UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2006
OR
[ ] 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)
717-747-1519
(Registrant's telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year,
if changed since the last report.)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [X]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
APPLICABLE ONLY TO CORPORATE ISSUERS
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date. On October 24, 2006, 3,499,833
shares of common stock, par value $2.50, were outstanding, which includes the
effect of the 5 percent stock dividend declared October 10, 2006.
-1-
Codorus Valley Bancorp, Inc.
FORM 10-Q INDEX
Page #
------
PART I - FINANCIAL INFORMATION
Item 1. Financial statements:
Consolidated balance sheets 3
Consolidated statements of income 4
Consolidated statements of cash flows 5
Consolidated statements of changes in shareholders' equity 6
Notes to consolidated financial statements 7
Item 2. Management's discussion and analysis of financial condition
and results of operations 13
Item 3. Quantitative and qualitative disclosures about market risk 26
Item 4. Controls and procedures 26
PART II - OTHER INFORMATION
Item 1. Legal proceedings 26
Item 1A. Risk factors 26
Item 2. Unregistered sales of equity securities and use of proceeds 27
Item 3. Defaults upon senior securities 27
Item 4. Submission of matters to a vote of security holders 27
Item 5. Other information 27
Item 6. Exhibits 27
SIGNATURES 30
-2-
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Codorus Valley Bancorp, Inc.
Consolidated Balance Sheets
Unaudited
September 30, December 31,
(dollars in thousands, except per share data) 2006 2005
------------- ------------
ASSETS
Interest bearing deposits with banks $ 156 $ 126
Cash and due from banks 12,633 11,959
Federal funds sold 13,181 0
-------- --------
Total cash and cash equivalents 25,970 12,085
Securities available-for-sale 64,206 58,111
Securities held-to-maturity (fair value $9,547 for
2006 and $9,686 for 2005) 9,097 9,101
Restricted investment in bank stock, at cost 1,962 2,452
Loans held for sale 1,616 1,522
Loans (net of deferred fees of $489 in 2006 and
$537 in 2005) 397,033 368,109
Less-allowance for loan losses (2,969) (2,538)
-------- --------
Net loans 394,064 365,571
Premises and equipment, net 10,703 10,962
Other assets 16,779 16,248
-------- --------
Total assets $524,397 $476,052
======== ========
LIABILITIES
Deposits
Noninterest bearing $ 49,511 $ 49,369
Interest bearing 383,909 335,785
-------- --------
Total deposits 433,420 385,154
Short-term borrowings 0 9,781
Long-term debt 45,743 39,712
Other liabilities 3,106 2,676
-------- --------
Total liabilities 482,269 437,323
SHAREHOLDERS' EQUITY
Preferred stock, par value $2.50 per share;
1,000,000 shares authorized; 0 shares issued
and outstanding 0 0
Common stock, par value $2.50 per share;
10,000,000 shares authorized; 3,499,833 shares
issued and outstanding on 9/30/06 and 3,160,821
on 12/31/05 8,750 7,902
Additional paid-in capital 28,796 23,035
Retained earnings 4,752 8,204
Accumulated other comprehensive loss (170) (412)
-------- --------
Total shareholders' equity 42,128 38,729
-------- --------
Total liabilities and shareholders' equity $524,397 $476,052
======== ========
See accompanying notes.
-3-
Codorus Valley Bancorp, Inc.
Consolidated Statements of Income
Unaudited
Three months ended Nine months ended
September 30, September 30,
------------------ ------------------
(dollars in thousands, except per share data) 2006 2005 2006 2005
------ ------- ------- --------
INTEREST INCOME
Loans, including fees $7,614 $5,748 $21,734 $ 16,137
Investment securities
Taxable 613 627 1,818 1,841
Tax-exempt 195 118 494 321
Dividends 31 15 101 51
Other 205 35 248 64
------ ------- ------- --------
Total interest income 8,658 6,543 24,395 18,414
INTEREST EXPENSE
Deposits 3,511 1,903 9,015 5,082
Federal funds purchased and other short-term
borrowings 0 5 133 62
Long-term debt 612 478 1,571 1,270
------ ------- ------- --------
Total interest expense 4,123 2,386 10,719 6,414
------ ------- ------- --------
Net interest income 4,535 4,157 13,676 12,000
PROVISION FOR LOAN LOSSES 145 150 500 525
------ ------- ------- --------
Net interest income after provision for
loan losses 4,390 4,007 13,176 11,475
NONINTEREST INCOME
Trust and investment services fees 299 276 939 856
Service charges on deposit accounts 480 424 1,400 1,193
Mutual fund, annuity and insurance sales 278 252 923 898
Income from bank owned life insurance 70 70 197 201
Other income 110 136 389 387
Gain on sales of mortgages 61 136 210 278
Loss on sales of securities 0 0 0 (86)
------ ------- ------- --------
Total noninterest income 1,298 1,294 4,058 3,727
NONINTEREST EXPENSE
Personnel 2,208 2,016 6,487 5,778
Occupancy of premises, net 321 340 1,053 991
Furniture and equipment 299 307 1,043 938
Postage, stationery and supplies 79 119 318 364
Professional and legal 104 97 214 238
Marketing and advertising 138 161 391 427
Other 631 527 2,037 1,642
------ ------- ------- --------
Total noninterest expense 3,780 3,567 11,543 10,378
------ ------- ------- --------
Income before income taxes 1,908 1,734 5,691 4,824
PROVISION FOR INCOME TAXES 501 451 1,500 1,228
------ ------- ------- --------
Net income $1,407 $1,283 $ 4,191 $ 3,596
====== ======= ======= ========
Net income per share, basic $ 0.40 $ 0.37 $ 1.20 $ 1.04
Net income per share, diluted $ 0.39 $ 0.36 $ 1.18 $ 1.02
====== ======= ======= ========
See accompanying notes.
-4-
Codorus Valley Bancorp, Inc.
Consolidated Statements of Cash Flows
Unaudited
Nine months ended
September 30,
-------------------
(dollars in thousands) 2006 2005
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 4,191 $ 3,596
Adjustments to reconcile net income to net cash provided by
operations
Depreciation 882 825
Provision for loan losses 500 525
Provision for losses on foreclosed real estate 0 17
Deferred federal income tax expense 28 0
Amortization of investment in real estate partnership 363 354
Income from bank owned life insurance (197) (201)
Originations of held for sale mortgages (16,546) (21,831)
Proceeds from sales of held for sale mortgages 16,662 21,966
Gain on sales of held for sale mortgages (210) (278)
Loss on sales of securities 0 86
Gain on sales of foreclosed real estate 0 (148)
Gain on sales of fixed assets (43) (3)
Stock-based compensation expense 39 0
Increase in accrued interest receivable and other assets (657) (330)
Increase in accrued interest payable and other liabilities 493 78
Other, net 202 228
-------- --------
Net cash provided by operating activities 5,707 4,884
CASH FLOWS FROM INVESTING ACTIVITIES
Securities available-for-sale
Purchases (15,187) (13,862)
Maturities and calls 9,339 11,003
Sales 0 3,918
Net decrease in restricted investment in bank stock 490 104
Net increase in loans made to customers (29,040) (38,295)
Purchases of premises and equipment (635) (1,810)
Investment in real estate partnership 0 (420)
Investment in nonconsolidated subsidiary (217) 0
Investment in life insurance (7) (7)
Purchase of insurance agency assets (63) (60)
Proceeds from the sale of premises and equipment 55 0
Proceeds from sales of foreclosed real estate 0 1,680
-------- --------
Net cash used in investing activities (35,265) (37,749)
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in demand and savings deposits 25,211 22,835
Net increase in time deposits 23,055 16,998
Net decrease in short-term borrowings (9,781) (12,337)
Proceeds from issuance of long-term debt 7,217 13,500
Repayment of long-term debt (1,186) (1,014)
Dividends paid (1,254) (1,143)
Issuance of common stock 187 225
Cash paid in lieu of fractional shares (6) (6)
-------- --------
Net cash provided by financing activities 43,443 39,058
-------- --------
Net increase in cash and cash equivalents 13,885 6,193
Cash and cash equivalents at beginning of year 12,085 8,085
-------- --------
Cash and cash equivalents at end of period $ 25,970 $ 14,278
======== ========
See accompanying notes.
-5-
Codorus Valley Bancorp, Inc.
Consolidated Statements of Changes in Shareholders' Equity
Unaudited
Accumulated
Additional Other
Common Paid-in Retained Comprehensive
(dollars in thousands, except per share data) Stock Capital Earnings (Loss) Income Total
------ ---------- -------- -------------- -------
For the nine months ended Setpember 30, 2006
Balance, December 31, 2005 $7,902 $23,035 $ 8,204 $(412) $38,729
Comprehensive income:
Net income 4,191 4,191
Other comprehensive income, net of tax:
Unrealized gains on securities, net 242 242
-------
Total comprehensive income 4,433
Cash dividends ($.36 per share, adjusted) (1,254) (1,254)
(2) 5% stock dividends - 324,372 shares at
fair value 811 5,572 (6,389) (6)
Stock-based compensation 39 39
Issuance of common stock -
14,640 shares under stock option plan 37 150 187
------ ------- ------- ----- -------
Balance, September 30, 2006 $8,750 $28,796 $ 4,752 $(170) $42,128
====== ======= ======= ===== =======
For the nine months ended September 30, 2005
Balance, December 31, 2004 $7,481 $20,293 $ 8,034 $ 174 $35,982
Comprehensive income:
Net income 3,596 3,596
Other comprehensive loss, net of tax:
Unrealized losses on securities, net (404) (404)
-------
Total comprehensive income 3,192
Cash dividends ($.329 per share, adjusted) (1,143) (1,143)
5% stock dividend - 149,593 shares at fair value 374 2,513 (2,893) (6)
Issuance of common stock -
14,638 shares under stock option plan 37 188 225
------ ------- ------- ----- -------
Balance, September 30, 2005 $7,892 $22,994 $ 7,594 $(230) $38,250
====== ======= ======= ===== =======
See accompanying notes.
-6-
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--BASIS OF PRESENTATION
The interim financial statements are unaudited. However, they reflect all
adjustments that are, in the opinion of management, necessary to present fairly
the financial condition and results of operations for the reported periods, and
are of a normal and recurring nature.
These statements should be read in conjunction with the notes to the audited
financial statements contained in the Corporation's Annual Report on Form 10-K
for the year ended December 31, 2005.
The consolidated financial statements include the accounts of Codorus Valley
Bancorp, Inc. and its wholly owned bank subsidiary, PeoplesBank, A Codorus
Valley Company (PeoplesBank), and its wholly owned nonbank subsidiary, SYC
Realty Company, Inc., (collectively referred to as Codorus Valley or
Corporation). PeoplesBank has two wholly owned subsidiaries, Codorus Valley
Financial Advisors, Inc. and SYC Settlement Services, Inc. All significant
intercompany account balances and transactions have been eliminated in
consolidation. The combined results of operations of the nonbank subsidiaries
are not material to the consolidated financial statements.
The results of operations for the nine month period ended September 30, 2006 are
not necessarily indicative of the results to be expected for the full year.
NOTE 2--SIGNIFICANT ACCOUNTING POLICIES
Stock dividend and per share computations
All per share computations include the effect of stock dividends declared
through October 10, 2006. The weighted average number of shares of common stock
outstanding used for basic and diluted calculations follows.
Three months ended Nine months ended
September 30, September 30,
------------------ -----------------
(dollars in thousands, except per share data) 2006 2005 2006 2005
------ ------ ------ ------
Net income $1,407 $1,283 $4,191 $3,596
------ ------ ------ ------
Weighted average shares outstanding (basic) 3,486 3,479 3,485 3,473
Effect of dilutive stock options 81 64 80 69
------ ------ ------ ------
Weighted average shares outstanding (diluted) 3,567 3,543 3,565 3,542
Basic earnings per share $ .40 $ .37 $ 1.20 $ 1.04
Diluted earnings per share $ .39 $ .36 $ 1.18 $ 1.02
Stock-Based Compensation
The Corporation adopted Statement of Financial Accounting Standards No. 123R,
"Share-Based Payments" (Statement 123R) in the first quarter of 2006, using the
"modified prospective method." Prior to the implementation of FAS 123R, stock
options issued under shareholder approved employee and director stock option
plans were accounted for under Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" (APB 25). Under APB 25, no
compensation expense was
-7-
recognized related to these plans. Stock options are granted at exercise prices
not less than the fair value of the common stock on the date of grant. See Note
6 - Stock-Based Compensation.
Comprehensive income
Accounting principles generally 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 equity section of the
balance sheet, such items, along with net income, are components of
comprehensive income. The components of other comprehensive income (loss) and
related tax effects are presented in the following table:
Three months ended Nine months ended
September 30, September 30,
------------------ -----------------
(Dollars in thousands) 2006 2005 2006 2005
------ ----- ----- -----
Unrealized holding gains (losses) arising
during the period $1,147 $(477) $ 367 $(698)
Reclassification adjustment for losses
(gains) included in income 0 0 0 86
------ ----- ----- -----
Net unrealized gains (losses) 1,147 (477) 367 (612)
Tax effect (390) 162 (125) 208
------ ----- ----- -----
Net of tax amount $ 757 $(315) $ 242 $(404)
====== ===== ===== =====
Recent Accounting Pronouncements
In September 2006, the Financial Accounting Standards Board issued FASB
Statement No. 157, "Fair Value Measurements," which defines fair value,
establishes a framework for measuring fair value under Generally Accepted
Accounting Principles, and expands disclosures about fair value measurements.
FASB Statement No. 157 applies to other accounting pronouncements that require
or permit fair value measurements. The new guidance is effective for financial
statements issued for fiscal years beginning after November 15, 2007, and for
interim periods within those fiscal years. The Corporation is currently
evaluating the potential impact, if any, of the adoption of FASB Statement No.
157 on our consolidated financial position, results of operations and cash
flows.
In June 2006, the Financial Accounting Standards Board issued FASB
Interpretation No. 48, "Accounting for Uncertainty in Income Taxes." The
interpretation clarifies the accounting for uncertainty in income taxes
recognized in a company's financial statements in accordance with Statement of
Financial Accountings Standards No.109, "Accounting for Income Taxes."
Specifically, the pronouncement prescribes a recognition threshold and a
measurement attribute for the financial statement recognition and measurement of
a tax position taken or expected to be taken in a tax return. The interpretation
also provides guidance on the related derecognition, classification, interest
and penalties, accounting for interim periods, disclosure and transition of
uncertain tax positions. The interpretation is effective for fiscal years
beginning after December 15, 2006. The Corporation is evaluating the impact of
this new pronouncement on its consolidated financial statements.
-8-
NOTE 3--DEPOSITS
The composition of deposits on September 30, 2006 and December 31, 2005, was as
follows:
September 30, December 31,
(Dollars in thousands) 2006 2005
------------- ------------
Noninterest bearing demand $ 49,511 $ 49,369
NOW 39,876 50,638
Money market 136,396 97,601
Savings 18,241 21,205
Time CDs less than $100,000 139,952 125,572
Time CDs $100,000 or more 49,444 40,769
-------- --------
Total deposits $433,420 $385,154
======== ========
NOTE 4--LONG-TERM DEBT
A summary of long-term debt at September 30, 2006 and December 31, 2005 follows:
September 30, December 31,
(Dollars in thousands) 2006 2005
------------- ------------
Obligations of PeoplesBank to FHLBP
Due 2007, 4.69%, amortizing 112 439
Due 2007, 4.68% 7,000 7,000
Due 2009, 3.47%, convertible quarterly
after December 2006 5,000 5,000
Due 2010, 4.32% 6,000 6,000
Due 2011, 4.30%, amortizing 4,569 4,757
Due 2012, 4.25%, amortizing 2,079 2,319
Due 2013, 3.46%, amortizing 3,521 3,869
Due 2014, 6.43%, convertible quarterly
after July 2009 5,000 5,000
Obligations of Codorus Valley Bancorp, Inc.
Due 2011, floating rate based on 1 month
LIBOR plus 1.50%, amortizing 1,582 1,641
Due 2034, floating rate based on 3 month
LIBOR plus 2.02%, callable quarterly
after December 2009 3,093 3,093
Due 2036, floating rate based on 3 month
LIBOR plus 1.54%, callable quarterly
after July 2011 7,217 0
------- -------
45,173 39,118
Capital lease obligation 570 594
------- -------
Total long-term debt $45,743 $39,712
======= =======
PeoplesBank's obligations to FHLBank Pittsburgh are fixed rate and
fixed/floating (convertible) rate instruments. The FHLBank Pittsburgh has an
option on the convertible borrowings to convert the rate to a floating rate
after the expiration of a specified period. The floating rate is based on the
LIBOR index plus a spread. If the FHLBank Pittsburgh elects to exercise its
conversion option, PeoplesBank may repay the converted loan without a prepayment
penalty.
-9-
Codorus Valley has three long-term obligations. The first is due 2011 and is
secured by a mortgage on the Codorus Valley Corporate Center office building at
105 Leader Heights Road, York, Pennsylvania. The second and third obligations
are due 2034 and 2036 and represent the issuance of trust preferred debt
securities. Trust preferred debt securities were issued to support planned
growth and are included in Tier 1 capital for regulatory capital purposes.
NOTE 5--REGULATORY MATTERS
Codorus Valley and PeoplesBank are subject to various regulatory capital
requirements administered by banking regulators. Failure to meet minimum capital
requirements can initiate certain mandatory and possible additional
discretionary actions by regulators that, if undertaken, could have a material
effect on Codorus Valley's financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, Codorus
Valley and PeoplesBank must meet specific capital guidelines that involve
quantitative measures of assets, liabilities, and certain off-balance sheet
items as calculated under regulatory accounting practices. The capital amounts
and classifications are also subject to qualitative judgments by the regulators.
Quantitative measures established by regulators to ensure capital adequacy
require Codorus Valley and PeoplesBank to maintain minimum ratios, as set forth
below, to total and Tier 1 capital as a percentage of risk-weighted assets, and
of Tier 1 capital to year-to-date average assets (leverage ratio). Management
believes that Codorus Valley and PeoplesBank were well capitalized on September
30, 2006, based on FDIC capital guidelines.
MINIMUM FOR
ACTUAL CAPITAL ADEQUACY WELL CAPITALIZED MINIMUM*
--------------- --------------------------- ----------------------------
(dollars in thousands) AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------- ----- -------------- ---------- -------------- -----------
CODORUS VALLEY BANCORP, INC. (CONSOLIDATED)
AT SEPTEMBER 30, 2006
Capital ratios:
Tier 1 risk based $51,844 12.11% > or = $17,121 > or = 4.0% n/a n/a
Total risk based 54,813 12.81 > or = 34,242 > or = 8.0 n/a n/a
Leverage 51,844 9.98 > or = 20,765 > or = 4.0 n/a n/a
AT DECEMBER 31, 2005
Capital ratios:
Tier 1 risk based $41,658 10.61% > or = $15,699 > or = 4.0% n/a n/a
Total risk based 44,196 11.26 > or = 31,398 > or = 8.0 n/a n/a
Leverage 41,658 9.57 > or = 17,420 > or = 4.0 n/a n/a
PEOPLESBANK, A CODORUS VALLEY COMPANY
AT SEPTEMBER 30, 2006
Capital ratios:
Tier 1 risk based $47,489 11.25% > or = $16,885 > or = 4.0% > or = $25,327 > or = 6.0%
Total risk based 50,458 11.95 > or = 33,770 > or = 8.0 > or = 42,212 > or = 10.0
Leverage 47,489 9.26 > or = 20,525 > or = 4.0 > or = 25,656 > or = 5.0
AT DECEMBER 31, 2005
Capital ratios:
Tier 1 risk based $37,201 9.62% > or = $15,463 > or = 4.0% > or = $23,194 > or = 6.0%
Total risk based 39,739 10.28 > or = 30,926 > or = 8.0 > or = 38,657 > or = 10.0
Leverage 37,201 8.66 > or = 17,184 > or = 4.0 > or = 21,480 > or = 5.0
* To be well capitalized under prompt corrective action provisions.
-10-
NOTE 6--STOCK-BASED COMPENSATION
The Corporation adopted Statement of Financial Accounting Standards No. 123R,
"Share-Based Payments" (Statement 123R) in the first quarter of 2006, using the
"modified prospective method." Statement 123R requires that the fair value of
equity awards to employees be recognized as compensation expense over the period
during which an employee is required to provide service in exchange for such
award. Compensation expense of $15,000 net of $0 tax effect for the three months
ended September 30, 2006 and $40,000 net of $0 tax effect for the nine months
ended September 30, 2006 was included in net income and earnings per share.
Comparatively, the impact on net income and earnings per share during 2005 that
would have occurred if compensation expense would have been recognized based on
the estimated fair value of the options on the date of grant is as follows:
Three months ended Nine months ended
(Dollars in thousands, except per share data) September 30, 2005 September 30, 2005
------------------ ------------------
Reported net income $1,283 $3,596
Total stock-based employee compensation
expense determined under fair value
based method for all awards, net of
related tax effects of $0 and $0 (81) (119)
------ ------
Pro forma net income $1,202 $3,477
Reported basic earnings per share $.37 $1.04
Reported diluted earnings per share $.36 $1.02
Pro forma basic earnings per share $.35 $1.00
Pro forma diluted earnings per share $.34 $.98
The Corporation's equity awards consist of stock options granted under three
stock option plans as follows: a 2000 Stock Incentive Plan (2000 Plan), a 1998
Independent Directors Stock Option Plan (1998 Plan) and a 1996 Stock Incentive
Plan (1996 Plan), collectively the Option Plans. All options available for grant
under the 1998 and 1996 Plans have been granted. The 2000 Plan also allows for
the granting of stock appreciation rights and restricted stock, none of which
have been granted to date at September 30, 2006.
Shares reserved and available for issuance as of September 30, 2006, adjusted
for stock dividends declared, were 134,374 for the 2000 Plan, 135,823 for the
1998 Plan, and 86,688 for the 1996 Plan. Shares reserved for future issuance
under each plan are subject to adjustment in the event of specified changes in
the Corporation's capital structure. Options awarded under these plans to date
have been granted with an exercise price equal to the fair value of the stock on
the grant date, a minimum vesting period of six months and an expiration period
of ten years. Upon exercise, the Corporation has historically issued from its
authorized, but unissued, common stock to satisfy the options.
The grant-date fair value, adjusted for stock dividends declared, of options
granted in June 2006 was $6.95 and in June 2005 was $6.53. The fair value of the
options awarded under the Option Plans is
-11-
estimated on the date of grant using the Black-Scholes valuation model, which is
dependent upon certain assumptions as presented below.
2006 2005
---- ----
Expected life (in years) 5.25 6.12
Risk-free interest rate 5.19% 3.89%
Expected volatility 46.4% 48.3%
Expected dividend yield 2.7% 2.6%
The expected life of the options was estimated using one half of the exercise
period plus the vesting period and represents the period of time that options
granted are expected to be outstanding. The risk-free interest rate is the U.S.
Treasury rate commensurate with the expected life of the options on the grant
date. Volatility of the Corporation's stock price was based on historical
volatility. Dividend yield was based on dividends for the most current year
divided by the average market price for the most current year.
A summary of stock options activity from all Plans, adjusted for stock dividends
declared, is shown below.
WEIGHTED AVERAGE WEIGHTED AVERAGE AGGREGATE
EXERCISE PRICE REMAINING INTRINSIC VALUE
OPTIONS PER SHARE CONTRACTUAL TERM ($000)
------- ---------------- ---------------- ---------------
Outstanding at January 1, 2006 288,922 $13.03 4.7 years $1,628
Granted 525 18.00
Exercised (15,372) 8.81
------- ------ --------- ------
Outstanding at September 30, 2006 274,075 $13.28 4.2 years $1,477
======= ====== ========= ======
Exerciseable at September 30, 2006 248,447 $12.90 3.7 years $1,433
======= ====== ========= ======
Intrinsic value represents the amount by which the market price of the stock on
the measurement date exceeded the exercise price of the option. The intrinsic
value of options exercised during the first nine months of 2006 was $149,000 and
2005 was $78,000. Cash received from such exercises in 2006 was $135,000 and the
tax benefit recognized was $51,000 and in 2005 was $198,000 and the tax benefit
recognized was $26,000.
As of September 30, 2006, total unrecognized compensation cost related to
nonvested options was $91,000. The cost is expected to be recognized over a
weighted average period of 1.6 years.
NOTE 7--CONTINGENT LIABILITIES
Management is not aware of any material contingent liabilities on September 30,
2006.
NOTE 8--GUARANTEES
Codorus Valley does not issue any guarantees that would require liability
recognition or disclosure, other than its standby letters of credit. Standby
letters of credit written are conditional commitments issued by the PeoplesBank
to guarantee the performance of a customer to a third party. Generally, all
letters of credit, when issued have expiration dates within one year. The credit
risk involved in issuing letters of credit is essentially the same as those that
are involved in extending loan facilities to customers. The Corporation
generally holds collateral and/or personal guarantees supporting these
commitments. The Corporation had $7,470,279 of standby letters of credit on
September 30, 2006,
-12-
compared to $2,777,000 on December 31, 2005. Management believes that the
proceeds obtained through a liquidation of collateral and the enforcement of
guarantees would be sufficient to cover the potential amount of future payment
required under the corresponding guarantees. The current amount of the liability
as of September 30, 2006 and December 31, 2005, for guarantees under standby
letters of credit issued, is not material.
ITEM 2. 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 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 Form
10-Q. These forward-looking statements are 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 occur in the
Form 10-Q, management is making forward-looking statements.
Readers should note that many factors, some of which are discussed elsewhere in
this report and in the documents that management incorporates 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-Q. These factors include:
- operating, legal and regulatory risks;
- economic, political and competitive forces affecting banking, securities,
asset management and credit services businesses; and
- the risk that management's analysis 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. Readers should carefully review the risk factors
described in other documents that Codorus Valley files periodically with the
Securities and Exchange Commission.
CRITICAL ACCOUNTING ESTIMATES:
Disclosure of Codorus Valley's significant accounting policies is included in
Note 1 to the consolidated financial statements of the 2005 Annual Report on
Form 10-K for the period ended December 31, 2005. Some of these policies are
particularly sensitive, requiring management to make significant judgments,
estimates and assumptions. Additional information is contained in Management's
Discussion and Analysis for the most sensitive of these issues, including the
provision and allowance for loan losses, located on pages 17 and 23 of this Form
10-Q.
-13-
Management makes significant estimates in determining the allowance for loan
losses. Management considers a variety of factors in establishing this estimate
such as current economic conditions, diversification of the loan portfolio,
delinquency statistics, results of internal loan reviews, financial and
managerial strengths of borrowers, adequacy of collateral, if collateral
dependent, or present value of future cash flows and other relevant factors.
Estimates related to the value of collateral also have a significant impact on
whether or not management continues to accrue income on delinquent loans and on
the amounts at which foreclosed real estate is recorded on the statement of
financial condition.
The Corporation changed its method of accounting for stock-based compensation in
2006, in accordance with Financial Accounting Statement No. 123(R), which is
described in Note 6 - Stock-Based Compensation of this report. Based on stock
options outstanding on September 30, 2006, approximately $91,000 will be
expensed over the weighted average period of 1.6 years.
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.
THREE MONTHS ENDED SEPTEMBER 30, 2006,
COMPARED TO THREE MONTHS ENDED SEPTEMBER 30, 2005
OVERVIEW
Net income for the three-month period ended September 30, 2006, was $1,407,000
or $.40 per share ($.39 diluted), compared to $1,283,000 or $.37 per share ($.36
diluted), for the same period of 2005. The $124,000 or 10 percent increase in
net income was the result of an increase in net interest income, which more than
offset an increase in noninterest expense. The $378,000 or 9 percent increase in
net interest income was primarily the result of increases in the volume of
business and consumer loans. An increase in yield on floating rate business
loans, the result of rising short-term market interest rates, also contributed.
The $213,000 or 6 percent increase in noninterest expense was primarily
attributable to increases in personnel and other expense. Current period
personnel expense reflected the planned addition of key sales and support staff,
increased health insurance premiums and normal merit increases. The increase in
other expense reflected increases in various expenses including: automated
teller machine/point of sale processing expense, Pennsylvania shares tax,
problem loan carrying costs, and employee related expenses associated with
training, seminars and business meetings.
NET INTEREST INCOME
Net interest income for the three-month period ended September 30, 2006, was
$4,535,000, an increase of $378,000 or 9 percent above the same period in 2005.
The increase in net interest income was primarily the result of increases in the
volume of business and consumer loans. An increase in yield on floating rate
business loans, the result of rising short-term market interest rates, also
contributed. The increase in other interest income resulted from an increase in
the volume and yield on federal funds sold, ie., overnight investments, which
increased in response to strong deposit growth. Earning assets averaged $477
million and yielded 7.31 percent (tax equivalent basis) for the third quarter of
2006, compared to $405 million and 6.48 percent, respectively, for the third
quarter of 2005.
Rising short-term market interest rates, a slightly inverted US treasury yield
curve, and competitive pricing pressures increased funding costs during the
current period, which lowered net interest margin. Interest bearing liabilities
averaged $429 million at an average rate of 3.81 percent for the third quarter
-14-
of 2006, compared to $354 million and 2.67 percent, respectively, for the third
quarter of 2005. The $75 million or 21 percent increase in the average volume of
interest bearing liabilities occurred primarily in money market deposits and
floating rate CDs. The net interest margin, on a tax equivalent basis, was 3.88
percent for the third quarter of 2006, compared to 4.14 percent for the same
period in 2005.
PROVISION FOR LOAN LOSSES
A $145,000 provision expense for loan losses was recorded for the three-month
period ended September 30, 2006, compared to $150,000 for the same period in
2005. The current period provision was based on management's assessment of
overall credit quality and macro-economic factors such as the relatively high
level of energy costs and interest rates, and a downturn in the real estate
market, which could portend debt service problems for some of our borrowers.
NONINTEREST INCOME
Total noninterest income for the current three-month period was $1,298,000,
which was approximately the same amount for the third quarter of 2005. During
the current period increases in income from wealth management and deposit
services were largely offset by a decrease in income from real estate settlement
services and gains from the sale of mortgages due to a downturn in the real
estate market.
NONINTEREST EXPENSE
Total noninterest expense for the current three-month period was $3,780,000, an
increase of $213,000 or 6 percent above the third quarter of 2005. The increase
was attributable primarily to a $192,000 or 10 percent increase in personnel
expense, which reflected the planned addition of key sales and support staff,
increased health insurance premiums and normal merit increases. Other expense
increased $104,000 or 20 percent due to increases in various expenses including:
automated teller machine/point of sale processing expense, Pennsylvania shares
tax, problem loan carrying costs and employee related expenses associated with
training, seminars and business meetings. The current period reflected a $40,000
or 34 percent decrease in postage, stationery and supplies, and a $23,000 or 14
percent decrease in marketing and advertising expense compared to the third
quarter of 2005. Both expenses in the third quarter of 2005 were relatively high
due to corporate expansion and implementation of a branding initiative.
INCOME TAXES
The provision for income tax was $501,000 for the third quarter of 2006,
compared to $451,000 for the same quarter in 2005. The $50,000 or 11 percent
increase in the tax provision was due in part to an increase in federal income
tax which resulted from a 10 percent increase in pretax income. An increase in
state income taxes also contributed to the overall increase in income tax.
Codorus Valley's effective federal income tax rate was approximately 25 percent,
compared to a marginal tax rate of 34 percent.
-15-
NINE MONTHS ENDED SEPTEMBER 30, 2006,
COMPARED TO NINE MONTHS ENDED SEPTEMBER 30, 2005
INCOME STATEMENT ANALYSIS
OVERVIEW
Net income for the nine month period ended September 30, 2006, was $4,191,000 or
$1.20 per share ($1.18 diluted), compared to $3,596,000 or $1.04 per share
($1.02 diluted), for the same period of 2005. The $595,000 or 17 percent
increase in net income was the result of increases in net interest income and
noninterest income, which more than offset an increase in noninterest expense.
The $1,676,000 or 14 percent increase in net interest income was attributable to
an increase in interest income and fees from a larger volume of business and
consumer loans, and higher yields on floating rate business loans. The net
interest margin was 4.06 percent for the current period compared to 4.16 percent
for the first nine months of 2005. The decrease in the net interest margin
reflects increased funding costs attributable to deposit growth and higher rates
affected by a flat/slightly inverted US treasury yield curve and competitive
price pressures. The $331,000 or 9 percent increase in noninterest income was
attributable primarily to increases in income from deposit and wealth management
services. The $1,165,000 or 11 percent increase in noninterest expense was
attributable to increases in personnel, furniture and equipment and occupancy
expenses associated in part with corporate expansion in the prior year, and
normal business growth. The other expense category, comprised of many individual
expenses, also increased due primarily to increases in problem asset carrying
costs, ATM/point-of-sale processing expense and charitable donations, among
others.
Net income as a percentage of average shareholder's equity (return on equity or
ROE), was 13.85 percent for the first nine months (annualized) of 2006, compared
to 12.85 percent for the same period of 2005. Net income as a percentage of
average total assets (return on assets or ROA), was 1.12 percent for both
periods. The efficiency ratio (noninterest expense as a percentage of net
operating revenue) for the current period was 63.6 percent, compared to 64.5
percent for the first nine months of 2005.
Total assets of the Corporation on September 30, 2006, were approximately $524
million, an increase of $48 million or 10 percent above December 31, 2005. Asset
growth occurred primarily in business and consumer loans, which were funded
primarily by growth in money market and CD deposits.
On September 30, 2006, nonperforming assets as a percentage of total loans and
net foreclosed real estate were 1.38 percent, compared to 0.36 percent for
September 30, 2005. Information regarding nonperforming assets is provided in
the Risk Management section of this report, including Table 3--Nonperforming
Assets. Based on a recent evaluation of probable loan losses and the current
loan portfolio, management believes that the allowance is adequate to support
losses inherent in the loan portfolio on September 30, 2006. An analysis of the
allowance is provided in Table 4--Analysis of Allowance for Loan Losses.
Throughout the current period Codorus Valley 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.
Note 5--Regulatory Matters, shows that the Corporation and PeoplesBank were well
capitalized on September 30, 2006.
A more detailed analysis of the factors and trends affecting corporate earnings
follows.
-16-
NET INTEREST INCOME
Net interest income for the nine month period ended September 30, 2006, was
$13,676,000, an increase of $1,676,000 or 14 percent above the same period in
2005. Earning assets averaged $461 million and yielded 7.17 percent (tax
equivalent) for 2006, compared to $391 million and 6.35 percent (tax
equivalent), respectively, for 2005. The $69 million or 18 percent increase in
average earning assets occurred primarily in business loans and secondarily in
consumer installment loans. The average portfolio balance of investment
securities for the current period was $71 million compared to $73 million for
2005; however, the yield for the current nine month period averaged 4.99 percent
(tax equivalent) or 64 basis points above 2005. The increase in other interest
income resulted from an increase in the volume and yield on federal funds sold,
ie., overnight investments, which increased in response to strong deposit
growth.
Rising short-term market interest rates, a slightly inverted US treasury yield
curve, and competitive pricing pressures continued to increase funding costs
throughout 2006, which lowered net interest margin. Interest bearing liabilities
averaged $410 million at an average rate of 3.50 percent for the first nine
months of 2006, compared to $344 million and 2.49 percent, respectively, for the
same period of 2005. The $66 million or 19 percent increase in the average
volume of interest bearing liabilities occurred primarily in money market
deposits and floating rate CDs. Deposit growth was favorably impacted by the
introduction of new money market products and the addition of two financial
centers in March 2005. The net interest margin, on a tax equivalent basis, was
4.06 percent for the first nine months of 2006, compared to 4.16 percent for the
same period in 2005.
In the period ahead, management expects that growth in net interest income will
continue to be constrained as a result of a flat/slightly inverted US treasury
yield curve environment and competitive pricing pressures. It is also possible
that some or most of the $9 million portfolio of securities held-to-maturity
will be called, at a premium, on the first call date, which ranges from December
2006 through June 2007. As described within the Balance Sheet Review section of
this report, if the securities are called it will result in a short-term
increase in interest income due to the recognition of the call premium; however,
replacement yields are expected to be lower.
PROVISION FOR LOAN LOSSES
A $500,000 provision expense for loan losses was recorded for the nine month
period ended September 30, 2006, compared to $525,000 for the same period in
2005. The current period provision was based on management's assessment of
overall credit quality, loan growth and macro-economic factors such as
relatively high energy costs and interest rates, and a downturn in the real
estate market. Information regarding nonperforming assets and the allowance for
loan losses can be found within those sections of this report.
NONINTEREST INCOME
The following table presents the components of total noninterest income for the
nine month period ended September 30, 2006, compared to the same period for
2005.
-17-
Table 1 - Noninterest income
Nine months ended Change
September 30, Increase (Decrease)
----------------- -------------------
(dollars in thousands) 2006 2005 $ %
------ ------ ---- ----
Trust and investment services fees $ 939 $ 856 $ 83 10%
Service charges on deposit accounts 1,400 1,193 207 17
Mutual fund, annuity and insurance sales 923 898 25 3
Income from bank owned life insurance 197 201 (4) (2)
Other income 389 387 2 1
Gain on sales of mortgages 210 278 (68) (24)
Loss on sales of securities 0 (86) 86 (100)
------ ------ ---- ----
Total noninterest income $4,058 $3,727 $331 9%
====== ====== ==== ====
The discussion that follows addresses changes within selected categories of
noninterest income.
Trust and investment services fees--For the first nine months of 2006, trust
fees increased $83,000 or 10 percent above 2005 due primarily to business
growth.
Service charges on deposit accounts--For the first nine months of 2006, service
charges on deposits increased $207,000 or 17 percent above 2005 due to an
increase in the volume of transactions and number of accounts. Check card (debit
card) and automated teller machine (ATM) commissions, and overdraft fees
continued to trend up in response to increased customer usage of check cards.
Other income--The other income category is comprised of many individual fees.
For the first nine months of 2006, other income was $389,000, approximately the
same amount as 2005. The current period contains a nonrecurring gain of $45,000
from the sale of two small parcels of land, totaling .3 acre, to the local
township for a road throughway. One parcel was held by Codorus Valley Bancorp,
Inc. and the other was held by its subsidiary PeoplesBank. The gain from the
sale was offset to some degree by a $37,000 decrease in income from real estate
settlement services, which resulted in part from a downturn in the real estate
market and competition.
Gain on sales of mortgages--For the first nine months of 2006, gains from the
sale of mortgages decreased $68,000 or 24 percent below the prior year due to a
decline in the volume of sales. The relatively high level of market interest
rates and home prices has resulted in a downturn in the real estate market,
which adversely affects mortgage banking operations.
Loss on sales of securities--For 2005, an infrequent loss of $86,000 was
recognized from the sale of securities available-for-sale in connection with an
"investment swap." The swap entailed selling low yielding investments at a loss
and replacing them with higher yielding investments, which increased portfolio
yield and interest income. There was no comparable transaction in 2006.
NONINTEREST EXPENSE
The following table presents the components of total noninterest expense for the
nine month period ended September 30, 2006, compared to the same period for
2005.
-18-
Table 2 - Noninterest expense
Nine months ended Change
September 30, Increase (Decrease)
----------------- -------------------
(dollars in thousands) 2006 2005 $ %
------- ------- ------ ----
Personnel $ 6,487 $ 5,778 $ 709 12%
Occupancy of premises, net 1,053 991 62 6
Furniture and equipment 1,043 938 105 11
Postage, stationery and supplies 318 364 (46) (13)
Professional and legal 214 238 (24) (10)
Marketing and advertising 391 427 (36) (8)
Other 2,037 1,642 395 24
------- ------- ------ ---
Total noninterest expense $11,543 $10,378 $1,165 11%
======= ======= ====== ===
The discussion that follows addresses changes in selected categories of
noninterest expense.
Personnel--For the first nine months of 2006, personnel expense, comprised of
wages, payroll taxes and employee benefits, increased $709,000 or 12 percent
above 2005 due to: planned staff additions, including financial center expansion
in the prior year; increased health insurance premiums; and normal merit
increases.
Occupancy of premises, net--For the first nine months of 2006, occupancy of
premises expense increased $62,000 or 6 percent above 2005 due primarily to
financial center expansion and renovation in the prior period.
Furniture and equipment--For the first nine months of 2006, furniture and
equipment expense increased $105,000 or 11 percent above 2005 due in part to
financial center expansion and renovation in the prior period. Current period
expense was also impacted by the timing of ATM maintenance contracts and the
bulk replacement of personal computers.
Postage, stationery and supplies--For the first nine months of 2006, postage,
stationery and supplies decreased $46,000 or 13 percent below 2005. The prior
period was relatively high due to corporate expansion and implementation of a
branding initiative.
Professional and legal--For the first nine months of 2006, professional and
legal expense decreased $24,000 or 10 percent below 2005 due to the settlement
of two lawsuits arising from routine bank business. During 2006, one of the
aforementioned lawsuits resulted in a $32,000 reimbursement to PeoplesBank for
legal expenses that it incurred in a prior period.
In the period ahead, consulting and auditing expenses are likely to increase as
Codorus Valley implements compliance with Section 404 of the Sarbanes-Oxley Act
of 2002. Section 404 requires publicly held companies to formally assess the
adequacy of controls over financial reporting, subject to independent audit
verification. The compliance deadline for Codorus Valley, a non-accelerated
filer, is presently December 31, 2007.
Marketing and advertising--For the first nine months of 2006, marketing and
advertising expense decreased $36,000 or 8 percent below 2005. The prior period
included expense associated with a
-19-
branding initiative for subsidiary PeoplesBank as well as costs to promote the
addition of two financial centers.
Other-- The other expense category is comprised of many individual expenses. For
the first nine months of 2006, other expense increased $395,000 or 24 percent
above 2005. The increase was due largely to increases in: problem asset carrying
costs (the current period reflected a larger portfolio of nonaccrual loans, the
prior period included a $151,000 gain from the sale of collateral),
ATM/point-of-sale processing expense (transaction volume), and charitable
donations, among others. Normal business growth also contributed to the increase
in other expense.
INCOME TAXES
The provision for income tax was $1,500,000 for the current nine month period
representing a $272,000 or 22 percent increase above the same period in 2005.
Approximately $219,000 of the increase was attributable to an increase in
federal income tax which resulted from an 18% increase in pretax income. Federal
income tax for both periods was reduced by the recognition of tax credits from
investments in low income housing partnerships. For the current period, tax
credits totaled $238,000, compared to $248,000 for the first nine months of
2005. Codorus Valley's effective federal income tax rate was approximately 25
percent, compared to a marginal tax rate of 34 percent. Additionally, state
income taxes increased $53,000 above 2005 due primarily to the implementation of
a loan production office in Maryland in January 2006.
BALANCE SHEET REVIEW
FEDERAL FUNDS SOLD
On September 30, 2006, federal funds sold, ie., overnight investments, were $13
million, compared to $0 for year-end 2005. The increase in federal funds sold
was caused primarily by an increase in liquidity from strong deposit growth
throughout the current period as described under the Deposits section of this
report.
SECURITIES AVAILABLE-FOR-SALE
On September 30, 2006, securities available-for-sale was $64 million, compared
to $58 million for year-end 2005. The 10 percent increase occurred primarily
from the purchase of high quality, tax-exempt municipal bonds with maturities
that range from eight to ten years.
SECURITIES HELD-TO-MATURITY
The $9 million portfolio of securities held-to-maturity consists of 13 fixed
rate, junior subordinated debt instruments that become callable for the first
time in December 2006 through June 2007, with one exception which becomes
callable in March 2008. If the securities are not called on their first call
date they become continuously callable thereafter. If the securities are called,
the issuer will be required to pay a call premium, which averages 4% on the
first call date. The call premium amortizes (decreases) over the next ten years
to par value. If the securities are called, it will result in a short-term
increase in interest income due to the recognition of the call premium; however,
replacement yields are expected to be lower.
-20-
LOANS
On September 30, 2006, loans were approximately $397 million, an increase of $29
million or 8 percent above year-end 2005. The increase was primarily
attributable to an increase in business loans and to a lesser degree consumer
loans. The year-to-date average yield (tax-equivalent basis) on loans was 7.61
percent for September 30, 2006, compared to 6.84 percent for the first nine
months of 2005.
DEPOSITS
On September 30, 2006, total deposits were approximately $433 million, an
increase of $48 million or 13 percent above year-end 2005. The increase in
deposits, which reflected the continuation of a long trend of successful sales
efforts, occurred primarily within the money market and CD categories, as shown
in Note 3--Deposits of this report. The increase in money market deposits was
partially the result of new money market products, which were priced
competitively and heavily promoted. CD growth occurred in variable rate CD's,
which re-price weekly based on the one year US Treasury bond rate. The trend of
rising short-term interest rates, since July 2004, was a factor in overall
deposit growth and product selection by bank customers. The increase in deposits
was also attributable in part to the addition of two financial centers in March
of 2005. The year-to-date average rate paid on interest-bearing deposits was
3.31 percent for September 30, 2006, compared to 2.22 percent for the first nine
months of 2005.
SHORT-TERM BORROWINGS AND LONG-TERM DEBT
On September 30, 2006, there were no short-term borrowings, compared to $10
million outstanding at year-end 2005. Deposit growth during the current period
provided funds to repay short-term borrowings. On September 30, 2006, long-term
debt was $46 million, compared to $40 million for year-end 2005. During June
2006, Codorus Valley issued $7.2 million in trust preferred debt securities to
support planned corporate growth. This obligation has a 30-year maturity, but is
callable at quarterly intervals after the fifth year. The interest rate is
variable tied to the 3-month LIBOR rate plus 154 basis points. A listing of
outstanding long-term debt instruments is provided in Note 4--Long-term Debt of
this report. The year-to-date average rate paid on long-term debt was 4.98
percent for September 30, 2006, compared to 4.78 percent for the first nine
months of 2005. Generally, funds for the payment of long-term debt come from
operations and refinancings.
SHAREHOLDERS' EQUITY AND CAPITAL ADEQUACY
Shareholders' equity or capital, as a source of funds, enables Codorus Valley to
maintain asset growth and absorb losses. Total shareholders' equity was
approximately $42.1 million on September 30, 2006, an increase of $3.4 million
or 9 percent above year-end 2005. The increase was attributable to profitable
operations.
On October 10, 2006, the Board of Directors declared a quarterly cash dividend
of $.135 per common share ($.129 adjusted), payable on or before November 14,
2006, to shareholders of record October 24, 2006. This follows three $.13 per
share cash dividends paid in August ($.124 adjusted), May ($.118 adjusted) and
February ($.118 adjusted). Total cash dividends for 2006 will total $.49 per
share, as adjusted, for an increase of $.04 or 9 percent above 2005. In
addition, on October 10, 2006, the Board of Directors declared a special 5
percent stock dividend payable on or before December 7, 2006, to shareholders of
record October 24, 2006, which will result in the issuance of approximately
166,659 common shares. This follows a 5 percent stock dividend distributed in
June 2006, which resulted in the issuance of 157,713 common shares.
-21-
As described under the caption, short-term borrowings and long-term debt,
Codorus Valley issued $7.2 million in trust preferred debt securities in June
2006 to support planned growth. The interest expense on trust preferred debt is
tax deductible, while the amount borrowed is included in Tier 1 capital, subject
to regulatory limitations, for regulatory capital purposes.
On October 14, 2004, the Corporation issued a press release, which was filed on
Form 8-K, announcing that the Board of Directors authorized the purchase, in
open market and privately negotiated transactions, of up to 4.9 percent or
approximately 146,000 shares of its then outstanding common stock. As of
September 30, 2006, the Corporation had not acquired any of its common stock
under the authorization reported in October 2004.
Codorus Valley 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 Note 5--Regulatory
Matters, to the financial statements. Management believes that Codorus Valley
and PeoplesBank were well capitalized on September 30, 2006, based on FDIC
capital guidelines.
RISK MANAGEMENT
NONPERFORMING ASSETS
Table 3--Nonperforming Assets, provides a summary of nonperforming assets and
related ratios. The paragraphs below provide information for selected categories
for September 30, 2006, compared to December 31, 2005.
Table 3-Nonperforming Assets
September 30, December 31,
(dollars in thousands) 2006 2005
------------- ------------
Nonaccrual loans $5,475 $1,034
Accruing loans that are contractually past due
90 days or more as to principal or interest 13 0
Foreclosed real estate, net of allowance 5 7
------ ------
Total nonperforming assets $5,493 $1,041
====== ======
Ratios:
Nonaccrual loans as a % of total period-end loans 1.38% 0.28%
Nonperforming assets as a % of total period-end
loans and net foreclosed real estate 1.38% 0.28%
Nonperforming assets as a % of total period-end
stockholders' equity 13.04% 2.69%
Allowance for loan losses as a multiple of
nonaccrual loans 0.5x 2.5x
On September 30, 2006, nonaccrual loans consisted of collateralized business and
mortgage loans, and consumer loans. The Corporation recognizes interest income
on a cash basis for nonaccrual loans. On
-22-
September 30, 2006, the $4,441,000 increase in nonaccrual loans was primarily
attributable to the addition of three unrelated business loans in the amounts of
$2,624,000, $686,000 and $526,000. The $2,624,000 loan, which has matured, has
been making interest payments and management believes that the net realizable
value of the real estate collateral, based on a recent independent appraisal,
along with personal guarantees is adequate to ensure the ultimate recovery of
interest and principal in full. In management's judgment the net realizable
value of the real estate collateral for the $686,000 loan is insufficient.
Accordingly, management established a $206,000 loss allowance for this account.
During the third quarter of this year a credit worthy guarantor was added to the
$526,000 account and brought all interest and principal current. Management
plans to reclassify this loan to accrual status in the fourth quarter. On
September 30, 2006, the nonaccrual loan portfolio was comprised of 21 unrelated
accounts ranging in size from $2,000 to $2,624,000. 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.
The level of loans contractually past due 90 days or more as to principal or
interest was insignificant for September 30, 2006 and December 31, 2005.
ALLOWANCE FOR LOAN LOSSES
Table 4--Analysis of Allowance for Loan Losses, shows the allowance was
$2,969,000 or .75 percent of total loans on September 30, 2006, compared to
$2,277,000 or .68 percent of total loans, respectively, on September 30, 2005.
The $692,000 or 30 percent increase in the allowance was based on management's
estimate to bring the allowance to a level reflective of risk in the portfolio,
loan growth, and macro-economic factors such as the relatively high level of
energy costs and interest rates, and a downturn in the real estate market. Based
on a recent evaluation of potential loan losses in the current portfolio,
management believes that the allowance is adequate to support losses inherent in
the loan portfolio on September 30, 2006.
-23-
Table 4-Analysis of Allowance for Loan Losses
(dollars in thousands) 2006 2005
------ ------
Balance-January 1, $2,538 $1,865
Provision charged to operating expense 500 525
Loans charged off:
Commercial 104 34
Real estate-mortgage 17 99
Consumer 22 59
------ ------
Total loans charged off 143 192
Recoveries:
Commercial 45 57
Real estate-mortgage 2 1
Consumer 27 21
------ ------
Total recoveries 74 79
------ ------
Net charge-offs 69 113
------ ------
Balance-September 30, $2,969 $2,277
------ ------
Ratios:
Net annualized charge-offs to
average total loans 0.02% 0.05%
Allowance for loan losses to total loans
at period-end 0.75% 0.68%
Allowance for loan losses to nonaccrual loans
and loans past due 90 days or more 54.1% 59.8%
LIQUIDITY
Codorus Valley's loan-to-deposit ratio, which is used as a broad measure of
liquidity, was approximately 91.6 percent on September 30, 2006, compared to
95.6 percent on December 31, 2005. Liquidity for both periods was adequate based
on availability from many sources, including the potential liquidation of a $64
million portfolio of available-for-sale securities, valued at September 30,
2006. Another important source of liquidity for PeoplesBank is available credit
from the FHLBank Pittsburgh. On June 30, 2006, the latest available date,
available funding from the FHLBank Pittsburgh was approximately $81 million. The
successful promotion of deposit products and the addition of two financial
centers in March 2005 have increased liquidity in the form of deposit growth.
The issuance of $7.2 million in trust preferred debt securities by Codorus
Valley in June 2006 also provided liquidity.
The Consolidated Statements of Cash Flows, included in this Form 10-Q report,
present the changes in cash from operations, investing and financing activities.
Off-Balance Sheet Arrangements
Codorus Valley'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 of existing loans, and letters of credit made under the
same standards as on-balance sheet instruments. Unused commitments on September
30, 2006, totaled $131,406,000 and consisted of $82,174,000 in unfunded
commitments of existing loans,
-24-
$41,762,000 to grant new loans and $7,470,000 in letters of credit. Due to fixed
maturity dates and specified conditions within these instruments, many will
expire without being drawn upon. Management believes that amounts actually drawn
upon can be funded in the normal course of operations and therefore do not
present a significant liquidity risk to Codorus Valley.
Contractual Obligations
Codorus Valley has various long-term contractual obligations outstanding at
September 30, 2006, including long-term debt, time deposits and obligations
under capital and operating leases, which were reported in Table 13 of the
Annual Report on Form 10-K for the year ended 2005. A comparative schedule of
deposits, which includes time deposits, is provided in Note 3 of this Form 10-Q
report. A comparative schedule of long-term debt is provided in Note 4.
MARKET RISK MANAGEMENT
In the normal course of conducting business, Codorus Valley is exposed to market
risk, principally interest rate risk, through the operations of its banking
subsidiary. Interest rate risk arises from market driven fluctuations in
interest rates, which may affect cash flows, income, expense and values of
financial instruments. An asset-liability management committee comprised of
members of management manages interest rate risk.
Codorus Valley performed a simulation on its balance sheet for September 30,
2006 and December 31, 2005. The results of the point-in-time analyses are shown
in Table 3--Interest Rate Sensitivity. The most likely scenario for September
30, 2006, assumes that short-term market interest rates will remain stable
through year-end 2006 and then decrease a total of 75-basis points (in 25-basis
points increments) over the remaining nine months of the 12-month simulation
period. Continued growth in interest rate sensitive liabilities, principally
floating rate CDs and money market funds have gradually shifted the balance
sheet to a liability sensitive position. Liability sensitivity means that
deposits and debt will reprice to a greater and faster degree than the loans and
investments that they fund. This suggests that earnings may increase if market
interest rates decrease. Conversely, earnings may decrease if short-term market
interest rates, which have been influenced by the Federal Reserve Bank,
increase. Under the low rate scenario (down 200 basis points) for both periods,
management presumed that trust preferred investment securities, which are
callable at a premium, would be called due to the relatively high coupon rate
and would result in a one time increase in interest income to the Corporation. A
detailed discussion of market interest rate risk is provided in the
Corporation's Annual Report on Form 10-K for the year ended December 31, 2005.
-25-
Table 5-Interest Rate Sensitivity
Change in
Forecasted Change in interest rates net income
interest rate ramped over 12 months -------------
scenario (basis points) $000's %
--------------- ------------------------ ------ ----
AT SEPTEMBER 30, 2006
Most likely -75 (70) (1.4)
High +200 (246) (5.0)
Flat (baseline) 0 0 0.0
Low -200 265 5.4
AT DECEMBER 31, 2005
Most likely +50 (1) 0.0
High +200 2 0.0
Flat (baseline) 0 0 0.0
Low -200 39 0.7
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Refer to the section entitled "Market risk management" within Management's
Discussion and Analysis of Consolidated Financial Condition and Results of
Operations on page 25 of this Form 10-Q.
ITEM 4. CONTROLS AND PROCEDURES
Codorus Valley maintains disclosure controls and procedures designed to ensure
that information required to be disclosed in the reports that the Corporation
files or submits under the Securities Exchange Act of 1934 is recorded,
processed, summarized and reported within the time periods specified in the
rules and forms of the Securities and Exchange Commission. Based upon their
evaluation of those controls and procedures performed as of September 30, 2006,
the chief executive and chief financial officers of Codorus Valley concluded
that Codorus Valley's disclosure controls and procedures were adequate.
Codorus Valley made no changes in its internal controls or in other factors that
has materially affected, or is reasonably likely to materially affect the
Corporation's internal control over financial reporting, as evaluated by the
chief executive and chief financial officers.
PART II--OTHER INFORMATION
ITEM 1. 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 government authorities.
ITEM 1A. RISK FACTORS
Management is not aware of any material changes in the risk factors previously
disclosed in the Corporation's Annual Report on Form 10-K for the year ended
December 31, 2005.
-26-
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Codorus Valley made no sales or repurchases of equity securities during the
quarter ended September 30, 2006.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Nothing to report.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Nothing to report.
ITEM 5. OTHER INFORMATION
Nothing to report.
ITEM 6. EXHIBITS
Exhibit
Number Description of Exhibit
------- -----------------------
3(i) Articles of Incorporation (Incorporated by reference to Exhibit 3(i)
to the Registrant's Current Report on Form 8-K, filed with the
Commission on October 14, 2005.)
3(ii) By-laws (Incorporated by reference to Exhibit 3(ii) to the
Registrant's Current Report on Form 8-K, filed with the Commission on
October 14, 2005.)
4 Rights Agreement dated as of November 4, 2005 (Incorporated by
reference to Exhibit 4 to the Registrant's Current Report on Form 8-K,
filed with the Commission on November 8, 2005.)
10.1 1996 Stock Incentive Plan (Incorporated by reference to Exhibit 99 of
Registration Statement No. 333-09277 on Form S-8, filed with the
Commission on July 31, 1996.)
10.2 Employment Agreement between Codorus Valley Bancorp, Inc.,
PeoplesBank, A Codorus Valley Company and Larry J. Miller dated
December 27, 2005. (Incorporated by reference to Exhibit 10.1 to the
Registrant's Current Report on Form 8-K, filed with the Commission on
January 3, 2006.)
10.3 Change of Control Agreement by and among Codorus Valley Bancorp, Inc.,
PeoplesBank, A Codorus Valley Company and Jann A. Weaver, dated
December 27, 2005. (Incorporated by reference to Exhibit 10.7 to the
Registrant's Current Report on Form 8-K, filed with the Commission on
January 3, 2006.)
10.4 Change of Control Agreement by and among Codorus Valley Bancorp, Inc.,
PeoplesBank, A Codorus Valley Company and Harry R. Swift, dated
December 27, 2005. (Incorporated by reference to Exhibit 10.6 to the
Registrant's Current Report on Form 8-K, filed with the Commission on
January 3, 2006.)
10.5 1998 Independent Directors Stock Option Plan (Incorporated by
reference to Exhibit 4.3 of Registrant Statement No. 333-61851 on Form
S-8, filed with the Commission on August 19, 1998.)
-27-
10.6 2000 Stock Incentive Plan (Incorporated by reference to Exhibit 4.3 of
Registration Statement No. 333-40532 on Form S-8, filed with the
Commission on June 30, 2000.)
10.7 2001 Employee Stock Bonus Plan (Incorporated by reference to Exhibit
99.1 of Registration Statement No. 333-68410 on Form S-8, filed with
the Commission on August 27, 2001.)
10.8 Dividend Reinvestment and Stock Purchase Plan (Incorporated by
reference to Exhibit 4(a) Registration Statement no. 33-46171 on
Amendment no. 4 to Form S-3, filed with the Commission on July 23,
2004.)
10.9 Amendment to Salary Continuation Agreement by and among PeoplesBank, A
Codorus Valley Company, a wholly owned subsidiary of Codorus Valley
Bancorp, Inc. and Larry J. Miller dated December 27, 2005.
(Incorporated by reference to Exhibit 10.3 to the Registrant's Current
Report on Form 8-K, filed with the Commission on January 3, 2006.)
10.10 Amendment to Salary Continuation Agreement by and among PeoplesBank, A
Codorus Valley Company, a wholly owned subsidiary of Codorus Valley
Bancorp, Inc. and Harry R. Swift dated December 27, 2005.
(Incorporated by reference to Exhibit 10.4 to the Registrant's Current
Report on Form 8-K, filed with the Commission on January 3, 2006.)
10.11 Amendment to Salary Continuation Agreement by and among PeoplesBank, A
Codorus Valley Company, a wholly owned subsidiary of Codorus Valley
Bancorp, Inc. and Jann A. Weaver dated December 27, 2005.
(Incorporated by reference to Exhibit 10.5 to the Registrant's Current
Report on Form 8-K, filed with the Commission on January 3, 2006.)
10.12 Form of Group Term Replacement Plan, dated December 1, 1998, as
amended, including Split Dollar Policy Endorsements pertaining to
senior officers of the Corporation's subsidiary, PeoplesBank, A
Codorus Valley Company. (Incorporated by reference to Exhibit 10.12 to
the Registrant's Annual Report on Form 10-K, filed on March 29, 2005.)
10.13 Sample form of Director Group Term Replacement Plan, dated December 1,
1998, including Split Dollar Policy Endorsements pertaining to
non-employee directors of the Corporation's subsidiary, PeoplesBank, A
Codorus Valley Company. (Incorporated by reference to Exhibit 10.13 to
the Registrant's Annual Report on Form 10-K, filed on March 29, 2005.)
10.14 Long Term Nursing Care Agreement between Codorus Valley Bancorp, Inc.,
PeoplesBank, A Codorus Valley Company and Larry J. Miller, dated
December 27, 2005. (Incorporated by reference to Exhibit 10.2 to the
Registrant's Current Report on Form 8-K, filed with the Commission on
January 3, 2006.)
10.15 Codorus Valley Bancorp, Inc. Change in Control and Supplemental
Benefit Trust Agreement between Codorus Valley Bancorp, Inc.,
PeoplesBank, A Codorus Valley Company and Hershey Trust Company, dated
January 25, 2006. (Incorporated by reference to Exhibit 10.1 to the
Registrant's Current Report on Form 8-K, filed with the Commission on
January 27, 2006.)
-28-
10.16 Amended and Restated Declaration of Trust of CVB Statutory Trust No.
2, dated June 28, 2006. (Incorporated by reference to Exhibit 10.1 to
the Registrant's Current Report on Form 8-K, filed with the Commission
on June 30, 2006.)
10.17 Indenture, dated as of June 28, 2006 between Codorus Valley Bancorp,
Inc., as issuer, and the trustee named therein, relating to the Junior
Subordinated Debt Securities due 2036. (Incorporated by reference to
Exhibit 10.2 to the Registrant's Current Report on Form 8-K, filed
with the Commission on June 30, 2006.)
10.18 Guarantee Agreement, dated June 28, 2006, between Codorus Valley
Bancorp, Inc. and the guarantee trustee named therein. (Incorporated
by reference to Exhibit 10.3 to the Registrant's Current Report on
Form 8-K, filed with the Commission on June 30, 2006.)
31a Certification of Principal Executive Officer Pursuant to Section 302
of the Sarbanes-Oxley Act of 2002
31b Certification of Principal Financial Officer Pursuant to Section 302
of the Sarbanes-Oxley Act of 2002
32 Certification of Principal Executive Officer and Principal Financial
Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
-29-
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has caused this report to be signed on its behalf by the authorized
undersigned.
Codorus Valley Bancorp, Inc.
(Registrant)
November 9, 2006 /s/ Larry J. Miller
Date ----------------------------------------
Larry J. Miller
President & CEO
(Principal executive officer)
November 9, 2006 /s/ Jann A. Weaver
Date ----------------------------------------
Jann A. Weaver
Treasurer & Assistant Secretary
(Principal financial and accounting
officer)
-30-