<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
/X/ Annual Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the fiscal year ended December 31, 1996
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 Number 0-17000
COMMERCIAL NATIONAL FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
Michigan 38-2799780
(State of Incorporation) (I.R.S. Employer Identification No.)
101 North Pine River Street
Ithaca, Michigan 48847
(Address of principal executive offices) (Zip Code)
Registrants's telephone number, including area code: (517) 875-4144
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $1 par value
(Title of Class)
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 if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. /X/
State the aggregate market value of the voting stock held by non-affiliates of
the registrant. The aggregate market value shall be computed by reference to
the price at which the stock was sold, or the average bid and asked prices of
such stock, as of a specified date within 60 days prior to the date of filing.
Aggregate market value as of March 7, 1997: $15,856,269
Indicate the number of shares outstanding of each of the registrant's classes
of common stock, as of the latest practicable date.
Common Stock outstanding as of March 7, 1997: 877,900.58 shares
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's annual report to security holders for the year
ended December 31, 1996, are incorporated by reference in Part II and Part IV.
Portions of the registrant's proxy statement for its April 22, 1997, annual
shareholders meeting are incorporated by reference in Part III.
<PAGE> 2
PART I
ITEM 1. BUSINESS
Commercial National Financial Corporation (the "Corporation" or
"registrant"), a bank 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").
The Bank's business is concentrated in a single industry segment -
commercial banking. The Bank provides a full range of banking services to
individuals, agricultural businesses, commercial businesses and light
industries located in its service area. The Bank maintains a diversified loan
portfolio, including loans to individuals for home mortgages, automobiles and
personal expenditures, and loans to business enterprises for current operations
and expansion. The Bank offers a variety of deposit vehicles, including
checking, savings, money market and individual retirement accounts and
certificates of deposit.
The principal markets for the Bank's 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
offices located in and near these communities. Neither the Corporation nor the
Bank has any material foreign assets or income.
The principal source of revenue for the Corporation and its subsidiary is
interest and fees on loans. On a consolidated basis, interest and fees on
loans accounted for 79.8% of the Corporation's total revenues in 1996, 78.1% in
1995 and 75.5% in 1994. Interest on investment securities accounted for 13.0%
of the Corporation's total revenues in 1996, 13.9% in 1995 and 16.1% in 1994.
At December 31, 1996, the Bank had no significant concentrations of loans
to any group of borrowers engaged in similar activities that would be impacted
by economic or other conditions.
The business of banking is highly competitive. In addition to competition
from other commercial banks, banks face competition from non-bank financial
institutions. Savings associations compete with commercial banks for deposits
and loans. Credit unions and finance companies compete for consumer loans.
Commercial banks compete for deposits with other investments such as mutual
funds and corporate and government debt securities. Financial service
providers compete for customers principally through price (interest rates paid
on deposits, interest rates charged on borrowings and fees charged for
services) and service (convenience and quality of services rendered to
customers).
The Bank competes directly with fifteen financial institutions in the
market it serves. The Bank's competitors include other commercial banks,
savings associations and local credit unions. The Bank ranks second in deposit
size when compared to the total deposits of the branches located in the market
the Bank serves. The Bank does not believe that its ability to compete for
loans and deposits is affected by the rank among its competitors.
Banks and bank holding companies are extensively regulated. The Bank is
chartered as a state bank under Michigan law and is supervised, examined and
regulated by the Michigan Financial Institutions Bureau and the Federal Deposit
Insurance Corporation ("FDIC"). The business activities of the registrant are
limited to banking and to other activities determined by the Board of Governors
of the Federal Reserve System to be closely related to banking. Deposits of
the Bank are insured by the FDIC to the extent provided by law.
Commercial banks are subject to a number of federal and state laws and
regulations that have a material impact on their business. These include,
among others, state usury laws, state laws relating to fiduciaries, the Truth
in Lending Act, the Equal Credit Opportunity Act, the Fair Credit Reporting
Act, the Expedited Funds Availability Act, the Community Reinvestment Act,
electronic funds transfer laws, redlining laws, antitrust laws, environmental
laws and privacy laws. The policies of the Federal Reserve System, and other
authorities, may materially affect the growth and distribution of loans,
investments and deposits and interest rates on deposits and loans.
1
<PAGE> 3
The FDIC Improvement Act of 1991 (the "FDIC Improvement Act"), revised
sections of the Federal Deposit Insurance Act affecting bank regulation,
deposit insurance and provisions for the funding of the bank insurance fund.
The FDIC Improvement Act also revised bank regulatory structures embodied in
several other federal banking statutes, links the bank regulators' authority to
intervene to the deterioration of a bank's capital level, places limits on real
estate lending and increases audit requirements. Among the significant
revisions that could have an impact on the Corporation is the authority granted
the FDIC to impose special assessments on insured depository institutions to
repay FDIC borrowings from the United States Treasury or other sources and to
establish semiannual assessment rates on bank insurance fund member banks so as
to maintain the bank insurance fund at the designated reserve ratio defined in
the FDIC Improvement Act. The FDIC Improvement Act also required the FDIC to
implement a system of risk-based premiums for deposit insurance pursuant to
which the premiums paid by a depository institution are based on the perceived
probability that the bank insurance fund will incur a loss in respect of such
institution.
Under 1994 amendments to the Federal Bank Holding Company Act, the
Corporation is authorized to acquire subsidiary banks in any state in which
state laws permit such acquisitions. Out-of-state bank holding companies in
any state are permitted to acquire banks located in Michigan if the laws of the
state in which the out-of-state bank holding company is located authorize a
bank holding company located in Michigan to acquire ownership of banks in that
state on a reciprocal basis. Under amendments to the Michigan Banking Code
which became effective on November 29, 1995, the Bank is authorized to merge
with or acquire out-of-state banks or branches in any state in which state laws
permit such acquisitions.
As of December 31, 1996, the Corporation and its subsidiary employed
approximately 95 employees on a full-time equivalent basis.
The statistical information on the following pages further describes
certain aspects of registrant's business.
2
<PAGE> 4
Interest Rates and Interest Differential
The following tables present an analysis of net interest earnings for the
periods indicated. All interest (including tax-exempt securities and
tax-exempt loans) is presented on a fully taxable-equivalent basis.
<TABLE>
<CAPTION>
Years Ending December 31(In thousands) 1996 1995
---------------------------------- ---------------------------
Average Average Average Average
Balance Interest Rate Balance Interest Rate
-------- -------------- -------- -------- -------- -------
<S> <C> <C> <C> <C> <C> <C>
Interest Earning Assets
Loans(1)(2) $114,034 $10,471 9.18% $104,175 $9,756 9.37%
Investment securities:
Taxable 15,317 956 6.24 17,896 1,131 6.32
Tax-exempt(2) 13,861 1,105 7.97 10,157 888 8.74
Fed funds sold 3,418 186 5.44 5,457 321 5.88
Federal Home Loan Bank stock 724 57 7.87 0
-------- ---------- -------- ------
Total earning assets 147,354 12,775 8.67 137,685 12,096 8.79
-------- ---------- -------- ------
Non-earning Assets
Cash and due from banks 4,703 4,283
Premises and equipment 3,827 2,869
Other assets 1,689 2,541
Allowance for loan losses (1,764) (1,573)
-------- --------
Total assets $155,809 $145,805
======== ========
Interest Bearing Liabilities
Savings and demand deposits $ 59,094 1,573 2.66 $ 59,363 1,647 2.77
Time deposits 54,944 3,092 5.63 51,576 2,817 5.46
Securities sold under agreement to
repurchase 5,911 299 5.06 4,912 278 5.66
U.S. Treasury demand notes 569 30 5.27 679 38 5.60
Long -term debt 5,063 283 5.59 0 _
-------- ---------- --------- -----
Total interest bearing
liabilities 125,581 5,277 4.20 116,530 4,780 4.10
-------- ---------- --------- -----
Non-interest Bearing Liabilities
Demand deposits 13,928 14,097
Other liabilities 1,092 927
Shareholders' equity 15,208 14,251
-------- --------
Total liabilities and
shareholders' equity $155,809 $145,805
======== ========
Net interest spread $7,498 4.47% $7,316 4.69%
====== ===== ====== =====
Net Yield on Interest Earning Assets
(net interest earnings divided by total
interest earning assets) 5.09% 5.31%
===== =====
</TABLE>
(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
balances.
(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
<PAGE> 5
The following table sets forth an analysis of interest
differential, including the effect of volume and rate changes on interest income
and expenses for the periods indicated. For purposes of these tables, change in
interest due to volume and rate were determined as follows:
<TABLE>
<CAPTION>
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. This variance
has been allocated to volume and rate changes in
proportion to the relationship of the absolute dollar
amounts of the change in each.
1996 1995
Compared to Compared to
1995 1994
--------------------------------------- ------------------------------------
Net Net
Increase Due to Due to Increase Due to Due to
(Decrease) Volume Rate (Decrease) Volume Rate
----------- ------- ------ ---------- ------ ------
<S> <C> <C> <C> <C> <C> <C>
(In Thousands)
Interest Income:
Loans(1)(2) $ 715 $908 $(193) $1,296 $ 560 $ 736
Investment securities:
Taxable (175) (161) (14) (120) (317) 197
Tax-exempt(2) 217 301 (84) 87 103 (16)
Fed funds sold (135) (112) (23) 109 8 101
Federal Home Loan Bank stock 57 57 0
---- ---- ----- ---- ---- -----
Total Interest Income 679 993 (314) 1,372 354 1,018
--- ---- ---- ------ --- -----
Interest Expense:
Interest bearing deposits
Savings (74) (10) (64) (66) (217) 151
Time 275 188 87 710 242 468
Securities sold under agreement
to repurchase 21 53 (32) 239 226 13
U.S. Treasury demand notes (8) (6) (2) 13 5 8
Long-term debt 283 283
--- ---- ---- ------ --- -----
Total Interest Expense 497 508 (11) 896 256 640
--- ---- ---- ------ --- -----
Net Interest Income $ 182 $485 $(303) $ 476 $ 98 $ 378
===== ==== ====== ===== ===== =====
</TABLE>
(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
balances.
(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%.
4
<PAGE> 6
Investment Portfolio
The book value of investment securities as of the dates indicated are
summarized as follows:
<TABLE>
<CAPTION>
December 31,
----------------------------------------------------------------------
1996 1995
---------------------------- ----------------------------
Held-to- Available- Held-to- Available-
Maturity for-Sale Maturity for-Sale
(Dollars in Thousands)
<S> <C> <C> <C> <C>
U.S. Treasury and other U.S.
government agencies and
corporations $11,173 $ 0 $15,807 $ 0
States of the U.S. and
political subdivisions 14,160 0 13,623 0
Other securities 0 1,461 0 437
------- ------ ------- ----
Total $25,333 $1,461 $29,430 $437
======= ====== ======= ====
</TABLE>
5
<PAGE> 7
The following table shows, by class of maturities as of December 31, 1996,
the amounts and weighted average yields of held-to-maturity securities (1):
<TABLE>
<CAPTION>
MATURING
-----------------------------------------------------------------------------------------------
After One but After Five but
Within One Year Within Five Years Within Ten Years After Ten Years Total
------------------ -------------------- ------------------ ------------------ --------------
Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield
-------- -------- --------- --------- -------- -------- -------- -------- ------- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
(Dollars In Thousands)
U.S. Treasury and
other U.S.
government
agencies and
corporations $7,676 6.04% $3,498 5.75% $ 0 $ 0 $11,174 5.95%
States and political
subdivisions (2) 1,716 7.84% 4,402 8.26% 7,651 8.09% 390 8.98% 14,159 8.14%
------ ------ ------ ---- -------
Total (3) $9,392 6.37% $7,900 7.14% $7,651 8.09% $390 8.98% $25,333 7.17%
====== ====== ====== ==== =======
</TABLE>
(1) The effective yields are weighted for the scheduled maturity of each
security and weighted average yields are calculated on the basis of par
value.
(2) Weighted average interest rates have been computed on a fully
taxable-equivalent basis. The rates shown on securities issued by states
and political subdivisions have been restated, assuming a 34% tax rate.
(3) As of December 31, 1996, the aggregate book value of investment
securities issued by the State of Michigan and all its political
subdivisions totaled $10,492 with an aggregate market value of $10,578.
6
<PAGE> 8
Loan Portfolio
The following table presents the amount of loans outstanding
at the indicated dates by loan type, based on classifications used for
regulatory reporting:
<TABLE>
<CAPTION>
December 31,
-----------------------
1996 1995
---- ----
<S> <C> <C>
(Dollars In Thousands)
Commercial, financial
and agriculture $ 66,170 $ 63,205
Real estate - construction 3,840 2,072
Real estate - mortgage 33,256 30,288
Consumer and other 19,059 13,714
-------- --------
Total loans $122,325 $109,279
======== ========
</TABLE>
The following table shows the maturity of loans (excluding
real estate mortgages and installment loans) outstanding at December 31, 1996.
Also provided are the amounts due after one year classified according to their
sensitivity to changes in interest rates.
<TABLE>
<CAPTION>
Due in One Due in One Due After
Year or Less to Five Years Five Years Total
------------ ------------- ---------- -----
<S> <C> <C> <C> <C>
(Dollars In Thousands)
Commercial, financial and
agricultural $18,922 $34,974 $12,274 $66,170
Real estate - construction 1,542 1,253 1,045 3,840
------- ------- ------- -------
Total $20,464 $36,227 $13,319 $70,010
======= ======= ======= =======
Loans due after one year:
With predetermined interest rates $24,404
With floating or adjustable interest rates 25,142
-------
Total $49,546
=======
</TABLE>
7
<PAGE> 9
The following table summarizes nonaccrual, past due, and restructured
loans at the dates indicated:
<TABLE>
<CAPTION>
December 31,
------------------------
1996 1995
----------- -----------
(Dollars in Thousands)
<S> <C> <C>
Nonaccrual loans $ 0 $178
Accruing loans past due
90 days or more 82 34
Restructured loans 60 27
---- ----
Total Non-performing Loans $142 $239
==== ====
</TABLE>
The Corporation estimates the following additional information with
respect to nonaccrual and restructured loans for the year ended December 31,
1996:
<TABLE>
<CAPTION>
(In Dollars)
<S> <C>
Interest income which would
have been recorded under
original term $18,207
=======
Interest income recorded
during the period $27,561(1)
=======
</TABLE>
Loan performance is reviewed regularly by loan review personnel, loan
officers and senior management. Loans are placed on nonaccrual status when
principal or interest is past due 90 days or more and the loan is not
well-secured and 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.
At December 31, 1996, the Corporation had $1,995,000 in domestic loans for
which payments are presently current, but where the borrowers are currently
experiencing financial difficulties. Those loans are subject to constant
management attention and their classification is reviewed on a regular basis.
As of December 31, 1996, there were no concentrations of loans exceeding
10% of total loans.
(1) During 1996 the Bank received payments of past due interest relating to
years ending December 31, 1995 and prior. The amount this interest was
approximately $19,000.
8
<PAGE> 10
Summary of Loan Loss Experience
The following table summarizes loan balances at the end of each period and
daily averages; changes in the allowance for possible loan losses arising from
loans charged off and recoveries on loans previously charged off, by loan
category; and additions to the allowance which have been charged to expense.
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
1996 1995
---------- ----------
(Dollars in Thousands)
<S> <C> <C>
Loans
Amount of loans outstanding at
end of period $122,325 $109,279
======== ========
Daily average of loans outstanding
for the period $114,034 $104,175
======== ========
Balance of allowance for loan
losses at beginning of period $ 1,669 $ 1,510
-------- --------
Loans charged off:
Commercial, financial and agricultural 33 143
Real estate - construction 0 0
Real estate - mortgage 27 5
Installment loans to individuals 115 40
-------- --------
Total loans charged off 175 188
-------- --------
Recoveries of loans previously charged off:
Commercial, financial, and agricultural 68 79
Real estate - construction 0 0
Real estate - mortgage 10 13
Installment loans to individuals 22 5
-------- --------
Total recoveries 100 97
-------- --------
Net charge-offs 75 91
-------- --------
Additions to allowance charged to
operating expense (1): 230 250
-------- --------
Allowance at end of period $ 1,824 $ 1,669
======== ========
Ratio of net charge-offs during period
to average loans outstanding 0.07% 0.09%
==== ====
Ratio of allowance for loan losses to
loans outstanding at end of period 1.49% 1.53%
==== ====
</TABLE>
(1) The provision for loan losses charged to expense is based on loan loss
experience and such 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.
9
<PAGE> 11
The allowance for loan losses has been allocated according to the amount
deemed to be reasonably necessary to provide for the possibility of losses
being incurred within the following categories at the dates indicated:
<TABLE>
<CAPTION>
December 31, 1996 December 31, 1995
---------------------- ----------------------
Percent Percent
of Loans of Loans
in Category in Category
to Total to Total
Allowance Loans Allowance Loans
--------- ----------- --------- -----------
(Dollars in Thousands)
<S> <C> <C> <C> <C>
Commercial, financial and
agricultural $ 713 54.09% $ 716 57.83%
Real estate - construction -- 3.14 -- 1.90
Real estate - mortgage 72 27.19 126 27.71
Installment 413 15.58 240 12.56
Unallocated 626 587
------ ------ ------ ------
Total $1,824 100.00% $1,669 100.00%
====== ====== ====== ======
</TABLE>
10
<PAGE> 12
Deposits
The daily average amounts of deposits and rates paid on such deposits for
the periods indicated are:
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------
1996 1995
---- ----
Amount Rate Amount Rate
------ ---- ------ ----
(Dollars in Thousands)
<S> <C> <C> <C> <C>
Non-interest bearing
demand deposits $ 13,928 -- $ 14,097 --
Interest bearing demand deposits 35,033 2.63% 33,282 .68%
Savings 24,061 2.70% 26,081 2.89%
Time deposits 54,944 5.63% 51,576 5.46%
-------- --------
Total Deposits $127,966 $125,036
======== ========
</TABLE>
11
<PAGE> 13
The time remaining until maturity of time certificates of deposits of
$100,000 or more at December 31, 1996, is as follows:
<TABLE>
<CAPTION>
Time Certificates
of Deposits
-----------------
<S> <C>
3 months or less $ 8,999
Over 3 through 6 months 2,010
Over 6 through 12 months 1,042
Over 12 months 2,527
-------
Total $14,578
=======
</TABLE>
12
<PAGE> 14
Short-term Borrowings
Short-term borrowed funds consist of securities sold under agreements to
repurchase, treasury tax and loan demand notes. The following amounts and
rates applied during the last two years:
<TABLE>
<CAPTION>
Securities Sold
Under Agreements Demand Notes Issued
To Repurchase To U.S. Treasury
------------------- -----------------------
1996 1995 1996 1995
-------- --------- ----------- ----------
(Dollars In Thousands)
<S> <C> <C> <C> <C>
Amounts outstanding at
year-end $5,602 $5,305 $ 942 $ 560
====== ====== ====== ======
Average amount outstanding
during year $5,911 $4,912 $ 569 $ 679
====== ====== ====== ======
Maximum amount outstanding
at any month-end $7,801 $7,511 $1,532 $2,357
====== ====== ====== ======
Weighted average interest
rate at year-end 4.93% 5.01% 5.18% 5.17%
====== ====== ====== ======
Weighted average interest
rate during year 5.06% 5.66% 5.27% 5.60%
====== ====== ====== ======
</TABLE>
The weighted average interest rates are derived by dividing the interest
expense for the period by the daily average balance during the period.
Long-term Borrowings
Long-term borrowings consist of borrowings from the Federal Home Loan
Bank("FHLB"). The following amounts and rates applied during the last two
years:
<TABLE>
<CAPTION>
FHLB
----------------------------
1996 1995
-------- --------
(Dollars In Thousands)
<S> <C> <C>
Amounts outstanding at
year-end $10,000 $0
======= ==
Average amount outstanding
during year $ 5,063 $0
======= ==
Maximum amount outstanding
at any month-end $10,000 $0
======= ==
Weighted average interest
rate at year-end 5.78%
=======
Weighted average interest
rate during year 5.59%
=======
</TABLE>
13
<PAGE> 15
ITEM 2. PROPERTIES.
The Bank currently conducts business from nine banking offices
including two branches located in supermarkets owned by a related party. The
executive offices of the Corporation are located at 101 North Pine River
Street, Ithaca, Michigan. The main office of the Bank is located at 301 North
State Street, Alma, Michigan. The main office property of the Bank is leased
for a term expiring on December 31, 2013. The branches of the Bank are located
in Alma, Greenville, Midland, Middleton, Pompeii, and St. Louis, Michigan.
The Bank owns the property for five of the branch office
locations. One branch office is leased pursuant to a lease that expires August
1, 1998, subject to 3 renewals of 10 years each. The Alma Supermarket Branch
is leased pursuant to a five year lease beginning June 1, 1995 with two five
year renewals. The Midland Supermarket Branch is leased pursuant to a five
year lease beginning January 1, 1996 with two five year renewals. Aggregate
rental expense represents less than 5% of the registrant's operating expenses.
The Corporation considers all of its facilities to be well maintained and in
generally good operating condition and suitable for the purposes for which they
are intended.
ITEM 3. LEGAL PROCEEDINGS.
The Corporation and the Bank are parties, as plaintiff or
defendant, to several legal proceedings, none of which is considered material,
and all of which arose in the ordinary course of business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
14
<PAGE> 16
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER
MATTERS.
The information under the captions "Common Stock Information"
and "Dividend Information" of the registrant's annual report to shareholders
for the year ended December 31, 1996, is here incorporated by reference to
Exhibit 13.
ITEM 6. SELECTED FINANCIAL DATA.
The information under the caption "Selected Financial Data" of
the registrant's annual report to shareholders for the year ended December 31,
1996, is here incorporated by reference to Exhibit 13.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The information under the heading "Management's Review and
Analysis" of the registrant's annual report to shareholders for the year ended
December 31, 1996, is here incorporated by reference to Exhibit 13.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The financial statements, notes and independent auditors'
report of the registrant's annual report to shareholders for the year ended
December 31, 1996, are here incorporated by reference to Exhibit 13.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
The Letter Concerning Change in Certifying Public Accountant
are here incorporated by reference to registrant's Form 8-K previously filed
December 28, 1995.
15
<PAGE> 17
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information set forth under the caption "Directors and
Executive Officers" and "Section 16(a) Beneficial Ownership Reporting
Compliance" in the registrant's definitive Proxy Statement for its April 22,
1997, annual meeting of shareholders is here incorporated by reference.
ITEM 11. EXECUTIVE COMPENSATION.
The information set forth under the captions "Compensation of
Executive Officers" and "Compensation of Directors" in the registrant's
definitive Proxy Statement for its April 22, 1997, annual meeting of
shareholders is here incorporated by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information set forth under the caption "Voting Securities"
in the registrant's definitive Proxy Statement for its April 22, 1997, annual
meeting of shareholders is here incorporated by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information set forth under the caption "Certain
Relationships" in the registrant's definitive Proxy Statement for its April 22,
1997, annual meeting of shareholders is here incorporated by reference.
16
<PAGE> 18
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a)(1) Financial Statements.
The following financial statements, notes to financial
statements, and independent auditors' reports of the Corporation and its
subsidiary are filed as part of this report:
Independent Auditors' Reports
Consolidated Balance Sheets - December 31, 1996 and 1995
Consolidated Statements of Income for each of the three years
ended December 31, 1996
Consolidated Statements of Shareholders' Equity for each of the
three years in the period ended December 31, 1996
Consolidated Statements of Cash Flows for each of the three
years in the period ended December 31, 1996
Notes to Consolidated Financial Statements
The financial statements, notes to financial statements, and
independent auditors' reports for the years ended December 31, 1996 and 1995,
listed above are incorporated by reference in Item 8 of this report from the
corresponding portions of the registrant's annual report to shareholders for
the year ended December 31, 1996. With the exception of the portions of the
registrant's annual report to shareholders for the year ended December 31, 1996
specifically incorporated herein by reference, such report shall not be deemed
filed as part of this annual report on Form 10-K.
(2) All schedules have been omitted because they are inapplicable or
otherwise not required.
(3) The following exhibits are filed as part of this report:
Number Exhibit
3(a) Restated Articles of Incorporation. Previously filed as an exhibit
to the registrant's Form S-4 filed January 22, 1988. Here
incorporated by reference.
3(b) Bylaws. Previously filed as an exhibit to the registrant's
Form S-4 filed January 22, 1988. Here incorporated by reference.
10(a) Form of Indemnity Agreement. Previously filed as an exhibit to the
registrant's Form S-4 filed January 22, 1988. Here incorporated by
reference.
10(b) 1989 Stock Option Plan. Previously filed as an exhibit to the
registrant's Form 10-K for the year ended December 31, 1988. Here
incorporated by reference.*
10(c) 1991 Stock Option Plan. Previously filed as an exhibit to the
registrant's Form 10-K for the year ended December 31, 1990. Here
incorporated by reference.*
10(d) Amendment to 1991 Stock Option Plan. Previously filed as an
exhibit to the registrant's Form 10-K for the year ended December
31, 1995. Here incorporated by reference.*
10(e) Lease for Main Office. Previously filed as an exhibit to
registrant's Form 10-K for the year ended December 31, 1991. Here
incorporated by reference.
10(f) Branch Purchase and Assumption Agreement. Previously filed as an
exhibit to registrant's Form 10-K for the year ended December 31,
1991. Here incorporated by reference.
10(g) Executive Employment, Change of Control and Severance Agreements.
Previously filed as an
17
<PAGE> 19
exhibit to registrant's Form 10-K for the year ended December
31, 1991. Here incorporated by reference.*
10(h) Branch Lease for Alma Supermarket Branch. Previously filed as
an exhibit to the registrant's Form 10-K for the year ended
December 31, 1995. Here incorporated by reference.
10(i) Branch Lease for Midland Supermarket Branch. Previously filed
as an exhibit to the registrant's Form 10-K for the year ended
December 31, 1995. Here incorporated by reference.
13 Incorporated portions from 1996 Annual Report to
Shareholders.
21 Subsidiary of Registrant. Previously filed as an
exhibit to the registrant's Form S-4 filed January 22, 1988.
Here incorporated by reference.
23 Consents of Independent Certified Public Accountants.
27 Financial Data Schedule.
* Management contract or compensatory plan or arrangement
The registrant will furnish a copy of any exhibit listed above to any
shareholder of the registrant without charge upon written request to Patrick
Duffy, Commercial National Financial Corporation, 101 North Pine River Street,
Ithaca, Michigan 48847.
(b) Reports on Form 8-K.
No reports on Form 8-K were filed for the fourth quarter of 1996.
(c) Exhibits.
See Item 14(a)(3)
(d) Financial Statement Schedules.
There are no financial statement schedules required to be filed
with this report.
18
<PAGE> 20
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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)
March 25, 1997 By: /s/ Dean E. Milligan
---------------------------------------------
Dean E. Milligan
President and Chief Executive Officer
19
<PAGE> 21
Pursuant to the requirements of the Securities Exchange Act of
1934, this report has been signed below by the following persons on behalf of
the registrant and in the capacities and on the dates indicated.
<TABLE>
<S> <C>
March 25, 1997 /s/ Dean E. Milligan
-----------------------------------------------
Dean E. Milligan
Director, President and Chief Executive Officer
(Principal Executive Officer)
March 25, 1997 /s/ Richard F. Abbott
-----------------------------------------------
Richard F. Abbott
Director
March 25, 1997 /s/ Jefferson P. Arnold
-----------------------------------------------
Jefferson P. Arnold
Director
March 25, 1997 /s/ Don J. Dewey
-----------------------------------------------
Don J. Dewey
Director
March 25, 1997 /s/ David A. Ferguson
-----------------------------------------------
David A. Ferguson
Director
March 25, 1997 /s/ Kenneth R. Luneack
-----------------------------------------------
Kenneth R. Luneack
Director
March 25, 1997 /s/ Kim C. Newson
-----------------------------------------------
Kim C. Newson
Director
March 25, 1997 /s/ Howard D. Poindexter
-----------------------------------------------
Howard D. Poindexter
Director
March 25, 1997 /s/ Scott E. Sheldon
-----------------------------------------------
Scott E. Sheldon
Director
March 25, 1997 /s/ Russell M. Simmet
-----------------------------------------------
Russell M. Simmet
Director
March 25, 1997 /s/ Joseph B. Simon
-----------------------------------------------
Joseph B. Simon
Director
March 25, 1997 /s/ Patrick G. Duffy
-----------------------------------------------
Patrick G. Duffy
(Principal Financial and Accounting Officer)
</TABLE>
20
<PAGE> 22
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
Number Exhibit Page
- ------ ------- ----
<S> <C> <C>
3(a) Restated Articles of Incorporation. Previously filed as an exhibit to the registrant's *
Form S-4 filed January 22, 1988. Here incorporated by reference.
3(b) Bylaws. Previously filed as an exhibit to the registrant's Form S-4 filed January *
22, 1988. Here incorporated by reference.
10(a) Form of Indemnity Agreement. Previously filed as an exhibit to the registrant's *
Form S-4 filed January 22, 1988. Here incorporated by reference.
10(b) 1989 Stock Option Plan. Previously filed as an exhibit to the registrant's Form *
10-K for the year ended December 31, 1988. Here incorporated by reference.
10(c) 1991 Stock Option Plan. Previously filed as an exhibit to the registrant's Form *
10-K for the year ended December 31, 1990. Here incorporated by reference.
10(d) Amendment to 1991 Stock Option Plan. Previously filed as an exhibit to the *
registrant's Form 10-K for the year ended December 31, 1995. Here incorporated by
reference.
10(e) Lease for Main Office. Previously filed as an exhibit to registrant's Form 10-K *
for the year ended December 31, 1991. Here incorporated by reference.
10(f) Branch Purchase and Assumption Agreement. Previously filed as an exhibit to *
registrant's Form 10-K for the year ended December 31, 1991. Here incorporated
by reference.
10(g) Executive Employment, Change of Control and Severance Agreements. Previously *
filed as an exhibit to registrant's Form 10-K for the year ended December 31, 1991.
Here incorporated by reference.
10(h) Branch Lease for Alma Supermarket Branch. Previously filed as an exhibit *
to the registrant's Form 10-K for the year ended December 31, 1995. Here incorporated
by reference.
10(i) Branch Lease for Midland Supermarket Branch. Previously filed as an *
exhibit to the registrant's Form 10-K for the year ended December 31, 1995. Here
incorporated by reference.
13 Incorporated Portions from 1996 Annual Report to Shareholders.
21 Subsidiary of Registrant. Previously filed as an exhibit to the registrant's Form *
S-4 filed January 22, 1988. Here incorporated by reference.
23 Consents of Independent Certified Public Accountants.
27 Financial Data Schedule.
</TABLE>
- ----------------
*This exhibit is filed by incorporation by reference to a prior filing.
21
<PAGE> 1
EXHIBIT 13
INCORPORATED PORTIONS FROM 1996 ANNUAL REPORT TO SHAREHOLDERS
<PAGE> 2
[CROWE CHIZEK LOGO]
REPORT OF INDEPENDENT AUDITORS
Board of Directors
Commercial National Financial Corporation
Ithaca, Michigan
We have audited the accompanying consolidated balance sheet of Commercial
National Financial Corporation as of December 31, 1996 and the related
consolidated statements of income, shareholders' equity and cash flows for the
year then ended. 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 audit. The consolidated financial statements
of Commercial National Financial Corporation as of and for the two years ended
December 31, 1995, were audited by other auditors whose report dated January
17, 1996, expressed an unqualified opinion on those statements.
We conducted our audit in accordance with generally accepted auditing
standards. 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 audit provides a reasonable basis
for our opinion.
In our opinion, the 1996 consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Commercial
National Financial Corporation as of December 31, 1996, and the results of its
operations and its cash flows for the year then ended in conformity with
generally accepted accounting principles.
Crowe, Chizek and Company LLP
Crowe, Chizek and Company LLP
South Bend, Indiana
January 10, 1997
14
<PAGE> 3
[BDO LETTERHEAD]
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders
Commercial National Financial Corporation
Ithaca, Michigan
We have audited the accompanying consolidated balance sheet of Commercial
National Financial Corporation and subsidiary as of December 31, 1995, and the
related consolidated statements of income, shareholders' equity and cash flows
for the years ended December 31, 1995 and 1994. These consolidated financial
statements are the responsibility of the Corporation's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the consolidated financial statements
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the consolidated
financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall consolidated 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 and subsidiary at December 31, 1995, and
results of their operations and their cash flows for the years ended December
31, 1995 and 1994, in conformity with generally accepted accounting principles.
BDO Seidman, LLP
Grand Rapids, Michigan
January 17, 1996
<PAGE> 4
COMMERCIAL NATIONAL FINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS
December 31, 1996 and 1995
<TABLE>
<CAPTION>
1996 1995
------------ ------------
<S> <C> <C>
ASSETS
Cash and due from banks $6,550,844 $5,725,357
Federal funds sold 6,600,000 2,850,000
------------ ------------
Total cash and cash equivalents 13,150,844 8,575,357
Securities held to maturity (fair value $25,484,000 - 1996;
$29,761,000 - 1995) 25,333,185 29,429,704
Federal Home Loan Bank stock, at cost 1,460,574 436,500
Loans, net of allowance for loan losses
$1,824,080 - 1996; $1,668,555 - 1995 120,501,244 107,610,521
Premises and equipment, net 4,047,374 3,327,967
Accrued interest and other assets 1,697,128 1,694,524
------------ ------------
Total assets $166,190,349 $151,074,573
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Deposits
Noninterest-bearing demand $17,110,034 $16,001,930
Interest-bearing demand 36,009,919 33,445,813
Savings 21,379,089 24,832,993
Time 58,517,780 55,420,543
------------ ------------
133,016,822 129,701,279
Securities sold under agreements to repurchase 5,602,246 5,305,435
U.S. Treasury demand notes 941,968 559,991
Accrued interest and other liabilities 1,133,650 865,180
Long-term borrowings 10,000,000 -
------------ ------------
Total liabilities 150,694,686 136,431,885
Shareholders' equity
Common stock, $1 par value: 1,750,000 shares
authorized; shares issued and outstanding 1996 - 872,982
and 1995 - 814,684 872,982 814,684
Additional paid-in capital 13,123,259 11,624,723
Retained earnings 1,499,422 2,203,281
------------ ------------
Total shareholders' equity 15,495,663 14,642,688
------------ ------------
Total liabilities and shareholders' equity $166,190,349 $151,074,573
============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE> 5
COMMERCIAL NATIONAL FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
Years ended December 31, 1996, 1995 and 1994
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Interest income
Loans, including fees $ 10,328,228 $ 9,612,355 $ 8,342,142
Taxable securities 956,006 1,131,274 1,250,848
Non-taxable securities 729,396 586,065 528,728
Federal funds sold and other 185,564 320,709 211,930
Federal Home Loan Bank stock dividends 56,982 - -
-------------- ------------ ------------
Total interest income 12,256,176 11,650,403 10,333,648
Interest expense
Deposits 4,665,374 4,464,310 3,819,551
Federal funds purchased and securities
sold under agreement to repurchase 298,549 278,230 -
Other borrowed funds 29,855 38,015 64,361
Long-term debt 283,428 - -
-------------- ------------ ------------
Total interest expense 5,277,206 4,780,555 3,883,912
-------------- ------------ ------------
NET INTEREST INCOME 6,978,970 6,869,848 6,449,736
Provision for loan losses 230,000 250,000 230,000
-------------- ------------ ------------
NET INTEREST INCOME AFTER PROVISION FOR
LOAN LOSSES 6,748,970 6,619,848 6,219,736
Noninterest income
Service charges on deposit accounts 291,903 212,759 302,688
Other 391,437 451,917 415,688
-------------- ------------ ------------
683,340 664,676 718,376
Noninterest expenses
Salaries and employee benefits 2,865,591 2,566,875 2,572,313
Occupancy 288,689 282,869 265,710
Furniture and equipment 597,391 400,633 333,689
FDIC insurance 125,619 149,509 290,777
Printing and supplies 341,825 220,543 165,415
Other 1,465,443 1,505,271 1,297,215
-------------- ------------ ------------
5,684,558 5,125,700 4,925,119
-------------- ------------ ------------
INCOME BEFORE INCOME TAXES 1,747,752 2,158,824 2,012,993
Income tax expense 316,000 491,000 481,000
-------------- ------------ ------------
NET INCOME $ 1,431,752 $ 1,667,824 $ 1,531,993
Per share information
Net income $ 1.65 $ 1.96 $ 1.85
============== ============ ============
Dividends $ 1.13 $ .97 $ .88
============== ============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE> 6
COMMERCIAL NATIONAL FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Years ended December 31, 1996, 1995 and 1994
<TABLE>
<CAPTION>
Additional
Common Paid-in Retained Securities
Stock Capital Earnings Valuation Total
-------- ----------- ----------- ---------- -----------
<S> <C> <C> <C> <C> <C>
BALANCE AT JANUARY 1, 1994 $704,011 $9,101,200 $2,435,254 $ 41,159 $12,281,624
Net income 1,531,993 1,531,993
Cash dividends, $.88 per share (726,406) (726,406)
Stock issued in payment of 5%
stock dividend 35,986 870,511 (909,976) (3,479)
Stock issued under dividend
reinvestment program 9,965 226,313 236,278
Stock issued under stock option
plans 10,985 171,131 182,116
Repurchase of 120 shares (120) (2,930) (3,050)
Change in securities valuation (41,159) (41,159)
-------- ----------- ----------- ---------- -----------
BALANCE AT DECEMBER 31, 1994 760,827 10,366,225 2,330,865 - 13,457,917
Net income 1,667,824 1,667,824
Cash dividends, $.97 per share (826,530) (826,530)
Stock issued in payment of 5%
stock dividend 38,623 926,970 (968,878) (3,285)
Stock issued under dividend
reinvestment program 11,612 264,183 275,795
Stock issued under stock option
plans 3,633 67,600 71,233
Repurchase of 11 shares (11) (255) (266)
-------- ----------- ----------- ---------- -----------
BALANCE AT DECEMBER 31, 1995 814,684 11,624,723 2,203,281 - 14,642,688
Net income 1,431,752 1,431,752
Cash dividends, $1.13 per share (978,958) (978,958)
Stock issued in payment of 5%
stock dividend 41,457 1,111,867 (1,156,653) (3,329)
Stock issued under dividend
reinvestment program 11,852 284,678 296,530
Stock issued under stock option
plans 4,995 102,149 107,144
Repurchase of 6 shares (6) (158) (164)
-------- ----------- ----------- ---------- -----------
BALANCE AT DECEMBER 31, 1996 $872,982 $13,123,259 $ 1,499,422 $ - $15,495,663
======== =========== =========== ========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE> 7
COMMERCIAL NATIONAL FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31, 1996, 1995 and 1994
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 1,431,752 $ 1,667,824 $ 1,531,993
Adjustments to reconcile net income to net
cash from operating activities
Provision for loan losses 230,000 250,000 230,000
Depreciation, amortization and accretion 579,699 481,748 739,405
Deferred federal income taxes (10,000) 8,000 (30,000)
Net change in accrued interest and
other assets (31,544) 696,158 133,092
Net change in accrued interest and
other liabilities 225,963 (112,865) 4,785
------------- ------------- -------------
Net cash from operating activities 2,425,870 2,990,865 2,609,275
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of held to maturity securities (6,433,248) (14,514,110) (19,068,224)
Proceeds from maturities of
held to maturity securities 10,430,000 14,260,000 15,625,000
Proceeds from maturities of
available for sale securities - - 3,000,000
Purchases of Federal Home Loan Bank
stock (1,024,074) (436,500) -
Net change in loans (13,120,723) (9,374,501) 1,799,433
Net purchases of premises and equipment (1,159,833) (1,094,207) (451,672)
------------- ------------ ------------
Net cash from investing activities (11,307,878) (11,159,318) 904,537
CASH FLOWS FROM FINANCING ACTIVITIES
Net change in deposits 3,315,543 4,611,153 (4,168,625)
Net change in other borrowed funds 678,788 2,487,262 1,609,017
Proceeds from long-term borrowings 10,000,000 - -
Proceeds from sale of common stock 403,674 347,028 418,394
Dividends paid and fractional shares (940,346) (800,068) (715,680)
Repurchased shares (164) (266) (3,050)
------------ ------------ ------------
Net cash from financing activities 13,457,495 6,645,109 (2,859,944)
------------ ------------ ------------
Net change in cash and cash equivalents 4,575,487 (1,523,344) 653,868
Cash and cash equivalents, at beginning of year 8,575,357 10,098,701 9,444,833
------------ ------------ ------------
CASH AND CASH EQUIVALENTS, AT END OF YEAR $ 13,150,844 $ 8,575,357 $ 10,098,701
============ ============ ============
Cash paid during the year for:
Interest $ 5,448,854 $ 4,683,824 $ 3,871,809
Federal income taxes, net of refunds 286,455 279,527 523,000
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE> 8
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
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), conform to generally accepted accounting principles 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 and the Bank. All significant intercompany
accounts and transactions have been eliminated in consolidation.
Nature of Operations and Concentrations of Credit Risk: The Corporation is a
one-bank holding company which conducts no direct business activities. All
business activities are performed by the Bank.
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 vehicles, including checking, savings, money
market, individual retirement accounts and certificates of deposit.
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, Montcalm and Midland Counties in Michigan.
Use of Estimates: To prepare financial statements in conformity with generally
accepted accounting principles, management makes estimates and assumptions
based on available information. These estimates and assumptions affect the
amounts reported in the financial statements and the disclosures provided.
Actual results could differ from these estimates.
Areas involving the use of management's estimates and assumptions include the
allowance for loan losses, fair values of certain securities and other
financial instruments, the determination and carrying value of impaired loans,
the carrying value of loans held for sale, the carrying value of other real
estate, the determination of other-than-temporary reductions in the fair value
of securities, recognition and measurement of loss contingencies, depreciation
of premises and equipment and the carrying value and amortization of
intangibles. Estimates that are more susceptible to change in the near term
include the fair value of financial instruments, and the allowance for loan
losses.
(Continued)
<PAGE> 9
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Cash Flow Reporting: Cash and cash equivalents are defined as cash and due from
banks and federal funds sold. Net cash flows are reported for customer loan
and deposit transactions and short-term borrowings with a maturity of 90 days
or less.
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 unrealized holding gains and losses reported separately in
shareholders' equity, net of tax. Securities are classified as trading when
held for short term periods in anticipation of market gains, and are carried at
fair value. Securities are written down to fair value when a decline in fair
value is not temporary.
Gains and losses on sales are determined using the specific identification
method. Interest and dividend income, adjusted by amortization of purchase
premiums and discounts, is included in earnings.
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 are reported at the principal balance outstanding, net of
deferred loan fees and costs, the allowance for loan losses, and charge-offs.
Interest income is reported on the interest method and includes amortization of
net deferred loan fees and costs over the loan term.
Interest income is not reported when full loan repayment is in doubt, typically
when payments are past due over 90 days, unless the loan is both well secured
and in the process of collection. Payments received on such loans are reported
as principal reductions.
Allowance for Loan Losses: Because some loans may not be repaid in full, an
allowance for loan losses is recorded. Increases to the allowance are recorded
by a provision for loan losses charged to expense. Estimating the risk of loss
and the amount of loss on any loan is necessarily subjective. Accordingly, the
allowance is maintained by management at a level considered adequate to cover
losses that are currently anticipated based on past loss experience, general
economic conditions, information about specific borrower situations including
their financial position and collateral values, and other factors and estimates
which are subject to change over time. While management may periodically
allocate portions of the allowance for specific problem loan situations, the
whole allowance is available for any loan charge-offs that occur. A problem
loan is charged-off by management as a loss when deemed uncollectible, although
collection efforts continue and future recoveries may occur.
(Continued)
<PAGE> 10
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Effective January 1, 1995, the Corporation adopted Statement of Financial
Accounting Standards (SFAS) No. 114, "Accounting by Creditors for Impairment of
a Loan," as amended by SFAS No. 118, "Accounting by Creditors for Impairment of
a Loan - Income Recognition and Disclosures."
Under SFAS No. 114 and No. 118, a loan is considered to be impaired when it is
probable that the Corporation will be unable to collect all principal and
interest amounts according to the contractual terms of the loan agreement.
Impaired loans are carried at the present value of expected cash flows
discounted at the loan's effective interest rate or at the fair value of the
collateral if the loan is collateral dependent. A portion of the allowance for
loan losses may be allocated to impaired loans. The effect of adopting these
standards was included in the provision for loan losses for 1995, and was not
considered material.
Smaller balance homogeneous loans are evaluated for impairment in total. Such
loans include residential first mortgage loans secured by one-to-four family
residences, residential construction loans, and automobile, home equity and
second mortgage loans. Commercial loans and mortgage loans secured by other
properties are evaluated individually for impairment. When analysis of
borrower operating results and financial condition indicates that underlying
cash flows of the borrower's business are not adequate to meet its debt service
requirements, the loan is evaluated for impairment. Loans are generally moved
to nonaccrual status when 90 days or more past due. These loans are often
considered impaired. Impaired loans, or portions thereof, are charged-off when
deemed uncollectible. The nature of disclosures for impaired loans is
considered generally comparable to prior nonaccrual and renegotiated loans and
non-performing and past-due asset disclosures.
Servicing Rights: Effective January 1, 1996, the Corporation adopted SFAS No.
122, "Accounting for Mortgage Servicing Rights." Prior to adopting SFAS No.
122, servicing right assets were recorded only for purchased rights to service
mortgage loans. Subsequent to adopting this standard, servicing rights
represent both purchased rights and the allocated value of servicing rights
retained on loans sold. Servicing rights are expensed in proportion to, and
over the period of, estimated net servicing revenues. Impairment is evaluated
based on the fair value of the rights, using groupings of the underlying loans
as to interest rates and then, secondarily, as to geographic and prepayment
characteristics. Any impairment of a grouping is reported as a valuation
allowance. The effect of adopting this standard was not material to the
consolidated financial statements.
Excess servicing receivable is reported when a loan sale results in servicing
in excess of normal amounts and is expensed over the life of the servicing on
the interest method.
Premises and Equipment: Asset cost is reported net of accumulated
depreciation. Depreciation expense is calculated on the straight-line method
over asset useful lives. These assets are reviewed for impairment under SFAS
No. 121 when events indicate the carrying amount may not be recoverable.
(Continued)
<PAGE> 11
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Other Real Estate: Real estate acquired in settlement of loans is initially
reported at estimated fair value at acquisition. When the real estate is
acquired, any excess of the related loan balance over the estimated fair value
is charged to the allowance for loan losses. 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.
Goodwill and Identified Intangibles: Goodwill is the excess of purchase price
over identified net assets in business acquisitions. Goodwill is expensed on
the straight-line method over no more than 25 years. Identified intangibles
represent the value of depositor relationships purchased and is expensed on
accelerated methods over 10 years. Goodwill and identified intangibles are
assessed for impairment based on estimated undiscounted cash flows, and written
down if necessary.
Employee Benefits: A benefit plan with 401(k) features cover substantially all
employees. The plan allows participant compensation deferrals, with up to 6%
of such deferrals matched at 100%. Expense of this defined contribution plan
is based on the annual matching contributions and an additional 1%
discretionary contribution.
Expense for employee compensation under stock option plans is based on APB
Opinion 25, with expense reported only if options are granted below market
price at grant date. Proforma disclosures of net income and earnings per share
are provided as if the fair value method of SFAS No. 123 were used for
stock-based compensation.
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.
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. Fractional shares are paid in cash for all stock
dividends.
(Continued)
<PAGE> 12
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
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.
Earnings and Dividends Per Share: Earnings per share of common stock is based
on weighted-average outstanding shares during the year plus dilutive common
stock equivalents using the average stock price. Common equivalent shares are
shares which may be issuable to employees upon exercise of outstanding stock
options. Diluted earnings per share is calculated assuming any conversions
occurred at the start of the year and uses ending market price, if more
dilutive. The number of shares used to calculate net income per share has been
adjusted for all stock dividends and was 866,811, 848,434 and 827,060 for 1996,
1995 and 1994, respectively.
Cash dividends per share are based on the number of shares outstanding at date
of declaration, retroactively adjusted for stock dividends.
Reclassifications: Some items in prior financial statements have been
reclassified to conform with the current presentation.
NOTE 2 - SECURITIES
Year end securities were as follows:
<TABLE>
<CAPTION>
Held to Maturity
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------- ---------- ---------- -----------
1996
- -------------------------------
<S> <C> <C> <C> <C>
U.S. Treasury securities $6,997,191 $9,452 $(5,643) $7,001,000
U.S. Government agency 4,175,955 9,471 (4,426) 4,181,000
State and municipal 14,160,039 254,530 (112,569) 14,302,000
----------- ---------- ---------- -----------
$25,333,185 $273,453 $(122,638) $25,484,000
=========== ========== ========== ===========
</TABLE>
(Continued)
<PAGE> 13
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
NOTE 2 - SECURITIES (Continued)
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------- ---------- ---------- -----------
1995
- -------------------------------
<S> <C> <C> <C> <C>
U.S. Treasury $9,518,339 $73,866 $(205) $9,592,000
U.S. Government agency 6,288,087 46,913 - 6,335,000
States and municipal 13,623,278 331,107 (120,385) 13,834,000
----------- ---------- ---------- -----------
$29,429,704 $451,886 $(120,590) $29,761,000
=========== ========== ========== ===========
</TABLE>
Contractual maturities of debt securities at year end 1996 were as follows.
Expected maturities may differ from contractual maturity because borrowers may
have the right to call or prepay obligations with or without call or prepayment
penalties.
<TABLE>
<CAPTION>
Held to Maturity Securities
------------------------------
Estimated
Amortized Fair
Cost Value
-------------- --------------
<S> <C> <C>
Due in one year or less $9,392,026 $9,411,130
Due from one to five years 7,899,971 7,946,456
Due from five to ten years 7,651,520 7,723,492
Due after ten years 389,668 402,922
-------------- --------------
$25,333,185 $25,484,000
============== ==============
</TABLE>
There were no sales of securities during 1996, 1995 and 1994.
Securities with par value of approximately $8,340,000 and $9,820,000 at year
end 1996 and 1995 were pledged to secure public deposits and for other
purposes, as required by law. In addition, $7,500,000 and $8,000,000 of
securities were pledged against repurchase agreements at year end 1996 and
1995.
Except as indicated below, total securities of any state (including all its
political subdivisions) were less than 10% of shareholders' equity. At year
end 1996 and 1995, the amortized cost of investment securities issued by the
state of Michigan and all its political subdivisions totaled $10,315,598 and
$9,726,408 with an estimated market value of $10,316,000 and $9,834,000.
(Continued)
<PAGE> 14
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
NOTE 3 - LOANS
Year end loans were as follows:
<TABLE>
<CAPTION>
1996 1995
--------------- ---------------
<S> <C> <C>
Real estate
Secured by single family residential properties $ 33,255,859 $ 30,288,224
Secured by nonfarm nonresidential properties 40,514,036 36,490,195
Secured by farmland 3,919,705 3,005,249
Secured by multi-family residential properties 7,568,156 4,352,142
Construction and land development 3,840,276 2,072,386
Consumer
Installment loans 18,169,809 12,998,384
Credit card and related plans 889,544 715,133
Commercial 14,167,939 19,357,363
--------------- ---------------
122,325,324 109,279,076
Allowance for loan losses (1,824,080) (1,668,555)
--------------- ---------------
$ 120,501,244 $ 107,610,521
=============== ===============
</TABLE>
Certain directors and executive officers of the Corporation, including
associates of such persons, were loan customers of the Corporation during 1996
and 1995. A summary of aggregate related party loan activity for loans
aggregating $60,000 or more to any related party is as follows:
<TABLE>
<CAPTION>
1996 1995
-------------- --------------
<S> <C> <C>
Balance at beginning of year $ 3,806,000 $ 3,737,000
New loans 9,189,000 11,542,000
Repayments (8,882,000) (11,473,000)
Other changes, net (115,000) -
-------------- --------------
Balance at end of year $ 3,998,000 $ 3,806,000
============== ==============
</TABLE>
Other changes include adjustments for persons included in one reporting period
that are not reported in the other reporting period.
(Continued)
<PAGE> 15
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
NOTE 4 - ALLOWANCE FOR LOAN LOSSES
Activity in the allowance for loan losses was as follows:
<TABLE>
<CAPTION>
1996 1995 1994
------------ ------------ ------------
<S> <C> <C> <C>
Beginning balance $ 1,668,555 $ 1,509,800 $ 1,370,154
Loans charged-off (175,051) (188,567) (220,667)
Recoveries of previous charge-offs 100,576 97,322 130,313
Provision charged to operations 230,000 250,000 230,000
------------ ------------ ------------
Ending balance $ 1,824,080 $ 1,668,555 $ 1,509,800
============ ============ ============
Impaired loans were as follows:
1996 1995
------------ ------------
Year end loans with no allowance for loan losses allocated $ 23,252 $ 134,969
Year end loans with allowance for loan losses allocated 53,379 169,643
------------ ------------
Total impaired loans $ 76,631 $ 304,612
============ ============
Amount of the allowance allocated $ 36,606 $ 60,907
============ ============
Average balance of impaired loans during the year $ 163,405 $ 295,491
============ ============
Interest income recognized during impairment $ 8,544 $ 12,905
============ ============
Cash-basis interest income recognized $ 26,592 $ 19,202
============ ============
</TABLE>
At year end 1996 and 1995 nonaccrual loans were $-0- and $178,000.
NOTE 5 - LOAN SERVICING
Mortgage loans serviced for others are not reported as assets. These loans
totalled $27,533,000 and $27,493,000 at year end 1996 and 1995. Related escrow
deposit balances were approximately $9,500 and $70,800 at year end 1996 and
1995.
(Continued)
<PAGE> 16
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
NOTE 6 - PREMISES AND EQUIPMENT
Year end premises and equipment were as follows:
<TABLE>
<CAPTION>
1996 1995
----------- ------------
<S> <C> <C>
Land $ 310,689 $ 310,689
Buildings and improvements 2,504,057 2,491,413
Furniture and equipment 4,614,840 3,612,465
------------ ------------
Total cost 7,429,586 6,414,567
Less accumulated depreciation (3,382,212) (3,086,600)
------------ ------------
$ 4,047,374 $ 3,327,967
============ ============
</TABLE>
Depreciation expense amounted to $431,784, $281,339 and $226,384 in 1996, 1995
and 1994, respectively.
NOTE 7 - DEPOSITS
The maturity of all certificates of deposits for the next five years is as
follows:
<TABLE>
<S> <C>
1997 $ 40,361,141
1998 10,101,716
1999 4,482,439
2000 1,333,045
2001 1,399,596
Thereafter 839,843
--------------
$ 58,517,780
==============
</TABLE>
Time deposit accounts individually exceeding $100,000 total $14,578,000 and
$10,527,000 at year end 1996 and 1995.
Related party deposits totaled $1,046,000 and $721,000 at year end 1996 and
1995.
(Continued)
<PAGE> 17
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
NOTE 8 - BORROWINGS
Federal funds purchased, securities sold under agreements to repurchase, and
treasury tax and loan deposits are financing arrangements. Physical control
is maintained for all securities sold under repurchase agreements. Information
concerning securities sold under agreements to repurchase is summarized as
follows:
<TABLE>
<CAPTION>
1996 1995
------------- -------------
<S> <C> <C>
Average daily balance during the year $ 5,818,000 $ 4,913,000
Average interest rate during the year 5.05% 5.66%
Maximum month-end balance during the year $ 7,801,000 $ 7,511,000
</TABLE>
Long-term borrowings at year end were:
<TABLE>
<CAPTION>
1996
------------
<S> <C>
Variable rate advances from Federal Home Loan Bank $ 3,000,000
Fixed rate advances from Federal Home Loan Bank 7,000,000
------------
$ 10,000,000
============
</TABLE>
Fixed interest rates on advances range from 4.97% to 6.66% for borrowings
outstanding at December 31, 1996. Advances with variable rates are based on
the 3-month LIBOR rate less 3 basis points. Pursuant to collateral agreements
with the Federal Home Loan Bank, advances are secured under a blanket lien
arrangement by mortgage loans with a carrying value of approximately
$26,172,000 at December 31, 1996. There were no long-term borrowings at year
end 1995.
At year end 1996, scheduled principal reductions on long-term borrowings were:
<TABLE>
<S> <C>
1997 $ 4,000,000
1998 3,000,000
1999 3,000,000
------------
$ 10,000,000
============
</TABLE>
NOTE 9 - EMPLOYEE BENEFITS
401(k) Plan: The Corporation maintains a 401(k) salary reduction plan under
which participants may make deferrals up to 15% of compensation. The annual
expense of the plan is based on fixed contributions of 1% and discretionary
matching contributions of 100% of the elective deferrals on the first 6% of the
participants compensation. Employee contributions are vested immediately and
the Corporation's matching contributions are vested after six years. The plan
covers substantially all employees of the Corporation. Contributions and
related expense attributable to the plan was approximately $92,000, $94,000 and
$98,000 in 1996, 1995 and 1994.
(Continued)
<PAGE> 18
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
NOTE 9 - EMPLOYEE BENEFITS (Continued)
Stock Option Plans: SFAS No. 123, which became effective for 1996, requires
proforma disclosures for companies that do not adopt its fair value accounting
method for stock-based employee compensation. Accordingly, the following
proforma information presents net income and earnings per share had the fair
value method been used to measure compensation cost for stock option plans.
The exercise price of options granted is equivalent to the market value of
underlying stock at the grant date. Accordingly, compensation cost actually
recognized for stock options was $0 for 1996, 1995 and 1994.
The fair value of options granted during 1996 and 1995 is estimated using the
following weighted-average information: risk-free interest rate of 6.15% and
6.00%, expected life of 4.3 years, expected dividends of 4.0% and 4.2% per year
and nominal expected stock price volatility.
<TABLE>
<CAPTION>
1996 1995
----- -----
<S> <C> <C>
Net income as reported $1,431,752 $1,667,824
Proforma net income 1,420,533 1,663,403
Earnings per share as reported $ 1.65 $ 1.96
Proforma primary earnings per share $ 1.64 $ 1.96
</TABLE>
In future years, the proforma effect of not applying this standard is expected
to increase as additional options are granted.
Stock option plans are used to reward employees and provide them with an
additional equity interest. Options are issued for 2 and 7 year periods, with
100% vesting occurring six months after grant date. At year end 1996, 17,354
shares were authorized for future grants. Information about option grants
follows.
<TABLE>
<CAPTION>
Number Weighted-average
of options exercise price
---------- ------------------
<S> <C> <C>
Outstanding, beginning of 1994 25,184 $15.34
Granted 7,107 21.58
Exercised (12,580) 14.30
Forfeited (4,628) 17.81
----------
Outstanding, end of 1994 15,083 18.65
Granted 11,584 22.67
Exercised (3,952) 18.01
Forfeited (8) 17.55
----------
Outstanding, end of 1995 22,707 20.81
Granted 11,251 26.67
Exercised (5,245) 20.43
Forfeited (218) 22.67
----------
Outstanding, end of 1996 28,495 23.18
==========
</TABLE>
(Continued)
<PAGE> 19
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
NOTE 9 - EMPLOYEE BENEFITS (Continued)
The weighted-average fair value of options granted in 1996 and 1995 was $2.02
and $3.89. At year end 1996, options outstanding had a weighted-average
remaining life of 4.30 years and a range of exercise price from $15.47 to
$26.67.
Options exerciseable at year end are as follows.
<TABLE>
<CAPTION>
Number Weighted-average
of options exercise price
---------- -----------------
<S> <C> <C>
1994 11,610 $15.78
1995 11,155 $18.91
1996 14,004 $20.43
</TABLE>
NOTE 10 - FEDERAL INCOME TAXES
Income tax expense consists of:
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- -----
<S> <C> <C> <C>
Current $ 326,000 $ 483,000 $ 511,000
Deferred (10,000) 8,000 (30,000)
------------ ---------- -----------
$ 316,000 $ 491,000 $ 481,000
=========== ========== ===========
</TABLE>
Year end deferred tax assets and liabilities consist of:
<TABLE>
<CAPTION>
1996 1995
---- ----
<S> <C> <C>
Allowance for loan losses $ 244,000 $ 192,000
Accumulated depreciation (259,000) (166,000)
Alternative minimum tax 43,000 -
Other 2,000 (6,000)
------- ----------
$ 30,000 $ 20,000
=========== ==========
</TABLE>
(Continued)
<PAGE> 20
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
NOTE 10 - FEDERAL INCOME TAXES (Continued)
The effective tax rate differs from the statutory federal income tax rate as
follows:
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Statutory rates $ 594,000 $ 734,000 $ 684,000
Increase (decrease) from
Tax-exempt interest income (299,000) (262,000) (233,000)
Goodwill amortization 14,000 14,000 14,000
Other, net 7,000 5,000 16,000
---------- ---------- ----------
$ 316,000 $ 491,000 $ 481,000
=========== ========== ==========
</TABLE>
NOTE 11 - COMMITMENTS, OFF-BALANCE-SHEET RISK AND CONTINGENCIES
There are various contingent liabilities that are not reflected in the
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 financial condition or results of operations.
At year end 1996 and 1995, reserves of $1,009,000 and $991,000 were required as
deposits with the Federal Reserve or as cash on hand. These reserves do not
earn interest.
The Corporation leases certain branch facilities under lease agreements
expiring through 2013, with optional renewal periods through 2028. Two of the
leases are with a related party. Rental expense on these leases totaled
$32,134 and $21,474 in 1996 and 1995, including $16,320 in 1996 and $5,650 in
1995 paid to the related party. As of December 31, 1996 there were no
significant future rental commitments.
Some financial instruments are used in the normal course of business to meet
the financing needs of customers and to reduce exposure to interest rate
changes. These financial instruments include commitments to extend credit,
standby letters of credit and financial guarantees. These involve, to varying
degrees, credit and interest-rate risk in excess of the amount reported in the
financial statements.
Exposure to credit loss if the other party does not perform is represented by
the contractual amount for commitments to extend credit, standby letters of
credit, and financial guarantees written. The same credit policies are used
for commitments and conditional obligations as are used for loans. Collateral
or other security is normally not required to support financial instruments
with credit risk.
(Continued)
<PAGE> 21
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
NOTE 11 - COMMITMENTS, OFF-BALANCE-SHEET RISK AND CONTINGENCIES
(Continued)
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the commitment.
Commitments generally have fixed expiration dates or other termination clauses
and may require payment of a fee. Since many of the commitments are expected
to expire without being used, the total commitments does not necessarily
represent future cash requirements. Standby letters of credit and financial
guarantees written are conditional commitments to guarantee a customer's
performance to a third party.
A summary of the notional or contractual amounts of financial instruments with
off-balance-sheet risk at year end follows:
<TABLE>
<CAPTION>
1996 1995
----------- -----------
<S> <C> <C>
Commitments to extend credit $23,568,000 $16,641,000
Standby letters of credit 1,054,000 937,000
----------- -----------
$24,622,000 $17,578,000
=========== ===========
</TABLE>
NOTE 12 - FAIR VALUES OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate fair values for
financial instruments. The carrying amount is considered to estimate fair
value for cash and cash equivalents, FHLB stock, demand and savings deposits,
short-term borrowings, and variable rate loans or deposits that reprice
frequently and fully. Securities fair values are based on quoted market prices
or, if no quotes are available, on the rate and term of the security and on
information about the issuer. For fixed rate loans or deposits and for
variable rate loans or deposits with infrequent repricing or repricing limits,
the fair value is estimated by discounted cash flow analyses or underlying
collateral values, where applicable. The fair value of long-term borrowings is
based on currently available rates for similar financing. The fair value of
other financial instruments and off-balance-sheet items approximate cost and
are not considered significant to this presentation.
(Continued)
<PAGE> 22
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
NOTE 12 - FAIR VALUES OF FINANCIAL INSTRUMENTS (Continued)
The estimated year end fair values of financial instruments were (in
thousands):
<TABLE>
<CAPTION>
1 9 9 6 1 9 9 5
-------------------- --------------------
Carrying Fair Carrying Fair
Value Value Value Value
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
FINANCIAL ASSETS
Cash and cash equivalents $ 13,151 $ 13,151 $ 8,575 $ 8,575
Securities 25,333 25,484 29,430 29,761
FHLB stock 1,461 1,461 437 437
Loans, net of allowance 120,501 120,925 107,611 109,783
--------- -------- --------- ---------
$ 160,446 $ 161,021 $ 146,053 $ 148,556
========= ========= ========= =========
FINANCIAL LIABILITIES
Demand and savings deposits $ (74,499) $ (74,499) $ (74,281) $(74,281)
Time deposits (58,518) (59,316) (55,420) (55,930)
Securities sold under repurchase agreements (5,602) (5,602) (5,305) (5,305)
U.S. Treasury demand notes (942) (942) (560) (560)
Long-term borrowings (10,000) (9,943) - -
--------- --------- --------- ---------
$(149,561) $(150,302) $(135,566) $(136,076)
========= ========= ========= =========
</TABLE>
NOTE 13 - REGULATORY MATTERS
The Company and Bank are subject to regulatory capital requirements
administered by federal banking agencies. Capital adequacy guidelines and
prompt corrective action regulations involve quantitative 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, and 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, although 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 are limited, as is asset
growth and expansion, and plans for capital restoration are required. The
minimum requirements are:
<TABLE>
<CAPTION>
Capital to risk-
weighted assets
-------------------------------- Tier 1 capital
Total Tier 1 to average assets
----- ------ -----------------
<S> <C> <C> <C>
Well capitalized 10% 6% 5%
Adequately capitalized 8% 4% 4%
Undercapitalized 6% 3% 3%
</TABLE>
(Continued)
<PAGE> 23
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
NOTE 13 - REGULATORY MATTERS (Continued)
<TABLE>
<CAPTION>
Minimum Required
Minimum Required To Be Well Capitalized
For Capital Under Prompt Corrective
Actual Adequacy Purposes Action Regulations
--------------------- ------------------- -----------------------
Amount Ratio Amount Ratio Amount Ratio
------ ------- ------ ------- ------ -------
<S> <C> <C> <C> <C> <C> <C>
1996
Total capital (to risk weighted assets)
Consolidated $16.9 14.3% $9.5 8.0% $11.9 10.0%
Bank $15.6 13.2% $9.5 8.0% $11.9 10.0%
Tier 1 capital (to risk weighted assets)
Consolidated $15.4 13.0% $4.7 4.0% $7.1 6.0%
Bank $14.2 11.9% $4.7 4.0% $7.1 6.0%
Tier 1 capital (to average assets)
Consolidated $15.4 9.4% $6.6 4.0% $8.2 5.0%
Bank $14.2 8.7% $6.5 4.0% $8.1 5.0%
1995
Total capital (to risk weighted assets)
Consolidated $15.8 15.0% $8.4 8.0% $10.5 10.0%
Bank $15.2 14.3% $8.5 8.0% $10.6 10.0%
Tier 1 capital (to risk weighted assets)
Consolidated $14.5 13.8% $4.2 4.0% $6.3 6.0%
Bank $13.8 13.0% $4.2 4.0% $6.4 6.0%
Tier 1 capital (to average assets)
Consolidated $14.5 9.6% $6.1 4.0% $7.6 5.0%
Bank $13.8 9.4% $5.9 4.0% $7.3 5.0%
</TABLE>
The Corporation and Bank were categorized as well capitalized at year end 1996.
(Continued)
<PAGE> 24
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
NOTE 14 - PARENT COMPANY CONDENSED FINANCIAL STATEMENTS
The Corporation's primary source of funds to pay dividends to shareholders is
the dividends it receives from the Bank. The Bank is subject to certain
restrictions on the amount of dividends it may declare without prior regulatory
approval. Accordingly, in 1997, the Bank may distribute to the Corporation, in
addition to 1997 net profits, approximately $3,764,000 in dividends without
prior approval from regulatory agencies.
Following are condensed parent company financial statements.
CONDENSED BALANCE SHEETS
December 31, 1996 and 1995
<TABLE>
<CAPTION>
ASSETS 1996 1995
----------- -----------
<S> <C> <C>
Cash $ 1,067,629 $ 909,967
Investment in subsidiary 14,266,764 13,887,793
Other 423,164 64,881
----------- -----------
Total assets $15,757,557 $14,862,641
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Dividends payable $ 261,894 $ 219,953
Shareholders' equity 15,495,663 14,642,688
----------- -----------
Total liabilities and shareholders' equity $15,757,557 $14,862,641
=========== ===========
</TABLE>
(Continued)
<PAGE> 25
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
NOTE 14 - PARENT COMPANY CONDENSED FINANCIAL STATEMENTS (Continued)
CONDENSED STATEMENTS OF INCOME
Years ended December 31, 1996, 1995 and 1994
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Interest on securities $ 12,019 $ - $ -
Dividends from subsidiary 1,059,300 979,600 -
---------- ---------- ----------
Total income 1,071,319 979,600 -
Other expense 18,538 - -
---------- ---------- ----------
NET INCOME BEFORE EQUITY IN UNDISTRIBUTED NET
INCOME OF SUBSIDIARY 1,052,781 979,600 -
Equity in undistributed net income of
subsidiary 378,971 688,224 $ 1,531,993
---------- ---------- ----------
NET INCOME $1,431,752 $ 1,667,824 $ 1,531,993
========== ========== ==========
Net income per share $ 1.65 $ 1.96 $ 1.85
======== ======== =========
</TABLE>
CONDENSED STATEMENTS OF CASH FLOWS
Years ended December 31, 1996, 1995 and 1994
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $1,431,752 $ 1,667,824 $ 1,531,993
Adjustment:
Equity in undistributed net income of
subsidiary (378,971) (688,224) (1,531,993)
Change in other assets (358,283) - -
---------- --------- ----------
Net cash from operating activities 694,498 979,600 -
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from sale of common stock 403,674 347,028 418,394
Dividends paid and fractional shares (940,346) (800,068) (715,680)
Repurchased shares (164) (266) (3,050)
---------- --------- -----------
Net cash for financing activities (536,836) (453,306) (300,336)
---------- --------- -----------
Net increase (decrease) in cash 157,662 526,294 (300,336)
Cash at the beginning of year 909,967 383,673 684,009
---------- --------- ----------
CASH AND CASH EQUIVALENTS, AT END OF YEAR $1,067,629 $ 909,967 $ 383,673
========= ========= ==========
</TABLE>
<PAGE> 26
SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
1996 1995 1994 1993 1992
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
(In thousands except financial ratios and per share data)
FOR THE YEAR
Net interest income $6,979 $6,870 $6,450 $5,973 $5,762
Provision for loan losses 230 250 230 105 170
Noninterest income 683 665 718 836 730
Noninterest expense 5,685 5,126 4,925 4,860 4,622
Net income 1,432 1,668 1,532 1,415 1,303
AT YEAR END
Total assets 166,190 151,075 142,875 144,239 146,546
Net loans 120,501 107,611 98,525 100,637 97,440
Total deposits 133,017 129,701 125,090 129,259 127,689
Long-term borrowings 10,000 - - - -
Shareholders' equity 15,496 14,643 13,458 12,282 10,962
Average shares outstanding 866,811 848,434 827,060 807,763 784,280
FINANCIAL RATIOS
Return on average assets .92% 1.15% 1.07% 1.00% 1.01%
Return on average
shareholders' equity 9.19 11.73 11.76 12.58 12.37
Average equity capital to
average assets 9.76 9.79 9.12 7.93 8.19
Allowance for loan losses to
loans 1.49 1.53 1.51 1.34 1.27
Tier 1 leverage 8.72 9.43 9.24 8.43 7.18
Total risk-based capital 13.16 14.29 15.23 13.73 12.35
Dividend pay-out 68.37 49.56 47.41 47.20 47.18
PER SHARE DATA
Net income $1.65 $1.96 $1.85 $1.75 $1.66
Cash dividends 1.13 .97 .88 .88 .83
Book value, end of year 17.75 17.11 16.04 15.07 14.09
</TABLE>
See notes to consolidated financial statements.
All per share data adjusted to reflect stock dividends.
<PAGE> 27
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
This financial analysis should be read in conjunction with the consolidated
financial statements and accompanying notes.
INTRODUCTION
The information in this financial analysis explains certain significant
financial matters over the past several years. The financial information
included in this annual report frequently compares current amounts to
historical amounts. Financial information is presented on a consolidated basis
including the subsidiary, Commercial Bank (the Bank), and the parent company,
Commercial National Financial Corporation (Commercial National, also herein
referred to as the consolidated entity). All per share information has been
restated to reflect the 5% stock dividends in 1996, 1995 and 1994.
BUSINESS OF COMMERCIAL NATIONAL
Commercial National is a one-bank holding company which conducts no direct
business activities. All business activities are performed by the Bank.
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 vehicles, including checking, savings, money
market, individual retirement accounts and certificates of deposit.
The principal source of revenue for Commercial National and the Bank is
interest and fees on loans. The Bank's results of operations depend primarily
on the level of its net interest income and other operating income and
operating expenses. Net interest income depends upon the volume of
interest-earning assets and interest-bearing liabilities and the interest rate
earned or paid on them, respectively. The Bank's results of operations are also
significantly affected by general economic and competitive conditions,
particularly changes in market interest rates, and actions of regulatory
authorities. On a consolidated basis, interest and fees on loans accounted for
79.8% of Commercial National's total income (comprised of interest income and
other income) in 1996, 78.1% in 1995, and 75.5% in 1994. Interest on
securities accounted for 13.0% of Commercial National's total revenues in 1996,
13.9% in 1995, and 16.1% in 1994.
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. Commercial National and the Bank serve these markets
through nine offices located in and near these communities.
Commercial National and the Bank employ approximately 95 persons on a full-time
equivalent basis.
<PAGE> 28
FINANCIAL CONDITION
COMPARISON OF 1996 TO 1995
Total assets increased to $166.2 million as of December 31, 1996 from $151.1
million as of December 31, 1995, an increase of $15.1 million or 10.0%.
Shareholders' equity increased approximately $850,000 or 5.83% from $14.6
million at December 31, 1995 to $15.5 million at December 31, 1996. The
increase in shareholders' equity was the result of $1.4 million in earnings for
1996 and approximately $400,000 from issuance of additional shares of common
stock, less the impact of cash dividends paid on common shares of approximately
$979,000.
Total cash and cash equivalents increased from $8.6 million at December 31,
1995 to $13.2 million at December 31, 1996. Securities held to maturity
decreased from $29.4 million at December 31, 1995 to $25.3 million at December
31, 1996. The increases in cash and cash equivalents is primarily a result of
the decrease in securities, and increases in deposits and long-term debt.
Net loans increased $12.9 million, or 12.0% from $107.6 million at December 31,
1995 to $120.5 million at December 31, 1996. Real estate loans for single
family houses increased by $3.0 million due to the Bank holding a greater
number of these loans versus selling them into the secondary market. Real
estate loans secured by nonfarm nonresidential properties, farmland,
multi-family residential properties and construction and land development
increased by $9.9 million and commercial loans declined $5.2 million, primarily
as the result of a change in the Bank's customer base. Consumer loans
increased $5.3 primarily due to increased financing needs relating to improved
automobile sales.
Total deposits increased $3.3 million or 2.5% from $129.7 million at December
31, 1995 to $133.0 million at December 31, 1996. The increase in deposits was
primarily the result of an increase of $3.1 million in time deposits.
Management attributes growth in time deposits to customer preferences for
higher yielding instruments of deposit as opposed to the liquidity afforded
lower yielding transactional accounts. The Bank's pricing of time deposits is
consistent with that of its competitors. At December 31, 1996 the Bank had
$40.4 million in time deposits with terms of one year or less.
Long-term borrowings increased to $10.0 million as of December 31, 1996, as the
Bank obtained advances from the Federal Home Loan Bank of Indianapolis ("FHLB")
during 1996. The FHLB has designed various borrowing programs to assist
financial institutions in managing liquidity needs and interest rate risk.
These advances have both fixed and variable interest rates and stated
maturities ranging through 1999. These advances were used to fund loan demand
as deposit growth did not provide sufficient funds during 1996.
<PAGE> 29
RESULTS OF OPERATIONS
COMPARISON OF 1996 TO 1995
GENERAL. Commercial National reported net income of $ 1.4 million in 1996, a
decrease of $300,000 or 17.6%, over 1995 net income of $1.7 million. Return on
average shareholders' equity for 1996 was 9.19% compared to 11.73% for 1995.
The 1996 return on average assets was 0.92% compared to 1.15% for 1995.
NET INTEREST INCOME. Net interest income is the difference between interest
earned on interest-earning assets and interest paid on interest-bearing
liabilities. Changes in the mix and volume of assets and liabilities, and the
yields and rates earned or paid, have a major impact on earnings. The level of
net interest income achieved is also influenced by market rates of interest,
the financial strength of loan customers and the federal government's monetary
policies. Interest income represented 94.7% of total income in 1996 and 94.6%
in 1995.
For the year ended December 31, 1996, total interest income was $12.3 million,
an increase of $600,000 from $11.7 million for 1995. Total interest expense
increased $500,000 from $4.8 million in 1995 to $5.3 million in 1996. As a
result, net interest income increased $100,000 from $6.9 million in 1995 to
$7.0 million in 1996.
INTEREST INCOME. On a fully taxable-equivalent basis (whereby tax-exempt
income is adjusted to be comparable to income from taxable investments), total
interest income increased by $688,000 or 5.69% from 1996 and 1995. The
increase is primarily due to a $9.7 million or 7.02%, increase in average
outstanding interest-earning assets ($147.3 million for 1996 and $137.7 million
for 1995). This increase is partially offset by a .12% decrease in average
interest rates from 8.78% in 1995 to 8.67% in 1996. The average interest rate
for loans decreased from 9.37% in 1995 to 9.18% in 1996. The decrease in the
average interest rate for loans is a direct result of the decrease in the prime
rate charged by the Bank; the majority of the Bank's loan portfolio rates are
tied to the prime rate. The Bank's prime rate decreased in early 1996 to 8.25%
compared to 1995 levels of 8.50 - 9.00%. This rate decrease was offset by
average loan growth of $9.9 million or 9.46%, which primarily consisted of
growth in the single family residential, nonfarm nonresidential and
multi-family real estate and consumer loan portions of the portfolio. Average
interest rates for securities decreased from 7.20% in 1995 to 7.06% in 1996,
largely due to the purchase of lower-rate securities as higher rate securities
matured and were replaced. The effect of this rate decrease was partially
offset by the effect of slightly increased average outstanding balances
resulting in a nominal increase in interest income on securities of 2.1% from
1995 to 1996. The average balance outstanding for federal funds sold decreased
by 37.4% from $5.5 million in 1995 to $3.4 million in 1996. The average
interest rate also decreased from 5.72% in 1995 to 5.44% in 1996 as a result of
the decrease in rates paid for federal funds sold in 1996 over 1995. The Bank
purchased Federal Home Loan Bank stock in 1995 and 1996 and first received
dividends in 1996 at a rate of 7.87%.
<PAGE> 30
INTEREST EXPENSE. Increases in total interest expense are primarily
attributable to the increases in the average outstanding balances of
interest-bearing liabilities, partially offset by the marginally lower average
interest rates. Interest expense on deposits increased as a result of changes
in deposit mix and greater reliance on higher priced time deposits to fund loan
growth. The average outstanding balance of time certificates of deposits and
the year end balance of time certificates of deposits increased $3.4 million or
6.5%, and $3.1 million or 5.6% respectively. Additionally, the rates paid on
these deposits increased as well from 5.46% in 1995 to 5.63% in 1996. The
increase in time certificates of deposit corresponds to the general increase in
market rates in 1996 for these deposits as well as the Bank's higher-yielding
"Evergreen" certificate of deposit program. Consistent with other financial
institutions, the Bank was forced to increase the rates offered on the higher
balance deposit products as increased yields on other investment vehicles drew
customer funds away from the Bank. Interest rates paid on interest-bearing
demand deposits and savings accounts decreased from 2.77% in 1995 to 2.66% in
1996. Interest expense on securities sold under agreement to repurchase
increased slightly. The decrease in rates paid, from 5.66% in 1995 to 5.06% in
1996, was offset by a 20.3% increase in the average balance from $4.4 million
in 1995 to $5.9 million in 1996. Interest expense on long-term debt of
$283,000 was incurred during 1996 as a result of the Bank obtaining $10 million
in advances from the FHLB.
The Bank is unable to predict the impact on future earnings as a result of the
higher rates paid on time deposits due to uncertainties regarding economic
conditions in 1997 and beyond. While the Bank expects rates paid on
interest-bearing demand deposits, savings accounts and time certificates of
deposit issued in 1997 will fall, earnings could be negatively impacted if
interest rates on interest-earning assets fall significantly due to changes in
market interest rates. The Bank would be negatively impacted as a large
portion of its loan portfolio consists of adjustable rate loans which fluctuate
with changes in the prime rate.
As discussed in the Asset/Liability Management section of this financial
review, the Bank attempts to manage the structure (i.e., categories and
maturities) of the balance sheet to minimize the effects of interest rate
fluctuations. The Bank's net interest margin (net interest income divided by
total earning assets) decreased from 5.31% in 1995 to 5.09% in 1996 and the
interest spread (average rate earned minus average rate paid) decreased from
4.68% in 1995 to 4.47% in 1996. While it is difficult to predict 1997 interest
rates, it is anticipated that rates will remain stable through most of the
year.
PROVISION AND ALLOWANCE FOR LOAN LOSSES. The provision for loan losses
reflects management's judgment of the cost associated with the credit risk
inherent in the loan portfolio. The provision is determined through
management's assessment of the quality of the loan portfolio, current as well
as future economic factors, and the volume of loans outstanding. Provision
amounts from year-to-year are also affected by the level of net charge-offs and
management's perception of the adequacy of the allowance for loan losses. The
provision for loan losses for 1996 was $230,000, a decrease of $20,000 over the
1995 provision of $250,000. Net charge-offs decreased slightly in 1996 to
$74,000 from $91,000 in 1995. The lack of a significant change in net
charge-offs is a result of the seasoning of the Bank's portfolio. However, due
to the substantial loan growth in 1996, future charge-off activity could
increase.
<PAGE> 31
At December 31, 1996, the allowance for loan losses amounted to $1.8 million or
1.49% of total loans outstanding, compared to $1.7 million or 1.53% of total
loans at December 31, 1995. The allowance is maintained in consideration of
the perceived credit risk in the loan portfolio. Management's determination of
the adequacy of the allowance for loan losses is based upon a continuing review
of the loan portfolio which includes past loan loss experience, current
economic conditions, loan volume, composition of the loan portfolio and
additional factors. The $100,000 increase in the allowance for loan losses
from 1995 to 1996 (compared to a $200,000 increase from 1994 to 1995) is
primarily attributable to loan growth.
Non-accrual, past due and restructured loans decreased by $97,000 or 40.6%,
from $239,000 to $142,000 at December 31, 1995 and 1996, respectively.
Generally, the accrual of interest income on a loan is suspended when the loan
becomes 90 days past due, unless the loan is fully secured and is in the
process of collection. A restructured loan is generally one that is accruing
interest, but on which concessions in terms have been granted as a result of
deterioration in the financial condition of the borrower. Management believes
that the allowance for loan losses is adequate at December 31, 1996 based upon
its analysis of loss potential. The Bank's policy is to maintain an allowance
sufficient to cover expected losses based on its analysis of the loan portfolio
and at a reasonable level considering historical net charge-offs for the Bank.
However, the Bank does expect the level of net charge-offs to increase in the
future as a result of planned loan growth and changes in the loan mix within
the portfolio.
At December 31, 1996 the Bank has no significant concentrations of loans to any
group of borrowers engaged in similar activities that would be impacted by
economic or other conditions.
NONINTEREST INCOME. Noninterest income primarily consists of fees for services
and products. Income related to service charges on deposit accounts consists
of fees for demand deposit accounts, overdraft and non-sufficient fund charges,
and automatic teller machine transactions. Total income from service charges
on deposit accounts was $292,000 for 1996 compared to $213,000 for 1995. The
increase from 1995 is primarily due to an increase in the Bank's per item
overdraft fee.
The remaining category of noninterest income is derived from services that
include fees for mortgage servicing and processing, mortgage fee income from
new and refinanced loans sold, safe deposit box rentals, travelers check sales
and other miscellaneous categories. Other income was $391,000 for 1996, a
$61,000 or a 13.5% decrease from the 1995 level of $452,000. The net decrease
was primarily comprised of $40,000 of interest received in 1995 upon the
amendment of prior year tax returns, and a $20,000 decrease in student loan fee
income. Beginning in 1996, student loans are primarily originated directly by
the borrower with colleges and universities.
Due to the variety of income sources included in noninterest income,
fluctuations in the level of income will occur from year to year. No other
individual component of this category is significant during 1995 or 1996.
<PAGE> 32
NONINTEREST EXPENSE. Noninterest expense increased $600,000 or 11.8% from $5.1
million in 1995 to $5.7 million in 1996. Four primary factors resulted in this
increase. First, salary and employee benefits increased $300,000 or 11.5% when
comparing 1996 to 1995. The increase is attributable to salaries associated
with a full year of operations for the supermarket branch which opened in 1995
and the opening of the Midland branch in January 1996. Second, expenses
associated with furniture and equipment increased $197,000 or 49.13% in 1996
primarily due to upgrades in technology. PC networks were installed in all
branches to automate the deposit and loan processes and imaging equipment was
purchased to further automate check processing. In 1997 additional equipment
will be purchased to begin offering home banking services for the Bank
customers. Third, printing and supplies expense increase $121,000 or 54.8% due
to additional costs associated with the new technology processes and the
opening of the Midland branch. Fourth, a decline in Federal Deposit Insurance
Corporation (FDIC) premium expense of $24,000 in 1996 helped to offset the
previous two increases discussed. This decline in FDIC premium expense was
incurred despite a $77,000 one-time assessment in 1996 to recapitalize the
Savings Association Insurance Fund ("SAIF").
INCOME TAXES. The effective federal income tax rate for 1996 was 18.1% which
is comparable to the 22.7% effective rate for 1995. The $175,000 decrease in
federal income taxes for 1996 is attributable to decreased pre-tax earnings and
factors resulting in an alternative minimum tax position.
COMPARISON OF 1995 TO 1994
GENERAL. Commercial National reported net income of $1.7 million in 1995, an
increase of $136,000, or 8.9%, over 1994 net income of $1.5 million. Return on
average shareholders' equity for 1995 was 11.7% compared to 11.8% for 1994.
The 1995 return on average assets was 1.15% compared to 1.07% for 1994.
NET INTEREST INCOME. For the year ended December 31, 1995, total interest
income was $11.7 million, an increase of $1.4 million or 13.6% from $10.3
million for 1994. Total interest expense increased $897,000 from $3.9 million
in 1994 to $4.8 million in 1995. As a result, net interest income increased
$420,000 from $6.4 million in 1994 to $6.9 million in 1995.
INTEREST INCOME. On a fully taxable-equivalent basis, total interest income
increased by $1.4 million from 1995 to 1994. This increase was due to a $2.3
million increase in average outstanding earning assets ($137.7 million for 1995
and $135.4 million for 1994) and an increase in average interest rates (8.79%
for 1995 and $7.92% for 1994). The Bank's prime rate increased in early 1995
to 9%, but fell nominally in late 1995 to 8.5%. This rate increase was
supplemented by total loan growth of approximately $9.2, or 9.2%, which
primarily consisted of growth in the nonfarm nonresidential real estate and
commercial portions of the portfolio. Average interest rates for securities
increased from 6.37% in 1994 to 7.53% in 1995, largely due to the purchase of
higher-rate investments as lower rate investments matured and were replaced.
The effect of this rate increase was more than offset by the effect of reduced
average outstanding balances, resulting in a nominal decrease in interest
income on securities. The average balance outstanding for short-term
investments increased by 3.50% from $5.3 million in 1994 to $5.5 million in
1995. The average interest rate for short-term investments also increased from
4.02% in 1994 to 5.88% in 1995 as a result of the increase in rates paid for
federal funds sold in 1995 over 1994.
<PAGE> 33
INTEREST EXPENSE. Interest on deposits increased as a result of changes in
deposit mix and greater reliance on higher priced time deposits to fund loan
growth. The average outstanding balance of time certificates of deposits and
the year end balance of time certificates of deposits increased $4.9 million or
10.7%, and $8.2 million or 17.5%, respectively. Additionally, the rates paid
on these deposits increased as well from 4.52% in 1994 to 5.46% in 1995.
Interest rates paid on interest-bearing demand deposits and savings accounts
also increased from 2.54% in 1994 to 2.77% in 1995. Consistent with other
financial institutions, the Bank was forced to increase the rates offered on
deposit products as increased yields on other investment vehicles drew customer
funds away from the Bank.
PROVISION AND ALLOWANCE FOR LOAN LOSSES. The provision for loan losses for
1995 was $250,000, an increase of $20,000 over the 1994 provision of $230,000.
The Bank experienced net charge-offs of $91,000 in 1995 and net charge-offs
$90,000 in 1994, a change of $1,000. The lack of significant change in net
charge-off loans is a result of the seasoning of the Bank's portfolio.
At December 31, 1995, the allowance for loan losses amounted to $1.7 million or
1.53% of total loans outstanding, compared to $1.5 million or 1.51% of total
loans at December 31, 1994. While the level of non-accrual, past due and
restructured loans decreased from the prior year, the allowance for loan losses
was increased in 1995 to a level comparable to the Bank's peer group
considering historical net charge-offs for the Bank and the industry as a
whole.
NONINTEREST INCOME. Total income from service charges on deposit accounts was
$213,000 for 1995 compared to $303,000 for 1994. The decrease from 1994 is
primarily due to the reduction of the Bank's per item overdraft fee. Other
income was $452,000 for 1995, a $36,000 or 8.65%, increase from the 1994 level
of $416,000. The increase was primarily comprised of three items; $74,000 of
interest received upon amendment of prior year tax returns, a $28,000 increase
in merchant charge card fees due to the offering of debit card services to Bank
deposit customers, offset by a $61,000 decrease in income generated from the
sale of single family residential mortgages in the secondary market. This
decrease was expected as purchase and refinancing activity remained low due to
higher long-term interest rates.
No other individual component of this category was significant during 1995 or
1994.
NONINTEREST EXPENSE. Salaries and employee benefits, totaling $2.6 million for
1995, remained consistent with the 1994 amount, changing only slightly due to
employee changes at different salary levels.
The FDIC assessment decreased $141,000 during 1995 to $150,000 compared to
$291,000 in 1994. The decrease was due to the Bank Insurance Fund (BIF) of the
FDIC meeting the legally mandated reserve level in the second quarter of 1995
and the resultant decrease in deposit premiums from $.23 to $.04 per $100 of
deposits effective June 1, 1995. Of the total $141,000 assessment paid in
1995, $116,000 was paid into the BIF and $34,000 was paid into the SAIF.
<PAGE> 34
Furniture and equipment expense and printing and supplies increased in 1995
primarily due to the opening of one supermarket branch and preparation for the
opening of a second supermarket branch. Of the $208,000 increase in other
expenses for 1995 compared to 1994, $47,000 was incurred for increased
advertising and $43,000 related to the write-off of a receivable for the
reimbursement of costs incurred for environmental remediation on property
foreclosed on and disposed of in prior years. The remaining difference is
attributable to a number of items which are not individually significant.
INCOME TAXES. The effective federal income tax rate for 1995 was 22.7% which
is comparable to the 23.9% effective rate for 1994. The $10,000 increase in
federal income taxes for 1995 is attributable to increased pre-tax earnings
offset by increased tax-exempt interest income.
ASSET/LIABILITY MANAGEMENT
Asset/Liability management involves developing, implementing and monitoring
strategies to maintain sufficient liquidity, maximize net interest income and
minimize the impact significant fluctuations in market interest rates have on
earnings. The Asset/Liability Committee is responsible for managing this
process. Much of this committee's efforts are focused on minimizing Commercial
National's sensitivity to changes in interest rates. One method of gauging
sensitivity is by a static gap analysis. Commercial National's static gap
position at December 31, 1996 is shown in the following table:
REPRICEABLE OR MATURING WITHIN
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------
0-30 31-90 91-365 Over 1
(In thousands) days days days year Total
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
INTEREST-EARNING ASSETS:
Loans $ 43,461 $ 3,190 $ 17,644 $58,030 $122,325
Securities - 2,000 7,599 15,734 25,333
Federal Home Loan Bank Stock 1,461 - - - 1,461
Federal funds sold 6,600 - - - 6,600
--------- --------- --------- ------- --------
Total interest-earning assets 51,522 5,190 25,243 73,764 155,719
--------- --------- --------- ------- --------
INTEREST-BEARING LIABILITIES:
Demand deposits 36,010 - - - 36,010
Savings deposits 21,379 - - - 21,379
Time deposits 12,323 10,876 17,162 18,157 58,518
Securities sold under
agreement to repurchase 5,457 145 - - 5,602
U.S. Treasury demand notes 942 - - - 942
Long-term borrowings - 2,000 2,000 6,000 10,000
--------- --------- --------- ------- --------
Total interest-bearing liabilities 76,111 13,021 19,162 24,157 132,451
--------- --------- --------- ------- --------
Asset (liability) gap $ (24,589) $ (7,831) $ 6,081 $49,607 $ 23,268
========= ========= ========= ======= ========
Cumulative asset (liability) gap $ (24,589) $ (32,420) $ (26,339) $23,268
========= ========= ========= =======
</TABLE>
<PAGE> 35
As shown, Commercial National had a cumulative liability gap position of $26.3
million within the one-year time frame. This position suggests that if market
interest rates decline in the next 12 months, Commercial National has the
potential to earn more net interest income. A limitation of the traditional
static gap analysis, however, is that it does not consider the timing or
magnitude of noncontractual repricing. In addition, the static gap analysis
treats demand and savings accounts as repriceable within 30 days, while
experience suggests that these categories of deposits are actually
comparatively resistant to rate sensitivity. Although the static gap
sensitivity varies from time frame to time frame, management has the ability to
adjust rates on deposit accounts in an effort to achieve a neutral interest
sensitivity position within the intermediate term.
LIQUIDITY
Liquidity is generally defined as the ability to meet cash flow requirements.
Commercial National manages liquidity at two levels, the parent company and its
subsidiary, Commercial Bank. The parent company's primary cash requirement is
to pay dividends to Commercial National's shareholders. Its primary source of
funds is dividends received from its subsidiary bank.
Commercial Bank's primary liquidity consideration is to meet the cash flow
needs of its customers, such as borrowings and deposit withdrawals. To meet
cash flow requirements, sufficient sources of liquid funds must be available.
These sources include short-term investments; repayments and maturities of
loans and securities; sales of assets; growth in deposits and other
liabilities; and bank profits. At December 31, 1996, Commercial Bank had
approximately $6.6 million in federal funds sold. In addition, approximately
$9.4 million of securities were scheduled to mature within one year. Principal
reductions received on loans also provide a continual stream of cash flows.
Another source of liquid funds is net cash provided from operating activities,
which provided $2.4 million of cash in 1996. Finally, as a member of the
Federal Home Loan Bank of Indianapolis, Commercial Bank can access advances
under a borrowing agreement. At December 31, 1996, the Bank had $10 million of
borrowings with the FHLB.
CAPITAL RESOURCES
Management believes that a strong capital position is paramount to its
continued profitability and continued depositor and investor confidence. It
also enables Commercial National flexibility to take advantage of expansion
opportunities and to accommodate larger commercial loan customers. Regulators
have established "risk based" capital guidelines for banks and bank holding
companies. Under the guidelines, minimum capital levels are based on the
perceived risk in asset categories and certain off-balance-sheet items, such as
loan commitments and standby letters of credit. Management monitors its
capital levels to comply with regulatory requirements. Commercial Bank's
capital ratios were well in excess of regulatory standards for classification
as "well capitalized" and approximated the capital ratios of Commercial
National. Being considered "well capitalized" is one condition for assessing
the federal deposit insurance premium at the lowest available rate.
<PAGE> 36
IMPACT OF INFLATION
The consolidated financial statements and notes thereto presented herein have
been prepared in accordance with generally accepted accounting principles,
which require the measurement of financial position and operating results in
terms of historical dollars without considering the change in the relative
purchasing power of money over time due to inflation. The impact of inflation
is reflected in the increased cost of Commercial National's operations. Nearly
all the assets and liabilities of Commercial National are financial, unlike
most industrial companies. As a result, performance is directly impacted by
changes in interest rates, which are indirectly influenced by inflationary
expectations. Commercial National's ability to match the interest sensitivity
of its financial assets to the interest sensitivity of its financial
liabilities in its asset/liability management may tend to minimize the effect
of changes in interest rates on it's performance. Changes in interest rates do
not necessarily move to the same extent as do changes in the prices of goods
and services.
NEW ACCOUNTING PRONOUNCEMENTS
SFAS NO. 125, "ACCOUNTING FOR TRANSFERS AND SERVICING OF FINANCIAL ASSETS AND
EXTINGUISHMENTS OF LIABILITIES"
This statement provides authoritative guidance as to the accounting and
financial reporting for transfers and servicing of financial assets and
extinguishments of liabilities. Example transactions covered by SFAS No. 125
include asset securitizations, repurchase agreements, wash sales, loan
participations, transfers of loans with recourse and servicing of loans. The
Standard is based on a consistent application of a financial-components
approach that focuses on control. The Statement provides consistent criteria
for distinguishing transfers of financial assets that are sales from transfers
that are secured borrowings. The Statement also requires measuring instruments
that have a substantial prepayment risk at fair value, much like debt
instruments classified as available for sale or trading. While SFAS No. 125
supersedes SFAS No. 122, "Accounting for Mortgage Servicing Rights," it only
marginally modifies the accounting and disclosure requirements of SFAS No. 122.
SFAS No. 125, as amended by SFAS No. 127, is effective on a prospective basis
for some transactions in 1997 and others in 1998. This statement is not
anticipated to have a material effect on Commercial National's financial
position or results of operation in 1997.
<PAGE> 37
COMMON STOCK INFORMATION
There is no established public trading market for the Commercial National
Financial Corporation common stock, and there is no published information
concerning bid or ask quotations. There were, so far as the Corporation's
management knows, 44 sales involving a total of 27,200 shares of stock during
1996. The price was reported to management for only some of these
transactions, and management is generally unable to confirm the prices which
were reported. During 1996 and 1995 the price ranges of transactions reported
were:
1 9 9 6 1 9 9 5
---------------------- ----------------------
Shares Actual Price Shares Actual Price
Traded Range Traded Range
First Quarter 6,300 $24.29 - 26.19 5,000 $21.82 - 23.18
Second Quarter 4,600 25.71 - 29.52 700 22.27 - 23.18
Third Quarter 13,600 25.71 - 27.38 9,500 22.50 - 23.18
Fourth Quarter 2,700 26.00 - 28.00 4,200 23.33 - 24.76
The above prices have been adjusted for the 5% stock dividend issued in
November 1996 and 1995.
There were 872,982 shares outstanding on December 31, 1996, and there are
approximately 593 shareholders or record.
DIVIDEND INFORMATION
The holders of the Commercial National Financial Corporation common stock are
entitled to dividends when, and if declared by the Board of Directors of the
Corporation 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 seven years. The
following table sets for the dividends per share declared during 1996 and 1995.
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
1995 $.23 $.24 $.25 $.25
1996 .26 .29 .29 .29
Per share amounts have been adjusted retroactively to reflect the 5% stock
dividends issued in November of 1996 and 1995.
The Corporation's principal source of funds to pay cash dividends is the
earnings of the Bank. Consequently, cash dividends are dependent upon the
earnings, capital requirements, regularly constraints and other factors
affecting the Bank. Based on projected earnings, management expects the
Corporation to declare and pay regular quarterly cash dividends on its common
shares in 1997.
<PAGE> 1
EXHIBIT 23
CONSENTS OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
<PAGE> 2
CONSENT OF INDEPENDENT AUDITORS
We hereby consent to the incorporation by reference and use of our report dated
January 10, 1997, which appears in Commercial National Financial Corporation's
annual report on Form 10-K for 1996, in that corporation's previously filed
registration statements, as amended, for that corporation's 1989 Stock Option
Plan (Registration No. 33-30392), Dividend Reinvestment Plan (Registration No.
33-30239), and 1991 Stock Option Plan (Registration No. 33-39772 and 33-92666).
CROWE, CHIZEK AND COMPANY LLP
CROWE, CHIZEK AND COMPANY LLP
March 20, 1997
South Bend, Indiana
<PAGE> 3
[BDO LETTERHEAD]
EXHIBIT 23
CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Commercial National Financial Corporation
Ithaca, Michigan
We hereby consent to the incorporation by reference and use of our report dated
January 17, 1996, which appears in Commercial National Financial Corporation's
annual report on Form 10-K for 1996, in that corporation's previously filed
registration statements, as amended, for that corporation's 1989 Stock Option
Plan (Registration No. 33-30392), Dividend Reinvestment Plan (Registration No.
33-30239), and 1991 Stock Option Plan (Registration No. 33-39772 and 33-92666).
BDO Seidman, LLP
Grand Rapids, Michigan
March 26, 1997
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-END> DEC-31-1996
<CASH> 6,551
<INT-BEARING-DEPOSITS> 115,907
<FED-FUNDS-SOLD> 6,600
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 1,461
<INVESTMENTS-CARRYING> 25,333
<INVESTMENTS-MARKET> 25,484
<LOANS> 122,325
<ALLOWANCE> 1,824
<TOTAL-ASSETS> 166,190
<DEPOSITS> 133,017
<SHORT-TERM> 6,544
<LIABILITIES-OTHER> 1,134
<LONG-TERM> 10,000
0
0
<COMMON> 873
<OTHER-SE> 0
<TOTAL-LIABILITIES-AND-EQUITY> 166,190
<INTEREST-LOAN> 10,328
<INTEREST-INVEST> 1,871
<INTEREST-OTHER> 57
<INTEREST-TOTAL> 12,256
<INTEREST-DEPOSIT> 4,665
<INTEREST-EXPENSE> 612
<INTEREST-INCOME-NET> 6,979
<LOAN-LOSSES> 230
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 5,685
<INCOME-PRETAX> 1,748
<INCOME-PRE-EXTRAORDINARY> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,432
<EPS-PRIMARY> 1.65
<EPS-DILUTED> 1.65
<YIELD-ACTUAL> 8.79
<LOANS-NON> 0
<LOANS-PAST> 82
<LOANS-TROUBLED> 60
<LOANS-PROBLEM> 142
<ALLOWANCE-OPEN> 1,669
<CHARGE-OFFS> 175
<RECOVERIES> 100
<ALLOWANCE-CLOSE> 1,824
<ALLOWANCE-DOMESTIC> 1,198
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 626
</TABLE>
