensation

 

 

 

 

 

 

 

 

157

 

 

 

 

 

 

 

 

157

 

Issuance of common stock:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

24,463 shares under the dividend reinvestment and stock purchase plan

 

 

 

 

 

61

 

 

136

 

 

 

 

 

 

 

 

197

 

14,316 shares under the employee stock purchase plan

 

 

 

 

 

36

 

 

39

 

 

 

 

 

 

 

 

75

 

18,306 shares of stock-based compensation awards

 

 

 

 

 

46

 

 

(46

)

 

 

 

 

 

 

 

0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, December 31, 2010

 

 

15,983

 

 

10,330

 

 

37,290

 

 

10,798

 

 

2,138

 

 

76,539

 

Net income

 

 

 

 

 

 

 

 

 

 

 

6,779

 

 

 

 

 

6,779

 

Other comprehensive income, net of tax

 

 

 

 

 

 

 

 

 

 

 

 

 

 

3,786

 

 

3,786

 

Preferred stock discount accretion

 

 

478

 

 

 

 

 

 

 

 

(478

)

 

 

 

 

0

 

Common stock cash dividends ($0.334 per share, adjusted)

 

 

 

 

 

 

 

 

 

 

 

(1,454

)

 

 

 

 

(1,454

)

Preferred stock dividends

 

 

 

 

 

 

 

 

 

 

 

(1,087

)

 

 

 

 

(1,087

)

Redemption of preferred stock and repurchase of common stock warrant

 

 

(16,461

)

 

 

 

 

(566

)

 

 

 

 

 

 

 

(17,027

)

Issuance of preferred stock

 

 

25,000

 

 

 

 

 

 

 

 

 

 

 

 

 

 

25,000

 

Stock-based compensation

 

 

 

 

 

 

 

 

229

 

 

 

 

 

 

 

 

229

 

Issuance of common stock:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

26,803 shares under dividend reinvestment and stock purchase plan

 

 

 

 

 

67

 

 

202

 

 

 

 

 

 

 

 

269

 

14,682 shares under employee stock option plan

 

 

 

 

 

37

 

 

87

 

 

 

 

 

 

 

 

124

 

11,257 shares under employee stock purchase plan

 

 

 

 

 

28

 

 

56

 

 

 

 

 

 

 

 

84

 

18,062 shares of stock-based compensation awards

 

 

 

 

 

45

 

 

(45

)

 

 

 

 

 

 

 

0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, December 31, 2011

 

 

25,000

 

 

10,507

 

 

37,253

 

 

14,558

 

 

5,924

 

 

93,242

 

Net income

 

 

 

 

 

 

 

 

 

 

 

9,394

 

 

 

 

 

9,394

 

Other comprehensive loss, net of tax

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(191

)

 

(191

)

Common stock cash dividends ($0.382 per share, adjusted)

 

 

 

 

 

 

 

 

 

 

 

(1,690

)

 

 

 

 

(1,690

)

5% common stock dividend, 211,564 shares at fair value

 

 

 

 

 

529

 

 

2,475

 

 

(3,010

)

 

 

 

 

(6

)

Preferred stock dividends

 

 

 

 

 

 

 

 

 

 

 

(384

)

 

 

 

 

(384

)

Stock-based compensation

 

 

 

 

 

 

 

 

339

 

 

 

 

 

 

 

 

339

 

Issuance of common stock:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

20,191 shares under dividend reinvestment and stock purchase plan

 

 

 

 

 

50

 

 

216

 

 

 

 

 

 

 

 

266

 

25,884 shares under employee stock option plan

 

 

 

 

 

65

 

 

199

 

 

 

 

 

 

 

 

264

 

10,784 shares under employee stock purchase plan

 

 

 

 

 

27

 

 

70

 

 

 

 

 

 

 

 

97

 

11,290 shares of stock-based compensation awards

 

 

 

 

 

28

 

 

(28

)

 

 

 

 

 

 

 

0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, December 31, 2012

 

$

25,000

 

$

11,206

 

$

40,524

 

$

18,868

 

$

5,733

 

$

101,331

 

See accompanying notes.

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Codorus Valley Bancorp, Inc.
Notes to Consolidated Financial Statements

NOTE 1-Summary of Significant Accounting Policies

Nature of Operations and Basis of Presentation
Codorus Valley Bancorp, Inc. (Corporation or Codorus Valley) is a one-bank holding company headquartered in York, Pennsylvania that provides a full range of banking services through its subsidiary, PeoplesBank, A Codorus Valley Company (PeoplesBank or Bank). PeoplesBank operates two wholly-owned subsidiaries, Codorus Valley Financial Advisors, Inc. (formerly SYC Insurance Services, Inc.) which sells nondeposit investment products, and SYC Settlement Services, Inc., which provides real estate settlement services. In addition, PeoplesBank may periodically create nonbank subsidiaries for the purpose of temporarily holding foreclosed properties pending the liquidation of these properties. PeoplesBank operates under a state charter and is subject to regulation by the Pennsylvania Department of Banking and the Federal Deposit Insurance Corporation. The Corporation is subject to regulation by the Federal Reserve Board and the state of Pennsylvania.

The consolidated financial statements include the accounts of Codorus Valley and its wholly-owned bank subsidiary, PeoplesBank, and its wholly-owned nonbank subsidiary, SYC Realty Company, Inc. SYC Realty is primarily used to hold foreclosed properties obtained by PeoplesBank pending the liquidation of these properties. The accounts of CVB Statutory Trust No. 1 and No. 2 are not included in the consolidated financial statements as discussed in Note 8 –Short-term Borrowings and Long-term Debt. All significant intercompany account balances and transactions have been eliminated in consolidation. The accounting and reporting policies of Codorus Valley and subsidiaries conform to accounting principles generally accepted in the United States of America and have been followed on a consistent basis.

In accordance with FASB ASC Topic 855, the Corporation evaluated the events and transactions that occurred after the balance sheet date of December 31, 2012 through the date these consolidated financial statements were issued.

Investment Securities
The classification of securities is determined at the time of acquisition and is reevaluated at each reporting date. Securities classified as available-for-sale are debt securities that the Corporation intends to hold for an indefinite period of time, but not necessarily to maturity. Any decision to sell a security classified as available-for-sale would be based on various factors, including significant movements in interest rates, changes in maturity mix of assets and liabilities, income or liquidity needs, regulatory considerations and other factors. Debt securities available-for-sale are carried at fair value, with unrealized gains and losses, net of taxes, reported as a component of accumulated other comprehensive income in shareholders’ equity. Premiums and discounts are recognized in interest income using the interest method over the estimated life of the security. Realized gains and losses from the sale of available-for-sale securities are computed on the basis of specific identification of the adjusted cost of each security and are shown net as a separate line item in the statement of income.

Declines in the fair value of available-for-sale securities below their cost that are deemed to be other-than-temporary are reflected in earnings as realized losses. In estimating other-than-temporary impairment losses, management must first assess whether (a) it has the intent to sell the security and (b) it is more likely than not that it will be required to sell the security prior to its anticipated recovery. These steps are done before assessing whether the cost basis of the investment will be recovered. The assessment of the probability of recovery would consider, among other things, the length of time and the extent to which the fair value has been less than cost and the financial condition and near-term prospects of the issuer. More information about investment securities is provided in Note 3 – Securities.

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Restricted Stock
Restricted stock, which represents required investments in the common stock of correspondent banks, is carried at cost and, as of December 31, 2012 and 2011, consisted primarily of the common stock of the Federal Home Loan Bank of Pittsburgh (FHLBP) and, to a lesser degree, Atlantic Central Bankers Bank (ACBB). Under the FHLBP’s Capital Plan, PeoplesBank is required to maintain a minimum member stock investment, both as a condition of becoming and remaining a member and as a condition of obtaining borrowings from the FHLBP. The FHLBP uses a formula to determine the minimum stock investment, which is based on the volume of loans outstanding, unused borrowing capacity and other factors.

For the fourth quarter of 2011, the FHLBP began paying a quarterly cash dividend on its common stock after a period of suspension since December 2008. The FHLBP reported that it will continue to monitor the condition of its private-label residential mortgage-back securities portfolio, its overall financial performance and retained earnings, developments in the mortgage and credit markets, and other relevant information as the basis for determining the status of dividends and excess capital stock repurchases in future quarters.

Management evaluates the restricted stock for impairment in accordance with FASB ASC Topic 942. Management’s determination of whether these investments are impaired is based on their assessment of the ultimate recoverability of their cost rather than by recognizing temporary declines in value. Using the FHLBP as an example, the determination of whether a decline affects the ultimate recoverability of cost is influenced by criteria such as: (1) the significance of the decline in net assets of the FHLBP as compared to the capital stock amount for the FHLBP and the length of time this situation has persisted; (2) commitments by the FHLBP to make payments required by law or regulation and the level of such payments in relation to the operating performance of the FHLBP; and (3) the impact of legislative and regulatory changes on institutions and, accordingly, on the customer base of the FHLBP. Management believes no impairment charge was necessary related to the restricted stock during the periods ended December 31, 2012 and 2011.

Loans Held for Sale
Loans held for sale are comprised of residential mortgage loans originated by the Bank and servicing of the loan is not retained after sale. Loans held for sale are reported at the lower of cost or fair value, as determined by the aggregate commitments from investors or current investor yield requirements. The amount, by which cost exceeds fair value, if any, is accounted for as a valuation allowance and is charged to expense in the period of the change. Gains or losses on sales of mortgage loans are recognized based on the difference between the selling price and the carrying value of the related mortgage loan and is recorded in noninterest income.

Loans
Loans receivable that management has the intent and ability to hold for the foreseeable future or until maturity or payoff, are stated at their outstanding unpaid principal balances less amounts charged off, net of an allowance for loan losses and any deferred fees or costs. Interest income is accrued on the unpaid principal balance. Generally, loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the yield (interest income) over the contractual life of the loan. The loans receivable portfolio is segmented into commercial and consumer loans. Commercial loans consist of the following industry classes: builder & developer, commercial real estate investor, residential real estate investor, hotel/motel, wholesale & retail, agriculture, manufacturing and all other. Consumer loans consist of the following classes: residential mortgage, home equity and all other.

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For all classes of loans receivable, the accrual of interest is discontinued when the contractual payment of principal or interest has become 90 days past due or management has serious doubts about further collectability of principal or interest, even though the loan is currently performing. A loan may remain on accrual status if it is in the process of collection and is either guaranteed or well secured. When a loan is placed on nonaccrual status, unpaid interest credited to income in the current year is reversed and unpaid interest accrued in prior years is charged against the allowance for loan losses. Interest received on nonaccrual loans, including impaired loans, generally is either applied against principal or reported as interest income, according to the Corporation’s judgment as to the collectability of principal. Generally, loans are restored to accrual status when the obligation is brought current, has performed in accordance with the contractual terms for a reasonable period of time, generally six months, and the ultimate collectability of the total contractual principal and interest is no longer in doubt. The past due status of all classes of loans receivable is determined based on contractual due dates for loan payments.

Allowance for Loan Losses
The allowance for loan losses represents the Corporation’s estimate of losses inherent in the loan portfolio as of the balance sheet date and is recorded as a reduction to loans. The allowance for loan losses is increased by the provision for loan losses, and decreased by charge-offs, net of recoveries. Loans deemed to be uncollectible are charged against the allowance for loan losses, and subsequent recoveries, if any, are credited to the allowance. All, or part, of the principal balance of loans receivable are charged off to the allowance as soon as it is determined that the repayment of all, or part, of the principal balance is highly unlikely. While the Corporation attributes a portion of the allowance to individual loans and groups of loans that it evaluates and determines to be impaired, the allowance is available to cover all charge-offs that arise from the loan portfolio.

The allowance for loan losses is maintained at a level considered adequate to provide for losses that can be reasonably anticipated. The Corporation performs a quarterly evaluation of the adequacy of the allowance. The allowance is based on the Corporation’s past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions and other relevant factors. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant revision as more information becomes available.

The allowance consists of specific, general and unallocated components. The specific component relates to loans that are classified as impaired, generally substandard and nonaccrual loans. For loans that are classified as impaired, an allowance is established when the collateral value (or discounted cash flows or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers pools of loans by loan class including commercial loans not considered impaired, as well as smaller balance homogeneous loans, such as residential real estate, home equity and other consumer loans. These pools of loans are evaluated for loss exposure based upon historical loss rates for each of these classes of loans, adjusted for qualitative (environmental) risk factors. Historical loss rates are based on a two year rolling average of net charge-offs. Qualitative risk factors that supplement historical losses in the evaluation of loan pools include:

 

 

 

 

Changes in national and local economies and business conditions

 

Changes in the value of collateral for collateral dependent loans

 

Changes in the level of concentrations of credit

 

Changes in the volume and severity of classified and past due loans

 

Changes in the nature and volume of the portfolio

 

Changes in collection, charge-off, and recovery procedures

 

Changes in underwriting standards and loan terms

 

Changes in the quality of the loan review system

 

Changes in the experience/ability of lending management and key lending staff

 

Regulatory and legal regulations that could affect the level of credit losses

 

Other pertinent environmental factors

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Each factor is assigned a value to reflect improving, stable or declining conditions based on the Corporation’s best judgment using relevant information available at the time of the evaluation. An unallocated component is maintained to cover uncertainties that could affect the Corporation’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the loan portfolio.

As disclosed in Note 4-Loans, the Corporation engages in commercial and consumer lending. Loans are made within the Corporation’s primary market area and surrounding areas, and include the purchase of whole loan or participation interests in loans from other financial institutions. Commercial related loans, which pose the greatest risk of loss to the Corporation, whether originated or purchased, are generally secured by real estate. Within the broad commercial loan segment, the builder & developer and commercial real estate investor loan classes generally present a higher level of risk than other commercial loan classifications. This greater risk is due to several factors, including the concentration of principal in a limited number of loans and borrowers, the effect of general economic conditions on income producing properties, unstable real estate prices and the dependency upon successful construction and sale or operation of the real estate project. Within the consumer loan segment, junior (i.e., second) liens present a slightly higher risk to the Corporation because economic and housing market conditions can adversely affect the underlying value of the collateral and the ability of some borrowers to service their debt.

A loan is considered impaired when, based on current information and events, it is probable that the Corporation will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered in determining impairment include payment status and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. The Corporation determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. Loans that are deemed impaired are evaluated for impairment loss based on the net realizable value of the collateral, as applicable. Loans that are not collateral dependent will rely on the present value of expected future cash flows discounted at the loan’s effective interest rate to determine impairment loss. Large groups of smaller balance homogeneous loans such as residential mortgage loans, home equity loans and other consumer loans are collectively evaluated for impairment, unless they are considered to be a troubled debt restructuring.

An allowance for loan losses is established for an impaired commercial loan if its carrying value exceeds its estimated fair value. For commercial loans secured by real estate, estimated fair values are determined primarily through third-party appraisals of the underlying collateral. When a real estate secured loan becomes impaired, a decision is made regarding whether an updated certified appraisal of the real estate is necessary. This decision is based on various considerations, including the age of the most recent appraisal, the loan-to-value ratio based on the most recent appraisal and the condition of the property. Appraisals are generally discounted to provide for selling costs and other factors to determine an estimate of the net realizable value of the property. For commercial loans secured by non-real estate collateral, such as accounts receivable, inventory and equipment, estimated fair values are determined based on the borrower’s financial statements, inventory reports, accounts receivable aging or equipment appraisals or invoices. Indications of value from these sources are generally discounted based on the age of the financial information or the quality of the assets. In instances when specific consumer related loans become impaired, they may be partially or fully charged off, which obviates the need for a specific allowance.

Loans whose terms are modified are classified as troubled debt restructurings if the Corporation grants borrowers experiencing financial difficulties concessions that it would not otherwise consider.

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Concessions granted under a troubled debt restructuring may involve an interest rate that is below the market rate given the associated credit risk of the loan or an extension of a loan’s stated maturity date. Loans classified as troubled debt restructurings are designated as impaired. Non-accrual troubled debt restructurings are restored to accrual status if principal and interest payments, under the modified terms, are current for a reasonable period of time, generally six consecutive months after modification and future payments are reasonably assured.

Federal regulatory agencies, as an integral part of their examination process, periodically review the Corporation’s allowance for loan losses and may require the Corporation to recognize additions to the allowance based on their judgments about information available to them at the time of their examination, which may not be currently available to the Corporation. Based on a comprehensive analysis of the loan portfolio, the Corporation believes that the level of the allowance for loan losses at December 31, 2012 is adequate.

Transfers of Financial Assets
Transfers of financial assets are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Corporation, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Corporation does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.

Premises and Equipment
Land is carried at cost. Premises and equipment are carried at cost less accumulated depreciation. Depreciation expense is calculated principally on the straight-line method over the assets’ estimated useful lives. Estimated useful lives are seven to forty years for buildings and improvements, three to twenty years for furniture and equipment and three to five years for computer equipment and software. Maintenance and repairs are charged to expense as incurred. The cost of significant improvements to existing assets is capitalized and amortized over the shorter of the asset’s useful life or related lease term. When facilities are retired or otherwise disposed of, the depreciated cost is removed from the asset accounts, and any gain or loss is reflected in the statement of income.

Foreclosed Real Estate
Foreclosed real estate, included in other assets, is comprised of property acquired through a foreclosure proceeding or property that is acquired through in substance foreclosure. Foreclosed real estate is initially recorded at fair value minus estimated costs to sell at the date of foreclosure, establishing a new cost basis. Any difference between the carrying value and the new cost basis is charged against the allowance for loan losses. Appraisals are generally used to determine fair value. After foreclosure, management reviews valuations at least quarterly and adjusts the asset to the lower of cost or fair value minus estimated costs to sell through a valuation allowance. Costs related to the improvement of foreclosed real estate are generally capitalized until the real estate reaches a saleable condition. Revenue and expense from operations and changes in the valuation allowance are included in noninterest expense. When a foreclosed real estate asset is ultimately sold, any gain or loss on the sale is included in the income statement as a component of noninterest expense. At December 31, 2012, foreclosed real estate, net of allowance was $3,633,000, compared to $16,243,000 for December 31, 2011.

Investments in Real Estate Partnerships
In March 2003, PeoplesBank acquired a 73.47 percent limited partner interest in a real estate joint venture known as Village Court, which was formed to develop, construct, own and operate a 60-unit affordable housing complex located in Dover Township, York County, Pennsylvania. Construction of the housing complex was completed in the fourth quarter of 2004 and the complex was fully leased by December 31, 2004. The investment balance included in other assets was $533,000 at December 31, 2012, compared to $846,000 at December 31, 2011. Additionally, PeoplesBank is a 99.99 percent limited partner in a real estate joint venture known as SMB Properties that rehabilitated and now operates seven buildings in the City of York, Pennsylvania as part of a revitalization initiative. The buildings provide low-income housing to qualified families and, to a lesser degree, space for commercial purposes. The investment balance included in other assets has been fully amortized as of December 31, 2012, compared to $22,000 at December 31, 2011.

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Investment and related tax credits are accounted for under the effective yield method of accounting under which tax credits are recognized as they are allocated, and the cost of the investment is amortized to provide a constant yield over the period that tax credits are allocated, generally ten years.

Bank Owned Life Insurance
PeoplesBank invests in bank owned life insurance (BOLI) as a source of funding for employee benefit expenses. BOLI involves the purchasing of life insurance by PeoplesBank on a select group of employees and directors. PeoplesBank is the owner and beneficiary of the policies. This life insurance investment is carried at the cash surrender value of the underlying policies and is included in other assets in the amount of $15,467,000 at December 31, 2012, compared to $14,814,000 at December 31, 2011.

Trust and Investment Services Assets
Assets held by PeoplesBank in a fiduciary or agency capacity for its customers are not included in the consolidated balance sheets since these items are not assets of PeoplesBank.

Advertising
Advertising costs are charged to expense when incurred.

Income Taxes
Deferred income taxes are provided on the liability method whereby deferred tax assets are recognized for deductible temporary differences and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted through the provision for income taxes for the effects of changes in tax laws and rates on the effective date.

The Corporation accounts for uncertain tax positions as required by FASB ASC Topic 740. FASB ASC Topic 740 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements. Specifically, the accounting standard prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return as well as guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. No significant income tax uncertainties have been identified by the Corporation; therefore, the Corporation recognized no adjustment for unrecognized income tax benefits for the years ended December 31, 2012 or 2011. The Corporation’s policy is to recognize interest and penalties on unrecognized tax benefits in income taxes expense in the Consolidated Statement of Income. The Company did not recognize any interest and penalties for the years ended December 31, 2012, 2011 and 2010. The tax years subject to examination by the taxing authorities are the years ended December 31, 2011, 2010, and 2009.

Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, the evaluation of other-than-temporary impairment losses for investment securities and the evaluation of impairment losses for foreclosed real estate.

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Fair Value of Financial Instruments
Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in Note 16. Fair value estimates involve uncertainties and matters of significant judgment. Changes in assumptions or in market conditions could significantly affect the estimates.

Per Common Share Data
Basic net income per common share is calculated as net income available to common shareholders divided by the weighted average number of common shares outstanding. Diluted net income per common share is calculated as net income available to common shareholders divided by the weighted average number of common shares outstanding plus common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Corporation relate solely to outstanding stock options and warrants and are determined using the treasury stock method. All share and per share amounts are adjusted for stock dividends that are declared prior to the issuance of the consolidated financial statements.

The computation of net income per common share for the years ended December 31, 2012, 2011 and 2010 is provided in the table below.

 

 

 

 

 

 

 

 

 

 

 

(in thousands, except per share data)

 

2012

 

2011

 

2010

 

Net income available to common shareholders

 

$

9,010

 

$

5,319

 

$

5,228

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding (basic)

 

 

4,441

 

 

4,366

 

 

4,298

 

Effect of dilutive stock options

 

 

61

 

 

28

 

 

6

 

Weighted average shares outstanding (diluted)

 

 

4,502

 

 

4,394

 

 

4,304

 

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per common share

 

$

2.03

 

$

1.22

 

$

1.22

 

Diluted earnings per common share

 

$

2.00

 

$

1.21

 

$

1.21

 

 

 

 

 

 

 

 

 

 

 

 

Anti-dilutive stock options and common stock warrants

 

 

 

 

 

 

 

 

 

 

excluded from the computation of earnings per share

 

 

106

 

 

188

 

 

486

 

Stock-Based Compensation
The Corporation accounts for its stock-based compensation awards in accordance with FASB ASC Topic 718, which requires public companies to recognize compensation expense, related to stock-based compensation awards in their statements of operations. Compensation expense is equal to the fair value of the stock-based compensation awards on the grant date and is recognized over the vesting period of such awards. More information is provided in Note 12.

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Cash Flow Information
For purposes of the statements of cash flows, the Corporation considers interest bearing deposits with banks, cash and due from banks, and federal funds sold to be cash and cash equivalents.

 

 

 

 

 

 

 

 

 

 

 

 

 

Years ended December 31,

 

(dollars in thousands)

 

2012

 

2011

 

2010

 

Cash paid during the period for:

 

 

 

 

 

 

 

 

 

 

Income taxes

 

$

2,825

 

$

1,960

 

$

1,719

 

Interest

 

$

10,578

 

$

12,525

 

$

13,219

 

 

 

 

 

 

 

 

 

 

 

 

Noncash investing and financing activities:

 

 

 

 

 

 

 

 

 

 

Transfer of loans to foreclosed real estate

 

$

231

 

$

3,013

 

$

9,104

 

Transfer of loans held for sale to the held-to-maturity portfolio

 

$

0

 

$

0

 

$

160

 

Increase in other liabilities for investment in foreclosed real estate

 

$

0

 

$

116

 

$

65

 

Increase in other liabilities for purchase of securities settling after year end

 

$

0

 

$

1,063

 

$

0

 

Increase in other liabilities for preferred stock dividends declared

 

$

63

 

$

313

 

$

0

 


Off-Balance Sheet Financial Instruments
In the ordinary course of business, the Corporation enters into off-balance sheet financial instruments consisting of commitments to extend credit and standby letters of credit. These financial instruments are recorded on the balance sheet when they become a receivable to the Corporation.

Comprehensive Income
Accounting principles generally accepted in the United States of America require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale securities, are reported as a separate component of the shareholders’ equity section of the balance sheet, such items, along with net income, are components of comprehensive income.

Segment Reporting
Management has determined that it operates in only one segment, community banking. The Corporation’s non-banking activities are insignificant to the consolidated financial statements.

Reclassification
Certain amounts in the 2011 and 2010 consolidated financial statements have been reclassified to conform to the 2012 presentation, which did not impact net income or shareholders’ equity.

Recent Accounting Pronouncements
The FASB issued ASU No. 2011-04, “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S GAAP and IFRSs.” This Update amends FASB ASC Topic 820, Fair Value Measurements, to bring U.S. GAAP for fair value measurements in line with International Accounting Standards. The Update clarifies existing guidance for items such as: the application of the highest and best use concept to non-financial assets and liabilities; the application of fair value measurement to financial instruments classified in a reporting entity’s stockholder’s equity; and disclosure requirements regarding quantitative information about unobservable inputs used in the fair value measurements of level 3 assets. The Update also creates an exception to Topic 820 for entities which carry financial instruments within a portfolio or group, under which the entity is now permitted to base the price used for fair valuation upon a price that would be received to sell the net asset position or transfer a net liability position in an orderly transaction. The Update also allows for the application of premiums and discounts in a fair value measurement if the financial instrument is categorized in level 2 or 3 of the fair value hierarchy. Lastly, the ASU contains new disclosure requirements regarding fair value amounts categorized as level 3 in the fair value hierarchy such as: disclosure of the valuation process used; effects of and relationships between unobservable inputs; usage of nonfinancial assets for purposes other than their highest and best use when that is the basis of the disclosed fair value; and categorization by level of items disclosed at fair value, but not measured at fair value for financial statement purposes. The Corporation adopted the provisions of ASU No. 2011-04 effective January 1, 2012. The fair value measurement provisions of ASU No. 2011-04 had no impact on the Corporation’s consolidated financial statements. See Note 16 to the consolidated financial statements for enhanced disclosures required by ASU No. 2011-04.

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In November 2008, the Securities and Exchange Commission (SEC) released a proposed roadmap regarding the potential use by U.S. issuers of financial statements prepared in accordance with International Financial Reporting Standards (IFRS). IFRS is a comprehensive series of accounting standards published by the International Accounting Standards Board (IASB). On July 13, 2012, the SEC published their final report on IFRS, which included an analysis of the issues related to possible incorporation of IFRS into the U.S. financial reporting regime. The SEC report was designed to inform the SEC commissioners for when they would come to decide whether, and if so, how, IFRS should be applied to the U.S. The next step for the SEC is to develop a recommendation on IFRS, but no timetable has been disclosed for completing this work. The Corporation will continue to monitor the development of the potential implementation of IFRS.

In February 2013, the FASB issued ASU No. 2013-02, “Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income.” The objective of this ASU is to improve the reporting of reclassifications out of accumulated other comprehensive income. This ASU requires an entity to report the effect of significant reclassifications out of accumulated other comprehensive income, by component, on the respective line items in the income statement if the amount being reclassified is required under U.S. generally accepted accounting principles (GAAP) to be reclassified in its entirety to net income. Reclassifications that are not required under U.S. GAAP to be reclassified in their entirety to net income in the same reporting period are required to be cross-referenced to other U.S. GAAP disclosures that provide additional detail about those amounts. The amendments do not change the current requirements for reporting net income or other comprehensive income in financial statements. However, the amendments require an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by component. In addition, an entity is required to present, either on the face of the statement where net income is presented or in the notes, significant amounts reclassified out of accumulated other comprehensive income. The provisions of this ASU are effective for public entities prospectively for reporting periods beginning after December 15, 2012. The update is not expected to have a material impact on the Corporation’s results of operations or financial condition.

NOTE 2-Restrictions on Cash and Due from Banks

The Bank is required to maintain average reserves, in the form of cash and balances with the Federal Reserve Bank, against its deposit liabilities. In 2012 and 2011, the reserves were met with vault cash. The Bank is also required to maintain compensating balances with certain correspondent banks which totaled $76,000 at December 31, 2012 compared to $126,000 at December 31, 2011.

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NOTE 3-Securities

A summary of securities, available-for-sale at December 31, 2012 and 2011 is provided below. The securities available-for-sale portfolio is generally comprised of high quality debt instruments, such as obligations of the United States government or agencies thereof and investments in the obligations of municipalities. With the exception of an approximately $14 million portfolio (fair value) of Texas municipal utility district bonds, which has its own criteria for investment (e.g., maximum debt to assessed valuation, minimum assessed valuation and district size, proximity to employment, etc.), the remaining municipal bonds were almost all rated A or above by a national rating service at December 31, 2012. The majority of municipal bonds in the portfolio are general obligation bonds, which can draw upon multiple sources of revenue, including taxes, for payment. Only a few bonds are revenue bonds, which are dependent upon a single revenue stream for payment, but they are for critical services such as water and sewer. In many cases, municipal debt issues are insured or, in the case of school districts of selected states, backed by specific loss reserves. At December 31, 2012, the fair value of the municipal bond portfolio was concentrated in the states of Pennsylvania at 40 percent and Texas at 17 percent.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Estimated

 

 

 

Amortized

 

Gross Unrealized

 

Fair

 

(dollars in thousands)

 

Cost

 

Gains

 

Losses

 

Value

 

December 31, 2012

 

 

 

 

 

 

 

 

 

 

 

 

 

Debt securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Treasury notes

 

$

5,001

 

$

31

 

$

0

 

$

5,032

 

U.S. agency

 

 

37,000

 

 

1,083

 

 

(25

)

 

38,058

 

U.S. agency mortgage-backed, residential

 

 

84,630

 

 

3,603

 

 

0

 

 

88,233

 

State and municipal

 

 

98,744

 

 

4,053

 

 

(58

)

 

102,739

 

Total debt securities

 

$

225,375

 

$

8,770

 

$

(83

)

$

234,062

 

December 31, 2011

 

 

 

 

 

 

 

 

 

 

 

 

 

Debt securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Treasury notes

 

$

10,003

 

$

131

 

$

0

 

$

10,134

 

U.S. agency

 

 

29,593

 

 

1,080

 

 

0

 

 

30,673

 

U.S. agency mortgage-backed, residential

 

 

103,017

 

 

3,456

 

 

(29

)

 

106,444

 

State and municipal

 

 

82,272

 

 

4,340

 

 

(2

)

 

86,610

 

Total debt securities

 

$

224,885

 

$

9,007

 

$

(31

)

$

233,861

 

The amortized cost and estimated fair value of debt securities at December 31, 2012 by contractual maturity are shown below. Actual maturities may differ from contractual maturities if call options on selected debt issues are exercised in the future. Mortgage-backed securities are included in the maturity categories based on average expected life.

 

 

 

 

 

 

 

 

 

 

Available-for-sale

 

(dollars in thousands)

 

Amortized
Cost

 

 

Fair
Value

 

Due in one year or less

 

$

17,501

 

$

17,651

 

Due after one year through five years

 

 

177,725

 

 

184,708

 

Due after five years through ten years

 

 

26,328

 

 

27,590

 

Due after ten years

 

 

3,821

 

 

4,113

 

Total debt securities

 

$

225,375

 

$

234,062

 

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Gross realized gains and losses on sales of securities, available-for-sale is shown below. Realized gains and losses are computed on the basis of specific identification of the adjusted cost of each security and are shown net as a separate line item in the income statement.

 

 

 

 

 

 

 

 

 

 

 

 

 

Years ended December 31,

 

(dollars in thousands)

 

2012

 

2011

 

2010

 

 

Realized gains

 

$

428

 

$

229

 

$

108

 

Realized losses

 

 

(1

)

 

(104

)

 

0

 

Net gains

 

$

427

 

$

125

 

$

108

 


Securities, issued by agencies of the federal government, with a carrying value of $135,348,000 and $136,827,000 on December 31, 2012 and December 31, 2011, respectively, were pledged to secure public and trust deposits, repurchase agreements and other short-term borrowings.

The table below shows gross unrealized losses and fair value, aggregated by investment category and length of time, for securities that have been in a continuous unrealized loss position, at December 31, 2012 and 2011.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Less than 12 months

 

12 months or more

 

Total

 

(dollars in thousands)

 

Fair
Value

 

Unrealized
Losses

 

Fair
Value

 

Unrealized
Losses

 

Fair
Value

 

Unrealized
Losses

 

December 31, 2012

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Debt securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. agency

 

$

8,251

 

$

(25

)

$

0

 

$

0

 

$

8,251

 

$

(25

)

State and municipal

 

 

11,565

 

 

(58

)

 

0

 

 

0

 

 

11,565

 

 

(58

)

Total temporarily impaired debt securities, available for sale

 

$

19,816

 

$

(83

)

$

0

 

$

0

 

$

19,816

 

$

(83

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2011

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Debt securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. agency mortgage-backed, residential

 

$

13,430

 

$

(29

)

$

0

 

$

0

 

$

13,430

 

$

(29

)

State and municipal

 

 

856

 

 

(2

)

 

0

 

 

0

 

 

856

 

 

(2

)

Total temporarily impaired debt securities, available for sale

 

$

14,286

 

$

(31

)

$

0

 

$

0

 

$

14,286

 

$

(31

)

The unrealized losses of $83,000 at December 31, 2012 within the less than 12 months category were attributable to three U.S. agency securities and twenty-six municipal securities, all rated A or above by a national rating service.

Securities available-for-sale are analyzed quarterly for possible other-than-temporary impairment. The analysis considers, among other factors: 1) whether the Corporation has the intent to sell its securities prior to market recovery or maturity; 2) whether it is more likely than not that the Corporation will be required to sell its securities prior to market recovery or maturity; 3) default rates/history by security type; 4) third-party securities ratings; 5) third-party guarantees; 6) subordination; 7) payment delinquencies; 8) nature of the issuer; and 9) current financial news.

The Corporation believes that unrealized losses at December 31, 2012 were primarily the result of changes in market interest rates and that it has the ability to hold these investments for a time necessary to recover the amortized cost. Through December 31, 2012, the Corporation has collected all interest and principal on its investment securities as scheduled. The Corporation believes that collection of the contractual principal and interest is probable and, therefore, all impairment is considered to be temporary.

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Table of Contents


NOTE 4-Loans

The table below provides the composition of the loan portfolio at December 31. The portfolio is comprised of two segments, commercial and consumer loans. The commercial loan segment is disaggregated by industry class which allows us to monitor risk and performance. Those industries representing the largest dollar investment and most risk are listed separately. The other commercial loans category is comprised of a multitude of industries, including health services, professional services, public administration, restaurant, service, transportation, finance, natural resources, recreation and religious organization. The Corporation has not engaged in sub-prime residential mortgage originations.

 

 

 

 

 

 

 

 

 

 

December 31,

 

(dollars in thousands)

 

2012

 

2011

 

Builder & developer

 

$

96,936

 

$

103,514

 

Commercial real estate investor

 

 

122,714

 

 

118,133

 

Residential real estate investor

 

 

66,419

 

 

62,564

 

Hotel/Motel

 

 

64,948

 

 

52,871

 

Wholesale & retail

 

 

70,443

 

 

60,328

 

Manufacturing

 

 

40,258

 

 

25,976

 

Agriculture

 

 

20,928

 

 

17,368

 

Other

 

 

124,834

 

 

124,821

 

Total commercial related loans

 

 

607,480

 

 

565,575

 

Residential mortgages

 

 

23,511

 

 

21,324

 

Home equity

 

 

65,858

 

 

58,390

 

Other

 

 

40,285

 

 

48,226

 

Total consumer related loans

 

 

129,654

 

 

127,940

 

Total loans

 

$

737,134

 

$

693,515

 

Concentrations of credit risk arise when a number of customers are engaged in similar business activities in the same geographic region or have similar economic features that could cause their ability to meet contractual obligations to be similarly affected by changes in economic conditions. Most of the Corporation’s business is with customers in York County, Pennsylvania and northern-central Maryland, specifically Baltimore, Harford and Carroll counties. Although this focus may pose a concentration risk geographically, the Corporation believes that the diverse local economy and our detailed knowledge of the customer base lessens this risk. At December 31, 2012 and 2011, the Corporation had two industry concentrations that exceeded 10 percent of the total loan portfolio: builder & developer, which was 13.2 and 14.9 percent of the portfolio at December 31, 2012 and 2011, respectively; and commercial real estate investor, which was 16.6 and 17.0 percent of the portfolio, respectively. Loans to borrowers within these industries are usually collateralized by real estate.

The principal balance of outstanding loans to directors, executive officers, principal shareholders and any associates of such persons was $429,000 at December 31, 2012 and $2,887,000 at December 31, 2011. During 2012, total additions were $1,307,000 and total repayments and reductions were $3,765,000. 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 collection. As of year-end 2012, all loans to this group were current and performing in accordance with contractual terms.

The Corporation’s internal risk rating system follows regulatory guidance as to risk classifications and definitions. Every approved loan is assigned a risk rating. Generally, risk ratings for commercial related loans and residential mortgages held for investment are determined by a formal evaluation of risk factors performed by the Corporation’s underwriting staff. For consumer loans, and commercial loans up to $750,000, the Corporation uses third-party credit scoring software models for risk rating purposes.

59


Table of Contents


The loan portfolio is monitored on a continuous basis by loan officers, loan review personnel and senior management. Adjustments of loan risk ratings are generally performed by the Special Asset Committee, which includes senior management. The Committee, which meets monthly, makes changes, as appropriate, to risk ratings when it becomes aware of credit events such as payment delinquency, cessation of a business or project, bankruptcy or death of the borrower, or changes in collateral value.

The Corporation uses ten risk ratings to grade loans. The first seven ratings, representing the lowest risk, are combined and given a “pass” rating. A pass rating is a satisfactory credit rating, which applies to a loan that is expected to perform in accordance with the loan agreement and has a low probability of loss. A loan rated “special mention” has a potential weakness which may, if not corrected, weaken the loan or inadequately protect the Corporation’s position at some future date. A loan rated “substandard” is inadequately protected by the current net worth or paying capacity of the borrower or of the collateral pledged. A “substandard” loan has a well-defined weakness or weaknesses that could jeopardize liquidation of the loan, which exposes the Corporation to loss if the deficiencies are not corrected. When circumstances indicate that collection of the loan is doubtful, the loan is risk rated “nonaccrual,” the accrual of interest income is discontinued, and any unpaid interest previously credited to income is reversed. Accordingly, the table below does not include the regulatory classification of “doubtful,” nor does it include the regulatory classification of “loss” because the Corporation promptly charges off loan losses.

The table below presents a summary of loan risk ratings by loan class at December 31, 2012 and 2011.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(dollars in thousands)

 

Pass

 

Special
Mention

 

Substandard

 

Nonaccrual

 

Total

 

December 31, 2012

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Builder & developer

 

$

79,101

 

$

6,567

 

$

11,013

 

$

255

 

$

96,936

 

Commercial real estate investor

 

 

107,415

 

 

9,563

 

 

2,459

 

 

3,277

 

 

122,714

 

Residential real estate investor

 

 

62,327

 

 

1,361

 

 

2,044

 

 

687

 

 

66,419

 

Hotel/Motel

 

 

64,948

 

 

0

 

 

0

 

 

0

 

 

64,948

 

Wholesale & retail

 

 

66,155

 

 

1,521

 

 

983

 

 

1,784

 

 

70,443

 

Manufacturing

 

 

39,559

 

 

0

 

 

699

 

 

0

 

 

40,258

 

Agriculture

 

 

20,457

 

 

0

 

 

471

 

 

0

 

 

20,928

 

Other

 

 

121,223

 

 

1,156

 

 

612

 

 

1,843

 

 

124,834

 

Total commercial related loans

 

 

561,185

 

 

20,168

 

 

18,281

 

 

7,846

 

 

607,480

 

Residential mortgage

 

 

23,421

 

 

5

 

 

32

 

 

53

 

 

23,511

 

Home equity

 

 

65,406

 

 

112

 

 

188

 

 

152

 

 

65,858

 

Other

 

 

39,318

 

 

325

 

 

351

 

 

291

 

 

40,285

 

Total consumer related loans

 

 

128,145

 

 

442

 

 

571

 

 

496

 

 

129,654

 

Total loans

 

$

689,330

 

$

20,610

 

$

18,852

 

$

8,342

 

$

737,134

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2011

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Builder & developer

 

$

90,429

 

$

11,392

 

$

533

 

$

1,160

 

$

103,514

 

Commercial real estate investor

 

 

102,374

 

 

13,519

 

 

161

 

 

2,079

 

 

118,133

 

Residential real estate investor

 

 

58,331

 

 

3,681

 

 

0

 

 

552

 

 

62,564

 

Hotel/Motel

 

 

52,871

 

 

0

 

 

0

 

 

0

 

 

52,871

 

Wholesale & retail

 

 

54,193

 

 

2,354

 

 

811

 

 

2,970

 

 

60,328

 

Manufacturing

 

 

25,262

 

 

0

 

 

714

 

 

0

 

 

25,976

 

Agriculture

 

 

16,879

 

 

0

 

 

489

 

 

0

 

 

17,368

 

Other

 

 

111,227

 

 

9,095

 

 

0

 

 

4,499

 

 

124,821

 

Total commercial related loans

 

 

511,566

 

 

40,041

 

 

2,708

 

 

11,260

 

 

565,575

 

Residential mortgage

 

 

21,113

 

 

7

 

 

34

 

 

170

 

 

21,324

 

Home equity

 

 

58,088

 

 

79

 

 

188

 

 

35

 

 

58,390

 

Other

 

 

47,359

 

 

597

 

 

34

 

 

236

 

 

48,226

 

Total consumer related loans

 

 

126,560

 

 

683

 

 

256

 

 

441

 

 

127,940

 

Total loans

 

$

638,126

 

$

40,724

 

$

2,964

 

$

11,701

 

$

693,515

 

60


Table of Contents


The table below presents a summary of impaired loans at December 31, 2012 and 2011. Generally, impaired loans are loans risk rated substandard and nonaccrual. An allowance is established for those individual loans that are commercial related and only those consumer related loans classified as troubled debt restructurings where the Corporation has doubt as to full recovery of the outstanding principal balance. The recorded investment represents outstanding unpaid principal loan balances adjusted for charge-offs.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2012

 

December 31, 2011

 

(dollars in thousands)

 

Recorded
Investment

 

Unpaid
Principal
Balance

 

Related
Allowance

 

Recorded
Investment

 

Unpaid
Principal
Balance

 

Related
Allowance

 

Impaired loans with no related allowance:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Builder & developer

 

$

12,211

 

$

12,211

 

$

0

 

$

2,627

 

$

2,627

 

$

0

 

Commercial real estate investor

 

 

5,736

 

 

5,836

 

 

0

 

 

3,965

 

 

4,065

 

 

0

 

Residential real estate investor

 

 

72

 

 

72

 

 

0

 

 

463

 

 

463

 

 

0

 

Hotel/Motel

 

 

0

 

 

0

 

 

0