SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
X Quarterly Report Pursuant to Section 13 or 15(d) of the
--- Securities and Exchange Act of 1934
For the quarterly period ended March 31, 2003, or
Transition Report Pursuant to Section 13 or 15(d) of the
--- Securities Exchange Act of 1934
For the Transition Period from ________ to _________
Commission File No. 0-17000
COMMERCIAL NATIONAL FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
Michigan 38-2799780
(State of Incorporation) (IRS Employer Identification No.)
101 North Pine River Street, Ithaca, Michigan 48847
(address of principal executive offices) (ZIP Code)
Registrant's telephone number, including area code: (989) 875-4144
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO
--------------- ---------------
Indicate by check mark whether the registrant is an accelerated filer (as
defined in rule 12b-2 of the Exchange Act).
YES NO X
--------------- ---------------
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding at April 30, 2003
----- -----------------------------
Common Stock 3,834,319
No Par Value
INDEX
PART I FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of March 31, 2003 (unaudited) and December 31, 2002 (Page 3)
Consolidated Statements of Income and Other Comprehensive (Page 4)
Income (unaudited) for the three months ended March
31, 2003 and March 31, 2002
Consolidated Statements of Changes in Shareholders' Equity (Page 5)
(unaudited) for the three months ended March 31,
2003 and March 31, 2002
Consolidated Statements of Cash Flows (unaudited) for the three months ended (Page 6)
March 31, 2003 and March 31, 2002
Notes to Consolidated Financial Statements (unaudited) (Page 7-9)
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (Page 10-14)
Item 3. Quantitative and Qualitative Disclosures about Market Risk (Page 14-15)
Item 4. Controls and Procedures (Page 16)
PART II OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K (Page 17-22)
SIGNATURES (Page 18)
COMMERCIAL NATIONAL FINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS
March 31, December 31,
2003 2002
---- ----
(Unaudited)
ASSETS
Cash and due from banks $ 5,897,385 $ 8,784,826
Federal funds sold 14,645,000 6,850,000
Other interest bearing deposits 6,237,906 3,634,988
------------- -------------
Total cash and cash equivalents 26,780,291 19,269,814
Securities available for sale 24,714,371 21,345,896
Securities held to maturity (fair value $ 4,884,988 -
March 31, 2003; $4,911,696 - December 31, 2002) 4,686,509 4,689,025
Federal Home Loan Bank stock, at cost 1,647,000 1,647,000
Gross loans receivable 178,442,268 184,448,296
Allowance for loan losses (2,909,709) (2,783,234)
------------- -------------
Net loans receivable 175,532,559 181,665,062
Bank owned life insurance 3,276,296 3,231,374
Premises and equipment, net 3,718,133 3,687,151
Accrued interest receivable and other assets 4,325,011 2,715,261
------------- -------------
Total assets $ 244,680,170 $ 238,250,583
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Deposits
Noninterest-bearing demand $ 21,897,704 $ 21,495,410
Interest-bearing demand 29,570,314 29,872,655
Savings 65,835,574 59,432,935
Time 55,150,377 55,258,479
------------- -------------
Total deposits 172,453,969 166,059,479
Securities sold under agreements to repurchase 17,231,601 14,266,239
Other short-term borrowings 249,210 491,840
Federal Home Loan Bank advances 29,971,560 32,807,086
Accrued expenses and other liabilities 667,169 921,967
------------- -------------
Total liabilities 220,573,509 214,546,611
Shareholders' equity
Common stock and paid-in-capital, no par value: 5,000,000 shares
authorized; shares issued and outstanding
March 31, 2003 - 3,816,047 and December 31,
2002 - 3,801,421 23,441,604 23,255,499
Retained earnings 235,909 3,908
Accumulated other comprehensive income, net of tax 429,148 444,565
------------- -------------
Total shareholders' equity 24,106,661 23,703,972
------------- -------------
Total liabilities and shareholders' equity $ 244,680,170 $ 238,250,583
============= =============
See accompanying notes
3
COMMERCIAL NATIONAL FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (Unaudited)
Three Months
Ended March 31,
2003 2002
---- ----
Interest and dividend income
Loans, including fees $ 3,094,094 $ 3,117,476
Taxable securities 179,618 208,946
Nontaxable securities 107,000 130,717
Federal funds sold 39,784 29,080
Federal Home Loan Bank stock dividends 24,000 20,584
Interest on other deposits 4,328 5,129
----------- -----------
Total interest and dividend income 3,448,824 3,511,932
Interest expense
Deposits 695,651 912,955
Securities sold under agreements to repurchase 45,995 31,159
Federal Home Loan Bank advances 412,063 383,943
Other 751 2,204
----------- -----------
Total interest expense 1,154,460 1,330,261
Net interest income 2,294,364 2,181,671
Provision for loan losses 120,000 120,000
----------- -----------
Net interest income after provision for loan losses 2,174,364 2,061,671
Noninterest income
Service charges and fees 117,258 106,812
Net gains on loan sales 281,010 55,693
Receivable financing fees 41,201 37,091
Net security gains - 23,397
Other 88,113 90,503
----------- -----------
Total noninterest income 527,582 313,496
Noninterest expense
Salaries and employee benefits 904,142 820,131
Occupancy and equipment 302,819 222,141
FDIC insurance 7,302 8,235
Printing, postage and supplies 71,167 73,773
Professional and outside services 87,751 104,207
Other 243,269 234,836
----------- -----------
Total noninterest expense 1,616,450 1,463,323
----------- -----------
Income before income tax expense 1,085,496 911,844
Income tax expense 319,400 248,100
----------- -----------
Net income $ 766,096 $ 663,744
=========== ===========
Net change in unrealized gains on securities available for sale $ (23,358) $ (98,850)
Reclassification adjustment for (gains) recognized in income - (23,397)
Tax effects 7,941 41,563
----------- -----------
Total comprehensive income $ 750,679 $ 583,060
=========== ===========
Per share information
Basic earnings $ 0.20 $ 0.18
Diluted earnings $ 0.20 $ 0.18
Dividends declared $ 0.14 $ 0.13
See accompanying notes
4
COMMERCIAL NATIONAL FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
Three Months ended March 31, 2003 and March 31, 2002 (Unaudited)
Accumulated
Shares Common Other
Issued Stock and Retained Comprehensive Total
and Paid in Earnings Income/(Loss), Shareholders'
Outstanding Capital (Deficit) Net of Tax Equity
- -------------------------------------------------------------------------------------------------------------------------------
Balance at January 1, 2002 3,725,085 $ 22,104,910 $ (416,257) $ 375,625 $ 22,064,278
Comprehensive income:
Net income 663,744 663,744
Net change in unrealized gains/(losses) on
securities available for sale (98,850) (98,850)
Reclassification adjustment for gains
recognized in income (23,397) (23,397)
Tax effects 41,563 41,563
------------
Total comprehensive income 583,060
Cash dividends declared, $.13 per share (500,082) (500,082)
Issued under dividend reinvestment program 20,702 197,405 197,405
Issued under stock option plans 1,796 16,289 16,289
Issued under employee benefit plan 3,152 32,303 32,303
Repurchase and retirement of shares (1,215) (13,016) (13,016)
---------- ------------- ---------- --------- ------------
Balance at March 31, 2002 3,749,520 $ 22,337,891 $ (252,595) $ 294,941 $ 22,380,237
========== ============= ========== ========= ============
- -------------------------------------------------------------------------------------------------------------------------------
Balance at January 1, 2003 3,801,421 $ 23,255,499 $ 3,908 $ 444,565 $ 23,703,972
Comprehensive income:
Net income 766,096 766,096
Net change in unrealized gains/(losses) on
securities available for sale (23,358) (23,358)
Tax effects 7,941 7,941
------------
Total comprehensive income 750,679
Cash dividends declared, $.14 per share (534,095) (534,095)
Issued under dividend reinvestment program 16,070 202,580 202,580
Issued under employee benefit plan 4,363 53,539 53,539
Repurchase and retirement of shares (5,807) (70,014) (70,014)
---------- ------------- ---------- ---------- -------------
Balance at March 31, 2003 3,816,047 $ 23,441,604 $ 235,909 $ 429,148 $ 24,106,661
========== ============= ========== ========== =============
See accompanying notes
5
COMMERCIAL NATIONAL FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
Three Months Ended
March 31,
2003 2002
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 766,096 $ 663,744
Adjustments to reconcile net income to net
cash from operating activities
Provision for loan losses 120,000 120,000
Net gains on loan sales (281,010) (55,693)
Originations of loans held for sale (11,705,370) (2,296,210)
Proceeds from sales of loans held for sale 11,986,380 2,351,902
Gain on sales of securities available for sale - (23,397)
Depreciation, amortization and accretion 162,185 130,513
Net change in accrued interest receivable and other assets (146,730) 1,333,261
Net change in accrued expenses and other liabilities (256,708) 171,615
------------ ------------
Net cash from operating activities 644,843 2,395,735
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of securities available for sale (8,170,046) (527,220)
Proceeds from maturities of securities available for sale 4,735,000 1,000,000
Proceeds from maturities of securities held to maturity - 912,900
Net change in loans 4,509,304 (8,700,288)
Purchases of premises and equipment, net (144,240) (82,174)
------------ ------------
Net cash from investing activities 930,018 (7,396,782)
CASH FLOW FROM FINANCING ACTIVITIES
Net change in deposits 6,394,490 (3,820,612)
Net change in securities sold under agreements to repurchase 2,965,362 965,521
Net change in U.S. Treasury demand notes (242,630) 779,919
Proceeds from Federal Home Loan Bank advances - 2,000,000
Repayment of Federal Home Loan Bank advances (2,835,526) (1,801,321)
Repurchase and retirement of shares of common stock (70,014) (13,016)
Dividends paid and fractional shares (532,185) (496,323)
Proceeds from sale of common stock 256,119 245,997
------------ ------------
Net cash from financing activities 5,935,616 (2,139,835)
------------ ------------
Net change in cash and cash equivalents 7,510,477 (7,140,882)
Cash and cash equivalents, at beginning of period 19,269,814 14,347,325
------------ ------------
CASH AND CASH EQUIVALENTS, AT END OF PERIOD $ 26,780,291 $ 7,206,443
============ ============
Cash paid during the period for
Interest $ 1,169,287 $ 1,380,840
Federal income taxes - -
See accompanying notes
6
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
Note 1-Summary of Significant Accounting Policies
Basic Presentation
The accompanying unaudited condensed consolidated financial statements were
prepared in accordance with Rule 10-01 of regulation S-X and the instructions
for Form 10-Q and, therefore, do not include all disclosures required by
accounting principles generally accepted in the United States of America for
complete presentation of financial statements. In management's opinion, the
condensed consolidated financial statements contain all adjustments (consisting
of normal recurring accruals) necessary to present fairly the financial
condition of Commercial National Financial Corporation as of March 31, 2003 and
December 31, 2002 and the results of its operations for the three months ending
March 31, 2003 and March 31, 2002. The results for the three months ended March
31, 2003 are not necessarily indicative of the results expected for the full
year.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of
Commercial National Financial Corporation (CNFC), Commercial Bank (Bank) and
CNFC Financial Services, Inc. and CNFC Mortgage Corporation, both wholly owned
subsidiaries of the Bank. All material intercompany accounts and transactions
have been eliminated in consolidation.
Nature of Operations, Industry Segments and Concentrations of Credit Risk
CNFC is a one-bank holding company, which conducts limited business activities.
The Bank performs the majority of business activities.
The Bank provides a full range of banking services to individuals, agricultural
businesses, commercial businesses and light industries located in its service
area. It maintains a diversified loan portfolio, including loans to individuals
for home mortgages, automobiles and personal expenditures, and loans to business
enterprises for current operations and expansion. The Bank offers a variety of
deposit products, including checking, savings, money market, individual
retirement accounts and certificates of deposit. While CNFC's chief
decision-makers monitor the revenue stream of various products and services,
operations are managed and financial performance is evaluated on a
corporation-wide basis. Accordingly, management considers all of the CNFC's
banking operations to be aggregated into one operating segment.
The principal markets for the Bank's financial services are the Michigan
communities in which the Bank is located and the areas surrounding these
communities. The Bank serves these markets through nine offices located in
Gratiot, Isabella 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. The allowance for loan losses and fair values of securities and other
financial instruments are particularly subject to change.
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 price equal to or greater
than the market price of the underlying common stock at date of grant. There
were no grants issued for the periods ending March 31, 2003 and 2002. 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.
March 31, 2003 March 31, 2002
-------------- --------------
Net income as reported $ 766,096 $ 663,744
Proforma net income 753,339 643,978
Basic earnings per share as reported $ .20 $ .18
Proforma basic earnings per share $ .20 $ .17
Diluted earnings per share as reported $ .20 $ .18
Proforma diluted earnings per share $ .20 $ .17
7
COMMERCIAL NATIONAL FINANCIAL CORPORATION
Cash Flow Reporting
Cash and cash equivalents include cash on hand, demand deposits with other
financial institutions and federal funds sold. Cash flows are reported net for
customer loan and deposit transactions, securities sold under agreements to
repurchase with original maturity of 90 days or less and U.S. Treasury demand
notes.
Earnings and Dividends Per Share
Basic earnings per common share is based on net income divided by the weighted
average number of common shares outstanding during the period. Diluted earnings
per common share shows the diluted effect of any additional potential common
shares. Earnings and dividends per common share are restated for all stock
splits and stock dividends.
Comprehensive Income
Comprehensive income consists of net income and other comprehensive income
(loss). Other comprehensive income (loss) includes the change in unrealized
appreciation and depreciation on securities available for sale, net of tax,
which is also recognized as a separate component of shareholders' equity.
Reclassifications
Some items in the prior year financial statements have been reclassified to
conform with the current year presentation.
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. The new accounting standards were adopted in 2003, and did
not have a material impact on Commercial's financial position or results of
operations.
Note 2 - Earnings Per Share
A reconciliation of the numerators and denominators of the basic earnings per
share and diluted earnings per share computations for the periods ended is
presented below. Stock options representing 147,981 and 129,360 shares of common
stock were not considered in computing diluted earnings per share for the three
month periods in 2002 and 2003 because they were antidilutive.
Three months ended
MARCH 31, March 31,
2003 2002
- ----------------------------------------------------------------------------------------------
BASIC EARNINGS PER SHARE:
Net income available to common shareholders $ 766,096 $ 663,744
Weighted-average common shares outstanding for
basic earnings per share 3,815,890 3,749,222
- ----------------------------------------------------------------------------------------------
BASIC EARNINGS PER SHARE $ .20 $ .18
==============================================================================================
DILUTED EARNINGS PER SHARE:
Net income available to common shareholders $ 766,096 $ 663,744
Weighted-average common shares outstanding for basic
earnings per share 3,815,890 3,749,222
Add:
8
COMMERCIAL NATIONAL FINANCIAL CORPORATION
Dilutive effect of assumed exercise of stock options 35,390 27,450
- ----------------------------------------------------------------------------------------------
Weighted-average common and dilutive additional potential
common shares outstanding 3,851,280 3,776,672
==============================================================================================
DILUTED EARNINGS PER SHARE $ .20 $ .18
==============================================================================================
9
COMMERCIAL NATIONAL FINANCIAL CORPORATION
ITEM 2: MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FINANCIAL CONDITION
Summary
Total assets at March 31, 2003 increased to $244,680,000 from $238,251,000 at
December 31, 2002. Federal funds sold and other interest bearing deposits
increased $10.4 million from December 31, 2002.
The historically low interest rate environment has continued to provide
incentive for residential real estate customers to refinance. The majority of
residential loan customers are requesting 15 and 30 year fixed rate mortgages.
The Bank has elected to sell the majority of these loans to the secondary
market. The net result is a decrease of $2.5 million in residential real estate
balances. A weak local economy has also negatively affected the demand for
business loans, which have decreased $3.5 million. CNFC has experienced a $6
million decrease in loans.
Accrued interest receivable and other assets increased by $1.6 million caused by
the transfer of $1.5 million in loans to foreclosed assets. This asset was
associated with a loan identified as a non-accrual loan at December 31, 2002.
Despite the low interest rates, short term liabilities including savings and
repurchase agreements have continued to grow. Deposit customers are more
concerned with safety of principal and lack interest rate incentive to invest
money long term. Savings account balances increased $6.4 million and repurchase
agreement balances increased $3.0 million. To offset the increased liquidity,
management elected not to replace maturing Federal Home Loan Bank advances.
The Bank is leasing a new facility located in Mt. Pleasant Michigan. Management
expects this location to be operational during the second quarter of 2003. The
leasehold improvements, including furniture and fixtures and technology
purchases should not exceed $250,000.
Liquidity
Management defines liquidity as the ability to fund appropriate levels of credit
worthy loans, meet the immediate cash withdrawal requirements of depositors, and
maintain access to sufficient resources to meet unexpected contingencies at a
reasonable cost, with minimal losses.
Management believes that the combination of available FHLB advances, Federal
funds lines of credit, the available for sale investment portfolio, and our
ability to sell mortgage loans provides adequate short and medium term sources
of liquidity. At a minimum the Bank has the following available to meet
short-term liquidity needs: $8,000,000 in available FHLB advances and $9,000,000
in short term federal funds lines of credit with correspondent banks.
CNFC also needs cash to pay dividends to its shareholders. The primary source of
cash is the dividends paid to CNFC by the Bank. Management believes that cash
from operations is sufficient to supply the cash needed to continue paying a
reasonable dividend.
10
COMMERCIAL NATIONAL FINANCIAL CORPORATION
Asset Quality
At March 31, 2003 CNFC has identified $3,887,000 of loans as non-performing.
This compares to $6,025,000 at December 31, 2002. The $3,887,000 in non-accrual
loans represents four business relationships and their related entities. All
non-accrual loans are considered impaired and the allowance for loan loss
allocated to these loans is $1,385,000. Approximately $1.3 million is allocated
to one relationship.
March 31, 2003 December 31, 2002
Total loans $ 178,442,268 $ 184,448,296
Non-accrual loans $ 3,551,017 $ 5,676,390
Accruing loans past due 90 days or more - -
Restructured Loans (non accrual) 335,519 348,520
- --------------------------------------------------------------------------------------------
Total non-performing loans 3,886,536 6,024,910
Repossessed assets and other real estate 1,620,970 120,970
- --------------------------------------------------------------------------------------------
Total non-performing assets $ 5,507,506 $ 6,145,880
============================================================================================
Total non-performing loans as a
percentage of total loans 2.18% 3.33%
============================================================================================
Allowance for loan loss as a percentage of
non-performing loans 74.87% 46.20%
============================================================================================
Total non-performing assets as a percentage of
total assets 2.25% .2.58%
============================================================================================
Allowance for Loan Loss
Three Months Ended Year Ended Three Months Ended
March 31, 2003 December 31, 2002 March 31, 2002
- -------------------------------------------------------------------------------------------------
Beginning balance $ 2,783,234 $ 2,586,025 $ 2,586,025
Loan charge-offs (71,006) (538,567) (7,997)
Loan recoveries 77,481 54,776 20,796
- ------------------------------------------------------------------------------------------------
Net loan recoveries/(charge-offs) 6,475 (483,791) 12,799
Provision for loan losses 120,000 681,000 120,000
- ------------------------------------------------------------------------------------------------
Ending balance $ 2,909,709 $ 2,783,234 $ 2,718,824
================================================================================================
Average loan balance $ 180,765,000 $ 179,831,000 $ 171,016,000
Percentage of net charge-offs
as a percentage of average loans .003% (.269)% .007%
The allowance for loan losses was 1.63% of total loans at March 31, 2003 and
1.51% at December 31, 2002. Management systematically evaluates the adequacy of
the allowance such that the balance is commensurate with the performance of the
loan portfolio, loan growth, and general market conditions. Each of these
factors is discussed in the following paragraphs.
For purposes of evaluating the adequacy of the allowance, the performance of the
loan portfolio is divided into three categories of loans: residential, 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. 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 four calendar
years. The Bank has
11
COMMERCIAL NATIONAL FINANCIAL CORPORATION
recorded net 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.
In accordance with FASB's 114 and 118, management identifies specific loans that
are experiencing financial difficulty, evaluates each loan for impairment and
attempts to identify a specific allowance for each loan. The dollar amount of
loans identified as impaired has decreased from $6,025,000 at December 31, 2002
to $3,887,000 at March 31, 2003. During the first quarter management began the
foreclosure process on approximately $1.5 million in non-accrual loans. This
balance was transferred to repossessed assets and other real estate. The Bank
also received a loan payoff on one non-accrual loan customer. In addition, the
Bank is receiving regular loan payments on approximately $3,441,000 of the
non-accrual loans.
Offsetting the positive news, is the fact that one loan customer, with a
specific reserve of $1.3 million, continues to struggle. The customer is
currently in violation of several loan covenants and is experiencing marginal
cash flow from operations. Management continues to work with the borrower to
rehabilitate the loan deficiencies, however, the long term viability of the
business is still not resolved. Though management believes the allowance for
loan loss is adequate at this time, a deterioration in the collateral or
performance of this customer may require management to increase the allowance
for loan loss above current levels.
Capital Resources
CNFC's capital ratios continue to exceed regulatory guidelines for a "well
capitalized" institution. It is management's intent to maintain capital ratios
in excess of the minimum required to be well capitalized. A summary of CNFC's
capital ratios follows:
Minimum Required to be
Well Capitalized Under Minimum Required
March 31, December 31, Prompt Corrective Action for Capital
2003 2002 Regulations Adequacy Purposes
- ---------------------------------------------------------------------------------------------------------
Total capital to
risk weighted assets 14.6% 14.2% 10.0% 8.0%
Tier 1 capital to
risk weighted assets 13.3% 13.0% 6.0% 4.0%
Tier 1 capital to
average assets 9.9% 10.0% 5.0% 4.0%
RESULTS OF OPERATIONS
Summary
Net income for the quarter ended March 31, 2003 was $766,000, an increase of
$102,000, or 15.4% compared to the same period in 2002. There are three primary
factors that affected the increase in net income: a $113,000 increase in net
interest income assisted by the recovery of $33,000 in non-accrual interest, a
$214,000 or 68% increase in non-interest income caused by continued strong level
of sales of residential real estate loans, and a 10.46% increase in non-interest
expense caused by the additional overhead to support our new facility in
Greenville. Return on average equity increased from 12.02% to 12.94%.
Net Interest Income
The following table illustrates the effect that changes in rates and balances of
interest-earning assets and interest-bearing liabilities had on tax-equivalent
net interest income for the three months ending March 31, 2003 and 2002.
12
COMMERCIAL NATIONAL FINANCIAL CORPORATION
Three Months Ending March 31,
2003 2002
---- ----
Interest Income (tax equivalent) $ 3,562,829 $ 3,639,262
Interest Expense 1,154,460 1,330,261
------------ ------------
Net Interest Income $ 2,408,369 $ 2,309,001
============ ============
Average Balances
Interest-earning Assets $226,091,079 $207,572,386
Interest-bearing Liabilities 194,132,893 176,770,888
------------ ------------
Net Differential $ 31,958,186 $ 30,801,498
============ ============
Average Yields/Rates (annualized)
Yield on Earning Assets 6.39% 7.11%
Rate Paid on Liabilities 2.41% 3.05%
------------ ------------
Interest Spread 3.98% 4.06%
============ ============
Net Interest Margin 4.32% 4.51%
============ ============
The change in tax equivalent net interest income is attributable to the
following:
Three Months Ending
March 31, 2003
Balance Rate Inc/(Dec)
--------- --------- ---------
Interest Earning Assets $ 183,256 $(259,689) $ (76,433)
Interest Bearing Liabilities 78,023 (253,824) (175,801)
--------- --------- ---------
Net Interest Income $ 105,233 $ (5,865) $ 99,368
========= ========= =========
The $99,000 increase in tax-equivalent net interest income for the three months
ending March 31, 2003 resulted from a 19 basis point decrease in margin offset
by an increase in average earning assets.
In response to continued economic weakness, the Federal Reserve lowered the
Federal funds target rate by 50 basis points in November of 2002. The decrease
in short term interest rates negatively impacted margin in the short run. Also
negatively impacting margin is the interest not earned and collected on
non-accrual loans.
Noninterest Income
Noninterest income for the three months ending March 31, 2003 was $528,000. This
represents a $215,000 or 68.69% increase over the same period in 2002.
Net gain on loan sales increased from $56,000 to $281,000. Residential real
estate interest rates were at or near 40 year lows during the first quarter of
2003. The Bank continued to experience significant refinancing activity. For the
three months ending March 31, 2003, the Bank originated and sold $11,705,000 in
residential real estate loans. This compares to $2,352,000 for the three months
ended March 31, 2002.
Noninterest Expense
Noninterest expense for the three months ending March 31, 2003 totaled
$1,616,000. This represents a $153,000 or 10.46% increase over the same period
in 2002.
Salary and benefit expense for the three months ending March 31, 2003 totaled
$904,000 compared to $820,000 for the same period in 2002, an increase of
$84,000 or 10.2%. Increased staffing for the new Greenville office is the
primary reason for the increase. Full time equivalent employees increased from
75 at March 31, 2002 to 80 at March 31, 2003.
13
COMMERCIAL NATIONAL FINANCIAL CORPORATION
Occupancy and equipment increased $80,678 or 36.32% compared to the same period
in 2002. The new Greenville office became fully operational during the fourth
quarter of 2002. Costs associated with this office, such as depreciation,
utilities, property taxes, and insurance contributed to the increase. The Bank
also began paying lease payments for the Mt. Pleasant location currently under
construction.
Professional fees for the quarter ending March 31, 2003 decreased $16,000 or
15.38% compared to the same period in 2002. During 2002, management had engaged
outside consultants to perform special projects including a market study of
Greenville Michigan and to assist with implementing an Overdraft Honor program.
ITEM 3: 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 has greater concern that interest rates
will rise significantly 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,
14
COMMERCIAL NATIONAL FINANCIAL CORPORATION
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 Table below summarizes the effect a 200 basis point immediate and parallel
shift of the yield curve has on net income. Net income may decrease in both a
falling and rising interest rate environment. In a falling interest rate
environment, management does not have the ability to lower deposit rates 200
basis points to offset a decrease in rates on earning assets. Therefore, if
rates decreased 200 basis points, margin would likely compress resulting in
lower net interest income. In a rising interest rate environment, the duration
of earning assets would most likely extend and money currently invested in short
term liabilities would benefit from the increase in rates. It is possible that
in this scenario, net interest income would also decrease. Though the interest
rate risk associated with a rising interest rate environment has increased,
management believes the risk is still acceptable.
Projected Percentage Change in Net Income
March 31, 2003 December 31, 2003 March 31, 2002
- -----------------------------------------------------------------------------------------------------
- -200 basis points (5.89)% (3.50)% (0.03)%
0 basis points 0.00 0.00 0.00
+200 basis points (12.01) (12.22) (4.79)
15
COMMERCIAL NATIONAL FINANCIAL CORPORATION
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures--Jeffrey S. Barker,
the Corporation's Principal Executive Officer, and Patrick G. Duffy,
the Corporation's Principal Financial Officer, have reviewed and
evaluated the effectiveness of the Corporation's disclosure controls
and procedures (as defined in Rules 240.13a-14(c) and 15d-14(c) under
the Securities Exchange Act of 1934 (the "Exchange Act)) as of a date
within ninety days before the filing date of this quarterly report.
Based on their evaluation, they have concluded that the Corporation's
disclosure controls and procedures are effective, providing them with
material information relating to the Corporation as required to be
disclosed in the reports the Corporation files or submits under the
Exchange Act on a timely basis.
(b) Changes in internal controls--There were no significant changes in the
Corporation's internal controls or in other factors that could
significantly affect the Corporation's disclosure controls and
procedures subsequent to the date of the evaluation, nor were there any
significant deficiencies or material weaknesses in the Corporation's
internal controls.
Forward Looking Statements
This discussion and analysis of financial condition and results of operations,
and other sections of this report contain forward looking statements that are
based on management's beliefs, assumptions, current expectations, estimates and
projections about the financial services industry, the economy, and about the
Corporation itself. Words such as "anticipates", "believes", "estimates",
"expects" "forecasts" "intends", "is likely", "plans", "product", "projects",
variations of such words and similar expressions are intended to identify such
forward-looking statements. These statements are not guarantees of future
performance and involve certain risks, uncertainties, and assumptions ("Future
Factors") that are difficult to predict with regard to timing, extent,
likelihood and degree of occurrence. Therefore, actual results and outcomes may
materially differ from what may be expressed or forecasted in such forward
looking statements. Furthermore, CNFC undertakes no obligation to update, amend
or clarify forward-looking statements, whether as a result of new information,
future events, or otherwise.
Future Factors include changes in interest rates and interest rate
relationships; demand for products and services; the degree of competition by
traditional and non-traditional competitors; changes in banking regulations and
tax laws; changes in prices, levies, and assessments; the impact of technology,
governmental and regulatory policy changes; the outcome of pending and future
litigation and contingencies; trends in customer behavior including their
ability to repay loans; and vicissitudes of the national and local economies.
These are representative of the Future Factors that could cause a difference
between an actual outcome and a forward-looking statement.
16
COMMERCIAL NATIONAL FINANCIAL CORPORATION
PART II. OTHER INFORMATION
ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
99.1 Certification of Chief Executive Officer and Chief
Financial Officer
(b) Report on Form 8-K
None
17
COMMERCIAL NATIONAL FINANCIAL CORPORATION
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Commercial National Financial Corporation
(Registrant)
Date: May 13, 2003 /s/ Jeffrey S. Barker
--------------------------------------------
Jeffrey S. Barker
President and Chief Executive Officer
/s/ Patrick G. Duffy
--------------------------------------------
Patrick G. Duffy
Executive Vice President and Chief Financial
Officer
18
COMMERCIAL NATIONAL FINANCIAL CORPORATION
I, Jeffrey S. Barker, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Commercial National
Financial Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act rules 13a-14 and 15d-14) for the registrant and have:
a. Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report
is being prepared;
b. Evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c. Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a. All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b. Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
DATE: MAY 13, 2003
/s/ Jeffrey S. Barker
--------------------------
Jeffrey S. Barker
President and Chief Executive Officer
19
COMMERCIAL NATIONAL FINANCIAL CORPORATION
I, Patrick G. Duffy, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Commercial National
Financial Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act rules 13a-14 and 15d-14) for the registrant and have:
a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report
is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
DATE: MAY 13, 2003
/s/ Patrick G. Duffy
----------------------------------
Patrick G. Duffy
Executive Vice President and Chief
Financial Officer
20
COMMERCIAL NATIONAL FINANCIAL CORPORATION
EXHIBIT INDEX
Exhibit Number Description
EXHIBIT 99.1 Certification of Quarterly Report on Form 10-Q of
Commercial National Financial Corporation
22