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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
Quarterly Report Pursuant Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the Quarterly Period ended MARCH 31, 2004. Commission File Number 000-27894
-------------- ---------
COMMERCIAL BANCSHARES, INC.
(Exact name of registrant as specified in its charter)
- -------------------------------------------------------------------------------
OHIO 34-1787239
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
118 S. SANDUSKY AVENUE, UPPER SANDUSKY, OHIO 43351
(Address of principal executive offices including zip code)
Registrant's telephone number, including area code: (419) 294-5781
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
none
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
Common Shares, no par value
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, 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 Securities Exchange Act of 1934). Yes [ ] No [X]
As of May 12, 2004, the last practicable date, there were 1,178,084 outstanding
of the registrant's common shares, no par value.
COMMERCIAL BANCSHARES, INC.
INDEX
Page
----
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets................................................... 3
Consolidated Statements of Income ............................................ 4
Condensed Consolidated Statements of Changes in Shareholders' Equity.......... 5
Condensed Consolidated Statements of Cash Flows .............................. 6
Notes to Consolidated Financial Statements ................................... 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations............................... 10
Item 3. Quantitative and Qualitative Disclosures about Market Risk.................... 19
Item 4. Controls and Procedures....................................................... 19
Part II - Other Information
Item 1. Legal Proceedings............................................................. 20
Item 2. Changes in Securities and Use of Proceeds..................................... 20
Item 3. Defaults Upon Senior Securities............................................... 20
Item 4. Submission of Matters to a Vote of Security Holders........................... 20
Item 5. Other Information............................................................. 20
Item 6. Exhibits and Reports on Form 8-K.............................................. 20
SIGNATURES ................................................................................. 21
EXHIBIT A: CEO 302 Certification ........................................................... 22
CFO 302 Certification ................................................... 23
CEO 906 Certification ................................................... 24
CFO 906 Certification ................................................... 25
2
COMMERCIAL BANCSHARES, INC.
CONSOLIDATED BALANCE SHEETS
(Unaudited)
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(Amounts in thousands)
March 31, December 31,
2004 2003
--------- ------------
ASSETS
Cash $ 6,428 $ 9,524
Federal funds sold 7,260 1,100
--------- ---------
Cash and cash equivalents 13,688 10,624
Securities available for sale 51,716 48,491
Total loans 201,561 206,274
Allowance for loan losses (2,463) (2,503)
--------- ---------
Loans, net 199,098 203,771
Premises and equipment, net 6,292 6,380
Accrued interest receivable 1,405 1,143
Other assets 2,660 2,431
--------- ---------
Total assets $ 274,859 $ 272,840
========= =========
LIABILITIES
Deposits
Noninterest-bearing demand $ 22,869 $ 26,123
Interest-bearing demand 71,176 68,656
Savings and time deposits 105,242 103,413
Time deposits $100,000 and greater 40,785 40,559
--------- ---------
Total deposits 240,072 238,751
FHLB advances 11,500 11,500
Accrued interest payable 262 415
Other liabilities 1,035 1,019
--------- ---------
Total liabilities 252,869 251,685
--------- ---------
SHAREHOLDERS' EQUITY
Common stock, no par value; 4,000,000 shares authorized,
1,178,084 and 1,164,722 shares issued in 2004 and 2003 11,074 10,684
Retained earnings 10,740 10,607
Deferred compensation plan shares, at cost,
13,407 and 11,033 shares in 2004 and 2003 (325) (270)
Treasury stock, 580 in 2004, 2,770 shares in 2003 (15) (70)
Accumulated other comprehensive income 516 204
--------- ---------
Total shareholders' equity 21,990 21,155
--------- ---------
Total liabilities and shareholders' equity $ 274,859 $ 272,840
========= =========
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See notes to the consolidated financial statements.
3
COMMERCIAL BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
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(Amounts in thousands, except per share data)
Three Months Ended
March 31,
----------------------
2004 2003
------ ------
INTEREST INCOME
Interest and fees on loans $3,458 $3,562
Interest on securities:
Taxable 247 159
Nontaxable 253 247
Other interest income 12 4
------ ------
Total interest income 3,970 3,972
------ ------
INTEREST EXPENSE
Interest on deposits 1,122 1,314
Interest on borrowings 132 131
------ ------
Total interest expense 1,254 1,445
------ ------
NET INTEREST INCOME 2,716 2,527
Provision for loan losses 300 300
------ ------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 2,416 2,227
------ ------
NONINTEREST INCOME
Service fees and overdraft charges 452 471
Gains on sale of securities, net 27 21
Other income 87 120
------ ------
Total noninterest income 566 612
------ ------
NONINTEREST EXPENSE
Salaries and employee benefits 1,160 1,179
Occupancy, furniture and equipment 269 238
State taxes 98 95
Data processing 213 178
FDIC deposit insurance 17 17
Professional fees 102 79
Amortization of intangibles 64 59
Other operating expense 543 534
------ ------
Total noninterest expense 2,466 2,379
------ ------
Income before income taxes 516 460
Income tax expense 93 87
------ ------
Net income $ 423 $ 373
====== ======
Basic earnings per common share $ .36 $ .32
====== ======
Diluted earnings per common share $ .36 $ .32
====== ======
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See notes to the consolidated financial statements.
4
COMMERCIAL BANCSHARES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES
IN SHAREHOLDERS' EQUITY
(Unaudited)
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(Amounts in thousands, except per share data)
Three Months Ended
March 31,
---------------------------
2004 2003
-------- --------
Balance at beginning of period $ 21,155 $ 20,778
Comprehensive income:
Net income 423 373
Change in net unrealized gain (loss) on securities
available for sale, net of reclassification and tax effects 312 (48)
-------- --------
Total comprehensive income 735 325
Shares issued, options exercised 10,777 shares in 2004,
489 shares in 2003 250 12
Shares issued for deferred compensation plan, 2,585 shares in 2004 61 --
Treasury stock purchase, 2,889 shares in 2004, 4,190 shares in 2003 (77) (104)
Treasury stock reissued for options exercised,
5,079 shares in 2004, 4,719 shares in 2003 90 79
Dividends paid ($.19 and $.19 per share in 2004 and 2003) (224) (221)
-------- --------
Balance at end of period $ 21,990 $ 20,869
======== ========
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See notes to the consolidated financial statements.
5
COMMERCIAL BANCSHARES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
- -------------------------------------------------------------------------------
Three Months Ended
March 31,
---------------------------
2004 2003
-------- --------
($ in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 423 $ 373
Adjustments (318) (106)
-------- --------
Net cash from operating activities 105 267
CASH FLOWS FROM INVESTING ACTIVITIES
Securities available for sale
Purchases (8,902) (12,954)
Maturities and repayments 5,525 1,809
Sales 627 5,468
Net change in loans 4,306 5,613
Proceeds from sale of foreclosed/repossessed assets 69 69
Bank premises and equipment expenditures (62) (208)
-------- --------
Net cash from investing activities 1,563 (203)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Net change in deposits 1,296 (25)
Net change in federal funds purchased -- 400
Common shares issued for stock options 311 12
Treasury shares purchased (77) (104)
Treasury shares reissued for stock options 90 79
Cash dividends paid (224) (221)
-------- --------
Net cash from financing activities 1,396 141
-------- --------
Net change in cash and cash equivalents 3,064 205
Cash and cash equivalents at beginning of period 10,624 7,057
-------- --------
Cash and cash equivalents at end of period $ 13,688 $ 7,262
======== ========
SUPPLEMENTAL DISCLOSURES
Cash paid for interest $ 1,407 $ 1,419
Cash paid for income taxes 185 170
Non-cash transfer of loans to foreclosed/repossessed assets 78 244
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See notes to the consolidated financial statements.
6
COMMERCIAL BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation: The accompanying consolidated financial statements
include the accounts of Commercial Bancshares, Inc. (the "Corporation") and its
wholly-owned subsidiaries, Commercial Financial and Insurance Agency, LTD
("Commercial Financial") and The Commercial Savings Bank (the "Bank") and the
Bank's wholly-owned subsidiary Advantage Finance, Inc. ("Advantage"). The Bank
also owns a 49% interest in Beck Title Agency, Ltd. which is accounted for using
the equity method of accounting. All significant inter-company balances and
transactions have been eliminated in consolidation. Although formed and filed
for in December of 2003, Commercial Financial has not yet begun operations of
its own.
These interim financial statements are prepared without audit and reflect all
adjustments of a normal recurring nature which, in the opinion of management,
are necessary to present fairly the consolidated financial position of the
Corporation at March 31, 2004, and results of operations and cash flows for the
periods presented. The accompanying consolidated financial statements do not
purport to contain all the necessary financial disclosures required by
accounting principles generally accepted in the United States of America that
might otherwise be necessary in the circumstances. The Annual Report for the
Corporation for the year ended December 31, 2003, contains consolidated
financial statements and related notes, which should be read in conjunction with
the accompanying consolidated financial statements.
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, and future results could differ. The collectibility of
loans, fair values of financial instruments, and status of contingencies are
particularly subject to change.
Income Taxes: Income tax expense is the sum of the current year income tax due
or refundable and the change in deferred income tax assets and liabilities. The
provision is based upon the expected effective tax rate for the full year.
Business Segments: While the Corporation's chief decision-makers monitor the
revenue streams of various products and services, operations are managed and
financial performance is evaluated on a company-wide basis. Accordingly, all of
the Corporation's operations are considered by management to be aggregated in
one reportable segment.
Newly Issued But Not Yet Effective Accounting Standards: Management is not aware
of any new pronouncements scheduled to be implemented in the near future.
Financial Statement Presentation: Certain items in prior financial statements
have been reclassified to conform to the current presentation of information.
NOTE 2 - EARNINGS PER SHARE
Weighted average shares used in determining basic and diluted earnings per share
are as follows:
2004 2003
---- ----
Weighted average shares outstanding during the period 1,172,441 1,163,393
Dilutive effect of exercisable stock options 3,181 2,511
--------- ---------
Weighted average shares considering dilutive effect 1,175,622 1,165,904
========= =========
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7
COMMERCIAL BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
At March 31, 2004 and 2003 there were 13,200 and 34,171 stock options that were
not considered in computing diluted earnings per share because they were
anti-dilutive. The reduction in the number of non-dilutive shares is a direct
result of both an increase in market value, which gave all but the 1999 plan
shares a realizable value, as well as the exercising of 15,856 shares, and the
forfeiture of another 15,538 shares due to the departure of a senior executive.
NOTE 3 - LOANS
Loans were as follows:
March 31, 2004 December 31, 2003
-------------- -----------------
($ in thousands)
Commercial and other loans $127,248 $129,171
Real estate loans 11,478 12,130
Construction loans 369 193
Home equity loans 13,631 13,445
Consumer and credit card loans 30,379 32,810
Consumer finance loans 18,456 18,525
-------- --------
Total loans $201,561 $206,274
======== ========
The subsidiary Bank is an authorized seller/servicer for the Federal Home Loan
Mortgage Corporation (FHLMC), but has curtailed such activity in favor of
originating new fixed-rate mortgages in conjunction with Countrywide,
Incorporated. Under this arrangement, the Bank no longer owns the originated
loans, but initiates the process through to closing, but final funding comes
directly from Countrywide, for which the Bank earns a fee. At March 31, 2004 and
December 31, 2003, loans sold to FHLMC for which the Bank has retained servicing
totaled $44,657,000 and $49,878,000, and real estate loans originated and held
for sale totaled zero in 2004 and at year end 2003.
Activity in the allowance for loan losses for the three months ended March 31
was as follows:
2004 2003
---- ----
($ in thousands)
Beginning balance $ 2,503 $ 2,091
Provision for loan loss 300 300
Loans charged off (353) (465)
Recoveries of loans previously charged-off 13 32
------- -------
Ending balance $ 2,463 $ 1,958
======= =======
Impaired loans were as follows:
March 31, 2004 December 31, 2003
-------------- -----------------
($ in thousands)
Period-end loans with no allocated allowance $1,769 $2,072
Period-end loans with allocated allowance 457 390
------ ------
Total $2,226 $2,462
====== ======
Amount of allowance for loan loss allocated $ 179 $ 89
Nonperforming loans were as follows:
March 31, 2004 December 31, 2003
-------------- -----------------
($ in thousands)
Loans past due over 90 days still on accrual $ 39 $ 83
Nonaccrual loans 2,187 2,377
The impaired and nonperforming loans have been considered in management's
evaluation of the adequacy of the allowance for loan losses. Nonperforming loans
include substantially all impaired loans
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8
COMMERCIAL BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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and smaller balance homogenous loans, such as residential mortgage and consumer
loans, that are collectively evaluated for impairment. All consumer loans
included have already been partially charged down to their estimated collateral
recovery value, thereby negating a need for specific impaired allowances.
NOTE 4 - OTHER COMPREHENSIVE INCOME
Other comprehensive income for the three months ended March 31 was as follows:
2004 2003
---- ----
($ in thousands)
Unrealized holding gains (losses) on securities available for sale $ 500 $ (52)
Less: Reclassification adjustment for losses (gains) recognized in income (27) (21)
----- -----
Net unrealized holding gains (losses) 473 (73)
Tax effect (161) 25
----- -----
Other comprehensive income $ 312 $ (48)
===== =====
NOTE 5 - STOCK COMPENSATION: Employee compensation expense under stock option
plans is reported using the intrinsic value method. No stock-based compensation
cost is reflected in net income, as all options granted had an exercise plan
equal to or greater than the market price of the underlying common stock at date
of grant. The following table illustrates the effect on net income and earnings
per share if expense was measured using the fair value recognition provisions of
FASB Statement No. 123, Accounting for Stock-Based Compensation (in thousands
except per share data).
Earnings for the three months ended March 31 was as follows:
2004 2003
---- ----
Income as reported $ 423 $ 373
Deduct: Stock-based compensation expense
determined under fair value based method 10 11
---- ---
Pro forma net income 413 362
Pro forma earnings per share
Basic $ .36 $ .32
Diluted .35 .31
Earnings per share as reported
Basic $ .36 $ .32
Diluted .36 .32
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9
COMMERCIAL BANCSHARES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
- -------------------------------------------------------------------------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
INTRODUCTION
The following discussion focuses on the consolidated financial condition of
Commercial Bancshares, Inc. at March 31, 2004, compared to December 31, 2003,
and the consolidated results of operations for the quarterly period ending March
31, 2004 compared to the same periods in 2003. The purpose of this discussion is
to provide the reader with a more thorough understanding of the consolidated
financial statements and related footnotes.
The registrant is not aware of any trends, events or uncertainties that will
have or are reasonably likely to have a material effect on the liquidity,
capital resources or operations except as discussed herein. Also, the
Corporation is not aware of any current recommendations by regulatory
authorities that would have such effect if implemented.
The Corporation is designated as a financial holding company by the Federal
Reserve Bank of Cleveland. This status enables the Corporation to take advantage
of changes in existing law made by the Financial Modernization Act of 1999. As a
result of being a financial holding company, the Corporation may be able to
engage in an expanded listing of activities determined to be financial in
nature. This will help the Corporation remain competitive in the future with
other financial service providers in the markets in which the Corporation does
business. There are more stringent capital requirements associated with being a
financial holding company. The Corporation intends to maintain its
categorization as a "well capitalized" bank, as defined by regulatory capital
requirements.
This quarter's discussion includes three tables detailing the dollar and percent
changes in ending and average balances for the analysis of the "Financial
Condition" section as well as the quarterly changes in income and expense items
for the "Results of Operations" section. The tables are provided to allow the
reader to reference all changes in balances and net income in a centralized
fashion, and then concentrate on the discussion of why the values changed rather
than get caught up in the details of each dollar change. The reader should be
able to get a clearer picture of the Corporation's overall performance when
coupled with the existing yield analysis tables.
FORWARD-LOOKING STATEMENTS
Certain statements contained in this report that are not historical facts are
forward-looking statements that are subject to certain risks and uncertainties.
When used herein, the terms "anticipates," "plans," "expects," "believes" and
similar expressions as they relate to the Corporation or its management are
intended to identify such forward-looking statements. The Corporation's actual
results, performance or achievements may materially differ from those expressed
or implied in the forward-looking statements. Risks and uncertainties that could
cause or contribute to such material differences include, but are not limited
to, general economic conditions, interest rate environment, competitive
conditions in the financial services industry, changes in law, government
policies and regulations, and rapidly changing technology affecting financial
services.
FINANCIAL CONDITION
Total assets increased by $2 million in the three month period ended March 31,
2004 compared to a smaller $240,000 increase the year before from the previous
year end. This represents less than a 1% increase in both years. The Bank
traditionally experiences a reduction in loan balances after year ends as
companies pay down loans made prior to year end and gear up for new projects,
especially in the
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10
COMMERCIAL BANCSHARES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
- -------------------------------------------------------------------------------
agricultural markets. Coupled with decisions to curtail involvement with the
horse trailer dealer from Denver, and to stop originating long-term fixed-rate
mortgage loans for sale in the secondary markets, these pay-downs have led to
lower overall loan totals. This year's falloff was about $1.5 million less than
last year's. At the same time, deposits have grown since year end, leading to
higher balances in cash balances and securities held for sale, both in overnight
and longer-term funds.
(dollars in thousands) ENDING BALANCES AS OF THE DATE SHOWN
----------------------------------------------------------------------------------------------
03/31/04 12/31/03 $ CHG % CHG 03/31/03 12/31/02 $ CHG % CHG
-------- -------- -------- ------ -------- -------- -------- ------
Cash & Fed funds 13,688 10,624 3,064 28.84 7,262 7,057 205 2.90
Securities AFS 51,716 48,491 3,225 6.65 45,257 39,668 5,589 14.09
Gross loans 201,561 206,274 (4,713) (2.28) 195,796 202,065 (6,269) (3.10)
Allowance for loan losses (2,463) (2,503) 40 (1.60) (1,958) (2,091) 133 (6.36)
-------- -------- -------- ------ -------- -------- -------- ------
Loans, net 199,098 203,771 (4,673) (2.29) 193,838 199,974 (6,136) (3.07)
Premises & Equipment 6,292 6,380 (88) (1.38) 6,255 6,167 88 1.43
Accrued interest receivable 1,405 1,143 262 22.92 1,355 1,197 158 13.20
Other Assets 2,660 2,431 229 9.42 3,074 2,738 336 12.27
-------- -------- -------- ------ -------- -------- -------- ------
Total assets 274,859 272,840 2,019 0.74 257,041 256,801 240 0.09
======== ======== ======== ====== ======== ======== ======== ======
Noninterest-bearing demand 22,869 26,123 (3,254) (12.46) 20,628 22,453 (1,825) (8.13)
Interest-bearing demand 71,176 68,656 2,520 3.67 63,153 64,678 (1,525) (2.36)
Savings and time deposits 105,242 103,413 1,829 1.77 104,492 102,363 2,129 2.08
Time deposits of $100k 40,785 40,559 226 0.56 34,510 33,314 1,196 3.59
-------- -------- -------- ------ -------- -------- -------- ------
Total deposits 240,072 238,751 1,321 0.55 222,783 222,808 (25) (0.01)
FHLB advances 11,500 11,500 0 0.00 11,500 11,500 0 0.00
Other borrowed funds 0 0 0 0.00 750 350 400 114.29
Accrued interest payable 262 415 (153) (36.87) 355 329 26 7.90
Other liabilities 1,035 1,019 16 1.57 784 1,036 (252) (24.32)
-------- -------- -------- ------ -------- -------- -------- ------
Total liabilities 252,869 251,685 1,184 0.47 236,172 236,023 149 0.06
Shareholders' equity 21,990 21,155 835 3.95 20,869 20,778 91 0.44
-------- -------- -------- ------ -------- -------- -------- ------
Total liabilities & equity 274,859 272,840 2,019 0.74 257,041 256,801 240 0.09
======== ======== ======== ===== ======== ======== ======== ======
As mentioned above, the management team decided two years ago to end our
involvement with a dealer in horse trailers based in Denver. As that decision
has progressed, repayments on loans in that portfolio have driven the balance
down from more than $35 million at year end 2001, to just over $17.8 million as
of March 31, 2004. In addition, the Bank has become an originator of long-term,
fixed-rate real estate loans for Countrywide, Incorporated. In doing so, the
Bank no longer has an inventory of loans originated and ready to be sold on its
books since the new loans are funded directly by Countrywide. In addition, the
partnership with Countrywide has allowed the Bank to package non-conforming
loans, which formerly were ineligible for sale, for sale or refinancing, thus
clearing them from the Bank's books. It is management's intent that only
adjustable rate mortgages be held in portfolio for investment purposes by the
Bank. Total real estate loan balances have shrunk from more than $42 million at
year end 2001, to just over $11.8 million as of March 31, 2004.
These two loan portfolio decisions were made in conjunction with a decision to
emphasize loan growth in commercial and agriculture loans at the Bank, as well
as consumer loans originated through Advantage Finance. Thus, loan growth in
those areas has more than offset the combined loss of more than $47 million in
balances in the horse trailer and real estate portfolios, with commercial and
agriculture loans.
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11
COMMERCIAL BANCSHARES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
- -------------------------------------------------------------------------------
While this growth has been constant over these last two years, pay offs of
short-term commercial loans and a slow down in consumer credit since this last
Christmas season have led to a reduction in gross loan balances of more than
$4.7 million since year end 2003.
The reserve for loan losses has been reduced by only $40,000 since year end as
net charge offs have just barely surpassed the provision for loan losses made
this year. This compares to a reduction of $133,000 in the reserve during the
first quarter last year. With the provisions made to the reserve at the end of
last year and the net charge-offs to-date this year, the reserve stands at just
over 1.22% of gross loans. This compares to a reserve of just over 1.21% at year
end, and a reserve of 1.00% at the end of March, 2003.
A third factor involved in the changing mix of portfolios throughout the Bank is
the mix of depository products, especially certificates of deposits. A large
block of higher-than-market-rate certificates were placed during the year 2001
for terms ranging from 21 to 28 months. These deposits stayed on the books
throughout 2001 and much of 2002, finally maturing in mid-year 2003. The
low-rate interest environment saw margins squeezed, but then bounce back as
those high-rate certificates were replaced with current-rate funds, reducing our
cost of funds. In the current environment, deposits have grown more than $1.3
million since year end 2003. While noninterest-bearing demand deposits have
declined about $3.3 million dollars, more than $4 million was used to pay off
gross loans on a one-for-one basis. Thus, without the loan/deposit matched
runoff, all deposit categories would have grown since year end. Deposits have
grown more than $17 million since March 31, 2003.
Other assets and cash balances reflect higher balances for accrued interest
receivable and cash on hand. In addition, the Bank has completely replaced it
aged ATM network last year, upgrading to the latest operating environment and
ready for the latest wave of innovations. In addition, the Bank is also in the
process of upgrading its internal computer network as well, and taking advantage
of some cost-saving changes to have the newest features for less investment at
each computer station.
Total shareholders' equity reflects current earnings of $423,000, less dividends
of $224,000 during the first three months of 2004. The change in unrealized fair
market value adds another $312,000 to that balance. Some executive officers
exercised existing stock options. This resulted in a net increase in
shareholders' equity of $263,000. In addition, $61,000 of stock was issued for
the directors' deferred compensation plan. During the same period last year,
equity grew by $373,000 in earnings, less $221,000 in dividends, less $13,000
for shares issued for exercised options.
Average balance changes for the three-month period tend to reflect the sustained
increases over a two year period. Thus, total average asset footings for the
first quarter of 2004 are 5.63% higher than the same quarter in 2003. The
average loan growth during the first quarter this year versus last year reflects
the sluggish nature of loan originations in light of the runoff of both real
estate and consumer balances. Any increases shown stand as tribute to the
efforts of the lending staff. Average balances for the reserve for loan losses
reflect $485,000 more for the three month period, reflecting the additions made
to the reserve for growth and the new mix of the loan portfolio at the end of
2003.
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12
COMMERCIAL BANCSHARES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
- -------------------------------------------------------------------------------
AVERAGE DAILY BALANCES FOR THE PERIODS SHOWN
(dollars in thousands) THREE MONTHS ENDED MARCH 31
---------------------------
2004 2003 $ CHG % CHG
---- ---- ----- -----
Cash & Fed funds 12,580 8,682 3,898 44.90
Securities AFS 48,957 41,179 7,778 18.89
Gross loans 201,550 197,923 3,627 1.83
Allowance for loan losses (2,550) (2,065) (485) 23.49
-------- -------- -------- -------
Loans, net 199,000 195,858 3,142 1.60
Premises & Equipment 6,342 6,247 95 1.52
Accrued interest receivable 1,289 1,307 (18) (1.38)
Other Assets 2,833 3,292 (459) (13.94)
-------- -------- -------- -------
Total assets 271,001 256,565 14,436 5.63
======== ======== ======== =======
Noninterest-bearing demand 21,892 19,599 2,293 11.70
Interest-bearing demand 71,141 64,004 7,137 11.15
Savings and time deposits 103,329 104,149 (820) (0.79)
Time deposits of $100k 39,286 34,039 5,247 15.41
-------- -------- -------- -------
Total deposits 235,648 221,791 13,857 6.25
FHLB advances 11,500 11,500 0 0.00
Other borrowed funds 0 315 (315) (100.00)
Accrued interest payable 431 408 23 5.64
Other liabilities 1,578 1,517 61 4.02
-------- -------- -------- -------
Total liabilities 249,157 235,531 13,626 5.79
Shareholders' equity 21,844 21,034 810 3.85
-------- -------- -------- -------
Total liabilities & equity 271,001 256,565 14,436 7.30
======== ======== ======== =======
The average balance increase of more than $7.7 million in securities available
for sale parallels the increase in public fund placements made on the deposit
side, most of which is carried in the $100,000 deposit account line. The
sustained low interest rate environment makes income generation hard when
dealing with the limited types of securities that are permissible for the Bank
to invest in. Much of the growth has been directed to "tax-free" investments.
State law changes have also made it imperative to concentrate on in-state issues
in order to pledge those securities as collateral for public funds deposits.
While it is possible to have individual out-of-state issues accepted as
collateral, it takes more effort and documentation. However, Ohio-based
securities tend to command a better reputation in the financial markets, easing
the decision to concentrate on in-state issues.
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13
COMMERCIAL BANCSHARES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
- -------------------------------------------------------------------------------
RESULTS OF OPERATIONS
Net income for the three months ended March 31, 2004 was $423,000, or $50,000
more than during the same period in 2003. Diluted earnings per share increased
to $.36 from $.32 for the quarters ended March 31 in the respective years.
Discussed below are the major factors that have influenced these operating
results.
CONSOLIDATED STATEMENTS OF INCOME FOR THE
PERIODS SHOWN
(dollars in thousands) THREE MONTHS ENDED MARCH 31
---------------------------
2004 2003 $ CHG % CHG
---- ---- ----- -----
Interest and fees on loans 3,458 3,562 (104) (2.92)
Taxable interest on securities 247 159 88 55.35
Tax-free interest on securities 253 247 6 2.02
Other interest income 12 4 8 225.00
----- ----- ----- ------
Total interest income 3,970 3,972 (2) (0.05)
Interest on deposits 1,122 1,314 (192) (14.61)
Interest on borrowings 132 131 1 0.00
----- ----- ----- ------
Total interest expense 1,254 1,445 (191) (13.28)
Net interest income 2,716 2,527 189 7.52
Provision for loan losses 300 300 0 0.00
----- ----- ----- ------
Net interest after PLL 2,416 2,227 189 8.53
Service and overdraft fees 452 471 (19) (4.25)
Gains/(losses) on asset sales 27 21 6 22.73
Other income 87 120 (33) (27.50)
----- ----- ----- ------
Total other income 566 612 (46) (7.83)
Salaries and employee benefits 1,160 1,179 (19) (1.61)
Occupancy, furniture & equip 269 238 31 13.98
State taxes 98 95 3 3.16
Data processing 213 178 35 18.99
FDIC deposit insurance 17 17 0 0.00
Professional fees 102 79 23 29.11
Amortization of intangibles 64 59 5 8.47
Other operating expense 543 534 9 1.31
----- ----- ----- ------
Total other expense 2,466 2,379 87 3.61
Income before taxes 516 460 56 12.17
Income taxes 93 87 6 6.90
----- ----- ----- ------
Net income 423 373 50 13.40
===== ===== ===== ======
The first table details the variance amounts and percentages for the three-month
period. The subsequent yield analysis table detail the combination of changing
portfolio balance mixes and the earning power behind the rates associated with
those balances.
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14
COMMERCIAL BANCSHARES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
- -------------------------------------------------------------------------------
Net interest income, the primary source of earnings, is the amount by which
interest and fees on loans and investments exceed the interest cost of deposits
and borrowings obtained to fund them. The volume and composition of
interest-earning assets and interest-bearing liabilities, as well as the level
of noninterest-bearing demand deposits and shareholders' equity, affect net
interest income. Also impacting net interest income is the susceptibility of
interest-earning assets and interest-bearing liabilities to changes in the
general market level of interest rates. Management attempts to manage the
repricing of assets and liabilities so as to achieve a stable level of net
interest income and reduce the effect of significant changes in the market level
of interest rates. This is accomplished through the pricing and promotion of
various loan and deposit products as well as the active management of the Bank's
portfolio of securities available for sale and borrowed funds.
Interest income for the three month period ending March 31, 2004 was $2,000 less
than the prior year's first quarter. On a fully-taxable equivalent basis, the
difference becomes an increase of $3,000 because of the Bank's higher
concentration of tax-free securities. The prime rate was lowered by 25 points
during the first quarter of 2003. This is reflected in the lower interest yield
of 6.49% on earning assets this year versus the first quarter yield of 6.95%
last year. To help offset the loss in yield, the Bank's earning assets grew more
than $14 million over the prior year's first quarter, netting to the $2,000
reduction in interest income. Interest expense shrank $191,000 for the quarter
as the cost of funds fell 50 points to 2.24%, but was paid out on an extra $11
million more in deposits and borrowed funds. Deposit costs fell 53 points to
2.11%, and average borrowing costs rose 8 points to 4.60% since the core $11.5
million of long-term funds held steady at 4.6%, although the Bank had almost
$131,000 less in short-term borrowed funds.
The provision for loan losses was the same $300,000 for the first quarter of
both 2004 and 2003. Additions to the provision were used to cover the growth in
the loan portfolio as well the losses experienced in the portfolio each year. As
shown earlier in Note 3, net charge offs for the quarter were $95,000 less than
last year. Management determines the adequacy of the allowance for loan losses
through its analysis of specific problem loans and historical charge-off
experience in addition to its evaluation of local and national economic
conditions. The Bank believes that the current allowance balance is sufficient
to cover probable identified losses in the loan portfolio.
Net interest income after the provision for loan losses was $189,000 more for
the first quarter 2004 than in 2003. Net interest income after the provision is
a measurement of how well the Bank has weathered changes in the interest rate
environment and variances in the quality of the assets in its portfolios. In
light of the sustained low-rate interest environment and rise in consumer debt
burden, the Bank has held its own in the face of such adversity.
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15
COMMERCIAL BANCSHARES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
- -------------------------------------------------------------------------------
The following table provides an analysis of the average balances, yields and
rates on interest-earning assets and interest-bearing liabilities.
Three Months Ended March 31,
-------------------------------------------------------------------
2004 2003
-------------------------------- -------------------------------
Average Average Average Average
balance Interest yield/rate balance Interest yield/rate
------- -------- ---------- ------- -------- ----------
($ in thousands)
Securities (1) $ 54,321 $ 631 4.68% $ 42,647 $ 524 4.98%
Loans (2) 199,000 3,458 6.99 195,858 3,562 7.38
---------- -------- --------- -------
Total interest-earning assets 253,321 4,089 6.49 238,505 4,086 6.95
Other assets 17,680 18,060
---------- ---------
Total assets $ 271,001 $ 256,565
========== =========
Deposits - interest bearing $ 213,756 1,122 2.11% $ 202,192 1,314 2.64%
Borrowed funds 11,499 132 4.60 11,815 131 4.52
---------- -------- --------- -------
Total interest-bearing deposits
and borrowings $ 225,254 1,254 2.24 $ 214,007 1,445 2.74
Noninterest-bearing demand deposits 21,893 19,599
Other liabilities 2,009 1,925
Shareholder's equity 21,844 21,034
---------- ---------
Total liabilities and
shareholders' equity $ 271,001 $ 256,565
========== =========
Net interest income $ 2,835 $ 2,641
======== =======
Interest rate spread 4.25% 4.21%
Net interest margin (3) 4.50% 4.49%
- -------------------------------------------------------------------------------
(1) Securities include federal funds sold for purposes of this yield table.
Average yields on all securities have been computed based on amortized
cost. Income on taxexempt securities has been computed on a fully-taxable
equivalent basis using a 34% tax rate and the average cost of funds to
support the purchases. The adjustment is $119,000 and $114,000 for 2004 and
2003.
(2) Average balance is net of deferred loan fees and loan discounts. Interest
income includes loan fees of $153,000 and $156,000 and deferred dealer
reserve expense of $62,000 and $97,000 in 2004 and 2003.
(3) Net interest income as a percentage of average interest-earning assets.
Total noninterest income declined $46,000 for the first quarter of 2004 compared
to the same period in 2003. Items contributing to the decrease included service
fees and overdraft charges for $21,000, and $3,000 lower cash servicing fees on
sold real estate loans, $3,000 lower fees from the Beck Title Agency, $6,000
less on standard DDA account fees, and $17,000 less in fees from loan
originations through Countrywide, Inc.
Total noninterest expense increased $87,000 in the three months of the first
quarter 2004 compared to the same period during 2003. Increases consisted of
$33,000 in depreciation of new computer equipment placed into service late last
year, $34,000 in data processing fees, specifically related to new
- -------------------------------------------------------------------------------
16
COMMERCIAL BANCSHARES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
- -------------------------------------------------------------------------------
communication lines, and $23,000 in consulting and legal fees. These increases
were partially offset by a reduction in personnel expenses, which declined by
$19,000.
The quarterly income before taxes for 2004 was $56,000 more than in 2003, due to
the net of all of the above changes. This performance, while still below
managements' goals, shows improvement in the basic earning power of the Bank
since there was a clear decrease in reliance upon asset sales to generate
income, and the Bank has absorbed a large amount of amortization of the non-cash
mortgage servicing rights as the Bank changes its approach to the very volatile
real estate origination market.
Taxes for the first quarter increased $6,000, reflecting both the increase in
earnings, and the emphasis on tax-free income sources. The Bank has repositioned
its portfolio to emphasize more state, county and municipal securities.
Change in net income after taxes is the result of netting all the changes in all
of the above categories. For the first quarter, that means income was up $50,000
from 2003. In all cases, earnings have been hampered by provisions for loan
losses and fewer gains on the sales of assets. While improvements have been
made, management still expects much higher levels of income as the net effect of
all the repositionings take effect.
CONTRACTUAL OBLIGATIONS AND COMMITMENTS
The Company has certain obligations and commitments to make future payments
under contracts. At March 31, 2004, the aggregate contractual obligations and
commitments are:
Contractual obligations
Payments Due by Period
Less Than 1-3 3-5 After
(in thousands) Total One Year Years Years 5 Years
----- -------- ----- ----- -------
Time deposits and certificates of deposit $124,622 $ 57,492 $ 56,000 $ 9,840 $ 1,290
Borrowed funds 11,500 -- -- 11,500 --
-------- -------- -------- -------- --------
Total $136,122 $ 57,492 $ 56,000 $ 21,340 $ 1,290
======== ======== ======== ======== ========
Other commitments
Amount of Commitment - Expiration by Period
Less Than 1-3 3-5 After
(in thousands) Total One Year Years Years 5 Years
----- -------- ----- ----- -------
Commitments to extend commercial credit $11,309 $10,478 $ 404 $ 141 $ 286
Commitments to extend consumer credit 13,322 3,381 502 1,417 8,022
Standby letters of credit 2,022 22 -- -- 2,000
------- ------- ------- ------- -------
Total $26,653 $13,881 $ 906 $ 1,558 $10,308
======= ======= ======= ======= =======
Items listed above under "Contractual obligations" represent standard bank
financing activity under normal terms and practices. Such funds normally
roll-over or are replaced by like items depending on then-current financing
needs. Items shown under "Other commitments" also represent standard bank
activity, but for extending credit to bank customers. Commercial credits
generally represent lines of credit or approved loans with drawable funds still
available under the contract terms. On an on-going basis, about half of these
amounts are expected to be drawn. Consumer credits generally represent
- -------------------------------------------------------------------------------
17
COMMERCIAL BANCSHARES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
- -------------------------------------------------------------------------------
amounts drawable under revolving home equity lines or credit card programs. Such
amounts are usually deemed less likely to be drawn upon in total as consumers
tend not to draw down all amounts on such lines. Utilization rates tend to be
fairly constant over time. Standby letters of credit represent guarantees to
finance specific projects whose primary source of financing come from other
sources. In the unlikely event of the other source's failure to provide
sufficient financing, the bank would be called upon to fill the need. The bank
is also continually engaged in the process of approving new loans in a bidding
competition with other banks. Terms of possible new loans are approved by
management and Board committees, with caveats and possible counter terms made to
the applicant customers. Those customers may accept those terms, make a counter
proposal, or accept terms from a competitor. These loans are not yet under
contract, but offers have been tendered, and would be required to be funded if
accepted. Such agreements represent about $3,527,000 at year end, for various
possible maturity terms.
LIQUIDITY AND CAPITAL RESOURCES
The Corporation's liquidity, primarily represented by cash and cash equivalents,
is a result of its operating, investing and financing activities, which are
summarized in the Condensed Consolidated Statements of Cash Flows. Cash and cash
equivalents amounted to $13,688,000 at March 31, 2004 compared to $10,624,000 at
December 31, 2003.
Liquidity refers to management's ability to generate sufficient cash to fund
current loan demand, meet deposit withdrawals, pay operating expenses and meet
other financial obligations. The principal sources of funds for the Bank are
deposits, loan repayments and maturities, sale of mortgage loans in the
secondary market, FHLB borrowings, sale of securities, and funds generated
through operations. Management believes that its sources of liquidity are
adequate to meet the needs of the Corporation.
Cash flows from daily activity resulted in an increase of more than $3 million
dollars in Cash and Cash Equivalents since December 31, 2003. That increase was
evenly shared between loan pay downs and an increase in deposits, which grew
nearly $1.3 million. While loans were down $4.3 million, nearly $3 million of
that was reinvested in Securities. Prior year activity for the first three
months of 2003 saw Cash grow by only $205,000, as deposits held steady,
overnight borrowed funds were paid down, and loan pay downs were used to fund
growth in the Securities portfolio,
Banking regulations have established minimum capital requirements for banks
including risk-based capital ratios and leverage ratios. Regulations require all
banks to have a minimum total risk-based capital ratio of 8%, with half of the
capital composed of core capital. Minimum leverage ratio requirements range from
3% to 5% of total assets. Core capital, or Tier 1 capital, includes common
equity, perpetual preferred stock and minority interests that are held by others
in consolidated subsidiaries minus intangible assets. Supplementary capital, or
Tier 2 capital, includes core capital and such items as mandatory convertible
securities, subordinated debt and the allowance for loan losses, subject to
certain limitations. Qualified Tier 2 capital can equal up to 100% of an
institution's Tier 1 capital with certain limitations in meeting the total
risk-based capital requirements.
At March 31, 2004, the Bank's leverage ratio was 7.72% and the risk-based
capital ratio was 11.07%, both of which exceeded the minimum regulatory
requirements to be considered well-capitalized. The Corporation's leverage and
risk-based capital ratios were 7.90% and 11.30% at March 31, 2004, exceeding
well-capitalized levels.
- -------------------------------------------------------------------------------
18
COMMERCIAL BANCSHARES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
- -------------------------------------------------------------------------------
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
A significant market risk to which the Corporation is exposed is interest
rate risk. The business of the Corporation and the composition of its balance
sheet consists of investments in interest-earning assets (primarily loans and
securities), which are funded by interest-bearing liabilities (deposits and
borrowings). These financial instruments have varying levels of sensitivity to
changes in the market rates of interest, resulting in market risk.
Interest rate risk is managed regularly through the Corporation's
Asset/Liability Management Committee (ALCO). The two primary methods to monitor
and manage interest rate risk are rate-sensitivity gap analysis and review of
the effects of various interest rate shock scenarios. Based upon ALCO's review,
there has been no significant change in the interest rate risk of the
Corporation since year-end 2003. (See Quantitative and Qualitative Disclosures
about Market Risk contained in the Annual Report to Shareholders for the year
ended December 31, 2003.)
ITEM 4 - CONTROLS AND PROCEDURES
Within the 90-day period prior to the filing date of this report, an evaluation
was carried out under the supervision and with the participation of the
Corporation's management, including its Chief Executive Officer and Chief
Financial Officer, of the effectiveness of its disclosure controls and
procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934). Based on their evaluation, the Corporation's
Chief Executive Officer and Chief Financial Officer have concluded that the
Corporation's disclosure controls and procedures are, to the best of their
knowledge, effective to ensure that information required to be disclosed by the
Corporation in reports that it files or submits under the Exchange Act is
recorded, processed, summarized and reported within the time periods specified
in Securities and Exchange Commission rules and forms. Subsequent to the date of
their evaluation, the Corporation's Chief Executive Officer and Chief Financial
Officer have concluded that there were no significant changes in the
Corporation's internal controls or in other factors that could significantly
affect its internal controls, including any corrective actions with regard to
significant deficiencies and material weaknesses.
- -------------------------------------------------------------------------------
19
COMMERCIAL BANCSHARES, INC.
FORM 10-Q
Quarter ended March 31, 2003
PART II - OTHER INFORMATION
- -------------------------------------------------------------------------------
Item 1 - Legal Proceedings:
There are no matters required to be reported under this item.
Item 2 - Changes in Securities and Use of Proceeds:
There are no matters required to be reported under this item.
Item 3 - Defaults upon Senior Securities:
There are no matters required to be reported under this item.
Item 4 - Submission of Matters to a Vote of Security Holders: There
are no matters required to be reported under this item.
Item 5 - Other Information:
There are no matters required to be reported under this item.
Item 6 - Exhibits and Reports on Form 8-K:
(a) Exhibit 11, Statement re computation of per share earnings
(reference is hereby made to Note 2 to the Consolidated
Financial Statements on page 7 hereof)
- -------------------------------------------------------------------------------
20
- -------------------------------------------------------------------------------
COMMERCIAL BANCSHARES, INC.
SIGNATURES
- --------------------------------------------------------------------------------
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
COMMERCIAL BANCSHARES, INC.
------------------------------------
(Registrant)
Date: 05/12/2004 /s/ Philip W. Kinley
---------------------- ------------------------------------
(Signature)
Philip W. Kinley
President and Chief Executive Officer
Date: 05/12/2004 /s/ John C. Haller
---------------------- ------------------------------------
(Signature)
John C. Haller
Senior Vice President and
Chief Financial Officer
- -------------------------------------------------------------------------------
21