SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
X Quarterly Report Pursuant to Section 13 or 15(d) of the
-
Securities and Exchange Act of 1934
For the quarterly period ended September 30, 2001, or
_ Transition Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the Transition Period from ________ to _________
Commission File No. 0-17000
COMMERCIAL NATIONAL FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
Michigan 38-2799780
(State of Incorporation) (IRS Employer Identification No.)
101 North Pine River Street, Ithaca, Michigan 48847
(address of principal executive offices) (ZIP Code)
Registrant's telephone number, including area code: (989) 875-4144
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES _____X______ NO ______________
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding at October 30, 2001
----- -------------------------------
Common Stock 3,383,509
No Par Value
- --------------------------------------------------------------------------------
COMMERCIAL NATIONAL FINANCIAL CORPORATION
INDEX
PART I FINANCIAL INFORMATION
- ------ ---------------------
Item 1. Financial Statements
Consolidated Balance Sheets as of September 30, 2001 (unaudited) and December 31, 2000 (Page 3)
Consolidated Statements of Income and Other Comprehensive Income (unaudited) for the (Page 4)
three and nine months ended September 30, 2001 and September 30, 2000
Consolidated Statements of Changes in Shareholders' Equity (unaudited) for the nine (Page 5)
months ended September 30, 2001 and September 30, 2000
Consolidated Statements of Cash Flows (unaudited) for the nine months ended September (Page 6)
30, 2001 and September 30, 2000
Notes to Consolidated Financial Statements (unaudited) (Page 7-10)
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (Page 11-15)
Item 3. Quantitative and Qualitative Disclosures about Market Risk (Page 16)
PART II OTHER INFORMATION
- ------- -----------------
Item 6. Exhibits and Reports on Form 8-K
b) Reports on Form 8-K (Page 17)
SIGNATURES (Page 18)
2
COMMERCIAL NATIONAL FINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS
September 30, December 31,
2001 2000
---- ----
(Unaudited)
ASSETS
Cash and due from banks $ 6,290,137 $ 7,112,021
Federal funds sold 10,075,000 350,000
------------- -------------
Total cash and cash equivalents 16,365,137 7,462,021
Securities available for sale 19,962,705 19,406,526
Securities held to maturity (fair value $7,903,303
September 30, 2001; $8,724,848 - December 31, 2000) 7,599,229 8,525,623
Federal Home Loan Bank stock, at cost 1,391,300 1,391,300
Gross loans receivable 172,092,329 176,833,244
Allowance for loan losses (2,865,922) (2,545,363)
------------- -------------
Net loans receivable 169,226,407 174,287,881
Premises and equipment, net 2,236,180 2,465,176
Accrued interest receivable and other assets 5,210,741 2,347,162
------------- -------------
Total assets $ 221,991,699 $ 215,885,689
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Deposits
Noninterest-bearing demand $ 19,725,874 $ 19,786,361
Interest-bearing demand 28,206,452 26,264,930
Savings 47,707,320 39,439,255
Time 68,022,188 72,303,355
------------- -------------
Total deposits 163,661,834 157,793,901
Securities sold under agreements to repurchase 9,487,067 8,023,767
Other short-term borrowings 1,508,757 1,770,195
Federal Home Loan Bank advances 24,092,551 26,500,000
Accrued expenses and other liabilities 1,548,478 1,687,744
------------- -------------
Total liabilities 200,298,687 195,775,607
Shareholders' equity
Common stock and paid-in-capital, no par value: 5,000,000 shares
authorized; shares issued and outstanding
September 30, 2001 - 3,367,361 and December 31,
2000 - 3,327,225 22,010,135 21,617,080
Accumulated deficit (783,416) (1,714,089)
Accumulated other comprehensive income, net of tax 466,293 207,091
------------- -------------
Total shareholders' equity 21,693,012 20,110,082
------------- -------------
Total liabilities and shareholders' equity $ 221,991,699 $ 215,885,689
============= =============
See accompanying notes
3
COMMERCIAL NATIONAL FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME AND OTHER COMPREHENSIVE INCOME (Unaudited)
For Three Months For Nine Months
Ended September 30, Ended September 30,
2001 2000 2001 2000
---- ---- ---- ----
Interest and dividend income
Loans, including fees $ 3,514,301 $ 3,760,498 $ 10,967,337 $ 10,576,943
Taxable securities 227,060 237,506 662,688 701,437
Nontaxable securities 135,531 146,952 411,761 436,897
Federal funds sold 62,202 7,489 173,679 81,452
Federal Home Loan Bank stock dividends 25,424 29,727 79,752 85,075
Interest on other deposits 8,892 14,109 21,079 32,904
------------ ------------ ------------ ------------
Total interest and dividend income 3,973,410 4,196,281 12,316,296 11,914,708
Interest expense
Deposits 1,296,603 1,477,359 4,224,618 4,046,611
Securities sold under agreements to repurchase 82,600 114,989 268,813 276,334
Federal Home Loan Bank advances 349,656 335,417 1,078,991 863,432
Other 4,532 13,302 19,468 35,648
------------ ------------ ------------ ------------
Total interest expense 1,733,391 1,941,067 5,591,890 5,222,025
Net interest income 2,240,019 2,255,214 6,724,406 6,692,683
Provision for loan losses 90,000 90,000 270,000 270,000
------------ ------------ ------------ ------------
Net interest income after provision for loan losses 2,150,019 2,165,214 6,454,406 6,422,683
Noninterest income
Service charges and fees 116,476 114,176 339,128 329,615
Net gains on loan sales 93,471 23,626 282,774 55,047
Receivable financing fees 34,256 37,395 191,885 193,273
Security gains 53,032 -- 209,915 --
Other 84,390 72,584 193,090 199,436
------------ ------------ ------------ ------------
Total noninterest income 381,625 247,781 1,216,792 777,371
Noninterest expense
Salaries and employee benefits 797,316 736,936 2,391,130 2,191,102
Occupancy and equipment 258,482 250,887 750,675 748,454
FDIC insurance 7,602 7,716 22,470 22,764
Printing, postage and supplies 57,048 68,302 199,847 196,643
Professional and outside services 73,390 63,028 263,665 232,287
Other 257,559 256,144 715,807 735,606
------------ ------------ ------------ ------------
Total noninterest expense 1,451,397 1,383,013 4,343,594 4,126,856
------------ ------------ ------------ ------------
Income before income tax expense 1,080,247 1,029,982 3,327,604 3,073,198
Income tax expense 313,500 298,000 988,500 899,000
------------ ------------ ------------ ------------
Net income $ 766,747 $ 731,982 $ 2,339,104 $ 2,174,198
============ ============ ============ ============
Net change in unrealized gains/(losses) on securities available
for sale $ 223,596 $ 252,216 $ 602,645 $ 248,741
Reclassification adjustment for (gains) recognized in income (53,032) -- (209,915) --
Tax effects (57,992) (85,754) (133,528) (84,572)
------------ ------------ ------------ ------------
Total Other Comprehensive Income $ 879,319 $ 898,444 $ 2,598,306 $ 2,338,367
============ ============ ============ ============
Per share information
Basic earnings $ 0.23 $ 0.21 $ 0.70 $ 0.62
Diluted earnings $ 0.23 $ 0.21 $ 0.69 $ 0.62
Dividends declared $ 0.14 $ 0.12 $ 0.42 $ 0.38
See accompanying notes
4
COMMERCIAL NATIONAL FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
Nine Months ended September 30, 2001 and September 30, 2000 (Unaudited)
Accumulated
Shares Common Other
Issued Stock and Comprehensive Total
and Paid in Accumulated Income/(Loss), Shareholders'
Outstanding Capital Deficit Net of Tax Equity
- -----------------------------------------------------------------------------------------------------------------------------------
Balance at January 1, 2000 3,348,476 $19,946,643 $ (830,339) $(151,771) $18,964,533
Comprehensive income:
Net income 2,174,198 2,174,198
Net change in unrealized gains/(losses) on
securities available for sale 248,741 248,741
Tax effects (84,572) (84,572)
-----------
Total comprehensive income 2,338,367
Cash dividends declared, $.38 per share (1,339,299) (1,339,299)
Issued under dividend reinvestment program 34,190 437,970 437,970
Issued under stock option plan 4,100 41,099 41,099
Issued under employee benefit plan 4,775 63,126 63,126
Repurchase and retirement of shares (71,633) (943,052) (943,052)
---------- ----------- ----------- --------- -----------
Balance at September 30, 2000 3,319,908 $19,545,786 $ 4,560 $ 12,398 $19,562,744
========== =========== =========== ========= ===========
- -----------------------------------------------------------------------------------------------------------------------------------
Balance at January 1, 2001 3,327,225 $21,617,080 $(1,714,089) $ 207,091 $20,110,082
Comprehensive income:
Net income 2,339,104 2,339,104
Net change in unrealized gains/(losses) on
securities available for sale 602,645 602,645
Reclassification adjustment for (gains)
recognized in income (209,915) (209,915)
Tax effects (133,528) (133,528)
-----------
Total comprehensive income 2,598,306
Cash dividends declared, $.42 per share (1,408,431) (1,408,431)
Issued under dividend reinvestment program 49,311 483,135 483,135
Issued under stock option plan 429 3,227 3,227
Issued under employee benefit plan 2,399 22,887 22,887
Repurchase and retirement of shares (12,003) (116,194) (116,194)
---------- ----------- ----------- --------- -----------
Balance at September 30, 2001 3,367,361 $22,010,135 $ (783,416) $ 466,293 $21,693,012
========== =========== =========== ========= ===========
See accompanying notes
5
COMMERCIAL NATIONAL FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
For Nine Months Ended
September 30,
2001 2000
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 2,339,104 $ 2,174,198
Adjustments to reconcile net income to net
cash from operating activities
Provision for loan losses 270,000 270,000
Net gains on loan sales (282,774) (55,047)
Originations of loans held for sale (18,383,350) (2,394,473)
Proceeds from sales of loans held for sale 18,666,124 2,586,520
Gain on sales of securities available for sale (209,915) -
Depreciation, amortization and accretion 380,617 420,943
Net change in accrued interest receivable and other assets (38,684) (349,649)
Net change in accrued expenses and other liabilities (139,266) 211,171
------------ ------------
Net cash from operating activities 2,601,856 2,863,663
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of securities available for sale (9,216,118) (5,071,911)
Proceeds from maturities of securities available for sale 6,670,000 3,955,000
Proceeds from sales of securities available for sale 2,523,549 -
Proceeds from maturities of securities held to maturity 1,010,000 -
Net change in loans 4,829,900 (19,961,159)
Purchases of bank owned life insurance (3,000,000)
Purchases of premises and equipment, net (163,041) (221,199)
------------ ------------
Net cash from investing activities 2,654,290 (21,299,269)
CASH FLOW FROM FINANCING ACTIVITIES
Net change in deposits 5,867,933 10,318,745
Net change in securities sold under agreements to repurchase 1,463,300 2,700,218
Net change in U.S. Treasury demand notes (261,438) (1,453,809)
Federal Home Loan Bank advances 15,000,000 26,000,000
Proceeds from Repayment of Federal Home Loan Bank (17,407,449) (19,000,000)
Repurchase of common stock shares (116,194) (943,052)
Dividends paid (1,408,431) (1,339,299)
Proceeds from sale of common stock 509,249 542,195
------------ ------------
Net cash from financing activities 3,646,970 16,824,998
------------ ------------
Net change in cash and cash equivalents 8,903,116 (1,610,608)
Cash and cash equivalents, at beginning of year 7,462,021 8,669,093
------------ ------------
CASH AND CASH EQUIVALENTS, AT END OF PERIOD $ 16,365,137 $ 7,058,485
============ ============
Cash paid during the period for
Interest $ 5,746,710 $ 5,118,758
Federal income taxes 1,203,081 771,640
See accompanying notes
6
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
Note 1-Summary of Significant Accounting Policies
Basic Presentation
The accompanying unaudited condensed consolidated financial statements were
prepared in accordance with Rule 10-01 of regulation S-X and the instructions
for Form 10-Q and, therefore, do not include all disclosures required by
generally accepted accounting principles for complete presentation of financial
statements. In management's opinion, the condensed consolidated financial
statements contain all adjustments (consisting of normal recurring accruals)
necessary to present fairly the financial condition of Commercial National
Financial Corporation as of September 30, 2001 and December 31, 2000 and the
results of its operations for the three and nine months ending September 30,
2001 and September 30, 2000. The results for the three and nine months ended
September 30, 2001 are not necessarily indicative of the results expected for
the full year.
Principals of Consolidation
The accompanying consolidated financial statements include the accounts of
Commercial National Financial Corporation (CNFC), Commercial Bank (Bank) and
CNFC Financial Services, Inc. and CNFC Mortgage Corporation, both wholly owned
subsidiaries of the Bank. All material intercompany accounts and transactions
have been eliminated in consolidation.
Nature of Operations, Industry Segments and Concentrations of Credit Risk
CNFC is a one-bank holding company, which conducts limited business activities.
The Bank performs the majority of business activities.
The Bank provides a full range of banking services to individuals, agricultural
businesses, commercial businesses and light industries located in its service
area. It maintains a diversified loan portfolio, including loans to individuals
for home mortgages, automobiles and personal expenditures, and loans to business
enterprises for current operations and expansion. The Bank offers a variety of
deposit products, including checking, savings, money market, individual
retirement accounts and certificates of deposit. While CNFC's chief
decision-makers monitor the revenue stream of various products and services,
operations are managed and financial performance is evaluated on a
corporation-wide basis. Accordingly, management considers all of the CNFC's
banking operations to be aggregated into one operating segment.
The principal markets for the Bank's financial services are the Michigan
communities in which the Bank is located and the areas surrounding these
communities. The Bank serves these markets through seven offices located in
Gratiot and Montcalm Counties in Michigan.
Use of Estimates
To prepare financial statements in conformity with generally accepted accounting
principles, management makes estimates and assumptions based on available
information. These estimates and assumptions affect the amounts reported in the
financial statements and the disclosures provided. Future results could differ.
The allowance for loan losses and fair values of securities and other financial
instruments are particularly subject to change.
Cash Flow Reporting
Cash and cash equivalents include cash on hand, demand deposits with other
financial institutions and federal funds sold. Cash flows are reported net for
customer loan and deposit transactions, securities sold under agreements to
repurchase with original maturity of 90 days or less and U.S. Treasury demand
notes.
Securities
Securities are classified as held to maturity and carried at amortized cost when
management has the positive intent and ability to hold them to maturity.
Securities are classified as available for sale when they might be sold before
maturity. Securities available for sale are carried at fair value, with net
unrealized holding gains and losses reported separately in other comprehensive
income (loss), net of tax. Trading securities are bought principally for sale in
the near term, and are reported at fair value with unrealized gains and losses
included in earnings. Securities are written down to fair value when a decline
in fair value is not temporary. CNFC did not classify securities for trading at
any time during 2001 or 2000.
Gains and losses on sales are determined using the amortized cost of the
specific security sold. Interest and dividend income, adjusted by amortization
of purchase premiums and discounts, is included in earnings.
7
COMMERCIAL NATIONAL FINANCIAL CORPORATION
Loans Held for Sale
Loans held for sale are reported at the lower of cost or market value in the
aggregate. Net unrealized losses are recorded in a valuation allowance by
charges to income.
Loans
Loans that management has the intent and the ability to hold for the foreseeable
future or until maturity or payoff are reported at the principal balance
outstanding, net of unearned interest, deferred loan fees and costs, and an
allowance for loan losses. Interest income is reported on the interest method
and includes amortization of net deferred loan fees and costs over the loan
term.
Interest income is not reported when full loan repayment is in doubt, typically
when payments are past due over 90 days, unless the loan is both well secured
and in the process of collection. Payments received on such loans are reported
as principal reductions.
Allowance for Loan Losses
The allowance for loan losses is a valuation allowance for probable credit
losses, increased by the provision for loan losses and decreased by charge-offs
less recoveries. Estimating the risk of loss and the amount of loss on any loan
is subjective. Accordingly, management estimates the allowance balance required
based on past loan loss experience, known and inherent risks in the portfolio,
information about specific borrower situations and estimated collateral values,
economic conditions, and other factors. Allocations of the allowance may be made
for specific loans, but the entire allowance is available for any loan that
should be charged-off. A problem loan is charged-off by management as a loss
when deemed uncollectible, although collection efforts continue and future
recoveries may occur.
Loan impairment is reported when full payment under the loan terms is not
expected. Impairment is evaluated in total for smaller-balance loans of similar
nature such as residential mortgage and consumer loans and individually for
other loans. If a loan is impaired, a portion of the allowance is allocated so
that the loan is reported, net, at the present value of estimated future cash
flows using the loan's existing rate or at the fair value of collateral if
repayment is expected solely from the collateral. Loans are evaluated for
impairment when payments are delayed, typically 90 days or more, or when it is
probable that all principal and interest amounts will not be collected according
to the original terms of the loan.
Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation.
Depreciation is computed using a combination of straight-line and accelerated
methods with useful lives ranging from 10 to 40 years for buildings and
improvements, and 3 to 10 years for furniture and equipment. These assets are
reviewed for impairment when events indicate their carrying amount may not be
recoverable from future undiscounted cash flows. Maintenance, repairs and minor
alterations are charged to current operations as expenditures occur. Major
improvements are capitalized.
Servicing Rights
Servicing rights represent both purchased rights and the allocated value of
servicing rights retained on loans sold. Servicing rights are expensed in
proportion to, and over the period of, estimated net servicing revenues.
Impairment is evaluated based on the fair value of the rights, using groupings
of the underlying loans as to interest rates and then, secondarily, as to
geographic and prepayment characteristics. Any impairment of a grouping is
reported as a valuation allowance.
Excess servicing receivable is reported when a loan sale results in servicing in
excess of normal amounts and is expensed over the life of the servicing on the
interest method.
Other Real Estate Owned
Real estate properties acquired in collection of a loan receivable are recorded
at fair value at acquisition. Any reduction to fair value from the carrying
value of the related loan is accounted for as a loan loss. After acquisition, a
valuation allowance reduces the reported amount to the lower of the initial
amount or fair value less costs to sell. Expenses, gains and losses on
disposition, and changes in the valuation allowance are reported in other
expense.
Securities Sold Under Agreements to Repurchase
All of these liabilities represent amounts advanced by various customers and are
secured by securities owned, as they are not covered by general deposit
insurance.
8
COMMERCIAL NATIONAL FINANCIAL CORPORATION
Employee Benefits
A benefit plan with 401(k) features covers substantially all employees. The plan
allows participant compensation deferrals. The amount of any matching
contribution is based solely on the discretion of the board of directors.
Historically, CNFC has matched up to 6% of such deferrals at 100%.
Stock Compensation
Expense for employee compensation under stock option plans is reported only if
options are granted below market price at grant date.
Income Taxes
Income tax expense is the sum of the current year income tax due or refundable
and the change in deferred tax assets and liabilities. Deferred tax assets and
liabilities are the expected future tax consequences of temporary differences
between the carrying amounts and tax bases of assets and liabilities, computed
using enacted tax rates. A valuation allowance, if needed, reduces deferred tax
assets to the amount expected to be realized.
Earnings and Dividends Per Share
Basic earnings per common share is based on net income divided by the weighted
average number of common shares outstanding during the period. Diluted earnings
per common share shows the diluted effect of any additional potential common
shares. Earnings and dividends per common share are restated for all stock
splits and stock dividends.
Stock Dividends
Dividends issued in stock are reported by transferring the market value of the
stock issued from retained earnings to common stock, to the extent of available
retained earnings. Any excess of fair value over available retained earnings is
considered a return of capital and thus is transferred from paid in capital.
Fractional shares are paid in cash for all stock dividends.
Comprehensive Income
Comprehensive income consists of net income and other comprehensive income
(loss). Other comprehensive income (loss) includes the change in unrealized
appreciation and depreciation on securities available for sale, net of tax,
which is also recognized as a separate component of shareholders' equity.
Financial Instruments with Off-Balance-Sheet Risk
Financial instruments include off-balance sheet credit instruments, such as
commitments to make loans and standby letters of credit issued to meet customer
needs. The face amount for these items represents the exposure to loss before
considering customer collateral or ability to repay. Such financial instruments
are recorded when they are funded.
Fair Values of Financial Instruments
Fair values of financial instruments are estimated using relevant market
information and other assumptions. Fair value estimates involve uncertainties
and matters of significant judgment regarding interest rates, credit risk,
prepayments, and other factors, especially in the absence of broad markets for
particular items. Changes in assumptions or in market conditions could
significantly affect the estimates. The fair value estimates of existing on-and
off-balance-sheet financial instruments do not include the value of anticipated
future business or values of assets and liabilities not considered financial
instruments.
Reclassifications
Some items in the prior year financial statements have been reclassified to
conform with the current year presentation.
Recent Accounting Pronouncements
Beginning January 1, 2001, a new accounting standard requires all derivatives to
be recorded at fair value. Unless designated as hedges, changes in these fair
value are recorded in the income statement. Fair value changes involving hedges
are generally recorded by offsetting gains and losses on the hedge and on the
hedged item, even if the fair value of the hedged item is not otherwise
recorded.
The adoption of this standard on January 1, 2001 did not have a material effect
on CNFC's financial position or results of operations.
9
COMMERCIAL NATIONAL FINANCIAL CORPORATION
Note 2 - Earnings Per Share
A reconciliation of the numerators and denominators of the basic earnings per
share and diluted earnings per share computations for the periods ended is
presented below:
For three months ended For nine months ended
September 30, September 30, September 30, September 30,
2001 2000 2001 2000
- ---------------------------------------------------------------------------------------------------------------------------
BASIC EARNINGS PER SHARE:
Net income available to common shareholders $ 766,747 $ 731,982 $2,339,104 $2,174,198
===========================================================================================================================
Weighted-average common shares outstanding for
basic earnings per share 3,356,864 3,511,114 3,356,864 3,511,114
===========================================================================================================================
BASIC EARNINGS PER SHARE $ .23 $ .21 $ .70 $ .62
===========================================================================================================================
DILUTED EARNINGS PER SHARE:
Net income available to common shareholders $ 766,747 $ 731,982 $2,339,104 $2,174,198
===========================================================================================================================
Weighted-average common shares outstanding for basic
earnings per share 3,356,864 3,511,114 3,356,864 3,511,114
Add:
Dilutive effect of assumed exercise of stock options 8,937 19,072 8,937 19,072
- ---------------------------------------------------------------------------------------------------------------------------
Weighted-average common and dilutive additional potential
common shares outstanding 3,365,801 3,530,186 3,365,801 3,530,186
===========================================================================================================================
DILUTED EARNINGS PER SHARE $ .23 $ .21 $ .69 $ .62
===========================================================================================================================
10
COMMERCIAL NATIONAL FINANCIAL CORPORATION
ITEM 2: MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
FINANCIAL CONDITION
Summary
Total assets at September 30, 2001 increased to $221,992,000 from the
$215,886,000 at December 31, 2000. Federal funds sold increased $9,725,000 and
gross loans decreased $4,741,000 compared to December 31, 2000. Loan demand
continues to remain weak. The events of September 11, 2001 and the subsequent
decreases in interest rates, has reduced the array of viable investment options
available to the Bank. In the short-term, we have elected to "shrink" the
balance sheet where possible. This, however, has been difficult, as the events
of September 11, 2001 appear to have caused investors to temporarily shift
assets to safety. We have experienced an $8,268,000 increase in savings account
balances since December 31, 2000.
Commercial loan payoffs resulted in the majority of the decrease in total loans.
As a result, September 30, 2001 loan totals decreased $4,741,000 compared to
December 31, 2000. Total loans were $172,092,000 as of September 30, 2001.
In response to the loan payoffs, management has the following practical
alternatives: reinvest funds into loans, invest excess funds in short to medium
term securities until suitable loan opportunities can be identified, or "shrink"
the balance sheet by paying off various deposit and other borrowings. Management
elected to offer below market rates on rate sensitive deposits, in effect
encouraging certain depositors to leave the Bank. Management has also repayed,
without penalty, short-term variable rate FHLB advances.
The Bank also continues to use various products offered by the Federal Home Loan
Bank of Indianapolis. At September 30, 2001 the Bank had $24,092,000 in
outstanding balances, compared to $26,500,000 at December 31, 2000.
Other assets increased $2,864,000. During the third quarter, management invested
$3,000,000 in Bank Owned Life Insurance commonly known as BOLI. This investment
is recorded in accrued interest receivable and other assets category of the
balance sheet.
Liquidity
Management defines liquidity as the ability to fund appropriate levels of credit
worthy loans, meet the immediate cash withdrawal requirements of depositors, and
maintain access to sufficient resources to meet unexpected contingencies at a
reasonable cost, with minimal losses.
The loan to deposit ratio at September 30, 2001 was 105.2% compared to 112.1% at
December 31, 2000. Management believes that the combination of available FHLB
advances, Federal funds lines of credit, the available for sale investment
portfolio, and our ability to sell mortgage loans provides adequate short and
medium term sources of liquidity. At a minimum the Bank has the following
available to meet short-term liquidity needs: $10,000,000 in available FHLB
advances and $9,000,000 in short term federal funds lines of credit with
correspondent banks.
CNFC also needs cash to pay dividends to its shareholders. The primary source of
cash is the dividends paid to CNFC by the Bank. Management believes that cash
from operations is sufficient to supply the cash needed to continue paying a
reasonable dividend. CNFC also has a $1,500,000 line of credit with a
correspondent institution. At December 31, 2000, CNFC had an outstanding balance
of $700,000. This balance has subsequently been paid off.
11
COMMERCIAL NATIONAL FINANCIAL CORPORATION
Asset Quality
At September 30, 2001 CNFC has identified $391,000 of loans as non-performing.
This compares to $354,000 at December 31, 2000. In addition, management has
identified $11,312,000 of loans at September 30, 2001 where the borrower is
experiencing some financial difficulty.
September 30, 2001 December 31, 2000
Total loans $ 172,092,329 $ 176,833,244
Non-accrual loans $ 344,562 $ 354,214
Accruing loans past due 90 days or more 46,000 -
Restructured loans - -
- -------------------------------------------------------------------------------------------------
Total non-performing loans $ 390,562 $ 354,214
=================================================================================================
Other real estate - -
- -------------------------------------------------------------------------------------------------
Total non-performing assets $ 390,562 $ 354,214
=================================================================================================
Total non-performing loans as a
percentage of total loans .23% .20%
=================================================================================================
Allowance for loan loss as a percentage of
non-performing loans 733.79% 718.59%
=================================================================================================
Allowance for Loan Loss
The allowance for loan losses was 1.67% of total loans at September 30, 2001 and
1.44% at December 31, 2000. Year to date net recoveries totaled $51,000. Year
2000 net charge-offs totaled $607,000. Approximately $649,000 relates to one
business loan relationship. Excluding this charge-off, CNFC recorded net
recoveries of $42,000 during 2000.
Year to date, CNFC expensed a provision of $270,000, which was the same as the
amount expensed for the nine months ended September 30, 2000. Management
continues to systematically evaluate the adequacy of the allowance such that the
balance is commensurate with the performance of the loan portfolio, loan growth,
general market conditions and other relevant factors. Included in the
calculation of the appropriate level for the allowance for loan loss is the risk
associated with approximately $11,312,000 of loans that management has
identified as experiencing some financial difficulty.
Nine Months Ended Year Ended Nine Months Ended
September 30, 2001 December 31, 2000 September 30, 2000
Beginning balance $ 2,545,363 $ 2,792,293 $ 2,792,293
Loan charge-offs (19,084) (689,892) (593,230)
Loan recoveries 69,643 82,962 38,725
- ----------------------------------------------------------------------------------------------
Net loan recoveries/(charge-offs) 50,559 (606,930) (554,505)
Provision for loan losses 270,000 360,000 270,000
- ----------------------------------------------------------------------------------------------
Ending balance $ 2,865,922 $ 2,545,363 $ 2,507,788
==============================================================================================
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COMMERCIAL NATIONAL FINANCIAL CORPORATION
Capital Resources
CNFC's capital ratios continue to exceed regulatory guidelines for a "well
capitalized" institution. It is management's intent to maintain capital ratios
in excess of the minimum required to be well capitalized. A summary of CNFC's
capital ratios follows:
Minimum Required to be Well
Capitalized Under Prompt
September 30, December 31, Corrective Action
2001 2000 Regulations
---- ---- -----------
Total capital to risk weighted assets 14.4% 13.1% 10.0%
==== ==== ====
Tier 1 capital to risk weighted assets 13.2% 11.9% 6.0%
==== ==== ====
Tier 1 capital to average assets 9.9% 9.4% 5.0%
==== ==== ====
RESULTS OF OPERATIONS
Summary
Net income for the quarter ended September 30, 2001 was $767,000, an increase of
$35,000, or 4.8% compared to the same period in 2000. A $134,000 or 54.0%
increase in noninterest income, generated by gains on sales of residential
mortgage loans and security sales, is the primary contributing factor to the
increase in net income. CNFC's net interest income decreased by $15,000,
primarily as a result of a decrease in margin during the quarter. Non-interest
expense for the quarter increased $68,000 or 4.9% compared to the same period in
2000. Increased salary and benefit costs account for $60,000 or 88.2% of the
overall increase in non-interest expense.
Year to date net income totaled $2,339,000, a $165,000 or 7.6% increase compared
to the same period in 2000. The major items affecting the third quarter of 2001
also impacted year to date income.
Net Interest Income
The following table illustrates the effect that changes in rates and balances of
interest-earning assets and interest-bearing liabilities had on tax-equivalent
net interest income for the three and nine months ending September 30, 2001 and
2000.
Three Months Ending September 30, Nine Months Ending September 30,
2001 2000 2001 2000
---- ---- ---- ----
Interest Income (tax equivalent) $ 4,094,321 $ 4,326,405 $ 12,776,059 $ 12,382,186
Interest Expense 1,733,391 1,941,067 5,591,890 5,222,025
------------ ------------ ------------ ------------
Net Interest Income $ 2,360,930 $ 2,385,338 $ 7,184,169 $ 7,160,161
============ ============ ============ ============
Average Balances
- ----------------
Interest-earning Assets $206,898,615 $198,763,637 $207,529,703 $193,091,714
Interest-bearing Liabilities 171,685,068 165,861,771 172,622,694 160,635,109
------------ ------------ ------------ ------------
Net Differential $ 35,213,547 $ 32,901,866 $ 34,907,009 $ 32,456,605
============ ============ ============ ============
Average Yields/Rates (annualized)
- ---------------------------------
Yield on Earning Assets 7.85% 8.64% 8.23% 8.54%
Rate Paid on Liabilities 4.01% 4.64% 4.33% 4.33%
------------ ------------ ------------ ------------
Interest Spread 3.84% 4.00% 3.90% 4.21%
============ ============ ============ ============
Net Interest Margin 4.53% 4.76% 4.63% 4.94%
============ ============ ============ ============
13
COMMERCIAL NATIONAL FINANCIAL CORPORATION
The change in tax equivalent net interest income is attributable to the
following:
Three Months Ending Nine Months Ending
September 30, 2001 September 30, 2001
Balance Rate Inc/(Dec) Balance Rate Inc/(Dec)
------- ---- --------- ------- ---- ---------
Interest Earning Assets $ 77,407 $(309,491) $(232,084) $ 791,261 $(397,388) $ 393,873
Interest Bearing Liabilities 42,305 (249,981) (207,676) 484,558 (114,693) 369,865
--------- --------- --------- --------- --------- ---------
Net Interest Income $ 35,102 $ (59,510) $ (24,408) $ 306,703 $(282,695) $ 24,008
========= ========= ========= ========= ========= =========
The $24,000 decrease in tax-equivalent net interest income for the three months
ending September 30, 2001 resulted from a decrease in margin offset by a
$2,312,000 in net earning assets. Net interest margin for the three months
ending September 30, 2001 decreased to 4.53% compared to 4.76% for the three
months ending September 30, 2000.
The Federal Reserve lowered the federal funds rate by 150 basis points in the
first quarter, 125 basis points in the second quarter and 75 basis points in the
third quarter of 2001. In response to the September 11, 2001 terrorist attacks,
the Federal Reserve decreased the federal funds rate by an additional 50 basis
points during October 2001. These changes in prime result in an almost immediate
decrease in the Bank's prime lending rate. In addition to lowering the target
federal funds rate, the Federal Reserve also provided additional liquidity to
the market place. During the week following the September 11, 2001 attack,
Commercial Bank earned between .375% and 1.0% on overnight federal funds sales.
The interest rate on a significant portion of the Bank's commercial loan
portfolio is tied to the prime-lending rate. As the Bank adjusts it's prime
lending rate accordingly, the Bank experiences an almost immediate decrease in
net interest income. In response, management has lowered retail deposit rates,
however, it is unable to lower the cost of retail deposits as quickly and to the
same extent as the Federal Reserve has lowered the federal funds target rate. In
addition, many customers are refinancing higher yielding, fixed rate, long-term
loans at lower rates.
Noninterest Income
Noninterest income for the three months ending September 30, 2001 was $382,000.
This represents a $134,000 or 54.0% increase over the same period in 2000.
The general decrease in interest rates during 2001 has spurred residential real
estate refinancing activity. Year to date, the Bank has originated $18,383,000
of residential mortgages subsequently sold to the secondary market. This
compares to $2,394,000 for the same period in 2000. Management has elected to
sell most 15 and 30 year fixed rate residential real estate mortgage loans
originated during the period. As a result, gains on loan sales have increased by
$228,000 or 414.5% compared to the three months ending September 30, 2000.
Also, CNFC elected to liquidate an equity investment held as available for sale
by the holding company. This resulted in $210,000 in securities gains.
Noninterest income for the nine months ending September 30, 2001 was $1,217,000,
a $440,000 or 56.6% increase. Factors affecting this increase were similar to
those described in the paragraphs above.
Noninterest Expense
Noninterest expense for the three months ending September 30, 2001 totaled
$1,451,000. This represents a $68,000 or 4.9% increase over the same period in
2000.
14
COMMERCIAL NATIONAL FINANCIAL CORPORATION
Salary and benefit expense for the three months ending September 30, 2001
totaled $797,000 compared to $737,000 for the same period in 2000, an increase
of $60,000 or 8.1%. The increase reflects normal salary increases, combined with
an approximately 16% increase in the cost of medical insurance. Bank staffing
levels have not significantly changed compared to the same period in 2000.
Professional fees for the three months ended September 30, 2001 increased
$10,000 or 15.8% compared to the same period in 2000. Increased accounting and
legal fees related to the formation of a mortgage subsidiary was the primary
reason for increased professional fees.
Noninterest expense for the six months ending September 30, 2001 totaled
$4,344,000. This represents a $217,000 or 5.3% increase over the same period in
2000. The primary factors affecting this increase are similar to those discussed
in the paragraphs above.
15
COMMERCIAL NATIONAL FINANCIAL CORPORATION
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
CNFC's primary market risk exposure is interest rate risk and, to a lesser
extent, liquidity risk. All of the CNFC's transactions are denominated in U.S.
dollars with no specific foreign exchange exposure. CNFC has a limited exposure
to commodity prices related to agricultural loans. Any impacts that changes in
foreign exchange rate and commodity prices would have on interest rates are
assumed to be insignificant.
Interest rate risk ("IRR") is the exposure of a banking organization's financial
condition to adverse movements in interest rates. Accepting this risk can be an
important source of profitability and stockholder value, however, excessive
levels of IRR could pose a significant threat to the CNFC's earnings and capital
base. Accordingly, effective risk management that maintains IRR at prudent
levels is essential to the CNFC's safety and soundness.
Evaluating a financial institution's exposure to changes in interest rates
includes assessing both the adequacy of the management process used to control
IRR and the organization's quantitative level of exposure. When assessing the
IRR management process, management seeks to ensure that appropriate policies,
procedures, management information systems and internal controls are in place to
maintain IRR at prudent levels with consistency and continuity. Evaluating the
quantitative level of IRR exposure requires the management to assess the
existing and potential future effects of changes in interest rates on its
consolidated financial condition, including capital adequacy, earnings,
liquidity, and, where appropriate, asset quality.
Forward Looking Statements
This discussion and analysis of financial condition and results of operations,
and other sections of this report contain forward looking statements that are
based on management's beliefs, assumptions, current expectations, estimates and
projections about the financial services industry, the economy, and about the
Corporation itself. Words such as "anticipates", "believes", "estimates",
"expects" "forecasts" "intends", "is likely", "plans", "product", "projects",
variations of such words and similar expressions are intended to identify such
forward-looking statements. These statements are not guarantees of future
performance and involve certain risks, uncertainties, and assumptions ("Future
Factors") that are difficult to predict with regard to timing, extent,
likelihood and degree of occurrence. Therefore, actual results and outcomes may
materially differ from what may be expressed or forecasted in such forward
looking statements. Furthermore, CNFC undertakes no obligation to update, amend
or clarify forward-looking statements, whether as a result of new information,
future events, or otherwise.
Future Factors include changes in interest rates and interest rate
relationships; demand for products and services; the degree of competition by
traditional and non-traditional competitors; changes in banking regulations and
tax laws; changes in prices, levies, and assessments; the impact of technology,
governmental and regulatory policy changes; the outcome of pending and future
litigation and contingencies; trends in customer behavior including their
ability to repay loans; and vicissitudes of the national and local economies.
These are representative of the Future Factors that could cause a difference
between an actual outcome and a forward-looking statement.
16
COMMERCIAL NATIONAL FINANCIAL CORPORATION
PART II. OTHER INFORMATION
Item 6 (b) Reports on Form 8-K
NONE
17
COMMERCIAL NATIONAL FINANCIAL CORPORATION
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Commercial National Financial Corporation
(Registrant)
Date: November 13, 2001
Jeffrey S. Barker
President and Chief Executive Officer
Patrick G. Duffy
Executive Vice President and Chief Financial
Officer
18