SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
X Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities and Exchange Act of 1934
For the quarterly period ended March 31, 2004, or
__ Transition Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the Transition Period from ________ to _________
Commission File No. 0-17000
COMMERCIAL NATIONAL FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
Michigan 38-2799780
(State of Incorporation) (IRS Employer Identification No.)
101 North Pine River Street, Ithaca, Michigan 48847
(address of principal executive offices) (ZIP Code)
Registrant's telephone number, including area code: (989) 875-4144
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES _____X______ NO ______________
Indicate by check mark whether the registrant is an accelerated filer (as
defined in rule 12b-2 of the Exchange Act).
YES ____________ NO ________X_____
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding at April 28, 2004
----- -----------------------------
Common Stock 4,089,121
No Par Value
INDEX
PART I FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of March 31, 2004 (unaudited) and December 31, 2003 (Page 3)
Consolidated Statements of Income and Other Comprehensive Income (unaudited) for (Page 4)
the three months ended March 31, 2004 and March 31, 2003
Consolidated Statements of Changes in Shareholders' Equity (unaudited) for the (Page 5)
three months ended March 31, 2004 and March 31, 2003
Consolidated Statements of Cash Flows (unaudited) for the three months ended (Page 6)
March 31, 2004 and March 31, 2003
Notes to Consolidated Financial Statements (unaudited) (Page 7-8)
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (Page 9-12)
Item 3. Quantitative and Qualitative Disclosures about Market Risk (Page 12-13)
Item 4. Controls and Procedures (Page 14)
PART II OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K (Page 15)
SIGNATURES (Page 16)
COMMERCIAL NATIONAL FINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS
ITEM 1. FINANCIAL STATEMENTS
March 31, December 31,
2004 2003
---- ----
(Unaudited)
ASSETS
Cash and due from banks $ 5,790,389 $ 6,113,498
Federal funds sold 4,119,492 644,807
Other interest bearing deposits 1,355,271 1,961,444
------------- -------------
Total cash and cash equivalents 11,265,152 8,719,749
Securities available for sale 22,503,753 23,029,107
Securities held to maturity (fair value $ 2,956,292 - March 31, 2004; $3,171,283
- December 31, 2003) 2,846,347 3,047,763
Federal Home Loan Bank stock, at cost 1,732,100 1,710,700
Gross loans receivable 193,630,555 194,389,682
Allowance for loan losses (2,046,075) (1,970,309)
------------- -------------
Net loans receivable 191,584,480 192,419,373
Bank owned life insurance 3,447,585 3,400,203
Premises and equipment, net 3,862,777 3,933,347
Accrued interest receivable and other assets 3,306,203 3,528,005
------------- -------------
Total assets $ 240,548,397 $ 239,788,247
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Deposits
Noninterest-bearing demand $ 19,951,997 $ 23,203,653
Interest-bearing demand 26,605,733 29,141,354
Savings 70,063,374 62,028,217
Time 54,912,073 55,191,313
------------- -------------
Total deposits 171,533,177 169,564,537
Securities sold under agreements to repurchase 14,359,710 11,766,630
Other short-term borrowings 289,154 412,389
Federal Home Loan Bank advances 28,241,898 32,104,222
Accrued expenses and other liabilities 1,578,982 1,657,642
------------- -------------
Total liabilities 216,002,921 215,505,420
Shareholders' equity
Common stock and paid-in-capital, no par value: 5,000,000 shares
authorized; shares issued and outstanding March 31,
2004 - 4,072,694 and December 31, 2003 - 4,052,480 24,358,609 24,117,375
Accumulated deficit (116,942) (112,306)
Accumulated other comprehensive income, net of tax 303,809 277,758
------------- -------------
Total shareholders' equity 24,545,476 24,282,827
------------- -------------
Total liabilities and shareholders' equity $ 240,548,397 $ 239,788,247
============= =============
See accompanying notes
3
COMMERCIAL NATIONAL FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (Unaudited)
Three Months Ended March 31,
2004 2003
---- ----
Interest and dividend income
Loans, including fees $ 3,003,173 $ 3,094,094
Taxable securities 153,802 179,618
Nontaxable securities 86,072 107,000
Federal funds sold 14,029 39,784
Federal Home Loan Bank stock dividends 21,496 24,000
Interest on other deposits 1,724 4,328
----------- -----------
Total interest and dividend income 3,280,296 3,448,824
Interest expense
Deposits 559,081 695,651
Securities sold under agreements to repurchase 26,866 45,995
Federal Home Loan Bank advances 354,426 412,063
Other 506 751
----------- -----------
Total interest expense 940,879 1,154,460
Net interest income 2,339,417 2,294,364
Provision for loan losses 90,000 120,000
----------- -----------
Net interest income after provision for loan losses 2,249,417 2,174,364
Noninterest income
Service charges and fees 103,593 117,258
Net gains on loan sales 52,175 281,010
Receivable financing fees 47,632 41,201
Other 77,661 88,113
----------- -----------
Total noninterest income 281,061 527,582
Noninterest expense
Salaries and employee benefits 973,523 904,142
Occupancy and equipment 336,880 302,819
FDIC insurance 6,480 7,302
Printing, postage and supplies 68,629 71,167
Professional and outside services 87,323 87,751
Other 272,119 243,269
----------- -----------
Total noninterest expense 1,744,954 1,616,450
----------- -----------
Income before income tax expense 785,524 1,085,496
Income tax expense 220,000 319,400
----------- -----------
Net income $ 565,524 $ 766,096
=========== ===========
Net change in unrealized gains on securities
available for sale $ 39,470 $ (23,358)
Tax effects (13,419) 7,941
----------- -----------
Total comprehensive income $ 591,575 $ 750,679
=========== ===========
Per share information
Basic earnings $ 0.14 $ 0.19
Diluted earnings $ 0.14 $ 0.19
Dividends declared $ 0.14 $ 0.13
See accompanying notes
4
COMMERCIAL NATIONAL FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
Three Months ended March 31, 2004 and March 31, 2003 (Unaudited)
Accumulated
Shares Common Retained Other
Issued Stock and Earnings/ Comprehensive Total
and Paid in (Accumulated Income/(Loss), Shareholders'
Outstanding Capital Deficit) Net of Tax Equity
----------- ------- -------- ---------- ------
Balance at January 1, 2003 3,801,421 $ 23,255,499 $ 3,908 $ 444,565 $ 23,703,972
Comprehensive income:
Net income 766,096 766,096
Net change in unrealized gains/(losses) on
securities available for sale (23,358) (23,358)
Tax effects 7,941 7,941
------------
Total comprehensive income 750,679
Cash dividends declared, $.13 per share (534,095) (534,095)
Issued under dividend reinvestment program 16,070 202,580 202,580
Issued under employee benefit plan 4,363 53,539 53,539
Repurchase and retirement of shares (5,807) (70,014) (70,014)
--------- ------------ ---------- --------- ------------
Balance at March 31, 2003 3,816,047 $ 23,441,604 $ 235,909 $ 429,148 $ 24,106,661
========= ============ ========== ========= ============
Balance at January 1, 2004 4,052,480 $ 24,117,375 $ (112,306) $ 277,758 $ 24,282,827
Comprehensive income:
Net income 565,524 565,524
Net change in unrealized gains/(losses) on
securities available for sale 39,470 39,470
Tax effects (13,419) (13,419)
------------
Total comprehensive income 591,575
Cash dividends declared, $.14 per share (570,160) (570,160)
Issued under dividend reinvestment program 17,571 210,510 210,510
Issued under employee benefit plan 2,643 30,724 30,724
--------- ------------ ---------- --------- ------------
Balance at March 31, 2004 4,072,694 $ 24,358,609 $ (116,942) $ 303,809 $ 24,545,476
========= ============ ========== ========= ============
See accompanying notes
5
COMMERCIAL NATIONAL FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
Three Months Ended
March 31,
2004 2003
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 565,524 $ 766,096
Adjustments to reconcile net income to net cash from operating activities
Provision for loan losses 90,000 120,000
Net gains on loan sales (52,175) (281,010)
Originations of loans held for sale (2,156,621) (11,705,370)
Proceeds from sales of loans held for sale 2,208,796 11,986,380
Net losses on sale of other real estate and repossessed assets 11,567 --
Stock dividends paid on Federal Home Loan Bank stock (21,400) --
Bank owned life insurance (47,382) (44,922)
Depreciation, amortization and accretion 192,137 162,185
Net change in accrued interest receivable and other assets 179,084 (101,808)
Net change in accrued expenses and other liabilities (81,452) (256,708)
------------ ------------
Net cash from operating activities 888,078 644,843
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of securities available for sale (1,493,860) (8,170,046)
Proceeds from maturities of securities available for sale 2,000,000 4,735,000
Proceeds from maturities of securities held to maturity 200,000 --
Net change in loans 744,893 4,509,304
Purchases of premises and equipment (61,466) (144,240)
Proceeds from sales of other real estate and repossessed assets 17,731 --
------------ ------------
Net cash from investing activities 1,407,298 930,018
CASH FLOW FROM FINANCING ACTIVITIES
Net change in deposits 1,968,640 6,394,490
Net change in securities sold under agreements to repurchase 2,593,080 2,965,362
Net change in U.S. Treasury demand notes (123,235) (242,630)
Proceeds from Federal Home Loan Bank advances 3,000,000 --
Repayment of Federal Home Loan Bank advances (6,862,324) (2,835,526)
Repurchase and retirement of shares of common stock -- (70,014)
Dividends paid (567,368) (532,185)
Proceeds from sale of common stock and fractional shares paid 241,234 256,119
------------ ------------
Net cash from financing activities 250,027 5,935,616
------------ ------------
Net change in cash and cash equivalents 2,545,403 7,510,477
Cash and cash equivalents, at beginning of period 8,719,749 19,269,814
------------ ------------
CASH AND CASH EQUIVALENTS, AT END OF PERIOD $ 11,265,152 $ 26,780,291
============ ============
Cash paid during the period for
Interest $ 940,749 $ 1,169,287
See accompanying notes
6
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
Note 1-Summary of Significant Accounting Policies
Basis of Presentation
The accompanying unaudited consolidated financial statements were prepared in
accordance with Rule 10-01 of regulation S-X and the instructions for Form 10-Q
and, therefore, do not include all disclosures required by accounting principles
generally accepted in the United States of America for complete presentation of
financial statements. In management's opinion, the consolidated financial
statements contain all adjustments (consisting of normal recurring accruals)
necessary to present fairly the financial condition of Commercial National
Financial Corporation as of March 31, 2004 and December 31, 2003 and the results
of its operations for the three months ending March 31, 2004 and March 31, 2003.
The results for the three months ended March 31, 2004 are not necessarily
indicative of the results expected for the full year.
Principles of Consolidation The accompanying consolidated financial statements
include the accounts of Commercial National Financial Corporation (CNFC),
Commercial Bank (Bank), CNFC Financial Services, Inc. and CNFC Mortgage
Corporation, both wholly owned subsidiaries of the Bank. All material
intercompany accounts and transactions have been eliminated in consolidation.
Nature of Operations, Industry Segments and Concentrations of Credit Risk CNFC
is a one-bank holding company, which conducts limited business activities. The
Bank performs the majority of business activities.
The Bank provides a full range of banking services to individuals, agricultural
businesses, commercial businesses and light industries located in its service
area. It maintains a diversified loan portfolio, including loans to individuals
for home mortgages, automobiles and personal expenditures, and loans to business
enterprises for current operations and expansion. The Bank offers a variety of
deposit products, including checking, savings, money market, individual
retirement accounts and certificates of deposit. While CNFC's chief
decision-makers monitor the revenue stream of various products and services,
operations are managed and financial performance is evaluated on a
corporation-wide basis. Accordingly, management considers all of the CNFC's
banking operations to be aggregated into one operating segment.
The principal markets for the Bank's financial services are the Michigan
communities in which the Bank is located and the areas surrounding these
communities. The Bank serves these markets through nine offices located in
Gratiot, Isabella and Montcalm Counties in Michigan.
Use of Estimates To prepare financial statements in conformity with accounting
principles generally accepted in the United States of America, management makes
estimates and assumptions based on available information. These estimates and
assumptions affect the amounts reported in the financial statements and the
disclosures provided. The allowance for loan losses and fair values of
securities and other financial instruments are particularly subject to change.
Stock Compensation Employee compensation expense under stock options is reported
using the intrinsic value method. No stock-based compensation cost is reflected
in net income as all options granted had an exercise price equal to or greater
than the market price of the underlying common stock at date of grant. There
were no grants for the periods ending March 31, 2004 and March 31, 2003. 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.
Three Months Ended
March 31, 2004 March 31, 2003
-------------- --------------
Net income as reported $ 565,524 $ 766,096
Stock-based compensation expense (25,601) (12,757)
----------- -----------
Proforma net income $ 539,923 $ 753,339
=========== ===========
Basic earnings per share as reported $ .14 $ .19
Proforma basic earnings per share $ .13 $ .19
Diluted earnings per share as reported $ .14 $ .19
Proforma diluted earnings per share $ .13 $ .19
7
COMMERCIAL NATIONAL FINANCIAL CORPORATION
Cash Flow Reporting Cash and cash equivalents include cash on hand, demand
deposits with other financial institutions and federal funds sold. Cash flows
are reported net for customer loan and deposit transactions, securities sold
under agreements to repurchase with original maturity of 90 days or less and
U.S. Treasury demand notes.
Earnings and Dividends Per Share Basic earnings per common share is based on net
income divided by the weighted average number of common shares outstanding
during the period. Diluted earnings per common share shows the diluted effect of
any additional potential common shares. Earnings and dividends per common share
are restated for all stock splits and stock dividends.
Comprehensive Income Comprehensive income consists of net income and other
comprehensive income (loss). Other comprehensive income (loss) includes the
change in unrealized appreciation and depreciation on securities available for
sale, net of tax, which is also recognized as a separate component of
shareholders' equity.
Reclassifications Some items in the prior year financial statements have been
reclassified to conform with the current year presentation.
Note 2 - Earnings Per Share
A reconciliation of the numerators and denominators of the basic earnings per
share and diluted earnings per share computations for the periods ended is
presented below. Stock options representing 135,828 and 99,248 shares of common
stock were not considered in computing diluted earnings per share for the three
month periods in 2003 and 2004 because they were antidilutive.
Three Months Ended
MARCH 31, March 31,
2004 2003
---------- ----------
BASIC EARNINGS PER SHARE:
Net income available to common shareholders $ 565,524 $ 766,096
Weighted-average common shares outstanding for
basic earnings per share 4,072,308 4,006,685
---------- ----------
BASIC EARNINGS PER SHARE $ .14 $ .19
========== ==========
DILUTED EARNINGS PER SHARE:
Net income available to common shareholders $ 565,524 $ 766,096
Weighted-average common shares outstanding for basic
earnings per share 4,072,308 4,006,685
Add:
Dilutive effect of assumed exercise of stock options 41,523 37,159
---------- ----------
Weighted-average common and dilutive additional potential
common shares outstanding 4,113,831 4,043,844
---------- ----------
DILUTED EARNINGS PER SHARE $ .14 $ .19
========== ==========
8
COMMERCIAL NATIONAL FINANCIAL CORPORATION
ITEM 2: MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FINANCIAL CONDITION
Summary
Total assets remained relatively unchanged at $240.5 million compared to $239.8
at December 31, 2003. Management classifies the economic environment as having
weak business loan demand offset by an active residential real estate market.
The residential real estate refinancing activity has been significantly reduced
as interest rates moved higher as economic reports suggest that the economy is
improving.
Liquidity
Management defines liquidity as the ability to fund appropriate levels of credit
worthy loans, meet the immediate cash withdrawal requirements of depositors, and
maintain access to sufficient resources to meet unexpected contingencies at a
reasonable cost, with minimal losses.
Management believes that the combination of available FHLB advances, Federal
funds lines of credit, the available for sale investment portfolio, and our
ability to sell mortgage loans provides adequate short and medium term sources
of liquidity. At a minimum the Bank has the following available to meet
short-term liquidity needs: $22.3 million in available FHLB advances based on
available collateral and $9 million in short term federal funds lines of credit
with correspondent banks.
CNFC also needs cash to pay dividends to its shareholders. The primary source of
cash is the dividends paid to CNFC by the Bank. Management believes that cash
from operations is sufficient to supply the cash needed to continue paying a
reasonable dividend.
Asset Quality
At March 31, 2004 CNFC has identified $3.3 million of loans as non-performing.
The entire balance is considered non-accrual. This compares to $825,000 at
December 31, 2003. All non-accrual loans are considered impaired. The specific
allowance for loan loss allocated to these loans is $384,000 at March 31, 2004
and $189,000 at December 31, 2003. During the quarter, management was able to
dispose of all assets identified as repossessed assets and other real estate
owned at December 31, 2003. The balance in repossessed assets and other real
estate at March 31, 2004 represents two residential real estate properties added
during the quarter.
March 31, 2004 December 31, 2003
-------------- -----------------
Total loans $193,630,555 $194,389,682
============ ============
Non-accrual loans $ 3,297,676 $ 825,129
Accruing loans past due 90 days or more -- --
Restructured Loans (non accrual) -- --
------------ ------------
Total non-performing loans 3,297,676 825,129
Repossessed assets and other real estate 102,313 598,011
------------ ------------
Total non-performing assets $ 3,399,989 $ 1,423,140
============ ============
Total non-performing loans as a
percentage of total loans 1.70% .42%
============ ============
Allowance for loan loss as a percentage of
non-performing loans 62.05% 238.78%
============ ============
Total non-performing assets as a percentage of
total assets 1.41% .59%
============ ============
9
COMMERCIAL NATIONAL FINANCIAL CORPORATION
Allowance for Loan Loss
Three Months Ended Year Ended Three Months Ended
March 31, 2004 December 31, 2003 March 31, 2003
-------------- ----------------- --------------
Beginning balance $ 1,970,309 $ 2,783,234 $ 2,783,234
Loan charge-offs (93,495) (3,120,283) (71,006)
Loan recoveries 79,261 406,358 77,481
------------- ------------- -------------
Net loan recoveries/(charge-offs) (14,234) (2,713,925) 6,475
Provision for loan losses 90,000 1,901,000 120,000
------------- ------------- -------------
Ending balance $ 2,046,075 $ 1,970,309 $ 2,909,709
============= ============= =============
Average loan balance $ 191,078,000 $ 184,693,000 $ 180,765,000
Percentage of net charge-offs
as a percentage of average loans 0.00% 1.47% 0.00%
Allowance for loan loss
as a percentage of total loans 1.06% 1.01% 1.61%
For purposes of evaluating the adequacy of the allowance, the performance of the
loan portfolio is divided into four classifications: non-classified, watch,
substandard-not impaired, and substandard-impaired. Management has subdivided
the classifications of non-classified and watch into the following categories of
loans: residential, consumer and business loans.
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 the last three year
historical charge-off experience.
Watch credits are loans that management has identified as having some change
that requires additional loan officer monitoring. These loans are generally
paying as agreed, however, the ability to meet debt obligations, while adequate,
has deteriorated. These loans are not considered impaired within the definition
of FAS 114 and 118 and are viewed as homogeneous categories.
Substandard-impaired and substandard-not impaired loans are business 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 not considered impaired are
grouped as a homogenous category. A reserve is established on this category
using historical loss experience. A specific reserve is calculated for each loan
identified as impaired, however, the total allowance is available for any loan.
Management believes the business loan portfolio contains the highest risk of
loss of principal. The assets identified as non-performing and/or non-accrual
are also considered impaired. The impaired loans are secured by real estate.
While no assurance can be given as to the ultimate value of the real estate,
management believes that currently there is sufficient value to limit
Commercial's exposure to $384,000. In addition, all loans currently identified
as non-accrual had been identified as either watch or substandard-not impaired
at December 31, 2003 and as such had been included in management's assessment of
the adequacy of the allowance for loan loss at December 31, 2003.
10
COMMERCIAL NATIONAL FINANCIAL CORPORATION
Capital Resources
CNFC's capital ratios continue to exceed regulatory guidelines for a "well
capitalized" institution. It is management's intent to maintain capital ratios
in excess of the minimum required to be well capitalized. A summary of CNFC's
capital ratios follows:
Minimum Required to be
Well Capitalized Under Minimum Required
March 31, December 31, Prompt Corrective Action for Capital
2004 2003 Regulations Adequacy Purposes
---- ---- ----------- -----------------
Total capital to
risk weighted assets 14.8% 14.4% 10.0% 8.0%
Tier 1 capital to
risk weighted assets 13.7% 13.3% 6.0% 4.0%
Tier 1 capital to
average assets 10.1% 10.2% 5.0% 4.0%
RESULTS OF OPERATIONS
Summary
Net income for the quarter ended March 31, 2004 was $566,000, a decrease of
$200,000 or 26.1% compared to the same period in 2003. The primary factors that
affected the decrease in net income are: a $45,000 increase in net interest
income, a $247,000 decrease in non-interest income caused by the significantly
reduced residential real estate refinancing activity and related sales of
residential real estate loans to the secondary market, a $30,000 decrease in the
provision for loan loss, and a $129,000 increase in non-interest expense caused
by the additional overhead to support our new facility in Mt. Pleasant.
Net Interest Income
The following table illustrates the effect that changes in rates and balances of
interest-earning assets and interest-bearing liabilities had on tax-equivalent
net interest income for the three months ending March 31, 2004 and 2003.
2004 2003
------------ ------------
Interest Income (tax equivalent) $ 3,384,718 $ 3,562,829
Interest Expense 940,879 1,154,461
------------ ------------
Net Interest Income $ 2,443,839 $ 2,408,368
============ ============
Average Balances
Interest-earning Assets $225,798,501 $226,091,079
Interest-bearing Liabilities 193,388,641 194,132,893
------------ ------------
Net Differential $ 32,409,860 $ 31,958,186
============ ============
Average Yields/Rates (annualized)
Yield on Earning Assets 6.01% 6.39%
Rate Paid on Liabilities 1.95% 2.41%
------------ ------------
Interest Spread 4.06% 3.98%
============ ============
Net Interest Margin 4.34% 4.32%
============ ============
11
COMMERCIAL NATIONAL FINANCIAL CORPORATION
The following table quantifies the effect on net interest income of changes in
the volume of assets and liabilities and the change in yields and cost of funds
for the three months ended March 31, 2004
Three Months Ending
March 31, 2004
Balance Rate Inc/(Dec)
------- ---- ---------
Interest Earning
Assets $ 157,616 $(335,727) $(178,111)
Interest Bearing
Liabilities 18,483 (232,065) (213,582)
--------- --------- ---------
Net Interest Income $ 139,133 $(103,662) $ 35,471
========= ========= =========
In general, interest rates began to trend upward during the first quarter of
2004, as economic data supported a strengthening economy. In the short run, this
has had little effect on CNFC's margin. Margin has remained stable at 4.34%
compared to 4.32% for the same period of 2003.
Noninterest Income
Noninterest income for the three months ending March 31, 2004 was $281,000. This
represents a $247,000 or 46.8% decrease over the same period in 2003.
The decrease in the net gain on loan sales of $229,000 or 81.5% compared to the
same period in 2003 was the primary reason for the overall decrease. Rising
interest rates has eliminated the incentive for residential real estate
customers to refinance existing loans. We do not anticipate a resumption of the
refinancing activity.
Noninterest Expense
Noninterest expense for the three months ending March 31, 2004 totaled
$1,745,000. This represents a $129,000 or 8.0% increase over the same period in
2003.
Salary and benefit expense for the three months ending March 31, 2004 totaled
$974,000 compared to $904,000 for the same period in 2003, an increase of
$69,000 or 7.7%. Mt. Pleasant staff was not hired until the second and third
quarters of 2003, therefore, the majority of the first quarter increase relates
to our Mt. Pleasant expansion. The increase is also partially due to increased
medical insurance premiums, which occurred during the third quarter of 2003.
Occupancy and equipment increased $34,000 or 11.2% compared to the same period
in 2003. Costs associated with operating the new Mt. Pleasant office contributed
to the increased occupancy and equipment expense.
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Commercial's primary market risk exposure is interest rate risk and, to a lesser
extent, liquidity risk. Commercial's transactions are denominated in U.S.
dollars with no specific foreign exchange exposure. Also, Commercial has a
limited exposure to commodity prices related to agricultural loans. Any impacts
that changes in foreign exchange rate and commodity prices would have on
interest rates are assumed to be insignificant.
Interest rate risk (IRR) is the exposure of a banking organization's financial
condition to movements in interest rates. Accepting this risk can be an
important source of profitability and stockholder value; however, excessive
levels of IRR could pose a threat to earnings and capital. Accordingly,
effective risk management that maintains IRR at prudent levels is essential to
Commercial's safety and soundness. Evaluating the quantitative level of IRR
exposure requires the assessment of existing and potential future effects of
changes in interest rates on its consolidated financial condition, including
capital adequacy, earnings, liquidity, and, where appropriate, asset quality.
Commercial's Asset/Liability Committee ("Committee") is responsible for managing
this process.
Commercial derives the majority of income from the excess of interest collected
over interest paid. The rates of interest earned on its assets and owed on its
liabilities generally are established contractually for a period of time. Since
market interest rates change over time, Commercial is exposed to lower profit
margins (or losses) if it cannot adapt to interest rate changes.
12
COMMERCIAL NATIONAL FINANCIAL CORPORATION
Commercial is also subject to repayment risk when interest rates fall. For
example, mortgage loans and other financial assets may be prepaid by a debtor so
that the debtor may refinance their obligations at lower rates. Prepayment of
assets carrying higher rates reduces interest income and overall asset yields.
Fluctuating interest rates and prepayment risk provide a challenge in managing
the net interest income of the Bank. For example: the Bank may fund a 15 year
fixed rate residential real estate loan with a long term amortizing Federal Home
Loan Bank Advance. In a stable interest rate environment, the Bank can
reasonably predict the net interest income earned. However, if rates fall
significantly, the residential mortgage customer may refinance their mortgage at
a lower rate. The Bank continues to pay the higher rate on the Federal Home Loan
Bank advance, thus eroding net interest income. In an alternative scenario, the
Bank funds the same 15 year fixed rate residential real estate loan with 1 year
certificates of deposits. If rates rise at the end of one year, the Bank will
pay more interest to continue to fund the residential mortgage loan with 1 year
certificates of deposit. The net interest income will be lower in year two than
it was in the first year of the mortgage loan.
An additional challenge management faces in managing net interest income is the
fact that what would maximize net interest income to the Bank may be in conflict
with the customers' request for products and services. In the current low
interest rate environment, management has greater concern that interest rates
will rise significantly over time rather than fall. Management would prefer to
offer variable rate loan products that would reprice upward as interest rates
rise. However, our loan customers are generally requesting long term fixed rate
loans. On the funding side, management would like to extend the maturities of
its liabilities to match the loan customers' request for longer term fixed rate
loans. However, our deposit customers' are reluctant to commit to long term
certificates of deposits.
Commercial's primary tool in measuring interest rate risk is to perform a
simulation analysis. This analysis forecasts the effect of various interest rate
changes on the balance sheet, economic value of equity, net interest income and
net income. One common scenario performed by the Committee is to "shock" the
balance sheet by assuming that Commercial has just experienced an immediate and
parallel shift in the yield curve up or down 200 basis points. The model, using
data and assumptions determined by management, reprice assets and liabilities at
new market rates. The objective of this testing is to determine how the Bank's
net interest income and the economic value of equity are affected by extreme
changes in interest rates. These results are recorded and compared to previous
results. Management performs this calculation monthly.
The limitation to this methodology is that the interest rate curve rarely shifts
200 basis points immediate and parallel. In addition, a downward 200 basis point
shift in today's interest rate environment is not likely. Management implemented
a new interest rate risk model during the first quarter of 2004. In addition to
the 200 basis point immediate and parallel shift in interest rates, management
performs additional projections using other interest rate environments. The
results listed below for the quarter ending March 31, 2003 were obtained using
the Bank's prior model.
The Table below summarizes the effect a 200 basis point immediate and parallel
shift of the yield curve has on net income. In a falling interest rate
environment, management does not have the ability to lower deposit rates 200
basis points to offset a decrease in rates on earning assets. Therefore, if
rates decreased 200 basis points, margin would likely compress resulting in
lower net interest income.
In an environment where interest rates increased 200 basis points in an
immediate and parallel shift in the yield curve, management projects that net
income will increase 10.75% during the next 12 months. The difference in net
income compared to December 31, 2003 is primarily due to the change in the
interest rate risk model used by management. Management believes that the new
model more accurately predicts the repricing opportunities and cash flow
comprising the balance sheet at December 31, 2003.
Projected Percentage Change in Net Income
March 31, 2004 December 31, 2003
-------------- -----------------
- -200 basis points (23.79)% .29%
0 basis points 0.00 0.00
+200 basis points 10.75% (34.95)%
13
COMMERCIAL NATIONAL FINANCIAL CORPORATION
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures - Jeffrey S. Barker, the
Corporation's Principal Executive Officer, and Patrick G. Duffy, the
Corporation's Principal Financial Officer, have reviewed and evaluated the
effectiveness of the Corporation's disclosure controls and procedures (as
defined in Rules 240.13a-15(e) and 15d-15(e) under the Securities Exchange
Act of 1934 (the "Exchange Act)) as of the end of the period covered by
this form 10Q quarterly report. Based on their evaluation, they have
concluded that the Corporation's disclosure controls and procedures were
effective as of March 31, 2004.
(b) Changes in internal controls - The Corporation also conducted an
evaluation of internal control over financial reporting to determine
whether any changes occurred during the quarter ended March 31, 2004, that
have materially affected, or are reasonably likely to materially affect,
the Corporation's internal control over financial reporting. Based on this
evaluation, there has been no such change during the quarter that ended
March 31, 2004.
Forward Looking Statements
This discussion and analysis of financial condition and results of operations,
and other sections of this report contain forward looking statements that are
based on management's beliefs, assumptions, current expectations, estimates and
projections about the financial services industry, the economy, and about the
Corporation itself. Words such as "anticipates", "believes", "estimates",
"expects" "forecasts" "intends", "is likely", "plans", "product", "projects",
variations of such words and similar expressions are intended to identify such
forward-looking statements. These statements are not guarantees of future
performance and involve certain risks, uncertainties, and assumptions ("Future
Factors") that are difficult to predict with regard to timing, extent,
likelihood and degree of occurrence. Therefore, actual results and outcomes may
materially differ from what may be expressed or forecasted in such forward
looking statements. Furthermore, CNFC undertakes no obligation to update, amend
or clarify forward-looking statements, whether as a result of new information,
future events, or otherwise.
Future Factors include changes in interest rates and interest rate
relationships; demand for products and services; the degree of competition by
traditional and non-traditional competitors; changes in banking regulations and
tax laws; changes in prices, levies, and assessments; the impact of technology,
governmental and regulatory policy changes; the outcome of pending and future
litigation and contingencies; trends in customer behavior including their
ability to repay loans; and vicissitudes of the national and local economies.
These are representative of the Future Factors that could cause a difference
between an actual outcome and a forward-looking statement.
14
COMMERCIAL NATIONAL FINANCIAL CORPORATION
PART II. OTHER INFORMATION
ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
Exhibit 31.1 Certification of Chief Executive Officer required by
Rule 13a-14(a).
Exhibit 31.2 Certification of Chief Financial Officer required by
Rule 13a-14(a).
Exhibit 32.1 Certification pursuant to 18 U.S.C. Section 1350 of
Chief Executive Officer.
Exhibit 32.2 Certification pursuant to 18 U.S.C. Section 1350 of
Chief Financial Officer.
(b) Report on Form 8-K
Current report on Form 8-K dated March 1, 2004 filed with the
Security and Exchange Commission on March 5, 2004 announcing the
2004 first quarter dividend.
Current report on Form 8-K dated January 27, 2004 filed with the
Security and Exchange Commission on January 28, 2004 announcing
fourth quarter 2003 earnings.
15
COMMERCIAL NATIONAL FINANCIAL CORPORATION
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Commercial National Financial Corporation
(Registrant)
Date: May 11, 2004 /s/ Jeffrey S. Barker
-------------------------------------
Jeffrey S. Barker
President and Chief Executive Officer
Date: May 11, 2004 /s/ Patrick G. Duffy
--------------------------------------
Patrick G. Duffy
Executive Vice President and Chief Financial
Officer
16
COMMERCIAL NATIONAL FINANCIAL CORPORATION
Exhibit Index
Exhibit
No. Description
-- -----------
Exhibit 31.1 Certification of Chief Executive Officer required by
Rule 13a-14(a).
Exhibit 31.2 Certification of Chief Financial Officer required by
Rule 13a-14(a).
Exhibit 32.1 Certification pursuant to 18 U.S.C. Section 1350 of
Chief Executive Officer.
Exhibit 32.2 Certification pursuant to 18 U.S.C. Section 1350 of
Chief Financial Officer.