Back to GetFilings.com
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
X Quarterly Report Pursuant to Section 13 or 15(d) of the
---
Securities and Exchange Act of 1934
For the quarterly period ended June 30, 2002, 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 No. 0-17000
COMMERCIAL NATIONAL FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
Michigan 38-2799780
(State of Incorporation) (IRS Employer Identification No.)
101 North Pine River Street, Ithaca, Michigan 48847
(address of principal executive offices) (ZIP Code)
Registrant's telephone number, including area code: (989) 875-4144
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 the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding at July 31, 2002
----- ----------------------------
Common Stock 3,596,009
No Par Value
COMMERCIAL NATIONAL FINANCIAL CORPORATION
INDEX
PART I FINANCIAL INFORMATION
- ------ ---------------------
Item 1. Financial Statements
Consolidated Balance Sheets as of June 30, 2002 (unaudited) and December 31, 2001 (Page 3)
Consolidated Statements of Income and Other Comprehensive
Income (unaudited) for the three and six months
ended June 30, 2002 and June 30, 2001 (Page 4)
Consolidated Statements of Changes in Shareholders' Equity
(unaudited) for the six months ended June 30, 2002
and June 30, 2001 (Page 5)
Consolidated Statements of Cash Flows (unaudited) for the six months ended (Page 6)
June 30, 2002 and June 30, 2001
Notes to Consolidated Financial Statements (unaudited) (Page 7-10)
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (Page 11-15)
Item 3. Quantitative and Qualitative Disclosures about Market Risk (Page 16-17)
PART II OTHER INFORMATION
- ------- -----------------
Item 4. Submission of Matters to A Vote of Security Holders (Page 19)
Item 6. Exhibits and Reports on Form 8-K (Page 21-22)
SIGNATURES (Page 20)
2
COMMERCIAL NATIONAL FINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS
June 30, December 31,
2002 2001
---- ----
(Unaudited)
ASSETS
Cash and due from banks $ 4,439,736 $ 7,282,523
Federal funds sold 5,000,000 5,000,000
Other interest bearing deposits 1,542,933 2,064,802
------------- -------------
Total cash and cash equivalents 10,982,669 14,347,325
Securities available for sale 19,030,230 20,471,202
Securities held to maturity (fair value $ 5,171,154 -
June 30, 2002; $7,730,608 - December 31, 2001) 4,939,276 7,496,656
Federal Home Loan Bank stock, at cost 1,391,300 1,391,300
Gross loans receivable 181,310,538 168,012,689
Allowance for loan losses (2,896,993) (2,586,025)
------------- -------------
Net loans receivable 178,413,545 165,426,664
Bank owned life insurance 3,140,376 3,050,296
Premises and equipment, net 2,782,647 2,599,704
Accrued interest receivable and other assets 2,167,155 3,614,733
------------- -------------
Total assets $ 222,847,198 $ 218,397,880
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Deposits
Noninterest-bearing demand $ 18,548,814 $ 22,199,334
Interest-bearing demand 26,896,098 29,033,317
Savings 56,910,538 50,116,477
Time 58,673,943 61,229,483
------------- -------------
Total deposits 161,029,393 162,578,611
Securities sold under agreements to repurchase 10,226,048 6,237,585
Other short-term borrowings 568,284 136,549
Federal Home Loan Bank advances 26,882,556 26,092,551
Accrued expenses and other liabilities 1,256,098 1,288,306
------------- -------------
Total liabilities 199,962,379 196,333,602
Shareholders' equity
Common stock and paid-in-capital, no par value: 5,000,000 shares
authorized; shares issued and outstanding
June 30, 2002 - 3,594,929 and December 31,
2001 - 3,547,700 22,546,647 22,104,910
Accumulated deficit (78,259) (416,257)
Accumulated other comprehensive income, net of tax 416,431 375,625
------------- -------------
Total shareholders' equity 22,884,819 22,064,278
------------- -------------
Total liabilities and shareholders' equity $ 222,847,198 $ 218,397,880
============= =============
See accompanying notes
3
COMMERCIAL NATIONAL FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME AND OTHER COMPREHENSIVE INCOME (Unaudited)
For Three Months For Six Months
Ended June 30, Ended June 30,
2002 2001 2002 2001
---- ---- ---- ----
Interest and dividend income
Loans, including fees $ 3,185,954 $ 3,672,834 $ 6,303,430 $ 7,453,036
Taxable securities 203,522 211,834 412,468 435,628
Nontaxable securities 118,375 136,329 249,092 276,230
Federal funds sold 11,492 59,478 40,572 111,477
Federal Home Loan Bank stock dividends 21,679 26,883 42,263 54,328
Interest on other deposits 3,447 5,972 8,576 12,187
----------- ----------- ----------- -----------
Total interest and dividend income 3,544,469 4,113,330 7,056,401 8,342,886
Interest expense
Deposits 862,783 1,417,776 1,775,738 2,928,015
Securities sold under agreements to repurchase 37,755 83,184 68,914 186,213
Federal Home Loan Bank advances 378,072 342,861 762,015 729,335
Other 1,103 5,233 3,307 14,936
----------- ----------- ----------- -----------
Total interest expense 1,279,713 1,849,054 2,609,974 3,858,499
Net interest income 2,264,756 2,264,276 4,446,427 4,484,387
Provision for loan losses 167,000 90,000 287,000 180,000
----------- ----------- ----------- -----------
Net interest income after provision for loan losses 2,097,756 2,174,276 4,159,427 4,304,387
Noninterest income
Service charges and fees 118,120 113,512 224,932 222,652
Net gains on loan sales 38,179 115,517 93,872 189,303
Receivable financing fees 46,647 70,950 83,738 157,629
Security gains 4,168 62,399 27,565 156,883
Other 113,260 61,945 203,763 108,700
----------- ----------- ----------- -----------
Total noninterest income 320,374 424,323 633,870 835,167
Noninterest expense
Salaries and employee benefits 805,584 787,419 1,625,715 1,593,814
Occupancy and equipment 223,574 242,234 445,715 492,193
FDIC insurance 8,178 7,314 16,413 14,868
Printing, postage and supplies 65,064 68,107 138,837 142,799
Professional and outside services 90,154 91,872 194,361 190,275
Other 256,818 239,328 491,654 458,248
----------- ----------- ----------- -----------
Total noninterest expense 1,449,372 1,436,274 2,912,695 2,892,197
----------- ----------- ----------- -----------
Income before income tax expense 968,758 1,162,325 1,880,602 2,247,357
Income tax expense 291,200 352,500 539,300 675,000
----------- ----------- ----------- -----------
Net income $ 677,558 $ 809,825 $ 1,341,302 $ 1,572,357
=========== =========== =========== ===========
Net change in unrealized gains/(losses) on securities available for sale $ 188,243 $ 85,926 $ 89,392 $ 379,049
Reclassification adjustment for (gains) recognized in income (4,168) (62,399) (27,565) (156,883)
Tax effects (62,586) (7,999) (21,021) (75,536)
----------- ----------- ----------- -----------
Total Comprehensive Income $ 799,047 $ 825,353 $ 1,382,108 $ 1,718,987
=========== =========== =========== ===========
Per share information
Basic earnings $ 0.19 $ 0.23 $ 0.37 $ 0.45
Diluted earnings $ 0.19 $ 0.23 $ 0.37 $ 0.45
Dividends declared $ 0.14 $ 0.13 $ 0.28 $ 0.26
See accompanying notes
4
COMMERCIAL NATIONAL FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
Six Months ended June 30, 2002 and June 30, 2001 (Unaudited)
Accumulated
Shares Common Other
Issued Stock and Comprehensive Total
and Paid in Accumulated Income/(Loss), Shareholders'
Outstanding Capital Deficit Net of Tax Equity
- -----------------------------------------------------------------------------------------------------------------------------
Balance at January 1, 2001 3,493,586 $ 21,617,080 $ (1,714,089) $ 207,091 $ 20,110,082
Comprehensive income:
Net income 1,572,357 1,572,357
Net change in unrealized gains/(losses) on
securities available for sale 379,049 379,049
Reclassification adjustment for gains
recognized in income (156,883) (156,883)
Tax effects (75,536) (75,536)
------------
Total comprehensive income 1,718,987
Cash dividends declared, $.26 per share (937,006) (937,006)
Issued under dividend reinvestment program 29,412 290,797 290,797
Issued under stock option plan 450 3,227 3,227
Issued under employee benefit plan 2,332 21,167 21,167
Repurchase and retirement of shares (8,610) (80,066) (80,066)
---------- ------------ ------------ ---------- ------------
Balance at June 30, 2001 3,517,170 $ 21,852,205 $ (1,078,738) $ 353,721 $ 21,127,188
========== ============ ============ ========== ============
=============================================================================================================================
Balance at January 1, 2002 3,547,700 $ 22,104,910 $ (416,257) $ 375,625 $ 22,064,278
Comprehensive income:
Net income 1,341,302 1,341,302
Net change in unrealized gains/(losses) on
securities available for sale 89,392 89,392
Reclassification adjustment for gains
recognized in income (27,565) (27,565)
Tax effects (21,021) (21,021)
------------
Total comprehensive income 1,382,108
Cash dividends declared, $.28 per share (1,003,304) (1,003,304)
Issued under dividend reinvestment program 41,277 406,127 406,127
Issued under stock option plan 6,609 47,690 47,690
Issued under employee benefit plan 3,695 39,713 39,713
Repurchase and retirement of shares (4,352) (51,793) (51,793)
---------- ------------ ------------ ---------- ------------
Balance at June 30, 2002 3,594,929 $ 22,546,647 $ (78,259) $ 416,431 $ 22,884,819
========== ============ ============ ========== ============
See accompanying notes
5
COMMERCIAL NATIONAL FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
For Six Months Ended
June 30,
2002 2001
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 1,341,302 $ 1,572,357
Adjustments to reconcile net income to net
cash from operating activities
Provision for loan losses 287,000 180,000
Net gains on loan sales (93,872) (189,303)
Originations of loans held for sale (4,401,919) (11,893,950)
Proceeds from sales of loans held for sale 4,495,791 12,083,253
Gain on sales of securities available for sale (27,565) (156,883)
Depreciation, amortization and accretion 252,216 252,598
Net change in accrued interest receivable and other assets 1,336,476 208,292
Net change in accrued expenses and other liabilities (39,105) (529,380)
------------ ------------
Net cash from operating activities 3,150,324 1,526,984
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of securities available for sale (1,533,829) (7,127,556)
Proceeds from maturities of securities available for sale 3,000,000 5,600,000
Proceeds from sales of securities available for sale -- 2,429,442
Proceeds from maturities of securities held to maturity 2,578,900 975,000
Net change in loans (13,275,506) 10,506,909
Purchases of premises and equipment, net (390,860) (103,121)
------------ ------------
Net cash from investing activities (9,621,295) 12,280,674
CASH FLOW FROM FINANCING ACTIVITIES
Net change in deposits (1,549,218) (1,941,486)
Net change in securities sold under agreements to repurchase 3,988,463 665,392
Net change in U.S. Treasury demand notes 431,735 (344,226)
Proceeds from Federal Home Loan Bank advances 5,000,000 13,000,000
Repayment of Federal Home Loan Bank advances (4,209,995) (17,230,031)
Repurchase and retirement of shares of common stock (51,793) (80,066)
Dividends paid and fractional shares (996,407) (933,305)
Proceeds from sale of common stock 493,530 315,191
------------ ------------
Net cash from financing activities 3,106,315 (6,548,531)
------------ ------------
Net change in cash and cash equivalents (3,364,656) 7,259,127
Cash and cash equivalents, at beginning of year 14,347,325 7,462,021
------------ ------------
CASH AND CASH EQUIVALENTS, AT END OF PERIOD $ 10,982,669 $ 14,721,148
============ ============
Cash paid during the period for
Interest $ 2,676,056 $ 3,981,266
Federal income taxes 610,000 774,999
See accompanying notes
6
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
Note 1-Summary of Significant Accounting Policies
Basic Presentation
The accompanying unaudited condensed consolidated financial statements were
prepared in accordance with Rule 10-01 of regulation S-X and the instructions
for Form 10-Q and, therefore, do not include all disclosures required by
accounting principles generally accepted in the United States of America for
complete presentation of financial statements. In management's opinion, the
condensed consolidated financial statements contain all adjustments (consisting
of normal recurring accruals) necessary to present fairly the financial
condition of Commercial National Financial Corporation as of June 30, 2002 and
December 31, 2001 and the results of its operations for the three and six months
ending June 30, 2002 and June 30, 2001. The results for the three and six months
ended June 30, 2002 are not necessarily indicative of the results expected for
the full year.
Principals of Consolidation
The accompanying consolidated financial statements include the accounts of
Commercial National Financial Corporation (CNFC), Commercial Bank (Bank) and
CNFC Financial Services, Inc. and CNFC Mortgage Corporation, both wholly owned
subsidiaries of the Bank. All material intercompany accounts and transactions
have been eliminated in consolidation.
Nature of Operations, Industry Segments and Concentrations of Credit Risk
CNFC is a one-bank holding company, which conducts limited business activities.
The Bank performs the majority of business activities.
The Bank provides a full range of banking services to individuals, agricultural
businesses, commercial businesses and light industries located in its service
area. It maintains a diversified loan portfolio, including loans to individuals
for home mortgages, automobiles and personal expenditures, and loans to business
enterprises for current operations and expansion. The Bank offers a variety of
deposit products, including checking, savings, money market, individual
retirement accounts and certificates of deposit. While CNFC's chief
decision-makers monitor the revenue stream of various products and services,
operations are managed and financial performance is evaluated on a
corporation-wide basis. Accordingly, management considers all of the CNFC's
banking operations to be aggregated into one operating segment.
The principal markets for the Bank's financial services are the Michigan
communities in which the Bank is located and the areas surrounding these
communities. The Bank serves these markets through seven offices located in
Gratiot and Montcalm Counties in Michigan.
Use of Estimates
To prepare financial statements in conformity with accounting principles
generally accepted in the United States of America, management makes estimates
and assumptions based on available information. These estimates and assumptions
affect the amounts reported in the financial statements and the disclosures
provided. Future results could differ. The allowance for loan losses and fair
values of securities and other financial instruments are particularly subject to
change.
Cash Flow Reporting
Cash and cash equivalents include cash on hand, demand deposits with other
financial institutions and federal funds sold. Cash flows are reported net for
customer loan and deposit transactions, securities sold under agreements to
repurchase with original maturity of 90 days or less and U.S. Treasury demand
notes.
Securities
Securities are classified as held to maturity and carried at amortized cost when
management has the positive intent and ability to hold them to maturity.
Securities are classified as available for sale when they might be sold before
maturity. Securities available for sale are carried at fair value, with net
unrealized holding gains and losses reported separately in other comprehensive
income (loss), net of tax. Trading securities are bought principally for sale in
the near term, and are reported at fair value with unrealized gains and losses
included in earnings. Securities are written down to fair value when a decline
in fair value is not temporary. CNFC did not classify any securities for trading
at any time during 2002 or 2001.
Gains and losses on sales are determined using the amortized cost of the
specific security sold. Interest and dividend income, adjusted by amortization
of purchase premiums and discounts, is included in earnings.
7
COMMERCIAL NATIONAL FINANCIAL CORPORATION
Loans Held for Sale
Loans held for sale are reported at the lower of cost or market value in the
aggregate. Net unrealized losses are recorded in a valuation allowance by
charges to income.
Loans
Loans that management has the intent and the ability to hold for the foreseeable
future or until maturity or payoff are reported at the principal balance
outstanding, net of unearned interest, deferred loan fees and costs, and an
allowance for loan losses. Interest income is reported on the interest method
and includes amortization of net deferred loan fees and costs over the loan
term.
Interest income is not reported when full loan repayment is in doubt, typically
when payments are past due over 90 days, unless the loan is both well secured
and in the process of collection. Payments received on such loans are reported
as principal reductions.
Allowance for Loan Losses
The allowance for loan losses is a valuation allowance for probable credit
losses, increased by the provision for loan losses and decreased by charge-offs
less recoveries. Estimating the risk of loss and the amount of loss on any loan
is subjective. Accordingly, management estimates the allowance balance required
based on past loan loss experience, known and inherent risks in the portfolio,
information about specific borrower situations and estimated collateral values,
economic conditions, and other factors. Allocations of the allowance may be made
for specific loans, but the entire allowance is available for any loan that
should be charged-off. A problem loan is charged-off by management as a loss
when deemed uncollectible, although collection efforts continue and future
recoveries may occur.
Loan impairment is reported when full payment under the loan terms is not
expected. Impairment is evaluated in total for smaller-balance loans of similar
nature such as residential mortgage and consumer loans and individually for
other loans. If a loan is impaired, a portion of the allowance is allocated so
that the loan is reported, net, at the present value of estimated future cash
flows using the loan's existing rate or at the fair value of collateral if
repayment is expected solely from the collateral. Loans are evaluated for
impairment when payments are delayed, typically 90 days or more, or when it is
probable that all principal and interest amounts will not be collected according
to the original terms of the loan.
Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation.
Depreciation is computed using a combination of straight-line and accelerated
methods with useful lives ranging from 10 to 40 years for buildings and
improvements, and 3 to 10 years for furniture and equipment. These assets are
reviewed for impairment when events indicate their carrying amount may not be
recoverable from future undiscounted cash flows. Maintenance, repairs and minor
alterations are charged to current operations as expenditures occur. Major
improvements are capitalized.
Servicing Rights
Servicing rights represent both purchased rights and the allocated value of
servicing rights retained on loans sold. Servicing rights are expensed in
proportion to, and over the period of, estimated net servicing revenues.
Impairment is evaluated based on the fair value of the rights, using groupings
of the underlying loans as to interest rates and then, secondarily, as to
geographic and prepayment characteristics. Any impairment of a grouping is
reported as a valuation allowance.
Other Real Estate Owned
Real estate properties acquired in collection of a loan receivable are recorded
at fair value at acquisition. Any reduction to fair value from the carrying
value of the related loan is accounted for as a loan loss. After acquisition, a
valuation allowance reduces the reported amount to the lower of the initial
amount or fair value less costs to sell. Expenses, gains and losses on
disposition, and changes in the valuation allowance are reported in other
expense.
Securities Sold Under Agreements to Repurchase
All of these liabilities represent amounts advanced by various customers and are
secured by securities owned, as they are not covered by general deposit
insurance.
8
COMMERCIAL NATIONAL FINANCIAL CORPORATION
Employee Benefits
A benefit plan with 401(k) features covers substantially all employees. The plan
allows participant compensation deferrals. The amount of any matching
contribution is based solely on the discretion of the board of directors.
Historically, CNFC has matched up to 6% of such deferrals at 100%.
Stock Compensation
Expense for employee compensation under stock option plans is reported only if
options are granted below market price at grant date.
Income Taxes
Income tax expense is the sum of the current year income tax due or refundable
and the change in deferred tax assets and liabilities. Deferred tax assets and
liabilities are the expected future tax consequences of temporary differences
between the carrying amounts and tax bases of assets and liabilities, computed
using enacted tax rates. A valuation allowance, if needed, reduces deferred tax
assets to the amount expected to be realized.
Earnings and Dividends Per Share
Basic earnings per common share is based on net income divided by the weighted
average number of common shares outstanding during the period. Diluted earnings
per common share shows the diluted effect of any additional potential common
shares. Earnings and dividends per common share are restated for all stock
splits and stock dividends.
Stock Dividends
Dividends issued in stock are reported by transferring the market value of the
stock issued from retained earnings to common stock, to the extent of available
retained earnings. Any excess of fair value over available retained earnings is
considered a return of capital and thus is transferred from paid in capital.
Fractional shares are paid in cash for all stock dividends.
Comprehensive Income
Comprehensive income consists of net income and other comprehensive income
(loss). Other comprehensive income (loss) includes the change in unrealized
appreciation and depreciation on securities available for sale, net of tax,
which is also recognized as a separate component of shareholders' equity.
Financial Instruments with Off-Balance-Sheet Risk
Financial instruments include off-balance sheet credit instruments, such as
commitments to make loans and standby letters of credit issued to meet customer
needs. The face amount for these items represents the exposure to loss before
considering customer collateral or ability to repay. Such financial instruments
are recorded when they are funded.
Fair Values of Financial Instruments
Fair values of financial instruments are estimated using relevant market
information and other assumptions. Fair value estimates involve uncertainties
and matters of significant judgment regarding interest rates, credit risk,
prepayments, and other factors, especially in the absence of broad markets for
particular items. Changes in assumptions or in market conditions could
significantly affect the estimates. The fair value estimates of existing on-and
off-balance-sheet financial instruments do not include the value of anticipated
future business or values of assets and liabilities not considered financial
instruments.
Reclassifications
Some items in the prior year financial statements have been reclassified to
conform with the current year presentation.
Recent Accounting Pronouncements
Effective January 1, 2002, CNFC adopted a new standard issued by the FASB on
impairment and disposal of long-lived assets. The effect of this on the
financial position and results of operations of the CNFC was not material.
A new accounting standard dealing with asset retirement obligations will apply
for 2003. The CNFC does not believe this standard will have a material affect on
its financial position or results of operations.
9
COMMERCIAL NATIONAL FINANCIAL CORPORATION
Note 2 - Earnings Per Share
A reconciliation of the numerators and denominators of the basic earnings per
share and diluted earnings per share computations for the periods ended is
presented below:
For three months ended For six months ended
JUNE 30, 2002 JUNE 30, 2001 JUNE 30, 2002 JUNE 30,2001
- ------------------------------------------------------------------------------------------------------------------------------
BASIC EARNINGS PER SHARE:
Net income available to common shareholders $ 677,558 $ 809,825 $ 1,341,302 $ 1,572,357
Weighted-average common shares outstanding for
basic earnings per share 3,588,118 3,515,302 3,588,118 3,515,302
- ------------------------------------------------------------------------------------------------------------------------------
BASIC EARNINGS PER SHARE $ .19 $ .23 $ .37 $ .45
==============================================================================================================================
DILUTED EARNINGS PER SHARE:
Net income available to common shareholders $ 677,558 $ 809,825 $ 1,341,302 $ 1,572,357
Weighted-average common shares outstanding for basic
earnings per share 3,588,118 3,515,302 3,588,118 3,515,302
Add:
Dilutive effect of assumed exercise of stock options 36,806 9,127 36,806 9,127
- ------------------------------------------------------------------------------------------------------------------------------
Weighted-average common and dilutive additional potential
common shares outstanding 3,624,924 3,524,429 3,624,924 3,524,429
==============================================================================================================================
DILUTED EARNINGS PER SHARE $ .19 $ .23 $ .37 $ .45
==============================================================================================================================
10
COMMERCIAL NATIONAL FINANCIAL CORPORATION
ITEM 2: MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
FINANCIAL CONDITION
Summary
Total assets at June 30, 2002 increased to $222,847,000 from the $218,398,000 at
December 31, 2001. Loan totals increased $13,298,000 or 7.9% compared to
December 31, 2001. The increase in loans is a result of increased in residential
real estate balances and commercial loan balances. Funding for the loan growth
came primarily from two sources: maturing securities held to maturity and a
$3,988,000 increase in repurchase agreements. Other assets decreased $1,335,000.
One million of repossessed assets included in other assets were sold at book
value during the first quarter.
Deposit decreased $1,549,000 as compared to December 31, 2001. The Bank
continues to experience a shift of certificate of deposit money into short-term
savings products. In particular, the Bank offers a high rate money market
account that has been popular with customers seeking safety and liquidity. It
continues to be difficult to attract long-term certificate of deposits without
offering excessively high interest rates.
The Bank is constructing a new office located in Greenville Michigan. As a
result, premises and equipment will continue to increase. Management anticipates
that this office will be fully operational in the fourth quarter of 2002.
Liquidity
Management defines liquidity as the ability to fund appropriate levels of credit
worthy loans, meet the immediate cash withdrawal requirements of depositors, and
maintain access to sufficient resources to meet unexpected contingencies at a
reasonable cost, with minimal losses.
The loan to deposit ratio at June 30, 2002 was 112.6% compared to 103.3% at
December 31, 2001. Management believes that the combination of available FHLB
advances, Federal funds lines of credit, the available for sale investment
portfolio, and our ability to sell mortgage loans provides adequate short and
medium term sources of liquidity. At a minimum the Bank has the following
available to meet short-term liquidity needs: $9,319,000 in available FHLB
advances and $9,000,000 in short term federal funds lines of credit with
correspondent banks.
CNFC also needs cash to pay dividends to its shareholders. The primary source of
cash is the dividends paid to CNFC by the Bank. Management believes that cash
from operations is sufficient to supply the cash needed to continue paying a
reasonable dividend. CNFC also has a $1,500,000 line of credit with a
correspondent institution.
11
COMMERCIAL NATIONAL FINANCIAL CORPORATION
Asset Quality
At June 30, 2002 CNFC has identified $7,201,000 of loans as non-performing. This
compares to $462,000 at December 31, 2001. The $7,201,000 in non-accrual loans
represents three business relationships and their related entities. All
non-accrual loans are considered impaired and the allowance for loan loss
allocated to these loans is $2,180,872. Excluding these non-performing loans,
the Bank had only $287,000 in loans past due greater than 30 days at June 30,
2002.
June 30, 2002 December 31, 2001
Total loans $ 181,310,538 $ 168,012,689
Non-accrual loans $ 7,200,911 $ 387,822
Accruing loans past due 90 days or more - 74,664
- -------------------------------------------------------------------------------------------------
Total non-performing loans 7,200,911 462,486
Repossessed assets and other real estate - 1,000,000
- -------------------------------------------------------------------------------------------------
Total non-performing assets $ 7,200,911 $ 1,462,486
=================================================================================================
Total non-performing loans as a
percentage of total loans 3.97% .28%
==================================================================================================
Allowance for loan loss as a percentage of
non-performing loans 40.23% 559.16%
==================================================================================================
Total non-performing assets as a percentage of
total assets 3.23% .67%
==================================================================================================
Allowance for Loan Loss
The allowance for loan losses was 1.60% of total loans at June 30, 2002 and
1.54% at December 31, 2001. Year to date net recoveries totaled $24,000. Year
2001 net charge-offs totaled $334,000. Approximately $390,000 relates to one
business loan relationship. Excluding this charge-off, CNFC recorded net
recoveries of $56,000 during 2001.
Management systematically evaluates the adequacy of the allowance such that the
balance is commensurate with the performance of the loan portfolio, loan growth,
general market conditions and other relevant factors. The loan portfolio has
increased $13,298,000 or 7.91% year to date primarily caused by an increase in
business lending. Business lending is inherently riskier than consumer or
residential real estate. In addition, loan quality has decreased as evidenced by
the increase in non-performing assets. For these reasons, management increased
the quarterly provision to $167,000, which was $77,000 more than the amount
expensed for the three months ended June 30, 2001. Year to date management has
increased the provision from $180,000 to $287,000.
Six Months Ended Year Ended Six Months Ended
June 30, 2002 December 31, 2001 June 30, 2001
- ----------------------------------------------------------------------------------------------
Beginning balance $ 2,586,025 $ 2,545,363 $ 2,545,363
Loan charge-offs (11,222) (415,904) (8,894)
Loan recoveries 35,190 81,566 56,899
- ----------------------------------------------------------------------------------------------
Net loan recoveries/(charge-offs) 23,968 (334,338) 48,005
Provision for loan losses 287,000 375,000 180,000
- ----------------------------------------------------------------------------------------------
Ending balance $ 2,896,993 $ 2,586,025 $ 2,773,368
==============================================================================================
12
COMMERCIAL NATIONAL FINANCIAL CORPORATION
Capital Resources
CNFC's capital ratios continue to exceed regulatory guidelines for a "well
capitalized" institution. It is management's intent to maintain capital ratios
in excess of the minimum required to be well capitalized. A summary of CNFC's
capital ratios follows:
Minimum Required to be
Well Capitalized Under
Prompt Corrective Action
June 30, 2002 December 31, 2001 Regulations
- ---------------------------------------------------------------------------------------------------------
Total capital to risk weighted assets 14.1% 14.4% 10.0%
Tier 1 capital to risk weighted assets 12.9% 13.1% 6.0%
Tier 1 capital to average assets 10.2% 9.7% 5.0%
RESULTS OF OPERATIONS
Summary
Net income for the quarter ended June 30, 2002 was $799,000, a decrease of
$26,000, or 3.2% compared to the same period in 2001. Management increased the
provision for loan losses by $77,000 compared to the same period in 2001. A
$104,000 or 24.5% decrease in noninterest income also contributed to the
decrease in net income. CNFC's net interest income remained virtually unchanged.
Non-interest expense for the quarter increased $13,000 or .91% compared to the
same period in 2001. Return on average equity decreased from 15.30% to 11.68%.
Net income for the six months ending June 30, 2002 was $1,382,108 compared to
$1,718,987 for the same period in 2001. The causes of the decreased net income
are similar to those described for the three months ending June 30, 2002. As a
result of lower net income and an increased equity base, return on average
equity decreased from 15.19% to 11.98%.
Net Interest Income
The following table illustrates the effect that changes in rates and balances of
interest-earning assets and interest-bearing liabilities had on tax-equivalent
net interest income for the three and six months ending June 30, 2002 and 2001.
Three Months Ending June 30, Six Months Ending June 30,
2002 2001 2002 2001
---- ---- ---- ----
Interest Income (tax equivalent) $ 3,677,418 $ 4,273,196 $ 7,316,630 $ 8,681,738
Interest Expense 1,279,713 1,849,054 2,609,974 3,858,499
------------ ------------ ------------ ------------
Net Interest Income $ 2,397,705 $ 2,424,142 $ 4,706,656 $ 4,823,239
============ ============ ============ ============
Average Balances
Interest-earning Assets $210,289,753 $206,343,557 $208,938,575 $207,850,476
Interest-bearing Liabilities 178,026,591 173,428,527 177,402,209 175,471,247
------------ ------------ ------------ ------------
Net Differential $ 32,263,162 $ 32,915,030 $ 31,536,366 $ 32,379,229
============ ============ ============ ============
Average Yields/Rates (annualized)
Yield on Earning Assets 7.01% 8.31% 7.06% 8.42%
Rate Paid on Liabilities 2.88% 4.28% 2.97% 4.43%
------------ ------------ ------------ ------------
Interest Spread 4.13% 4.03% 4.09% 3.99%
============ ============ ============ ============
Net Interest Margin 4.57% 4.71% 4.54% 4.68%
============ ============ ============ ============
13
COMMERCIAL NATIONAL FINANCIAL CORPORATION
The change in tax equivalent net interest income is attributable to the
following:
Three Months Ending Six Months Ending
June 30, 2002 June 30, 2002
Balance Rate Inc/(Dec) Balance Rate Inc/(Dec)
------- ---- --------- ------- ---- ---------
Interest Earning Assets $ 107,397 $ (703,175) $ (595,778) $ 18,396 $(1,383,504) $(1,365,108)
Interest Bearing Liabilities (9,721) (559,620) (569,341) (85,906) (1,162,619) (1,248,525)
----------- ----------- ----------- ----------- ----------- -----------
Net Interest Income $ 117,118 $ (143,555) $ (26,437) $ 104,302 $ (220,885) $ (116,583)
=========== =========== =========== =========== =========== ===========
The $26,000 decrease in tax-equivalent net interest income for the three months
ending June 30, 2002 resulted from a 14 basis point decrease in margin offset by
an increase in average earning assets.
In response to the September 11th attacks and a slowing national economy, the
Federal Reserve Open Market Committee lowered the discount rate 475 basis points
during 2001. These decreases in the discount rate result in an almost immediate
decrease in the Bank's prime lending rate.
The interest rate on a significant portion of the Bank's commercial loan
portfolio is tied to the prime-lending rate. As the Bank adjusts its prime
lending rate, the Bank experiences an almost immediate decrease in net interest
income. In response, management has lowered retail deposit rates, however, it is
unable to lower the cost of retail deposits as quickly and to the same extent as
the Federal Reserve has lowered the federal funds target rate. Also, management
has elected, over time, to fund loans with FHLB amortizing advances, generally
for periods of 5 to 7 years. The amortizing advances are used to offset future
interest rate risk in a rising rate environment. The cost of FHLB advances has
not decreased as quickly as the general decrease in rates. The effect of these
various items has resulted in a decrease in margin from 4.71% for the three
months ended June 30, 2001 to 4.57% for the same period in 2002.
Margin for the six months ending June 30, 2002 decreased 14 basis points for
similar reasons as discussed above.
Noninterest Income
Noninterest income for the three months ending June 30, 2002 was $320,000. This
represents a $104,000 or 24.5% decrease over the same period in 2001.
Net gain on loan sales decreased from $116,000 to $38,000. Residential real
estate interest rates were historically low during the fourth quarter of 2001.
As a result, the Bank experienced significant refinancing activity. Though
current residential mortgage loan rates remain historically low, current
interest rates are higher than those experienced in the fourth quarter of 2001.
Therefore, refinancing activity has decreased. The gains on loan sales are now
primarily the result of lending money for the purchase of residential real
estate.
Receivable financing decreased from $71,000 to $47,000 as the result of lower
volume of receivables financed with fewer customers.
In 2001, CNFC elected to liquidate several investments held as available for
sale by the holding company. This resulted in $62,000 in securities gains during
the second quarter of 2001. During the second quarter of 2002 the Bank recorded
a gain of $4,000 resulting from municipal securities called at a premium.
The majority of the $51,000 increase in other income reflects the income
recorded on the Bank's investment in bank owned life insurance (BOLI).
14
COMMERCIAL NATIONAL FINANCIAL CORPORATION
Non-interest income for the six months ending June 30, 2002 decreased $201,000
or 24.07%. The contributing factors to the decrease are similar to those
discussed above.
Noninterest Expense
Noninterest expense for the three months ending June 30, 2002 totaled
$1,449,000. This represents a $13,000 or .91% increase over the same period in
2001. Management has focused on controlling expense during the first six months
of 2002. However, during the next six months, management anticipates that
various expense categories will increase as the new Greenville office is
completed and becomes operational.
Salary and benefit expense for the three months ending June 30, 2002 totaled
$806,000 compared to $787,000 for the same period in 2001, an increase of
$19,000 or 2.4%. Bank staffing levels have not significantly changed compared to
the same period in 2001. During the third quarter of 2002, medical insurance
policies expire. Anecdotal evidence suggests that CNFC can anticipate double
digit increases as part of the renewal process. Also, staffing levels will
increase in order to staff the new office located in Greenville.
Non-interest expense for the six months ending June 30, 2002 totaled $2,913,000,
a $21,000 or .73% increase compared to the six months ending June 30, 2001.
Factors affecting the increase are similar to those discussed above.
15
COMMERCIAL NATIONAL FINANCIAL CORPORATION
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Asset liability management involves developing, implementing and monitoring
strategies to maintain sufficient liquidity, maximize net interest income and
minimize the impact that significant fluctuations in market interest rates would
have on earnings. Commercial's Asset/Liability Committee (ALCO) is responsible
for managing this process.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Commercial's primary market risk exposure is interest rate risk and, to a lesser
extent, liquidity risk. Commercial's transactions are denominated in U.S.
dollars with no specific foreign exchange exposure. Also, Commercial has a
limited exposure to commodity prices related to agricultural loans. Any impacts
that changes in foreign exchange rate and commodity prices would have on
interest rates are assumed to be insignificant.
Interest rate risk (IRR) is the exposure of a banking organization's financial
condition to adverse movements in interest rates. Accepting this risk can be an
important source of profitability and stockholder value; however, excessive
levels of IRR could pose a significant threat to earnings and capital.
Accordingly, effective risk management that maintains IRR at prudent levels is
essential to Commercial's safety and soundness.
Evaluating exposure to changes in interest rates includes assessing both the
adequacy of management's process used to control IRR and the organization's
quantitative level of exposure. When assessing the IRR management process,
Commercial seeks to ensure that appropriate policies, procedures, management
information systems and internal controls are in place to maintain IRR at
prudent levels with consistency and continuity. Evaluating the quantitative
level of IRR exposure requires the assessment of existing and potential future
effects of changes in interest rates on its consolidated financial condition,
including capital adequacy, earnings, liquidity, and, where appropriate, asset
quality.
Commercial derives the majority of income from the excess of interest collected
over interest paid. The rates of interest earned on its assets and owed on its
liabilities generally are established contractually for a period of time. Since
market interest rates change over time, Commercial is exposed to lower profit
margins (or losses) if it cannot adapt to interest rate changes.
For example, assume that an institution's assets carry long-term fixed rates and
that those assets are funded with short-term liabilities. If market interest
rates rise by the time the short-term liabilities must be refinanced, the
increase in the institution's interest expense may exceed the interest earned on
its long-term assets. Accordingly, an institution's profits could decrease.
Commercial is also subject to repayment risk when interest rates fall. For
example, mortgage loans and other financial assets may be prepaid by a debtor so
that the debtor may refinance their obligations at new, lower rates. Prepayments
of assets carrying higher rates reduces interest income and overall asset
yields.
Several ways an institution can manage IRR include: selling existing assets or
repaying certain liabilities; matching repricing periods for new assets and
liabilities, for example, by shortening terms of new loans or investments and
hedging existing assets, liabilities, or anticipated transactions. An
institution might also invest in more complex financial instruments intended to
hedge or otherwise change IRR. Interest rate swaps, futures contracts, options
on futures, and other such derivative financial instruments are often used for
this purpose. Because these instruments are sensitive to interest rate changes,
they require management's expertise to be effective. Commercial has not
purchased derivative financial instruments in the past and does not presently
intend to purchase such instruments.
ALCO uses various techniques to monitor IRR. Commercial's primary tool in
measuring interest rate risk is to perform a simulation analysis. This analysis
forecasts the effect of various interest rate changes on the balance sheet,
economic value of equity, net interest income and net income.
16
COMMERCIAL NATIONAL FINANCIAL CORPORATION
ALCO monitors the effect on the balance sheet and income statement of various
interest rate scenarios. One common scenario performed by ALCO is to "shock" the
balance sheet by assuming that Commercial has just experienced an immediate and
parallel shift in the yield curve up or down 200 basis points. These results are
recorded and compared to previous results. Management performs this calculation
quarterly.
The results of this calculation combined with a review of market interest rates,
economic conditions, loan demand, local deposit interest rates and other
factors, allows ALCO to structure the balance sheet with the goal of maximizing
net interest income and minimizing interest rate risk. ALCO applies the
percentage change anticipated in net interest income to the net interest income
actually earned to determine if the change is within acceptable limits. ALCO has
concluded from these results that Commercial has an acceptable level of interest
rate risk.
Forward Looking Statements
This discussion and analysis of financial condition and results of operations,
and other sections of this report contain forward looking statements that are
based on management's beliefs, assumptions, current expectations, estimates and
projections about the financial services industry, the economy, and about the
Corporation itself. Words such as "anticipates", "believes", "estimates",
"expects" "forecasts" "intends", "is likely", "plans", "product", "projects",
variations of such words and similar expressions are intended to identify such
forward-looking statements. These statements are not guarantees of future
performance and involve certain risks, uncertainties, and assumptions ("Future
Factors") that are difficult to predict with regard to timing, extent,
likelihood and degree of occurrence. Therefore, actual results and outcomes may
materially differ from what may be expressed or forecasted in such forward
looking statements. Furthermore, CNFC undertakes no obligation to update, amend
or clarify forward-looking statements, whether as a result of new information,
future events, or otherwise.
Future Factors include changes in interest rates and interest rate
relationships; demand for products and services; the degree of competition by
traditional and non-traditional competitors; changes in banking regulations and
tax laws; changes in prices, levies, and assessments; the impact of technology,
governmental and regulatory policy changes; the outcome of pending and future
litigation and contingencies; trends in customer behavior including their
ability to repay loans; and vicissitudes of the national and local economies.
These are representative of the Future Factors that could cause a difference
between an actual outcome and a forward-looking statement.
17
COMMERCIAL NATIONAL FINANCIAL CORPORATION
PART II. OTHER INFORMATION
Item 4 Submission of Matter to A Vote of Security Holders
Item 6 Exhibits and Reports on Form 8-K
(a) Exhibits:
99.1 Certification of Chief Executive Officer and Chief
Financial Officer
(b) Report on Form 8-K
None filed during the quarter ending June 30, 2002
18
COMMERCIAL NATIONAL FINANCIAL CORPORATION
ITEM 4. SUBMISSION OF MATTER TO A VOTE OF SECURITY HOLDERS
Commercial National Financial Corporation held its annual meeting of
Shareholders on April 23, 2002. A total of 3,147,275 shares were represented in
person or by proxy, or more than 88% of total shares outstanding.
Proposal: Shareholders elected ten Director nominees named in the Proxy
Statement.
Name For Against
- ---------------------------------------------------------------------
Richard F. Abbott 3,143,766 3,509
Jefferson P. Arnold 3,141,708 5,567
Jeffrey S. Barker 3,143,766 3,509
Don J. Dewey 3,141,232 6,043
Patrick G. Duffy 3,143,766 3,509
David A. Ferguson 3,143,766 3,509
Paul B. Luneack 3,143,766 3,509
Kim C. Newson 3,141,708 5,567
Howard D. Poindexter 3,143,766 3,509
Scott E. Sheldon 3,137,116 10,159
19
COMMERCIAL NATIONAL FINANCIAL CORPORATION
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.
Commercial National Financial Corporation
(Registrant)
Date: August 13, 2002 /s/ JEFFREY S. BARKER
--------------------------------------
Jeffrey S. Barker
President and Chief Executive Officer
/s/ PATRICK G. DUFFY
--------------------------------------
Patrick G. Duffy
Executive Vice President and Chief Financial
Officer
20
EXHIBIT INDEX
Exhibit No. Description
99.1 Certification of Chief Executive Officer and Chief
Financial Officer
21