10-Q 1 grange_10q.txt U.S. 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 June 30, 2003. [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission file number 0-13664 GRANGE NATIONAL BANC CORP PENNSYLVANIA 23-2314065 ------------------------------------ ---------------------- (State or other jurisdiction of (I.R.S. Employer Incorporation or organization) Identification No.) 198 E. Tioga St., Tunkhannock, Pennsylvania ------------------------------------------- (Address of principal executive offices) (570) 836-2100 ---------------------------------------------------- (Registrant's telephone number, including area code) Check whether the issuer (1) 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 periods 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 APPLICABLE ONLY TO CORPORATE ISSUERS State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practical date: 1,636,074. Transitional Small Business Disclosure Format (Check one): Yes ; No X ----- ----- GRANGE NATIONAL BANC CORP. AND SUBSIDIARY PART I. FINANCIAL INFORMATION ITEM 1. Unaudited Financial Statements

1 GRANGE NATIONAL BANC CORP. AND SUBSIDIARY Consolidated Statements of Financial Position, June 30, 2003 and December 31, 2002

See Notes to Consolidated Financial Statements 2 GRANGE NATIONAL BANC CORP. AND SUBSIDIARY Consolidated Statements of Income and Comprehensive Income (Unaudited)

See Notes to Consolidated Financial Statements 3 GRANGE NATIONAL BANC CORP. AND SUBSIDIARY Consolidated Statements of Changes in Stockholders' Equity (Unaudited)

See Notes to Consolidated Financial Statements 4 GRANGE NATIONAL BANC CORP AND SUBSIDIARY Consolidated Statements of Cash Flow (Unaudited)

See Notes to Consolidated Financial Statements 5 GRANGE NATIONAL BANC CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. BUSINESS COMBINATION AND PRINCIPLES OF COMBINATION: Grange National Banc Corp. (Company) was organized and incorporated under the laws of the Commonwealth of Pennsylvania on October 2, 1984, for the purpose of becoming a bank holding company. On April 30, 1985 the Company acquired the Grange National Bank of Wyoming County (Bank) pursuant to a plan of reorganization and merger. The Bank became a wholly owned subsidiary of the Company, and each outstanding share of Bank common stock was converted into one share of Company common stock. The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiary (Bank) with the reorganization accounted for as a pooling of interests. 2. BASIS OF PRESENTATION: The accompanying unaudited consolidated financial statements have been prepared in conformity with the accounting principles and practices reflected in the annual financial statements, and reflect all adjustments which are normal and recurring and, in the opinion of management, necessary for a fair presentation of the results of operations for the interim periods. The results of operations reported in interim financial statements are not necessarily indicative of results to be expected for the year. 3. PREFERRED STOCK: The Company authorized 1,000,000 of preferred stock at $5 par value. At December 31, 2002 and June 30, 2003, no shares were issued nor outstanding. 4. EARNINGS PER SHARE Earnings per share have been calculated using shares effected for the 2 for 1 stock split announced July 18, 2002. 5. SUBSEQUENT EVENTS: Effective as of June 7, 2003, the Company entered into an Agreement and Plan of Merger with Community Bank System, Inc., a bank holding company based in DeWitt, New York ("CBSI"). Pursuant to the Merger Agreement, subject to the satisfaction of a number of conditions, the Company will merge with and into CBSI, with CBSI being the surviving corporation. Following the Merger, CBSI expects to merge the Company's bank subsidiary, Grange National Bank, with and into CBSI's bank subsidiary, Community Bank, N.A., with Community Bank being the continuing bank. 6 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION: Our net income for the three and six months ending June 30, 2003 totaled $1,080,000 and $2,112,000, which is 30% and 20% higher than the $831,000 and $1,761,000 of net income for the same periods last year. Net interest income for the three and six months ending June 30, 2003 increased by $287,000 to $2,501,000, and $569,000 to $4,943,000 compared to $2,214,000 and $4,374,000 for the same periods in 2002, increases of 13% in each period. Interest income during these same time periods increased by $257,000 or 7% for the three month period and $520,000 or 7% for the six month period, compared to 2002, while interest expense decreased by $30,000 or 2% for the three month period, and $49,000 or 1% for the six month period compared to 2002. The increase in interest income on loans was $258,000 or 10% for the second quarter, and $634,000 or 12% for the six months ended June 30, as compared to the same time last year. Interest income from investment securities increased by $1,000 for the second quarter, and decreased by$100,000 or 4% for the six months ended June 30, as compared to the same time last year. The Federal Reserve has dramatically reduced interest rates for the last two years, subsequently putting pressure on loan rates. Financial institutions, including ours, have been constantly refinancing mortgages at lower interest rates. The New York prime rate has dropped to rates lower than we have seen in a generation. Many of our loans are tied to the prime rate, and this as well has reduced our interest income. Overall our interest income is up due to higher volumes of loans. Competition for mortgages and other loans requires us to keep lowering our rates. We continue to lower the rates we pay on deposits in order to preserve our net interest margin, but are limited by competition and our need to retain retail customers. We believe that interest rates are near the bottom of their cycle, but do not anticipate rates to rise very soon or very fast. Interest income on deposits in banks decreased by $3,000 from $17,000 to $14,000 during the second quarter and decreased by $14,000 from $45,000 to $31,000 for the six months ending June 30, 2003, as compared to the same times last year. We are receiving substantially lower interest on our balances and we have had lower balances. The decrease in interest expense is due to lower interest rates paid to customers, offset by higher balances for the second quarter and the six months ending June 30, 2003 as compared to the same times in 2002. For the six months ending June 30, the average total sources to fund earning assets increased $33,579, from $221,639 to $255,218 in 2003, while the average interest rate decreased from 2.81% to 2.40%. Deposit growth continues to provide funds for loans and liquidity. Loan demand during the year has been strong as loans increased $9,376,000 or 6% from $151,347,000 at December 31, 2002 to $160,723,000 at June 30, 2003. Loan demand is softening as the third quarter begins. Balances of investment securities decreased by $3,041,000 since December 31, 2002. Interest bearing deposits at banks increased by $7,364,000, to $16,306,000 from $8,942,000. We have refrained from reinvesting proceeds from maturing bonds and principal payments from our bond portfolio, in light of our impending merger with Community Bank Systems. Deposit growth was light during the first half of the year, increasing only $10,644,000, or 5%. Our Scranton office continues to exceed our expectations for deposit growth reaching over $17,000,000 in deposits at June 30 of this year. 7 The provision for loan loss during the three and six months ending June 30, 2003 was $75,000 and $150,000, as compared to $90,000 and $155,000 for the same periods in 2002. The allowance for loan losses was $1,576,000 and $1,445,000 at June 30, 2003 and December 31, 2002, respectively. This represents 0.98% and 0.95% of total loans, 163% and 238% of non-performing loans, and 150% and 210% of non-performing assets, respectively. We have kept the provision at a rate to keep it constant with the current loan portfolio growth, as we have not seen any abnormal changes in the quality of the portfolio. The provision for loan losses and related allowance for loan losses are based upon our continued evaluation of the current loan portfolio considering things such as general economic conditions, adequacy of collateral on past due loans, past and expected loan loss experience, composition of the loan portfolio, any unusual risk concentrations, allowance as a percentage of total loans and any other relevant factors. The reserve is not divided to provide for any individual loan or loan classification. The total allowance balance is available to absorb losses from all loans included in the portfolio. The following sets forth loans past due 90 days or more on which interest has continued to be accrued for June 30, 2003 and December 31, 2002.

Non-accrual loans increased from $79,000 at December 31, 2002 to $652,000 at June 30, 2003. The increase in non-accrual loans is primarily due to one customer. The loans are well secured and we do not anticipate any loss. The overall quality remains very good, and management expects non-performing assets to remain at substantially the same levels as a proportion of loans. Investments in securities decreased by $3,041,000 or 4% from December 31, 2002 to June 30, 2003. The average rates earned on available for sale, held to maturity and deposits in banks were 4.30%, 6.34% and 1.53% for the three months ended June 30, 2003, as compared to 5.94%, 6.63% and 2.44% for the three months ended June 30, 2002. For the six months ended June 30, 2003 the average rates were 5.38%, 6.71% and 1.46%, as compared to 6.11%, 6.77% and 2.35% for the six months ended June 30, 2002. As of June 30, 2003, the fair value of the Bank's investments classified as held to maturity exceeded their amortized value by $485,000, and the fair value of investments classified as available for sale exceeded their amortized value by $3,215,000. This is reflected as an increase in the Company's equity of approximately $2,121,000, net of deferred income tax. 8 Low interest rates and the uncertainty of when higher interest rates will return have changed investors' perceptions in the market. Many investors expect interest rates to remain low for quite some time. This has caused the value of our investments classified as available for sale, to rise. When interest rates will eventually increase is a matter of much debate and concern. Because of our impending merger with Community Bank Systems, we are not currently purchasing additional investments. This will allow the combined entity the most flexibility in its strategic planning. There have been no adverse credit valuations on any of our investments For the three months ending June 30, 2003, as compared to the same period in 2002, salaries and employee benefits increased by $130,000 or 19% from $691,000 to $821,000 and occupancy expense increased $25,000 or 20% from $123,000 to $148,000. Equipment expense increased $30,000 or 28% from $107,000 to $137,000, and other operating expenses increased $40,000 or 9% from $426,000 to $466,000. For the six months ending June 30, 2003, as compared to the same period in 2002, salaries and employee benefits increased by $267,000 or 20% from $1,342,000 to $1,609,000 and occupancy expense increased $58,000 or 21% from $271,000 to $329,000. Equipment expense increased $25,000 or 12% from $214,000 to $239,000, and other operating expenses increased $38,000 or 5% from $789,000 to $827,000. Salary and employee cost increases are due to adding our Wyalusing office and a new bank officer to manage and develop business for our western offices. Increases in occupancy, equipment and other operating expenses have slowed significantly due to our impending merger. Specific merger expenses will be incurred during the third and fourth quarters. Monthly we perform an interest rate and liquidity analysis to monitor the Bank's interest rate sensitivity gap and liquidity needs. These reports are reviewed by the Board of Directors and used to formulate ways to improve the Bank's interest rate gap. We place a great emphasis on adjustable rate loan products, such as variable rate home equity loans and annually adjustable mortgage loans as well as adjustable rate and short term investments, in order to minimize interest rate risk. Since 1991 the Comptroller of the Currency has required all national banks to meet certain "Risk Based Capital" standards. These standards weight certain assets based on the risk of the asset, and also includes certain off-balance sheet items. The table below sets forth the Bank's Tier 1 and Tier 2 capital, risk adjusted assets (including off-balance sheet items) and the Bank's risk-based capital ratios under the guidelines, for June 30, 2003 and December 31, 2002.

9 GRANGE NATIONAL BANC CORP. AND SUBSIDIARY Average Balances, Interest Income/Expense and Rates

(1)Average balances are daily averages. (2) Demand deposits, stockholders' equity and other non-interest bearing liabilities less non-earning assets. (3) Non-accrual loans are reflected in the loan balances, but contributing no interest income. (4) Tax exempt interest income has been converted to a tax equivalent basis at the US Federal income tax rate of 34%. See Notes to Consolidated Financial Statements 11 PART II. OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits (b) Reports on Form 8-K (ii) Statement re: computation of earnings per share: Primary earnings per share is computed by dividing net income by the weighted average number of shares of common stock and common stock equivalents outstanding during the quarter. Stock options are considered common stock equivalents and are included in the computation of the number of shares outstanding using the treasury stock method. The number of shares used to calculate earnings per share for the periods presented are as indicated in each period. During the current fiscal quarter, the company filed an 8-K on April 30, 2003 announcing its first quarter earnings, and an 8-K on June 19, 2003 announcing its an Agreement and Plan of Merger with Community Bank System, Inc., a bank holding company based in DeWitt, New York. 12 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. GRANGE NATIONAL BANC CORP. (Registrant) Date August 13, 2003 /s/ Thomas A. McCullough --------------------------------- --------------------------- Thomas A. McCullough President Chief Executive Officer Date August 13, 2003 /s/ Philip O. Farr --------------------------------- ------------------------------ Philip O. Farr Vice President and Comptroller Chief Financial Officer Chief Accounting Officer 13 CERTIFICATIONS I, Thomas A. McCullough, certify that: 1. I have reviewed this Quarterly report on Form 10-Q of Grange National Banc Corp.; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: a. designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b. evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c. presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a. all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b. any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Dated: August 13, 2003 /s/ Thomas A. McCullough ----------------------------------- Thomas A. McCullough President and Chief Executive Officer 14 I, Philip O. Farr, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Grange National Banc Corp.; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: a. designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b. evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c. presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a. all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b. any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Dated: August 13, 2003 /s/ Philip O. Farr ---------------------------- Philip O. Farr Vice President and Chief Financial Officer 15

GRANGE NATIONAL BANC CORP 10-Q