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, 2004, 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 by check mark whether the registrant is an accelerated filer (as
defined in rule 12b-2 of the Exchange Act).
YES [ ] NO [X]
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 28, 2004
----- ----------------------------
Common Stock
No Par Value 4,081,157
- --------------------------------------------------------------------------------
INDEX
PART I FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of June 30, 2004 (unaudited) and December 31, 2003 (Page 3)
Consolidated Statements of Income and Other Comprehensive Income (unaudited) for
the three and six months ended June 30, 2004 and June 30, 2003 (Page 4)
Consolidated Statements of Changes in Shareholders' Equity (unaudited) for the
six months ended June 30, 2004 and June 30, 2003 (Page 5)
Consolidated Statements of Cash Flows (unaudited) for the six months ended
June 30, 2004 and June 30, 2003 (Page 6)
Notes to Consolidated Financial Statements (unaudited) (Page 7-9)
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (Page 10-13)
Item 3. Quantitative and Qualitative Disclosures about Market Risk (Page 13-15)
Item 4. Controls and Procedures (Page 15)
PART II OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K (Page 16-17)
SIGNATURES (Page 16)
COMMERCIAL NATIONAL FINANCIAL CORPORATION
ITEM 1: FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
June 30, December 31,
2004 2003
---- ----
(Unaudited)
ASSETS
Cash and due from $ 4,016,269 $ 6,113,498
Federal funds sold 3,111,733 644,807
Other interest bearing deposits 1,535,265 1,961,444
- -------------------------------------------------------------------------------------------------------------------
Total cash and cash equivalents 8,663,267 8,719,749
Securities available for sale 21,201,536 23,029,107
Securities held to maturity (fair value $2,302,421-
June 30, 2004; $3,171,283-December 31, 2003) 2,229,975 3,047,763
Federal Home Loan Bank stock, at cost 1,886,500 1,710,700
Gross loans receivable 200,188,290 194,389,682
Allowance for loan losses (2,147,475) (1,970,309)
- -------------------------------------------------------------------------------------------------------------------
Net loans 198,040,815 192,419,373
Bank owned life insurance 3,492,495 3,400,203
Premises and equipment, net 4,012,052 3,933,347
Accrued interest receivable and other assets 3,623,928 3,528,005
- -------------------------------------------------------------------------------------------------------------------
Total assets $ 243,150,568 $ 239,788,247
===================================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Deposits
Non-interest bearing demand $ 21,328,466 $ 23,203,653
Interest-bearing demand 28,420,224 29,141,354
Savings 60,022,921 62,028,217
Time 55,840,124 55,191,313
- -------------------------------------------------------------------------------------------------------------------
Total deposits 165,611,735 169,564,537
Securities sold under agreements to repurchase 12,912,011 11,766,630
Other short-term borrowings 380,893 412,389
Federal Home Loan Bank advances 37,728,548 32,104,222
Accrued expenses and other liabilities 2,002,063 1,657,642
- -------------------------------------------------------------------------------------------------------------------
Total liabilities 218,635,250 215,505,420
Shareholders' equity
Common stock and paid-in-capital, no par value: 5,000,000 shares
Authorized; shares issued and outstanding June 30, 2004-
4,076,894 and December 31, 2003-4,052,480 24,391,178 24,117,375
Accumulated earnings/(deficit) 67,358 (112,306)
Accumulated other comprehensive income, net of tax 56,782 277,758
- -------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 24,515,318 24,282,827
- -------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 243,150,568 $ 239,788,247
===================================================================================================================
See accompanying notes
3
COMMERCIAL NATIONAL FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (Unaudited)
Three Months Six Months
Ended June 30, Ended June 30,
2004 2003 2004 2003
Interest and dividend income
Loans, including fees $ 3,085,743 $ 3,125,574 $ 6,088,916 $ 6,219,668
Taxable securities 140,372 183,544 294,174 363,162
Nontaxable securities 81,407 99,804 167,479 206,804
Federal funds sold 5,434 27,245 19,463 67,029
Federal Home loan Bank stock dividends 19,319 20,358 40,815 44,358
Interest on other deposits 1,824 6,087 3,548 10,415
- -----------------------------------------------------------------------------------------------------------------------------
Total interest and dividend income 3,334,099 3,462,612 6,614,395 6,911,436
Interest expense
Deposits 535,168 645,281 1,094,249 1,340,932
Securities sold under agreements to repurchase 32,039 39,441 58,905 85,436
Federal Home Loan Bank advances 350,584 386,290 705,010 798,353
Other 620 668 1,126 1,419
- -----------------------------------------------------------------------------------------------------------------------------
Total interest expense 918,411 1,071,680 1,859,290 2,226,140
Net interest income 2,415,688 2,390,932 4,755,105 4,685,296
Provision for loan losses 90,000 1,230,000 180,000 1,350,000
- -----------------------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 2,325,688 1,160,932 4,575,105 3,335,296
Noninterest income
Service charges and fees 114,044 117,151 217,637 234,409
Net gain on loan sales 51,024 260,121 103,199 541,131
Receivable financing fees 47,054 43,225 94,686 84,426
Other 207,663 15,990 285,324 104,103
- -----------------------------------------------------------------------------------------------------------------------------
Total noninterest income 419,785 436,487 700,846 964,069
- -----------------------------------------------------------------------------------------------------------------------------
Noninterest expense
Salaries and employee benefits 989,490 929,527 1,963,013 1,833,669
Occupancy and equipment 331,838 319,674 668,718 622,493
FDIC insurance 6,449 6,882 12,929 14,184
Printing, postage and supplies 61,909 66,764 130,538 137,931
Professional and outside services 88,053 104,508 175,376 192,259
Other 312,814 273,046 584,933 516,315
- -----------------------------------------------------------------------------------------------------------------------------
Total non-interest expense 1,790,553 1,700,401 3,535,507 3,316,851
- -----------------------------------------------------------------------------------------------------------------------------
Income/(loss) before income tax expense 954,920 (102,982) 1,740,444 982,514
Income tax expense/(benefit) 281,000 (105,400) 501,000 214,000
- -----------------------------------------------------------------------------------------------------------------------------
Net income $ 673,920 $ 2,418 $ 1,239,444 $ 768,514
=============================================================================================================================
Net change in unrealized gains on securities available
for sale $ (374,282) $ 103,547 $ (334,812) $ 80,189
Tax effects 127,256 (35,205) 113,836 (27,264)
- -----------------------------------------------------------------------------------------------------------------------------
Total comprehensive income $ 426,894 $ 70,760 $ 1,018,468 $ 821,439
=============================================================================================================================
Per share information
Basic earnings $ .17 $ - $ .30 $ .19
Diluted earnings $ .16 $ - $ .30 $ .19
Dividends declared $ .12 $ .13 $ .26 $ .27
See accompanying notes
4
COMMERCIAL NATIONAL FINANCIAL CORPORATION
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
Six Months Ended June 30, 2004 and June 30, 2003 (Unaudited)
Accumulated
Shares Common Retained Other
Issued Stock and Earnings/ Comprehensive Total
and Paid in (Accumulated Income/(Loss), Shareholder'
Outstanding Capital Deficit) Net of Tax Equity
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at January 1, 2003 3,801,421 $ 23,255,499 $ 3,908 $ 444,565 $ 23,703,972
Comprehensive income:
Net income 768,514 768,514
Net change in unrealized gains/(losses) on
securities available for sale 80,189 80,189
Tax effect (27,264) (27,264)
------------
Total comprehensive income 821,439
Cash dividends declared, $.27 per share (1,070,794) (1,070,794)
Issued under dividend reinvestment plan 34,086 409,032 409,032
Issued under stock option plans 48 318 318
Issued under employee benefit plan 3,370 40,956 40,956
Repurchase and retirement of shares (13,126) (157,326) (157,326)
- -----------------------------------------------------------------------------------------------------------------------------------
Balance at June 30, 2003 3,825,799 $ 23,548,479 $ (298,372) $ 497,490 $ 23,747,597
===================================================================================================================================
Accumulated
Shares Common Retained Other
Issued Stock and Earnings/ Comprehensive Total
and Paid in (Accumulated Income/(Loss), Shareholder'
Outstanding Capital Deficit) Net of Tax Equity
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at January 1, 2004 4,052,480 $ 24,117,375 $ (112,306) $ 277,758 $ 24,282,827
Comprehensive income:
Net income 1,239,444 1,239,444
Net change in unrealized gains/(losses) on
securities available for sale (334,812) (334,812)
Tax effect 113,836 113,836
------------
Total comprehensive income 1,018,468
Cash dividends declared, $.26 per share (1,059,780) (1,059,780)
Issued under dividend reinvestment plan 35,690 401,748 401,748
Issued under employee benefit plan 3,646 46,772 46,772
Repurchase and retirement of shares (14,922) (174,717) (174,717)
- ---------------------------------------------------------------------------------------------------------------------------------
Balance at June 30, 2004 4,076,894 $ 24,391,178 $ 67,358 $ 56,782 $ 24,515,318
=================================================================================================================================
See accompanying notes
5
COMMERCIAL NATIONAL FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
Six Months Ended
June 30,
2004 2003
---- ----
Cash flows from operating activities
Net income $ 1,239,444 $ 768,514
Adjustments to reconcile net income to net cash from operating activities
Provision for loan losses 180,000 1,350,000
Net gains on loan sales (103,199) (541,131)
Originations of loans held for sale (4,750,948) (22,696,920)
Proceeds from sales of loans held for sale 4,854,147 23,238,051
Net losses on sale of other real estate and repossessed assets 11,452 -
Stock dividends paid on Federal Home loan Bank stock (175,800) (21,800)
Bank owned life insurance (92,292) (91,107)
Depreciation, amortization and accretion 382,695 343,188
Net change in accrued interest receivable and other assets (11,270) (103,608)
Net change in accrued expenses and other liabilities 422,168 182,651
- --------------------------------------------------------------------------------------------------------------------
Net cash from operating activities 1,956,397 2,427,838
Cash flow from investing activities
Purchases of securities available for sale (4,627,095) (14,425,946)
Proceeds from maturities of securities available for sale 6,002,743 10,517,199
Proceeds from maturities of securities held to maturity 815,000 1,280,000
Net change in loans (5,801,442) (1,492,050)
Purchases of premises and equipment (341,501) (411,571)
Proceeds from sale of other real estate and repossessed activities 17,731 81,478
- --------------------------------------------------------------------------------------------------------------------
Net cash from investing activities (3,934,564) (4,450,890)
Cash flow from financing activities
Net change in deposits (3,952,802) 825,152
Net change in securities sold under agreements to repurchase 1,145,381 896,482
Net change in U.S. treasury demand notes (31,496) (49,856)
Proceeds from Federal Home Loan Bank advances 14,000,000 -
Repayment of Federal Home Loan Bank advances (8,375,674) (4,386,337)
Repurchase and retirement of shares of common stock (174,717) (157,326)
Dividends paid (1,137,527) (1,066,280)
Proceeds from sale of common stock and fractional shares paid 448,520 450,306
- --------------------------------------------------------------------------------------------------------------------
Net cash from financing activities 1,921,685 (3,487,859)
- --------------------------------------------------------------------------------------------------------------------
Net change in cash and cash equivalents (56,482) (5,510,911)
Cash and cash equivalents, at beginning of period 8,719,749 19,269,814
- --------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, at end of period $ 8,663,267 $ 13,758,903
====================================================================================================================
Cash paid during the period for
Interest $ 1,877,421 $ 2,250,080
Federal income taxes $ - $ 684,000
See accompanying notes
6
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
Note 1-Summary of Significant Accounting Policies
Basis of Presentation
The accompanying unaudited 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 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, 2004 and December 31, 2003 and the results
of its operations for the three and six months ending June 30, 2004 and June 30,
2003. The results for the three and six months ended June 30, 2004 are not
necessarily indicative of the results expected for the full year.
Principles of Consolidation The accompanying consolidated financial statements
include the accounts of Commercial National Financial Corporation (CNFC),
Commercial Bank (Bank), 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 nine offices located in
Gratiot, Isabella 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. The allowance for loan losses and fair values of
securities and other financial instruments are particularly subject to change.
Stock Compensation Employee compensation expense under stock options is reported
using the intrinsic value method. No stock-based compensation cost is reflected
in net income as all options granted had an exercise price equal to or greater
than the market price of the underlying common stock at date of grant. There
were no grants for the period ending June 30, 2004. The following table
illustrates the effect on net income and earnings per share if expense was
measured using the fair value recognition provisions of SFAS No. 123, Accounting
for Stock-Based Compensation Expense.
7
COMMERCIAL NATIONAL FINANCIAL CORPORATION
Quarter to Date Year to Date
June 30, 2004 June 30, 2003 June 30, 2004 June 30, 2003
- --------------------------------------------------------------------------------------------------------------------------
Net income as reported $ 673,920 $ 2,418 $ 1,239,444 $ 768,514
Stock-based compensation expense (22,916) (28,470) (48,517) (53,361)
- ------------------------------------------------------------------------------------------------------------------------
Proforma net income/(loss) $ 651,004 $ (26,052) $ 1,190,927 $ 715,153
========================================================================================================================
Basic earnings per share as reported $ .17 $ .00 $ .30 $ .19
Proforma basic earnings per share $ .16 $ (.01) $ .29 $ .18
Diluted earnings per share as reported $ .16 $ .00 $ .30 $ .19
Proforma diluted earnings per share $ .16 $ (.01) $ .29 $ .18
The pro forma effects are computed using option pricing models, using the
following weighted-average assumptions as of the grant date. There were no
grants for the period ending June 30, 2004.
Quarter to Date Year to Date
June 30, 2003 June 30, 2003
- --------------------------------------------------------------------
Risk-free interest rate 3.57% 3.57%
Expected option life 10.00 10.00
Expected stock price volatility 21.10 21.10
Dividend yield 4.31% 4.31%
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.
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.
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.
Reclassifications Some items in the prior year financial statements have been
reclassified to conform with the current year presentation.
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. Stock options representing 48,792 and 99,248 shares of common
stock were not considered in computing diluted earnings per share for the three
and six month periods in 2003 and 2004 because they were antidilutive.
8
COMMERCIAL NATIONAL FINANCIAL CORPORATION
Three Months Ended Six Months Ended
JUNE 30, June 30, JUNE 30, June 30,
2004 2003 2004 2003
- -------------------------------------------------------------------------------------------------------------------------
BASIC EARNINGS PER SHARE:
Net income available to common shareholders $ 673,920 $ 2,418 $1,239,444 $ 768,514
Weighted-average common shares outstanding for
basic earnings per share 4,080,036 4,026,688 4,077,805 4,016,489
- -------------------------------------------------------------------------------------------------------------------------
BASIC EARNINGS PER SHARE $ .17 $ .00 $ .30 $ .19
=========================================================================================================================
DILUTED EARNINGS PER SHARE:
Net income available to common shareholders $ 673,920 $ 2,418 $1,239,444 $ 768,514
Weighted-average common shares outstanding for basic
earnings per share 4,080,036 4,026,688 4,077,805 4,016,489
Add:
Dilutive effect of assumed exercise of stock options 39,366 43,111 39,366 43,111
- -------------------------------------------------------------------------------------------------------------------------
Weighted-average common and dilutive additional potential
common shares outstanding 4,119,402 4,069,799 4,117,171 4,059,600
=========================================================================================================================
DILUTED EARNINGS PER SHARE $ .16 $ .00 $ .30 $ .19
=========================================================================================================================
9
COMMERCIAL NATIONAL FINANCIAL CORPORATION
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FINANCIAL CONDITION
Summary
Total assets ended the quarter at $243.2 million compared to $239.8 million at
December 31, 2003. Management classifies the economic environment as having weak
business loan demand offset by an active residential real estate market. The
residential real estate refinancing activity has been significantly reduced as
interest rates moved higher.
Loan totals increased $5.8 million as a result of growth in the residential real
estate loan portfolio. The business loan portfolio has decreased $3.6 million
since December 31, 2003 while the residential real estate portfolio has
increased $8.9 million.
During the first six months of 2003, CNFC charged-off $1,945,000 of loan
balances to the allowance for loan losses compared to $104,000 during the same
period in 2004. Loan quality has improved, however, CNFC continues to work with
several business loan customers, representing $2.9 million in loan balances,
experiencing financial difficulties.
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.
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: $17 million in available FHLB advances based on
available collateral and $9 million in short term federal funds lines of credit
with correspondent banks and the Federal Reserve. In addition, CNFC has secured
a $5 million line of credit with a correspondent bank. The stock of Commercial
Bank secures the line of credit. The interest rate on the line of credit is
equal to the prime interest rate at June 30, 2004 of 4.00%.
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.
Asset Quality
At June 30, 2004 CNFC has identified $2.9 million of loans as non-performing.
This compares to $825,000 at December 31, 2003. All non-accrual loans are
considered impaired. The specific allowance for loan loss allocated to these
loans is $335,000 at June 30, 2004 and $189,000 at December 31, 2003. The
balance in repossessed assets and other real estate at June 30, 2004 represents
two residential real estate properties which management believes will not result
in material loss.
10
COMMERCIAL NATIONAL FINANCIAL CORPORATION
June 30, 2004 December 31, 2003
------------ -----------------
Total loans $200,188,290 $194,389,682
Non-accrual loans $ 2,842,349 $ 825,129
Accruing loans past due 90 days or more 84,346 -
Restructured Loans (non accrual) - -
- -----------------------------------------------------------------------------------
Total non-performing loans 2,926,695 825,129
Repossessed assets and other real estate 102,428 598,011
- -----------------------------------------------------------------------------------
Total non-performing assets $ 3,029,123 $ 1,423,140
===================================================================================
Total non-performing loans as a
percentage of total loans 1.46% .42%
===================================================================================
Allowance for loan loss as a percentage of
non-performing loans 73.38% 238.78%
===================================================================================
Total non-performing assets as a percentage of
total assets 1.25% .59%
===================================================================================
Allowance for Loan Loss Summary of Activity
Six Months Ended Year Ended Six Months Ended
June 30, 2004 December 31, 2003 June 30, 2003
- -------------------------------------------------------------------------------------------------------
Beginning balance $ 1,970,309 $ 2,783,234 $ 2,783,234
Loan charge-offs (103,800) (3,120,283) (1,945,362)
Loan recoveries 100,966 406,358 83,843
- -----------------------------------------------------------------------------------------------------
Net loan recoveries/(charge-offs) (2,834) (2,713,925) (1,861,519)
Provision for loan losses 180,000 1,901,000 1,350,000
- -----------------------------------------------------------------------------------------------------
Ending balance $ 2,147,475 $ 1,970,309 $ 2,271,715
=====================================================================================================
Average loan balance $ 194,077,000 $ 184,693,000 $ 181,230,000
Percentage of net charge-offs
as a percentage of average loans 0.00% (1.47)% (1.03)%
Allowance for loan loss
as a percentage of total loans 1.07% 1.01% 1.24%
For purposes of evaluating the adequacy of the allowance, the performance of the
loan portfolio is divided into four classifications: non-classified, watch,
substandard-not impaired, and substandard-impaired. Management has subdivided
the classifications of non-classified and watch into the following categories of
loans: residential, consumer and business loans.
Non-classified loans are loans that are viewed as homogeneous categories. These
loans are generally current and performing as agreed. Commercial establishes a
reserve on these categories of non-classified loans using the last three year
historical charge-off experience.
Watch credits are loans that management has identified as having some change
that requires additional loan officer monitoring. These loans are generally
paying as agreed, however, the ability to meet debt obligations, while adequate,
has deteriorated. These loans are not considered impaired within the definition
of FAS 114 and 118 and are viewed as homogeneous categories.
Substandard-impaired and substandard-not impaired loans are business loans that
management reviews for impairment under FAS 114 and 118. Management reviews
these loans individually for impairment using either the present value of
expected cash flow or the value of collateral. Loans not considered impaired are
11
COMMERCIAL NATIONAL FINANCIAL CORPORATION
grouped as a homogenous category. A reserve is established on this category
using historical loss experience. A specific reserve is calculated for each loan
identified as impaired, however, the total allowance is available for any loan.
Management believes the business loan portfolio contains the highest risk of
loss of principal. The assets identified as non-performing and/or non-accrual
are considered impaired. The impaired loans are secured by real estate and
supported by appraisals, however, in a weak economy the ability to ultimately
collected the full amount represented by the appraisal is not certain.
Management is aware of recent completed sales involving similar types of real
estate and believes that there is sufficient value to limit Commercial's
exposure to $335,000. However, no assurance can be given that the ultimate
exposure is significantly higher than this amount.
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 Minimum Required
June 30, December 31, Prompt Corrective Action for Capital
2004 2003 Regulations Adequacy Purposes
- ------------------------------------------------------------------------------------------------------------------------
Total capital to
risk weighted assets 14.7% 14.4% 10.0% 8.0%
Tier 1 capital to
risk weighted assets 13.5% 13.3% 6.0% 4.0%
Tier 1 capital to
average assets 10.2% 10.2% 5.0% 4.0%
RESULTS OF OPERATIONS
Summary
Net income for the quarter ended June 30, 2004 was $674,000, an increase of
$672,000 compared to the same period in 2003. The primary factor that affected
the decrease in net income is: a $1,140,000 decrease in the provision for loan
loss.
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, 2004 and 2003.
Three Months Ending June 30, Six Months Ending June 30,
2004 2003 2004 2003
- --------------------------------------------------------------------------------------------------------------------
Interest income (tax equivalent) $ 3,434,938 $ 3,574,006 $ 6,819,657 $ 7,136,836
Interest expense 918,411 1,071,680 1,859,290 2,226,140
- --------------------------------------------------------------------------------------------------------------------
Net interest income $ 2,516,527 $ 2,502,326 $ 4,960,367 $ 4,910,696
====================================================================================================================
Average balances
Interest-earning assets $226,731,682 $224,495,461 $226,265,092 $225,288,866
Interest-bearing liabilities 192,797,459 193,030,080 193,035,283 193,547,969
- --------------------------------------------------------------------------------------------------------------------
Net differential $ 33,934,223 $ 31,465,381 $ 33,229,809 $ 31,740,897
====================================================================================================================
Average Yields/Rates (annualized)
Yield on earning assets 6.08% 6.38% 6.04% 6.39%
Rate paid in liabilities 1.91% 2.23% 1.93% 2.32%
- --------------------------------------------------------------------------------------------------------------------
Interest spread 4.17% 4.15% 4.11% 4.07%
====================================================================================================================
Net interest margin 4.45% 4.47% 4.40% 4.40%
====================================================================================================================
12
COMMERCIAL NATIONAL FINANCIAL CORPORATION
The following table quantifies the effect on net interest income of changes in
the volume of assets and liabilities and the change in yields and cost of funds
for the three and six months ended June 30, 2004
Three Months Ending Six Months Ending
June 30, 2004 June 30, 2004
Balance Rate Inc/(Dec) Balance Rate Inc/(Dec)
------- ---- --------- ------- ---- ---------
Interest Earning Assets $ 173,351 $(312,419) $(139,068) $ 330,753 $(647,932) $(317,179)
Interest Bearing Liabilities 27,724 (180,993) (153,269) 46,334 (413,184) (366,850)
--------- --------- --------- --------- --------- ---------
Net Interest Income $ 145,627 $(131,426) $ 14,201 $ 284,419 $(234,748) $ 49,671
========= ========= ========= ========= ========= =========
In general, interest rates have trended upward during the first and second
quarters of 2004, as economic data supported a strengthening economy. In the
short run, this has had little effect on CNFC's margin. Margin has remained
stable at 4.45% compared to 4.47% for the same period of 2003.
The factors affecting the $50,000 increase in tax equivalent net interest income
for the six months ending June 30, 2004 are similar to those described above for
the three months ending June 30, 2004.
Noninterest Income
Noninterest income for the three months ending June 30, 2004 was $420,000. This
represents a $16,000 or 3.7% decrease over the same period in 2003.
The decrease in the net gain on loan sales of $209,000 or 80.4% compared to the
same period in 2003 was the primary reason for the overall decrease. Rising
interest rates eliminated the incentive for residential real estate customers to
refinance existing loans. We do not anticipate a resumption of the refinancing
activity.
Offsetting the decrease in net gain on loan sales was a $192,000 or 1200.0%
increase in other noninterest income. As rates have increased, the average life
of the residential real estate mortgage loan portfolio has extended. This has
resulted in an increase in the value of mortgage servicing rights. During the
second quarter of 2004, CNFC recorded a recovery of $132,000 in the value of
mortgage servicing rights previously expensed to a valuation allowance.
The factors affecting the $263,000 decrease in noninterest income for the six
months ending June 30, 2004 are similar to those described above for the three
months ending June 30, 2004.
Noninterest Expense
Noninterest expense for the three months ending June 30, 2004 totaled
$1,791,000. This represents a $91,000 or 5.4% increase over the same period in
2003.
Salary and benefit expense for the three months ending June 30, 2004 totaled
$989,000 compared to $930,000 for the same period in 2003, an increase of
$59,000 or 6.3%. The increase represents normal merit increases in salary, and
normal increases in related benefit expense.
Professional fees for the quarter ending June 30, 2004 totaled $88,000 compared
to $105,000 for the same period in 2003. This represents a $17,000 or 16.2%
decrease. Included in the 2003 totals was $18,000 in employment search fees. The
search fees for 2004 are $0.
The factors affecting the $219,000 increase in noninterest expense for the six
months ending June 30, 2004 are similar to those described above for the three
months ending June 30, 2004.
ITEM 3: 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
13
COMMERCIAL NATIONAL FINANCIAL CORPORATION
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 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 threat to earnings and capital. Accordingly,
effective risk management that maintains IRR at prudent levels is essential to
Commercial's safety and soundness. 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's Asset/Liability Committee ("Committee") is responsible for managing
this process.
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.
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 lower rates. Prepayment of
assets carrying higher rates reduces interest income and overall asset yields.
Fluctuating interest rates and prepayment risk provide a challenge in managing
the net interest income of the Bank. For example: the Bank may fund a 15 year
fixed rate residential real estate loan with a long term amortizing Federal Home
Loan Bank Advance. In a stable interest rate environment, the Bank can
reasonably predict the net interest income earned. However, if rates fall
significantly, the residential mortgage customer may refinance their mortgage at
a lower rate. The Bank continues to pay the higher rate on the Federal Home Loan
Bank advance, thus eroding net interest income. In an alternative scenario, the
Bank funds the same 15 year fixed rate residential real estate loan with 1 year
certificates of deposits. If rates rise at the end of one year, the Bank will
pay more interest to continue to fund the residential mortgage loan with 1 year
certificates of deposit. The net interest income will be lower in year two than
it was in the first year of the mortgage loan.
An additional challenge management faces in managing net interest income is the
fact that what would maximize net interest income to the Bank may be in conflict
with the customers' request for products and services. In the current low
interest rate environment, management has greater concern that interest rates
will rise significantly over time rather than fall. Management would prefer to
offer variable rate loan products that would reprice upward as interest rates
rise. However, our loan customers are generally requesting long term fixed rate
loans. On the funding side, management would like to extend the maturities of
its liabilities to match the loan customers' request for longer term fixed rate
loans. However, our deposit customers' are reluctant to commit to long term
certificates of deposits.
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 cash flows associated with CNFC's assets and liabilities. One
common scenario performed by the Committee 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. The model, using data and
assumptions determined by management, reprice assets and liabilities at new
market rates. The objective of this testing is to determine how the Bank's net
income and the economic value of equity are affected by extreme changes in
interest rates. These results are recorded and compared to previous results.
Management performs this calculation monthly.
The limitation to this methodology is that the interest rate curve rarely shifts
200 basis points immediate and parallel. In addition, a downward 200 basis point
shift in today's interest rate environment is not likely. Management implemented
a new interest rate risk model during the first quarter of 2004. In addition to
the 200 basis point immediate and parallel shift in interest rates, management
performs additional projections using other interest rate environments, asset
growth assumptions and funding strategies. The results listed below for December
31, 2003 were obtained using the Bank's prior model.
The Table below summarizes the effect a 200 basis point immediate and parallel
shift of the yield curve has on net income. In a falling interest rate
environment, management does not have the ability to lower
14
COMMERCIAL NATIONAL FINANCIAL CORPORATION
deposit rates 200 basis points to offset a decrease in rates on earning assets.
Therefore, if rates decreased 200 basis points, margin would likely compress
resulting in lower net interest income and potentially lower net income.
In an environment where interest rates increased 200 basis points in an
immediate and parallel shift in the yield curve, management projects that net
income will increase during the next 12 months. The difference in June 30, 2004
projected net income compared to December 31, 2003 is primarily due to the
change in the interest rate risk model used by management. Management believes
that the new model more accurately predicts the repricing opportunities and cash
flows comprising the balance sheet at June 30, 2004.
Projected Percentage Change in Net Income
June 30, 2004 December 31, 2003
------------- -----------------
- -200 basis points (6.8%) .3%
0 basis points 0.0 0.0
+200 basis points 3.7% (35.0%)
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures-Jeffrey S. Barker,
the Corporation's Principal Executive Officer, and Patrick G. Duffy,
the Corporation's Principal Financial Officer, have reviewed and
evaluated the effectiveness of the Corporation's disclosure controls
and procedures (as defined in Rules 240.13a-15(e) and 15d-15(e) under
the Securities Exchange Act of 1934 (the "Exchange Act)) as of the
end of the period covered by this Form 10-Q quarterly report. Based
on their evaluation, they have concluded that the Corporation's
disclosure controls and procedures were effective as of June 30,
2004.
(b) Changes in internal controls-The Corporation also conducted an
evaluation of internal control over financial reporting to determine
whether any changes occurred during the quarter ended June 30, 2004,
that have materially affected, or are reasonably likely to materially
affect, the Corporation's internal control over financial reporting.
Based on this evaluation, there has been no such change during the
quarter that ended June 30, 2004.
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.
15
COMMERCIAL NATIONAL FINANCIAL CORPORATION
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.
PART II. OTHER INFORMATION
ITEM 2 CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY
SECURITIES
The following table shows information relating to the repurchase of shares of
Commercial National Financial Corporation common stock for the three months
ended June 30, 2004:
Total Number Maximum
of Shares Number
Purchased as of Shares
Part of Publicly That May Yet be
Total Number Average Announced Purchased Under
of Shares Price Paid Plans or the Plans or
Purchased Per Share Programs(1) Programs(1)
- --------------------------------------------------------------------------------------------------------
April 1-30 1,957 $ 11.52 1,957 74,852
May 1-31 1,970 11.52 1,970 72,882
June 1-30 10,995 11.26 10,995 61,887
- -------------------------------------------------------------------------------------------------------
Total 14,922 $ 11.34 14,922 61,887
=======================================================================================================
- ------------
(1) A stock repurchase program was established during 1998. The board of
directors of Commercial National Financial Corporation has authorized the
repurchase of up to 383,340 shares. The repurchase program has no expiration
date.
ITEM 4 SUBMISSIONS OF MATTERS TO A VOTE OF SECURITY HOLDERS
Commercial National Financial Corporation held its annual meeting of
shareholders on April 27, 2004. A total of 3,440,613 shares were represented in
person or by proxy, or more than 84.39% of the total shares outstanding.
Proposal: Shareholders elected 10 Director nominees named in the Proxy
Statement.
Name For Against
- ------------------------------------------------------------------------------------
Richard F. Abbott 3,426,572 14,041
Jefferson P. Arnold 3,424,300 16,313
Jeffrey S. Barker 3,426,635 13,978
Don J. Dewey 3,426,127 14,486
Patrick G. Duffy 3,426,635 13,978
David A. Ferguson 3,402,582 38,031
Paul B. Luneack 3,428,252 12,361
Kim C. Newson 3,426,127 14,486
Howard D. Poindexter 3,428,252 12,361
Scott E. Sheldon 3,424,787 15,826
ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
Exhibit 31.1 Certification of Chief Executive Officer
required by Rule 13a-14(a).
Exhibit 31.2 Certification of Chief Financial Officer
required by Rule 13a-14(a).
16
COMMERCIAL NATIONAL FINANCIAL CORPORATION
Exhibit 32.1 Certification pursuant to 18 U.S.C. Section
1350 of Chief Executive Officer.
Exhibit 32.2 Certification pursuant to 18 U.S.C. Section
1350 of Chief Financial Officer.
(b) Reports on Form 8-K
Current report on Form 8-K dated May 27, 2004 filed with
the Securities and Exchange Commission on May 27, 2004,
under Item 5, announcing the 2004 second quarter dividend.
Current report on Form 8-K dated May 6, 2004 filed with the
Securities and Exchange Commission on May 10, 2004, under
Item 9, announcing first quarter 2004 earnings.
Current report on Form 8-K dated May 19, 2004 filed with
the Securities and Exchange Commission on May 25, 2004,
under Item 5, announcing the election of Robert S. Elmore
to the board of directors of 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: July 31, 2004 /s/ Jeffrey S. Barker
---------------------------------------------
Jeffrey S. Barker
President and Chief Executive Officer
Date: July 31, 2004 /s/ Patrick G. Duffy
---------------------------------------------
Patrick G. Duffy
Executive Vice President and Chief
Financial Officer
17
10-Q EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION
- ----------- -----------
EX-31.1 Certification of Chief Executive Officer
required by Rule 13a-14(a).
EX-31.2 Certification of Chief Financial Officer
pursuant required by Rule 13a-14(a)
EX-32.1 Certification pursuant to 18 U.S.C. Section
1350 of Chief Executive Officer
EX-32.2 Certification pursuant to 18 U.S.C. Section
1350 of Chief Financial Officer