COMMERCIAL NATIONAL FINANCIAL CORPORATION
EXHIBIT 13
INCORPORATED PORTIONS FROM 2002 ANNUAL REPORT TO SHAREHOLDERS
13
CONTENTS
Report from the President................................................................................. 2
Selected Financial Data................................................................................... 3
Management's Discussion and Analysis...................................................................... 4-18
Management's Responsibility for Financial Statements...................................................... 19
Report of Independent Auditors............................................................................ 20
Consolidated Balance Sheets............................................................................... 21
Consolidated Statements of Income......................................................................... 22
Consolidated Statements of Changes in Shareholders' Equity................................................ 23
Consolidated Statements of Cash Flows..................................................................... 24
Notes to Consolidated Financial Statements................................................................ 25-38
Common Stock and Dividend Information..................................................................... 39
Directors and Officers.................................................................................... 40
Locations, Transfer Agent and Market Makers............................................................... 42
The cover photographs represent the exterior and
interior of our new Greenville office located on
M-57, just west of Greenville. The office opened
on October 14, 2002. True North Architecture of
Grand Rapids designed the building. Houseman
Construction Company of Grand Rapids served as
general contractor for the project.
The back cover photograph was taken at the flag
raising ceremony conducted by American Legion Post
101.
To Our Shareholders:
The past year proved to be very challenging, as we knew it would be. Three major
factors had a negative impact on the earnings for 2002, historically low
interest rates, the slowing economy and our expansion in Greenville.
Consequently, net income for 2002 declined slightly from last year's record
level to $2,901,000.
During 2002, we continued our strong level of cash dividends, increasing from 51
cents per share to 54 cents per share adjusted for the twelfth consecutive 5%
stock dividend paid in November 2002. Return on average equity was 12.6% for the
year while total shareholder equity increased over 7% to $23,704,000, far
exceeding any regulatory minimum capital requirements. Return on average assets
was a respectable 1.28%.
We continue to stay focused on controlling our non-interest expenses.
Non-interest expenses increased only 2.5% or $148,000 over the prior year. Our
new Greenville headquarters construction and start up costs accounted for a
major portion of that increase. Full time equivalent staffing rose from 74 to 79
over the course of 2002. However, this investment in highly skilled people will
generate substantial returns in the months and years to come as we grow our
business in the Greenville market.
The new Greenville facilities are featured on this year's cover. Commercial Bank
Greenville operates as a locally controlled affiliate of Commercial Bank and is
managed by a board of directors comprised of several Greenville area
businessmen, Jerry L. Bayak, President of Commercial Bank Greenville; Andrew P.
Shafley, Senior Vice President of Commercial Bank and myself as chairman of
Commercial Bank Greenville. Jerry Bayak has more than 11 years in banking and
served successfully in a similar capacity at First Community Bank in Cheboygan,
Michigan. The remaining directors are Carl Barberi, Assistant Superintendent of
Greenville Public Schools; Ed Koehn, President of Ed Koehn Ford Lincoln Mercury,
Inc.; Jerry Pitcher, a local real estate developer and property manager; Brad
Stauffer, Director of Corporate Finance for Northland Corporation and Wade
Thornton, owner of the Winter Inn in Greenville. Making the day to day decisions
within the local market permits us to compete more effectively in Greenville.
A very positive sign going forward is the 2002 loan growth. Total loans
increased just over $16,000,000 to end 2002 at $184,400,000, up nearly 10%. We
are fortunate to have a very talented and hardworking group of lenders as
evidenced by our continued growth.
In order to help continue this growth we are currently in the process of opening
a unique new office in Mt. Pleasant, Michigan. It will be located in the
Tallgrass Office Park on Broomfield Road. Over the past several years we have
developed some excellent business relationships in the Mt. Pleasant area and I
am confident we can expand our business with this new office. It will be a
rather small office by most standards, however, it is designed to service
primarily commercial business customers with an exceptionally high level of
personal service. By limiting both the size of the office and our staffing needs
we anticipate that the office will be profitable very quickly.
If you have not visited our website recently I encourage you to do so at
www.commercial-bank.com. You will find links to our mortgage website that allow
customers to shop rates and products, as well as apply on line and be approved
for their mortgage 24 hours a day 365 days a year. This exciting new feature has
already increased our residential mortgage business and keeps us on the leading
edge of technology in this very competitive segment of our business.
Thank you for your continued support and investment in Commercial National
Financial Corporation.
Sincerely,
Jeffrey S. Barker
President and CEO
SELECTED FINANCIAL DATA
2002 2001 2000 1999 1998
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(In thousands except financial ratios and per share data)
FOR THE YEAR
Net interest income $ 8,922 $ 8,952 $ 9,002 $ 8,416 $ 7,559
Provision for loan losses (681) (375) (360) (360) (360)
Noninterest income 1,823 1,842 1,026 1,099 1,355
Noninterest expense (6,033) (5,885) (5,572) (5,347) (5,070)
- --------------------------------------------------------------------------------------------------------------------
Income before income tax expense 4,031 4,534 4,096 3,808 3,484
Income tax expense (1,130) (1,331) (1,193) (1,077) (924)
- --------------------------------------------------------------------------------------------------------------------
Net income $ 2,901 $ 3,203 $ 2,903 $ 2,731 $ 2,560
====================================================================================================================
AT YEAR END
Total assets $ 238,251 $ 218,398 $ 215,886 $ 191,022 $ 181,096
Net loans 181,665 165,427 174,288 149,675 133,526
Total deposits 166,059 162,579 157,794 147,204 141,175
FHLB advances 32,807 26,093 26,500 16,500 11,500
Shareholders' equity 23,704 22,064 20,110 18,965 17,660
FINANCIAL RATIOS
Return on average assets 1.28% 1.48% 1.43% 1.47% 1.47%
Return on average shareholders' equity 12.60 14.93 14.67 14.67 14.39
Average shareholders' equity to average assets 10.14 9.90 9.74 10.04 10.19
Allowance for loan losses to total loans 1.51 1.54 1.44 1.83 1.73
Tier 1 leverage capital ratio 10.00 9.74 9.35 9.98 9.92
Total risk-based capital ratio 14.21 14.38 13.14 14.27 14.26
Dividend pay-out 70.35 59.48 62.23 63.37 57.68
PER SHARE DATA(1)
Basic earnings $ .77 $ .86 $ .79 $ .74 $ .69
Diluted earnings .76 .86 .78 .74 .68
Dividends declared .54 .51 .48 .48 .41
Book value, end of year 6.24 5.92 5.48 5.14 4.87
(1) All per share data adjusted to reflect stock splits and stock dividends.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
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Introduction
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The following discussion provides information about the financial condition and
results of operations of Commercial National Financial Corporation. It should be
read in conjunction with the consolidated financial statements included
elsewhere in this Annual Report.
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Business of Commercial National Financial Corporation
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Commercial National Financial Corporation (the Corporation or Commercial), a
financial holding company, was incorporated in Michigan on December 30, 1987. On
May 31, 1988, the Corporation acquired all of the stock of Commercial National
Bank, a national banking association chartered in 1962. On December 30, 1992,
Commercial National Bank converted to a state-chartered bank under the name
Commercial Bank (the Bank).
On July 16, 1997, the Bank acquired an inactive insurance agency, Commercial
National Financial Services Incorporated (the Agency). The Agency in turn
purchased a minority interest in Michigan Bankers Title of Northern Michigan,
LLC (the Title Agency). During 2000, Michigan Bankers Title of Northern Michigan
was dissolved. The Agency made a similar investment in Michigan Bankers Title of
Eastern Michigan. The investment in the Title Agency and the related dividends
earned are not material.
The Bank established a relationship with The Centennial Group (Centennial), a
financial planning group headquartered in Lansing, Michigan in 2000. Through
customer referrals to a registered representative of Centennial, the Agency
receives commissions for the placement of products and fee based services.
During 2001, Commercial Bank formed a mortgage company, CNFC Mortgage
Corporation, 100% owned by Commercial Bank. CNFC Mortgage Corporation allows
Commercial to pursue out of market mortgages and offer products and services not
normally provided by community banks.
Business is concentrated primarily in a single industry segment - commercial
banking. The Bank provides a full range of banking services to individuals,
agricultural and commercial businesses and industries located in its service
area. The Bank 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. Commercial Bank
offers a variety of deposit products, including checking, savings, money market,
individual retirement accounts and certificates of deposit.
The principal markets for financial services are the mid-Michigan communities in
which the Bank is located and the areas immediately surrounding these
communities. The Bank serves these markets through nine locations in or near
these communities. Commercial does not have any material foreign assets or
income.
The principal source of revenue for Commercial is interest and fees on loans. On
a consolidated basis, interest and fees on loans accounted for 79.47% of total
revenue in 2002, 79.71% in 2001, and 83.80% in 2000. Interest on investment
securities accounted for 7.82% of total revenue in 2002, 8.04% in 2001, and
8.82% in 2000.
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Highlights
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2002 COMPARED TO 2001
Net income for the year ended December 31, 2002 was $2,901,000, a $302,000 or
9.4% decrease from the $3,203,000 earned in 2001. The 2002 return on average
equity decreased to 12.60% from 14.93% in 2001. The return on average assets for
2002 also decreased to 1.28% from 1.48% in 2001. Basic earnings per share
decreased from $.86 per share for the year ending December 31, 2001 to $.77 per
share for the year ending December 31, 2002.
Three major events affecting 2002 results were historically low interest rates,
a slowing local economy and the Bank's expansion in the Greenville, Michigan
market.
In an attempt to stimulate a slowing economy, the Federal Reserve lowered the
discount rate from 1.75% at December 31, 2001 to 1.25% at December 31, 2002.
This resulted in a 40 year low interest rate environment. The low interest rates
continue to provide incentive to residential real estate mortgage customers to
refinance their existing mortgage loans. Gain on loan sales increased $85,000
from the record $613,000 recorded in 2001.
The slowing economy negatively affected the Bank's loan portfolio.
Non-performing loans increased from $462,000 at December 31, 2001 to $6 million
at December 31, 2002. The increase in non-performing loans, led management to
increase the provision for loan loss by $306,000. The interest income not
recorded on the non-performing loans totaled $450,000. This had a negative
impact on the Bank's margin which decreased from 4.46% for the year ending
December 31, 2001 to 4.32% for the year ending December 31, 2002.
Our expansion into Greenville had a short-term negative impact on non-interest
expense as management completed and staffed a new office. This new office
resulted in an increase in personnel which increased salary, benefit and
occupancy costs. In anticipation of the increased expenses of the new location,
management has attempted to control costs in other areas of the Bank. Management
was able to limit the overall increase in non-interest expense to $148,000 or
2.52% compared to the year ending December 31, 2001.
Total assets at December 31, 2002 increased $19.9 million to $238.3 million from
$218.4 million at December 31, 2001. Total gross loans at December 31, 2002
increased $16.2 million compared to December 31, 2001. Increases in the
commercial loan, and residential real estate loan portfolios were the primary
source for the increased loan totals.
2001 COMPARED TO 2000
Net income for the year ended December 31, 2001 was $3,203,000, 10.3% or
$300,000 more than the $2,903,000 earned in 2000. The 2001 return on average
equity increased to 14.93% from 14.67% in 2000. The return on average assets for
2001 also increased slightly to 1.48% from 1.43% in 2000. Basic earnings per
share increased from $.79 per share to $.86 per share.
The primary contributing factors resulting in the improved 2001 earnings are as
follows: an $815,000 or 79.5% increase in non-interest income offset by a
$50,000 or .6% decrease in net interest income and a $313,000 or 5.62% increase
in non-interest expense.
Total assets at December 31, 2001 increased slightly to $218.4 million from
$215.9 million at December 31, 2000. Total gross loans at December 31, 2001
decreased $8.8 million compared to December 31, 2000. Commercial loan payoffs,
combined with the increased refinancing and subsequent sale of residential
mortgage loans to the secondary market contributed to the decrease in loan
balances.
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Net Interest Income
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The largest component of Commercial's operating income is net interest income.
Net interest income is the difference between interest and fees earned on
earning assets and the interest paid on deposits and other borrowings. A number
of factors influence net interest income. These factors include: changes in
volume and mix of interest-earning assets and interest-bearing liabilities,
government monetary and fiscal policies, and national and local market interest
rates. The performance of the loan portfolio can also influence net interest
income.
The following table illustrates how, in general, rates have changed since
December 31, 2000. The Treasury yield curve on October 16, 2001 reflects the
initial response of the market to the events of September 11, 2001.
December 31, December 31, October 16, December 31,
2002 2001 2001 2000
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3 month 1.19% 1.72% 2.22% 5.09%
6 month 1.24% 1.81% 2.20% 5.79%
1 year 1.74% 3.18% 2.74% 5.43%
2 year 1.74% 3.18% 2.74% 5.15%
5 year 3.05% 4.43% 3.79% 5.01%
10 year 4.08% 5.10% 4.59% 5.11%
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Average Balance Sheet and Analysis of Net Interest Income
Years ended December 31,
-------------2002--------- ------------2001------------- -----------2000------------
AVERAGE YIELD/ Average Yield/ Average Yield/
BALANCE INTEREST RATE Balance Interest Rate Balance Interest Rate
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(Dollars in thousands)
Interest-earning assets:
Loans receivable (1)(2) $ 179,831 $ 12,755 7.09% $ 172,714 $ 14,379 8.33% $ 164,389 $ 14,591 8.88%
Investment securities
Taxable 14,723 773 5.25 15,118 884 5.85 15,711 941 5.99
Tax-exempt (2) 9,974 717 7.19 11,212 844 7.53 11,826 891 7.53
Federal funds sold and
other interest-bearing deposits 8,112 111 1.37 8,463 252 2.98 3,012 137 4.55
Federal Home Loan Bank stock 1,495 91 6.09 1,391 104 7.48 1,391 115 8.27
-------------------- ---------------------- --------------------
Total interest-earning assets 214,135 14,447 6.75 208,898 16,463 7.88 196,329 16,675 8.49
Non-earning assets:
Cash and due from banks 5,100 4,645 4,848
Premises and equipment, net 2,953 2,319 2,593
Other assets 7,851 3,570 2,037
Allowance for loan losses (2,888) (2,731) (2,777)
--------- --------- ---------
Total assets $ 227,151 $ 216,701 $ 203,030
========= ========= =========
Interest-bearing liabilities:
Interest-bearing deposits
Interest-bearing demand $ 28,371 152 .54 $ 26,825 280 1.04 $ 26,083 429 1.64
Savings 56,630 1,039 1.83 44,729 1,237 2.77 42,344 1,191 2.81
Time 57,610 2,197 3.81 69,625 3,831 5.50 68,335 3,928 5.75
Securities sold under agreements
to repurchase 9,398 156 1.66 8,462 313 3.70 6,727 400 5.95
U.S. Treasury demand notes,
Federal funds purchased, and
other borrowings 397 6 1.51 597 23 3.85 842 55 6.53
Federal Home Loan Bank advances 29,227 1,641 5.61 23,715 1,461 6.16 19,369 1,296 6.69
-------------------- ---------------------- --------------------
Total interest-bearing liabilities 181,633 5,191 2.86 173,953 7,145 4.11 163,700 7,299 4.46
Noninterest-bearing liabilities:
Noninterest-bearing demand 19,675 20,148 18,382
Other liabilities 2,812 1,152 1,169
Shareholders' equity 23,031 21,448 19,779
--------- --------- ---------
Total liabilities and
shareholders' equity $ 227,151 $ 216,701 $ 203,030
========= ========= =========
Net interest income/interest rate spread $ 9,256 3.89% $ 9,318 3.77% $ 9,376 4.03%
========= ==== ========= ==== ========= ====
Net interest margin (3) 4.32% 4.46% 4.78%
==== ==== ====
(1) Average outstanding balances include non-accruing loans. Interest on loans
receivable include fees. The inclusion of non-accruing loans and fees does
not have material effect on either the average outstanding balance or the
average yield.
(2) Yields on tax-exempt loans and securities are computed on a fully
taxable-equivalent basis using a federal income tax rate of 34%.
(3) Net interest earnings divided by average interest-earnings assets.
The following table analyzes the effect of volume and rate changes on interest
income and expense for the periods indicated.
Years ended December 31,
2 0 0 2 2 0 0 1 2 0 0 0
------COMPARED TO 2001----- -----Compared to 2000---- -----Compared to 1999--------
NET AMOUNT AMOUNT Net Amount Amount Net Amount Amount
INCREASE DUE TO DUE TO Increase Due to Due to Increase Due to Due to
(DECREASE) VOLUME RATE (Decrease) Volume Rate (Decrease) Volume Rate
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(In thousands)
Interest income:
Loans receivable (1) (2) $(1,623) $ 505 $(2,128) $ (212) $ 693 $(905) $ 2,338 $ 1,896 $ 442
Investment securities:
Taxable (113) (20) (93) (57) (35) (22) (76) (126) 50
Tax-exempt (2) (127) (89) (38) (47) (46) (1) (83) (38) (45)
Federal funds sold and
other interest- bearing deposits (141) (5) (136) 115 162 (47) (14) (40) 26
Federal Home Loan Bank stock (13) 6 (19) (11) -- (11) 4 -- 4
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Total interest income (2,017) 397 (2,414) (212) 774 (986) 2,169 1,692 477
Interest expense:
Interest-bearing deposits
Interest-bearing demand (128) 9 (137) (149) 7 (156) 4 17 (13)
Savings (198) 218 (416) 46 66 (20) 143 33 110
Time (1,634) (458) (1,176) (97) 71 (168) 911 540 371
Securities sold under
agreements to repurchase (158) 15 (173) (87) 64 (151) 84 5 79
U.S. Treasury demand notes, Federal
funds purchased and other borrowings (17) (3) (14) (32) (9) (23) 24 13 11
Federal Home Loan Bank advances 181 310 (129) 165 268 (103) 433 314 119
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Total interest expense (1,954) 91 (2,045) (154) 467 (621) 1,599 922 677
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Net interest income $ (63) $ 306 $ (369) $ (58) $ 307 $(365) $ 570 $ 770 $ (200)
===============================================================================================================================
(1) Loan fees are included in interest income and are used to calculate average
rates earned. Non-accrual loans are included in the average loan balance.
(2) Yields on tax-exempt loans and investment securities are computed on a
fully taxable-equivalent basis using a federal income tax rate of 34%.
(3) For purposes of these tables, changes in interest due to volume and rate
were determined as follows: Volume Variance = Change in volume times old
rate; Rate Variance = change in rate times old volume; Rate/ Volume
Variance =Change in rate times change in volume allocated to volume and
rate changes in proportion to the relationship of the absolute dollar
amounts of the change in each.
2002 COMPARED TO 2001
During 2002 interest rates continued to fall in response to a slowing national
economy. The Federal Reserve Open Market Committee decreased the discount rate
50 basis points during 2002. This was in addition to the 475 basis point
decrease in the discount rate during 2001. Interest rates, in general, reached
40 year lows. The low interest rates continued to provide home owners with
incentive to refinance their mortgage loans. In addition, business loan
customers were also requesting to refinance loans at lower interest rates.
In response, management continued to lower deposit rates. Despite lowering
deposit rates, deposit balances increased as customers sought liquidity and
safety.
Loan growth continued to positively impact net interest income. Despite a
slowing economy, average loan balances increased $7.1 million. The additional
interest income helped offset the decrease in net interest income due to
decreased yields on earning assets.
Negatively impacting margin is the interest income not recorded on
non-performing loans. During 2002, interest that was not recorded on loans
placed on non-accrual totaled $450,000. Had this income been recorded during
2002, margin would have been 4.53% instead of 4.32%.
2001 COMPARED TO 2000
During 2001 interest rates changed in response to a slowing national economy and
the events of September 11th. The Federal Reserve Open Market Committee
decreased the discount rate 475 basis points during 2001. The Bank's
prime lending rate correspondingly decreased from 9.50% at December 31, 2000 to
4.75% at December 31, 2001.
In response to the decrease in interest rates during 2001, the Bank attempted to
lower the cost of interest-bearing liabilities. However, time deposits and FHLB
advances did not reprice as quickly as the yields on earning assets decreased.
In response to economic uncertainty, customers, seeking stability and security,
increased funds held in liquid deposit products. Interest-bearing demand,
savings, and time deposits all averaged higher balances during 2001 compared to
2000.
The increase in deposit balances, combined with slow loan demand and
management's decision to sell a majority of the 15 and 30 year fixed rate
residential real estate loans originated during 2001, resulted in a shift in the
mix of earning assets to lower yielding assets. Average Federal Funds sold
increased $5.5 million during the year.
The combination of these factors contributed to a 32 basis point decrease in
Commercial's net interest margin during 2001. This resulted in a $58,000
decrease in tax equivalent net interest income.
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Noninterest Income
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2002 COMPARED TO 2001
Noninterest income for the year ended December 31, 2002 was $1,824,000 compared
to $1,841,000 for the year ended December 31, 2001.
As of December 31, 2001 management noted an increase in residential real estate
mortgage rates and a corresponding decrease in residential real estate mortgage
applications. Management anticipated a slow down in the refinancing activity
during the first quarter of 2002. However, mortgage rates decreased during 2002
to 40 year lows. As a result, the Bank experienced significant mortgage
refinancing activity again during 2002. The Bank originated and sold $32.7
million in residential mortgage loans during 2002 compared to the record $33.4
million in 2001. The Bank was able to average a slightly higher gain on the
loans sold during 2002.
During September of 2001, the Bank purchased $3 million in bank owned life
insurance policies. The year ending December 31, 2002 reflects a full year of
dividends earned on the investment. No additional purchases were made during
2002.
During 2001, Commercial recorded $211,000 in net gains on the sale of
securities. The sale of equity securities held by the holding company accounted
for $201,000 of the gain. The $201,000 gain was non-recurring.
2001 COMPARED TO 2000
Noninterest income for the year ended December 31, 2001 was $1,841,000 compared
to $1,026,000 for the year ended December 31, 2000.
Historically low 15 and 30 year fixed residential mortgage rates resulted in a
mortgage refinancing boom during 2001. Management elected to sell the majority
of the 15 and 30 year fixed rate loans to the secondary market. Net gains on
mortgage loan sales increased $530,000 or 638.9% over the prior year.
During 2001, Commercial recorded $211,000 in net gains on the sale of
securities. The sale of equity securities held by the holding company accounted
for $201,000 of the gain.
Years ended December 31,
2002 2001 2000
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(In thousands)
Service charge and fees $ 494 $ 453 $ 444
Net gains on mortgage loan sales 698 613 83
Dividends on bank owned life
insurance 181 50 --
Receivable financing fees 158 227 237
Net gains on sale of securities 28 211 --
Other 265 287 262
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Total noninterest income $1,824 $1,841 $1,026
===========================================================
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Noninterest Expense
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Years ended December 31,
2002 2001 2000
- --------------------------------------------------------------
(In thousands)
Salaries $2,689 $2,570 $2,362
Employee benefits 665 660 595
Furniture and equipment 603 658 679
Professional fees 343 354 302
Occupancy 328 314 327
Printing and supplies 197 186 181
Director fees 182 156 165
Telephone 146 127 121
Postage 102 87 89
Advertising 84 71 74
Other insurance 60 55 63
Other taxes 54 47 113
FDIC insurance 31 31 30
Other expenses 549 569 471
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Total noninterest expense $6,033 $5,885 $5,572
==============================================================
Efficiency Ratio 54.45% 52.74% 53.67%
==============================================================
Noninterest expense as percentage
of average assets 2.66% 2.72% 2.74%
==============================================================
Salaries and employee benefits as
a percentage of average assets 1.48% 1.49% 1.46%
==============================================================
2002 COMPARED TO 2001
Noninterest expense for the year ending December 31, 2002 increased $148,000 or
2.5%. Commercial's efficiency ratio increased from 52.74% to 54.45%.
During October of 2002, the Bank opened a new office in Greenville, Michigan.
Costs associated with opening this office negatively impacted several expense
categories including salaries, employee benefits, occupancy, postage, printing
and supplies, advertising, telephone and director fees. Management anticipates
that the new office will reach break even early in 2003.
Salary expense increased $119,000 or 4.6%. The increase primarily reflects
normal salary adjustments and the addition of staff at the new Greenville
office. The new Greenville employees were hired during the third and fourth
quarters of 2002. Full time equivalents increased from 74 at December 31, 2001
to 79 at December 31, 2002.
Director fees, for the year ending December 31, 2002, compared to December 31,
2001, increased $26,000 partially related to the addition of a Greenville
affiliate board of directors.
2001 COMPARED TO 2000
Noninterest expense for the year ending December 31, 2001 increased $313,000 or
5.6%. Commercial's efficiency ratio continued to improve, decreasing from 53.67%
to 52.74%.
Salary costs increased $208,000 or 8.81%. The increase reflects merit increases
and an increase in the incentive compensation paid. Also, full time equivalents
(FTE's) increased from 72 to 74.
Benefit costs increased $65,000 or 10.92% primarily as a result of a
double-digit increase in medical insurance costs. Management expects 2002
medical insurance costs to significantly increase. Management is exploring
options to control medical insurance costs.
Professional fees increased $52,000 or 17.1%. Cost of forming CNFC Mortgage
Corporation was the primary cause of the increase. Management also uses third
parties to support or replace some functions previously performed by Bank
personnel. For example, during 2001, management contracted with third party
providers to conduct security testing of the Bank's electronic banking platform.
This testing provides independent assurance by industry experts that our
electronic banking system is secure. Management will continue to use external
expertise to assist in managing risk and identifying opportunities for growth
where appropriate.
Other taxes decreased from $113,000 during 2000 to $47,000 in 2001. Tax benefits
associated with forming CNFC Mortgage Corporation helped reduce the Michigan
Single Business Tax expense during 2001.
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Income Tax Expense
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Commercial's 2002 income tax expense was $1,130,000 compared to $1,331,000 in
2001 and $1,193,000 in 2000. The increase from 2000 through 2001 was primarily
the result of increased income before income tax and a decrease in tax-exempt
interest income in relation to total pretax income. The decrease in income tax
expense for 2002 was primarily due to a lower pretax net income and a decrease
in tax-exempt interest. The average balance in tax-exempt securities decreased
$1,238,000 in 2002, $614,000 in 2001 and $505,000 during 2000.
The statutory federal tax rate during 2002, 2001, and 2000, was 34%.
Commercial's effective tax rate was lower than the statutory rate in all three
years, primarily due to tax-exempt interest income. The effective tax rate was
28.03% in 2002, 29.35% in 2001, and 29.13% in 2000.
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Investment Portfolio
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Commercial's Asset/Liability Management Committee ("Committee") is responsible
for developing investment guidelines and strategies. The Committee uses an
investment advisor to help select appropriate investments for the portfolio.
Decisions to purchase securities and the maturity date selected are coordinated
with an overall plan to manage liquidity and interest rate exposure.
For example, the U.S. Treasury and government agency securities identified as
available for sale are laddered to mature over five years with the intent of
achieving a three year average life. The investment time horizon and the average
life are periodically adjusted to reflect the effects of loan demand, cost of
funding and the interest rate environment. In the current low interest rate
environment, management is electing to shorten the average maturity. The
Committee has also elected to use callable government agency securities to
provide protection in the event that interest rates rise. The book value of
callable securities totaled $8.5 million at December 31, 2002 compared to $8.6
million at December 31, 2001.
The Committee does not invest in derivative securities. Commercial holds no
impaired securities at December 31, 2002. As of December 31, 2002, the aggregate
book value of investment securities issued by the State of Michigan and all its
political subdivisions totaled $6.4 million with an aggregate market value of
$6.4 million.
The following table shows securities by classification as of December 31, 2002,
the amounts and weighted-average yields by maturity period:
- ----------------------------------------------------------------MATURING--------------------------------------------------------
Within After One But After Five But After
One Within Five Within Ten Ten
Year Years Years Years Total
Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield
- --------------------------------------------------------------------------------------------------------------------------------
AVAILABLE FOR SALE
U.S. Treasuries
and government
agencies $ 9,203,187 3.75% $ 6,900,738 5.81% $ -- $ -- $16,103,925 4.61%
State and municipal(1) 279,334 5.57% 2,374,237 5.89% 1,690,964 6.67% 395,210 6,23% 4,739,745 6.23%
Other 502,226 4.97% -- -- -- 502,226 4.97%
- -----------------------------------------------------------------------------------------------------------------------
Total $ 9,984,747 $ 9,274,975 $ 1,690,964 $ 395,210 $21,345,896
=======================================================================================================================
Held to Maturity
State and
municipal(1) $ 1,636,431 6.90% $ 2,872,594 7.18% $ 180,000 9.12% $ -- $ 4,689,025 7.16%
- -----------------------------------------------------------------------------------------------------------------------
Total $ 1,636,431 $ 2,872,594 $ 180,000 $ -- $ 4,689,025
=======================================================================================================================
(1) Yields on tax-exempt securities are computed on a fully taxable-equivalent
basis
The amortized cost of investment securities, as of the dates indicated, are
summarized as follows:
December 31,
2 0 0 2 2 0 0 1 2 0 0 0
AVAILABLE HELD TO Available Held to Available Held to
FOR SALE MATURITY for Sale Maturity for Sale Maturity
- ---------------------------------------------------------------------------------------------------------------
(In thousands)
U.S. Treasuries and
government agencies $15,627 $ -- $14,588 $ -- $13,994 $ --
State and municipal 4,544 4,689 4,224 7,497 3,393 8,526
Other 501 -- 1,090 -- 1,706 --
- ---------------------------------------------------------------------------------------------------------------
Total $20,672 $ 4,689 $19,902 $ 7,497 $19,093 $ 8,526
===============================================================================================================
- --------------------------------------------------------------------------------
Loan Portfolio
- --------------------------------------------------------------------------------
The following table presents the amount of loans outstanding by loan type:
December 31,
2002 2001 2000 1999 1998
- -----------------------------------------------------------------------------------------------------------------------
(In thousands)
Commercial, financial and
agricultural $ 104,092 $ 92,566 $ 91,860 $ 80,116 $ 70,272
Real estate - construction 11,952 12,556 19,318 16,145 11,127
Real estate - mortgage 61,652 55,893 57,945 47,085 42,988
Consumer and other 6,752 6,998 7,710 9,121 11,483
- -----------------------------------------------------------------------------------------------------------------------
Total loans $ 184,448 $ 168,013 $ 176,833 $ 152,467 $ 135,870
=======================================================================================================================
The following table shows the maturity of loans (excluding real estate-mortgage
and consumer and other loans) outstanding at December 31, 2002. Also provided
are the amounts due after one year, classified according to their sensitivity to
changes in interest rates.
Due Due
Due After One After Five Due
Within But Within But Within After
One Year Five Years Ten Years Ten Years Total
- ----------------------------------------------------------------------------------------------------------------------
Commercial, financial and agricultural $ 27,108 $ 66,399 $ 9,871 $ 714 $104,092
Real estate - construction 5,392 3,554 1,438 1,568 11,952
- ----------------------------------------------------------------------------------------------------------------------
Total $ 32,500 $ 69,953 $ 11,309 $ 2,282 $116,044
======================================================================================================================
Loans due after one year:
Fixed rate $ 59,775
Floating or adjustable rate 23,769
- ------------------------------------------------------
Total $ 83,544
======================================================
Lending efforts are concentrated primarily in the Michigan communities in which
Commercial's branches are located. Commercial also finances projects in other
communities generally as a result of supporting the business activities of our
customers and their related interests. Commercial has no foreign loans.
2002 COMPARED TO 2001
Total loans increased $16.4 million or 9.8% during 2002. The Bank's lenders are
primarily focused on developing residential real estate markets and business
loan customers. Both areas increased during 2002. Commercial, financial and
agricultural loan category grew $11.5 million or 12.5%. Real estate-mortgages
increased $5.8 million or 10.3%.
2001 COMPARED TO 2000
Total loans decreased $8.8 million or 5.0% during 2001. Loan demand decreased in
response to the slowing economy. This is best reflected in the real
estate-construction category, which decreased $6.8 million. Management also
elected to sell the majority of 15 and 30 year fixed rate residential real
estate loans originated during 2001. The result was a decrease in real estate
mortgages of $2.1 million.
- --------------------------------------------------------------------------------
Asset Quality
- --------------------------------------------------------------------------------
The following table summarizes non-accrual, past due and restructured loans:
December 31,
2002 2001 2000 1999 1998
- ----------------------------------------------------------------------------------------------------------------------
(In thousands)
Non-accrual loans $5,676 $ 388 $ 354 $ 963 $ 25
Accruing loans past due 90 days or more -- 75 -- 14 30
Restructured loans 349 -- -- -- 37
- ----------------------------------------------------------------------------------------------------------------------
Total non-performing loans 6,025 463 354 977 92
Repossessed assets, and other real estate 121 1,000 42 -- --
- ----------------------------------------------------------------------------------------------------------------------
Total non-performing assets $6,146 $1,463 $ 396 $ 977 $ 92
======================================================================================================================
Total non-performing loans
as a percentage of total loans 3.27% .28% .20% .65% .07%
======================================================================================================================
Total non-performing assets as a percentage
of total assets 2.58% .67% .18% .51% .05%
======================================================================================================================
Through Officer and Director Loan Committees, management reviews and monitors
the quality of the various loan portfolios. Loan performance is also reviewed
annually by independent, external loan review personnel. The scope of the
independent loan review is established by the Audit Committee. Independent loan
review results are communicated in writing to the Audit Committee and the Board
of Directors.
Loans are placed on non-accrual status when principal or interest is past due 90
days or more, the loan is not well-secured, and is in the process of collection
or when reasonable doubt exists concerning collectibility of interest or
principal. Any interest previously accrued in the current period, but not
collected, is reversed and charged against current earnings.
As of December 31, 2002 there were no concentrations of loans exceeding 10% of
total loans.
Non-performing loans have increased from $463,000 to $6.0 million, a $5.6
million increase. The $6.0 million represents six business loan relationships.
In addition to the $6.0 million in non-performing loans, management has
identified an additional $2.6 million as impaired, which are still accruing.
These customers are current and paying all loans as agreed as of December 31,
2002.
- --------------------------------------------------------------------------------
Provision and Allowance for Loan Losses
- --------------------------------------------------------------------------------
The provision for loan losses is the amount added to the allowance for loan
losses to absorb losses that are currently believed to have been incurred. The
loan loss provision is based on historical loss experience, loan growth,
performance of the portfolio, and general market conditions, which, in
management's judgment, deserve current recognition in maintaining an adequate
allowance for loan losses. During 2002, Commercial modified its methodology to
more accurately reflect the performance of its portfolio over time. The effect
of this change has been to reduce the unallocated portion of the allowance for
loan loss compared to prior years.
Management classifies loans into one of three classifications for the purpose of
calculating the appropriate allowance for loan loss: non-classified, watch loans
and
substandard/doubtful loans. Within these three classifications management has
identified four loan categories: personal, credit lines, residential real estate
and business.
Non-classified loans are loans that are viewed as homogeneous categories. These
loans are generally current and performing as agreed. Commercial establishes a
reserve on these categories of non-classified loans using historical loss
experience. The loss experience is updated at least annually.
Watch credits are loans that management has identified as having some change
that requires additional loan officer monitoring. These loans are generally
paying as agreed, however, the ability to meet debt obligations, while adequate,
has deteriorated. These loans are generally not considered impaired.
Substandard and doubtful loans are commercial loans that management reviews for
impairment under FAS 114 and 118. Management reviews these loans individually
for impairment using either the present value of expected cash flow or the value
of collateral. Loans in this category can be impaired, non-performing, both nor
neither. Generally, loans in this category are considered impaired. A specific
reserve is calculated for each loan however, the total allowance is available
for any loan.
2002 COMPARED TO 2001
For purposes of evaluating the adequacy of the allowance, the performance of the
loan portfolio is divided into three categories of loans: residential mortgages,
consumer and business loans. A general provision is determined for each of these
categories using the historical loss experience of each category over the last
five years.
Historically, Commercial's loan portfolio can be described as performing well,
except for periodic problems with one or two business loan customers. Commercial
recorded net charge-offs of $484,000 for the year. Of the $538,000 in gross
charge-offs, $511,000 relates to one business loan relationship. Excluding this
charge-off, Commercial recorded net recoveries of $27,000.
The residential real estate loan portfolio has experienced net recoveries during
the last five calendar years of $70,000. Management exited the indirect
automobile market approximately 5 years ago and focused consumer lending efforts
at our existing customer base. As a result, the consumer loan portfolio has
experienced net recoveries in three of the last five calendar years. The Bank
has recorded a total of net consumer loan recoveries for the last four calendar
years of $5,000. Despite a slowing economy, the consumer and residential real
estate portfolios continue to perform at levels consistent with prior years.
The business loan portfolio, however, is not performing as well compared to
historical trends. In accordance with SFAS No. 114 and 118, management
identifies specific loans that are experiencing financial difficulty, evaluates
each loan for impairment and attempts to identify a specific allocation of the
allowance for each loan. The dollar amount of loans identified as impaired has
increased from $463,000 at December 31, 2001 to $8.7 million at December 31,
2002. Of the $8.7 million, management has placed $5.7 million on non-accrual.
Though this trend is negative and does warrant an increase in the allowance for
loan loss, there are mitigating circumstances which management believes limits
the need to increase the allowance above current levels: Commercial Bank is
receiving regular payments on all but one of the loans placed on non-accrual,
and management believes the loss exposure related to $3.6 million of non-accrual
loans is zero based on an assessment of collateral and the current operating
condition of the businesses.
The loans identified as non-performing and impaired are generally well secured
by real estate. Of the $8.7 million identified as impaired $5.9 million have
specific allocations. The total allocated to the impaired loans is $2.1 million
with approximately $1.5 million allocated to one loan relationship.
Though no assurance can be provided that the financial condition of these
customers will continue to improve, there are indications that the financial
condition of the non-accrual loan customers is generally stable with positive
short-term outlooks. For these reasons, management increased the provision for
loan losses from $375,000 during 2001 to $681,000 during 2002.
2001 COMPARED TO 2000
Management noted that the combination of interest rate increases implemented by
the Federal Reserve during 2000 and events of September 11th slowed the economy.
In addition to anecdotal evidence that the local economy slowed, management
noted an increase in past due loans.
For these reasons, management increased the provision for loan losses to
$375,000 for 2001 from $360,000 in 2000.
The allowance for loan losses has been allocated according to the amount deemed
to be reasonably necessary to provide for the probability of losses being
incurred as follows:
December 31,
2 0 0 2 2 0 0 1 2 0 0 0 1 9 9 9 1 9 9 8
PERCENT Percent Percent Percent Percent
OF LOANS of Loans of Loans of Loans of Loans
TO TOTAL to Total to Total to Total to Total
ALLOWANCE LOANS Allowance Loans Allowance Loans Allowance Loans Allowance Loans
- -----------------------------------------------------------------------------------------------------------------------------------
(In thousands)
Commercial, financial
and agricultural $2,398 56.43% $ 993 55.09% $1,265 51.95% $1,352 52.55% $ 596 51.72%
Real estate - construction 26 6.48 15 7.47 17 10.92 -- 10.59 -- 8.19
Real estate - mortgage 122 33.43 114 33.27 120 32.77 100 30.88 96 31.64
Consumer and other 92 3.66 342 4.17 427 4.36 351 5.98 362 8.45
Unallocated 145 -- 1,122 -- 716 -- 989 -- 1,290 --
- -----------------------------------------------------------------------------------------------------------------------------------
Total $2,783 100.00% $2,586 100.00% $2,545 100.00% $2,792 100.00% $2,344 100.00%
===================================================================================================================================
The following table summarizes changes in the allowance for possible loan
losses.
Years ended December 31,
2002 2001 2000 1999 1998
- ----------------------------------------------------------------------------------------------------------------------------
(In thousands)
Loans
Amount of loans outstanding at
end of year $ 184,448 $ 168,013 $ 176,833 $ 152,467 $ 135,870
============================================================================================================================
Daily average of loans
outstanding for the year $ 179,831 $ 172,714 $ 164,389 $ 143,026 $ 128,312
============================================================================================================================
Balance of allowance at beginning of year $ 2,586 $ 2,545 $ 2,792 $ 2,344 $ 2,064
Loans charged off:
Commercial, financial and agricultural (511) (389) (662) -- (33)
Real estate - mortgage -- -- -- -- --
Consumer and other (27) (27) (28) (29) (139)
- ----------------------------------------------------------------------------------------------------------------------------
Total loans charged off (538) (416) (690) (29) (172)
- ----------------------------------------------------------------------------------------------------------------------------
Recoveries of loans previously charged off:
Commercial, financial, and agricultural 26 48 10 76 33
Real estate - mortgage -- 1 44 15 10
Consumer and other 28 33 29 26 49
- ----------------------------------------------------------------------------------------------------------------------------
Total recoveries 54 82 83 117 92
- ----------------------------------------------------------------------------------------------------------------------------
Net (charge-offs)/recoveries (484) (334) (607) 88 (80)
Provision for loan losses (1) 681 375 360 360 360
- ----------------------------------------------------------------------------------------------------------------------------
Allowance at end of period $ 2,783 $ 2,586 $ 2,545 $ 2,792 $ 2,344
============================================================================================================================
Ratio of net (charge-offs)/recoveries during period to
average loans outstanding during
the period (.27)% (.19)% (.37)% .06% (.06)%
============================================================================================================================
Ratio of allowance for loan losses to
loans outstanding at end of period 1.51% 1.54% 1.44% 1.83% 1.73%
============================================================================================================================
(1)The provision for loan losses charged to expense is based on loan loss
experience, loan growth and other factors which, in management's judgment,
deserve current recognition in maintaining an adequate allowance for loan
losses. These other factors include, but are not limited to, a review of current
economic conditions as they relate to loan collectibility and reviews of
specific loans to evaluate their collectibility.
- --------------------------------------------------------------------------------
Liquidity
- --------------------------------------------------------------------------------
Liquidity is generally defined as the ability to meet cash flow needs of
customers for loans and deposit withdrawals. To meet cash flow requirements,
sufficient sources of liquid funds must be available. These sources include
short-term investments, repayments of loans, maturing and called securities,
sales of assets, growth in deposits and other liabilities and profits.
At December 31, 2002, Commercial had $6.9 million in Federal Funds sold compared
to $5.0 at December 31, 2001. The Bank also has $3.9 million of additional
borrowing capacity, based on the collateral formula, at the Federal Home Loan
Bank and $9.0 million of borrowing capacity with correspondent banks. The
Federal Reserve also approved the Bank for a $1.5 million line of credit with
the Federal Reserve Discount Window.
During 2002, Commercial generated $4.5 million in cash from operating
activities. All of these sources are available to meet cash flow needs of loan
and deposit customers.
Commercial also needs cash to pay dividends to its shareholders. The primary
source of cash is the dividends paid to the parent by the Bank. Management
believes that cash from operations is sufficient to supply the cash needed to
continue paying a reasonable dividend. Commercial was also approved for a $1.5
million line of credit with a correspondent institution that expired in the
fourth quarter of 2002. At December 31, 2002 Commercial was negotiating a
replacement line of credit. This line of credit, however, is currently not
available.
- --------------------------------------------------------------------------------
Capital Resources
- --------------------------------------------------------------------------------
At December 31, 2002, capital totaled $23,704,000. Management monitors the
capital levels of the Corporation and the Bank to provide for current and future
business opportunities and to meet regulatory guidelines for "well capitalized"
institutions. "Well capitalized" institutions are eligible for reduced FDIC
premiums, and also enjoy other reduced regulatory restrictions.
At December 31, 2002, the Corporation and the Bank exceeded all regulatory
minimum capital requirements and are considered to be "well capitalized".
- --------------------------------------------------------------------------------
Asset Liability Management
- --------------------------------------------------------------------------------
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Commercial's primary market risk exposure is interest rate risk and, to a lesser
extent, liquidity risk. Commercial's transactions are denominated in U.S.
dollars with no specific foreign exchange exposure. Also, Commercial has a
limited exposure to commodity prices related to agricultural loans. Any impacts
that changes in foreign exchange rate and commodity prices would have on
interest rates are assumed to be insignificant.
Interest rate risk (IRR) is the exposure of a banking organization's financial
condition to movements in interest rates. Accepting this risk can be an
important source of profitability and stockholder value; however, excessive
levels of IRR could pose a threat to earnings and capital. Accordingly,
effective risk management that maintains IRR at prudent levels is essential to
Commercial's safety and soundness. Evaluating the quantitative level of IRR
exposure requires the assessment of existing and potential future effects of
changes in interest rates on its consolidated financial condition, including
capital adequacy, earnings, liquidity, and, where appropriate, asset quality.
Commercial's Asset/Liability Committee ("Committee") is responsible for managing
this process.
Commercial derives the majority of income from the excess of interest collected
over interest paid. The rates of interest earned on its assets and owed on its
liabilities generally are established contractually for a period of time. Since
market interest rates change over time, Commercial is exposed to lower profit
margins (or losses) if it cannot adapt to interest rate changes.
Commercial is also subject to repayment risk when interest rates fall. For
example, mortgage loans and other financial assets may be prepaid by a debtor so
that the debtor may refinance their obligations at lower rates. Prepayment of
assets carrying higher rates reduces interest income and overall asset yields.
Fluctuating interest rates and prepayment risk provide a challenge in managing
the net interest income of the Bank. For example: the Bank may fund a 15 year
fixed rate residential real estate loan with a long term amortizing Federal Home
Loan Bank Advance. In a stable interest rate environment, the Bank can
reasonably predict the net interest income earned. However, if rates fall
significantly, the residential mortgage customer may refinance their mortgage at
a lower rate. The Bank continues to pay the higher rate on the Federal Home Loan
Bank advance, thus eroding net interest income. In an alternative scenario, the
Bank funds the same 15 year fixed rate residential real estate loan with 1 year
certificates of deposits. If rates rise at the end of one year, the Bank will
pay more interest to continue to fund the residential mortgage loan with 1 year
certificates of deposit. The net interest income will be lower in year two than
it was in the first year of the mortgage loan.
An additional challenge management faces in managing net interest income is the
fact that what would maximize net interest income to the Bank may be in conflict
with the customers request for products and services. In the current low
interest rate environment, management believes that there is greater risk that
interest rates will rise over time rather than fall. Management would prefer to
offer variable rate loan products that would reprice upward as interest rates
rise. However, our loan customers are generally requesting long term fixed rate
loans. On the funding side, management would like to extend the maturities of
its liabilities to match the loan customers request for longer term fixed rate
loans. However, our deposit customers are reluctant to commit to long term
certificate of deposits.
Commercial's primary tool in measuring interest rate risk is to perform a
simulation analysis. This analysis forecasts the effect of various interest rate
changes on the balance sheet, economic value of equity, net interest income and
net income. One common scenario performed by the Committee is to "shock" the
balance sheet by assuming that Commercial has just experienced an immediate and
parallel shift in the yield curve up or down 200 basis points. The model, using
data and assumptions determined by management, reprice assets and liabilities at
new market rates. The objective of this testing is to determine how the Bank's
net interest income and the economic value of equity are affected by extreme
changes in interest rates. These results are recorded and compared to previous
results. Management performs this calculation quarterly.
The limitation to this methodology is that the interest rate curve rarely shifts
200 basis points immediate and parallel. In addition, a downward 200 basis point
shift in today's interest rate environment is not likely. Management is in the
process of evaluating software that would allow for comparison of alternative
interest rate scenarios, and provide management with better information to
assess alternative funding and investing strategies.
The following table illustrates how Commercial's net interest income might be
affected by a 200 basis point immediate and parallel shift in the yield curve.
The Committee applies the percentage change anticipated in net interest income
to the net interest income actually earned to determine if the change is within
acceptable limits. In the current low interest rate environment Commercial's net
interest income might decrease $539,000 if interest rates increase 200 basis
points in an immediate parallel shift in the yield curve. This compares to a
$225,000 decrease for the year ending December 31, 2001.
Net Interest Percentage Projected
Income at Change in Net Net Interest
Interest rate change December 31, 2002 Interest Income Income
- -------------------------------------------------------------------------------------------------------
- -200 BASIS POINTS $ 8,922,000 (1.56)% 8,782,000
0 BASIS POINTS 8,922,000 0.00 8,922,000
+200 BASIS POINTS 8,922,000 (6.04) 8,383,000
Net Interest Percentage Projected
Income at Change in Net Net Interest
Interest rate change December 31, 2001 Interest Income Income
- -------------------------------------------------------------------------------------------------------
- -200 basis points $ 8,952,000 1.32% $ 9,070,000
0 basis points 8,952,000 0.00 8,952,000
+200 basis points 8,952,000 (2.51) 8,727,000
The following table illustrates how Commercial's economic value of equity might
be impacted if interest rates increase or decrease 200 basis points. The
economic value of equity reflects the impact the change in interest rates has
over the long term (greater than 12 months). If rates increase 200 basis points
immediately, the economic value of equity would decrease $1.7 million or 9.44%.
This compares to an estimated decrease of $3.1 million or 10.29% decrease for
the year ending December 31, 2001.
December 31, 2002
Percentage Projected
Book Value Economic Change in Economic Economic
Interest rate change of Equity Value of Equity Value of Equity Value of Equity
- -------------------------------------------------------------------------------------------------------
- -200 BASIS POINTS $ 23,704,000 $ 29,748,000 10.32% $ 32,818,000
0 BASIS POINTS 23,704,000 29,748,000 0.00 29,748,000
+200 BASIS POINTS 23,704,000 29,748,000 (9.44) 26,970,000
December 31, 2001
Percentage Projected
Book Value Economic Change in Economic Economic
Interest rate change of Equity Value of Equity Value of Equity Value of Equity
- -------------------------------------------------------------------------------------------------------
- -200 basis points $ 22,064,000 $ 30,214,000 5.83% $ 31,975,000
0 basis points 22,064,000 30,214.000 0.00 30,214,000
+200 basis points 22,064,000 30,214,000 (10.29) 27,105,000
- --------------------------------------------------------------------------------
Forward Looking Statement
- --------------------------------------------------------------------------------
This discussion and analysis of financial condition and results of operations
and other sections of this Annual 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
Commercial itself.
Words such as "anticipates", "believes", "estimates", "expects", "forecasts",
"foresee", "intends", "is likely",
"plans", "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, Commercial 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;
- - changes in 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 as well as their ability to repay loans;
and
- - changes in 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.
- --------------------------------------------------------------------------------
Management's Responsibility for Financial Statements
- --------------------------------------------------------------------------------
Management is responsible for the preparation of the Commercial National
Financial Corporation's consolidated financial statements and related
information appearing in this Annual Report. Management believes that the
consolidated financial statements fairly reflect the form and substance of
transactions and reasonably present Commercial National Financial Corporation's
financial position and results of operations and were prepared in conformity
with generally accepted accounting principles in the United States of America.
Management also has included in Commercial's financial statements, amounts that
are based on estimates and judgments which it believes are reasonable under the
circumstances.
Commercial National Financial Corporation maintains internal controls designed
to provide reasonable assurance that all assets are safeguarded and financial
records are reliable for preparing the consolidated financial statements.
Commercial complies with laws and regulations relating to safety and soundness
which are designated by the FDIC and other appropriate federal banking agencies.
The selection and training of qualified personnel and the establishment and
communication of accounting and administrative policies and procedures are
elements of this control system. The effectiveness of internal controls is
monitored by a program of internal audit. Management recognizes that the cost of
internal controls should not exceed the benefits derived and that there are
inherent limitations to be considered. Management believes that Commercial
National Financial Corporation provides the appropriate balance between costs of
controls and the related benefits.
The independent auditors have audited Commercial's consolidated financial
statements in accordance with auditing standards generally accepted in the
United States of America and provide an objective, independent review of the
fairness of the reported operating results and financial position. The Board of
Directors of Commercial National Financial Corporation has an Audit Committee
composed of five non-management Directors. The Committee meets periodically with
the internal auditors and the independent auditors.
Jeffrey S. Barker Patrick G. Duffy
President and Executive Vice President and
Chief Executive Officer Chief Financial Officer
COMMERCIAL NATIONAL FINANCIAL CORPORATION
- --------------------------------------------------------------------------------
Report of Independent Auditors
- --------------------------------------------------------------------------------
[CROWE LOGO]
Board of Directors and Shareholders
Commercial National Financial Corporation
Ithaca, Michigan
We have audited the accompanying consolidated balance sheets of Commercial
National Financial Corporation as of December 31, 2002 and 2001, and the related
consolidated statements of income, changes in shareholders' equity and cash
flows for each of the three years in the period ended December 31, 2002. These
financial statements are the responsibility of the Corporation's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free from material misstatement. An audit includes examining, on
a test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Commercial National
Financial Corporation as of December 31, 2002 and 2001, and the results of its
operations and its cash flows for each of the three years in the period ended
December 31, 2002 in conformity with accounting principles generally accepted in
the United States of America.
Crowe, Chizek and Company LLP
Grand Rapids, Michigan
January 30, 2003
COMMERCIAL NATIONAL FINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS
December 31,
2002 2001
- ------------------------------------------------------------------------------------------------------------------------
ASSETS
Cash and due from banks $ 8,784,826 $ 7,282,523
Federal funds sold 6,850,000 5,000,000
Other interest bearing deposits 3,634,988 2,064,802
- ------------------------------------------------------------------------------------------------------------------------
Total cash and cash equivalents 19,269,814 14,347,325
Securities available for sale 21,345,896 20,471,202
Securities held to maturity (fair value $ 4,911,696 - 2002, $7,730,608 - 2001) 4,689,025 7,496,656
Federal Home Loan Bank stock, at cost 1,647,000 1,391,300
Gross loans receivable 184,448,296 168,012,689
Allowance for loan losses (2,783,234) (2,586,025)
- ------------------------------------------------------------------------------------------------------------------------
Net loans receivable 181,665,062 165,426,664
Bank owned life insurance 3,231,374 3,050,296
Premises and equipment, net 3,687,151 2,599,704
Accrued interest receivable and other assets 2,715,261 3,614,733
- ------------------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $ 238,250,583 $ 218,397,880
========================================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Deposits
Noninterest-bearing $ 21,495,410 $ 22,199,334
Interest-bearing demand 29,872,655 29,033,317
Savings 59,432,935 50,116,477
Time 55,258,479 61,229,483
- ------------------------------------------------------------------------------------------------------------------------
Total deposits 166,059,479 162,578,611
Securities sold under agreements to repurchase 14,266,239 6,237,585
Other short-term borrowings 491,840 136,549
Federal Home Loan Bank advances 32,807,086 26,092,551
Accrued expenses and other liabilities 921,967 1,288,306
- ------------------------------------------------------------------------------------------------------------------------
Total liabilities 214,546,611 196,333,602
Shareholders' equity
Common stock and paid-in-capital, no par value-
5,000,000 shares authorized; shares issued
and outstanding 2002 - 3,801,421 and 2001 - 3,547,700 23,255,499 22,104,910
Retained earnings (deficit) 3,908 (416,257)
Accumulated other comprehensive income, net of tax 444,565 375,625
- ------------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 23,703,972 22,064,278
- ------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 238,250,583 $ 218,397,880
========================================================================================================================
See accompanying notes
COMMERCIAL NATIONAL FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
Years ended December 31,
2002 2001 2000
- -------------------------------------------------------------------------------------------------------------------
Interest and dividend income
Loans, including fees $ 12,664,572 $ 14,299,287 $ 14,520,084
Taxable securities 772,644 884,291 940,900
Nontaxable securities 473,237 557,143 588,049
Federal funds sold 89,126 218,151 42,602
Federal Home Loan Bank stock dividends 90,562 103,424 114,801
Interest on other deposits 21,881 34,930 94,510
- -------------------------------------------------------------------------------------------------------------------
Total interest and dividend income 14,112,022 16,097,226 16,300,946
Interest expense
Deposits 3,387,852 5,348,350 5,547,894
Securities sold under agreements to repurchase 155,698 313,409 399,902
Federal Home Loan Bank advances 1,641,283 1,460,433 1,296,623
Other 5,644 22,844 54,898
- -------------------------------------------------------------------------------------------------------------------
Total interest expense 5,190,477 7,145,036 7,299,317
- -------------------------------------------------------------------------------------------------------------------
NET INTEREST INCOME 8,921,545 8,952,190 9,001,629
Provision for loan losses 681,000 375,000 360,000
- -------------------------------------------------------------------------------------------------------------------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 8,240,545 8,577,190 8,641,629
- -------------------------------------------------------------------------------------------------------------------
Noninterest income
Service charges and fees 493,776 453,356 443,723
Net gains on loan sales 697,717 612,998 82,957
Receivable financing fees 157,933 226,598 237,349
Bank owned life insurance dividends 181,078 50,296 -
Net security gains/(losses) 27,565 210,674 (228)
Other 265,432 287,366 262,016
- -------------------------------------------------------------------------------------------------------------------
Total noninterest income 1,823,501 1,841,288 1,025,817
- -------------------------------------------------------------------------------------------------------------------
Noninterest expense
Salaries and employee benefits 3,353,616 3,230,200 2,957,475
Occupancy and equipment 930,711 972,010 1,005,865
FDIC insurance 30,708 30,588 30,312
Printing, postage and supplies 299,001 273,252 270,787
Professional and outside services 342,857 353,872 302,134
Director fees 181,700 155,650 164,500
Other 894,573 869,318 840,843
- -------------------------------------------------------------------------------------------------------------------
Total noninterest expense 6,033,166 5,884,890 5,571,916
- -------------------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAX EXPENSE 4,030,880 4,533,588 4,095,530
Income tax expense 1,130,000 1,331,000 1,193,000
- -------------------------------------------------------------------------------------------------------------------
NET INCOME $ 2,900,880 $ 3,202,588 $ 2,902,530
===================================================================================================================
Per share information
Basic earnings $ .77 $ .86 $ .79
Diluted earnings $ .76 $ .86 $ .78
Dividends declared $ .54 $ .51 $ .48
See accompanying notes
COMMERCIAL NATIONAL FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
Years ended December 31, 2002, 2001, and 2000
Accumulated
Shares Other
Issued Common Retained Comprehensive Total
and Stock and Paid Earnings Income/(Loss), Shareholders'
Outstanding In Capital (Deficit) Net of Tax Equity
- -----------------------------------------------------------------------------------------------------------------------
BALANCE AT JANUARY 1, 2000 3,189,024 $ 19,946,643 $ (830,339) $(151,771) $18,964,533
Comprehensive income:
Net income 2,902,530 2,902,530
Net change in unrealized gains (losses) on
securities available for sale 543,502 543,502
Reclassification adjustment for (gains) losses
recognized in income 228 228
Tax effects (184,868) (184,868)
---------------------
Total comprehensive income 3,261,392
-----------
Cash dividends declared, $0.48 per share (1,805,059) (1,805,059)
Payment of 5% stock dividend 159,315 1,979,594 (1,981,221) (1,627)
Issued under dividend reinvestment program 48,515 570,704 570,704
Issued under stock option plans 4,357 41,643 41,643
Issued under employee benefit plan 5,273 66,032 66,032
Repurchase and retirement of shares (79,259) (987,536) (987,536)
- -----------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2000 3,327,225 21,617,080 (1,714,089) 207,091 20,110,082
Comprehensive income:
Net income 3,202,588 3,202,588
Net change in unrealized gains (losses) on
securities available for sale 466,028 466,028
Reclassification adjustment for (gains) losses
recognized in income (210,674) (210,674)
Tax effects (86,820) (86,820)
---------------------
Total comprehensive income 3,371,122
-----------
Cash dividends declared, $0.51 per share (1,904,756) (1,904,756)
Payment of 5% stock dividend 166,244 (1,288) (1,288)
Issued under dividend reinvestment program 72,254 667,093 667,093
Issued under stock option plans 3,877 36,520 36,520
Issued under employee benefit plan 3,236 30,024 30,024
Repurchase and retirement of shares (25,136) (244,519) (244,519)
- -----------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2001 3,547,700 22,104,910 (416,257) 375,625 22,064,278
COMPREHENSIVE INCOME:
NET INCOME 2,900,880 2,900,880
NET CHANGE IN UNREALIZED GAINS (LOSSES) ON
SECURITIES AVAILABLE FOR SALE 132,019 132,019
RECLASSIFICATION ADJUSTMENT FOR (GAINS) LOSSES
RECOGNIZED IN INCOME (27,565) (27,565)
TAX EFFECTS (35,514) (35,514)
---------------------
TOTAL COMPREHENSIVE INCOME 2,969,820
-----------
CASH DIVIDENDS DECLARED, $0.54 PER SHARE (2,040,876) (2,040,876)
PAYMENT OF 5% STOCK DIVIDEND 181,256 439,839 (439,839) -
ISSUED UNDER DIVIDEND REINVESTMENT PROGRAM 74,687 793,897 793,897
ISSUED UNDER STOCK OPTION PLANS 10,411 89,775 89,775
ISSUED UNDER EMPLOYEE BENEFIT PLAN 4,756 54,410 54,410
REPURCHASE AND RETIREMENT OF SHARES (17,389) (227,332) (227,332)
- -----------------------------------------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 2002 3,801,421 $ 23,255,499 $ 3,908 $ 444,565 $23,703,972
=======================================================================================================================
See accompanying notes
COMMERCIAL NATIONAL FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31, 2002, 2001, and 2000
2002 2001 2000
- -----------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 2,900,880 $ 3,202,588 $ 2,902,530
Adjustments to reconcile net income to net
cash from operating activities
Provision for loan losses 681,000 375,000 360,000
Depreciation, amortization and accretion 507,845 510,476 565,347
Net security (gain)/losses (27,565) (210,674) 228
Net gains on loan sales (697,717) (612,998) (82,957)
Originations of loans held for sale (32,728,901) (33,429,150) (4,087,779)
Proceeds from sales of loans held for sale 33,426,618 34,042,148 4,307,736
Accrued interest receivable and other assets 803,850 (1,446,264) (458,670)
Accrued expenses and other liabilities (402,199) (429,959) 196,092
- -----------------------------------------------------------------------------------------------------------------------
Net cash from operating activities 4,463,811 2,001,167 3,702,527
- -----------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of securities available for sale (7,213,146) (12,272,389) (5,016,284)
Purchases of securities held to maturity - - (552,142)
Proceeds from maturities of securities available for sale 6,360,000 9,170,000 3,675,000
Proceeds from maturities of securities held to maturity 2,823,900 1,010,000 855,000
Proceeds from sales of securities available for sale - 2,523,549 200,000
Purchases of Federal Home Loan Bank Stock (255,700) - -
Net change in loans (17,045,958) 8,523,713 (25,161,003)
Purchase of bank owned life insurance - (3,000,000) -
Purchases of premises and equipment (1,495,500) (641,764) (316,361)
- ------------------------------------------------------------------------------------------------------------------------
Net cash from investing activities (16,826,404) 5,313,109 (26,315,790)
- ------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net change in deposits 3,480,868 4,784,710 10,589,869
Net change in securities sold under agreements to repurchase 8,028,654 (1,786,182) 3,334,210
Net change in U.S. Treasury demand notes 355,291 (933,646) (1,120,444)
Proceeds from line of credit - (700,000) 700,000
Proceeds from Federal Home Loan Bank advances 14,000,000 17,000,000 36,000,000
Repayment of Federal Home Loan Bank advances (7,285,465) (17,407,449) (26,000,000)
Dividends paid and fractional shares (2,005,016) (1,874,235) (1,786,660)
Proceeds from sale of common stock 938,082 732,349 676,752
Repurchase and retirement of shares of common stock (227,332) (244,519) (987,536)
- ------------------------------------------------------------------------------------------------------------------------
Net cash from financing activities 17,285,082 (428,972) 21,406,191
- -----------------------------------------------------------------------------------------------------------------------
Net change in cash and cash equivalents 4,922,489 6,885,304 (1,207,072)
Cash and cash equivalents at beginning of year 14,347,325 7,462,021 8,669,093
- -----------------------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 19,269,814 $ 14,347,325 $ 7,462,021
=======================================================================================================================
Cash paid during the year for
Interest $ 5,281,266 $ 7,361,383 $ 7,114,180
Federal income taxes 1,430,000 1,533,000 1,096,640
See accompanying notes
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002 and 2001
- --------------------------------------------------------------------------------
Note 1 - Summary Of Significant Accounting Policies
- --------------------------------------------------------------------------------
The accounting and reporting policies of Commercial National Financial
Corporation (the Corporation) and its wholly-owned subsidiary, Commercial Bank
(the Bank) (together referred to as Commercial), conform to accounting
principles generally accepted in the United States of America and to general
practice within the banking industry. The following describes the significant
accounting and reporting policies which are employed in the preparation of the
consolidated financial statements.
PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the
accounts of the Corporation, the Bank, CNFC Mortgage Corporation and CNFC
Financial Services Inc., both wholly-owned subsidiaries of the Bank.
Intercompany accounts and transactions are eliminated in consolidation.
NATURE OF OPERATIONS, BUSINESS SEGMENTS AND CONCENTRATIONS OF CREDIT RISK The
Corporation 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
the Corporation's chief decision makers monitor the revenue stream of various
products and services, operations are managed and financial performance is
evaluated as one Corporation. Accordingly, all of Commercial's banking
operations are considered by management 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 immediately surrounding
these communities. The Bank serves these markets through nine offices located in
Gratiot and Montcalm Counties in Michigan.
USE OF ESTIMATES To prepare financial statements in conformity with accounting
principles generally accepted in the United States of America, management makes
estimates and assumptions based on available information. These estimates and
assumptions affect the amounts reported in the financial statements and the
disclosures provided, and 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 maturities 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 in other comprehensive
income. Other securities such as Federal Home Loan Bank Stock are carried at
cost.
Gains and losses on sales are determined using the amortized cost of the
specific security sold. Interest and dividend income, includes amortization of
purchase premiums and discounts. Securities are written down to fair value when
a decline in fair value is not temporary.
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.
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002 and 2001
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. In all cases, loans are placed on nonaccrual or
charged-off at an earlier date if collection of principal or interest is
considered doubtful.
All interest accrued but not received for loans placed on nonaccrual is reversed
against interest income. Interest received on such loans is accounted for on the
cash-basis or cost-recovery method, until qualifying for return to accrual.
Loans are returned to accrual status when all the principal and interest amounts
contractually due are brought current and future payments are reasonably
assured.
ALLOWANCE FOR LOAN LOSSES The allowance for loan losses is a valuation allowance
for probable incurred credit losses, increased by the provision for loan losses
and decreased by charge-offs less recoveries. Management estimates the allowance
balance using past loan loss experience, the nature and volume of 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, in
management's judgment, should be charged-off. Loan losses are charged against
the allowance when management believes the uncollectibility of a loan balance is
confirmed.
A loan is impaired 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 on an individual loan basis
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.
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.
OTHER FORECLOSED ASSETS Assets acquired in collection of a loan receivable are
recorded at the lower of cost or market 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. Other foreclosed assets amounted to $121,000 and
$1,000,000, at December 31, 2002 and 2001.
BANK OWNED LIFE INSURANCE The Corporation purchased life insurance policies on
certain officers. Corporate owned life insurance is recorded at its cash
surrender value or the amount that can be realized.
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.
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, Commercial has matched up to 6% of such deferrals at
100%.
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002 and 2001
STOCK COMPENSATION Employee compensation expense under stock options is reported
using the intrinsic value method. No stock-based compensation cost is reflected
in net income, as all options granted had an exercise plan equal to or greater
than the market price of the underlying common stock at date of grant. The
following table illustrates the effect on net income and earnings per share if
expense was measured using the fair value recognition provisions of SFAS No.
123, Accounting for Stock-Based Compensation Expense.
2002 2001 2000
- ------------------------------------------------------------------------
Net income as reported $ 2,900,880 $ 3,202,586 $ 2,902,530
Proforma net income 2,821,816 3,160,831 2,872,694
Basic earnings per share
as reported $ .77 $ .86 $ .79
Proforma basic earnings
per share $ .75 $ .86 $ .78
Diluted earnings per
share as reported $ .76 $ .86 $ .78
Proforma diluted
earnings per share $ .74 $ .85 $ .77
The proforma effects are computed using option pricing models, using the
following weighted-average assumptions as of grant date.
2002 2001 2000
- --------------------------------------------------------
Risk-free interest rate 4.08% 5.10% 5.75%
Expected life in years 9.4 9.2 4.6
Expected dividends 4.70% 5.14% 4.67%
Stock price volatility 40.82% 48.74% 22.83%
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 dilutive effect
of any additional potential common shares. Earnings and dividends per common
share are restated for all stock splits and stock dividends, including the 5%
stock dividends paid in November 2002, 2001 and 2000.
STOCK DIVIDENDS Dividends issued in stock are reported by transferring the
market value of the stock issued from retained earnings to common stock and
additional paid-in capital 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. Other comprehensive income includes the net change in
unrealized appreciation (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, as more fully
disclosed separately. 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 does 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.
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002 and 2001
NEWLY ISSUED BUT NOT YET EFFECTIVE ACCOUNTING STANDARDS
New accounting standards on asset retirement obligations, restructuring
activities and exit costs, operating leases, and early extinguishment of debt
were issued in 2002. Management determined that when the new accounting
standards are adopted in 2003 they will not have a material impact on
Commercial's financial position or results of operations.
- --------------------------------------------------------------------------------
Note 2 - Securities
- --------------------------------------------------------------------------------
The fair value of available for sale securities and the related gross unrealized
gains and losses recognized in accumulated other comprehensive income (loss)
were as follows:
GROSS GROSS
UNREALIZED UNREALIZED FAIR
AVAILABLE FOR SALE GAINS LOSSES VALUE
- -------------------------------------------------------------------------------------------------
DECEMBER 31, 2002
- -------------------------------------------------------------------------------------------------
U.S. TREASURIES AND GOVERNMENT AGENCIES $ 477,156 $ (434) $ 16,103,925
STATE AND MUNICIPALS 207,171 (11,780) 4,739,745
CORPORATE 1,470 - 502,226
- -------------------------------------------------------------------------------------------------
TOTAL $ 685,797 $ (12,214) $ 21,345,896
=================================================================================================
December 31, 2001
- -------------------------------------------------------------------------------------------------
U.S. Treasuries and government agencies $ 504,915 $ - $ 15,092,944
State and municipals 79,299 (33,753) 4,269,965
Corporate 18,669 - 1,108,293
- -------------------------------------------------------------------------------------------------
Total $ 602,883 $ (33,753) $ 20,471,202
=================================================================================================
The carrying amount, unrecognized gains and losses, and fair value of securities
held to maturity were as follows:
GROSS GROSS
CARRYING UNRECOGNIZED UNRECOGNIZED FAIR
HELD TO MATURITY AMOUNT GAINS LOSSES VALUE
- -----------------------------------------------------------------------------------------------------------------------
DECEMBER 31, 2002
- -----------------------------------------------------------------------------------------------------------------------
STATE AND MUNICIPALS $ 4,689,025 $ 222,671 $ - $ 4,911,696
=======================================================================================================================
December 31, 2001
- -----------------------------------------------------------------------------------------------------------------------
State and municipals $ 7,496,656 $ 233,952 $ - $ 7,730,608
=======================================================================================================================
The fair value of debt securities and carrying amounts, if different, at
year-end 2002, by contractual maturity are shown below.
Available for Sale Held to Maturity
- -----------------------------------------------------------------------------------------------
Fair Carrying Fair
Value Amount Value
- -----------------------------------------------------------------------------------------------
Due in one year or less $ 9,984,747 $ 1,636,431 $ 1,663,479
Due from one to five years 9,274,975 2,872,594 3,064,163
Due from five to ten years 1,690,964 180,000 184,054
Due from ten years plus 395,210 - -
- -----------------------------------------------------------------------------------------------
Total $ 21,345,896 $ 4,689,025 $ 4,911,696
===============================================================================================
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002 and 2001
There were eight security sales in 2001 and one security sale during 2000 and
1999. All sales, except the one sale recorded during 2000, resulted in a gross
gain.
In addition to Federal Home Loan Bank (FHLB) stock, securities having an
amortized cost of approximately $16,122,000 and $8,948,000 at year-end 2002 and
2001 were pledged to secure FHLB advances, public deposits, securities sold
under agreements to repurchase and U.S. Treasury demand notes.
Except as indicated, total securities of any state (including all its political
subdivisions) were less than 10% of shareholders' equity. At year-end 2002 and
2001, the amortized cost of securities issued by the state of Michigan and all
its political subdivisions totaled $6,407,000 and $8,865,000 with an estimated
market value of $6,668,000 and $9,061,000.
- --------------------------------------------------------------------------------
Note 3 - Loans Receivable
- --------------------------------------------------------------------------------
Year-end loans receivable are as follows:
2002 2001
- ----------------------------------------------------------------------
Real estate
Secured by single family
residential properties $ 61,651,977 $ 55,892,943
Secured by non-farm
nonresidential properties 62,854,082 50,205,498
Secured by farmland 2,173,633 2,246,543
Secured by multi-family
residential properties 10,545,095 14,356,263
Construction/land development 11,951,805 12,556,297
Installment loans 6,751,968 6,997,245
Commercial 28,519,736 25,757,900
- ----------------------------------------------------------------------
Gross loans receivable 184,448,296 168,012,689
Allowance for loan losses (2,783,234) (2,586,025)
- ----------------------------------------------------------------------
Net loans receivable $ 181,665,062 $ 165,426,664
======================================================================
Loans held for sale, included in real estate secured by single family
residential properties, were $1,673,000 and $1,042,000 at year-end 2002 and
2001.
Certain directors and executive officers, including associates of such persons,
were loan customers of Commercial during 2002 and 2001. A summary of aggregate
related party loan activity for loans aggregating $60,000 or more to any related
party is as follows:
2002 2001
- -----------------------------------------------------------
Balance at beginning of year $ 4,413,000 $ 7,486,000
New loans 12,537,000 5,983,000
Repayments (11,141,000) (6,724,000)
Other changes, net 488,000 (2,332,000)
- -----------------------------------------------------------
Balance at end of year $ 6,297,000 $ 4,413,000
===========================================================
Other changes include adjustments for persons included in one reporting period
that are not reported in the other reporting period.
- --------------------------------------------------------------------------------
Note 4 - Allowance For Loan Losses
- --------------------------------------------------------------------------------
Activity in the allowance for loan losses was as follows:
2002 2001 2000
- ------------------------------------------------------------------------------
Beginning balance $ 2,586,025 $ 2,545,363 $ 2,792,293
Loan charge-offs (538,567) (415,904) (689,892)
Loan recoveries 54,776 81,566 82,962
- ------------------------------------------------------------------------------
Net loan recoveries
(charge-offs) (483,791) (334,338) (606,930)
Provision for loan losses 681,000 375,000 360,000
- ------------------------------------------------------------------------------
Ending balance $ 2,783,234 $ 2,586,025 $ 2,545,363
==============================================================================
Impaired loans were as follows:
2002 2001 2000
- ----------------------------------------------------------------------------
Year-end loans with
allowance for loan
losses allocated $5,907,493 $3,621,686 $ 242,924
Year-end loans with
no allowance
for loan losses allocated 2,757,205 -- --
- ----------------------------------------------------------------------------
Total impaired loans $8,664,698 $3,621,686 $ 242,924
============================================================================
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002 and 2001
Additional information regarding impaired loans is as follows:
2002 2001 2000
- --------------------------------------------------------------------------
Amount of the
allowance allocated $2,100,175 $ 31,730 $ 1,200
Average balance of
impaired loans during
the year 7,249,949 4,692,348 909,387
Interest income
recognized during
impairment 82,223 271,996 --
Cash-basis interest income
recognized 85,392 228,905 --
December 31,
2002 2001
- ------------------------------------------------------------------------
Non-accrual loans $5,676,390 $ 387,822
Accruing loans past due 90 days or more -- 74,664
Restructured loans 348,520 --
- ------------------------------------------------------------------------
Total non-performing loans $6,024,910 $ 462,486
========================================================================
Total non-performing loans
as a percentage of total loans 3.27% .28%
========================================================================
- --------------------------------------------------------------------------------
Note 5 - Loan Servicing
- --------------------------------------------------------------------------------
Mortgage loans serviced for others are not reported as assets. These loans
totaled $62,072,000 and $53,507,000 at year-end 2002 and 2001. Related escrow
deposit balances were approximately $(25,000) and $(3,000).
- --------------------------------------------------------------------------------
Note 6 - Premises And Equipment, Net
- --------------------------------------------------------------------------------
Year-end premises and equipment consist of:
2002 2001
- ------------------------------------------------------------
Land $ 810,059 $ 775,395
Buildings and improvements 3,637,688 2,712,577
Equipment 2,115,653 2,326,865
- ------------------------------------------------------------
Total cost 6,563,400 5,814,837
Less accumulated depreciation (2,876,249) (3,215,133)
- ------------------------------------------------------------
Net premises and equipment $ 3,687,151 $ 2,599,704
============================================================
Depreciation expense was $408,054, $507,232 and $545,696 in 2002, 2001 and 2000.
- --------------------------------------------------------------------------------
Note 7 - Deposits
- --------------------------------------------------------------------------------
At year-end 2002, stated maturities of time deposits were as follows, for the
years ending December 31:
2003 $ 32,586,118
2004 13,259,234
2005 4,861,584
2006 1,859,923
2007 2,069,808
Thereafter 621,812
- -------------------------------------------------------
Total time deposits $ 55,258,479
=======================================================
Time deposits in denominations of $100,000 or more were $12,613,000 and
$16,703,000 at year-end 2002 and 2001. At year-end 2002, stated maturities of
time deposits in denominations of $100,000 or more were as follows:
In 3 months or less $ 4,558,000
Over 3 through 6 months 2,347,000
Over 6 through 12 months 2,408,000
Over 12 months 3,300,000
- -----------------------------------------------------
Total time deposits > $100,000 $ 12,613,000
=====================================================
Related party deposits were $1,173,000 and $967,000 at year-end 2002 and 2001.
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002 and 2001
- --------------------------------------------------------------------------------
Note 8 - Securities Sold Under Agreement to Repurchase
- --------------------------------------------------------------------------------
Information concerning securities sold under agreements to repurchase is
summarized as follows:
2002 2001
- -------------------------------------------------------
Amount outstanding at
year-end $ 14,266,239 $ 6,237,585
Weighted average interest
rate at year-end 1.43% 1.71%
Average daily balance
during the year $ 9,382,805 $ 8,458,557
Weighted average interest
rate during the year 1.65% 3.53%
Maximum month end
balance during the year $ 14,266,239 $ 9,863,415
- --------------------------------------------------------------------------------
Note 9 - Federal Home Loan Bank Advances
- --------------------------------------------------------------------------------
Federal Home Loan Bank (FHLB) advances totaled $32,807,000 and $26,093,000 at
year-end 2002 and 2001. The $32,807,000 of advances for 2002 have fixed interest
rates ranging from 3.91% to 7.31% with an average rate of 5.37%. They mature
from January 14, 2003, through March 7, 2011. The $26,093,000 of advances
outstanding at December 31, 2001 have fixed interest rates ranging from 4.26% to
7.31% with an average rate of 5.80%. They mature from February 27, 2002, through
March 7, 2011.
At year-end, the type of advances were as follows:
2002 2001
- -----------------------------------------------------
Amortizing $ 25,307,086 $ 17,592,551
Bullet 3,500,000 4,500,000
Putable 4,000,000 4,000,000
- -----------------------------------------------------
Total $ 32,807,086 $ 26,092,551
=====================================================
Pursuant to collateral agreements with the Federal Home Loan Bank, in addition
to Federal Home Loan Bank stock, advances are secured, under a blanket lien
arrangement, by qualified 1-to-4 family mortgage loans, qualified multi-family
loans and SBA government guaranteed loans with a carrying value of approximately
$53,720,000 and $50,521,000 at year-end 2002 and 2001.
At year-end, scheduled principal reductions on these advances were as follows
for the years ending December 31:
2002 2001
- --------------------------------------------------------
2002 $ - $ 4,649,946
2003 8,702,864 7,550,839
2004 5,138,642 3,866,746
2005 8,125,567 6,535,396
2006 1,923,599 565,800
Thereafter 8,916,414 2,923,824
- --------------------------------------------------------
Total FHLB advances $ 32,807,086 $ 26,092,551
========================================================
- --------------------------------------------------------------------------------
Note 10 - Other Short-term Borrowings
- --------------------------------------------------------------------------------
During 2000, CNFC established a $1.5 million line of credit with a correspondent
bank. The interest rate is LIBOR plus 1.75% and is fixed for periods of one, two
or three months, generally determined at the option of the borrower. The line of
credit was available for a period of 1 year. The line of credit expired during
2002. A replacement line of credit is not available at December 31, 2002. At
December 31, 2001, $0 was outstanding on the line.
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002 and 2001
- --------------------------------------------------------------------------------
Note 11 - Employee Benefits
- --------------------------------------------------------------------------------
EMPLOYEE BENEFIT PLAN Commercial's employee benefit plan allows participants to
defer up to 15% of their compensation. Commercial's annual contribution to the
plan is based solely on the discretion of the board of directors. Historically,
Commercial has matched 100% of the elective deferrals on the first 6% of the
participant's compensation. Employee and employer contributions are vested
immediately. The plan covers substantially all employees.
Employer expense associated with funding the 401(k) plan was approximately
$132,000, $126,000, and $108,000, in 2002, 2001, and 2000.
STOCK OPTION PLAN Stock option plans are used to reward employees and provide
them with an additional equity interest. Options issued to employees prior to
2001 were issued for a 7 year period with vesting occurring over a 5 year
period. During 2001 the lives of all outstanding employee options were extended
from 7 years to 10 year periods. The vesting schedule remained unchanged.
Options granted to directors prior to 2001 were issued for 2 year periods with
vesting occurring after 6 months. During 2001 the lives of all outstanding
director options were extended from 2 to 10 year periods.
On April 24, 2001, shareholders approved the 2001 Stock Option Incentive Plan.
The plan allows for the issuance of 262,500 shares. The 1991 Stock Option Plan
expired by its terms on April 22, 2001.
Information about option grants follows.
Number Weighted Average
of Options Exercise Price
- -----------------------------------------------------------
Outstanding, beginning of 2000 104,041 $ 8.75
Granted 45,452 11.45
Exercised (4,739) 8.65
- -----------------------------------------------------------
Outstanding, end of 2000 144,754 9.60
Granted 56,493 9.07
Exercised (4,045) 9.03
- -----------------------------------------------------------
OUTSTANDING, END OF 2001 197,202 9.46
GRANTED 48,044 14.29
EXERCISED (10,509) 7.95
FORFEITED (2,898) 11.91
- -----------------------------------------------------------
OUTSTANDING, END OF 2002 231,839 $ 10.50
===========================================================
The weighted-average fair value of options granted in 2002, 2001, and 2000 was
$4.16, $3.11, $2.12. At year-end 2002, options outstanding had a
weighted-average remaining life of 7.1 years and a range of exercise price from
$4.28 to $14.29.
Options exerciseable at year-end are as follows:
Number Weighted Average
of Options Exercise Price
- -----------------------------------------------------------
2000 69,870 $ 8.41
2001 102,265 $ 8.89
2002 127,986 $ 9.66
- --------------------------------------------------------------------------------
Note 12 - Federal Income Taxes
- --------------------------------------------------------------------------------
Income tax expense consists of:
2002 2001 2000
- -----------------------------------------------------
Current $ 1,229,000 $ 1,340,000 $ 1,189,185
Deferred (99,000) (9,000) 3,815
- -----------------------------------------------------
$ 1,130,000 $ 1,331,000 $ 1,193,000
=====================================================
Income tax expense calculated at the statutory federal income tax rate of 34%
differs from actual income tax expense as follows:
2002 2001 2000
- -----------------------------------------------------------------
Statutory rates $ 1,370,000 $1,541,420 $ 1,393,000
Increase (decrease) from
Tax-exempt interest
income (199,000) (208,000) (213,000)
Other, net (41,000) (2,420) 13,000
- -----------------------------------------------------------------
$ 1,130,000 $1,331,000 $ 1,193,000
=================================================================
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002 and 2001
Year-end deferred tax assets and liabilities consist of:
2002 2001
- ---------------------------------------------------------------
Allowance for loan losses $ 571,000 $ 504,000
Interest on non-accrual loans 133,000 --
Accumulated depreciation (130,000) (75,000)
Mortgage servicing rights (159,000) (109,000)
Net unrealized gain on
securities available for sale (229,000) (194,000)
Other (1,000) (5,000)
- ---------------------------------------------------------------
185,000 121,000
Valuation allowance -- --
- ---------------------------------------------------------------
Net deferred tax asset $ 185,000 $ 121,000
===============================================================
- --------------------------------------------------------------------------------
Note 13 - Earnings Per Share
- --------------------------------------------------------------------------------
A reconciliation of the numerators and denominators of the basic earnings per
share and diluted earnings per share computations for the years ended is
presented below:
2002 2001 2000
- ------------------------------------------------------------------------------------
BASIC EARNINGS PER SHARE:
Net income available to
common shareholders $2,900,880 $3,202,588 $2,902,530
====================================================================================
Weighted-average common
shares outstanding for
basic earnings per share 3,779,628 3,704,768 3,687,187
====================================================================================
BASIC EARNINGS PER SHARE $ .77 $ .86 $ .79
====================================================================================
2002 2001 2000
- ------------------------------------------------------------------------------------
DILUTED EARNINGS PER SHARE:
Net income available to
common shareholders $2,900,880 $3,202,588 $2,902,530
====================================================================================
Weighted-average common
shares outstanding for
basic earnings per share 3,779,628 3,704,768 3,687,187
Add:
Dilutive effect of assumed exercise
of stock options 40,671 11,714 19,085
- ------------------------------------------------------------------------------------
Weighted-average common
and dilutive additional potential
common shares outstanding 3,820,299 3,716,482 3,706,272
====================================================================================
Diluted earnings per share $ .76 $ .86 $ .78
====================================================================================
Stock options for 56,389, 106,552, and 26,580 shares of common stock were not
considered in computing diluted earnings per common share for 2002, 2001, and
2000 because they were anti-dilutive.
- --------------------------------------------------------------------------------
Note 14 - Commitments, Off-Balance-Sheet Risk And Contingencies
- --------------------------------------------------------------------------------
There are various contingent liabilities that are not reflected in the
consolidated financial statements, including claims and legal actions arising in
the ordinary course of business. In the opinion of management, after
consultation with legal counsel, the ultimate disposition of these matters is
not expected to have a material effect on Commercial's financial condition or
results of operations.
CASH RESERVE AND CLEARING BALANCES
At year-end 2002 and 2001, cash reserve and clearing balance requirements of
$1,447,000 and $1,556,000 were required as
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002 and 2001
deposits with the Federal Reserve or as cash on hand. These balances do not earn
interest.
LOAN COMMITMENTS
Commercial is a party to financial instruments with off-balance-sheet risk in
the normal course of business to meet financing needs of its customers. These
financial instruments include commitments to make loans, unused lines of credit
and standby letters of credit. Contractual amounts of these instruments
represent the exposure to credit loss in the event of non-performance by the
other party to financial instruments for commitments to make loans, unused lines
of credit and standby letters of credit. Commercial follows the same credit
policy to make such commitments as it uses for on-balance-sheet items.
Since many commitments to make loans expire without being used, the amount of
commitments shown do not necessarily represent future cash commitments. No
losses are anticipated as a result of these transactions. Collateral obtained
upon exercise of commitments is determined using management's credit evaluation
of the borrowers and may include real estate, business assets, deposits and
other items. Commitments at year-end are as follows:
2002 2001
- -----------------------------------------------------------
Commitments to extend credit $ 22,007,000 $ 26,867,000
Standby letters of credit 175,000 216,000
- -----------------------------------------------------------
Total commitments $ 22,182,000 $ 27,083,000
===========================================================
At December 31, 2002, fixed and variable interest rate commitments were
$3,693,000 and $18,489,000. Fixed rate commitments interest rates and terms
ranged from 5.00% to 16.20% and one year to fifteen years.
- --------------------------------------------------------------------------------
Note 15 - Fair Values Of Financial Instruments
- --------------------------------------------------------------------------------
Financial instruments at year-end are as follows, in thousands:
2002 2001
- ------------------------------------------------------------------------------------------------------------------
CARRYING FAIR Carrying Fair
VALUE VALUE Value Value
- ------------------------------------------------------------------------------------------------------------------
FINANCIAL ASSETS
Cash and cash equivalents $ 19,270 $ 19,270 $ 14,347 $ 14,347
Securities 26,035 26,258 27,968 28,202
FHLB stock 1,647 1,647 1,391 1,391
Loans, net of allowance 181,665 189,851 165,427 168,981
Accrued interest receivable 1,065 1,065 1,222 1,222
- ------------------------------------------------------------------------------------------------------------------
Total financial assets $ 229,682 $ 238,091 $ 210,355 $ 214,143
==================================================================================================================
FINANCIAL LIABILITIES
Demand and savings deposits $ (110,801) $ (110,801) $ (101,349) $ (101,349)
Time deposits (55,258) (56,369) (61,229) (62,985)
Securities sold under agreements
to repurchase (14,266) (14,266) (6,238) (6,238)
Other short-term borrowings (492) (492) (137) (137)
Federal Home Loan Bank advances (32,807) (34,050) (26,093) (27,050)
Accrued interest payable (297) (297) (387) (387)
- ------------------------------------------------------------------------------------------------------------------
Total financial liabilities $ (213,921) $ (216,275) $ (195,433) $ (198,146)
==================================================================================================================
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002 and 2001
The following methods and assumptions were used to estimate fair values for
financial instruments:
- Carrying amount is considered to estimate fair value for cash
and cash equivalents, Federal Home Loan Bank (FHLB) stock,
demand and savings deposits, securities sold under agreements
to repurchase, other short term borrowings, accrued interest
receivable, accrued interest payable, and variable rate loans
or deposits that reprice frequently and fully.
- Securities fair values are based on quoted market prices or,
if no quotes are available, on the rate and term of the
security and on information about the issuer.
- Fixed rate loans and deposits, and variable rate loans and
deposits with infrequent repricing or repricing limits, is
estimated using discounted cash flow analyses or underlying
collateral values, where applicable.
- Fair value of Federal Home Loan Bank advances is based on
currently available rates for similar financing.
- Fair value of other financial instruments and
off-balance-sheet items approximate cost and are not
considered significant to this presentation.
While these estimates of fair value are based on management's judgment of the
most appropriate factors, there is no assurance that if Commercial had disposed
of such items at December 31, 2002 and 2001, the estimated fair values would
have been achieved. Market values may differ depending on various circumstances
not taken into consideration in this methodology. The estimated fair values at
December 31, 2002 and 2001 should not necessarily be considered to apply at
subsequent dates.
- --------------------------------------------------------------------------------
Note 16 - Regulatory Matters
- --------------------------------------------------------------------------------
The Corporation and Bank are subject to regulatory capital requirements
administered by federal banking agencies. Capital adequacy guidelines and prompt
corrective action regulations involve quantitative and qualitative measures of
assets, liabilities, and certain off-balance-sheet items calculated under
regulatory accounting practices. Capital amounts and classifications are also
subject to qualitative judgments by regulators about components, risk
weightings, and other factors. The regulators can lower classifications in
certain cases. Failure to meet various capital requirements can initiate
regulatory action that could have a direct material effect on the financial
statements.
The prompt corrective action regulations provide five classifications, including
well capitalized, adequately capitalized, undercapitalized, significantly
undercapitalized, and critically undercapitalized. These terms are not used to
represent overall financial condition.
If only adequately capitalized, regulatory approval is required to accept
brokered deposits. If undercapitalized, capital distributions, asset growth and
expansion are limited. Plans for capital restoration are also required. The
Corporation and Bank were categorized as well capitalized at year-end 2002 and
2001.
Commercial's primary source of funds to pay dividends to shareholders is the
dividends received from the Bank. The Bank is subject to certain State and
Federal restrictions on the amount of dividends it may declare without prior
regulatory approval. In 2003, the Bank may distribute to the Corporation, in
addition to 2003 net profits, approximately $2,743,000 in dividends without
prior approval from regulatory agencies.
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002 and 2001
Actual capital levels (in millions) and minimum required levels were:
Minimum Required
Minimum Required To Be Well Capitalized
For Capital Under Prompt Corrective
Actual Adequacy Purposes Action Regulations
2002 Amount Ratio Amount Ratio Amount Ratio
- --------------------------------------------------------------------------------------------------------------------
TOTAL CAPITAL (TO RISK WEIGHTED ASSETS)
CONSOLIDATED $ 25.5 14.2% $ 14.3 8.0% $ 17.9 10.0%
BANK 20.4 11.6 14.1 8.0 17.7 10.0
TIER 1 CAPITAL (TO RISK WEIGHTED ASSETS)
CONSOLIDATED 23.2 13.0 7.2 4.0 10.8 6.0
BANK 18.2 10.3 7.1 4.0 10.6 6.0
TIER 1 CAPITAL (TO AVERAGE ASSETS)
CONSOLIDATED 23.2 10.0 9.3 4.0 11.7 5.0
BANK 18.2 7.9 9.2 4.0 11.5 5.0
2001
- --------------------------------------------------------------------------------------------------------------------
Total capital (to risk weighted assets)
Consolidated $ 23.8 14.4% $ 13.2 8.0% $ 16.5 10.0%
Bank 19.2 11.8 13.0 8.0 16.2 10.0
Tier 1 capital (to risk weighted assets)
Consolidated 21.7 13.1 6.6 4.0 9.9 6.0
Bank 17.2 10.6 6.5 4.0 9.7 6.0
Tier 1 capital (to average assets)
Consolidated 21.7 9.7 8.9 4.0 11.1 5.0
Bank 17.2 7.8 8.8 4.0 11.0 5.0
- --------------------------------------------------------------------------------
Note 17 - Parent Corporation Condensed
- --------------------------------------------------------------------------------
Following are condensed parent only financial statements.
CONDENSED BALANCE SHEETS
December 31,
2002 2001
- --------------------------------------------------------------------
ASSETS
Cash $ 2,893,804 $ 1,949,287
Investment in subsidiary 18,713,218 17,622,056
Loans, net 2,598,599 3,097,132
Other assets 31,145 27,356
- --------------------------------------------------------------------
Total assets $ 24,236,766 $22,695,831
====================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Dividends payable $ 532,185 $ 496,325
Other liabilities 609 135,228
Shareholders' equity 23,703,972 22,064,278
- --------------------------------------------------------------------
Total liabilities and
shareholders' equity $ 24,236,766 $22,695,831
====================================================================
CONDENSED STATEMENTS OF INCOME
Years ended December 31,
2002 2001 2000
- ------------------------------------------------------------------------------------
Dividends from subsidiary $ 1,800,000 $ 1,950,000 $ 2,073,000
Interest and fees on loans 183,904 257,065 146,524
Interest on securities -- 6,080 67,543
Gain/(loss) on sale of security -- 201,005 (228)
Other income -- 908 163
- ------------------------------------------------------------------------------------
Total income 1,983,904 2,415,058 2,287,002
Interest expense -- 3,602 9,754
Other expense 58,246 79,678 72,677
- ------------------------------------------------------------------------------------
Income before income taxes
and equity in undistributed
net income of subsidiary 1,925,658 2,331,778 2,204,571
Income tax expense (47,000) (129,000) (23,000)
Equity in undistributed
net income of subsidiary 1,022,222 999,810 720,959
- ------------------------------------------------------------------------------------
NET INCOME $ 2,900,880 $ 3,202,588 $ 2,902,530
====================================================================================
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002 and 2001
CONDENSED STATEMENTS OF CASH FLOWS
Years ended December 31,
2002 2001 2000
- ---------------------------------------------------------------------------------------
CASH FLOWS FROM
OPERATING ACTIVITIES
Net income $ 2,900,880 $ 3,202,588 $ 2,902,530
Adjustment:
Equity in undistributed net
income (1,022,222) (999,810) (720,959)
Amortization -- -- 12,286
(Gain) Loss on sale of security -- (201,005) 228
Net change in:
Other assets (3,789) 2,071 (3,583)
Other liabilities (134,619) 91,485 43,252
- ---------------------------------------------------------------------------------------
Net cash from
operating activities 1,740,250 2,095,329 2,233,754
CASH FLOWS FROM
INVESTING ACTIVITIES
Purchase of securities
available for sale -- -- (466,995)
Sales/maturities of securities
available for sale -- 1,514,905 500,000
Net change in loans 498,533 (59,899) (1,409,504)
- ---------------------------------------------------------------------------------------
Net cash from investing
activities 498,533 1,455,006 (1,376,499)
CASH FLOWS FROM
FINANCING ACTIVITIES
Borrowings -- (700,000) 700,000
Dividends paid (2,005,016) (1,874,235) (1,786,660)
Sale of common stock and
fractional shares paid 938,082 732,349 676,752
Repurchase of common stock (227,332) (244,519) (987,536)
- ---------------------------------------------------------------------------------------
Net cash from
financing activities (1,294,266) (2,086,405) (1,397,444)
- ---------------------------------------------------------------------------------------
Net change in cash
and cash equivalents 944,517 1,463,930 (540,189)
Cash and cash equivalents
at the beginning of year 1,949,287 485,357 1,025,546
- ---------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS
AT END OF YEAR $ 2,893,804 $ 1,949,287 $ 485,357
=======================================================================================
- --------------------------------------------------------------------------------
Note 18 - Dividend Reinvestment Plan
- --------------------------------------------------------------------------------
Commercial established a Dividend Reinvestment Plan for its shareholders in
1992. The Plan permits the issuance of previously authorized and unissued
shares. As of December 31, 2002, 171,336 shares of authorized but unissued
common stock were reserved for Plan requirements.
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002 and 2001
- --------------------------------------------------------------------------------
Note 19 - Stock Repurchase Plan
- --------------------------------------------------------------------------------
Commercial announced a stock repurchase plan in 1998. The Plan permits the
repurchase of up to 365,086 shares of the Corporation's outstanding shares of
common stock. As of December 31, 2002, Commercial had repurchased and retired
264,282 shares in accordance with the program.
- --------------------------------------------------------------------------------
Note 20 - Quarterly Financial Data (Unaudited)
- --------------------------------------------------------------------------------
Interest Net Interest Net Earnings Per Share
Income Income Income Basic Diluted
- --------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------
2002
- --------------------------------------------------------------------------------------------------------------
FIRST QUARTER $ 3,511,932 $ 2,181,671 $ 663,744 $ .18 $ .18
SECOND QUARTER 3,544,469 2,264,756 677,558 .18 .18
THIRD QUARTER 3,557,094 2,243,602 742,625 .20 .19
FOURTH QUARTER 3,498,527 2,231,516 816,953 .21 .21
2001
- --------------------------------------------------------------------------------------------------------------
First Quarter $ 4,229,556 $ 2,220,111 $ 762,532 $ .20 $ .20
Second Quarter 4,113,330 2,264,276 809,825 .22 .22
Third Quarter 3,973,410 2,240,019 766,747 .21 .21
Fourth Quarter 3,780,930 2,227,784 863,484 .23 .23
- --------------------------------------------------------------------------------
Common Stock Information
- --------------------------------------------------------------------------------
Commercial National Financial Corporation common stock is listed on the NASD
Over the Counter Bulletin Board under the symbol CEFC. Several brokers provide a
market for the stock. Commercial is aware of a minimum of 701 shareholders of
record and 3,801,421 common shares outstanding at December 31, 2002.
All prices have been adjusted for the 5% stock dividends issued in November 2002
and November 2001.
During 2002 and 2001 the price ranges of transactions reported were:
Shares Actual Price
Traded Range
- ---------------------------------------------------------------
2002 Low High
- ---------------------------------------------------------------
FIRST QUARTER 23,000 $9.57 $10.95
SECOND QUARTER 6,600 10.71 15.00
THIRD QUARTER 8,300 12.11 14.29
FOURTH QUARTER 43,700 11.30 13.33
- ---------------------------------------------------------------
2001
- ---------------------------------------------------------------
First Quarter 17,430 $8.26 $ 9.96
Second Quarter 26,670 7.24 9.50
Third Quarter 6,720 8.37 10.14
Fourth Quarter 26,985 8.60 10.45
- --------------------------------------------------------------------------------
Dividend Information
- --------------------------------------------------------------------------------
The holders of Commercial National Financial Corporation common stock are
entitled to dividends when, and if, declared by the Board of Directors of
Commercial out of funds legally available for that purpose. The Board of
Directors does not declare dividends based on any predetermined dividend policy
but has paid regular quarterly cash dividends for the past thirteen years.
The following table sets forth the dividends per share declared during 2002 and
2001. The dividends per share have been adjusted for the 5% stock dividends
issued in November 2002 and November 2001.
2002 2001
- --------------------------------------------------------
First Quarter $ .13 $ .12
Second Quarter .13 .12
Third Quarter .14 .13
Fourth Quarter .14 .14
- --------------------------------------------------------
Total dividends declared per share $ .54 $ .51
========================================================
- --------------------------------------------------------------------------------
Commercial National Financial Corporation
- --------------------------------------------------------------------------------
DIRECTORS
Howard D. Poindexter Chairperson of the Board, Manager of Poindexter Farms
Richard F. Abbott Vice Chairperson of the Board, Retired EVP of the Corporation and Bank
Jefferson P. Arnold Attorney, Arnold Law Office
Jeffrey S. Barker President and CEO of the Corporation and Bank
Don J. Dewey President and Funeral Director, Dewey Funeral Homes, Inc.
Patrick G. Duffy Chief Financial Officer of the Corporation and Bank
David A. Ferguson Member, Chodoka LLC
Paul B. Luneack Vice President, Ken Luneack Construction, Inc and Bear Truss Company
Kim C. Newson President, Alma Hardware Corporation
Scott E. Sheldon Owner, Kernen-Sheldon and Shepherd Insurance Agencies
OFFICERS
Jeffrey S. Barker President and Chief Executive Officer
Patrick G. Duffy Executive Vice President - Chief Financial Officer
- --------------------------------------------------------------------------------
Commercial Bank
- --------------------------------------------------------------------------------
OFFICERS
Scott E. Sheldon Chairperson of the Board Wendy M. Lombard AVP - Mortgage Lending - Ithaca
Kim C. Newson Vice Chairperson of the Board Vicki L. Nelson AVP - Mortgage Lending - Greenville
Jeffrey S. Barker President and Chief Executive Officer Karen M. Taylor AVP- Mortgage Lending - Alma
Patrick G. Duffy EVP - Chief Financial Officer Carol L. Vallance AVP - Customer Relations - Alma
Andrew P. Shafley SVP - Senior Loan Officer Tamera L. Fisher Loan Officer - Alma
Daniel E. Raleigh VP - Marketing, Personnel and Branch Kathryn K. Greening Loan Officer - Alma
Administration
Kevin D. Collison VP - Commercial Lending - Ithaca Dawn K. Riley Loan Officer - Greenville
Thomas D. Cooper VP - Commercial Lending - Ithaca Heather A. Lamentola Branch Supervisor - St. Louis
Jerry L. Bayak VP - Commercial Lending - Greenville Cathy M. Patterson Controller
Corey S. Bailey AVP - Lending - Alma Rebecca A. Smith Administrative Assistant - Transfer
Janet M. Davison AVP - Manager/Information Systems
- --------------------------------------------------------------------------------
Commercial Bank-Greenville
- --------------------------------------------------------------------------------
DIRECTORS
Jeffrey S. Barker Chairman, Commercial Bank Greenville; President and CEO, Commercial Bank
Carl Barberi Assistant Superintendent, Greenville Public Schools
Jerry L. Bayak President, Commercial Bank - Greenville
Edwin L. Koehn President, Ed Koehn Ford Lincoln Mercury Inc.
Gerald D. Pitcher Real estate developer and property manager
Andrew P. Shafley Commercial Bank, Senior Vice President-Senior Loan Officer
Bradley S. Stauffer Director of Corporate Finance, Northland Corporation
L. Wade Thorton Owner, Winter Inn
OFFICERS
Jerry L. Bayak President
Vicki L. Nelson Assistant Vice President - Mortgage Lending
Dawn K. Riley Loan Officer
Pictures of Greenville Directors and officer
- --------------------------------------------------------------------------------
COMMERCIAL BANK LOCATIONS
- --------------------------------------------------------------------------------
ALMA 301 NORTH STATE ST. Ph. (989) 463-2185 Fax (989) 463-5996
119 WEST CENTER* Ph. (989) 463-3120
1500 WRIGHT AVE.* Ph. (989) 463-3901
ITHACA 101 N. PINE RIVER* Ph. (989) 875-4144 Fax (989) 875-4534
MIDDLETON 101 NORTH NEWTON ST.* Ph. (989) 236-7236 Fax (989) 236-7732
POMPEII 105 E. FULTON ST. Ph. (989) 838-2525
ST. LOUIS 104 N. MILL ST.* Ph. (989) 681-5738 Fax (989) 681-3509
* Denotes Bank locations with ATMs on site.
- --------------------------------------------------------------------------------
COMMERCIAL BANK-GREENVILLE LOCATIONS
- --------------------------------------------------------------------------------
GREENVILLE 10530 W. CARSON CITY RD.* Ph. (616) 754-7166 Fax (616) 754-2118
101 NORTH LAFAYETTE ST.* Ph. (616) 225-3680 Fax (616) 754-3174
- --------------------------------------------------------------------------------
Dividend Reinvestment Plan
- --------------------------------------------------------------------------------
As a service to its shareholders, Commercial National Financial Corporation
sponsors a Dividend Reinvestment Plan. The Plan allows a shareholder to purchase
this stock without brokerage commissions using dividends. For information about
this plan, contact the Corporation's Transfer Agent.
- --------------------------------------------------------------------------------
Transfer Agent
- --------------------------------------------------------------------------------
Commercial National Financial Corporation
Care of Ms. Rebecca A. Smith
101 North Pine River, P.O. Box 280
Ithaca, Michigan 48847
- --------------------------------------------------------------------------------
Corporate Headquarters
- --------------------------------------------------------------------------------
101 North Pine River
Ithaca, Michigan 48847
www.commercial-bank.com
Phone (989) 875-4144
Fax (989) 875-4534
- --------------------------------------------------------------------------------
10-K Availability
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Commercial National's annual report on Form 10-K is available upon written
request without charge from:
Commercial National Financial Corporation,
Care of Mr. Patrick G. Duffy, Executive Vice President -
Chief Financial Officer,
101 North Pine River, P.O. Box 280
Ithaca, Michigan 48847
Phone (989) 875-4144
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Market Makers
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WILLIAM KAHL R. NICHOLAS BACH MICHAEL T. SEEKELL PETER VANDERSCHAAF CHRISTOPHER TURNER JAMES CRAWFORD
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Wachovia Securities Howe Barnes Investment Inc. Robert W. Baird & Co. Stifel, Nicolaus & Co. McDonald & Co. Raymond James
1-800-292-1960 1-800-800-4693 1-800-888-6200 1-800-676-0477 1-800-526-7705 1-800-521-9767
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COMMERCIAL NATIONAL FINANCIAL CORPORATION
101 N. Pine River
P.O. Box 280
Ithaca, Michigan 48847
www.commercial-bank.com
(989) 875-4144