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CVLY > SEC Filings for CVLY > Form 10-Q on 13-Nov-2012All Recent SEC Filings

Show all filings for CODORUS VALLEY BANCORP INC

Form 10-Q for CODORUS VALLEY BANCORP INC


13-Nov-2012

Quarterly Report


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 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 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.

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-Q. 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, which 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 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.

Critical accounting policies

We have identified critical accounting policies for the Corporation to include allowance for loan losses, valuation of foreclosed real estate and evaluation of other-than-temporary impairment losses of securities. There were no material changes made to the critical accounting policies disclosed in the 2011 Annual Report on Form 10-K in regards to application or related judgments and estimates used. A detailed disclosure pertaining to critical accounting estimates is provided in Item 7 of the Corporation's 2011 Annual Report on Form 10-K.

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Three months ended September 30, 2012,
compared to three months ended September 30, 2011

FINANCIAL HIGHLIGHTS

The Corporation earned net income available to common shareholders (earnings) totaling $1,809,000 for the quarter ended September 30, 2012, compared to $4,000 for the quarter ended September 30, 2011. The $1,805,000 increase in earnings for the third quarter of 2012, compared to the third quarter of 2011, was primarily the result of a decrease in the provision for loan losses, an increase in interest and noninterest income and a decrease in preferred stock dividends, which more than offset increases in noninterest expense and provision for income taxes.

The $2,910,000 or 82 percent decrease in the provision for loan losses for the third quarter of 2012, compared to the third quarter of 2011, reflected an unusually large provision in the third quarter of 2011 to replenish the allowance for loan losses for the partial charge-off of two unrelated loans totaling $3,175,000.

The $324,000 or 4 percent increase in net interest income for the third quarter of 2012, compared to the third quarter of 2011, resulted primarily from 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. The average volume of interest earning assets, principally commercial loans, increased $59 million or 6 percent, during the current quarter compared to the third quarter of 2011. Income from the increase in loan volume was offset by decreasing asset yields.

The $503,000 or 28 percent increase in total noninterest income for the third quarter of 2012, compared to the same quarter of 2011, was due in part to a $167,000 or 132 percent increase in gains from increased sales of residential mortgage loans, principally refinancings, stimulated by the low level of market interest rates. The infrequent recognition of gains from the sale of securities totaling $382,000 during the current quarter also contributed to the increase in noninterest income. Approximately $9 million of U.S agency mortgage-backed securities (MBS) were selectively sold to remove relatively low yielding instruments that were prepaying principal faster than anticipated and small odd-lot pieces from the MBS portfolio.

The $595,000 or 91 percent decrease in preferred stock dividends and discount accretion for the third quarter of 2012, compared to the third quarter of 2011, reflected the recognition of $379,000 of unamortized discount in the third quarter of 2011, which coincided with the full redemption of preferred stock under the U.S. Treasury's Capital Purchase Program. The decrease in preferred stock dividends also reflects a decrease in the dividend rate caused by the addition of loans above a predetermined baseline portfolio balance that qualified for the U.S. Treasury's Small Business Lending Fund Program.

The $1,877,000 or 30 percent increase in total noninterest expense for the third quarter of 2012, compared to the same quarter of 2011, was due primarily to increases in foreclosed real estate costs and personnel expenses. The $1,284,000 or 600 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 dated August 30, 2012. The $588,000 or 18 percent increase in personnel expense was due to normal business growth, which included the impact of franchise expansion in September 2011, and the accrual of annual performance incentives.

The provision for income tax for the third quarter of 2012 was $511,000, compared to an income tax benefit of $139,000 for the third quarter of 2011. The increase in income taxes was primarily the result of the significant increase in income before income taxes.

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The schedule below presents selected performance metrics for the third quarter of 2012 and 2011.

                                         Three months ended
                                           September 30,
                                          2012         2011
Basic earnings per share               $     0.41    $   0.00
Diluted earnings per share             $     0.40    $   0.00
Cash dividend payout ratio                   25.7 %        nm
Return on average assets                     0.71 %      0.26 %
Return on average equity                     7.50 %      3.04 %
Net interest margin (tax equivalent)         3.70 %      3.79 %
Net overhead ratio                           2.38 %      1.81 %
Efficiency ratio                            72.48 %     58.13 %
Average equity to average assets             9.44 %      8.68 %

nm - not meaningful

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

INCOME STATEMENT ANALYSIS

Net interest income

Net interest income for the three-month period ended September 30, 2012, was $8,931,000, an increase of $324,000 or 4 percent above the third quarter of 2011. The increase was primarily the result of 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 3.70 percent for the third quarter of 2012, compared to 3.79 percent for the third quarter of 2011.

The $130,000 or 1 percent decrease in total interest income for the current quarter, compared to the third quarter of 2011, was due primarily to a decrease in yields on earning assets, which was reflective of the long duration of historically low market interest rates. Interest earning assets averaged $998 million and yielded 4.77 percent (tax equivalent basis) for the current quarter, compared to $939 million and 5.11 percent, respectively, for the third quarter of 2011. The $59 million or 6 percent increase in the average volume of interest earning assets, principally commercial loans, partially offset the decrease in the average yield.

The $454,000 or 15 percent decrease in total interest expense for the current quarter, compared to the third quarter of 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 $865 million at an average rate of 1.23 percent for the current quarter, compared to $835 million and 1.49 percent, respectively, for the third quarter of 2011. The $30 million or 4 percent increase in the average volume of interest bearing liabilities reflected growth in core deposits, principally money market and demand deposits. The Corporation defines core deposits as all deposits except certificates of deposit.

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


                                             Three months ended September 30,
                                        2012                                 2011
                           Average                  Yield/      Average                   Yield/
(dollars in thousands)     Balance     Interest      Rate       Balance      Interest      Rate

Assets
Interest bearing
deposits with banks      $    54,940   $      35       0.25 % $    25,187   $       17       0.27 %
Federal funds sold                 0           0       0.00             0            0       0.00
Investment securities:
Taxable                      145,974         836       2.28       151,295          977       2.56
Tax-exempt                    85,500         900       4.19        78,139          882       4.48
Total investment
securities                   231,474       1,736       2.98       229,434        1,859       3.21

Loans:
Taxable (1)                  698,606      10,000       5.69       669,875       10,001       5.92
Tax-exempt                    13,257         193       5.79        14,411          215       5.92
Total loans                  711,863      10,193       5.70       684,286       10,216       5.92
Total earning assets         998,277      11,964       4.77       938,907       12,092       5.11
Other assets (2)              58,406                               62,076
Total assets             $ 1,056,683                          $ 1,000,983
Liabilities and
Shareholders' Equity
Deposits:
Interest bearing
demand                   $   338,046   $     340       0.40 % $   314,788   $      511       0.64 %
Savings                       34,188          21       0.24        29,543           27       0.36
Time                         431,089       2,083       1.92       428,168        2,279       2.11
Total interest bearing
deposits                     803,323       2,444       1.21       772,499        2,817       1.45
Short-term borrowings         25,438          36       0.56        11,724           29       0.98
Long-term debt                36,050         197       2.17        51,063          285       2.21
Total interest bearing
liabilities                  864,811       2,677       1.23       835,286        3,131       1.49

Noninterest bearing
deposits                      84,527                               73,553
Other liabilities              7,565                                5,247
Shareholders' equity          99,780                               86,897

Total liabilities and
shareholders' equity     $ 1,056,683                          $ 1,000,983
Net interest income                    $   9,287                            $    8,961
Net interest margin
(3)                                                    3.70 %                                3.79 %

(1) Average balance includes average nonaccrual loans of $10,948,000 for 2012 and $19,080,000 for 2011. Interest includes net loan fees of $275,000 for 2012 and $231,000 for 2011.
(2) Average balance includes average bank owned life insurance, foreclosed real estate and unrealized holding gains (losses) on investment securities.
(3) Net interest income annualized 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)

                                                   Three months ended
                                                      September 30,
                                                      2012 vs. 2011
                                          Increase (decrease) due to change in
(dollars in thousands)                    Volume           Rate            Net

Interest Income
Interest bearing deposits with banks   $          20    $        (2 )  $        18
Federal funds sold                                 0              0              0
Investment securities:
Taxable                                          (27 )         (114 )         (141 )
Tax-exempt                                        83            (65 )           18
Loans:
Taxable                                          639           (640 )           (1 )
Tax-exempt                                       (17 )           (5 )          (22 )
Total interest income                            698           (826 )         (128 )
Interest Expense
Deposits:
Interest bearing demand                           34           (205 )         (171 )
Savings                                            4            (10 )           (6 )
Time                                              16           (212 )         (196 )
Short-term borrowings                             35            (28 )            7
Long-term debt                                   (86 )           (2 )          (88 )
Total interest expense                             3           (457 )         (454 )
Net interest income                    $         695    $      (369 )  $       326

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

For the three-month period ended September 30, 2012, the provision for loan losses was $650,000, which was the level needed to maintain the adequacy of the allowance for loan losses. Comparatively, the $3,560,000 provision recorded for the third quarter of 2011, which was unusually large, replenished the allowance for the partial charge-off of two unrelated loans totaling $3,175,000 as reported on a Form 8-K filed October 31, 2011 and a Form 8-K/A filed on November 10, 2011. Information about loan quality is provided in the Nonperforming Assets section of this report on page 50.

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Noninterest income

The following table presents the components of total noninterest income for the third quarter of 2012, compared to the third quarter of 2011.

Table 3 - Noninterest income

                                       Three months ended                Change
                                         September 30,             Increase (Decrease)
(dollars in thousands)                 2012          2011           $               %

Trust and investment services
fees                                $      450    $      384   $        66              17 %
Income from mutual fund, annuity
and insurance sales                        227           308           (81 )           (26 )
Service charges on deposit
accounts                                   635           657           (22 )            (3 )
Income from bank owned life
insurance                                  157           164            (7 )            (4 )
Other income                               151           153            (2 )            (1 )
Net gain on sales of loans held
for sale                                   293           126           167             133
Net gain (loss) on sales of
securities                                 382             0           382              nm
Total noninterest income            $    2,295    $    1,792   $       503              28 %

nm - not meaningful

The discussion that follows addresses changes in selected categories of noninterest income.

Trust and investment services fees-The $66,000 or 17 percent increase in trust and investment services fees was due to new business and to a lesser degree market appreciation.

Income from mutual fund, annuity and insurance sales-The $81,000 or 26 percent decrease in income from mutual fund, annuity and insurance sales was due to a decrease in sales. The low interest rate environment has negatively affected the sale of annuity products and economic and political uncertainties have resulted in some investors maintaining larger cash positions.

Service charges on deposit accounts-The $22,000 or 3 percent decrease in service charge income was 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 pricing restrictions that took effect July 1, 2011.

Net gain on sales of loans held for sale-The $167,000 or 133 percent increase in gains from the sale of loans was due primarily to an increase in the volume of residential mortgage loan sales. The low level of market interest rates influenced by the Federal Reserve Bank to stimulate the U.S. economy continue to stimulate residential mortgage loan refinancings.

Net gain on sales of securities-$382,000 in gains were recognized in the current quarter from the sale of approximately $9 million 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 pieces from the MBS portfolio.

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Noninterest expense

The following table presents the components of total noninterest expense for the third quarter of 2012, compared to the third quarter of 2011.

Table 4 - Noninterest expense

                                       Three months ended                Change
                                         September 30,            Increase (Decrease)
(dollars in thousands)                 2012          2011           $              %

Personnel                           $    3,806    $    3,218   $        588            18 %
Occupancy of premises, net                 485           501            (16 )          (3 )
Furniture and equipment                    490           434             56            13
Postage, stationery and supplies           116           128            (12 )          (9 )
Professional and legal                     155           205            (50 )         (24 )
Marketing and advertising                  259           278            (19 )          (7 )
FDIC insurance                             181           223            (42 )         (19 )
Debit card processing                      181           169             12             7
Charitable donations                        26            37            (11 )         (30 )
Telephone                                  127           128             (1 )          (1 )
External data processing                   149           107             42            39
Foreclosed real estate including
(gains) losses on sales                  1,498           214          1,284           600
Impaired loan carrying costs                36            95            (59 )         (62 )
Other                                      685           580            105            18
Total noninterest expense           $    8,194    $    6,317   $      1,877            30 %

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

Personnel-The $588,000 or 18 percent increase in personnel expense was due to normal business growth, which included the impact of a branch office addition in September 2011, and the accrual of annual performance incentives.

Foreclosed real estate including (gains) losses on sales-The $1,284,000 or 600 percent increase in foreclosed real estate costs reflected increased provisioning for impairment losses, including the $1,027,000 provision relating to a foreclosed property, as previously reported on Form 8-K filed on August 30, 2012.

Other-The $105,000 or 18 percent increase in other expense, which is comprised of many underlying expenses, was primarily the result of timing and normal business growth.

Income taxes

The provision for income tax for the third quarter of 2012 was $511,000, compared to an income tax benefit of $139,000 for the third quarter of 2011. The increase in income taxes was primarily the result of the significant increase in income before income taxes. For both periods, the Corporation's statutory federal income tax rate was 34 percent. The Corporation's effective income tax rate was 22 percent for the third quarter of 2012, compared to a negative rate for the third quarter of 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.

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Preferred stock dividends and discount accretion

Preferred stock dividends for the third quarter of 2012 were $62,000, compared to preferred stock dividends and discount accretion totaling $657,000 for the third quarter of 2011. The $595,000 or 91 percent decrease reflected the recognition of $379,000 of unamortized discount in the third quarter of 2011, which coincided with the full redemption of preferred stock under the U.S. Treasury's Capital Purchase Program. The decrease in preferred stock dividends also reflected a decrease in the dividend rate caused by the addition of loans above a predetermined baseline portfolio balance that qualified for a lower rate under the U.S. Treasury's Small Business Lending Fund Program. Information about U.S. Treasury capital programs is provided in Note 10-Shareholders' Equity of this report.

Nine months ended September 30, 2012,
compared to nine months ended September 30, 2011

FINANCIAL HIGHLIGHTS

The Corporation earned net income available to common shareholders (earnings) totaling $6,619,000 for the nine month period ended September 30, 2012, compared to $2,896,000 for the same period of 2011. The $3,723,000 or 129 percent increase in earnings was primarily the result of a decrease in the provision for loan losses, an increase in interest and noninterest income and a decrease in preferred stock dividends, which more than offset increases in noninterest expense and provision for income taxes.

The $3,635,000 or 76 percent decrease in the provision for loan losses for the first nine months of 2012, compared to the same period of 2011, reflected an unusually large provision in the third quarter of 2011 to replenish the allowance for loan losses for the partial charge-off of two unrelated loans totaling $3,175,000.

The $2,178,000 or 9 percent increase in net interest income for the first nine months of 2012, compared to the same period of 2011, resulted primarily from a larger volume of interest 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.

The $746,000 or 14 percent increase in noninterest income for the first nine months of 2012, compared to the same period of 2011, resulted primarily from a $411,000 increase in gains from the sale of residential mortgage loans. Market interest rates decreased to record low levels during the current period, leading to an increase in residential mortgage loan refinancings. A $456,000 increase in pretax gains from the infrequent sale of investment securities during the current period also contributed to the increase in noninterest income.

The $827,000 or 72 percent decrease in preferred stock dividends and discount accretion for the first nine months of 2012, compared to the same period of 2011, was the 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 last year's redemption of preferred stock issued under the Treasury's Capital Purchase Program.

The $2,129,000 or 10 percent increase in noninterest expense for the first nine months of 2012, compared to the same period of 2011, was due primarily to increases in personnel expenses and foreclosed real estate costs. The $1,063,000 or 10 percent increase in personnel expense was due to normal business growth, which included the impact of franchise expansion in September 2011, and the accrual of annual performance incentives. The $997,000 or 76 percent increase in foreclosed real estate costs reflected increased provisioning for impairment . . .

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