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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2004
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM -- TO --
Commission file number 0-30665
CNB Financial Services, Inc.
- --------------------------------------------------------------------------------
(Exact Name of Registrant as specified in its charter)
United States of America 55-0773918
- ------------------------------- ------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
101 S. Washington Street,
Berkeley Springs, WV 25411
- ------------------------------- ------------------------------------
(Address of principal (Zip Code)
executive offices)
Issuer's telephone number, ( 304 ) 258 - 1520
----- ------------ ----------------
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 Exchange Act Rule 12b-2).
YES [ ] NO [X]
The aggregate value of the common stock of the Registrant that was held by
non-affiliates as of the most recently completed second fiscal quarter (June 30,
2004), was approximately $30.9 million. This amount was based on the last
closing sale price of a share of common stock of $80.00 as of the same date.
Common Stock $1 par value, 458,048 shares outstanding as of November 10, 2004
CNB FINANCIAL SERVICES, INC.
TABLE OF CONTENTS
PART 1: FINANCIAL INFORMATION
PAGE
Item 1. Financial Statements
Consolidated Statements of Financial Condition as of September 30, 2004 (Unaudited)
and December 31, 2003..........................................................................3
Consolidated Statements of Income for the Three and Nine Months ended September 30, 2004 and
2003 (Unaudited)...............................................................................4
Consolidated Statements of Changes in Shareholders' Equity for the Three and Nine
Months Ended September 30, 2004 (Unaudited) and the Year Ended December 31, 2003...............5
Consolidated Statements of Cash Flows for the Nine Months
Ended September 30, 2004 and 2003 (Unaudited)..................................................6
Notes to Consolidated Financial Statements (Unaudited)..........................................7
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations for the Three and Nine Months ended September 30, 2004..................13
Item 3. Quantitative and Qualitative Disclosures about Market Risk.....................................22
Item 4. Controls and Procedures........................................................................23
PART II: OTHER INFORMATION
Item 1. Legal Proceedings............................................................................25
Item 6. Exhibits and Reports on Form 8-K..............................................................25
SIGNATURES....................................................................................26
Forward-Looking Statements
The Private Securities Litigation Reform Act of 1995 indicates that
the disclosure of forward-looking information is desirable for investors and
encourages such disclosure by providing a safe harbor for forward-looking
statements that involve risk and uncertainty. All statements other than
statements of historical fact included in this Form 10-Q including statements in
Management's Discussion and Analysis of Financial Condition and Results of
Operations are, or may be deemed to be, forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934. In order to comply with the terms of the safe
harbor, CNB notes that a variety of factors could cause CNB's actual results and
experience to differ materially from the anticipated results or other
expectations expressed in those forward-looking statements. These factors could
include the following possibilities: (1) competitive pressures among depository
and other financial institutions may increase significantly; (2) changes in the
interest rate environment may reduce margins; (3) general economic conditions
may become unfavorable resulting in reduced credit quality or demand for loans;
(4) legislative or regulatory changes could increase expenses; and (5)
competitors may have greater financial resources and develop products that
enable them to compete more successfully than CNB.
2
CNB FINANCIAL SERVICES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
SEPTEMBER 30, DECEMBER 31,
ASSETS 2004 2003
------------- -------------
(Unaudited)
Cash and due from banks $ 8,700,922 $ 7,641,280
Federal funds sold 5,533,000 3,000
Securities available for sale
(at approximate market value) 53,071,551 39,361,934
Federal Home Loan Bank (FHLB) stock, at cost 963,100 865,700
Federal Reserve Bank stock, at cost 129,650 129,650
Loans and lease receivable, net 154,401,210 144,665,208
Accrued interest receivable 992,836 838,659
Premises and equipment, net 5,620,900 5,288,633
Cash surrender value of life insurance 1,172,193 1,065,435
Deferred income taxes 283,220 352,405
Intangible assets 767,423 23,795
Other assets 842,984 820,052
------------- -------------
TOTAL ASSETS $ 232,478,989 $ 201,055,751
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Deposits:
Demand $ 34,804,073 $ 29,485,097
Interest-bearing demand 51,363,361 34,042,317
Savings 31,362,426 24,360,890
Time, $100,000 and over 36,804,658 36,642,560
Other time 57,417,399 56,367,865
------------- -------------
$ 211,751,917 $ 180,898,729
Accrued interest payable 578,175 673,624
FHLB borrowings -- 1,200,000
Securities sold under repurchase agreement 211,475 --
Accrued expenses and other liabilities 1,642,254 1,714,457
------------- -------------
TOTAL LIABILITIES $ 214,183,821 $ 184,486,810
------------- -------------
SHAREHOLDERS' EQUITY
Common stock, $1 par value; 5,000,000 shares
authorized; 458,048 shares outstanding $ 458,048 $ 458,048
Capital surplus 3,863,592 3,863,592
Retained earnings 14,073,902 12,460,556
Accumulated other comprehensive income (100,374) (213,255)
------------- -------------
TOTAL SHAREHOLDERS' EQUITY $ 18,295,168 $ 16,568,941
------------- -------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 232,478,989 $ 201,055,751
============= =============
The Notes to Consolidated Financial Statements are an integral part of these
statements.
3
CNB FINANCIAL SERVICES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------- -------------------------
2004 2003 2004 2003
----------- ----------- ----------- -----------
INTEREST INCOME
Interest and fees on loans $ 2,523,826 $ 2,445,543 $ 7,337,321 $ 7,134,740
Interest and dividends on securities
U.S. Government agencies and
corporations 314,847 316,991 809,716 993,924
Mortgage backed securities 94,657 109,466 261,151 432,353
State and political subdivisions 76,377 16,465 179,471 44,190
Other 2,525 3,499 12,436 15,597
Interest on federal funds sold 18,933 3,500 26,539 16,481
----------- ----------- ----------- -----------
$ 3,031,165 $ 2,895,464 $ 8,626,634 $ 8,637,285
----------- ----------- ----------- -----------
INTEREST EXPENSE
Interest on interest bearing demand, $ 805,898 $ 969,351 $ 2,330,769 $ 3,258,959
savings and time deposits
Interest on federal funds purchased -- 555 -- 825
Interest on borrowings 767 1,877 4,924 1,877
----------- ----------- ----------- -----------
$ 806,665 $ 971,783 $ 2,335,693 $ 3,261,661
----------- ----------- ----------- -----------
NET INTEREST INCOME $ 2,224,500 $ 1,923,681 $ 6,290,941 $ 5,375,624
PROVISION FOR LOAN LOSSES 102,000 57,000 283,000 194,000
----------- ----------- ----------- -----------
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES $ 2,122,500 $ 1,866,681 $ 6,007,941 $ 5,181,624
----------- ----------- ----------- -----------
NONINTEREST INCOME
Service charges on deposit accounts $ 318,885 $ 255,337 $ 862,918 $ 693,431
Other service charges, commissions
and fees 117,472 90,042 308,092 277,472
Insurance commissions 36,792 29,426 103,505 80,060
Other operating income 11,221 16,290 42,207 61,681
Net gain on sale of securities -- 63,981 135,546 161,073
Income from title company 4,380 16,500 32,000 40,050
Gain (loss) on sale of other real estate owned -- (876) -- (876)
----------- ----------- ----------- -----------
$ 488,750 $ 470,700 $ 1,484,268 $ 1,312,891
----------- ----------- ----------- -----------
NONINTEREST EXPENSES
Salaries $ 681,509 $ 592,531 $ 1,897,930 $ 1,755,359
Employee benefits 234,092 188,652 673,299 617,792
Occupancy of premises 93,620 75,296 256,031 223,110
Furniture and equipment expense 219,626 165,621 632,636 468,056
Other operating expenses 456,172 387,628 1,404,490 1,299,865
----------- ----------- ----------- -----------
$ 1,685,019 $ 1,409,728 $ 4,864,386 $ 4,364,182
----------- ----------- ----------- -----------
INCOME BEFORE INCOME TAXES $ 926,231 $ 927,653 $ 2,627,823 $ 2,130,333
PROVISION FOR INCOME TAXES 290,942 329,127 835,838 775,611
----------- ----------- ----------- -----------
NET INCOME $ 635,289 $ 598,526 $ 1,791,985 $ 1,354,722
=========== =========== =========== ===========
BASIC EARNINGS PER SHARE $ 1.39 $ 1.31 $ 3.91 $ 2.96
=========== =========== =========== ===========
The Notes to Consolidated Financial Statements are an integral part of these
statements.
4
CNB FINANCIAL SERVICES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
ACCUMULATED
OTHER TOTAL
COMMON CAPITAL RETAINED COMPREHENSIVE SHAREHOLDERS'
STOCK SURPLUS EARNINGS INCOME EQUITY
-------------- -------------- --------------- ------------- ---------------
BALANCE, DECEMBER 31, 2002 $ 458,048 $ 3,863,592 $11,267,374 $ 681,004 $16,270,018
-----------
Comprehensive income:
Net income for 2003 - - 1,742,840 - 1,742,840
Change in unrealized gains
(losses) on securities
available for sale (net of tax
of $382,304) - - - (623,758) (623,758)
Change in minimum pension liability
adjustment (net of tax of $165,792) (270,501) (270,501)
-----------
Total Comprehensive Income - - - - 848,581
-----------
Cash dividends ($1.20 per share) - - (549,658) - (549,658)
--------- ----------- ----------- ---------- -----------
BALANCE, DECEMBER 31, 2003 $ 458,048 $ 3,863,592 $12,460,556 $ (213,255) $16,568,941
-----------
Comprehensive income:
Net income for nine months
ended September 30, 2004 - - 1,791,985 - 1,791,985
Change in unrealized gains
(losses) on securities
available for sale (net of tax
of $69,185) - - - 112,881 112,881
-----------
Total Comprehensive Income - - - - 1,904,866
-----------
Cash dividends ($0.39 per share) - - (178,639) - (178,639)
--------- ----------- ----------- ---------- -----------
BALANCE, SEPTEMBER 30, 2004 (unaudited) $ 458,048 $ 3,863,592 $14,073,902 $ (100,374) $18,295,168
========= =========== =========== ========== ===========
The Notes to Consolidated Financial Statements are an integral part of these
statements.
5
CNB FINANCIAL SERVICES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
NINE MONTHS ENDED
SEPTEMBER 30,
----------------------------
2004 2003
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 1,791,985 $ 1,354,722
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 554,020 407,785
Provision for loan losses 283,000 194,000
Net (gain) on sale of securities (135,546) (161,073)
Loss on sale of real estate owned -- 876
(Increase) decrease in accrued interest receivable (119,651) 35,500
(Increase) in other assets (84,169) (68,716)
(Decrease) in accrued interest payable (95,449) (182,214)
(Increase) in cash surrender value on life insurance in excess
of premiums paid (47,936) (15,000)
Increase (decrease) in accrued expenses and other liabilities (78,784) 169,311
Amortization of deferred loan (fees) cost 13,916 6,349
Amortization (accretion) of premium and discount on investments 53,266 127,613
------------ ------------
NET CASH PROVIDED BY OPERATING ACTIVITIES $ 2,134,652 $ 1,869,153
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net (increase) in loans $ (1,612,945) $(12,015,627)
Proceeds from sales of securities 6,391,436 11,628,314
Proceeds from maturities, repayments and calls of securities 11,983,142 23,091,545
Purchases of securities (31,819,849) (35,181,253)
Purchases of Federal Home Loan Bank stock (561,100) (211,800)
Redemptions of Federal Home Loan Bank stock 463,700 --
Purchases of premises and equipment (461,757) (478,324)
Proceeds from sales of other real estate owned, net -- 924
Net (increase) decrease in federal funds sold (5,530,000) 3,561,674
Premiums paid on life insurance (58,822) (68,566)
Cash from acquired branch 5,020,017 --
------------ ------------
NET CASH (USED IN) INVESTING ACTIVITIES $(16,186,178) $ (9,673,113)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in demand and savings deposits $ 21,432,367 $ 7,546,479
Net (decrease) in time deposits (5,154,035) (582,766)
Net increase in securities sold under repurchase agreement 211,475 --
Net increase (decrease) in FHLB borrowings (1,200,000) 1,250,000
Cash dividends paid (178,639) (178,639)
------------ ------------
NET CASH PROVIDED BY FINANCING ACTIVITIES $ 15,111,168 $ 8,035,074
------------ ------------
NET INCREASE IN CASH AND CASH EQUIVALENTS $ 1,059,642 $ 231,114
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 7,641,280 7,832,735
------------ ------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 8,700,922 $ 8,063,849
============ ============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period:
Interest $ 2,431,142 $ 3,443,874
Income taxes $ 864,009 $ 582,000
Net transfer to foreclosed real estate, held for sale from loans
receivable $ -- $ 105,528
The Company acquired certain assets and liabilities associated with the Hancock
Branch of Fidelity Bank. In conjunction with the acquisition, the assets
acquired and liabilities assumed were as follows:
Fair value of assets acquired $ 9,561,420
------------
Fair value of liabilities assumed $ 14,581,437
------------
Liabilities assumed in excess of assets acquired $ 5,020,017
============
The Notes to Consolidated Financial Statements are an integral part of these
statements.
6
CNB FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Note 1. Basis of Presentation and Contingencies
In the opinion of CNB Financial Services, Inc. ("CNB" or the
"Company"), the accompanying unaudited consolidated financial
statements contain all adjustments (consisting of only normal recurring
accruals) necessary for a fair presentation of CNB financial condition
as of September 30, 2004 and the results of operations for the three
and nine months ended September 30, 2004 and 2003 and cash flows for
the nine months ended September 30, 2004 and 2003.
The accompanying unaudited financial statements have been
prepared in accordance with the instructions for Form 10-Q. These
financial statements should be read in conjunction with the
consolidated financial statements and the notes included in CNB's
Annual Report for the year ended December 31, 2003.
In the ordinary course of business, the company and its
subsidiary are involved in various legal proceedings.
In the opinion of the management of CNB, there are no
proceedings pending to which CNB is a party or to which its property is
subject, which, if determined adversely to CNB, would be material in
relation to CNB's financial condition. There are no proceedings pending
other than ordinary routine litigation incident to the business of CNB.
In addition, no material proceedings are pending or are known to be
threatened or contemplated against CNB by government authorities.
Note 2. Business Combinations
On June 11, 2004, Citizens National Bank purchased certain
assets and liabilities associated with the Hancock Branch of Fidelity
Bank, a subsidiary bank of Mercantile Bankshares Corporation (formerly
Home Federal). The results of the Hancock Branch's operations have been
included in the consolidated financial statements since that date.
The following table provides information concerning the
allocations of the purchase price and the fair values of the assets and
liabilities acquired of the Hancock branch:
AT JUNE 11, 2004
- -----------------------------------------------------------------------
Assets acquired:
Loans $ 8,419,973
Accrued interest receivable 34,526
Fixed assets 324,166
Intangible asset-premium on deposits 780,616
Prepaid expenses 2,139
-------------
Total assets acquired $ 9,561,420
-------------
Liabilities assumed:
Deposit accounts $ (14,574,856)
Accrued expenses (6,581)
-------------
Total liabilities assumed $ (14,581,437)
-------------
Cash from acquired branch $ (5,020,017)
=============
7
CNB FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Note 2. Business Combinations (continued)
Citizens National Bank recorded $781,000 of core deposit
intangible, which has a weighted-average useful life of 7 years.
Note 3. Securities
The amortized cost and estimated market value of debt
securities at September 30, 2004 and December 31, 2003 by contractual
maturity are shown below. Expected maturities will differ from
contractual maturities because borrowers may have the right to call or
prepay obligations with or without call or prepayment penalties.
Securities are summarized as follows:
SEPTEMBER 30, 2004 WEIGHTED
-------------------------------------------------------------------------- AVERAGE
GROSS GROSS ESTIMATED TAX
AMORTIZED UNREALIZED UNREALIZED FAIR EQUIVALENT
COST GAINS LOSSES VALUE YIELD
--------------- --------------- --------------- ----------------- -------------
Available for sale:
U.S. Government agencies
and corporations
After 1 but within 5 years $12,406,091 $ 184,866 $ 32,287 $12,558,670 3.87%
After 5 but within 10 years 21,880,150 122,410 119,117 21,883,443 4.14
----------- ----------- ----------- -----------
$34,286,241 $ 307,276 $ 151,404 $34,442,113 4.04%
----------- ----------- ----------- -----------
States and political subdivisions
Within one year $ 25,000 $ 1,832 $ -- $ 26,832 4.50%
After 1 but within 5 years 1,565,031 13,309 -- 1,578,340 3.08
After 5 but within 10 years 8,106,299 120,010 37,048 8,189,261 3.70
----------- ----------- ----------- -----------
$ 9,696,330 $ 135,151 $ 37,048 $ 9,794,433 3.60%
----------- ----------- ----------- -----------
Mortgage backed securities $ 8,814,582 $ 44,252 $ 23,829 $ 8,835,005 4.49%
----------- ----------- ----------- -----------
Total securities available for sale $52,797,153 $ 486,679 $ 212,281 $53,071,551 4.04%
=========== =========== =========== ===========
Restricted:
Federal Reserve Bank stock $ 129,650 $ -- $ -- $ 129,650 6.00%
Federal Home Loan Bank stock 963,100 -- -- 963,100 1.60
----------- ----------- ----------- -----------
Total restricted investments $ 1,092,750 $ -- $ -- $ 1,092,750 2.12%
=========== =========== =========== ===========
8
CNB FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Note 3. Securities (continued)
DECEMBER 31, 2003 WEIGHTED
---------------------------------------------------------------- AVERAGE
GROSS GROSS ESTIMATED TAX
AMORTIZED UNREALIZED UNREALIZED FAIR EQUIVALENT
COST GAINS LOSSES VALUE YIELD
---------- ---------- ---------- ---------- -----------
Available for sale:
U.S. Government agencies
and corporations
Within one year $ 3,679,936 $ 56,310 $ -- $ 3,736,246 4.41%
After 1 but within 5 years 4,015,285 182,346 21,560 4,176,071 4.76
After 5 but within 10 years 17,436,050 32,346 162,056 17,306,340 4.26
----------- ----------- ----------- -----------
$25,131,271 $ 271,002 $ 183,616 $25,218,657 4.36%
----------- ----------- ----------- -----------
States and political subdivisions
After 1 but within 5 years $ 468,556 $ 7,274 $ 193 $ 475,637 2.85%
After 5 but within 10 years 4,143,424 42,818 6,904 4,179,338 3.42
----------- ----------- ----------- -----------
$ 4,611,980 $ 50,092 $ 7,097 $ 4,654,975 3.07%
----------- ----------- ----------- -----------
Mortgage backed securities $ 9,526,351 $ 42,478 $ 80,527 $ 9,488,302 4.44%
----------- ----------- ----------- -----------
Total securities available for sale $39,269,602 $ 363,572 $ 271,240 $39,361,934 4.25%
=========== =========== =========== ===========
Restricted:
Federal Reserve Bank stock $ 129,650 $ -- $ -- $ 129,650 6.00%
Federal Home Loan Bank stock 865,700 -- -- 865,700 3.52
----------- ----------- ----------- -----------
Total restricted investments $ 995,350 $ -- $ -- $ 995,350 3.84%
=========== =========== =========== ===========
The carrying value of securities pledged to secure public
deposits and for other purposes as required or permitted by law totaled
$29,944,041 at September 30, 2004 and $15,337,515 at December 31, 2003.
Also, a security with a carrying value of $248,985 is designated for
customer repurchase agreements at September 30, 2004.
Proceeds from sales of securities available for sale
(excluding maturities) during the nine months ended September 30, 2004
and the year ended December 31, 2003 were $6,391,436 and $13,044,280,
respectively. Gross gains (losses) of $135,546 and $(-0-) during the
nine months ended September 30, 2004 and $210,572 and $(69,122) for the
year ended December 31, 2003 were realized on the respective sales.
9
CNB FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Note 3. Securities (continued)
The following table shows our investments' gross unrealized
losses and fair value, aggregated by investment category and length of
time that individual securities have been in a continuous unrealized
loss position, at September 30, 2004.
LESS THAN 12 MONTHS 12 MONTHS OR MORE TOTAL
-------------------------------- --------------------------------- -----------------------------
FAIR UNREALIZED FAIR UNREALIZED FAIR UNREALIZED
Description of Securities VALUE LOSSES VALUE LOSSES VALUE LOSSES
- ------------------------------- --------------- --------------- --------------------------------- -----------------------------
U.S. government agencies
and corporations $12,114,050 $ 88,679 $ 2,434,720 $ 62,726 $14,548,770 $ 151,405
State and political subdivisions 1,933,548 8,415 - - 1,933,548 8,415
Mortgage backed securities 2,294,368 37,048 904,652 15,413 3,199,020 52,461
--------------- --------------- --------------- --------------- --------------- -------------
Total temporarily impaired
securities $16,341,966 $ 134,142 $ 3,339,372 $ 78,139 $19,681,338 $ 212,281
=============== =============== =============== =============== =============== =============
Note 4. Loans and Leases Receivable
Major classifications of loans at September 30, 2004 and
December 31, 2003, were as follows:
SEPTEMBER 30, DECEMBER 31,
2004 2003
------------- -------------
Loans:
Real estate $ 109,109,789 $ 98,404,610
Commercial real estate 21,933,070 21,521,317
Consumer 16,314,697 16,852,449
Commercial 8,276,319 8,934,099
Overdrafts 80,499 135,958
------------- -------------
$ 155,714,374 $ 145,848,433
Leases: 172,172 186,318
------------- -------------
$ 155,886,546 $ 146,034,751
Net deferred loan fees, costs,
premiums and discounts 268,277 238,220
Allowance for loan losses (1,753,613) (1,607,763)
------------- -------------
$ 154,401,210 $ 144,665,208
============= =============
10
CNB FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Note 4. Loans and Leases Receivable (continued)
An analysis of the allowance for possible loan losses is as
follows:
SEPTEMBER 30, DECEMBER 31,
--------------------------------- -----------
2004 2003 2003
----------- ----------- -----------
Balance, Beginning $ 1,607,763 $ 1,484,448 $ 1,484,448
Provision charged to
operations 283,000 194,000 312,000
Recoveries 129,011 50,689 80,626
Loans charged off (266,161) (177,789) (269,311)
----------- ----------- -----------
Balance, Ending $ 1,753,613 $ 1,551,348 $ 1,607,763
=========== =========== ===========
Loans are placed in nonaccrual status when, in the judgment of
management, the probability of collection of interest is deemed to be
insufficient to warrant further accrual. When interest accruals are
discontinued, interest credited to income is reversed. Nonaccrual loans
are restored to accrual status when all delinquent principal and
interest becomes current or the loan is considered secured and in the
process of collection. Certain loans that are determined to be
sufficiently collateralized may continue to accrue interest after
reaching 90 days past due. A summary of nonperforming loans is as
follows:
SEPTEMBER 30, DECEMBER 31,
--------------------------------- -----------
2004 2003 2003
----------- ----------- -----------
Nonaccrual loans $ 436,162 $ 625,137 $ 348,660
Loans past due 90 days or more still
accruing interest - 81,152 27,045
----------- ----------- -----------
Total $ 436,162 $ 706,289 $ 375,705
=========== =========== ===========
Note 5. Time Deposits
At September 30, 2004, the scheduled maturities of time
deposits are as follows:
TIME DEPOSITS ALL TIME
$100,000 AND OVER DEPOSITS
----------------- --------
Within 3 months $ 4,989,050 $11,736,763
3 months thru 6 months 3,570,534 8,808,617
6 months thru 12 months 2,002,896 6,846,632
Over 12 months 26,242,178 66,830,045
----------- -----------
$36,804,658 $94,222,057
=========== ===========
11
CNB FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Note 6. Federal Home Loan Bank Borrowings
SEPTEMBER 30, DECEMBER 31,
--------------------------------------- -----------------
2004 2003 2003
----------------- ----------------- -----------------
Federal Home Loan Bank advances $ - $ - $ 1,200,000
Citizens National Bank is a member of the Federal
Home Loan Bank ("FHLB") of Pittsburgh and, as such, can take advantage of
the FHLB program for overnight and term advances at published daily
rates. Under the terms of a blanket collateral agreement, advances from
the FHLB are collateralized by qualifying mortgages and US government
agencies and mortgage-backed securities. In addition, all of the Bank's
stock in the FHLB is pledged as collateral for such debt. Advances
available under this agreement are limited by available and qualifying
collateral and the amount of FHLB stock held by the borrower.
Note 7. Supplemental Retirement Plan
On January 2, 2004, the Bank entered into a
nonqualified supplemental retirement benefit agreement with the President
which when fully vested would pay the President or his beneficiary an
amount of $30,000 per year for 10 years beginning June 11, 2011, if he
retires on or after May 29, 2011. Termination of employment prior to that
date other than by reasons of death or disability will result in a
reduced benefit. The expense for the three and nine months ended
September 30, 2004 was $8,160 and $24,480, respectively.
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
GENERAL
CNB Financial Services, Inc. ("CNB" or the "Company") was
organized under the laws of West Virginia in March 2000 at the
direction of the Board of Directors of Citizens National Bank (the
"Bank") for the purpose of becoming a financial services holding
company. The Company's primary function is to direct, plan and
coordinate the business activities for the Bank and its subsidiary. We
refer to the Company and its subsidiary as "CNB".
On August 31, 2000, the Bank, via merger, became a
wholly-owned subsidiary of the Company and the shareholders of the Bank
became shareholders of the Company. Each Bank shareholder received two
shares of the Company stock for each share of the Bank's common stock.
The merger was accounted for as a pooling of interests.
The Bank was organized on June 20, 1934, and has operated in
Berkeley Springs in Morgan County, West Virginia, as a national banking
association continuously since that time. The Bank is a full-service
commercial bank conducting general banking and trust activities through
five full-service offices and three automated teller machines located
in Morgan and Berkeley Counties, West Virginia and Washington County,
Maryland. The Bank formed CNB Insurance Services, Inc., a wholly owned
subsidiary, which is a property and casualty insurance agency selling
primarily personal lines of insurance.
The Bank exercised an option in December 2003 to purchase a
parcel of land in Falling Waters, Berkeley County, West Virginia for
the future site of an additional full-service branch. The expected
building completion date is the first quarter of 2005.
On January 26, 2004, CNB entered into an agreement to purchase
certain assets and liabilities associated with the Hancock Branch of
Fidelity Bank, a subsidiary bank of Mercantile Bankshares Corporation
(formerly Home Federal). The purchase, which took place on June 11,
2004, increased the assets and liabilities of CNB by $14.6 million. CNB
assumed responsibility for all the deposit services including checking,
savings and certificate of deposits. Additionally, CNB acquired loans,
equipment and leasehold improvements and assumed the lease for the real
estate located at 333 East Main Street, Hancock, Maryland.
The following discussion and analysis presents the significant
changes in financial condition and results of operations of CNB for the
three and nine months ended September 30, 2004 and 2003. This
discussion may include forward-looking statements based upon
management's expectations. Actual results may differ. We have rounded
amounts and percentages used in this discussion and have based all
average balances on daily averages.
CRITICAL ACCOUNTING POLICIES
CNB has established various accounting policies which govern
the application of accounting principles generally accepted in the
United States of America in the preparation and presentation of CNB's
consolidated financial statements. The significant accounting policies
of CNB are described in "Item 1, Critical Accounting Policies" and Note
1: Summary of Significant Accounting Policies of the Consolidated
Financial Statements on Form 10-K as of December 31, 2003, and along
with the disclosures presented in other financial statement notes,
provide information on how significant assets and liabilities are
valued in the financial statements and how those values are determined.
Certain accounting policies involve significant judgments, assumptions
and estimates by management that have a material impact on the carrying
value of certain assets and liabilities, which management considers to
be critical accounting policies. The judgments, assumptions and
estimates used by management are based on historical experience,
knowledge of the accounts and other factors, which are believed to be
reasonable under the circumstances. Because of the nature of the
judgment and assumptions made by management, actual results could
differ from these judgments and estimates, which could have a material
impact on the carrying values of assets and liabilities and the results
of operations of the Company.
13
CNB views the determination of the allowance for loan losses
as a critical accounting policy that requires the most significant
judgments, assumptions and estimates used in the preparation of its
consolidated financial statements. For a more detailed discussion on
the allowance for loan losses, see Nonperforming Loans and Allowance
For Loan Losses in the Management's Discussion and Analysis and
Allowance for Loan Losses in Note 1: Summary of Significant Accounting
Policies and Note 4: Loans and Leases Receivable in the Notes to
Consolidated Financial Statements in the Form 10-K for December 31,
2003.
EARNINGS SUMMARY
Net income for the three months ended September 30, 2004 was
$635,000 or $1.39 per share compared to $599,000 or $1.31 per share for
the same period in 2003. Annualized return on average assets and
average equity were 1.1% and 14.8% respectively, for the three months
ended September 30, 2004, compared with 1.2% and 14.1%, respectively,
for the three months ended September 30, 2003.
Net income for the nine months ended September 30, 2004 was
$1.8 million or $3.91 per share compared to $1.4 million or $2.96 per
share for the same period in 2003. Annualized return on average assets
and average equity were 1.1% and 13.9% respectively, for the nine
months ended September 30, 2004, compared with .9% and 10.8%,
respectively, for the nine months ended September 30, 2003.
Early in the year 2004, earnings projections for the second
half of 2004 were for net income to show a decrease over the first half
of 2004 due to the additional expenses related to the opening of the
new branch facility and the slowing of the maturities of the higher
interest bearing 36 month Certificate of Deposits causing interest
expense to level out. However, actual net income results have exceeded
projections due to the bank's investment capabilities of a large
depositor's funds and the expenses related to the opening of the new
branch facility being significantly lower than expected. Loan growth is
expected to remain flat through the remainder of 2004. Due to the
rising rate environment, net income and net interest income may be
negatively impacted in the short term as a result of the increased cost
of deposits.
NET INTEREST INCOME
Net interest income represents the primary component of CNB's
earnings. It is the difference between interest and fee income related
to earning assets and interest expense incurred to carry
interest-bearing liabilities. Changes in the volume and mix of interest
earning assets and interest bearing liabilities, as well as changing
interest rates, impact net interest income. To manage these changes,
their impact on net interest income and the risk associated with them,
CNB utilizes an ongoing asset/liability management program. This
program includes analysis of the difference between rate sensitive
assets and rate sensitive liabilities, earnings sensitivity to rate
changes, and source and use of funds. A discussion of net interest
income and the factors impacting it is presented below.
Net interest income for the three months ended September 30,
2004 increased by $301,000 or 15.6% over the same period in 2003.
Interest income for the three months ended September 30, 2004 increased
by $136,000 or 4.7% compared to the same period in 2003, while interest
expense decreased by $165,000 or 17.0% during the three months ended
September 30, 2004, as compared to the same period in the prior year.
Net interest income for the nine months ended September 30,
2004 increased by $915,000 or 17.0% over the same period in 2003.
Interest income for the nine months ended September 30, 2004 decreased
by $11,000 or .1% compared to the same period in 2003, while interest
expense decreased by $926,000 or 28.4% during the nine months ended
September 30, 2004, as compared to the same period in the prior year.
Increased net interest income for the three and nine month
period is attributable to a higher level of net interest earning assets
offset by a decrease in the rates earned thereon. The Bank continues to
experience a shift in the asset mix from lower yielding investment
securities to
14
higher yielding loans due to the continued steady loan growth. The
decrease in the rates earned on interest earning assets is due to the
current economic conditions. The Bank has continued to experience steady
deposit growth. Although the average balance on interest bearing
liabilities increased, total interest expense decreased due to a
decrease in the average rates paid on all interest bearing liabilities.
During the third quarter of 2004 compared to the same period
in 2003, average net interest earning assets increased $24.5 million or
13.3% and average net interest bearing liabilities increased $21.1
million or 13.9% contributed to increased net interest income. CNB
experienced a 19 basis point increase in the ratio of net interest
income to average interest earning assets. The 70 basis point decrease
in rates paid on average interest bearing liabilities offset by a 37
basis point decrease in rates earned on average interest earning assets
resulted in the increase in the net interest margin.
During the first nine months of 2004 compared to the same
period in 2003, average net interest earning assets increased $14.2
million or 7.8% and average net interest bearing liabilities increased
$10.9 million or 7.3% contributed to increased net interest income. CNB
experienced a 43 basis point increase in the ratio of net interest
income to average interest earning assets. The 97 basis point decrease
in rates paid on average interest bearing liabilities offset by a 37
basis point decrease in rates earned on average interest earning assets
resulted in the increase in the net interest margin.
See Table 1 and Table 2 - Distribution of Assets, Liabilities,
and Shareholders' Equity; Interest Rates and Interest Differential.
The net interest margin is impacted by the change in the
spread between yields on earning assets and rates paid on interest
bearing liabilities.
15
TABLE 1. DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY;
INTEREST RATES AND INTEREST DIFFERENTIAL
SEPTEMBER 30, 2004 SEPTEMBER 30, 2003
--------------------------------------- -------------------------------------
QTR QTR
AVERAGE QTR YIELD/ AVERAGE QTR YIELD/
BALANCE INTEREST RATE (4) BALANCE INTEREST RATE (4)
--------------------------------------- -------------------------------------
(IN THOUSANDS OF DOLLARS)
Interest earning assets:
Federal funds sold $ 5,161 $ 19 1.33% $ 1,785 $ 3 0.90%
Securities:
Taxable 38,858 412 4.24 42,980 434 4.04
Tax-exempt (1) 8,729 76 5.28 1,526 13 5.16
Loans (net of unearned interest) (2)(5)(6) 156,359 2,453 6.28 138,341 2,334 6.75
--------------------------------------- -------------------------------------
Total interest earning assets (1) $ 209,107 $ 2,960 5.66% $ 184,632 $ 2,784 6.03%
--------------------------------------- -------------------------------------
Nonearning assets:
Cash and due from banks $ 9,661 $ 7,193
Bank premises and equipment, net 5,595 4,674
Other assets 4,480 3,061
Allowance for loan losses (1,760) (1,553)
------------- --------------
Total assets $ 227,083 $ 198,007
============= ==============
Interest bearing liabilities:
Savings deposits $ 30,829 $ 42 0.54% $ 23,211 $ 29 0.50%
Time deposits 95,126 622 2.62 94,107 854 3.63
NOW accounts 35,727 121 1.35 25,775 72 1.12
Money market accounts 10,205 21 0.82 7,276 14 0.77
Borrowings 293 1 1.37 747 2 1.07
--------------------------------------- -------------------------------------
Total interest bearing liabilities $ 172,180 $ 807 1.87% $ 151,116 $ 971 2.57%
--------------------------------------- -------------------------------------
Noninterest bearing liabilities:
Demand deposits $ 35,529 $ 27,359
Other liabilities 2,242 2,610
Shareholders' equity 17,132 16,922
------------- --------------
Total liabilities and
shareholders' equity $ 227,083 $ 198,007
============= ==============
---------- ------------
Net interest income (1) $ 2,153 $ 1,813
========== ============
Net interest spread (3) 3.79% 3.46%
============ =========
Net interest income to average 4.12% 3.93%
============ =========
interest earning assets (1)
(1) Yields are expressed on a tax equivalent basis using a 34% tax rate.
(2) For the purpose of these computations, nonaccruing loans are included in the
amounts of average loans outstanding.
(3) Net interest spread is the difference between the weighted average yield on
interest-earning assets and the weighted average cost of interest-bearing
liabilities.
(4) Yields/Rates are expressed on annualized basis.
(5) Interest income on loans excludes fees of $71,000 in 2004 and $111,000 in
2003.
(6) Interest income on loans includes fees of $18,343 in 2004 and $41,255 in
2003 from the Business Manager Program, student loans and lease receivables.
16
TABLE 2. DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY;
INTEREST RATES AND INTEREST DIFFERENTIAL
SEPTEMBER 30, 2004 SEPTEMBER 30, 2003
------------------------------------ --------------------------------------
YTD YTD
AVERAGE YTD YIELD/ AVERAGE YTD YIELD/
BALANCE INTEREST RATE (4) BALANCE INTEREST RATE (4)
------------------------------------ --------------------------------------
(IN THOUSANDS OF DOLLARS)
Interest earning assets:
Federal funds sold $ 2,677 $ 27 1.05% $ 1,894 $ 16 1.07%
Securities:
Taxable 34,439 1,083 4.19 44,660 1,453 4.34
Tax-exempt (1) 7,049 180 5.16 1,201 33 5.55
Loans (net of unearned interest) (2)(5)(6) 152,103 7,125 6.25 134,290 6,817 6.77
-------------------------------------- -------------------------------------
Total interest earning assets (1) $ 196,268 $ 8,415 5.72% $ 182,045 $ 8,319 6.09%
-------------------------------------- -------------------------------------
Nonearning assets:
Cash and due from banks $ 8,975 $ 6,695
Bank premises and equipment, net 5,403 4,731
Other assets 3,488 3,090
Allowance for loan losses (1,709) (1,527)
------------- --------------
Total assets $ 212,425 $ 195,034
============= ==============
Interest bearing liabilities:
Savings deposits $ 27,674 $ 107 0.52% $ 22,590 $ 84 0.50%
Time deposits 93,299 1,907 2.73 94,779 2,924 4.11
NOW accounts 29,000 260 1.20 24,861 213 1.14
Money market accounts 9,461 57 0.80 6,643 38 0.76
Borrowings 553 5 1.21 257 3 1.56
-------------------------------------- -------------------------------------
Total interest bearing liabilities $ 159,987 $ 2,336 1.95% $ 149,130 $ 3,262 2.92%
-------------------------------------- -------------------------------------
Noninterest bearing liabilities:
Demand deposits $ 32,924 $ 26,794
Other liabilities 2,277 2,446
Shareholders' equity 17,237 16,664
------------- --------------
Total liabilities and
shareholders' equity $ 212,425 $ 195,034
============= ==============
---------- -----------
Net interest income (1) $ 6,079 $ 5,057
========== ===========
Net interest spread (3) 3.77% 3.17%
============= =========
Net interest income to average
interest earning assets (1) 4.13% 3.70%
============= =========
(1) Yields are expressed on a tax equivalent basis using a 34% tax rate.
(2) For the purpose of these computations, nonaccruing loans are included in the
amounts of average loans outstanding.
(3) Net interest spread is the difference between the weighted average yield on
interest-earning assets and the weighted average cost of interest-bearing
liabilities.
(4) Yields/Rates are expressed on annualized basis.
(5) Interest income on loans excludes fees of $212,000 in 2004 and $318,000 in
2003.
(6) Interest income on loans includes fees of $84,031 in 2004 and $110,594 in
2003 from the Business Manager Program, student loans and lease receivables.
17
PROVISION FOR LOAN LOSSES
The amount charged to provision for loan losses is based on
management's evaluation of the loan portfolio. Management determines
the adequacy of the allowance for loan losses, based on past loan loss
experience, current economic conditions and composition of the loan
portfolio. The allowance for loan losses is the best estimate of
management of the probable losses which have been incurred as of a
balance sheet date.
The provision for loan losses is a charge to earnings which is
made to maintain the allowance for loan losses at a sufficient level.
The provision for loan losses for the three months ended September 30,
2004, and September 30, 2003, amounted to $102,000 and $57,000,
respectively. The provision for loan losses for the nine months ended
September 30, 2004, and September 30, 2003, amounted to $283,000 and
$194,000, respectively. Loan quality remains stable, past dues are
minimal and nonaccruals have decreased for the same period; however,
nonaccruals have increased slightly from December 31, 2003 to September
30, 2004. Management believes the allowance for loan losses is adequate
and is not aware of any information relating to the loan portfolio
which it expects will materially impact future operating results,
liquidity or capital resources. In addition, federal regulators may
require additional reserves as a result of their examination of the
bank. See "Nonperforming Assets and Allowance for Loan Losses" for
further discussion.
NONINTEREST INCOME
Noninterest income for the three months ended September 30,
2004 increased $18,000 or 3.8% to $489,000 from $471,000 in the third
quarter of 2003. Noninterest income for the nine months ended September
30, 2004 increased $171,000 or 13.1% to $1.5 million from $1.3 million
during the first nine months of 2003. The increase in noninterest
income is attributable, in general, to an increase in service charge
fees effective October 1, 2003 the bank assesses its customers.
Specifically, noninterest income increased due to fees generated from
the Bounce Protection program, insurance commissions, ATM and debit
card fees and offset by a decrease in gain on sale of investment
securities. This increase for the first nine months of 2004 was offset
by a decrease in overdraft fees, travel club fees and miscellaneous
customer service fees. The fees related to the Bounce Protection
program, ATM and debit card fees have a direct correlation to the
increased deposit base of the bank. Insurance commissions increased due
to a large group health account written in the third quarter of 2003
and general rate increases from the insurance companies.
NONINTEREST EXPENSES
Noninterest expenses for the three months ended September 30,
2004, increased $275,000 or 19.5% and for the nine months ended
September 30, 2004, increased $500,000 or 11.5%. Salaries increased due
to normal merit increases, several new hires, salaries for employees of
the acquired Hancock branch and additional payroll expenses related to
the conversion of the Hancock branch. The increase in furniture and
equipment expense was due to an increase in software amortization
associated with the 2003 upgrade of the Bank's technology systems.
Another factor relating to the increase in furniture and equipment
expense was an increase in the cost and number of equipment maintenance
contracts the Bank entered into primarily due to the 2003 technology
system upgrade. The increase in other operating expenses was due to an
increase in stationery, supplies & printing, telephone, legal fees and
advertising expense offset by a decrease in postage, data processing
expense and bounce protection expense. The increase in stationery,
supplies and printing, legal fees and advertising are a direct result
of the Bank's acquisition of the full service branch of Fidelity Bank
in Hancock, Maryland. Bounce protection expense decreased due to the
expiration of the Bank's contract with Pinnacle Financial Strategies in
February 2004.
18
INCOME TAXES
The Bank's provision for income taxes decreased $38,000 or
11.6% to $291,000 for the three months ended September 30, 2004 and
increased $60,000 or 7.8% to $836,000 for the nine months ended
September 30, 2004. The effective tax rates for the second quarter of
2004 and 2003 were 31.4% and 35.5%, respectively and for the first nine
months of 2004 and 2003 were 31.8% and 36.4%, respectively. The Bank's
income tax expense differs from the amount computed at statutory rates
primarily due to the tax-exempt earnings from certain investment
securities.
FINANCIAL CONDITION
The Bank's total assets as of September 30, 2004 increased
$31.4 million or 15.6% to $232.5 million from December 31, 2003 due in
part to the acquisition of the Hancock branch. In particular, $8.4
million in loans, $324,000 in premises and equipment were acquired
along with $781,000 in core deposit intangible assets. The Bank's total
liabilities increased $29.7 million or 16.1% to $214.2 million. The
total liabilities which were assumed were $14.6 million in deposits and
$6,600 in other accrued expenses.
The following discussion of the financial condition of the
Bank excludes the acquisition of the Hancock branch assets and
liabilities. The Bank's assets also increased due primarily to a $1.1
million increase in cash and due from banks, $5.5 million increase in
federal funds sold, $13.7 million increase in investment securities and
a $1.3 million increase in loans. The Bank's liabilities also increased
$16.3 million due to deposit growth, offset by a decrease of $1.2
million in borrowings and an additional $65,000 in accrued expenses and
other liabilities. Shareholders' equity increased $1.7 million to $18.3
million at September 30, 2004, primarily due to net income of $1.8
million and $113,000 increase in accumulated other comprehensive income
offset by the semi-annual cash dividend of $179,000. The components of
accumulated other comprehensive income at September 30, 2004, were
unrealized gains and losses on available for sale securities, net of
deferred income taxes and minimum pension liability adjustment, net of
deferred income taxes. The unrealized gains and losses are primarily a
function of available market interest rates relative to the yield being
generated on the available for sale portfolio. No earnings impact
results unless the securities are actually sold.
LOAN PORTFOLIO
At September 30, 2004, total loans increased $9.7 million or
6.7% to $154.4 million from $144.7 million at December 31, 2003. This
increase is mainly a result of the purchase of $8.4 million in loans
from the Hancock branch acquisition. The Bank experienced steady loan
growth in the first half of 2004 offset by a $3.0 million decrease in
loans during the third quarter of 2004 due in part to three large
commercial lines of credit being reduced resulting in a net increase in
loans of $1.3 million for the year. The Bank expects loan growth to
remain flat through the remainder of 2004.
19
NONPERFORMING ASSETS AND ALLOWANCE FOR LOAN LOSSES
Nonperforming assets consist of nonaccrual loans, loans which
are past due 90 days or more and still accruing interest, restructured
loans and other real estate owned. The following table summarized the
Bank's nonperforming assets as of the periods shown:
SEPTEMBER 30, DECEMBER 31,
------------------------------------ ----------------
2004 2003 2003
---------------- ---------------- ----------------
Nonaccrual loans $ 436,162 $ 625,137 $ 348,660
Loans past due 90 days or more
still accruing interest - 81,152 27,045
---------------- ---------------- ----------------
Total nonperforming loans $ 436,162 $ 706,289 $ 375,705
---------------- ---------------- ----------------
Other real estate owned $ - $ 107,619 $ -
---------------- ---------------- ----------------
Total nonperforming assets $ 436,162 $ 813,908 $ 375,705
================ ================ ================
Nonperforming loans/Total loans 0.28% 0.50% 0.26%
Nonperforming assets/Total assets 0.19% 0.41% 0.19%
Allowance for loan losses/Total loans 1.14% 1.11% 1.11%
As of September 30, 2004, the Bank has no loans which
management considers to be impaired. Management is aware of three
borrowers who have exhibited weaknesses. Their loans have aggregate
uninsured balances of $998,000. A specific allowance of $80,000 related
to these loans has been established as part of the allowance for loan
losses. The loans are collateralized and management anticipates any
additional potential loss would be minimal.
The allowance for loan losses is the best estimate by
management of the probable losses which have been incurred as of a
balance sheet date. Management makes this determination quarterly by
its analysis of overall loan quality, changes in the mix and size of
the loan portfolio, previous loss experience, general economic
conditions, information about specific borrowers and other factors. The
Bank's methodology for determining the allowance for loan losses
established both an allocated and an unallocated component. The
allocated portion of the allowance represents the results of analyses
of individual loans that the Bank monitors for potential credit
problems and pools of loans within the portfolio. Management bases the
allocated portion of the allowance for loans principally on current
loan risk ratings, historical loan loss rates adjusted to reflect
current conditions, as well as analyses of other factors that may have
affected the collectibility of loans in the portfolio. The Bank
analyzes all commercial loans it is monitoring as potential credit
problems to determine whether those loans are impaired, with impairment
measured by reference to the borrowers' collateral values and cash
flows.
The unallocated portion of the allowance for loan losses
represents the results of analyses that measure probable losses
inherent in the portfolio that are not adequately captured in the
allocated allowance analyses. These analyses include consideration of
unidentified losses inherent in the portfolio resulting from changing
underwriting criteria, changes in the types and mix of loans
originated, industry concentrations and evaluations, allowance levels
relative to selected overall credit criteria and other economic
indicators used to estimate probable incurred losses. At September 30,
2004, the allowance for loans losses totaled $1.8 million compared to
$1.6 million at December 31, 2003. The allowance for loans losses as a
percentage of loans was 1.1% as of September 30, 2004 and December 31,
2003.
20
An analysis of the allowance for loan losses is summarized
below:
In thousands SEPTEMBER 30, DECEMBER 31,
--------------------------------------- ------------------------------------------
2004 2003
--------------------------------------- ------------------------------------------
PERCENT OF PERCENT OF
LOANS IN EACH LOANS IN EACH
CATEGORY TO CATEGORY TO
AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS
------------------ ----------------------------------------- ---------------------
Commercial, financial $ 843 19% $ 782 21%
and agriculture
Real estate - residential 466 70 401 67
mortgage
Installment and other 274 11 274 12
Unallocated 170 N/A 151 N/A
------------------ -------------------- ------------------ ---------------------
Total $ 1,753 100% $ 1,608 100%
================== ==================== ================== =====================
DEPOSITS
The Bank's deposits increased $30.9 million or 17.1% during
the nine months ended September 30, 2004. This increase is mainly a
result of the assumption of $14.6 million in deposits from the Hancock
acquisition. The breakdown of the assumed deposits are $8.2 million in
demand and savings and $6.4 million in certificates of deposit. The
Bank continues to experience a change in the deposit account mix
through the first nine months of 2004. Steady growth continues in
regular demand, interest-bearing demand and savings deposits due to the
continued customer growth in all the Bank's branches. The change in the
deposit account mix is attributable to the continued maturity of rate
sensitive certificate of deposits and customers temporarily placing
their money in demand or savings accounts. The Bank experienced an
overall increase of $1.2 million in other time deposits and rate
sensitive jumbo certificate of deposits during the first nine months of
2004. This increase is attributable to the $6.4 million in certificates
of deposit acquired from the Hancock branch acquisition offset by a
decrease of $5.2 million, which is primarily due to the maturities of
the 36-month Ultimate Certificate of Deposits. Deposits, in general,
have experienced an increase due to customer's concerns with the weak
economy and stock market.
CAPITAL RESOURCES
Shareholders' equity increased $1.7 million or 10.4% during
the first nine months of 2004 due to $1.8 million in net income and
$113,000 increase in accumulated other comprehensive income offset by
the semi-annual cash dividend of $179,000. The Bank is subject to
regulations of the Office of the Comptroller of the Currency that
impose certain minimum regulatory capital requirements. Under each
measure, the Bank was substantially in excess of the minimum regulatory
requirements, and, by definition was "well capitalized" at September
30, 2004. The following table summarized, as of September 30, 2004, the
Bank's capital ratios.
Components Actual Required
of Capital Ratio Ratio
---------- ----- -----
Tier 1 Capital $18,088 8.0% 4.0%
Total Risk Based Capital $19,770 14.7% 8.0%
RECENTLY ISSUED ACCOUNTING STANDARDS
On March 9, 2004, the SEC staff issued Accounting Bulletin No.
105, "Application of Accounting Principles to Loan Commitments", which
provides guidance regarding mortgage loan interest rate lock
commitments related to loans held for sale as written options,
effective for
21
commitments entered into after March 31, 2004. This Statement had no
material effect on the Company's consolidated financial statements.
In November 2003, the EITF reached consensus on Issue 03-1,
"The Meaning of Other-Than-Temporary Impairment and Its Application to
Certain Investments." Issue 03-1 provides guidance in the recognition
and measurement of other-than-temporary impairment for certain
securities, including:
- All debt securities and equity securities that are subject
to the scope of SFAS No. 115, "Accounting for Certain
Investments in Debt and Equity Securities"; and
- Equity securities that are not subject to the scope of SFAS
No. 115 and that are accounted for under the cost method of
accounting, or cost method investments.
Issue 03-1 also provides guidance on disclosure requirements
for other-than-temporary impairment for cost method investments. The
guidance in these areas of Issue 03-1 is effective for fiscal years
ending after June 15, 2004. The implementation of these areas of Issue
03-1 is not anticipated to have a material impact on our financial
statements. We have previously adopted the disclosure provisions of
Issue 03-1 for debt and equity investments that are accounted for under
SFAS No. 115. Those requirements were effective for fiscal years ending
after December 15, 2003.
On September 30, 2004, the FASB issued a final FSP EITF Issue
03-1-1 that delays the effective date for the measurement and
recognition guidance contained within Issue 03-1. Disclosures required
by Issue 03-1 have not been deferred. The FASB noted that this delay
does not suspend existing accounting requirements for assessing whether
impairments of held to maturity and available for sale securities are
other-than-temporary, including current guidance for cost method
investments.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the exposure to economic loss that arises from
changes in the values of certain financial instruments. The types of
market risk exposures generally faced by banking entities include
interest rate risk, equity market price risk, foreign currency risk and
commodity price risk. Due to the nature of its operations, only equity
market price risk and interest rate risk are significant to the Bank.
The objective of the Bank's liquidity management program is
to ensure the continuous availability of funds to meet the withdrawal
demands of depositors and the credit needs of borrowers. The basis of
the Bank's liquidity comes from the stability of its core deposits.
Liquidity is also available through the available for sale securities
portfolio and short-term funds such as federal funds sold which totaled
$58.6 million, or 25.2% of total assets at September 30, 2004. In
addition, liquidity may be generated through loan repayments and over
$3.0 million of available borrowing arrangements with correspondent
banks. At September 30, 2004, management considered the Bank's ability
to satisfy its anticipated liquidity needs over the next twelve months.
Management believes that the Bank is well positioned and has ample
liquidity to satisfy these needs. The Bank generated $2.1 million of
cash from operations in the first nine months of 2004, which compares
to $1.9 million during the same time period in 2003. Additional cash of
$15.1 million was generated through net financing activities through
September 30, 2004, which compares to $8.0 million for the first nine
months of 2003. These proceeds along with proceeds from the sales and
calls of investment securities were used to fund loans and purchase
securities during each year. Net cash used in investing activities
totaled $16.2 million during the first nine months of 2004 compared to
$9.7 million during the same time period in 2003. Details on both the
sources and uses of cash are presented in the Consolidated Statements
of Cash Flows contained in the financial statements.
The objective of the Bank's interest rate sensitivity
management program, also known as asset/liability management, is to
maximize net interest income while minimizing the risk of adverse
effects from changing interest rates. This is done by controlling the
mix and maturities of
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interest sensitive assets and liabilities. The Bank has established an
asset/liability committee for this purpose. Daily management of the
Bank's sensitivity of earnings to changes in interest rates within the
Bank's policy guidelines are monitored by using a combination of
off-balance sheet and on-balance sheet financial instruments. The Bank's
Chief Executive Officer, Senior Lending Officer, Chief Financial Officer
and the Chief Operations Officer monitor day to day deposit flows,
lending requirements and the competitive environment. Rate changes occur
within policy guidelines if necessary to minimize adverse effects. Also,
the Bank's policy is intended to ensure the Bank measures a range of
rate scenarios and patterns of rate movements that are reasonably
possible. The Bank measures the impact that 200 basis point changes in
rates would have on earnings over the next twelve months.
In analyzing interest rate sensitivity for policy measurement,
the Bank compares its forecasted earnings in both a "high rate" and
"low rate" scenario to a base-line scenario. The Bank's base-line
scenario is its estimated most likely path for future short-term
interest rates over the next 12 months. The "high rate" and "low rate"
scenarios assumes a 100 and 200 basis point increases or decreases in
the prime rate from the beginning point of the base-line scenario over
the most current 12-month period. The Bank's policy limit for the
maximum negative impact on earnings resulting from "high rate" or "low
rate" scenarios is 10 percent. The policy measurement period is 12
months in length, beginning with the first month of the forecast.
The Bank's base-line scenario holds the prime rate constant at
4.75 percent through September 2005. Based on the October 2004 outlook,
if interest rates increased or decreased by 200 basis points, the model
indicates that net interest income during the policy measurement period
would be affected by less than 10 percent, in both an increasing or
decreasing interest rate scenario.
CONTRACTUAL OBLIGATIONS
During the quarter and nine months ended September 30, 2004,
the Bank entered into contracts related to the construction of the
Spring Mills Branch facility in north Berkeley County, West Virginia
totaling $893,656. There were no other material changes outside the
normal course of business to the quantitative and qualitative
disclosures about contractual obligations previously reported on Form
10-K for the year ended December 31, 2003. See Item 7, "Management's
Discussion and Analysis of Financial Condition and Results of
Operations - Contractual Obligations" in the Form 10-K for December 31,
2003 for a detailed discussion.
ITEM 4. CONTROLS AND PROCEDURES
The Company's chief executive officer and chief financial
officer, based on their evaluation as of the end of the reporting
period of this quarterly report of the Company's disclosure controls
and procedures (as defined in Rule 13 (a) - 14 (c) of the Securities
Exchange Act of 1934), have concluded that the Company's disclosure
controls and procedures are adequate and effective for purposes of Rule
13 (a) - 14 (c) and timely, alerting them to material information
relating to the Company required to be included in the Company's
filings with the Securities and Exchange Commission under the
Securities Exchange Act of 1934.
There have been no changes in the Company's internal controls
over financial reporting in the fiscal quarter ended September 30,
2004, that have materially affected, or are reasonably likely to
materially affect, our internal controls over financial reporting.
Presently, the Bank is planning to engage consultants to
assist in the documentation of internal controls and make
recommendations for improvements, if necessary, as part of the
compliance with Section 404 of the Sarbanes-Oxley Act.
As exhibits to this quarterly report on Form 10-Q,
certificates of the chief executive officer and chief financial officer
appear. This form of certification is required in accordance with
Section 302 of the Sarbanes-Oxley Act of 2002. This section of the
quarterly report on Form 10-Q is the information concerning the
controls evaluation referred to in the Section 302 certifications. This
information should be read in conjunction with those certifications for
a more complete understanding of the topics presented.
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Disclosure controls are procedures that a company designs with
the objective of ensuring that information required to be disclosed in
their reports filed under the Securities Exchange Act of 1934 (such as
this Form 10-Q), is recorded, processed, summarized and reported within
the time period specified under the SEC's rules and forms. Disclosure
controls are also designed with the objective of ensuring that such
information is accumulated and communicated to management, including
the CEO and CFO, as appropriate, to allow timely decisions regarding
required disclosure. Internal controls are procedures that a company
designs with the objective of providing reasonable assurance that
transactions are properly authorized, assets are safeguarded against
unauthorized or improper use and transactions are properly recorded and
reported all to permit the preparation of a company's financial
statements in conformity with generally accepted accounting principles.
The Company's management, including the CEO and CFO, does not
expect that our disclosure controls or internal controls will prevent
all error and fraud. A control system, no matter how well conceived and
operated, can provide only reasonable, not absolute, assurance that the
objectives of the control system are met. Further, the design of a
control system must reflect that fact that there are resource
constraints, and the benefits of controls must be considered relative
to their costs. Because of the inherent limitations in all control
systems, no evaluation of controls can provide absolute assurance that
all control issues and instances of fraud, if any, within the company
have been detected. These inherent limitations include the realities
that judgments and decision-making can be faulty, and that breakdowns
can occur because of simple error or mistake. Additionally, controls
can be circumvented by the individual acts of some persons, by
collusion of two or more people, or by management override of the
control. The design of any system of control also is based in part upon
certain assumptions about the likelihood of future events and there can
be no assurance that any design will succeed in achieving its stated
goals under all potential future conditions. Over time, controls may
become inadequate because of changes in conditions, or the degree of
compliance with the policies or procedures may deteriorate.
Based upon the controls evaluation conducted by our CEO and CFO, they
have concluded that, subject to the limitations noted above, the
company's disclosure controls are effective to ensure that material
information relating to CNB Financial Services and its subsidiaries is
made known to management, including the CEO and CFO, particularly
during that period when our periodic reports are being prepared, and
that our internal controls are effective to provide reasonable
assurance that our financial statements are fairly presented in
conformity with generally accepted accounting principles.
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PART II: OTHER INFORMATION
Item 1. Legal Proceedings
None; however, CNB is involved in various legal proceedings
occurring in the ordinary course of business. There are no
material legal proceedings to which CNB or its subsidiary is a
part, or to which any of their property is subject.
Item 6. Exhibits and Reports on Form 8-K
a.) Exhibits:
31.1 Certification of the Chief Executive Officer pursuant to
18 U.S.C. Section 1350, as adopted pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002
31.2 Certification of the Chief Financial Officer pursuant to
18 U.S.C. Section 1350, as adopted pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002
32.1 Certification of the Chief Executive Officer pursuant to
18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002
32.2 Certification of the Chief Financial Officer pursuant to
18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002
b.) Reports on Form 8-K:
Date of Report Item Description
-------------- ---- -----------
August 9, 2004 7, 9 & 12 The Company issued a press
release that announced
operating results of its
first six months ended
June 30, 2004.
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SIGNATURES
In accordance with the requirements of the Securities Exchange Act of
1934, the registrant caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.
CNB Financial Services, Inc.
----------------------------
(Registrant)
Date November 12, 2004 /s/ Thomas F. Rokisky, President/CEO
----------------- ------------------------------------
Date November 12, 2004 /s/ Rebecca S. Stotler, Vice President/CFO
----------------- ------------------------------------
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