<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
X Quarterly Report Pursuant to Section 13 or 15(d) of the
-- Securities and Exchange Act of 1934
For the quarterly period ended March 31, 1999, 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 May 1, 1999
----- --------------------------
Common Stock 1,002,946
No Par Value
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COMMERCIAL NATIONAL FINANCIAL CORPORATION
INDEX
PART I FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of
March 31, 1999 and December 31, 1998 (Page 3)
Consolidated Statements of Income for
the three months ended March 31, 1999 and March (Page 4)
31, 1998
Consolidated Statements of Shareholders'
Equity for the periods ended March 31, 1999 (Page 5)
and December 31, 1998
Consolidated Statements of Cash Flows for the
three months ended March 31, 1999 and (Page 6)
March 31, 1998
Notes to Consolidated Financial Statements (Page 7-10)
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations (Page 11-17)
PART II OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
a) Exhibit 27-Financial Data Schedule (Page 20)
b) Reports on Form 8-K (Page 18)
SIGNATURES (Page 19)
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COMMERCIAL NATIONAL FINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS
March 31, 1999 (Unaudited) and December 31, 1998
<TABLE>
<CAPTION>
March 31, December 31,
1999 1998
---- ----
(Unaudited)
<S> <C> <C>
ASSETS
Cash and due from banks $ 5,417,918 $ 8,555,428
Federal funds sold 200,000 4,000,000
------------ -------------
Total cash and cash equivalents 5,617,918 12,555,428
Securities available for sale 19,683,938 17,311,849
Securities held to maturity (fair value $10,721,981 -
March 31, 1999; $12,510,000 - December 31, 1998) 10,298,016 12,017,433
Federal Home Loan Bank stock, at cost 1,391,300 1,391,300
Loans receivable, net of allowance for loan losses
$2,492,308 - March 31, 1999; $2,343,976 - December 31, 1998 135,667,464 133,525,631
Premises and equipment, net 2,794,471 2,790,001
Accrued interest receivable and other assets 1,801,633 1,503,999
------------ -------------
Total assets $177,254,740 $ 181,095,641
============ =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Deposits
Noninterest-bearing demand $ 16,958,620 $ 20,048,154
Interest-bearing demand 23,961,184 25,461,761
Savings 40,287,807 38,783,466
Time 57,941,699 56,881,316
------------ -------------
Total deposits 139,149,310 141,174,697
Securities sold under agreements to repurchase 7,739,090 6,965,058
U.S. Treasury demand notes 357,629 1,552,997
Federal Home Loan Bank advances 10,500,000 11,500,000
Accrued expenses and other liabilities 1,595,267 2,242,787
------------ -------------
Total liabilities 159,341,296 163,435,539
Shareholders' equity
Common stock and paid in capital, no par value: 5,000,000 shares
authorized; shares issued and outstanding
March 31, 1999 - 997,807 and December 31,
1998 - 994,331 17,640,737 17,525,466
Retained earnings (deficit) 204,642 (8,483)
Accumulated other comprehensive income, net of tax 68,065 143,119
------------ -------------
Total shareholders' equity 17,913,444 17,660,102
------------ -------------
Total liabilities and shareholders' equity $177,254,740 $ 181,095,641
============ =============
</TABLE>
- -------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
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COMMERCIAL NATIONAL FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
Periods ended March 31, 1999 and 1998 (Unaudited)
<TABLE>
<CAPTION>
For Three Months
Ended March 31,
1999 1998
---------- ----------
<S> <C> <C>
Interest and dividend income
Loans receivable, including fees $2,839,137 $2,748,620
Taxable securities 233,288 253,745
Nontaxable securities 165,183 175,358
Federal funds sold 37,659 118,665
Federal Home Loan Bank stock dividends 27,445 27,445
---------- ----------
Total interest and dividend income 3,302,712 3,323,833
Interest expense
Deposits 1,095,995 1,222,423
Securities sold under agreements to repurchase 77,615 67,784
Federal Home Loan Bank advances 164,696 204,161
Other 4,547 5,806
---------- ----------
Total interest expense 1,342,853 1,500,174
Net interest income 1,959,859 1,823,659
Provision for loan losses 90,000 90,000
---------- ----------
Net interest income after provision for loan losses 1,869,859 1,733,659
Noninterest income
Service charges and fees 109,824 109,831
Net gains on loan sales 82,636 101,051
Receivable financing fees 90,668 105,820
Other 68,535 7,595
---------- ----------
Total noninterest income 351,663 324,297
Noninterest expenses
Salaries and employee benefits 672,864 633,266
Occupancy and equipment 249,336 262,040
FDIC insurance 5,583 5,457
Printing, postage and supplies 70,581 46,238
Professional and outside services 80,754 52,479
Other 252,866 256,493
---------- ----------
Total noninterest expense 1,331,984 1,255,973
---------- ----------
Income before income tax expense 889,538 801,983
Income tax expense 247,600 197,116
---------- ----------
Net income $ 641,938 $ 604,867
========== ==========
Per share information
Basic earnings $ 0.64 $ 0.60
Diluted earnings $ 0.64 $ 0.60
Dividends declared $ 0.43 $ 0.34
</TABLE>
- -------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
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COMMERCIAL NATIONAL FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Periods ended March 31, 1999 (Unaudited) and
December 31, 1998
<TABLE>
<CAPTION>
Accumulated
Common Other
Stock and Retained Comprehensive Total
Paid in Earnings Income Shareholders'
Capital (deficit) Net of Tax Equity
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Balance at December 31, 1997 $ 16,231,861 $ 647,697 $ 3,584 $ 16,883,142
Comprehensive income:
Net income 2,560,014 2,560,014
Net change in unrealized gains on
securities available for sale 211,418 211,418
Tax effect (71,883) (71,883)
---------- ------------
Total other comprehensive income 139,535 139,535
------------
Total comprehensive income 2,699,549
------------
Cash dividends declared, $1.47 per share (1,476,518) (1,476,518)
Issued 47,779 shares in payment of
5% stock dividend 1,735,374 (1,739,676) (4,302)
Issued 16,622 shares under dividend
reinvestment program 548,186 548,186
Issued 4,943 shares under stock option plans 122,357 122,357
Repurchase of 29,997 shares (1,112,312) (1,112,312)
------------ ------------
Balance at December 31, 1998 17,525,466 (8,483) 143,119 17,660,102
Comprehensive income:
Net income 641,938 641,938
Net change in unrealized gains on
securities available for sale (113,718) (113,718)
Tax effect 38,664 38,664
---------- ------------
Total other comprehensive income (75,054) (75,054)
------------
Total comprehensive income 566,884
Cash dividends declared, $.43 per share (428,813) (428,813)
Issued 4,416 shares under dividend
reinvestment program 151,852 151,852
Issued 605 shares under stock option plans 22,076 22,076
Repurchase of 2,200 shares (83,700) (83,700)
Issued 654 shares to employee stock
ownership plan 25,043 25,043
------------ --------- -------- ------------
Balance at March 31, 1999 $ 17,640,737 $ 204,642 $ 68,065 $ 17,913,444
============ ========= ======== ============
</TABLE>
- -------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
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COMMERCIAL NATIONAL FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Periods ended March 31, 1999 and 1998 (Unaudited)
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
For Three Months Ended
March 31,
1999 1998
------------ ------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 641,938 $ 604,867
Adjustments to reconcile net income to net
cash from operating activities
Provision for loan loss 90,000 90,000
Net gains on loan sales (82,636) (46,244)
Originations of loans held for sale (3,967,938) (4,184,787)
Proceeds from sales of loans held for sale 4,019,351 4,231,031
Depreciation, amortization and accretion 180,133 129,465
Net change in accrued interest receivable and other assets (205,088) (254,254)
Net change in accrued expenses and other liabilities (647,520) (92,419)
------------ ------------
Net cash from operating activities 28,240 477,659
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of securities available for sale (2,515,863) (9,068,396)
Proceeds from maturities of securities available for sale -- 3,000,000
Proceeds from maturities of securities held to maturity 1,716,600 2,000,000
Purchases of securities held to maturity -- --
Net change in loans (2,258,644) (3,082,144)
Purchases of premises and equipment, net (147,578) (15,671)
------------ ------------
Net cash from investing activities (3,205,485) (7,166,211)
CASH FLOW FROM FINANCING ACTIVITIES
Net change in deposits (2,025,387) 174,769
Net change in securities sold under agreements to repurchase 774,032 1,543,320
Net change in U.S. Treasury demand notes (1,195,368) (2,222,678)
Repayment of Federal Home Loan Bank advances (1,000,000) --
Repurchase of common stock shares (83,700) --
Dividends paid and fractional shares (428,813) (345,383)
Proceeds from sale of common stock 198,971 143,895
------------ ------------
Net cash from financing activities (3,760,265) (706,077)
------------ ------------
Net change in cash and cash equivalents (6,937,510) (7,394,629)
Cash and cash equivalents, at beginning of year 12,555,428 15,176,724
------------ ------------
CASH AND CASH EQUIVALENTS, AT END OF PERIOD $ 5,617,918 $ 7,782,095
============ ============
Cash paid during the period for
Interest $ 1,379,642 $ 1,512,871
Federal income taxes 333,000 70,373
</TABLE>
- -------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
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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 March 31, 1999 and December 31, 1998, and the
results of its operations for the three months ending March 31, 1999 and March
31, 1998. The results for the three months ended March 31, 1999 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), Commercial Bank (Bank) and
CNFC Financial Services, Inc., a wholly owned subsidiary of the Bank. All
material intercompany accounts and transactions have been eliminated in
consolidation.
Nature of Operations, Industry Segments and Concentrations of Credit Risk
The Corporation is a one-bank holding company which conducts limited business
activities. The Bank performs the majority of business activities.
The Bank provides a full range of banking services to individuals, agricultural
businesses, commercial businesses and light industries located in its service
area. It maintains a diversified loan portfolio, including loans to individuals
for home mortgages, automobiles and personal expenditures, and loans to business
enterprises for current operations and expansion. The Bank offers a variety of
deposit products, including checking, savings, money market, individual
retirement accounts and certificates of deposit. While the Corporation's chief
decision makers monitor the revenue stream of various Corporate products and
services, operations are managed and financial performance is evaluated on a
Corporation-wide basis. Accordingly, all of the Corporation's banking operations
are considered by management to be aggregated into one operating segment.
The principal markets for the Bank's financial services are the Michigan
communities in which the Bank is located and the areas immediately surrounding
these communities. The Bank serves these markets through seven offices located
in Gratiot and Montcalm 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, 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
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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 1999 or 1998.
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.
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 Receivable
Loans receivable are reported at the principal balance outstanding, net of
unearned interest, deferred loan fees and costs, and an allowance for loan
losses. Interest income is reported on the interest method and includes
amortization of net deferred loan fees and costs over the loan term.
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
The allowance for loan losses is a valuation allowance for probable credit
losses, increased by the provision for loan losses and decreased by charge-offs
less recoveries. Estimating the risk of loss and the amount of loss on any loan
is necessarily subjective. Accordingly, management estimates the allowance
balance required based on past loan loss experience, known and inherent risks in
the portfolio, information about specific borrower situations and estimated
collateral values, economic conditions, and other factors. Allocations of the
allowance may be made for specific loans, but the entire allowance is available
for any loan that, in management's judgment, should be charged-off. A problem
loan is charged-off by management as a loss when deemed uncollectible, although
collection efforts continue and future recoveries may occur.
Loan impairment is reported when full payment under the loan terms is not
expected. Impairment is evaluated in total for smaller-balance loans of similar
nature such as residential mortgage and consumer loans and on an individual loan
basis for other loans. If a loan is impaired, a portion of the allowance is
allocated so that the loan is reported, net, at the present value of estimated
future cash flows using the loan's existing rate or at the fair value of
collateral if repayment is expected solely from the collateral. Loans are
evaluated for impairment when payments are delayed, typically 90 days or more,
or when it is probable that all principal and interest amounts will not be
collected according to the original terms of the loan.
Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation.
Depreciation is computed using a combination of straight-line and accelerated
methods with useful lives ranging from 10 to 40 years for buildings and
improvements, and 3 to 10 years for furniture and equipment. These assets are
reviewed for impairment when events indicate their carrying amount may not be
recoverable from future undiscounted cash flows. Maintenance, repairs and minor
alterations are charged to current operations as expenditures occur. Major
improvements are capitalized.
Servicing Rights
Servicing rights represent both purchased rights and the allocated value of
servicing rights retained on loans sold. Servicing rights are expensed in
proportion to, and over the period of, estimated net servicing revenues.
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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.
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.
Other Real Estate Owned
Real estate properties acquired in collection of a loan receivable are recorded
at fair value at acquisition. Any reduction to fair value from the carrying
value of the related loan is accounted for as a loan loss. After acquisition, a
valuation allowance reduces the reported amount to the lower of the initial
amount or fair value less costs to sell. Expenses, gains and losses on
disposition, and changes in the valuation allowance are reported in other
expense.
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 are 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.
Securities Sold Under Agreements to Repurchase
All of these liabilities represent amounts advanced by various customers and are
secured by securities owned, as they are not covered by general deposit
insurance.
Employee Benefits
A benefit plan with 401(k) features cover substantially all employees. The plan
allows participant compensation deferrals. The amount of any Corporation
matching contribution is based solely on the discretion of the board of
directors. Historically, the Corporation has matched up to 6% of such deferrals
at 100%.
Expense for employee compensation under stock option plans is reported only if
options are granted below market price at grant date.
Income Taxes
Income tax expense is the sum of the current year income tax due or refundable
and the change in deferred tax assets and liabilities. Deferred tax assets and
liabilities are the expected future tax consequences of temporary differences
between the carrying amounts and tax bases of assets and liabilities, computed
using enacted tax rates. A valuation allowance, if needed, reduces deferred tax
assets to the amount expected to be realized.
Earnings and Dividends Per Share
Basic earnings per common share is based on net income divided by the weighted
average number of common shares outstanding during the period. Diluted earnings
per common share shows the diluted effect of any additional potential common
shares. Earnings and dividends per common share are restated for all stock
splits and stock dividends.
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.
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Comprehensive Income
Comprehensive income consists of net income and other comprehensive income.
Other comprehensive income includes the change in unrealized appreciation and
depreciation on securities available for sale, net of tax, which is also
recognized as a separate component of shareholders' equity.
Financial Instruments with Off-Balance-Sheet Risk
The Corporation, in the normal course of business, makes commitments to make
loans, which are not recorded in the financial statements.
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.
Reclassifications
Some items in the prior year financial statements have been reclassified to
conform with the current year presentation.
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ITEM 2: MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Financial Condition
Total assets for the quarter ending March 31, 1999 decreased to $177,255,000
from the $181,096,000 at the quarter ending December 31, 1998. Total loans were
$138,160,000 as of March 31,1999. This is a $2,290,000 or 1.6% increase from
December 31, 1998 balance of $135,870,000. The increase was primarily a result
of demand for business and home mortgage loans. Investment securities increased
slightly to $29,982,000 at March 31, 1999 compared to $29,329,000 at December
31, 1998.
Deposits decreased 1.4% during the period. Total deposits at March 31, 1999 were
$139,149,000 compared to $141,175,000 at December 31, 1999. Federal Home Loan
Bank (FHLB) advances decreased to $10,500,000 from $11,500,000 at December 31,
1998. Fed funds sold and securities sold under repurchase agreement were the
primary funding sources for loans.
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 99.3%
compared to 96.2% at December 31, 1998. 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: $13,500,000 in available
FHLB advances and $9,000,000 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 1.80% of total loans at March 31, 1999
compared to 1.73% at December 31, 1998. Loans past due greater than 30 days
totaled $223,000 or .2% of total loans. Loan quality remains at acceptable
levels compared to long term historical trends.
Net year to date recoveries totaled $58,000 compared to net charge-offs of
$4,000 for the three months ending March 31, 1998. During the quarter the Bank
expensed a provision of $90,000 to the allowance compared to $90,000 during the
same period in 1998. 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.
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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>
Minimum Required to be Well
March 31, December 31, March 31, December 31, Capitalized Under Promptx
1999 1998 1998 1997 Corrective Action Regulations
---- ---- ---- ---- -----------------------------
<S> <C> <C> <C> <C> <C>
Total capital to risk 14.3% 14.3% 14.8% 14.7% 10.0%
===== ===== ===== ===== =====
weighted assets
Tier 1 capital to risk 13.0% 13.0% 13.6% 13.5% 6.0%
===== ===== ===== ===== ====
weighted assets
Tier 1 capital to 10.0% 9.9% 9.9% 10.3% 5.0%
===== ==== ==== ===== ====
average assets
</TABLE>
Results of Operations
Net income for the quarter ended March 31, 1999 was $642,000, an increase
of $37,000, or 6.1% compared to the same period in 1998.
Return on average shareholders' equity for the three months ended March 31, 1999
and 1998 was 14.40% and 14.21% respectively. Return on average assets for the
three months ending March 31, 1999 and 1998 was 1.46% and 1.41% 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 months ending March 31, 1999 and 1998.
1999 1998
------------ ------------
Interest Income (tax equivalent) $ 3,469,424 $ 3,502,936
Interest Expense 1,342,853 1,500,174
------------ ------------
Net Interest Income $ 2,126,571 $ 2,002,762
Average Volume
Interest-earning Assets $170,930,157 $166,267,989
Interest-bearing Liabilities 140,835,882 139,712,137
------------ ------------
Net Differential $ 30,094,275 $ 26,555,852
============ ============
Average Yields/Rates
Yield on Earning Assets 8.23% 8.54%
Rate Paid on Liabilities 3.87% 4.35%
------------ ------------
Interest Spread 4.36% 4.19%
============ ============
Net Interest Margin 5.05% 4.89%
============ ============
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The change in net interest income is attributable to the following:
Three Months Ending
March 31, 1999
Volume Rate Inc/(Dec)
-------- -------- --------
Interest Earning Assets $ 47,600 $(87,692) $(40,092)
Interest Bearing Liabilities (8,307) (50,639) (58,946)
-------- -------- --------
Net Interest Income $ 55,907 $(37,053) $ 18,854
======== ======== ========
The increase in net interest income is due to an increase in earning assets and
an increase in margin. Net interest margin for the three months ending March 31,
1999 increased to 5.05% compared to 4.89% for the three months ending March 31,
1998. In general, interest rates have declined during the last 12 months, and
the yield curve remained flat. The Bank was able to improve margin through a
combination of measures including: decreasing the rate paid on deposits and
other funds faster than the rate decreased on earning assets, increasing the
average earning balances, and shifting lower yielding earning assets to higher
yielding business loans.
Non-interest Income
Non-interest income for the three months ending March 31, 1999 was $352,000.
This represents a $28,000 or 8.6% increase over the same period in 1998. The
Bank received full payment of a previously charged off loan including $16,000 in
interest.
Non-interest Expense
Non-interest expense for the three months ending March 31, 1999 totaled
$1,332,000. This represents a $76,000 or 6.1% increase over the same
period in 1998.
Salary and benefit expense for the three months ending March 31, 1999 totaled
$673,000 compared to $633,000 an increase of $40,000 or 6.3%. The increase
reflects normal base salary increases, and a general increase in the cost of
medical insurance and other benefit plans.
Professional and outside services increased $28,000 or 53.8% primarily related
for services rendered for remediating Y2K related programs, and the upgrade,
installation and service of PC's, networks and related periphials. Management
anticipates that these costs will be reduced in the third and fourth quarter of
1999.
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
13
<PAGE> 14
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.
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 March 31,
1999. 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
14
<PAGE> 15
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.
Principal/Notional Amount Maturing in:
<TABLE>
<CAPTION>
1999 2000 2001 2002 2003 THEREAFTER TOTAL FAIR VALUE
---- ---- ---- ---- ---- ---------- ----- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
RATE SENSITIVE ASSETS:
FIXED INTEREST RATE LOANS $8,131 $9,033 $10,620 $ 9,327 $21,701 $ 26,385 $ 85,197 $ 84,857
AVERAGE INTEREST RATE 6.70% 8.25% 8.72% 8.52% 8.32% 7.88% 8.09%
VARIABLE INTEREST RATE LOANS 16,599 4,843 2,336 4,629 2,244 22,312 52,963 52,963
AVERAGE INTEREST RATE 8.51% 8.68% 8.75% 8.39% 8.49% 7.73% 8.20%
FIXED INTEREST RATE SECURITIES 3,790 5,030 5,810 4,260 4,190 6,670 29,750 29,821
AVERAGE INTEREST RATE 6.58% 6.20% 5.93% 6.24% 6.28% 7.12% 6.42%
FHLB STOCK 1,391 1,391 1,391
AVERAGE INTEREST RATE 7.99% 7.99%
FEDERAL FUNDS SOLD 200 200 200
AVERAGE INTEREST RATE 4.94% 4.94%
RATE SENSITIVE LIABILITIES:
NON INTEREST BEARING DEMAND 16,959 16,959 16,959
INTEREST BEARING DEMAND 23,961 23,961 43,298
AVERAGE INTEREST RATE 1.67% 1.67%
SAVINGS 40,288 40,288 20,951
AVERAGE INTEREST RATE 2.48% 2.48%
TIME DEPOSITS 33,272 17,233 3,847 1,863 1,319 408 57,942 58,315
AVERAGE INTEREST RATE 4.29% 4.58% 5.09% 4.72% 4.73% 4.78% 4.46%
REPURCHASE AGREEMENTS 7,739 7,739 7,739
AVERAGE INTEREST RATE 4.69% 4.69%
U.S. TREASURY DEMAND NOTES 358 358 358
AVERAGE INTEREST RATE 4.63% 4.63%
FIXED RATE FHLB ADVANCES 2,000 4,000 1,000 1,500 1,000 9,500 9,265
AVERAGE INTEREST RATE 6.60% 6.40% 6.50% 5.28% 5.35% 5.93%
VARIABLE RATE FHLB ADVANCE 1,000 1,000 997
AVERAGE INTEREST RATE 4.97% 4.97%
</TABLE>
Year 2,000 Issues
Commercial 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.
Commercial recognizes the need to ensure that its operation will not be
adversely impacted by Year 2000 (Y2K) software failures. Commercial has
established a process for evaluating and managing risks associated with this
issue. A Technology Committee comprised of management and independent members of
the Board of Directors meet regularly to ensure that progress is made in
identifying non-compliant systems and developing appropriate responses to
correct the deficiencies.
The State Of Readiness
15
<PAGE> 16
The process of addressing the Y2K issue includes seven phases: I-Awareness,
II-Inventory, III-Assessment, IV-Analysis, V-Conversion, VI-Implementation,
VII-Post Implementation.
The Bank has successfully completed Phases I-VI. Final remediation of critical
systems was completed by March 31, 1999. Management is confident that all
mission critical systems will perform on December 31, 1999.
Cost To Address The Year 2000 Issue
Management has prepared a budget to estimate the cost of completing the seven
phases in our Y2K plan. The expenses associated with Y2K are compared to budget
and reported to the Technology Committee.
The largest cost element associated with the Y2K has been the opportunity cost
associated with management, board of directors and employee time developing our
plan, completing the seven phases and documenting our plan results.
During 1999 we will upgrade equipment and technology that may directly or
indirectly address Y2K issues totaling an estimated $480,000.
Risk Associated With The Year 2000 Issue
Management is confident that all mission critical systems will function
correctly on January 1, 2000. We are also confident that our large deposit and
loan customers are aware of, and are addressing Y2K.
However, there are several risks that management cannot fully control. These
risks include the ability of large institutional and government agencies to be
adequately prepared, the public's perception and response to the negative media
portrayal of the Y2K, and regulatory risk that the agencies responsible for the
Bank's oversight are not satisfied with our efforts to address the Y2K issue.
Large institutional entities include the Social Security Administration,
Internal Revenue Service, etc. These entities electronically deposit and gather
funds from our customers' accounts. We are unable to control or influence their
level of preparedness. Our customers may perceive their inability to properly
process and deliver transactions to the Bank as the Bank's Y2K failure.
The media is increasingly focused on the Y2K issue. Their focus has been on what
can go wrong, rather than what companies have done to address the issue. Some of
the "alleged" experts are advocating drastic preparedness plans for individuals,
including the withdrawal of all or most of their cash. The public's response to
this media information is difficult to predict. Though we are addressing the
anticipated need for additional liquidity and cash, we cannot accurately predict
the actual requirement. During 1999 we will focus our energy on public relations
to explain what we have done to reduce the risk of Y2K and what our contingency
plans are for dealing with any problems.
The Bank is subject to regulatory examination related to the Y2K issue. The
Federal Depository Insurance Corporation (FDIC) examines the Bank to determine
if our plan appears adequate, we are making sufficient progress in addressing
our Y2K issues, and that we are adequately reporting the status of Y2K to the
Bank's board of directors. In the event that the regulators determine that we
are not meeting their expectations, they have the authority to enforce
compliance.
Contingency Plans
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 offsite imaging and mainframe sites. We were able
to perform all necessary functions.
16
<PAGE> 17
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.
Modifications to the plan should be completed by June 30, 1999.
Forward Looking Statements
This discussion and analysis of financial condition and results of operations,
and other sections of this report contain forward looking statements that are
based on management's beliefs, assumptions, current expectations, estimates
and projections about the financial services industry, the economy, and about
the Corporation itself. Words such as "anticipates", "believes", "estimates",
"expects" "forecasts" "intends", "is likely", "plans", "product", "projects",
variations of such words and similar expressions are intended to identify such
forward-looking statements. These statements are not guarantees of future
performance and involve certain risks, uncertainties, and assumptions ("Future
Factors") that are difficult to predict with regard to timing, extent,
likelihood and degree of occurrence. Therefore, actual results and outcomes may
materially differ from what may be expressed or forecasted in such forward
looking statements. Furthermore, CNFC undertakes no obligation to update, amend
or clarify forward-looking statements, whether as a result of new information,
future events, or otherwise.
Future Factors include changes in interest rates and interest rate
relationships; demand for products and services; the degree of competition by
traditional and non-traditional competitors; changes in banking regulations and
tax laws; changes in prices, levies, and assessments; the impact of technology,
governmental and regulatory policy changes; the outcome of pending and future
litigation and contingencies; trends in customer behavior including their
ability to repay loans; and vicissitudes of the national and local economies.
These are representative of the Future Factors that could cause a difference
between an actual outcome and a forward-looking statement.
17
<PAGE> 18
COMMERCIAL NATIONAL FINANCIAL CORPORATION
PART II. OTHER INFORMATION
Item 6 (a) Exhibit 27 Financial Data
Item 6 (b) Reports on Form 8-K
None
18
<PAGE> 19
COMMERCIAL NATIONAL FINANCIAL CORPORATION
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Commercial National Financial Corporation
(Registrant)
Date: May 10, 1999
/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
19
<PAGE> 20
EXHIBIT INDEX
-------------
EXHIBIT NO. DESCRIPTION
- ----------- -----------
27 FINANCIAL DATA SCHEDULE
<TABLE> <S> <C>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> MAR-31-1999
<CASH> 5418
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 200
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 21075
<INVESTMENTS-CARRYING> 10298
<INVESTMENTS-MARKET> 10722
<LOANS> 138160
<ALLOWANCE> 2492
<TOTAL-ASSETS> 177255
<DEPOSITS> 139149
<SHORT-TERM> 8097
<LIABILITIES-OTHER> 1595
<LONG-TERM> 10500
0
0
<COMMON> 17641
<OTHER-SE> 273
<TOTAL-LIABILITIES-AND-EQUITY> 177255
<INTEREST-LOAN> 2839
<INTEREST-INVEST> 426
<INTEREST-OTHER> 38
<INTEREST-TOTAL> 3303
<INTEREST-DEPOSIT> 1096
<INTEREST-EXPENSE> 1343
<INTEREST-INCOME-NET> 1960
<LOAN-LOSSES> 90
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 1332
<INCOME-PRETAX> 890
<INCOME-PRE-EXTRAORDINARY> 890
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 642
<EPS-PRIMARY> .64
<EPS-DILUTED> .64
<YIELD-ACTUAL> 4.82
<LOANS-NON> 0
<LOANS-PAST> 223
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 2344
<CHARGE-OFFS> 7
<RECOVERIES> 65
<ALLOWANCE-CLOSE> 2492
<ALLOWANCE-DOMESTIC> 1920
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 572
</TABLE>
