SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 30, 2006
[ ] 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 0-11535
CITY NATIONAL BANCSHARES CORPORATION
(Exact name of registrant as specified in its charter)
New Jersey 22-2434751
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
900 Broad Street, 07102
Newark, New Jersey (Zip Code)
(Address of principal executive offices)
Registrant's telephone number, including area code: (973) 624-0865
Securities Registered Pursuant to Section 12(b) of the Act: None
Securities Registered Pursuant to Section 12(g) of the Act:
Title of each class
Common stock, par value $10 per share
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
----- -----
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes No X
----- -----
Indicate by check mark whether the Registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
Yes No X
----- -----
The aggregate market value of voting stock held by non-affiliates of the
Registrant as of October 23, 2006 was approximately $5,664,000.
There were 132,926 shares of common stock outstanding at October 23, 2006.
1
Index
Page
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheet as of September 30, 2006 (Unaudited)
and December 31, 2005............................................ 3
Consolidated Statement of Income (Unaudited) for the Nine Months
Ended September 30, 2006 and 2005 and for the Three Months Ended
September 30, 2006 and 2005...................................... 4
Consolidated Statement of Cash Flows (Unaudited) for the Nine
Months Ended September 30, 2006 and 2005......................... 5
Notes to Consolidated Financial Statements (Unaudited)........... 8
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations............................................ 8
Item 3. Quantitative and Qualitative Disclosures about Market Risk....... 15
Item 4. Controls and Procedures.......................................... 15
PART II. OTHER INFORMATION............................................... 15
Item 1. Legal proceedings................................................ 15
Item 6. Exhibits and Reports on Form 8-K................................. 15
Signatures............................................................... 18
2
CITY NATIONAL BANCSHARES CORPORATION AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
September 30, December 31,
Dollars in thousands, except share data 2006 2005
------------- ------------
ASSETS
Cash and due from banks $ 7,227 $ 6,260
Federal funds sold 6,300 15,200
Interest bearing deposits with banks 671 1,260
Investment securities available for sale 101,242 109,725
Investment securities held to maturity (Market value of $45,006 at September 30,
2006 and $39,427 at December 31, 2005) 45,046 39,419
Loans held for sale 524 124
Loans 195,503 179,093
Less: Allowance for loan losses 2,275 2,165
-------- --------
Net loans 193,228 176,928
-------- --------
Premises and equipment 4,090 4,342
Accrued interest receivable 2,221 1,917
Bank-owned life insurance 4,692 3,870
Other assets 4,909 4,496
-------- --------
TOTAL ASSETS $370,150 $363,541
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Demand $ 35,200 $ 31,492
Savings 158,800 155,232
Time 123,822 125,705
-------- --------
Total deposits 317,822 312,429
Accrued expenses and other liabilities 5,795 4,730
Short-term borrowings -- 540
Long-term debt 20,538 20,700
-------- --------
Total liabilities 344,155 338,399
Commitments and contingencies
Stockholders' equity
Preferred stock, no par value: Authorized 100,000 shares ;
Series A, issued and outstanding 8 shares in 2006 and 2005 200 200
Series C, issued and outstanding 108 shares in 2006 and 2005 27 27
Series D, issued and outstanding 3,280 shares in 2006 and 2005 820 820
Preferred stock, no par value, perpetual noncumulative: Authorized 200 shares;
Series E, issued and outstanding 33 shares in 2006 and 28 shares in 2005 1,650 1,400
Preferred stock, no par value, perpetual noncumulative: Authorized 7,000 shares;
Series F, issued and outstanding 7,000 shares in 2006 and 2005 6,790 6,790
Common stock, par value $10: Authorized 400,000 shares;
134,530 shares issued in 2006 and 2005
132,926 shares outstanding in 2006 and 133,650 shares outstanding in 2005 1,345 1,345
Surplus 1,115 1,115
Retained earnings 15,245 14,464
Accumulated other comprehensive loss (1,098) (973)
Treasury stock, at cost - 1,604 and 880 common shares in 2006 and 2005, respectively (99) (46)
-------- --------
Total stockholders' equity 25,995 25,142
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $370,150 $363,541
======== ========
See accompanying notes to unaudited consolidated financial statements.
3
CITY NATIONAL BANCSHARES CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- -------------------
DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA 2006 2005 2006 2005
-------- -------- -------- --------
INTEREST INCOME
Interest and fees on loans $ 3,630 $ 2,801 $ 9,926 $ 7,962
Interest on Federal funds sold and securities
purchased under agreements to resell 48 88 691 438
Interest on deposits with banks 14 7 55 18
Interest and dividends on investment securities:
Taxable 1,476 1,444 4,399 4,225
Tax-exempt 314 167 861 504
-------- -------- -------- --------
Total interest income 5,482 4,507 15,932 13,147
-------- -------- -------- --------
INTEREST EXPENSE
Interest on deposits 2,277 1,475 6,616 4,049
Interest on short-term borrowings 85 69 108 80
Interest on long-term debt 334 312 971 911
-------- -------- -------- --------
Total interest expense 2,696 1,856 7,695 5,040
-------- -------- -------- --------
Net interest income 2,786 2,651 8,237 8,107
Provision for loan losses 65 15 114 92
-------- -------- -------- --------
Net interest income after provision for loan losses 2,721 2,636 8,123 8,015
-------- -------- -------- --------
OTHER OPERATING INCOME
Service charges on deposit accounts 296 288 869 862
Agency fees on commercial loans 73 88 254 276
Other income 201 211 611 661
Net (losses) gains on sales of investment securities (3) 4 (19) (23)
-------- -------- -------- --------
Total other operating income 567 591 1,715 1,776
-------- -------- -------- --------
OTHER OPERATING EXPENSES
Salaries and other employee benefits 1,406 1,349 4,133 3,897
Occupancy expense 232 228 684 616
Equipment expense 137 148 413 418
Data processing expense 73 70 235 235
Other expenses 670 684 2,037 1,884
-------- -------- -------- --------
Total other operating expenses 2,518 2,479 7,502 7,050
-------- -------- -------- --------
Income before income tax expense 770 748 2,336 2,741
Income tax expense 173 197 539 793
======== ======== ======== ========
NET INCOME $ 597 $ 551 $ 1,797 $ 1,948
======== ======== ======== ========
NET INCOME PER COMMON SHARE
Basic $ 3.36 $ 4.12 $ 9.11 $ 14.07
Diluted 3.11 3.92 8.91 13.59
======== ======== ======== ========
Basic average common shares outstanding 133,114 133,609 133,382 133,646
Diluted average common shares outstanding 144,103 140,689 143,898 138,341
======== ======== ======== ========
See accompanying notes to unaudited consolidated financial statements.
4
CITY NATIONAL BANCSHARES CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30,
-------------------
IN THOUSANDS 2006 2005
-------- --------
OPERATING ACTIVITIES
Net income $ 1,797 $ 1,948
Adjustments to reconcile net income to net cash from operating activities:
Depreciation and amortization 443 346
Provision for loan losses 114 92
Premium amortization on investment securities 127 66
Net losses on sales and early redemptions of investment securities 19 23
Gains on loans held for sale (24) (10)
Loans originated for sale (2,414) (795)
Proceeds from sales and principal payments from loans held for sale 2,038 805
Increase in accrued interest receivable (304) (101)
Deferred income taxes (81) (514)
Net increase in bank-owned life insurance (822) (7)
(Increase) decrease in other assets (251) 124
Increase in accrued expenses and other liabilities 1,065 1,490
-------- --------
Net cash provided by operating activities 1,707 3,467
-------- --------
INVESTING ACTIVITIES
Increase in loans, net (16,414) (13,399)
Decrease in interest bearing deposits with banks 589 18
Proceeds from maturities of investment securities available for sale,
including sales, principal payments and early redemptions 35,930 54,436
Proceeds from maturities of investment securities held to maturity,
including sales, principal payments and early redemptions 701 8,178
Proceeds from sales of investment securities available for sale 3,339 14,527
Purchases of investment securities available for sale (31,116) (73,762)
Purchases of investment securities held to maturity (6,350) (2,999)
Purchases of premises and equipment (191) (724)
-------- --------
Net cash used in investing activities (13,512) (13,725)
-------- --------
FINANCING ACTIVITIES
Increase in deposits 5,393 32,705
Decrease in short-term borrowings (540) (630)
Decrease in long-term debt (162) (325)
Issuance of common stock -- 10
Issuance of preferred stock 250 8,140
Purchases of treasury stock (53) (30)
Dividends paid on preferred stock (582) (67)
Dividends paid on common stock (434) (403)
-------- --------
Net cash provided by financing activities 3,872 39,400
-------- --------
Net (decrease) increase in cash and cash equivalents (7,933) 29,142
Cash and cash equivalents at beginning of period 21,460 11,717
-------- --------
Cash and cash equivalents at end of period $ 13,527 $ 40,859
-------- --------
CASH PAID DURING THE YEAR
Interest $ 6,776 $ 4,200
Income taxes 922 413
See accompanying notes to unaudited consolidated financial statements.
5
CITY NATIONAL BANCSHARES CORPORATION AND SUBSIDIARY
Notes to Consolidated Financial Statements (Unaudited)
1. Principles of consolidation
The accompanying consolidated financial statements include the accounts of City
National Bancshares Corporation (the "Corporation") and its subsidiaries, City
National Bank of New Jersey (the "Bank" or "CNB"), City National Bank of New
Jersey Capital Trust I and City National Bank Capital Trust II. All intercompany
accounts and transactions have been eliminated in consolidation.
2. Basis of presentation
The accompanying unaudited consolidated financial statements have been prepared
in accordance with U.S. generally accepted accounting principles for interim
financial information. Accordingly, they do not include all the information and
footnotes required by U.S. generally accepted accounting principles for complete
financial statements. These consolidated financial statements should be reviewed
in conjunction with the financial statements and notes thereto included in the
Corporation's December 31, 2005 Annual Report to Stockholders.
In the opinion of management, all adjustments (consisting of normal recurring
accruals) considered necessary for a fair presentation of the financial
statements have been included. Operating results for the three and nine months
ended September 30, 2006 are not necessarily indicative of the results that may
be expected for the year ended December 31, 2006. In preparing the financial
statements, management is required to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosures of contingent
liabilities as of the date of the balance sheet and revenues and expenses for
related periods. Actual results could differ significantly from those estimates.
3. Net income per common share
The following table presents the computation of net income per common share.
Three Months Ended Nine Months Ended
September 30, September 30,
------------------- -------------------
In thousands, except per share data 2006 2005 2006 2005
-------- -------- -------- --------
Net income $ 597 $ 551 $ 1,797 $ 1,948
Dividends on preferred stock (149) -- (582) (67)
-------- -------- -------- --------
Net income applicable to basic
common shares $ 448 $ 551 $ 1,215 $ 1,881
======== ======== ======== ========
NUMBER OF AVERAGE COMMON SHARES
Basic 133,114 133,609 133,382 133,646
Diluted 144,103 140,689 143,898 138,341
-------- -------- -------- --------
NET INCOME PER COMMON SHARE
Basic $ 3.36 $ 4.12 $ 9.11 $ 14.07
Diluted 3.11 3.92 8.91 13.59
Basic income per common share is calculated by dividing net income less
dividends paid on preferred stock by the weighted average number of common
shares outstanding. On a diluted basis, both net income and common shares
outstanding are adjusted to assume the conversion of the convertible preferred
stock, if conversion is deemed dilutive.
Net income per share data has been revised for the third quarter and first nine
months of 2005. For these periods, the Corporation had accrued the dividends to
be paid on preferred stock. SFAS No. 128,
6
"Earnings per Share" (FAS 128) requires that net income available to common
shareholders be computed by deducting from net income dividends declared in the
period, not accrued, on preferred stock. In addition, during 2005, the
Corporation issued convertible preferred stock. FAS 128 requires that the
dilutive effect of convertible securities be reflected in net income per share
by applying the if-converted method. The Corporation had not applied the
if-converted method in calculating net income per share for the third quarter or
first nine months of 2005. The Corporation has concluded that these adjustments
are immaterial to the financial statements on both a qualitative and
quantitative basis for the previously issued 2005 third quarter and the first
nine months financial statements. Accordingly, adjustments have been made in the
current period financial statements.
4. Comprehensive income (loss)
Total comprehensive income (loss) includes net income and other comprehensive
income or loss which is comprised of unrealized gains and losses on investment
securities available for sale, net of taxes. The Corporation's total
comprehensive income (loss) for the three months ended September 30, 2006 and
2005 was $1,544,000 and ($287,000), respectively, while total comprehensive
income for the nine months ended September 30, 2006 and 2005 was $1,672,000 and
$1,150,000. The difference between the Corporation's net income and total
comprehensive income for these periods relates to the change in net unrealized
gains and losses on investment securities available for sale during the
applicable period of time.
5. Reclassifications
Certain reclassifications have been made to the 2005 consolidated financial
statements in order to conform with the 2006 presentation.
6. Recent Accounting Pronouncements
In May 2005, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standard ("SFAS") No. 154, "Accounting Changes and Error
Corrections: a replacement of APB Opinion No. 20 and FASB Statement 3",
requiring a corporation to apply voluntary changes in accounting principles
retrospectively wherever it is practicable. The retrospective application
requirement replaces the requirement in APB 20 to recognize most voluntary
changes in accounting principles by including the cumulative effect of the
change in net income during the period the change occurred. Retrospective
application will be the required transition period for new accounting
pronouncements in the event that a newly-issued pronouncement does not specify
transition guide. SFAS No. 154 is effective for accounting periods starting in
the fiscal year beginning after December 15, 2005. The adoption of FSP FAS 115-1
did not have a significant impact on the Corporation's financial condition or
results of operations.
In November 2005, the FASB issued FASB Staff Position FAS 115-1 and FAS 124-1.
"The Meaning of Other-Than-Temporary Impairment and its Application to Certain
Investments" ("FSP FAS 115-1"). FSP FAS 115-1 addresses the determination as to
whether an investment is considered impaired, whether the impairment is other
than temporary, and the measurement of an impairment loss. FSP FAS 115-1
requires that (1) for each individual impaired security, a company asset its
ability and intent to hold to recovery and to designate an expected recovery
period in order to avoid recognizing an impairment charge through earnings; (2)
a company need not make such an assertion for minor impairments caused by
changes in interest rate and sector spreads; (3) the company must recognize an
impairment charged on securities impaired as a result of interest rate and/or
sector spreads immediately upon changing their assertion to an intent to sell
such security; and (4) defines when a change in a company's assertion for one
security would not call into question assertions conducted in reporting periods
beginning after December 15, 2005. The adoption of FAP FAS 115-1 did not have a
significant impact on the Corporation's financial condition or results of
operations.
In February 2006, the FASB issued SFAS No. 155 "Accounting for Certain Hybrid
Financial Instruments", amending SFAS No. 133 and 140, requiring the separate
valuation of embedded derivatives from the
7
host contracts where cash flows of a security are disproportionately distributed
to different classes of investors. SFAS No. 155 is effective as of the beginning
of the first fiscal year beginning after September 15, 2006. The Corporation is
currently evaluating the impact of the Statement on its financial statements.
In July 2006, the FASB issued Interpretation No. 48 "Accounting for Income Tax
Uncertainties". FASB Statement No. 109 and defines the threshold for recognizing
the benefits of tax return positions in the financial statements as "more likely
than not" to be sustained by the taxing authorities. Interpretation No. 48 is
effective as of the beginning of the first fiscal year beginning after December
15, 2006. The Corporation is currently evaluating the impact of the
Interpretation on its financial statements.
In September 2006, the Securities and Exchange Commission (SEC) issued Staff
Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements
when Quantifying Misstatements in Current Year Financial Statements ("SAB 108"),
to address diversity in practice in quantifying financial statement
misstatements. SAB 108 requires that the Corporation quantify misstatements
based on their impact on each of its financial statements and related
disclosures. SAB 108 is effective as of the end of the Corporation's 2006 fiscal
year, allowing a one-time transitional cumulative effect adjustment to retained
earnings as of January 1, 2006 for errors that were not previously deemed
material, but are material under the guidance in SAB 108. The Corporation is
currently evaluating the impact of adopting SAB 108 on its financial statements.
Item 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The purpose of this analysis is to provide information relevant to understanding
and assessing the Corporation's results of operations for the first nine months
and third quarter of the current and previous years and financial condition at
the end of the current quarter and previous year-end.
CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS
This management's discussion and analysis contains forward-looking statements
within the meaning of the Private Securities Litigation Reform Act of 1995. Such
statements are not historical facts and include expressions about management's
expectations about new and existing programs and products, relationships,
opportunities, and market conditions. Such forward-looking statements involve
certain risks and uncertainties. These include, but are not limited to,
unanticipated changes in the direction of interest rates, effective income tax
rates, loan prepayment assumptions, deposit growth, the direction of the economy
in New Jersey and New York, continued levels of loan quality, continued
relationships with major customers as well as the effects of general economic
conditions and legal and regulatory issues and changes in tax regulations.
Actual results may differ materially from such forward-looking statements. The
Corporation assumes no obligation for updating any such forward-looking
statements at any time.
EXECUTIVE SUMMARY
The primary source of the Corporation's income comes from net interest income,
which represents the excess of interest earned on interest earning assets over
the interest paid on interest-bearing liabilities. This income is subject to
interest rate risk resulting from changes in interest rates. The most
significant component of the Corporation's interest earning assets is its loan
portfolio. In addition to the aforementioned interest rate risk, the portfolio
is subject to credit risk.
During 2005, the Federal Reserve Bank raised the target federal funds interest
rate from 2.25% to 4.25% and has continued to raise the rate during the first
three quarters of 2006 to 5.25%. Concurrently, the spread between the
three-month U.S. Treasury bill rate and the 10-year U.S. Treasury bond rate has
narrowed from 32 basis points at the end of 2005 to 24 basis points at the end
of September 2006. These rate increases have caused the yield curve to remain
flat during the first nine months of 2006 and has led to continued interest rate
compression throughout the banking industry, leading to generally lower interest
rate margins. As a result, the Corporation's net interest margin declined from
3.40% in the first nine months of 2005 to 3.24% in the first nine months of
2006, generating an increase in net interest
8
income of less than 2%. This, along with lower sources of non-interest income
and higher levels of non-interest expense, resulted in a 7.8% decline in net
income in the first nine months of 2006, from $1,948,000 to $1,797,000.
RESULTS OF OPERATIONS
Net income rose to $597,000 for the third quarter of 2006 from $551,000 for the
same 2005 quarter. Related earnings per share on a diluted basis declined to
$3.11 from $3.92. Higher net interest income was the reason for the improvement
in earnings. Net income declined 7.8% to $1,797,000 for the first three quarters
of 2006 from $1,948,000 for the similar 2005 period. The reduction occurred
primarily due to a $217,000 recovery of a credit card fraud loss recorded in the
second quarter of 2005 that did not recur in 2006 along with a $119,000 loss
incurred by an unconsolidated subsidiary compared to income of $10,000 recorded
in the similar 2005 period. Related earnings per share on a diluted basis
decreased to $8.91 from $13.59. Higher net interest income was the primary
reason for the earnings improvement. The lower earnings per share in both
periods were due to the additional dilution resulting from preferred stock
issuances that have occurred during the past year. The Corporation expects to
experience continued earnings per share dilution until the newly raised capital
can be leveraged.
The first three quarters of 2006 and 2005 each include the accretion of deferred
income into interest income as an earnings enhancement totalling $32,000 and
$62,000, respectively. This income was received from the U.S. Treasury Community
Development Financial Institution ("CDFI") Fund for purchasing long-term
certificates of deposits from banks in low-income areas at below market rates
and extending credit at below-market rates to consumers in low-income areas.
FINANCIAL CONDITION
At September 30, 2006, total assets rose to $370.1 million from $363.5 million
at the end of 2005, while total deposits increased to $317.8 million from $312.4
million, comprising most of this asset growth. Average assets also rose during
the first nine months of 2006, increasing $30.3 million, or 8.8% to $375.5
million from $345.2 million a year earlier. This increase was due primarily to
higher loan balances, funded by increased deposit and capital levels.
Federal funds sold
Federal funds sold totalled $6.3 million at September 30, 2006 compared to $15.2
million at the end of 2005, while the related average balance declined to $19.8
million for the first nine months of 2006 from $21.1 million for the first nine
months of 2005. Both decreases resulted from a reduction in short-term municipal
deposit balances that were temporarily invested in Federal funds sold.
Interest bearing deposits with banks
Interest bearing deposits declined to $671,000 at September 30, 2006 compared to
$1.3 million at the end of 2005, while average interest bearing deposits with
banks rose to $1.1 million for the first nine months of 2006 from $843,000 in
the first nine months of 2005. Both changes were due to the Bank's participation
in acquiring certificates of deposit issued under the U.S. Treasury CDFI Fund
Bank Enterprise Award Program, which is being phased out.
Investments
The investment securities available for sale ("AFS") portfolio declined to
$101.2 million at September 30, 2006 from $109.7 million at the end of 2005,
while the net related unrealized loss, net of tax, increased to $1.1 million
from $973,000 at the end of 2005. The decline in the portfolio resulted from the
reinvestment of maturity and payment proceeds into the held to maturity
tax-exempt investment portfolio. The unrealized loss rose due to the increase in
interest rates, although the loss has declined by almost 50% since the end of
the second quarter due to the Federal Reserve Bank's decision to leave the
Federal funds target rate unchanged. Investments held to maturity ("HTM")
increased to $45 million at September 30, 2006 from $39.4 million at the end of
2005. The increase occurred due to the purchase of medium
9
term tax-exempt securities, which have held favorable yield advantages to
taxable investments during the first nine months of 2006.
Most of the decrease in the AFS portfolio consisted of mortgage-backed
securities ("MBS") payments, as the Corporation continued to mitigate its
interest rate risk by not reinvesting the proceeds into the MBS portfolio. At
September 30, 2006, the Corporation held mortgage-backed securities with a
carrying value totalling $67.4 million, representing 45.5% of the total
investment portfolio compared to $77.7 million, representing 52.1% at the end of
2005. These investments carry a significant degree of interest rate risk due to
the uncertainty of the underlying prepayment assumptions.
Loans
Loans rose to $195.5 million at September 30, 2006 from $179.1 million at
December 31, 2005, while average loans increased 14% to $186.2 million for the
first nine months of 2006 from $163.3 million in the first nine months of 2005.
Most of the increase occurred in the commercial real estate portfolio, which
comprises most of the Corporation's loan portfolio. The Corporation originates
nominal consumer or residential mortgage loans to hold in the portfolio. The
Corporation expects this trend to continue.
Provision and allowance for loan losses
Changes in the allowance for loan losses are set forth below.
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ -----------------
(Dollars in thousands) 2006 2005 2006 2005
------ ------ ------ ------
Balance at beginning of period $2,200 $2,151 $2,165 $2,076
Provision for loan losses 65 15 114 92
Recoveries of previous charge-offs 11 17 56 28
------ ------ ------ ------
2,276 2,183 2,335 2,196
Less: Charge-offs 1 7 60 20
------ ------ ------ ------
Balance at end of period $2,275 $2,176 $2,275 $2,176
====== ====== ====== ======
The allowance for loan losses is a critical accounting policy and is maintained
at a level determined by management to be adequate to provide for inherent
losses in the loan portfolio. The reserve is increased by provisions charged to
operations and recoveries of loan charge-offs. The reserve is based on
management's evaluation of the loan portfolio and several other factors,
including past loan loss experience, general business and economic conditions,
concentrations of credit and the possibility that there may be inherent losses
in the portfolio which cannot currently be identified. Although management uses
the best information available, the level of the allowance for loan losses
remains an estimate which is subject to significant judgment and short-term
change.
September 30, December 31, September 30,
2006 2005 2005
------------- ------------ -------------
Allowance for loan
losses as a percentage of:
Total loans 1.16% 1.21% 1.26%
Total nonperforming loans 39.10% 107.39% 86.97%
Total nonperforming assets
(nonperforming loans and OREO) 39.10% 107.39% 86.97%
Net charge-offs as a percentage
of average loans (year-to-date) --% .02% --%
10
Nonperforming loans
Nonperforming loans include loans on which the accrual of interest has been
discontinued or loans which are contractually past due 90 days or more as to
interest or principal payments on which interest income is still being accrued.
After principal payments are current, delinquent interest payments are credited
to income when received. The following table presents the principal amounts of
nonperforming loans.
September 30, December 31, September 30,
(Dollars in thousands) 2006 2005 2005
------------- ------------ -------------
Nonaccrual loans
Commercial $ 794 $ 742 $ 885
Installment 43 85 92
Real estate 3,574 1,020 1,222
------ ------ ------
Total 4,411 1,847 2,199
------ ------ ------
Loans past due 90 days
or more and still accruing
Commercial -- -- --
Installment 41 7 8
Real estate 1,366 162 295
------ ------ ------
Total 1,407 169 303
------ ------ ------
Total nonperforming loans $5,818 $2,016 $2,502
====== ====== ======
Nonperforming loans rose to $5.8 million at September 30, 2006 from $2 million
at December 31, 2005 due primarily to an increase in commercial real estate
nonperforming loans. No single nonperforming loan exceeded $1 million. Because
management considers collateral values and guarantees adequate, there were no
impairment charges on nonaccrual loans recorded for the nine months ending
September 30, 2006 or September 30, 2005.
Deposits
The Bank's deposit levels may change significantly on a daily basis because
deposit accounts maintained by municipalities represent a significant part of
the Bank's deposits and are more volatile than commercial or retail deposits.
These municipal accounts represent a substantial part of the Bank's deposits,
and tend to have high balances and comprised most of the Bank's accounts with
balances of $100,000 or more at September 30, 2006 and December 31, 2005. These
accounts are used for operating and short-term investment purposes by the
municipalities. All the foregoing deposits require collateralization with
readily marketable U.S. Government securities.
While the collateral maintenance requirements associated with the Bank's
municipal and U.S. Government account relationships might limit the ability to
readily dispose of investment securities used as such collateral, management
does not foresee any need for such disposal, and in the event of the withdrawal
of any of these deposits, these securities are readily marketable.
Total deposits rose $5.4 million to $317.8 million at September 30, 2006 from
$312.4 million at the end of 2005, while average deposits rose 8.4%, to $321.6
million for the first nine months of 2006 from $296.8
11
million for the first nine months of 2005. The increases occurred due to higher
short-term municipal deposit balances.
Total demand deposits rose to $35.2 million at September 30, 2006 from $31.5
million at the end of 2005, while average demand deposits for the first nine
months of 2006 increased to $39 million from $35.8 million for the first nine
months of 2005. The growth in demand deposits resulted from higher municipal
deposit account balances.
Money market deposit accounts totalled $97.4 million at September 30, 2006
compared to $94.1 million at the end of 2005 and averaged $88.9 million for the
first nine months of 2006 compared to $72.9 million in the same period of 2005,
an increase of 22%. The increase in both balances resulted from higher municipal
deposit account balances.
Super NOW accounts totalled $30 million at September 30, 2006 compared to $28.4
million at the end of 2005, and averaged $34.8 million for the first nine months
of 2006 compared to $33.3 million in the first three quarters of 2005.
Passbook and statement savings accounts totalled $31.4 million at September 30,
2006, compared to $32.7 million at December 31, 2005 and averaged $32.5 million
for the first nine months of 2006, down slightly from $34.7 million for the same
period in 2005.
Time deposits declined to $123.8 million at September 30, 2006 from $125.7
million at December 31, 2005, while average time deposits rose to $126.4 million
for the first three quarters of 2006 from $120.1 million for the similar 2005
period. The increase in average time deposits was due to the increased municipal
deposits.
Short-term borrowings
There were no short-term borrowings at the end of the third quarter of 2006
compared to $540,000 at December 31, 2005, while the related average balances
were $2.8 million for the first nine months of 2006 compared to $3.1 million for
the first nine months of 2005. The decreases resulted primarily from lower
levels of federal funds purchased.
Long-term debt
Long-term debt was relatively unchanged at September 30, 2006 from December 31,
2005, while the related average balance was $20.6 million for the first nine
months of 2006 compared to $22.6 million for the same period in 2005, due to
repayments of Federal Home Loan Bank advances.
Capital
Risk-based capital ratios are expressed as a percentage of risk-adjusted assets,
and relate capital to the risk factors of a bank's asset base, including
off-balance sheet risk exposures. Various weights are assigned to different
asset categories as well as off-balance sheet exposures depending on the risk
associated with each. In general, less capital is required for less risk.
Capital levels are managed through asset size and composition, issuance of debt
and equity instruments, treasury stock activities, dividend policies and
retention of earnings.
During the first nine months of 2006, the Corporation issued $250,000 of
noncumulative convertible preferred stock in a private offering. The Corporation
also issued $8.2 million of preferred stock during 2005. Proceeds from both
transactions have been retained at the holding company until they are needed by
the subsidiary bank for deposit growth or other purposes.
At September 30, 2006, the Corporation's leverage, core capital (Tier 1) and
total (Tier 1 plus Tier 2) risked-based capital ratios were 9.05%, 14.29% and
15.50%, respectively, while the Bank's ratios were 6.03%, 9.53% and 10.56%,
respectively.
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The Corporation adopted FIN 46R as of December 31, 2003 and elected to
retroactively restate all periods presented. FIN 46R required the Corporation to
deconsolidate its investment in the subsidiary trust formed in connection with
the issuance of trust preferred securities. The deconsolidation of the
subsidiary trusts results in the Corporation reporting on its balance sheet the
subordinated debentures that have been issued from City National Bancshares to
the subsidiary trusts. The adoption of FIN 46R did not have a significant effect
on the Corporation's consolidated financial statements. In July 2003, the Board
of Governors of the Federal Reserve System instructed bank holding companies to
continue to include the trust preferred securities in their Tier 1 capital for
regulatory capital purposes until notice is given to the contrary. There can be
no assurance that the Federal Reserve will continue to allow institutions to
include trust preferred securities in Tier 1 capital for regulatory capital
purposes. As of September 30, 2006, assuming the Corporation was not allowed to
include the $7.0 million in trust preferred securities issued by the subsidiary
trusts in Tier 1 capital, the Corporation would remain "well capitalized."
Capital levels are managed through asset size and composition, issuance of debt
and equity instruments, treasury stock activities, dividend policies and
retention of earnings.
RESULTS OF OPERATIONS
Net interest income
In the third quarter of 2006, net interest income on a fully tax equivalent
("FTE") basis rose 10.7% to $2,950,000 from $2,665,000 for the same 2005 period,
while the net interest margin declined to 3.28% from 3.36%. The lower margin
resulted from the flat yield curve.
On a fully taxable equivalent ("FTE") basis, net interest income rose $328,000,
or 3.9% to $8,683,000 for the first nine months of 2006 from $8,355,000 for the
same period in 2005, while the related net interest margin declined 16 basis
points, to 3.24% from 3.40%. Higher levels of earning assets, which averaged
$358.2 million for the first nine months of 2006 compared to $327.3 million for
the same period in 2005, was the primary contributor to the higher net interest
income. The increased assets were funded by higher municipal deposit balances.
Interest margin compression, resulting from a flat yield curve, where short-term
rates have risen faster than long-term rates, contributed to the lower margin
and limited the increase in net interest income for September 30. 2005.
Interest income on a FTE basis increased $2 million, or 14.9% for the first nine
months of 2006 due to both higher rates and the aforementioned increase in
earning assets. The yield on interest earning assets rose 66 basis points, from
5.45% to 6.11%. The increase in earning assets occurred primarily in the
commercial real estate loan portfolio.
Interest income from Federal funds sold rose 57.8% for the first nine months of
2006 due to a higher average rate. The federal funds target rate has been raised
100 basis points by the Federal Reserve Bank since the end of 2005 to 5.25%. The
related yield increased from 2.78% to 4.66%.
Interest income on taxable investment securities rose $174,000 for the first
nine months of 2006 due to a higher average rate. The taxable investment
portfolio averaged $122.7 million in 2006 compared to $126.9 million in 2005.
Tax-exempt income on a FTE basis was 70.7% higher due to increased volume as the
tax-exempt portfolio averaged $28.4 million in 2006 compared to $15.2 million in
2005.
Interest income on loans rose 27% for the first nine months of 2006 due to
higher loan volume and a higher average rate. Total loans averaged $186.2
million for the first nine months of 2006 compared to $163.3 million a year
earlier, an increase of 14%. The most significant increase occurred in the
commercial real estate portfolio.
Interest expense rose 52.7% in the first nine months of 2006, as the average
rate paid on interest bearing liabilities rose by 101 basis points, from 2.35%
to 3.36%. Additionally, the cost to fund interest earning
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assets rose from 2.06% to 2.87%. Most of this increase was due to the higher
average balances of interest-bearing money market deposit accounts along with
higher rates paid on non-deposit interest-bearing liabilities. Interest expense
on money market accounts increased to $2.6 million for the first nine months of
2006 from $1.4 million for the first nine months of 2005 due to both higher
volume and an increase in the average rate paid from 2.49% to 3.92%. Interest
expense on Super NOW deposits increased by 247.7% for the first nine months of
2006 compared to a year earlier due primarily to a higher average rate paid in
2006. Interest expense on time deposits rose 43.2% for the first nine months of
2006 compared to a year earlier also due primarily to the higher average rate
paid in 2006.
Provision for loan losses
The provision rose in the third quarter of 2006 to $65,000 from $15,000 for the
similar quarter in 2005, while the provision increased to $114,000 for the first
nine months of 2006 from $92,000 in the comparable 2005 period. The increases
occurred due to higher levels of nonperforming loans.
Other operating income
Other operating income, including the results of investment securities
transactions, decreased by 4.1% to $567,000 in the third quarter of 2006
compared to $591,000 for the similar 2005 period, while such income decreased by
3.4% to $1,715,000 for the nine months of 2006 compared to $1,776,000 in the
year-earlier period. Both decreases occurred due to losses incurred by an
unconsolidated leasing company in which the Bank owns a minority interest,
compared to gains recorded in 2005.
Other operating expenses
Other operating expenses rose nominally in the third quarter of 2006 to
$2,518,000 from $2,479,000 in the third quarter of 2005, with higher employee
benefit expense offset by lower branch opening expenses. Other operating
expenses for the first nine months of 2006 rose 6.4% to $7,502,000 from
$7,050,000 a year earlier primarily due to increased salary and employee benefit
expense, offset in part by lower supplies expense and grand opening expenses and
a second quarter 2005 $217,000 insurance recovery of a credit card fraud loss,
that did not recur in 2006.
Income tax expense
Income tax expense as a percentage of pretax income was 22.5% in the third
quarter of 2006 compared to 26.3% in the third quarter of 2005. For the first
nine months of 2006 the percentage was 23.1% compared to 28.9% a year earlier.
Both reductions reflect higher levels of tax-exempt investment income resulting
from purchases of tax-exempt investment securities and bank-owned life
insurance.
LIQUIDITY
The liquidity position of the Corporation is dependent on the successful
management of its assets and liabilities so as to meet the needs of both deposit
and credit customers. Liquidity needs arise primarily to accommodate possible
deposit outflows and to meet borrowers' requests for loans. Such needs can be
satisfied by investment and loan maturities and payments, along with the ability
to raise short-term funds from external sources.
It is the responsibility of the Asset/Liability Management Committee ("ALCO") to
monitor and oversee all activities relating to liquidity management and the
protection of net interest income from fluctuations in interest rates.
The Bank depends primarily on deposits as a source of funds and also provides
for a portion of its funding needs through short-term borrowings, such as
Federal Funds purchased, securities sold under repurchase agreements and
borrowings under the U.S. Treasury tax and loan note option program. The
14
Bank also utilizes the Federal Home Loan Bank for longer-term funding purposes.
Finally, the holding company utilizes the capital markets when necessary, having
raised $8.2 million through the issuance of preferred stock during the first
three quarters of 2005.
The major contribution during the first nine months of 2006 from operating
activities to the Corporation's liquidity came from proceeds from the sale of
loans, while the highest use of cash was for the origination of loans to be sold
in the secondary market.
Net cash used in investing activities was primarily for purchases of investment
securities available for sale, while sources of cash provided by investing
activities were derived primarily from proceeds from maturities, principal
payments and early redemptions of investment securities available for sale.
The major contribution during the first nine months of 2006 from financing
activities was from an increase in deposits, while there were no significant
uses of funds.
Item 3
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Due to the nature of the Corporation's business, market risk consists primarily
of its exposure to interest rate risk. Interest rate risk is the impact that
changes in interest rates have on earnings. The principal objective in managing
interest rate risk is to maximize net interest income within the acceptable
levels of risk that have been established by policy. There are various
strategies which may be used to reduce interest rate risk, including the
administration of liability costs, the reinvestment of asset maturities and the
use of off-balance sheet financial instruments. The Corporation does not
presently utilize derivative financial instruments to manage interest rate risk.
Interest rate risk is monitored through the use of simulation modeling
techniques, which apply alternative interest rate scenarios to periodic
forecasts of changes in interest rates, projecting the related impact on net
interest income. The use of simulation modeling assists management in its
continuing efforts to achieve earnings growth in varying interest rate
environments.
Key assumptions in the model include anticipated prepayments on mortgage-related
instruments, contractual cash flows and maturities of all financial instruments,
deposit sensitivity and changes in interest rates.
These assumptions are inherently uncertain, and as a result, these models cannot
precisely estimate the effect that higher or lower rate environments will have
on net interest income. Actual results may differ from simulated projections due
to the timing, magnitude or frequency of interest rate changes, as well as
changes in management's strategies.
Based on the results of the most recent interest simulation model, the
Corporation is interest rate sensitive in a rates-up environment. If interest
rates rose 200 basis points from current rates in an immediate and parallel
shock, net interest income would decrease 9.9%; if rates decreased 200 basis
points, net interest income would rise by 10.1%. Accordingly, the Corporation is
more liability- sensitive since the interest rate risk is greater in a rising
rate environment.
ITEM 4. CONTROLS AND PROCEDURES
The Corporation's Chief Executive Officer and Chief Financial Officer, with the
assistance of other members of the Corporation's management, have evaluated the
effectiveness of the Corporation's disclosure controls and procedures as of the
end of the period covered by this Quarterly Report on Form 10-Q. Based on such
evaluation, the Corporation's Chief Executive Officer and Chief Financial
Officer have concluded that the Corporation's disclosure controls and procedures
are effective.
15
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In the normal course of business, the Corporation or its subsidiaries may, from
time to time, be party to various legal proceedings relating to the conduct of
its business. In the opinion of management, the consolidated financial
statements will not be materially affected by the outcome of any pending legal
proceedings.
ITEM 1A. RISK FACTORS
For a summary of risk factors relevant to the corporation and its subsidiary's
operations, please refer to Par I, Item 1a in the Corporation's December 31,
2005 Annual Report to Stockholders. There have been no material changes in the
risk factors since December 31, 2005.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
(3)(a) The Corporation's Restated Articles of Incorporation (incorporated here
in by reference to Exhibit (3)(d) of the Corporation's Current Report on Form
8-K dated July 28, 1992).
(3)(b) Amendments to the Corporation's Articles of Incorporation establishing
the Corporation's Non-cumulative Perpetual Preferred Stock, Series A
(incorporated herein by reference to Exhibit (3)(b) of the Corporation's Annual
Report on Form 10-K for the year ended December 31, 1995).
(3)(c) Amendments to the Corporation's Articles of Incorporation establishing
the Corporation's Non-cumulative Perpetual Preferred Stock, Series B
(incorporated herein by reference to Exhibit (3)(c) of the Corporation's Annual
Report on Form 10-K for the year ended December 31, 1995).
(3)(d) Amendments to the Corporation's Articles of Incorporation establishing
the Corporation's Non-cumulative Perpetual Preferred Stock, Series C
(incorporated herein by reference to Exhibit (3)(i) to the Corporation's Annual
Report on Form 10-K for the year ended December 31, 1996).
(3)(e) Amendments to the Corporation's Articles of Incorporation establishing
the Corporation's Non-cumulative Perpetual Preferred Stock, Series D
(incorporated herein by reference to Exhibit filed with the Corporation's
current report on Form 10-K dated July 10, 1997).
(3)(f) Amendments to the Corporation's Articles of Incorporation establishing
the Corporation's Non-cumulative Perpetual Preferred Stock, Series E
(incorporated herein by reference to Exhibit filed with the Corporation's
current report on Form 8-K filed on March 4, 2005).
(3)(g) Amendment to the Corporation's Articles of Incorporation establishing he
Corporation's MultiMode Series F Non-cumulative Redeemable Preferred Stock
(incorporated herein by reference to Exhibit (3)(f) of the Corporation's
Quarterly Report on Form 10-Q for the quarter ended September 30, 2005).
(3)(h) Amendment to the By-Laws of the Corporation (incorporated herein by
reference to Exhibit (3)(c) of the Corporation's Annual Report on Form 10-K for
the year ended December 31, 1991).
(3)(i) By-Laws of the Corporation (incorporated herein by reference to
Exhibit (3)(c) of the Corporation's Annual Report on Form 10-K for the year
ended December 31, 1988).
(4)(a) The Debenture Agreements between the Corporation and its Noteholders
(incorporated herein by reference to Exhibit (4)(a) of the Corporation's Annual
Report on Form 10-K for the year ended December 31, 1993).
(4)(b) Note Agreement dated December 28, 1995 by and between the Corporation and
the Prudential Foundation (incorporated herein by reference to Exhibit (4)(b) to
the Company's Annual Report on Form 10-K for the year ended December 31, 1995).
(4)(c) Indenture dated July 11, 2002 between the Corporation and Wilmington
Trust Company (incorporated herein by reference to Exhibit 4(c) to the Company's
Quarterly Report on Form 10-Q for the quarter ended June 30, 2002).
16
(10)(a) The Employee's Profit Sharing Plan of City National Bank of New Jersey
(incorporated herein by reference to Exhibit (10) of the Corporation's Annual
Report on Form 10-K for the year ended December 31, 1988).
(10)(b) The Employment Agreement among the Corporation, the Bank and Louis E.
Prezeau dated May 5, 2003 (incorporated herein by reference to Exhibit (10)(b)
to the Corporation's Quarterly Report on Form 10-K for the year ended December
31, 2003).
(10)(c) Lease and option Agreement dated May 6, 1995 by and between the RTC and
City National Bank of New Jersey (incorporated herein by reference to Exhibit
(10)(d) to the Corporation's Annual Report on Form 10-K for the year ended
December 31, 1995).
(10)(d) Amended and Restated Asset Purchase and Sale Agreement between the Bank
and Carver Federal Savings Bank dated as of February 27, 2001 (incorporated by
reference to Exhibit 10(d) to the Corporation's Annual Report on Form 10-K for
the year ended December 31, 2000).
(10)(e) Secured Promissory Note of the Corporation dated December 28, 2001
payable to National Community Investment Fund in the principal amount of
$1,000,000, (incorporated by reference to Exhibit 10(e) to the Corporation's
Annual Report on Form 10-K for the year ended December 31, 2001).
(10)(f) Loan Agreement dated December 28, 2001 by and between the Corporation
and National Community Investment Fund (incorporated by reference to Exhibit
10(f) to the Corporation's Annual Report on Form 10-K for the year ended
December 31, 2001).
(10)(g) Pledge Agreement dated December 28, 2001 by and between the Corporation
and National Community Investment Fund (incorporated by reference to Exhibit
10(g) to the Corporation's Annual Report on Form 10-K for the year ended
December 31, 2001).
(10)(h) Asset Purchase and Sale Agreement between the Bank and Carver Federal
Savings Bank dated as of January 26, 1998 (incorporated by reference to Exhibit
10(h) to the Corporation's Annual Report on Form 10-K for the year ended
December 31, 1998).
(10)(i) Promissory Note dated May 6, 2002 payable to United Negro College Fund,
Inc., in the principal amount of $200,000 (incorporated by reference to Exhibit
10(i) to the Corporation's Quarterly Report on Form 10-Q for quarter ended March
31, 2002).
(10)(j) Guarantee Agreement dated July 11, 2002 from the Corporation in favor of
Wilmington Trust Company, as trustee for holders of securities issued by City
National Bank of New Jersey Capital Trust I (incorporated by reference to
Exhibit 10(j) to the Company's Quarterly Report on Form 10-Q for the quarter
ended June 30, 2002).
(10)(k) Amended and Restated Declaration of Trust of City National Bank of New
Jersey Capital Trust I, dated July 11, 2002 (incorporated by reference to
Exhibit 10(k) to the Company's Quarterly Report on Form 10-Q for the quarter
ended June 30, 2002).
(10)(l) Purchase and Assumption Agreement dated as of March 31, 2004, by and
among Prudential Savings Bank, F.S.B., The Prudential Bank and Trust Company and
the Bank (incorporated by reference to Exhibit 10(l) to the Corporation's
Quarterly Report on Form 10-Q for the quarter ended March 31, 2004).
(10)(m) Guarantee Agreement dated March 17, 2004 from the Corporation in favor
of U.S. Bank, N.A., as trustee for holders of securities issued by City National
Bank of New Jersey Capital Statutory Trust II (incorporated by reference to
Exhibit 10(m) to the Corporation's Quarterly Report on Form 10-Q for the quarter
ended March 31, 2004).
17
(10)(n) Purchase Agreement dated September 27, 2005 by and between Sandler
O'Neil & Partners, L.P., and the Corporation with respect to issue and sale of
7,000 shares of the Corporation's MultiMode Series F Noncumulative Redeemable
Preferred Stock (incorporated by reference to Exhibit 10(n) to the Corporation's
Quarterly Report on Form 10-Q for the quarter ended September 30, 2005).
(11) Statement regarding computation of per share earnings. The required
information is included on page 6.
(31) Certifications of Principal Executive Officer and Principal Financial
Officer (Section 302 of the Sarbanes-Oxley Act of 2002).
(32) Certifications of Principal Executive Officer and Principal Financial
Officer under 18 U.S.C. Section 1350 (Section 906 of the Sarbanes-Oxley Act of
2002)
(c) Reports on Form 8-K.
No reports on Form 8-K were filed during the quarter ended September 30,
2006.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
CITY NATIONAL BANCSHARES CORPORATION
(Registrant)
November 8, 2006 /s/ Edward R. Wright
----------------------------------------
Edward R. Wright
Senior Vice President and Chief
Financial Officer (Principal Financial
and Accounting Officer)
18