<PAGE> 1
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
X Quarterly Report Pursuant to Section 13
--- or 15(d) of the Securities and Exchange
Act of 1934
For the quarterly period ended September 30, 1998, or
Transition Report Pursuant to Section 13 or 15(d) of the
--- Securities Exchange Act of 1934
For the Transition Period from to
-------- ---------
Commission File No. 0-17000
COMMERCIAL NATIONAL FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
Michigan 38-2799780
(State of Incorporation) (IRS Employer Identification No.)
101 North Pine River Street, Ithaca, Michigan 48847
(address of principal executive offices) (ZIP Code)
Registrant's telephone number, including area code: (517) 875-4144
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO
------------ --------------
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding at October 21, 1998
----- -------------------------------
Common Stock 956,305
No Par Value
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<PAGE> 2
COMMERCIAL NATIONAL FINANCIAL CORPORATION
INDEX
<TABLE>
<CAPTION>
PART I FINANCIAL INFORMATION
- ------ ---------------------
<S> <C> <C>
Item 1. Financial Statements
Consolidated Balance Sheets as of September 30, 1998 and December 31, 1997 (Page 3)
Consolidated Statements of Income for the three and nine months ended September 30, (Page 4)
1998 and September 30, 1997
Consolidated Statements of Shareholders' Equity for the periods ended September 30, (Page 5)
1998 and December 31, 1997
Consolidated Statements of Cash Flows for the nine months ended September 30, 1998 and (Page 6)
September 30, 1997
Notes to Consolidated Financial Statements (Page 7-8)
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (Page 9-15)
PART II OTHER INFORMATION
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Item 6. Exhibits and Reports on Form 8-K
a) Exhibit 27-Financial Data Schedule (Page 18)
b) Reports on Form 8-K (Page 16)
SIGNATURES (Page 17)
</TABLE>
2
<PAGE> 3
COMMERCIAL NATIONAL FINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS
September 30, 1998 (Unaudited) and December 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
---- ----
(Unaudited)
<S> <C> <C>
ASSETS
Cash and due from banks $ 6,405,971 $ 5,576,724
Federal funds sold 2,100,000 9,600,000
----------------- -----------------
Total cash and cash equivalents 8,505,971 15,176,724
Securities available for sale 17,167,659 8,436,349
Securities held to maturity (fair value $13,985,372 -
September 30, 1998; $20,847,000 - December 31, 1997) 13,462,228 20,383,446
Federal Home Loan Bank stock, at cost 1,391,300 1,391,300
Loans receivable, net of allowance for loan losses
$2,268,017 - September 30, 1998; $2,063,668 - December 31, 1997 127,320,094 122,457,789
Premises and equipment, net 2,815,544 3,188,743
Accrued interest receivable and other assets 1,894,477 1,370,472
----------------- -----------------
Total assets $ 172,557,273 $ 172,404,823
================= =================
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Deposits
Noninterest-bearing demand $ 16,325,092 $ 17,102,386
Interest-bearing demand 41,588,944 37,233,745
Savings 20,585,001 20,365,980
Time 56,839,519 59,244,780
----------------- -----------------
Total deposits 135,338,556 133,946,891
Securities sold under agreements to repurchase 6,606,234 4,151,844
U.S. Treasury demand notes 417,145 2,753,486
Federal Home Loan Bank advances 11,000,000 13,000,000
Accrued expenses and other liabilities 1,600,006 1,669,460
----------------- -----------------
Total liabilities 154,961,941 155,521,681
Shareholders' equity
Common stock, no par value: 1,750,000 shares
authorized; shares issued and outstanding
September 30, 1998 -952,046 and December 31,
1997 - 954,322 954,322
Additional paid-in capital 16,021,283 15,277,539
Retained earnings 1,426,150 647,697
Net unrealized gain on securities available
for sale, net of tax 147,899 3,584
----------------- -----------------
Total shareholders' equity 17,595,332 16,883,142
----------------- -----------------
Total liabilities and shareholders' equity $ 172,557,273 $ 172,404,823
================= =================
</TABLE>
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See accompanying notes to consolidated financial statements.
3
<PAGE> 4
COMMERCIAL NATIONAL FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
Periods ended September 30, 1998 and 1997 (Unaudited)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
For Three Months For Nine Months
Ended September 30, Ended September 30,
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Interest and dividend income
Loans receivable, including fees $ 2,857,483 $ 2,876,543 $ 8,450,111 $ 8,380,672
Taxable securities 222,723 167,470 704,528 497,675
Nontaxable securities 187,861 178,212 553,245 553,368
Federal funds sold 103,019 26,670 304,937 180,983
Federal Home Loan Bank stock dividends 28,159 27,913 83,354 77,044
----------- ----------- ----------- -----------
Total interest and dividend income 3,399,245 3,276,808 10,096,175 9,689,742
Interest expense
Deposits 1,203,211 1,156,891 3,635,537 3,459,933
Securities sold under agreements
to repurchase 80,779 73,251 225,188 245,050
Federal Home Loan Bank advances 190,915 186,070 612,551 478,190
Other 6,556 6,743 18,445 20,878
----------- ----------- ----------- -----------
Total interest expense 1,481,461 1,422,955 4,491,721 4,204,051
NET INTEREST INCOME 1,917,784 1,853,853 5,604,454 5,485,691
Provision for loan losses 90,000 90,000 270,000 305,000
----------- ----------- ----------- -----------
NET INTEREST INCOME AFTER PROVISION FOR
LOAN LOSSES 1,827,784 1,763,853 5,334,454 5,180,691
Noninterest income
Service charges and fees 123,773 125,127 359,297 314,433
Net gain on loan sales 88,232 28,342 289,154 212,133
Other 107,389 202,617 363,170 250,448
----------- ----------- ----------- -----------
Total noninterest income 319,394 356,086 1,011,621 777,014
Noninterest expense
Salaries and employee benefits 647,730 604,440 1,931,420 1,974,125
Occupancy and equipment 243,912 226,298 766,723 713,884
FDIC insurance 5,676 5,153 16,758 15,459
Printing, postage and supplies 63,522 75,048 176,566 245,665
Professional and outside services 62,571 54,448 197,973 164,726
Branch closing cost - - 546,614
Other 241,234 306,125 745,524 914,837
----------- ----------- ----------- -----------
Total noninterest expense 1,264,645 1,271,512 3,834,964 4,575,310
----------- ----------- ----------- -----------
INCOME BEFORE INCOME TAX EXPENSE 882,533 848,427 2,511,111 1,382,395
Income tax expense 238,000 226,195 652,000 291,669
----------- ----------- ----------- -----------
NET INCOME $ 644,533 $ 622,232 $ 1,859,111 $ 1,090,726
=========== =========== =========== ===========
Per share information
Basic earnings $ 0.67 $ 0.67 $ 1.94 $ 1.17
Diluted earnings $ 0.67 $ 0.67 $ 1.92 $ 1.17
Dividends declared $ 0.40 $ 0.29 $ 1.12 $ 0.91
</TABLE>
- --------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
4
<PAGE> 5
COMMERCIAL NATIONAL FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Periods ended September 30, 1998 (Unaudited) and December 31, 1997
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<TABLE>
<CAPTION>
Accumulated
Additional Other Total
Common Paid-in Retained Comprehensive Shareholders'
Stock Capital Earnings Income Equity
----- ------- -------- ------ ------
<S> <C> <C> <C> <C> <C>
BALANCE AT JANUARY 1, 1997 $ 872,982 $ 13,123,259 $ 1,499,422 $ 15,495,663
Net income 1,692,110 1,692,110
Other comprehensive income, net of tax:
Net change in unrealized gain on
securities available for sale $ 3,584 3,584
------------
Comprehensive income 1,695,694
------------
Cash dividends declared,
$1.24 per share (1,171,442) (1,171,442)
Stock issued in payment of 5%
stock dividend 45,246 1,323,423 (1,372,393) (3,724)
Stock issued under dividend
reinvestment program 14,839 375,900 390,739
Stock issued under stock option
plans 21,255 454,957 476,212
------------ ------------ ------------ ------------ ------------
BALANCE AT DECEMBER 31, 1997 954,322 15,277,539 647,697 3,584 16,883,142
Net income 1,859,111 1,859,111
Other comprehensive income, net of tax:
Net change in unrealized gain on
securities available for sale 144,315 144,315
------------
Comprehensive income 2,003,426
------------
Transfer to additional paid in capital (963,846) 963,846
Cash dividends declared,
$1.12 per share (1,080,658) (1,080,658)
Stock Buy Back (682,336) (682,336)
Stock issued under dividend
reinvestment program 8,555 385,901 394,456
Stock issued under stock option
plans 969 76,333 77,302
------------ ------------ ------------ ------------ ------------
BALANCE AT SEPTEMBER 30, 1998 $ -- $ 16,021,283 $ 1,426,150 $ 147,899 $ 17,595,332
============ ============ ============ ============ ============
</TABLE>
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See accompanying notes to consolidated financial statements.
5
<PAGE> 6
COMMERCIAL NATIONAL FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Periods ended September 30, 1998 and 1997 (Unaudited)
_______________________________________________________________________________
<TABLE>
<CAPTION>
For Nine Months Ended
September 30,
1998 1997
---- ----
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 1,859,111 $ 1,090,726
Adjustments to reconcile net income to net
cash from operating activities
Provision for loan losses 270,000 305,000
Net gains on loan sales (298,140) (86,221)
Originations of loans held for sale (11,752,081) (6,367,393)
Proceeds from sales of loans held for sale 12,740,720 6,431,114
Depreciation, amortization and accretion 509,767 356,498
Write-off of assets associated with branch closing -- 486,612
Net change in accrued interest receivable
and other assets (438,742) 27,482
Net change in accrued expenses and
other liabilities (69,453) 46,447
------------ ------------
Net cash from operating activities 2,821,182 2,290,265
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of securities available for sale (15,548,422) (2,994,844)
Proceeds from maturities of securities
available for sale 7,000,000 --
Proceeds from maturities of
securities held to maturity 6,945,000 6,710,000
Purchases of securities held to maturity -- (2,626,478)
Net change in loans (6,032,858) (6,198,895)
Purchases of premises and equipment, net (74,133) (149,433)
------------ ------------
Net cash from investing activities (7,710,413) (5,259,650)
CASH FLOWS FROM FINANCING ACTIVITIES
Net change in deposits 1,391,665 (6,522,704)
Net change in securities sold
under agreements to repurchase 2,454,390 (1,928,731)
Net change in U.S. Treasury demand notes (2,336,341) 349,987
Proceeds from Federal Home Loan Bank
advances -- 7,000,000
Repayment of Federal Home Loan Bank
advances (2,000,000) (4,000,000)
Stock Buy Back (682,336)
Dividends paid and fractional shares (1,080,658) (763,946)
Proceeds from sale of common stock 471,758 729,602
------------ ------------
Net cash from financing activities (1,781,522) (5,135,792)
------------ ------------
Net change in cash and cash equivalents (6,670,753) (8,105,177)
Cash and cash equivalents, at beginning of year 15,176,724 13,150,844
------------ ------------
CASH AND CASH EQUIVALENTS, AT END OF PERIOD $ 8,505,971 $ 5,045,667
============ ============
Cash paid during the period for
Interest $ 4,568,371 $ 4,361,307
Federal income taxes $ 740,372 $ 283,251
</TABLE>
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See accompanying notes to consolidated financial statements.
6
<PAGE> 7
Notes to Consolidated Financial Statements (Unaudited)
Note 1-Summary of Significant Accounting Policies
Basic Presentation
The accompanying unaudited condensed consolidated financial statements were
prepared in accordance with Rule 10-01 of regulation S-X and the instructions
for Form 10-Q and, therefore, do not include all disclosures required by
generally accepted accounting principles for complete presentation of financial
statements. In the opinion of management, the condensed consolidated financial
statements contain all adjustments (consisting of normal recurring accruals)
necessary to present fairly the financial condition of Commercial National
Financial Corporation as of September 30, 1998 and December 31, 1997, and the
results of its operations for the three and nine months ending September 30,
1998 and September 30, 1997. The results for the three and nine months ended
September 30, 1998 are not necessarily indicative of the results expected for
the full year.
Principals of Consolidation
The accompanying consolidated financial statements include the accounts of
Commercial National Financial Corporation (CNFC) and its wholly owned
subsidiary, Commercial Bank (Bank). All material intercompany accounts and
transactions have been eliminated in consolidation.
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, and future results could
differ. The allowance for loan losses and fair values of securities and other
financial instruments are particularly subject to change.
Cash Flow Reporting
Cash and cash equivalents include cash on hand, demand deposits with other
financial institutions and federal funds sold. Cash flows are reported net for
customer loan and deposit transactions, securities sold under agreements to
repurchase with original maturity of 90 days or less and U.S. Treasury demand
notes.
Securities
Securities are classified as held to maturity and carried at amortized cost when
management has the positive intent and ability to hold them to maturity.
Securities are classified as available for sale when they might be sold before
maturity. Securities available for sale are carried at fair value, with net
unrealized holding gains and losses reported separately in shareholders' equity,
net of tax. Trading securities are bought principally for sale in the near term,
and are reported at fair value with unrealized gains and losses included in
earnings. Securities are written down to fair value when a decline in fair value
is not temporary. CNFC did not classify securities for trading at any time
during 1998 or 1997.
Gains and losses on sales are determined using the amortized cost of the
specific security sold. Interest and dividend income, adjusted by amortization
of purchase premiums and discounts, is included in earnings.
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.
7
<PAGE> 8
Earnings and Dividends Per Share
Basic and diluted earnings per common share are computed under a new accounting
standard, SFAS No. 128, effective beginning with the quarter ended December 31,
1997. All prior earnings per common share amounts have been restated to be
comparable. Basic earnings per common share is based on net income divided by
the weighted average number of common shares outstanding during the period.
Diluted earnings per common share shows the diluted effect of any additional
potential common shares. Earnings and dividends per common share are restated
for all stock splits and stock dividends. The average number of shares used to
calculate basic earnings per share for the periods ending September 30, 1998 and
September 30, 1997 were 960,740 and 932,365 respectively. The average number of
shares used to calculate diluted earnings per share for the periods ending
September 30, 1998 and September 30, 1997 were 965,786 and 934,315 respectively.
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.
Comprehensive Income
Under a new accounting standard, comprehensive income is now reported for all
periods. Comprehensive income includes both net income and other comprehensive
income. Other comprehensive income includes the change in unrealized gains and
losses on securities for sale, foreign currency translation adjustments, and
additional minimum pension liability.
Reclassifications
Some items in the prior year financial statements have been reclassified to
conform with the current year presentation.
8
<PAGE> 9
ITEM 2: MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
FINANCIAL CONDITION
Total assets for the quarter ending September 30, 1998 increased slightly to
$172,557,000 from the $172,405,000 at the quarter ending December 31, 1997.
Total loans were $129,588,000 as of September 30, 1998. This is a $5,067,000 or
4.1% increase from December 31, 1997 balance of $124,521,000. The increase was
primarily a result of demand for business and home mortgage loans.
Investment securities totaled $30,630,000 at September 30, 1998, compared to
$28,820,000 at December 31, 1997. The current flat Treasury yield curve, and
relatively low interest rates have reduced the desirability of investments. All
security purchases are classified as available for sale.
Deposits increased 1.0% during the period. Total deposits at September 30, 1998
were $135,339,000 compared to $133,947,000 at December 31, 1997. Federal Home
Loan Bank (FHLB) advances decreased to $11,000,000 from $13,000,000 at December
31, 1997.
The board of directors authorized management to repurchase a maximum of 50,000
shares of CNFC stock. At September 30, 1998, management had negotiated in
private transactions or purchased on the open market 17,736 shares at a cost of
$682,336.
LIQUIDITY
Management defines liquidity as the ability to fund appropriate levels of credit
worthy loans, meet the immediate cash withdrawal requirements of depositors, and
maintain access to sufficient resources to meet unexpected contingencies at a
reasonable cost and or with minimum losses.
While modest loan growth continues, the Bank's deposit base has not increased at
the same rate. The loan to deposit ratio based on ending balances was 95.7% at
September 30, 1998 compared to 93.0% at December 31, 1997. Management is
confident that the combination of available FHLB advances, Federal funds lines
of credit, the available for sale investment portfolio, and our ability to sell
mortgage loans and the government guaranteed portion of commercial loans
provides adequate short and medium term sources of liquidity. At a minimum the
Bank has the following available to meet short term liquidity needs: $2,100,000
in Fed funds sold, $8,000,000 in available FHLB advances and $6,000,000 in short
term lines of credit with correspondent banks.
CNFC also needs cash to pay dividends to its shareholders. The primary source of
cash is the dividends paid to CNFC by the Bank. Management believes that cash
from operations is sufficient to supply the cash needed to continue paying a
reasonable dividend.
ASSET QUALITY AND THE ALLOWANCE FOR LOAN LOSS
The allowance for loan losses was 1.75% of total loans at September 30, 1998
compared to 1.66% at December 31, 1997. Loans past due greater than 30 days
totaled $968,000 or .7% of total loans. Loan quality remains at acceptable
levels compared to long term historical trends.
Net year to date charge-offs totaled $65,000 compared to $137,000 for the nine
months ending September 30, 1997. During the quarter the Bank expensed a
provision of $90,000 to the allowance compared to $90,000 during the same period
in 1997. Management continues to systematically evaluate the adequacy of the
allowance such that the balance is commensurate with the performance of the loan
portfolio, general market conditions and other relevant factors.
9
<PAGE> 10
CAPITAL RESOURCES
CNFC's capital ratios continue to exceed regulatory guidelines for a "well
capitalized" institution. A summary of CNFC's capital ratios follows:
<TABLE>
<CAPTION>
September 30, December 31, September December 31, Minimum Required to be Well
1998 1997 30, 1997 1996 Capitalized Under Prompt
Corrective Action Regulations
<S> <C> <C> <C> <C> <C>
Total capital to risk
weighted assets 14.8% 14.7% 14.8% 14.3% 10.0%
==== ==== ==== ==== ====
Tier 1 capital to
risk weighted assets 13.5% 13.5% 13.6% 13.0% 6.0%
==== ==== ==== ==== ====
Tier 1 capital to
average assets 10.1% 10.3% 10.2% 9.4% 5.0%
==== ==== ==== ==== ====
</TABLE>
RESULTS OF OPERATIONS
Net income for the quarter ended September 30, 1998 was $645,000, an increase of
$23,000 compared to the same period in 1997. The third quarter of 1998 benefited
from strong mortgage loan activity including new home purchases and refinancing
resulting in $88,000 in gains on loan sales. Year to date net income totaled
$1,859,000 compared to $1,091,000 for the same period of 1997.
Return on average shareholders' equity for the three months ended September 30,
1998 and 1997 was 14.46% and 15.14% respectively. Return on average assets for
the three months ending September 30, 1998 and 1997 was 1.48% and 1.52%
respectively. Year to date return on average equity was 14.06% and 9.05% for
1998 and 1997 respectively. Year to date return on average assets was 1.43% and
.89% for 1998 and 1997 respectively.
Net Interest Income
The following table illustrates the effect that changes in rates and volumes of
interest-earning assets and interest-bearing liabilities had on net interest
income for the three and nine months ending September 30, 1998 and 1997.
<TABLE>
<CAPTION>
Three Months Ending Nine Months Ending
September 30, September 30,
1998 1997 1998 1997
<S> <C> <C> <C> <C>
Interest Income (tax equivalent) $ 3,511,000 $ 3,387,000 $ 10,436,000 $ 10,032,000
Interest Expense 1,481,000 1,423,000 4,492,000 4,204,000
------------ ------------ ------------ ------------
Net Interest Income $ 2,030,000 $ 1,964,000 $ 5,944,000 $ 5,828,000
============ ============ ============ ============
Average Volume
Interest-earning Assets $164,881,000 $154,742,000 $165,084,000 $154,849,000
Interest-bearing Liabilities 137,916,000 130,440,000 138,991,000 131,436,000
------------ ------------ ------------ ------------
Net differential $ 26,965,000 $ 24,302,000 $ 26,093,000 $ 23,413,000
============ ============ ============ ============
Average Yields/Rates
Yield on Earning Assets 8.45% 8.68% 8.45% 8.66%
Rate Paid on Liabilities 4.26% 4.33% 4.32% 4.28%
------------ ------------ ------------ ------------
Interest Spread 4.19% 4.35% 4.13% 4.38%
============ ============ ============ ============
Net Interest Margin 4.88% 5.03% 4.81% 5.03%
============ ============ ============ ============
</TABLE>
10
<PAGE> 11
The change in net interest income is attributable to the following:
<TABLE>
<CAPTION>
Three Months Ending September 30, 1998 Nine Months Ending September 30, 1998
Volume Rate Inc/(Dec) Volume Rate Inc/(Dec)
<S> <C> <C> <C> <C> <C> <C>
Interest Earning
Assets $ 165,000 $ (40,000) $ 125,000 $ 526,000 $(122,000) $ 404,000
Interest Bearing
Liabilities 89,000 (30,000) 59,000 303,000 (15,000) 288,000
--------- --------- --------- --------- --------- ---------
Net Interest
Income $ 76,000 $ (10,000) $ 66,000 $ 223,000 $(107,000) $ 116,000
========= ========= ========= ========= ========= =========
</TABLE>
The increase in net interest income is due to an increase in earning assets. Net
interest margin for the three months ending September 30, 1998 decreased to
4.88% compared to 5.03% for the three months ending September 30, 1997. Several
factors have lead to the decrease in margin. A drop in long term interest rates
has resulted in a general trend to refinancing of home mortgage loans at lower
rates, the drop in interest rates has also made it difficult to replace maturing
investments and business loans with assets earning comparable yields. Market
pressures have made it more difficult to reduce deposit rates quickly enough to
offset the decrease in yield on earning assets. In the short term, the Bank's
earning assets are more sensitive to shifts in interest rates than are the
interest bearing liabilities. The same trend occurred for the nine months ending
September 30 1998 and 1997.
Non-interest Income
Non-interest income for the three months ending September 30, 1998 was $319,000.
This represents a $37,000 or 10.4% decrease over the same period in 1997. Year
to date 1998 non interest income was $1,012,000 compared to $777,000 during the
same period in 1997.
The low interest rates during 1998 have resulted in a significant increase in
mortgage loan refinances. A majority of the 15 and 30 year fixed rates loans
originated were sold to the secondary market. This resulted in a significant
increase in gains on mortgage loan sales. Also, the Bank's receivable factoring
program has performed well.
Non-interest Expense
Non-interest expense for the three months ending September 30, 1998 totaled
$1,265,000. This represents a $7,000 decrease over the same period in 1997.
Year to date non-interest expense totaled $ 3,835,000 compared to $4,575,000 for
the same period in 1997. Comparing the September 30, 1998 year to date results
with September 30, 1997 year to date results adjusted for the $547,000
non-recurring charge, non interest expense decreased $194,000 or 4.8%.
In general, overhead expenses were lower due to management's continued emphasis
on controlling expenses. CNFC's ratio of non-interest expense to average assets
for the quarter ending September 30, 1998 decreased to 2.94 % from 3.11% for the
quarter ending September 30, 1997.
Salary and benefit expense for the three months ending September 30, 1998
totaled $648,000 compared to $604,000 an increase of $14,000 or 7.2%. At
September 30, 1997, the Bank had several unfilled positions. The increase is
largely attributable to filling the vacant positions. The increase also reflects
normal base salary increases, and a general increase in the cost of medical
insurance and other benefit plans. Management continues to focus on the optimal
use of our employees and associated control of overhead costs.
Occupancy and equipment expense for the three months ending September 30, 1998
increased $18,000 or 8.0% compared to same period of 1997. Increased
depreciation expense related to changes in the estimated useful life of various
technology related assets is the primary cause for this increase.
11
<PAGE> 12
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Commercial's primary market risk exposure is interest rate risk and, to a lesser
extent, liquidity risk. All of the Corporation's transactions are denominated in
U.S. dollars with no specific foreign exchange exposure. The Corporation has a
limited exposure to commodity prices related to agricultural loans. Any impacts
that changes in foreign exchange rate and commodity prices would have on
interest rates are assumed to be insignificant.
Interest rate risk ("IRR") is the exposure of a banking organization's financial
condition to adverse movements in interest rates. Accepting this risk can be an
important source of profitability and stockholder value, however, excessive
levels of IRR could pose a significant threat to the Corporation's earnings and
capital base. Accordingly, effective risk management that maintains IRR at
prudent levels is essential to the Corporation's safety and soundness.
Evaluating a financial institution's exposure to changes in interest rates
includes assessing both the adequacy of the management process used to control
IRR and the organization's quantitative level of exposure. When assessing the
IRR management process, the Corporation seeks to ensure that appropriate
policies, procedures, management information systems and internal controls are
in place to maintain IRR at prudent levels with consistency and continuity.
Evaluating the quantitative level of IRR exposure requires the Corporation to
assess the existing and potential future effects of changes in interest rates on
its consolidated financial condition, including capital adequacy, earnings,
liquidity, and, where appropriate, asset quality.
The Federal Reserve Board, together with the Office of the Comptroller of the
Currency and the Federal Deposit Insurance Corporation, adopted a Joint Agency
Policy Statement on IRR effective June 26, 1996. The policy statement provides
guidance to examiners and bankers on sound practices for managing IRR, which
will form the basis for ongoing evaluation of the adequacy of IRR management at
supervised institutions. The policy statement also outlines fundamental elements
of sound management that have been identified in prior Federal Reserve guidance
and discusses the importance of these elements in the context of managing IRR.
Specifically, the guidance emphasizes the need for active board of directors and
senior management oversight and a comprehensive risk management process that
effectively identifies, measures, and controls IRR.
Financial institutions derive their income primarily from the excess of interest
collected over interest paid. The rates of interest an institution earns on its
assets and owes on its liabilities generally are established contractually for a
period of time. Since market interest rates change over time, an institution is
exposed to lower profit margins (or losses) if it cannot adapt to interest rate
changes. For example, assume that an institution's assets carry intermediate -or
long term fixed rates and that those assets are funded with short-term
liabilities. If market interest rates rise by the time the short-term
liabilities must be refinanced, the increase in the institution's interest
expense on its liabilities may not be sufficiently offset if assets continue to
earn at the long-term fixed rates. Accordingly, an institution's profits could
decrease on existing assets because the institution will either have lower net
interest income or, possibly, net interest expense. Similar risks exist when
assets are subject to contractual interest rate ceilings, or rate sensitive
assets are funded by longer-term, fixed-rate liabilities in a decreasing rate
environment.
Various techniques might be used by an institution to minimize IRR. One approach
used by the Corporation is to periodically analyze its assets and liabilities
and make future financing and investment decisions based on payment streams,
interest rates, contractual maturities, and estimated sensitivity to actual or
potential changes in market interest rates. Such activities fall under the broad
definition of asset/liability management. The Corporation's primary
asset/liability management technique is the measurement of its asset/liability
gap. That is, the difference between the cash flow amounts of interest-sensitive
assets and liabilities that will be refinanced or repriced during a given
period. For example, if the asset amount to be priced exceeds the corresponding
liability amount for a certain day, month, year, or longer period, the
institution is in an asset-sensitive gap position. In this situation, net
interest income would increase if market interest rates rose or decrease if
market interest rates fell. If, alternatively,
12
<PAGE> 13
more liabilities than assets will reprice, the institution is in a
liability-sensitive position. Accordingly, net income would decline when rates
rose and increase when rates fell. Also, these examples assume that interest
rate changes for assets and liabilities are of the same magnitude, whereas
actual rate changes generally differ in magnitude for assets and liabilities.
Several ways an institution can manage IRR include: selling existing assets or
repaying certain liabilities; matching repricing periods for new assets and
liabilities for example, by shortening terms of new loans or investments; and
hedging existing assets, liabilities, or anticipated transactions. An
institution might also invest in more complex financial instruments intended to
hedge or otherwise change IRR. Interest rate swaps, futures contracts, options
on futures, and other such derivative financial instruments often are used for
this purpose. Because these instruments are sensitive to interest rate changes,
they require management expertise to be effective. The Corporation has not
purchased derivative financial instruments in the past and does not presently
intend to purchase such instruments.
Financial institutions are also subject to prepayment risk in falling rate
environments. For example, mortgage loans and other financial assets may be
prepaid by a debtor so that the debtor may refund its obligations at new, lower
rates. Prepayments of assets carrying higher rates reduce the Corporation's
interest income and overall asset yields. Certain portions of an institution's
liabilities may be short-term or due on demand, while most of its assets may be
invested in long-term loans or investments. Accordingly, the Corporation seeks
to have in place sources of cash to meet short-term demands. These funds can be
obtained by increasing deposits, borrowing, or selling assets. Also, Federal
Home Loan Bank advances and short-term borrowings provide additional sources of
liquidity for the Corporation.
The following table provides information about the Corporation's financial
instruments that are sensitive to changes in interest rates as of September 30,
1998. The Corporation had no derivative financial instruments, or trading
portfolio, as of that date. The expected maturity date values for loans
receivable, mortgage-backed securities, and investment securities were
calculated without adjusting the instrument's contractual maturity date for
expectations of prepayments. Expected maturity date values for interest-bearing
core deposits were not based upon estimates of the period over which the
deposits would be outstanding, but rather the opportunity for repricing.
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Principal/Notional Amount Maturing in:
<TABLE>
<CAPTION>
1998 1999 2000 2001 2002 Thereafter Total Fair Value
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Rate Sensitive Assets
Fixed interest rate loans $2,370 $7,020 $10,502 $14,926 $9,180 $29,006 $73,004 $75,225
Average interest rate 10.31% 9.69% 9.45% 8.65% 8.64% 7.96% 8.63%
Variable interest rate loans 5,735 13,474 3,019 4,415 5,106 24,835 56,584 56,584
Average interest rate 10.02% 9.68% 9.67% 9.58% 9.42% 8.46% 9.15%
Fixed interest rate securities 1,265 5,080 5,445 4,985 3,760 9,680 30,215 31,153
Average interest rate 8.88% 6.50% 6.38% 6.12% 6.29% 7.00% 6.65%
FHLB stock 1,391 1,391 1,391
Average interest rate 8.03% 8.03%
Federal funds sold 2,100 2,100 2,100
Average interest rate 5.72% 5.72%
Rate Sensitive Liabilities:
Non-interest bearing demand 16,325 16,325 16,325
Interest bearing demand 41,589 41,589 41,589
Average interest rate 2.72% 2.72%
Savings 20,585 20,585 20,585
Average interest rate 2.18% 2.18%
Time deposits 15,337 28,497 7,235 2,757 1,599 1,414 56,840 57,096
Average interest rate 4.98% 4.86% 5.10% 5.20% 4.74% 5.09% 4.94%
Repurchase agreements 6,606 6,606 6,606
Average interest rate 5.03% 5.03%
U.S. Treasury demand notes 417 417 417
Average interest rate 5.52% 5.52%
Fixed rate FHLB advances 1,000 3,000 4,000 1,000 2,000 11,000 10,715
Average interest rate 5.88% 6.11% 6.40% 6.50% 5.52% 6.07%
</TABLE>
YEAR 2000 ISSUES
CNFC is aware of the issues associated with the programming code in existing
computer systems as the year 2000 approaches. The "Year 2000" will affect
virtually every computer operation in some way by the rollover of the two digit
value used to represent the year to 00. The issue is whether computer software
will properly recognize the date-sensitive information when the year changes to
2000. Systems that do not properly recognize such information could generate
erroneous data or cause a system failure.
CNFC recognizes the need to ensure its operation will not be adversely impacted
by Year 2000 software failures. CNFC has established a process for evaluating
and managing risks associated with this issue. This process includes the
formation of a Technology Committee comprised of management and independent
members of the board of directors to ensure that progress is made in identifying
non-compliant systems and developing appropriate responses to correct the
deficiencies.
Management has obtained representation from all critical vendors regarding the
fitness of their products related to the year 2000 issue. We are in the process
of remediating those critical systems that may not be year 2000 compliant. We
are also independently assessing and verifying and were necessary, testing the
results of proxy testing and representation made by vendors. We anticipate that
all critical systems will be compliant by December 31, 1998. In addition, we
anticipate that all important but less critical systems will be remediated by
March 31, 1999. The financial impact to CNFC as of September 1998 should not be
material.
During the first quarter of 1998, the mid Michigan area experienced an unusually
powerful storm system that interrupted electrical power for 4 business days.
During the course of this event, we activated our disaster recovery plan,
including the full staffing of operation of offsite imaging and mainframe sites.
14
<PAGE> 15
We were able to adequately perform all necessary functions. From this experience
we were able to revise and modify our disaster plan in preparedness for a
complete system failure related to the year 2000 problem. However, we do not
expect to activate this plan.
FORWARD LOOKING STATEMENTS
This discussion and analysis of financial condition and results of operations,
and other sections of this annual report contain forward looking statements that
are based on management's beliefs, assumptions, current expectations, estimates
and projections about the financial services industry, the economy, and about
the Corporation itself. Words such as "anticipates", "believes", "estimates",
"expects" "forecasts" "intends", "is likely", "plans", "product", "projects",
variations of such words and similar expressions are intended to identify such
forward-looking statements. These statements are not guarantees of future
performance and involve certain risks, uncertainties, and assumptions ("Future
Factors") that are difficult to predict with regard to timing, extent,
likelihood and degree of occurrence. Therefore, actual results and outcomes may
materially differ from what may be expressed or forecasted in such forward
looking statements. Furthermore, CNFC undertakes no obligation to update, amend
or clarify forward-looking statements, whether as a result of new information,
future events, or otherwise.
Future Factors include changes in interest rates and interest rate
relationships; demand for products and services; the degree of competition by
traditional and non-traditional competitors; changes in banking regulations and
tax laws; changes in prices, levies, and assessments; the impact of technology,
governmental and regulatory policy changes; the outcome of pending and future
litigation and contingencies; trends in customer behavior including their
ability to repay loans; and vicissitudes of the national and local economies.
These are representative of the Future Factors that could cause a difference
between an actual outcome and a forward-looking statement.
15
<PAGE> 16
COMMERCIAL NATIONAL FINANCIAL CORPORATION
PART II. OTHER INFORMATION
Item 6 (a) Exhibit 27 Financial Data
Item 6 (b) Reports on Form 8-K
None
16
<PAGE> 17
COMMERCIAL NATIONAL FINANCIAL CORPORATION
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Commercial National Financial Corporation
(Registrant)
Date: November 12 ,1998
/s/ Jeffrey S. Barker
------------------------------------------
Jeffrey S. Barker
President and Chief Executive Officer
/s/ Patrick G. Duffy
------------------------------------------
Patrick G. Duffy
Vice President and Chief Financial Officer
17
<PAGE> 18
Index to Exhibits
Exhibit
No. Description
--- -----------
27 Financial Data Schedule
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> SEP-30-1998
<CASH> 6,406
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 2,100
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 17,168
<INVESTMENTS-CARRYING> 30,405
<INVESTMENTS-MARKET> 31,153
<LOANS> 129,588
<ALLOWANCE> 2,268
<TOTAL-ASSETS> 172,557
<DEPOSITS> 135,339
<SHORT-TERM> 7,023
<LIABILITIES-OTHER> 1,600
<LONG-TERM> 11,000
0
0
<COMMON> 0
<OTHER-SE> 16,021
<TOTAL-LIABILITIES-AND-EQUITY> 172,557
<INTEREST-LOAN> 8,450
<INTEREST-INVEST> 1,341
<INTEREST-OTHER> 305
<INTEREST-TOTAL> 10,096
<INTEREST-DEPOSIT> 3,636
<INTEREST-EXPENSE> 4,492
<INTEREST-INCOME-NET> 5,604
<LOAN-LOSSES> 270
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 3,835
<INCOME-PRETAX> 2,511
<INCOME-PRE-EXTRAORDINARY> 2,511
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,859
<EPS-PRIMARY> 1.94
<EPS-DILUTED> 1.92
<YIELD-ACTUAL> 5.01
<LOANS-NON> 0
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 2,064
<CHARGE-OFFS> 138
<RECOVERIES> 73
<ALLOWANCE-CLOSE> 2,268
<ALLOWANCE-DOMESTIC> 1,105
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 1,253
</TABLE>
