COMMERCIAL NATIONAL FINANCIAL CORPORATION
EXHIBIT 13
INCORPORATED PORTIONS FROM 2003 ANNUAL REPORT TO SHAREHOLDERS
13
.
.
.
CONTENTS
Report from the President................................................................................. 3
Mt. Pleasant Office....................................................................................... 4
Selected Financial Data................................................................................... 5
Management's Discussion and Analysis of Financial Condition and Results of Operations..................... 6-22
Management's Responsibility for Financial Statements...................................................... 23
Report of Independent Auditors............................................................................ 24
Consolidated Balance Sheets............................................................................... 25
Consolidated Statements of Income......................................................................... 26
Consolidated Statements of Changes in Shareholders' Equity................................................ 27
Consolidated Statements of Cash Flows..................................................................... 28
Notes to Consolidated Financial Statements................................................................ 29-44
Customer Profiles......................................................................................... 45
Directors and Officers.................................................................................... 46-47
Common Stock and Dividend Information..................................................................... 48
Locations, Transfer Agent and Market Makers............................................................... 49
1
[LOGO]
2
[LOGO]
To Our Shareholders:
During 2003 we opened a new office, and made tremendous gains in our mortgage
loan portfolio, however, our income was below expectations. Net income for the
past year totaled $2,236,000 compared to $2,901,000 for the prior year, or a
decline of 22.9%. The disappointing drop in income is primarily attributable to
a very large increase to the provision for loan losses and expenses associated
with our expansions in both Greenville and Mt. Pleasant.
The increase to the provision for loan losses was the result of losses incurred
relating to two large commercial loan relationships in the manufacturing sector.
We attempted to resolve the problems over many months. It became apparent during
the second quarter of 2003 that it was in our best interest to work out of these
two relationships, which resulted in a loss. No balances with these customers
remain on our books at year end.
Had the additional provision for loan losses not been necessary, net income for
2003 would have increased just over 10% compared to the prior year, despite the
increased costs associated with our new offices in Greenville and Mt. Pleasant.
However, both of these new banking facilities should position us to grow our
business in their respective markets.
Our affiliate bank, Commercial Bank Greenville, has been open for a little more
than a year now and under the leadership of Jeff Loomis, our new President in
Greenville, we are experiencing solid gains in both loans and deposits. Jeff
brings over 20 years of community bank experience to Commercial Bank Greenville.
Recently, The Centennial Group added Linda Posati, a new Registered
Representative, to our bank in Greenville. Linda has been providing financial
services to the Greenville market since 1987.
The new Mt. Pleasant office opened in June 2003 and has been very favorably
received by both new and existing customers, some of whom are featured in this
annual report. Vice President, Wayne Heminger, and Branch Manager, Sandy
Lucksted, head up our unique new Mt. Pleasant office designed and staffed to
provide the utmost in personalized service.
While net income declined for 2003, our dividend payout remained strong. Cash
dividends were $.54 per share compared to $.51 for the prior year or an increase
of 5.9%. The resulting dividend yield for the past year was 4.8% at year end. At
the same time the total capital ratio for the company is just over 10% and
substantially exceeds all regulatory capital requirements.
Looking forward to 2004, we plan to continue our strong growth in real estate
mortgage lending. Real estate mortgage loans totaled $77,400,000 at the end of
2003 compared to $61,600,000 for the prior year, a 25% increase. Recently, Karen
Taylor was promoted to Vice President - Mortgage Lending to head up that
important role in the bank. She will be adding two new Mortgage Originators
beginning March 1, 2004, and we have developed several new innovative loan
products. We are also updating our interactive web site to process both
conventional mortgages and home equity loans. We look forward to continued
growth in this important segment of our business. I encourage you to visit our
mortgage loan web site at www.cbloan.info.
Thank you for your continued support and investment in Commercial National
Financial Corporation.
Sincerely,
Jeffrey S. Barker
President and CEO
3
[LOGO]
PICTURES OF MT. PLEASANT
4
[LOGO]
SELECTED FINANCIAL DATA
2003 2002 2001 2000 1999
--------- --------- --------- --------- ---------
(In thousands except financial ratios and per share data)
FOR THE YEAR
Net interest income $ 9,704 $ 8,922 $ 8,952 $ 9,002 $ 8,416
Provision for loan losses (1,901) (681) (375) (360) (360)
Noninterest income 2,028 1,823 1,842 1,026 1,099
Noninterest expense (6,762) (6,033) (5,885) (5,572) (5,347)
--------- --------- --------- --------- ---------
Income before income tax expense 3,069 4,031 4,534 4,096 3,808
Income tax expense (833) (1,130) (1,331) (1,193) (1,077)
--------- --------- --------- --------- ---------
Net income $ 2,236 $ 2,901 $ 3,203 $ 2,903 $ 2,731
========= ========= ========= ========= =========
AT YEAR END
Total assets $ 239,788 $ 238,251 $ 218,398 $ 215,886 $ 191,022
Net loans 192,419 181,665 165,427 174,288 149,675
Total deposits 169,565 166,059 162,579 157,794 147,204
FHLB advances 32,104 32,807 26,093 26,500 16,500
Shareholders' equity 24,283 23,704 22,064 20,110 18,965
FINANCIAL RATIOS
Return on average assets .94% 1.28% 1.48% 1.43% 1.47%
Return on average shareholders' equity 9.21 12.60 14.93 14.67 14.67
Average shareholders' equity to average assets 10.22 10.14 9.90 9.74 10.04
Allowance for loan losses to total loans 1.01 1.51 1.54 1.44 1.83
Tier 1 leverage capital ratio 10.19 10.00 9.74 9.35 9.98
Total risk-based capital ratio 14.40 14.21 14.38 13.14 14.27
Dividend pay-out 97.33 70.35 59.48 62.23 63.37
PER SHARE DATA(1)
Basic earnings $ .55 $ .73 $ .82 $ .75 $ .70
Diluted earnings .55 .72 .82 .74 .70
Dividends declared .54 .51 .49 .46 .46
Book value, end of year 5.99 5.94 5.64 5.22 4.90
(1) All per share data adjusted to reflect stock splits and stock dividends.
5
[LOGO]
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
INTRODUCTION
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.
BUSINESS OF COMMERCIAL NATIONAL FINANCIAL CORPORATION
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 is 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.
The Bank concentrates its efforts primarily in two areas, commercial lending and
residential real estate lending. Loan, deposit and other products are designed
to support these market segments. The Bank also provides a full range of
traditional banking services to individuals located in its service area.
Commercial Bank offers a variety of deposit products, including checking,
savings, money market, individual retirement accounts, certificates of deposit
and repurchase agreements.
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 also lends outside the principal geographic market
where the Bank has locations in support of existing customers. 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 79.25% of total
revenue in 2003, 79.47% in 2002, and 79.71% in 2001. Interest on investment
securities accounted for 6.82% of total revenue in 2003, 7.82% in 2002, and
8.04% in 2001.
CRITICAL ACCOUNTING POLICIES
The "Management's Discussion and analysis of Financial Condition and Results of
Operations," as well as disclosures found elsewhere in the annual report, are
based upon Commercial's consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States of America. The preparation of these financial statements requires
Commercial to estimate and make judgments that affect the
6
[LOGO]
reported amounts of assets, liabilities, revenues and expenses. Material
estimates that are particularly susceptible to significant change in the near
term relate to the determination of the allowance for loan losses, the valuation
mortgage servicing assets and the valuation of stock options. Actual results
could differ significantly from these estimates.
Allowance for Loan Losses
The allowance for loan losses is maintained at a level believed adequate by
management to absorb probable losses inherent in the consolidated loan
portfolio. Management's evaluation of the adequacy of the allowance is an
estimate based on an assessment of loss exposure on individual loans identified
as substandard or substandard and impaired, and an assessment of the performance
of homogenous categories of loans. A detailed discussion of Commercial's
allowance for loan loss methodology is included in the Provision and Allowance
for Loan Losses section of the management discussion and analysis.
Mortgage Servicing Assets
Servicing assets are recognized as separate assets when loans are sold with
servicing retained. Capitalized servicing rights are amortized into noninterest
income in proportion to, and over the period of, the estimated future net
servicing income of the underlying financial assets. Servicing assets are valued
based upon the estimated fair value of the rights. Value is determined by
stratifying servicing rights by predominant characteristics, including term, and
rate and applying a discounted cash flow model to determine an estimated market
value. Some of the assumptions used in the discounted cash flow model, including
the estimated life of the servicing asset, can influence the final market value.
Negative adjustments to the value (referred to as impairment), are recognized
through a valuation allowance by charges against mortgage servicing income. See
Note 5 of the consolidated financial statements for additional information.
Stock Options
Incentive and non-qualified stock options are periodically issued to certain
employees and directors under shareholder approved stock option plans. The
options are granted at an exercise price equal to the fair value of the
underlying shares at the date of grant. Employee options are generally granted
for a term of 10 years with a 5 year vesting schedule. Director options are
granted for a term of 10 years with a 6 month vesting schedule.
Management uses the Black-Scholes option pricing model to determine the fair
value of stock options. This model has certain limitations, such as not
factoring in the non-transferability of employee options. The model is generally
used to value options with terms shorter than the contractual ten-year life.
Because of these limitations, and the use of subjective assumptions in the
model, this and other option pricing models do not necessarily provide a
reliable measure of the fair value of stock options. In the current market place
we are unable to find a reasonably priced model that will provide a more
reliable measure of fair value. Management also believes that obtaining an
independent appraisal of value would be cost prohibitive and also inherently
unreliable.
The more significant assumptions used in estimating the fair value of stock
options include the risk-free interest rate, the dividend yield, the weighted
average expected life of the stock options and the expected price volatility of
our common stock. The risk-free interest rate is based on U.S. Treasury
securities with a term equal to the expected life of the stock options. The
dividend yield is based on Commercial's expected dividend payout level. The
expected life is based on historical experience adjusted for changes in terms
and the amount of awards granted. The expected volatility, which is the
assumption where the most judgment is used, is based on historical volatility.
See notes 1 and 10 of Commercial's consolidated financial statements for further
discussion of stock options.
Management believes the accounting estimates related to the allowance for loan
losses, valuations of mortgage servicing assets and the valuation of stock
options are critical accounting estimates. These estimates are susceptible to
change from period to period because they require management to make assumptions
concerning future events. Management regularly discusses the methodology used to
determine these accounting estimates with the audit committee of the board of
directors.
HIGHLIGHTS
2003 COMPARED TO 2002
Net income for the year ended December 31, 2003 was $2,236,000, a $665,000 or
22.9% decrease from the $2,901,000 earned in 2002. The 2003 return on average
equity decreased
7
[LOGO]
to 9.21% from 12.60% in 2002. The return on average assets for 2003 also
decreased to .94% from 1.28% in 2002. Basic earnings per share decreased from
$.73 per share for the year ending December 31, 2002 to $.55 per share for the
year ending December 31, 2003.
The major factors affecting 2003 results were falling interest rates, weak
business loan demand, credit weakness in the business loan portfolio, and cost
of expanding into Mt. Pleasant, Michigan.
Interest rates, in general, continued to fall during the first 8 months of 2003.
The decrease in interest rates provided incentive for residential real estate
loan customers to refinance their existing residential real estate mortgages.
The refinancing activity contributed to a net gain on loan sales of $818,000, a
$120,000 or 17.2% increase compared to 2002. Commercial originated and sold to
the secondary market $33.6 million in residential real estate loans compared to
$32.7 million during 2002. This resulted in a $4.8 million or 7.8% increase in
Commercial's mortgage servicing portfolio.
Credit weakness in the business loan portfolio required Commercial to increase
the provision for loan loss to $1,901,000 from $681,000, a $1,220,000 or 179.15%
increase. Commercial also recorded gross charge-offs related to business loans
of $2,996,000.
In June of 2003, Commercial opened an office in Mt. Pleasant, Michigan. The
office allows the Bank to support the deposit needs of existing business loan
customers located in or near Mt. Pleasant. This office also provides a base of
operation from which Commercial can pursue additional residential real estate
and business lending opportunities. Costs of opening and staffing this location,
combined with a full year of cost of operating our newest Greenville, Michigan
office contributed to the $729,000 or 12.1% increase in non-interest expense.
Total assets at December 31, 2003 increased $1.5 million to $239.8 million.
Total gross loans increased $9.9 million primarily as a result of a $15.8
million increase in the residential real estate loan portfolio offset by an $5.4
million decrease in business related loans. Federal Funds totaling $6.2 million
and $1.7 million in other interest bearing deposits were used to partially fund
the increase in loans.
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 $.82 per share for the year ending December 31, 2001 to $.73 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 into Greenville, Michigan.
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
aFt December 31, 2002. The increase in non-performing loans, resulted in an
increase in the provision for loan loss of $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, Michigan had a short-term negative impact on
non-interest expense as management completed and staffed a new office. This new
office increased 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.
8
[LOGO]
NET INTEREST INCOME
Treasury Yields
December 31, December 31, December 31, October 16, December 31,
2003 2002 2001 2001 2000
------------ ------------ ----------- ---------- ------------
3 month .93% 1.19% 1.72% 2.22% 5.09%
6 month 1.01% 1.24% 1.81% 2.20% 5.79%
1 year 1.86% 1.74% 3.18% 2.74% 5.43%
2 year 1.86% 1.74% 3.18% 2.74% 5.15%
5 year 3.24% 3.05% 4.43% 3.79% 5.01%
10 year 4.27% 4.08% 5.10% 4.59% 5.11%
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 above table illustrates how, in general, treasury 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.
2003 COMPARED TO 2002
During 2003, long term interest rates continued to fall. Residential real estate
and other long term borrowers continued to refinance loans at lower rates.
Maturing securities were also replaced at lower yields. To help improve the
yield on earning assets management invested excess Fed Funds into residential
real estate loans. The yield on earning assets also improved as a result of the
return to accrual status of $1.2 million in non-accrual loans and the related
recapture of non-accrual interest. The net effect of these events was a 44 basis
point decrease in the yield on earning assets.
In response to lower yields on earning assets, management continued to lower the
cost of deposit and other funding sources where possible. This included $8.7
million in FHLB maturing advances which were renewed at lower cost. Commercial
was able to lower the cost of funds by 69 basis points.
The net effect of the events affecting the yield on earning assets and the cost
of interest bearing liabilities was a 14 basis point increase in Commercial's
margin from 4.32% to 4.46%. The increase in margin combined with an increase of
$9.3 million in average earning assets resulted in a $709,000 increase of tax
equivalent net interest income.
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%.
9
[LOGO]
Average Balance Sheet and Analysis of Net Interest Income
Years ended December 31,
--------------2003----------- ------------2002-------------
AVERAGE YIELD/ Average Yield/
BALANCE INTEREST RATE Balance Interest Rate
--------- -------- ------ --------- -------- ------
(Dollars in thousands)
Interest-earning assets:
Loans receivable (1)(2) $ 184,693 $ 12,644 6.85% $ 179,831 $ 12,755 7.09%
Investment securities
Taxable 18,850 697 3.70 14,723 773 5.25
Tax-exempt (2) 8,361 586 7.01 9,974 717 7.19
Federal funds sold and
other interest-bearing deposits 9,948 97 .98 8,112 111 1.37
Federal Home Loan Bank stock 1,676 85 5.07 1,495 91 6.09
--------- -------- --------- --------
Total interest-earning assets 223,528 14,109 6.31 214,135 14,447 6.75
Non-earning assets:
Cash and due from banks 5,343 5,100
Premises and equipment, net 3,851 2,953
Other assets 7,480 7,851
Allowance for loan losses (2,820) (2,888)
--------- ---------
Total assets $ 237,382 $ 227,151
========= =========
Interest-bearing liabilities:
Interest-bearing deposits
Interest-bearing demand $ 29,427 $ 142 .48% $ 28,371 $ 152 .54%
Savings 63,077 654 1.04 56,630 1,039 1.83
Time 54,220 1,652 3.05 57,610 2,197 3.81
Securities sold under agreements
to repurchase 14,151 148 1.05 9,398 156 1.66
U.S. Treasury demand notes,
Federal funds purchased, and
other borrowings 295 3 1.02 397 6 1.51
Federal Home Loan Bank advances 29,643 1,545 5.21 29,227 1,641 5.61
--------- -------- --------- --------
Total interest-bearing liabilities 190,813 4,144 2.17 181,633 5,191 2.86
Noninterest-bearing liabilities:
Noninterest-bearing demand 21,334 19,675
Other liabilities 967 2,812
Shareholders' equity 24,268 23,031
--------- ---------
Total liabilities and
shareholders' equity $ 237,382 $ 227,151
========= =========
Net interest income/interest rate spread $ 9,965 4.14% $ 9,256 3.89%
======== ====== ======== ======
Net interest margin (3) 4.46% 4.32%
====== ======
Years ended December 31,
-------------2001-------------
Average Yield/
Balance Interest Rate
---------- -------- ------
(Dollars in thousands)
Interest-earning assets:
Loans receivable (1)(2) $ 172,714 $ 14,379 8.33%
Investment securities
Taxable 15,118 884 5.85
Tax-exempt (2) 11,212 844 7.53
Federal funds sold and
other interest-bearing deposits 8,463 252 2.98
Federal Home Loan Bank stock 1,391 104 7.48
---------- --------
Total interest-earning assets 208,898 16,463 7.88
Non-earning assets:
Cash and due from banks 4,645
Premises and equipment, net 2,319
Other assets 3,570
Allowance for loan losses (2,731)
----------
Total assets $ 216,701
==========
Interest-bearing liabilities:
Interest-bearing deposits
Interest-bearing demand $ 26,825 $ 280 1.04%
Savings 44,729 1,237 2.77
Time 69,625 3,831 5.50
Securities sold under agreements
to repurchase 8,462 313 3.70
U.S. Treasury demand notes,
Federal funds purchased, and
other borrowings 597 23 3.85
Federal Home Loan Bank advances 23,715 1,461 6.16
---------- --------
Total interest-bearing liabilities 173,953 7,145 4.11
Noninterest-bearing liabilities:
Noninterest-bearing demand 20,148
Other liabilities 1,152
Shareholders' equity 21,448
----------
Total liabilities and
shareholders' equity $ 216,701
==========
Net interest income/interest rate spread $ 9,318 3.77%
======== ======
Net interest margin (3) 4.46%
======
(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.
10
[LOGO]
The following table analyzes the effect of volume and rate changes on interest
income and expense for the periods indicated.
Years ended December 31,
2003 2002 2001
-------COMPARED TO 2002------ -----Compared to 2001------ -------Compared to 2000------
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
---------- ------- -------- ---------- ------ ------- ---------- ------ --------
(In thousands)
Interest income:
Loans receivable (1) (2) $ (111) $ 333 $ (444) $ (1,623) 505 $(2,128) $ (212) $ 693 $ (905)
Investment securities:
Taxable (76) 153 (229) (113) (20) (93) (57) (35) (22)
Tax-exempt (2) (131) (113) (18) (127) (89) (38) (47) (46) (1)
Federal funds sold and
other interest- bearing deposits (14) 18 (32) (141) (5) (136) 115 162 (47)
Federal Home Loan Bank stock (6) 9 (15) (13) 6 (19) (11) - (11)
--------- ------ ------- --------- ----- ------- --------- ------ -------
Total interest income (338) 400 (738) (2,017) 397 2,414) (212) 774 (986)
Interest expense:
Interest-bearing deposits
Interest-bearing demand (10) 5 (15) (128) 9 (137) (149) 7 (156)
Savings (385) 67 (452) (198) 218 (416) 46 66 (20)
Time (545) (103) (442) (1,634) (458) (1,176) (97) 71 (168)
Securities sold under
agreements to repurchase (8) 50 (58) (158) 15 (173) (87) 64 (151)
U.S. Treasury demand notes, Federal
funds purchased and other borrowings (3) (1) (2) (17) (3) (14) (32) (9) (23)
Federal Home Loan Bank advances (96) 22 (118) 181 310 (129) 165 268 (103)
--------- ------ ------- --------- ----- ------- --------- ------ -------
Total interest expense (1,047) 40 (1,087) (1,954) 91 (2,045) (154) 467 (621)
--------- ------ ------- --------- ----- ------- --------- ------ -------
Net interest income $ 709 $ 360 $ 349 $ (63) $ 306 $ (369) $ (58) $ 307 $ (365)
========= ====== ======= ========= ===== ======= ========= ====== =======
(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.
NONINTEREST INCOME
Years ended December 31,
2003 2002 2001
------ ------ ------
(In thousands)
Service charge and fees $ 469 $ 494 $ 453
Net gains on mortgage loan sales 818 698 613
Dividends on bank owned life
insurance 169 181 50
Receivable financing fees 166 158 227
Net gains on sale of securities - 28 211
Gain on sale of other real estate 259 - -
Other 147 265 287
------ ------ ------
Total noninterest income $2,028 $1,824 $1,841
====== ====== ======
2003 COMPARED TO 2002
Noninterest income for the year ended December 31, 2003 was $2,028,000, a
$204,000 or 11.1% increase compared to the year ended December 31, 2002.
Service charge and fees decreased $25,000 as a result of checking and money
market product restructuring. The restructuring process reduced the number of
checking and money market products and eliminated several activity and minimum
balance fees.
Residential real estate mortgage rates continued to fall during the first eight
months of 2003. The low interest rates provided incentive for residential real
estate mortgage
11
[LOGO]
customers to refinance their mortgage loans. The refinancing activity resulted
in net gain on loan sales of $818,000, a $120,000 or 17.1% increase compared to
2002. Management anticipates that higher interest rates will significantly
decrease the net gain on mortgage loan sales during 2004.
Gain on sale of other real estate was $259,000. The gain was the result of a
sale of real estate related to a business loan identified as nonperforming at
December 31, 2002.
Other income decreased by $119,000 or 44.9% as a result of the increased rate of
amortizing mortgage servicing rights and the recording of a $132,000 valuation
allowance to recognize a decline in the value of mortgage servicing rights.
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.
At December 31, 2001 management noted an increase in residential real estate
mortgage rates and a corresponding decrease in residential real estate mortgage
applications. However, mortgage rates decreased during 2002 to 40 year lows. 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.
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.
NONINTEREST EXPENSE
Years ended December 31,
2003 2002 2001
-------- -------- --------
(In thousands)
Salaries $ 2,949 $ 2,689 $ 2,570
Employee benefits 750 665 660
Furniture and equipment 797 603 658
Professional fees 390 343 354
Occupancy 388 328 314
Printing and supplies 172 197 186
Director fees 199 182 156
Telephone 111 146 127
Postage 100 102 87
Advertising 95 84 71
Other insurance 66 60 55
Other taxes 25 54 47
FDIC insurance 28 31 31
Other expenses 692 549 569
-------- -------- --------
Total noninterest expense $ 6,762 $ 6,033 $ 5,885
======== ======== ========
Efficiency ratio 56.38% 54.45% 52.74%
======== ======== ========
Noninterest expense as percentage
of average assets 2.85% 2.66% 2.72%
======== ======== ========
Salaries and employee benefits as
a percentage of average assets 1.56% 1.48% 1.49%
======== ======== ========
2003 COMPARED TO 2002
Noninterest expense for the year ending December 31, 2003 increased $729,000 or
12.1%. Commercial's efficiency ratio increased from 54.45% to 56.38%.
During June of 2003, the Bank opened an office in Mt. Pleasant, Michigan. Costs
of opening and operating this office and a full year of cost of our newest
Greenville, Michigan location negatively impacted several expense categories
including salaries, employee benefits, occupancy, furniture and equipment and
director fees.
Salary expense increased $260,000 or 9.7%. The increase reflects 12 month
expense for the Greenville office staff, salary expense for new employees at the
Mt. Pleasant office and normal salary increases. Full time equivalents increased
from 79 at December 31, 2002 to 82 at December 31, 2003.
Telephone expense decreased $35,000 or 24.0%. During 2003, the Bank was also
able to renegotiate cost of lines extending from the Ithaca office to all other
locations at favorable terms.
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%.
[LOGO]
12
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.
INCOME TAX EXPENSE
Commercial's 2003 income tax expense was $833,000 compared to $1,130,000 in 2002
and $1,331,000 in 2001. The decrease from 2001 through 2003 was primarily the
result of decreased income before income tax offset by a decrease in tax-exempt
interest income. The decrease in income tax expense for 2003 was primarily due
to lower pretax net income and a decrease in tax-exempt interest. The average
balance in tax-exempt securities decreased $1,613,000 in 2003, $1,238,000 in
2002, and $614,000 in 2001.
The statutory federal tax rate during 2003, 2002, and 2001, 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
27.14% in 2003, 28.03% in 2002, and 29.35% in 2001.
INVESTMENT PORTFOLIO
The following table shows securities by classification as of December 31, 2003,
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 $ 5,097,188 5.10% $13,109,144 2.94% $ - $ - $18,206,332 3.54%
State and municipal(1) 295,202 6.18% 1,911,573 6.43% 1,733,521 6.38% 882,479 5.65% 4,822,775 5.97%
----------- ----- ----------- ----- ----------- ----- ----------- ----- ----------- -----
Total $ 5,392,390 $15,020,717 $ 1,733,521 $ 882,479 $23,029,107
=========== ===== =========== ===== =========== ===== =========== ===== =========== =====
HELD TO MATURITY
State and
municipal (1) $ 1,005,318 7.00% $ 1,947,445 7.37% $ 95,000 9.16% $ - $ 3,047,763 7.30%
----------- ----- ----------- ----- ----------- ----- ----------- ----- ----------- -----
Total $ 1,005,318 $ 1,947,445 $ 95,000 $ - $ 3,047,763
=========== ===== =========== ===== =========== ===== =========== ===== =========== =====
(1) Yields on tax-exempt securities are computed on a fully
taxable-equivalent basis
The previous table which shows the contractual maturity of securities by
classification does not account for the effect of call dates on the cash flow of
the investment securities portfolio. During 2004, $8.5 million in available for
sale U.S. Treasury and government agency securities maturing in years 2005
through 2008 will reach a call date. Interest rates in effect at December 31,
2003 lead management to believe that $7.1 million of the securities reaching a
call date will likely be called by the issuer.
[LOGO]
13
The amortized cost of investment securities, as of the dates indicated, are
summarized as follows:
December 31,
2003 2002 2001
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 $ 18,028 $ - $ 15,627 $ - $ 14,588 $ -
State and municipal 4,580 3,048 4,544 4,689 4,224 7,497
Other - - 501 - 1,090 -
-------- --------- -------- --------- -------- --------
Total $ 22,608 $ 3,048 $ 20,672 $ 4,689 $ 19,902 $ 7,497
======== ========= ======== ========= ======== ========
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 $10.2 million at December 31, 2003 compared to $8.5
million at December 31, 2002.
The Committee does not invest in derivative securities. Commercial holds no
impaired securities at December 31, 2003. As of December 31, 2003, the aggregate
book value of investment securities issued by the State of Michigan and all its
political subdivisions totaled $5.0 million with an aggregate market value of
$5.2 million.
LOAN PORTFOLIO
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 focuses its lending efforts in
two categories: business lending and residential real estate lending. The Bank
does not engage in indirect lending, credit cards, or sub-prime lending.
Commercial has no foreign loans.
2003 COMPARED TO 2002
Total loans increased $9.9 million or 5.4% during 2003. The Bank's portfolio mix
changed during 2003 as commercial, financial and agricultural loans decreased by
$8.1 million while residential real estate loans increased $15.8 million.
Several factors caused the $8.1 million decrease in commercial, financial and
agricultural loans: the resolution of impaired and problem loans through
charge-off or refinancing with other institutions, and weak business loan
demand. The Bank charged-off $3.0 million in commercial, financial and
agricultural loans during 2003.
Several factors caused the $15.8 million increase in residential real estate
loans: loan interest rates encouraging refinancing and purchase money
transactions, and the Bank's need to invest excess liquidity.
As interest rates continued to fall during the first eight months of 2003,
residential real estate refinancing and purchase money transactions remained
strong. Fifteen and 30 year fixed rate loans underwritten to Federal Home Loan
Mortgage Corporation (Freddie Mac) standards were the most popular products with
Commercial's customers.
As loans are sold to Freddie Mac, the Bank's liquidity increases. With a lack of
investment options, combined with weak loan demand, the funds received from
Freddie Mac were generally invested in Federal Funds at .98% average yield
during 2003. The yield on the residential real estate
[LOGO]
14
loans originated during 2003 ranged from 4.25% to 7.5%. Management determined
the break even point comparing holding mortgages and earning interest income vs.
selling the mortgages, recording a gain on sale and investing proceeds in
Federal Funds was as short as four months. Management elected to hold in
portfolio a portion of 15 and 30 year fixed rate loans originated during 2003.
Also, not all residential real estate loan customers qualify or request 15 and
30 year fixed rate loans. In these instances the Bank offers alternative
products including adjustable rate mortgages, and first time home buyer
programs. These loans are also kept in portfolio.
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%.
The following table presents the amount of loans outstanding by loan type:
December 31,
2003 2002 2001 2000 1999
----------- ----------- ----------- ------------ ------------
(In thousands)
Commercial, financial and
agricultural $ 95,947 $ 104,092 $ 92,566 $ 91,860 $ 80,116
Real estate - construction 14,698 11,952 12,556 19,318 16,145
Real estate - mortgage 77,454 61,652 55,893 57,945 47,085
Consumer and other 6,291 6,752 6,998 7,710 9,121
----------- ----------- ----------- ----------- -----------
Total loans $ 194,390 $ 184,448 $ 168,013 $ 176,833 $ 152,467
=========== =========== =========== =========== ===========
The following table shows the maturity of loans (excluding real estate-mortgage
and consumer and other loans) outstanding at December 31, 2003. 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 $ 24,834 $ 61,993 $ 8,249 $ 871 $ 95,947
Real estate - construction 4,177 7,982 832 1,707 14,698
-------- ---------- ---------- --------- ---------
Total $ 29,011 $ 69,975 $ 9,081 $ 2,578 $ 110,645
======== ========== ========== ========= =========
Loans due after one year:
Fixed rate $ 32,117
Floating or adjustable rate 49,517
--------
Total $ 81,634
========
ASSET QUALITY
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.
[LOGO]
15
As of December 31, 2003 there were no concentrations of loans exceeding 10% of
total loans.
2003 COMPARED TO 2002
Non-performing loans decreased from $6.0 million to $825,000, a $5.2 million
decrease. The $825,000 of non-performing loans is considered impaired.
The $6.0 million in nonperforming loans at December 31, 2002 represented six
business loan relationships. During 2003, management was able to resolve all but
two of the relationships.
The $825,000 in non-performing loans represents three business loan
relationships, two of which management believes, will be resolved during the
first quarter of 2004.
The $5.2 million decrease in non-performing loans was resolved as follows:
Balance at beginning of year $ 6.0
Charged-off (2.8)
Cash received (1.8)
Returned to accrual status (1.2)
Additions .6
----------
Balance at end of year $ .8
==========
2002 COMPARED TO 2001
Non-performing loans 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 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.
The following table summarizes non-accrual, past due and restructured loans:
December 31,
2003 2002 2001 2000 1999
------- -------- -------- ------- --------
(In thousands)
Non-accrual loans $ 825 $ 5,676 $ 388 $ 354 $ 963
Accruing loans past due 90 days or more - - 75 - 14
Restructured loans - 349 - - -
------- -------- -------- ------- --------
Total non-performing loans 825 6,025 463 354 977
Repossessed assets, and other real estate 598 121 1,000 42 -
------- -------- -------- ------- --------
Total non-performing assets $ 1,423 $ 6,146 $ 1,463 $ 396 $ 977
======= ======== ======== ======= ========
Total non-performing loans
as a percentage of total loans .42% 3.27% .28% .20% .65%
======= ======== ======== ======= ========
Total non-performing assets as a percentage
of total assets .59% 2.58% .67% .18% .51%
======= ======== ======== ======= ========
PROVISION AND ALLOWANCE FOR LOAN LOSSES
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,
2003 2002 2001
PERCENT Percent Percent
OF LOANS of Loans of Loans
TO TOTAL to Total to Total
ALLOWANCE LOANS Allowance Loans Allowance Loans
--------- -------- --------- ------- --------- --------
(In thousands)
Commercial, financial
and agricultural $ 1,563 49.36% $ 2,398 56.43% $ 993 55.09%
Real estate - construction 298 7.56 26 6.48 15 7.47
Real estate - mortgage - 39.84 122 33.43 114 33.27
Consumer and other 64 3.24 92 3.66 342 4.17
Unallocated 45 145 - 1,122 -
--------- ------ --------- ------ --------- ------
Total $ 1,970 100.00% $ 2,783 100.00% $ 2,586 100.00%
========= ====== ========= ====== ========= ======
December 31,
2000 1999
Percent Percent
of Loans of Loans
to Total to Total
Allowance Loans Allowance Loans
--------- --------- --------- ---------
(In thousands)
Commercial, financial
and agricultural $ 1,265 51.95% $ 1,352 52.55%
Real estate - construction 17 10.92 - 10.59
Real estate - mortgage 120 32.77 100 30.88
Consumer and other 427 4.36 351 5.98
Unallocated 716 - 989 -
---------- ------ --------- ------
Total $ 2,545 100.00% $ 2,792 100.00%
========== ====== ========= ======
[LOGO]
16
The following table summarizes changes in the allowance for loan losses.
Years ended December 31,
2003 2002 2001 2000 1999
---------- ---------- ---------- ----------- ----------
(In thousands)
Amount of loans outstanding at end of year $ 194,390 $ 184,448 $ 168,013 $ 176,833 $ 152,467
========== ========== ========== =========== ==========
Daily average of loans
outstanding for the year $ 184,693 $ 179,831 $ 172,714 $ 164,389 $ 143,026
========== ========== ========== =========== ==========
Balance of allowance at beginning of year $ 2,783 $ 2,586 $ 2,545 $ 2,792 $ 2,344
Loans charged off:
Commercial, financial and agricultural (2,996) (511) (389) (662) -
Real estate - mortgage - - - - -
Consumer and other (124) (27) (27) (28) (29)
---------- ---------- ---------- ----------- ----------
Total loans charged off (3,120) (538) (416) (690) (29)
---------- ---------- ---------- ----------- ----------
Recoveries of loans previously charged off:
Commercial, financial, and agricultural 385 26 48 10 76
Real estate - mortgage - - 1 44 15
Consumer and other 21 28 33 29 26
---------- ---------- ---------- ----------- ----------
Total recoveries 406 54 82 83 117
---------- ---------- ---------- ----------- ----------
Net (charge-offs)/recoveries (2,714) (484) (334) (607) 88
Provision for loan losses (1) 1,901 681 375 360 360
---------- ---------- ---------- ----------- ----------
Allowance at end of period $ 1,970 $ 2,783 $ 2,586 $ 2,545 $ 2,792
========== ========== ========== =========== ==========
Ratio of net (charge-offs)/recoveries during period to
average loans outstanding during the period (1.47)% (.27)% (.19)% (.37)% .06%
========== ========== ========== =========== ==========
Ratio of allowance for loan losses to
loans outstanding at end of period 1.01% 1.51% 1.54% 1.44% 1.83%
========== ========== ========== =========== ==========
(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.
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.
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 four classifications for the purpose of
calculating the appropriate allowance for loan loss: non-classified, watch
loans, substandard not impaired and substandard impaired. Within these four
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 quarterly.
Watch loans 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. The reserve on
these categories of loans is determined using historical loss experience. The
loss experience is updated quarterly.
Substandard 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 or
neither.
[LOGO]
17
A specific reserve is calculated for each substandard loan determined to be
impaired. Generally, loans identified as impaired are generally considered
non-performing and are placed on non-accrual. A reserve based on historical loss
experience is established for substandard loans not identified as impaired.
This method of determining the allowance, while believed to be in compliance
with generally accepted accounting principals, has limitations and is inherently
subjective. For example the methodology relies on management's ability to
properly identify and classify loans into appropriate categories. The Audit
Committee attempts to support the assertions made by management by using the
results of independent loan review services.
This methodology also relies on the historical performance of the loan portfolio
to establish reserves for non-classified loans. Historical losses may have the
effect of overstating the required reserve in an improving economy and may
understate reserves in a weakening economy.
Also, management identifies loss exposure on loans considered impaired. Impaired
loans are generally associated with entities dealing with a variety of problems.
These problems sometimes affect the quality of financial information supplied to
the Bank and may limit management's ability to assess the quality of collateral.
While management uses its best estimate of loss exposure, these estimates may
change as more information becomes available.
2003 COMPARED TO 2002
The allowance for loan losses at December 31, 2003 was 1.01% of loans
outstanding, compared to 1.51% at December 31, 2002.
Historically, Commercial's loan portfolio can be described as performing well,
except for periodic problems with a few business loan customers. The majority of
the credit risk at Commercial has always been in the commercial, agricultural
and financial portfolio as evident by historical charge-offs. The allowance
calculation allocates $1.6 million of the $2.0 million to the commercial,
agricultural and financial portfolio.
During 2003, the Bank experienced problems with two large loan relationships
previously identified as impaired. These relationships resulted in net
charge-offs of $2.7 million. The charge-offs were larger than the previously
estimated loss exposure identified by management, therefore, $1.9 million was
provided to the allowance during 2003. Excluding these two relationships the
business portfolio recognized net recoveries of $.1 million.
The dollar amount of loans identified as non-performing has decreased from $6.0
million at December 31, 2002 to $825,000 at December 31, 2003. Management
believes that approximately $235,000 of the non-performing loans will be
resolved during the first quarter of 2004.
The mortgage loan portfolio continues to perform well. For the fifth consecutive
year the Bank did not record any gross charge-off related to a residential
mortgage loan. The consumer loan portfolio, while recording net charge-offs of
$103,000, also continues to perform well.
2002 COMPARED TO 2001
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. 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
increased from $3.6 million 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
[LOGO]
18
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.
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. It also
includes access to unused Federal Funds lines of credit, borrowing capacity at
the Federal Home Loan Bank and other pre-approved credit facilities.
Generally, the Bank attempts to limit excess liquidity held in the form of
Federal Funds sold. At December 31, 2003, Commercial had $.6 million in Federal
Funds sold compared to $6.9 million at December 31, 2002. The Bank has $13.2
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 2003, Commercial generated $6.3 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.
CAPITAL RESOURCES
At December 31, 2003, capital totaled $24,283,000. 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, 2003, 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
[LOGO]
19
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. 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 for the Bank may be in
conflict with the customer's 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 analysis 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.
A limitation with this methodology is that the interest rate curve rarely
experiences a 200 basis points immediate and parallel increase or decrease in
interest rates. Management is in the process of implementing 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 $1,084,000 if interest rates increase 200 basis
points in an immediate parallel shift in the yield curve. This compares to a
$539,000 decrease for the year ending December 31, 2002.
If interest rates were to experience a 200 basis point immediate and parallel
decrease in the yield curve, Commercial might experience a slight increase in
net interest income. At current interest rates, management does not have the
ability to lower interest rates on the majority of deposit products 200 basis
points. However, asset yields can decrease by 200 basis points.
The following table illustrates how Commercial's net interest income might be
affected by a 200 basis point immediate and parallel decrease in the yield
curve. Commercial's net
[LOGO]
20
interest income might increase $10,000 if interest rates decreased 200 basis
points in an immediate parallel shift in the yield curve. This compares to a
$140,000 decrease for the year ending December 31, 2002.
Management has used this and other information to make the following decisions.
Management elected to hold some longer term residential mortgage loans. This
decision reduced excess liquidity and, in the short run, improved net interest
income. To offset some of the interest rate risk, management used longer term
Federal Home Loan Bank advances to reduce the negative impact to net interest
income if interest rates increase. Management believes that an increase in
interest rates is more likely than a decrease.
Net Interest Percentage Projected
Income at Change in Net Net Interest
Interest rate change December 31, 2003 Interest Income Income
- -------------------- ------------------ --------------- ------------
- -200 BASIS POINTS $ 9,704,000 .10% $ 9,714,000
0 BASIS POINTS 9,704,000 0.00 9,704,000
+200 BASIS POINTS 9,704,000 (11.17) 8,620,000
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
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 $6.8 million or 25.20%. This compares to an estimated decrease of
$2.8 million or 9.34% decrease for the year ending December 31, 2002. If rates
decrease 200 basis points immediately, the economic value of equity would
increase $5.8 million or 21.64%. This compares to an estimated increase of $3.1
million or 10.32% increase for the year ending December 31, 2002.
December 31, 2003
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 $ 24,283,000 $ 26,933,000 21.64% $ 32,761,000
0 BASIS POINTS 24,283,000 26,933,000 0.00 26,933,000
+200 BASIS POINTS 24,283,000 26,933,000 (25.20) 20,146,000
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 (9.34) 26,970,000
[LOGO]
21
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; and
- - trends in customer behavior as well as their ability to repay loans.
These are representative of the Future Factors that could cause a difference
between an actual outcome and a forward-looking statement.
[LOGO]
22
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 accounting principles generally accepted 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
[LOGO]
23
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, 2003 and 2002, 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, 2003. 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, 2003 and 2002, and the results of its
operations and its cash flows for each of the three years in the period ended
December 31, 2003 in conformity with accounting principles generally accepted in
the United States of America.
Crowe Chizek and Company LLC
Grand Rapids, Michigan
January 30, 2004
[LOGO]
24
COMMERCIAL NATIONAL FINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS
December 31,
2003 2002
------------------------------
ASSETS
Cash and due from banks $ 6,113,498 $ 8,784,826
Federal funds sold 644,807 6,850,000
Other interest bearing deposits 1,961,444 3,634,988
------------- -------------
Total cash and cash equivalents 8,719,749 19,269,814
Securities available for sale 23,029,107 21,345,896
Securities held to maturity (fair value $ 3,171,283 - 2003, $4,911,696 - 2002) 3,047,763 4,689,025
Federal Home Loan Bank stock, at cost 1,710,700 1,647,000
Gross loans receivable 194,389,682 184,448,296
Allowance for loan losses (1,970,309) (2,783,234)
------------- -------------
Net loans receivable 192,419,373 181,665,062
Bank owned life insurance 3,400,203 3,231,374
Premises and equipment, net 3,933,347 3,687,151
Accrued interest receivable and other assets 3,528,005 2,715,261
------------- -------------
TOTAL ASSETS $ 239,788,247 $ 238,250,583
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Deposits
Noninterest-bearing $ 23,203,653 $ 21,495,410
Interest-bearing demand 29,141,354 29,872,655
Savings 62,028,217 59,432,935
Time 55,191,313 55,258,479
------------- -------------
Total deposits 169,564,537 166,059,479
Securities sold under agreements to repurchase 11,766,630 14,266,239
Other short-term borrowings 412,389 491,840
Federal Home Loan Bank advances 32,104,222 32,807,086
Accrued expenses and other liabilities 1,657,642 921,967
------------- -------------
Total liabilities 215,505,420 214,546,611
Shareholders' equity
Common stock and paid-in-capital, no par value-
5,000,000 shares authorized; shares issued
and outstanding 2003 - 4,052,480 and 2002 - 3,801,421 24,117,375 23,255,499
Retained earnings/(accumulated deficit) (112,306) 3,908
Accumulated other comprehensive income, net of tax 277,758 444,565
------------- -------------
Total shareholders' equity 24,282,827 23,703,972
------------- -------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 239,788,247 $ 238,250,583
============= =============
See accompanying notes
[LOGO]
25
COMMERCIAL NATIONAL FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
Years ended December 31,
2003 2002 2001
---------------------------------------------
Interest and dividend income
Loans, including fees $ 12,582,171 $ 12,664,572 $ 14,299,287
Taxable securities 696,893 772,644 884,291
Nontaxable securities 386,531 473,237 557,143
Federal funds sold 83,229 89,126 218,151
Federal Home Loan Bank stock dividends 85,328 90,562 103,424
Interest on other deposits 14,113 21,881 34,930
------------- ------------- -------------
Total interest and dividend income 13,848,265 14,112,022 16,097,226
------------- ------------- -------------
Interest expense
Deposits 2,447,889 3,387,852 5,348,350
Securities sold under agreements to repurchase 148,493 155,698 313,409
Federal Home Loan Bank advances 1,545,107 1,641,283 1,460,433
Other 2,677 5,644 22,844
------------- ------------- -------------
Total interest expense 4,144,166 5,190,477 7,145,036
------------- ------------- -------------
NET INTEREST INCOME 9,704,099 8,921,545 8,952,190
Provision for loan losses 1,901,000 681,000 375,000
------------- ------------- -------------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 7,803,099 8,240,545 8,577,190
------------- ------------- -------------
Noninterest income
Service charges and fees 469,337 493,776 453,356
Net gains on loan sales 818,023 697,717 612,998
Gain on sale of other real estate 258,619 - -
Receivable financing fees 166,424 157,933 226,598
Bank owned life insurance dividends 168,829 181,078 50,296
Net security gains - 27,565 210,674
Other 146,691 265,432 287,366
------------- ------------- -------------
Total noninterest income 2,027,923 1,823,501 1,841,288
------------- ------------- -------------
Noninterest expense
Salaries and employee benefits 3,698,560 3,353,616 3,230,200
Occupancy and equipment 1,219,326 930,711 972,010
FDIC insurance 27,909 30,708 30,588
Printing, postage and supplies 272,017 299,001 273,252
Professional and outside services 390,434 342,857 353,872
Director fees 199,395 181,700 155,650
Other 954,579 894,573 869,318
------------- ------------- -------------
Total noninterest expense 6,762,220 6,033,166 5,884,890
------------- ------------- -------------
INCOME BEFORE INCOME TAX EXPENSE 3,068,802 4,030,880 4,533,588
Income tax expense 833,000 1,130,000 1,331,000
------------- ------------- -------------
NET INCOME $ 2,235,802 $ 2,900,880 $ 3,202,588
============= ============= =============
Per share information
Basic earnings $ .55 $ .73 $ .82
Diluted earnings $ .55 $ .72 $ .82
Dividends declared $ .54 $ .51 $ .49
See accompanying notes
[LOGO]
26
COMMERCIAL NATIONAL FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
Years ended December 31, 2003, 2002, and 2001
Accumulated
Shares Retained Other
Issued Common Earnings/ Comprehensive Total
and Stock and Paid (Accumulated Income/(Loss), Shareholders'
Outstanding In Capital Deficit) Net of Tax Equity
- ------------------------------------------------------------------------------------------------------------------------------
BALANCE AT JANUARY 1, 2001 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, $ .49 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, $ .51 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
COMPREHENSIVE INCOME:
NET INCOME 2,235,802 2,235,802
NET CHANGE IN UNREALIZED GAINS (LOSSES) ON
SECURITIES AVAILABLE FOR SALE (252,738) (252,738)
TAX EFFECTS 85,931 85,931
------------- ------------
TOTAL COMPREHENSIVE INCOME 2,068,995
------------
CASH DIVIDENDS DECLARED, $ .54 PER SHARE (2,176,213) (2,176,213)
PAYMENT OF 5% STOCK DIVIDEND 192,904 175,803 (175,803) -
ISSUED UNDER DIVIDEND REINVESTMENT PROGRAM 71,388 844,725 844,725
ISSUED UNDER STOCK OPTION PLANS 48 318 318
ISSUED UNDER EMPLOYEE BENEFIT PLAN 4,900 59,134 59,134
REPURCHASE AND RETIREMENT OF SHARES (18,181) (218,104) (218,104)
--------- ------------- ------------ ------------- ------------
BALANCE AT DECEMBER 31, 2003 4,052,480 $ 24,117,375 $ (112,306) $ 277,758 $ 24,282,827
========= ============= ============ ============= ============
See accompanying notes
[LOGO]
27
COMMERCIAL NATIONAL FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31, 2003, 2002, and 2001
2003 2002 2001
-----------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 2,235,802 $ 2,900,880 $ 3,202,588
Adjustments to reconcile net income to net
cash from operating activities
Provision for loan losses 1,901,000 681,000 375,000
Depreciation, amortization and accretion 722,564 507,845 510,476
Net security (gain)/losses - (27,565) (210,674)
Net gains on loan sales (818,023) (697,717) (612,998)
Net gains on sale of other real estate and
repossessed assets (258,619) - (14,546)
Originations of loans held for sale (33,642,975) (32,728,901) (33,429,150)
Proceeds from sales of loans held for sale 34,460,998 33,426,618 34,042,148
Stock dividends paid on Federal Home Loan Bank stock (63,700) - -
Increase in bank owned life insurance 168,829 181,078 50,296
Accrued interest receivable and other assets (1,053,829) 622,772 (1,649,284)
Accrued expenses and other liabilities 700,493 (402,199) (429,959)
------------- ------------- -------------
Net cash from operating activities 4,352,540 4,463,811 1,833,897
------------- ------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of securities available for sale (18,286,462) (7,213,146) (12,272,389)
Proceeds from maturities of securities available for sale 16,112,199 6,360,000 9,170,000
Proceeds from maturities of securities held to maturity 1,635,000 2,823,900 1,010,000
Proceeds from sales of securities available for sale - - 2,523,549
Purchases of Federal Home Loan Bank stock - (255,700) -
Net change in loans (14,262,128) (17,045,958) 8,523,713
Purchase of bank owned life insurance - (3,000,000)
Purchases of premises and equipment, net (719,680) (1,495,500) (641,764)
Proceeds from sales of other real estate and
repossessed assets 1,850,290 - 167,270
------------- ------------- -------------
Net cash from investing activities (13,670,781) (16,826,404) 5,480,379
------------- ------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net change in deposits 3,505,058 3,480,868 4,784,710
Net change in securities sold under agreements to repurchase (2,499,609) 8,028,654 (1,786,182)
Net change in U.S. Treasury demand notes (79,451) 355,291 (933,646)
Repayment of line of credit - - (700,000)
Proceeds from Federal Home Loan Bank advances 8,000,000 14,000,000 17,000,000
Repayment of Federal Home Loan Bank advances (8,702,864) (7,285,465) (17,407,449)
Dividends paid and fractional shares (2,141,031) (2,005,016) (1,874,235)
Proceeds from issuance of common stock 904,177 938,082 732,349
Repurchase and retirement of shares of common stock (218,104) (227,332) (244,519)
------------- ------------- -------------
Net cash from financing activities (1,231,824) 17,285,082 (428,972)
------------- ------------- -------------
Net change in cash and cash equivalents (10,550,065) 4,922,489 6,885,304
Cash and cash equivalents at beginning of year 19,269,814 14,347,325 7,462,021
------------- ------------- -------------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 8,719,749 $ 19,269,814 $ 14,347,325
============= ============= =============
Cash paid during the year for
Interest $ 4,195,298 $ 5,281,266 $ 7,361,383
Federal income taxes 788,000 1,430,000 1,533,000
Supplemental Disclosure of non-cash activity
Transfers from loans to repossessed assets $ 475,000 $ 10,000 $ 1,000,892
Transfers from loans to other real estate owned 1,602,313 120,969 170,690
See accompanying notes
[LOGO]
28
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003 and 2002
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, 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, 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.
[LOGO]
29
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003 and 2002
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. Larger groups of smaller
homogenous loans, such as consumer and residential real estate loans, are
collectively evaluated for impairment, and accordingly, they are not separately
identified for impairment disclosure.
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 5 to 33
years for buildings and improvements, and 3 to 7 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 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 $598,000 and
$121,000 at December 31, 2003 and 2002.
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%.
[LOGO]
30
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003 and 2002
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.
2003 2002 2001
------------------------------------------
Net income as reported $ 2,235,802 $ 2,900,880 $ 3,202,586
Stock based compensation
expense determined
under fair value method 127,334 79,064 41,755
------------ ----------- -----------
Proforma net income $ 2,108,468 $ 2,821,816 $ 3,160,831
============ =========== ===========
Basic earnings per share
as reported $ .55 $ .73 $ .82
Proforma basic earnings
per share $ .52 $ .71 $ .81
Diluted earnings per
share as reported $ .55 $ .72 $ .82
Proforma diluted
earnings per share $ .52 $ .70 $ .81
The proforma effects are computed using option pricing models, using the
following weighted-average assumptions as of grant date.
2003 2002 2001
- -------------------------------------------------
Risk-free interest rate 4.05% 4.08% 5.10%
Expected life in years 10.0 9.4 9.2
Expected dividends 4.30% 4.70% 5.14%
Stock price volatility 22.82% 40.82% 48.74%
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 2003, 2002 and 2001.
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.
DIVIDEND RESTRICTION Banking regulations require maintaining certain capital
levels and may limit the dividends paid by the bank to the holding company or by
the
[LOGO]
31
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003 and 2002
holding company or by the holding company to shareholders. These restrictions
pose no practical limit on the ability of the bank or holding company to pay
dividends at historical levels.
LOSS CONTINGENCIES Loss contingencies, including claims and legal actions
arising in the ordinary course of business, are recorded as liabilities when the
likelihood of loss is probable and an amount or range of loss can be reasonably
estimated. Management does not believe there now are such matters that will have
a material effect on the financial statements.
RESTRICTIONS ON CASH Cash on hand or on deposit with the Federal Reserve Bank of
$1,259,000 and $1,447,000 was required to meet regulatory reserve and clearing
requirements at year end 2003 and 2002. These balances do not earn interest.
RECLASSIFICATIONS Some items in the prior year financial statements have been
reclassified to conform with the current year presentation.
ADOPTION OF NEW ACCOUNTING STANDARDS During 2003, the Company adopted FASB
Statement 149, Amendment of Statement 133 on Derivative Instruments and Hedging
Activities, FASB Statement 150, Accounting for Certain Financial Instruments
with Characteristics of both Liabilities and Equities, FASB Statement 132
(revised 2003), Employers' Disclosures about Pensions and Other Postretirement
Benefits, FASB Interpretation 45, Guarantor's Accounting and Disclosure
Requirements for Guarantees, and FASB Interpretation 46, Consolidation of
Variable Interest Entities. Adoption of the new standards did not materially
affect the Corporation's operating results or financial condition.
Statement 149 indicates that commitments to make mortgage loans should be
accounted for as derivatives if the loans are to be held for sale, because the
commitment represents a written option and accordingly is recorded at the fair
value of the option liability.
Statement 150 requires reporting mandatorily redeemable shares as liabilities,
as well as obligations not in the form of shares to repurchase shares that may
require cash payment and some obligations that may be settled by issuing a
variable number of equity shares.
Statement 132 (revised 2003) requires additional disclosures about the assets,
obligations, cash flows of defined benefit pension and postretirement plans, as
well as the expense recorded for such plans.
Interpretation 45 requires recognizing the fair value of guarantees made and
information about the maximum potential payments that might be required, as well
as the collateral or other recourse obtainable. Interpretation 45 covers
guarantees such as standby letters of credit, performance guarantees, and direct
or indirect guarantees of the indebtedness of others, but not guarantees of
funding.
Interpretation 46, as revised in December 2003, changes the accounting model for
consolidation from one based on consideration of control through voting
interests to a different model. Whether to consolidate an entity will now also
consider whether that entity has sufficient equity at risk to enable it to
operate without additional financial support, whether the equity owners in that
entity lack the obligation to absorb expected losses or the right to receive
residual returns of the entity, or whether voting rights in the entity are not
proportional to the equity interest and substantially all the entity's
activities are conducted for an investor with few voting rights.
NEWLY ISSUED BUT NOT YET EFFECTIVE ACCOUNTING STANDARDS There are no newly
issued, but not yet effective accounting standards that are expected to have a
material impact on the Company's operating results or financial condition.
[LOGO]
32
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003 and 2002
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, 2003
- -----------------------------------------------------------------------------------------------------
U.S. TREASURIES AND GOVERNMENT AGENCIES $ 208,333 $ (29,844) $ 18,206,332
STATE AND MUNICIPALS 242,540 (184) 4,822,775
------------- ------------ -------------
TOTAL $ 450,873 $ (30,028) $ 23,029,107
============= ============ =============
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
============= ============ =============
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, 2003
- -----------------------------------------------------------------------------------------------------------------------
STATE AND MUNICIPALS $ 3,047,763 $ 123,520 $ - $ 3,171,283
============= ============= ============= =============
December 31, 2002
------------- ------------- ------------- -------------
State and municipals $ 4,689,025 $ 222,671 $ - $ 4,911,696
============= ============= ============= =============
The fair value of debt securities and carrying amounts, if different, at
year-end 2003, by contractual maturity are shown below.
Available for Sale Held to Maturity
- ----------------------------------------------------------------------------------------------------------
Fair Carrying Fair
Value Amount Value
- ----------------------------------------------------------------------------------------------------------
Due in one year or less $ 5,392,390 $ 1,005,318 $ 1,018,866
Due from one to five years 15,020,717 1,947,445 2,056,747
Due from five to ten years 1,733,521 95,000 95,670
Due from ten years plus 882,479 - -
------------- ------------- -------------
Total $ 23,029,107 $ 3,047,763 $ 3,171,283
============= ============= =============
Sales of available for sale securities were as follows:
2003 2002 2001
---- ---- ----
Proceeds $ - $ - $ 2,523,549
Gross gains - - 210,674
Gross losses - - -
[LOGO]
33
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003 and 2002
There were no securities sold during 2002, however, called securities resulted
in gains of $27,565.
Securities with unrealized losses at year-end 2003 not recognized into income
are as follows:
Less than 12 Months 12 Months or More Total
Fair Unrealized Fair Unrealized Fair Unrealized
Description of Securities Value Loss Value Loss Value Loss
- ------------------------------------------------------------------------------------------------------------------------------------
U.S. Treasury and government agencies $ - $ - $ 2,916,866 $ 29,844 $ 2,916,866 $ 29,844
State and municipals - - 201,730 184 201,730 184
-------- --------- -------------- ------------ ----------- -----------
Total temporarily impaired $ - $ - $ 3,118,596 $ 30,028 $ 3,118,596 $ 30,028
======== ========= ============== ============ =========== ===========
The unrealized losses have not been realized into income because the issuers of
the bonds are of high credit quality and management has the ability to hold the
securities for the foreseeable future. The decline in market value is primarily
due to an increase in interest rates from the purchase date of the bonds. The
fair value is expected to recover as the bonds approach their maturity date.
Securities having a carrying amount of approximately $18,150,000 and $16,613,000
at year-end 2003 and 2002 were pledged to secure 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 2003 and
2002, the amortized cost of securities issued by the state of Michigan and all
its political subdivisions totaled $4,971,000 and $6,407,000 with an estimated
market value of $5,186,000 and $6,668,000.
NOTE 3 - LOANS RECEIVABLE
Year-end loans receivable are as follows:
2003 2002
- ----------------------------------------------------------------
Real estate
Secured by single family
residential properties $ 77,454,148 $ 61,651,977
Secured by non-farm
nonresidential properties 54,625,115 62,854,082
Secured by farmland 2,059,878 2,173,633
Secured by multi-family
residential properties 9,197,821 10,545,095
Construction/land development 14,698,223 11,951,805
Installment loans 6,291,176 6,751,968
Commercial 30,063,321 28,519,736
------------- -------------
Gross loans receivable 194,389,682 184,448,296
Allowance for loan losses (1,970,309) (2,783,234)
------------- -------------
Net loans receivable $ 192,419,373 $ 181,665,062
============= =============
Loans held for sale, included in real estate secured by single family
residential properties, were $347,000 and $1,673,000 at year-end 2003 and 2002.
Certain directors and executive officers, including associates of such persons,
were loan customers of Commercial during 2003 and 2002. A summary of aggregate
related party loan activity for loans aggregating $60,000 or more to any related
party is as follows:
2003 2002
- -----------------------------------------------------------
Balance at beginning of year $ 6,297,000 $ 4,413,000
New loans 9,477,000 12,537,000
Repayments (12,593,000) (11,141,000)
Other changes, net 28,000 488,000
----------- --------------
Balance at end of year $ 3,209,000 $ 6,297,000
=========== ==============
Other changes include adjustments for persons included in one reporting period
that are not reported in the other reporting period.
[LOGO]
34
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003 and 2002
NOTE 4 - ALLOWANCE FOR LOAN LOSSES
Activity in the allowance for loan losses was as follows:
2003 2002 2001
- ------------------------------------------------------------------
Beginning balance $ 2,783,234 $ 2,586,025 $ 2,545,363
Loan charge-offs (3,120,283) (538,567) (415,904)
Loan recoveries 406,358 54,776 81,566
----------- ----------- -----------
Net loan recoveries
(charge-offs) (2,713,925) (483,791) (334,338)
Provision for loan
losses 1,901,000 681,000 375,000
----------- ----------- -----------
Ending balance $ 1,970,309 $ 2,783,234 $ 2,586,025
=========== =========== ===========
Impaired loans were as follows:
2003 2002 2001
- ------------------------------------------------------------------
Year-end loans with
allowance for loan
losses allocated $ 625,129 $ 5,907,493 $ 3,621,686
Year-end loans with
no allowance
for loan losses
allocated 200,000 2,757,205 -
----------- ----------- -----------
Total impaired
loans $ 825,129 $ 8,664,698 $ 3,621,686
=========== =========== ===========
Additional information regarding impaired loans is as follows:
2003 2002 2001
- ----------------------------------------------------------------------
Amount of the
allowance allocated $ 189,379 $ 2,100,175 $ 31,730
Average balance of
impaired loans during
the year 4,716,561 7,249,949 4,692,348
Interest income
recognized during
impairment 115,951 82,223 271,996
Cash-basis interest income
recognized 115,951 85,392 228,905
December 31,
2003 2002
- ----------------------------------------------------------------
Non-accrual loans $ 825,129 $5,676,390
Accruing loans past due 90 days or more - -
Restructured loans - 348,520
---------- ----------
Total non-performing loans $ 825,129 $6,024,910
========== ==========
Total non-performing loans
as a percentage of total loans .42% 3.27%
========== ==========
Non-performing loans includes both smaller balance homogenous loans that are
collectively evaluated for impairment and individually classified impaired
loans.
NOTE 5 - LOAN SERVICING
Mortgage loans serviced for others are not reported as assets. These loans
totaled $66,897,000 and $62,072,000 at year-end 2003 and 2002. Related escrow
deposit balances were approximately $28,000 and $(25,000).
2003 2002
- -----------------------------------------------------
Loans held for sale $ 346,856 $ 1,673,000
Less: Allowance to
adjust to lower of
cost or market - -
----------- -----------
Loans held for sale, net $ 346,856 $ 1,673,000
=========== ===========
Activity for capitalized mortgage servicing rights and the related valuation
allowance follows:
Servicing rights 2003 2002 2001
- -------------------------------------------------------------
Beginning balance $ 467,822 $ 321,369 $135,931
Additions 260,707 250,241 239,044
Amortized to expense (198,848) (103,788) (53,606)
Direct write-downs - - -
--------- --------- --------
Ending balance $ 529,681 $ 467,822 $321,369
========= ========= ========
[LOGO]
35
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003 and 2002
Valuation allowance 2003 2002 2001
- --------------------------------------------------------------
Beginning balance $ - $ - $ -
Additions expensed 131,591 - -
Reductions credited to
expense - - -
Direct write downs - - -
--------- --------- --------
Ending balance $ 131,591 $ - $ -
========= ========= ========
NOTE 6 - PREMISES AND EQUIPMENT, NET
Year-end premises and equipment consist of:
2003 2002
- ------------------------------------------------------------
Land $ 815,059 $ 810,059
Buildings and improvements 3,907,109 3,637,688
Equipment 2,492,693 2,115,653
----------- -----------
Total cost 7,214,861 6,563,400
Less accumulated depreciation (3,281,514) (2,876,249)
----------- -----------
Net premises and equipment $ 3,933,347 $ 3,687,151
=========== ===========
Depreciation expense was $473,484, $408,054 and $507,232 in 2003, 2002 and 2001.
NOTE 7 - DEPOSITS
At year-end 2003, stated maturities of time deposits were as follows, for the
years ending December 31:
2004 $ 33,482,921
2005 12,837,568
2006 3,728,775
2007 2,610,003
2008 2,170,440
Thereafter 361,606
---------------
Total time deposits $ 55,191,313
===============
Time deposits in denominations of $100,000 or more were $12,759,000 and
$12,613,000 at year-end 2003 and 2002.
At year-end 2003, stated maturities of time deposits in denominations of
$100,000 or more were as follows:
In 3 months or less $ 4,060,000
Over 3 through 6 months 2,686,000
Over 6 through 12 months 2,011,000
Over 12 months 4,002,000
--------------
Total time deposits > $100,000 $ 12,759,000
==============
Related party deposits were $1,971,000 and $1,173,000 at year-end 2003 and 2002.
[LOGO]
36
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003 and 2002
NOTE 8 - SECURITIES SOLD UNDER AGREEMENT TO REPURCHASE
Information concerning securities sold under agreements to repurchase is
summarized as follows:
2003 2002
- -------------------------------------------------------------
Amount outstanding at
year-end $ 11,766,630 $ 14,266,239
Weighted average interest
rate at year-end .89% 1.43%
Average daily balance
during the year $ 14,148,985 $ 9,382,805
Weighted average interest
rate during the year 1.05% 1.65%
Maximum month end
balance during the year $ 17,231,601 $ 14,266,239
NOTE 9 - FEDERAL HOME LOAN BANK ADVANCES
Federal Home Loan Bank (FHLB) advances totaled $32,104,000 and $32,807,000 at
year-end 2003 and 2002.
At year-end, the type of advances were as follows:
2003 2002
- -----------------------------------------------------
Amortizing $ 22,104,222 $ 25,307,086
Variable 6,000,000 -
Bullet - 3,500,000
Callable 4,000,000 4,000,000
------------- -------------
Total $ 32,104,222 $ 32,807,086
============= =============
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
$65,648,000 and $53,720,000 at year-end 2003 and 2002.
At year-end, scheduled principal reductions on these advances were as follows
for the years ending December 31:
2003 2002
- -----------------------------------------------------
2003 $ - $ 8,702,864
2004 11,208,697 5,138,642
2005 8,306,553 8,125,567
2006 2,174,163 1,923,599
2007 2,339,531 2,080,937
Thereafter 8,075,278 6,835,477
----------- -----------
Total FHLB advances $32,104,222 $32,807,086
=========== ===========
Scheduled principal reductions and related weighted average rate grouped by
advance type for the year ending December 31, 2003 are as follows:
2004 2005 2006 2007 Thereafter Total
- ---------------------------------------------------------------------------------------------------------------------------------
Amount Cost Amount Cost Amount Cost Amount Cost Amount Cost Amount Cost
- ---------------------------------------------------------------------------------------------------------------------------------
Amortizing $ 5,208,697 5.53% $6,306,553 5.71% $2,174,163 4.44% $2,339,531 4.38% $6,075,278 4.31% $22,104,222 5.02%
Variable 6,000,000 1.26 - - - - 6,000,000 1.26
Callable - 2,000,000 6.01 - - 2,000,000 4.52 4,000,000 5.26
----------- ---- ---------- ---- ---------- ---- ---------- ---- ---------- ---- ----------- ----
Total $11,208,697 3.25% $8,306,553 5.78% $2,174,163 4.44% $2,339,531 4.38% $8,075,278 4.36% $32,104,222 4.34%
=========== ==== ========== ==== ========== ==== ========== ==== ========== ==== =========== ====
[LOGO]
37
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003 and 2002
NOTE 10 - 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
$138,000, $132,000, and $126,000, in 2003, 2002, and 2001.
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 289,406 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 2001 151,994 $ 9.14
Granted 59,318 8.64
Exercised (4,247) 8.60
------- --------
Outstanding, end of 2001 207,065 9.01
Granted 50,448 13.61
Exercised (11,033) 7.57
Forfeited (3,043) 11.34
------- --------
OUTSTANDING, END OF 2002 243,437 10.00
GRANTED 50,454 11.90
EXERCISED (51) 6.31
FORFEITED - -
------- --------
OUTSTANDING, END OF 2003 293,840 $ 10.32
======= ========
The weighted-average fair value of options granted in 2003, 2002, and 2001, was
$2.11, $3.96, and $2.96. At year-end 2003, options outstanding had a
weighted-average remaining life of 6.7 years and a range of exercise price from
$5.36 to $13.61.
Options exerciseable at year-end are as follows:
Number Weighted Average
of Options Exercise Price
- -------------------------------------------
2001 107,381 $ 8.47
2002 134,388 $ 9.19
2003 182,585 $ 9.65
Options outstanding at year-end were as follows.
Options Outstanding Options Excercisable
- ------------------------------------------------------------------------------------ -------------------------------------
Range of Outstanding Weighted-Average Excercisable
Exercise as of Remaining Weighted-Average as of Weighted-Average
Prices December 31, 2003 Contractual Life Exercise Price December 31, 2003 Exercise Price
- ---------------------------------------------------------------------------------------------------------------------------------
$ 4.08-5.44 2,318 1.7 $ 5.36 2,318 $ 5.36
5.44-6.81 31,735 3.2 6.44 31,735 6.44
6.81-8.17 - 0.0 0.00 - 0.00
8.17-9.53 78,819 6.3 8.95 55,688 9.08
9.53-10.89 35,102 5.4 9.66 28,820 9.66
10.89-12.25 97,072 7.9 11.42 45,663 11.20
12.25-13.61 48,794 8.5 13.61 18,361 13.61
- -------------- ------- --- --------- ------- ---------
$ 4.08-13.61 293,840 6.7 $ 10.33 182,585 $ 9.65
[LOGO]
38
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003 and 2002
NOTE 11 - FEDERAL INCOME TAXES
Income tax expense consists of:
2003 2002 2001
- ----------------------------------------------------------
Current $ 325,000 $1,229,000 $1,340,000
Deferred 508,000 (99,000) (9,000)
----------- ---------- ----------
$ 833,000 $1,130,000 $1,331,000
=========== ========== ==========
Income tax expense calculated at the statutory federal income tax rate of 34%
differs from actual income tax expense as follows:
2003 2002 2001
- --------------------------------------------------------------------
Statutory rates $ 1,043,000 $1,370,000 $ 1,541,420
Increase (decrease) from
Tax-exempt interest
income (159,000) (199,000) (208,000)
Life insurance (65,000) (63,000) (17,000)
Other, net 14,000 22,000 14,580
----------- ---------- -----------
$ 833,000 $1,130,000 $ 1,331,000
=========== ========== ===========
Year-end deferred tax assets and liabilities consist of:
2003 2002
- -----------------------------------------------------------------
Allowance for loan losses $ 294,000 $ 571,000
Interest on non-accrual loans 16,000 133,000
Accumulated depreciation (231,000) (130,000)
Mortgage servicing rights (135,000) (159,000)
Net unrealized gain on
securities available for sale (143,000) (229,000)
Other (38,000) (1,000)
---------- ----------
(237,000) 185,000
Valuation allowance - -
---------- ----------
Net deferred tax asset $ (237,000) $ 185,000
========== ==========
NOTE 12 - EARNINGS PER SHARE
A reconciliation of the numerators and denominators of the basic earnings per
share and diluted earnings per share computations is presented below for the
years ended:
2003 2002 2001
- ---------------------------------------------------------------------
BASIC EARNINGS PER SHARE:
Net income available to
common shareholders $2,235,802 $2,900,880 $3,202,588
========== ========== ==========
Weighted-average common
shares outstanding for
basic earnings per share 4,030,331 3,968,609 3,890,006
========== ========== ==========
BASIC EARNINGS PER SHARE $ .55 $ .73 $ .82
========== ========== ==========
DILUTED EARNINGS PER SHARE:
Net income available to
common shareholders $2,235,802 $2,900,880 $3,202,588
========== ========== ==========
Weighted-average common
shares outstanding for
basic earnings per share 4,030,331 3,968,609 3,890,006
Add:
Dilutive effect of assumed
Exercise of stock options 42,211 42,705 12,300
---------- ---------- ----------
Weighted-average common
and dilutive additional
potential common shares
outstanding 4,072,542 4,011,314 3,902,306
========== ========== ==========
Diluted earnings per share $ .55 $ .72 $ .82
========== ========== ==========
Stock options for 99,248, 59,208, and 111,880, shares of common stock were not
considered in computing diluted earnings per common share for 2003, 2002, and
2001 because they were anti-dilutive.
[LOGO]
39
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003 and 2002
NOTE 13 - 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.
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:
2003 2002
- -----------------------------------------------------------
Commitments to extend credit $ 22,870,000 $ 22,007,000
Standby letters of credit 248,000 175,000
------------- ------------
Total commitments $ 23,118,000 $ 22,182,000
============= ============
At December 31, 2003, fixed and variable interest rate commitments were
$2,280,000 and $20,838,000. Fixed rate commitments interest rates and terms
ranged from 0.00% to 16.20% and six months to fifteen years.
Leases and Other Contractual Commitments
Commercial occupies two locations under long-term operating leases. In addition,
Commercial is party to long-term contracts for data processing and operating
systems. The future minimum annual commitments under all operating leases and
other contractual commitments as of December 31, 2003 are as follows:
Lease and Other
Year Contractual Commitments
- ---------------------------------------------------------
2004 $ 155,607
2005 119,820
2006 121,482
2007 123,144
2008 79,920
Thereafter 28,080
-------------
Total $ 628,053
=============
NOTE 14 - FAIR VALUES OF FINANCIAL INSTRUMENTS
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, term of the security
and information about the issuer.
- Fixed rate loans and time deposits, and variable rate loans
with infrequent repricing, are 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.
[LOGO]
40
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003 and 2002
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, 2003 and 2002, 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, 2003 and 2002 should not necessarily be considered to apply at
subsequent dates.
Financial instruments at year-end are as follows:
2003 2002
- -----------------------------------------------------------------------------------------------------------------
CARRYING FAIR Carrying Fair
VALUE VALUE Value Value
- -----------------------------------------------------------------------------------------------------------------
FINANCIAL ASSETS
Cash and cash equivalents $ 8,720,000 $ 8,720,000 $ 19,270,000 $ 19,270,000
Securities 26,077,000 26,200,000 26,035,000 26,258,000
FHLB stock 1,711,000 1,711,000 1,647,000 1,647,000
Loans, net of allowance 192,419,000 196,585,000 181,665,000 189,851,000
Accrued interest receivable 1,000,000 1,000,000 1,065,000 1,065,000
------------- ------------- ------------- -------------
Total financial assets $ 229,927,000 $ 234,216,000 $ 229,682,000 $ 238,091,000
============= ============= ============= =============
FINANCIAL LIABILITIES
Demand and savings deposits $(114,373,000) $(114,373,000) $(110,801,000) $(110,801,000)
Time deposits (55,191,000) (56,119,000) (55,258,000) (56,369,000)
Securities sold under agreements
to repurchase (11,767,000) (11,767,000) (14,266,000) (14,266,000)
Other short-term borrowings (412,000) (412,000) (492,000) (492,000)
Federal Home Loan Bank advances (32,104,000) (33,140,000) (32,807,000) (34,050,000)
Accrued interest payable (245,000) (245,000) (297,000) (297,000)
------------- ------------- ------------- -------------
Total financial liabilities $(214,092,000) $(216,056,000) $(213,921,000) $(216,275,000)
============= ============= ============= =============
NOTE 15 - CAPITAL REQUIREMENTS AND RESTRICTIONS ON RETAINED EARNINGS
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 2003 and
2002.
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. The Corporation's ability to pay dividends is dependant on
the Bank, which is restricted by state law and
[LOGO]
41
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003 and 2002
regulations. These regulations pose no practical restrictions to paying
dividends at historical levels. In 2004, the Bank may distribute to the
Corporation, in addition to 2004 net profits, approximately $2,171,000 in
dividends without prior approval from regulatory agencies.
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
Amount Ratio Amount Ratio Amount Ratio
-------- ----- -------- ------- --------- --------
2003
TOTAL CAPITAL (TO RISK WEIGHTED ASSETS)
CONSOLIDATED $ 26.0 14.4% $ 14.4 8.0% $ 18.0 10.0%
BANK 21.6 12.1 14.2 8.0 17.8 10.0
TIER 1 CAPITAL (TO RISK WEIGHTED ASSETS)
CONSOLIDATED 24.0 13.3 7.2 4.0 10.8 6.0
BANK 19.7 11.1 7.1 4.0 10.7 6.0
TIER 1 CAPITAL (TO AVERAGE ASSETS)
CONSOLIDATED 24.0 10.2 9.4 4.0 11.8 5.0
BANK 19.7 8.5 9.3 4.0 11.7 5.0
2002
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
[LOGO]
42
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003 and 2002
NOTE 16 - PARENT CORPORATION CONDENSED
Following are condensed parent only financial statements.
CONDENSED BALANCE SHEETS
December 31,
2003 2002
------------ -----------
ASSETS
Cash $ 2,372,702 $ 2,893,804
Investment in subsidiary 19,967,806 18,713,218
Loans, net 2,482,316 2,598,599
Other assets 29,101 31,145
------------ -----------
Total assets $ 24,851,925 $24,236,766
============ ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Dividends payable $ 567,367 $ 532,185
Other liabilities 1,731 609
Shareholders' equity 24,282,827 23,703,972
------------ -----------
Total liabilities and shareholders' equity $ 24,851,925 $24,236,766
============ ===========
CONDENSED STATEMENTS OF INCOME
Years ended December 31,
2003 2002 2001
----------- ---------- ----------
Dividends from subsidiary $ 750,000 $1,800,000 $1,950,000
Interest and fees on loans 159,133 183,904 257,065
Interest on securities - - 6,080
Gain on sale of security - - 201,005
Other income - - 908
----------- ---------- ----------
Total income 909,133 1,983,904 2,415,058
Interest expense - - 3,602
Other expense 64,726 58,246 79,678
----------- ---------- ----------
Income before income taxes
and equity in undistributed
net income of subsidiary 844,407 1,925,658 2,331,778
Income tax expense 30,000 47,000 129,000
Equity in undistributed
net income of subsidiary 1,421,395 1,022,222 999,810
----------- ---------- ----------
NET INCOME $ 2,235,802 $2,900,880 $3,202,588
=========== ========== ==========
CONDENSED STATEMENTS OF CASH FLOWS
Years ended December 31,
2003 2002 2001
----------- ----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 2,235,802 $ 2,900,880 $ 3,202,588
Adjustment:
Equity in undistributed net income (1,421,395) (1,022,222) (999,810)
Gain on sale of security - - (201,005)
Net change in:
Other assets 2,044 (3,789) 2,071
Other liabilities 1,122 (134,619) 91,485
----------- ----------- -----------
Net cash from operating activities 817,573 1,740,250 2,095,329
CASH FLOWS FROM INVESTING ACTIVITIES
Sales/maturities of securities
available for sale - - 1,514,905
Net change in loans 116,283 498,533 (59,899)
----------- ----------- -----------
Net cash from investing activities 116,283 498,533 1,455,006
CASH FLOWS FROM FINANCING ACTIVITIES
Borrowings - - (700,000)
Dividends paid (2,141,031) (2,005,016) (1,874,235)
Issuance of common stock and
fractional shares paid 904,177 938,082 732,349
Repurchase of common stock (218,104) (227,332) (244,519)
----------- ----------- -----------
Net cash from financing activities (1,454,958) (1,294,266) (2,086,405)
----------- ----------- -----------
Net change in cash and cash equivalents (521,102) 944,517 1,463,930
Cash and cash equivalents
at the beginning of year 2,893,804 1,949,287 485,357
----------- ----------- -----------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 2,372,702 $ 2,893,804 $ 1,949,287
=========== =========== ===========
NOTE 17 - DIVIDEND REINVESTMENT PLAN
Commercial established a Dividend Reinvestment Plan for its shareholders in
1992. The Plan permits enrolled shareholders to automatically use dividends paid
on common stock to purchase additional shares of Commercial's common stock at
95% of fair market value on the investment date. As of December 31, 2003,
104,946 shares of authorized but unissued common stock were reserved for Plan
requirements.
[LOGO]
43
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003 and 2002
NOTE 18 - STOCK REPURCHASE PLAN
Commercial announced a stock repurchase plan in 1998. The Plan permits the
repurchase of up to 383,340 shares of the Corporation's outstanding shares of
common stock. As of December 31, 2003, Commercial had repurchased and retired
296,512 shares in accordance with the program.
NOTE 19 - QUARTERLY FINANCIAL DATA (UNAUDITED)
Interest Net Interest Net Earnings Per Share
Income Income Income Basic Diluted
----------- ----------- ----------- ------- -------
2003
FIRST QUARTER $ 3,448,824 $ 2,294,364 $ 766,096 $ .19 $ .19
SECOND QUARTER 3,462,612 2,390,932 2,418 .00 .00
THIRD QUARTER 3,582,911 2,608,255 818,436 .20 .20
FOURTH QUARTER 3,353,918 2,410,548 648,852 .16 .16
----------- ----------- ----------- ------- -------
TOTAL $13,848,265 $ 9,704,099 $ 2,235,802 $ .55 $ .55
=========== =========== =========== ======= =======
2002
First Quarter $ 3,511,932 $ 2,181,671 $ 663,744 $ .17 $ .17
Second Quarter 3,544,469 2,264,756 677,558 .17 .17
Third Quarter 3,557,094 2,243,602 742,625 .19 .18
Fourth Quarter 3,498,527 2,231,516 816,953 .20 .20
----------- ----------- ----------- ------- -------
Total $14,112,022 $ 8,921,545 $ 2,900,880 $ .73 $ .72
=========== =========== =========== ======= =======
[LOGO]
44
PICTURES AND PROFILES OF CUSTOMERS
[LOGO]
45
PICTURES OF BOARD OF DIRECTORS AND MT. PLEASANT STAFF
[LOGO]
46
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
Kim C. Newson Vice Chairperson of the Board
Jeffrey S. Barker President and Chief Executive Officer
Patrick G. Duffy EVP - Chief Financial Officer
Andrew P. Shafley SVP - Senior Loan Officer
Daniel E. Raleigh VP - Marketing, Personnel and Branch Administration
Kevin D. Collison VP - Commercial Lending - Ithaca
Thomas D. Cooper VP - Commercial Lending - Ithaca
Wayne C. Heminger VP - Commercial Lending - Mt. Pleasant
Jeffrey B. Loomis VP - Commercial Lending - Greenville
Karen M. Taylor VP - Mortgage Lending - Alma
Corey S. Bailey AVP - Lending - Alma
Janet M. Davison AVP - Manager - Information Systems
Kathryn K. Greening AVP - Mortgage Processing - Alma
Wendy M. Lombard AVP - Mortgage Lending - Ithaca
Vicki L. Nelson AVP - Mortgage Lending - Greenville
Cathy M. Patterson AVP - Controller
Dawn K. Riley AVP - Loan Officer - Greenville
Carol L. Vallance AVP - Customer Relations - Alma
Heather A. Lamentola Security Officer - St. Louis
Jayne I. Norris Loan Officer - Alma
Rebecca A. Smith Administrative Assistant - Transfer Agent
Linda M. Vaughn Business Loan Administrator
COMMERCIAL BANK-GREENVILLE
DIRECTORS
Jeffrey S. Barker Chairman, Commercial Bank-Greenville; President and CEO,
Commercial Bank
Carl Barberi Assistant Superintendent, Greenville Public Schools
Jeffrey B. Loomis 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
Jeffrey B. Loomis President
Vicki L. Nelson AVP - Mortgage Lending
Dawn K. Riley AVP - Lending
[LOGO]
47
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 707 shareholders of
record and 4,052,480 common shares outstanding at December 31, 2003.
All prices have been adjusted for the 5% stock dividends issued in November 2003
and November 2002.
During 2003 and 2002 the price ranges of transactions reported were:
Shares Actual Price
Traded Range
------ --------------------
2003 Low High
------ ------- -------
FIRST QUARTER 29,200 $ 10.95 $ 13.14
SECOND QUARTER 19,600 11.66 12.52
THIRD QUARTER 16,500 11.29 12.38
FOURTH QUARTER 26,800 10.50 12.38
------ ------- -------
2002
First Quarter 24,150 $9.09 $ 10.40
Second Quarter 6,930 10.17 14.25
Third Quarter 8,715 11.50 13.58
Fourth Quarter 45,885 10.74 12.66
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 fourteen years.
The following table sets forth the dividends per share declared during 2003 and
2002. The dividends per share have been adjusted for the 5% stock dividends
issued in November 2003 and November 2002.
2003 2002
------- -------
First Quarter $ .13 $ .12
Second Quarter .13 .13
Third Quarter .14 .13
Fourth Quarter .14 .13
------- -------
Total dividends declared per share $ .54 $ .51
======= =======
[LOGO]
48
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
MT. PLEASANT 1234 E. BROOMFIELD RD. STE. #8 Ph. (989) 775-0355 Fax (989) 779-1946
POMPEII 105 E. FULTON ST. Ph. (989) 838-2525
ST. LOUIS 104 N. MILL ST.* Ph. (989) 681-5738 Fax (989) 681-3509
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
*Denotes Bank locations with ATMs on site.
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
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
MARKET MAKERS
WILLIAM KAHL R. NICHOLAS BACH MICHAEL T. SEEKELL PETER VANDERSCHAAF CHRISTOPHER TURNER MICHAEL HEBNER
Wachovia Securities Howe Barnes Investment Robert W. Baird Stifel, Nicolaus McDonald & Co. Raymond James
Inc. & Co. & Co.
1-800-292-1960 1-800-800-4693 1-800-888-6200 1-800-676-0477 1-800-526-7705 1-800-521-9767
[LOGO]
49
COMMERCIAL NATIONAL FINANCIAL CORPORATION
101 N. Pine River
P.O. Box 280
Ithaca, Michigan 48847
www.commercial-bank.com
(989) 875-4144
[LOGO]
50