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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, 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 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)
Registrant's telephone number, including area code: (517) 875-4144
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, no 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 12, 1999: $25,783,791
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 12, 1999: 997,739 shares
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's annual report to security holders for the year
ended December 31, 1998, are incorporated by reference in Part II and Part IV.
Portions of the registrant's proxy statement for its April 27, 1999, annual
shareholders meeting are incorporated by reference in Part III.
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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,
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 seven 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 75.92% of the Corporation's total revenues in 1998, 79.69% in
1997, and 79.82% in 1996. Interest on investment securities accounted for 11.19%
of the Corporation's total revenues in 1998, 9.85% in 1997, and 13.03% in 1996.
At December 31, 1998, 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 entities 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.
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
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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 to 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.
ITEM 2. PROPERTIES.
The Bank currently conducts business from seven banking offices. 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, 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, 2008, subject to 2
renewals of 10 years each. 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.
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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, 1998, 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, 1998, 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 Discussion and Analysis and
Results of Operations" of the registrant's annual report to shareholders for the
year ended December 31, 1998, is here incorporated by reference to Exhibit 13.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information under the heading "Quantitative and Qualitative Disclosures
About Market Risk" of the registrant's annual report to shareholders for the
year ended December 31, 1998, is here incorporated by reference to Exhibit 13.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The financial statements, notes and report of independent auditors' included
in the registrant's annual report to shareholders for the year ended December
31, 1998, are here incorporated by reference to Exhibit 13.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Not applicable
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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 27, 1999, 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 27, 1999, 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 27, 1999, 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 27, 1999, annual meeting
of shareholders is here incorporated by reference.
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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
report of independent auditor of the Corporation and its subsidiary are filed as
part of this report:
Independent Auditors' Reports
Consolidated Balance Sheets - December 31, 1998 and
1997
Consolidated Statements of Income for each of the
three years ended December 31, 1998, 1997 and 1996
Consolidated Statements of Shareholders' Equity for
each of the three years in the period ended
December 31, 1998, 1997 and 1996
Consolidated Statements of Cash Flows for each of the
three years in the period ended December 31, 1998,
1997 and 1996
Notes to Consolidated Financial Statements
The financial statements, notes to financial statements, and report of
independent auditor for the years ended December 31, 1998, 1997 and 1996 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, 1998. With the exception of the portions of the
registrant's annual report to shareholders for the year ended December 31, 1998
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) 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(b) 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(c) 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(d) Amendment to 1991 Stock Option Plan.*
10(e) Change in Control Agreement.*
13 Incorporated Portions from 1998 Annual
Report to Shareholders.
21 Subsidiary of Registrant. Previously filed
as an exhibit to the registrant's Form S-4
filed
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January 22, 1988. Here incorporated by
reference.
23 Consent of 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 were filed for the fourth quarter of 1998.
(c)Exhibits.
See Item 14(a)(3)
(d)Financial Statement Schedules.
There are no financial statement schedules required to be filed with this
report.
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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 26, 1999 By: /s/ Jeffrey S. Barker
-------------------------------------
Jeffrey S. Barker
President and Chief Executive Officer
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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.
March 26, 1999 /s/ Jeffrey S. Barker
---------------------------------
Jeffrey S. Barker
Director, President and Chief
Executive Officer
(Principal Executive Officer)
March 26, 1999 /s/ Richard F. Abbott
---------------------------------
Richard F. Abbott
Director
March 26, 1999 /s/ Jefferson P. Arnold
---------------------------------
Jefferson P. Arnold
Director
March 26, 1999 /s/ Don J. Dewey
---------------------------------
Don J. Dewey
Director
March 26, 1999 /s/ David A. Ferguson
---------------------------------
David A. Ferguson
Director
March 26, 1999 /s/ Kenneth R. Luneack
---------------------------------
Kenneth R. Luneack
Director
March 26, 1999 /s/ Kim C. Newson
---------------------------------
Kim C. Newson
Director
March 26, 1999 /s/ Howard D. Poindexter
---------------------------------
Howard D. Poindexter
Director
March 26, 1999 /s/ Scott E. Sheldon
---------------------------------
Scott E. Sheldon
Director
March 26, 1999 /s/ Russell M. Simmet
---------------------------------
Russell M. Simmet
Director
March 26, 1999 /s/ Patrick G. Duffy
---------------------------------
Patrick G. Duffy
(Principal Financial and
Accounting Officer)
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<TABLE>
<CAPTION>
INDEX TO EXHIBITS
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) 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(b) 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(c) 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(d) Amendment to 1991 Stock Option Plan. 10
10(e) Change in Control Agreement. 14
13 Incorporated Portions from 1998 Annual Report to Shareholders. 17
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 Consent of Independent Certified Public Accountants. 18
27 Financial Data Schedule. 20
</TABLE>
- ------------------------
*This exhibit is filed by incorporation by reference to a prior filing.
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EXHIBIT 10(D)
AMENDMENT TO 1991 STOCK OPTION PLAN
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AMENDMENT TO THE COMMERCIAL NATIONAL FINANCIAL CORPORATION 1991 STOCK OPTION
PLAN
The Board of Directors has unanimously approved an amendment to the Commercial
National Financial Corporation 1991 Stock Option Plan (the "Plan") to increase
the maximum number of shares of Commercial National Financial Corporation common
stock which may be issued under the Plan by 50,000 shares and unanimously
recommends to the shareholders that they approve such amendment. The Plan was
approved by shareholders at the annual meeting of shareholders held on April 23,
1991. An amendment to the Plan authorizing an additional 30,000 shares was
approved by shareholders at the annual meeting of Shareholders held on April 25,
1995. After the 1995 amendment to the Plan was approved, 60,388 shares were
authorized for issuance under the Plan. Through the issuance of stock dividends
by the Corporation, the number of shares authorized under the Plan reached
69,906 as of December 31, 1997.
Pursuant to action by the stock option committee, options to purchase 61,773 of
the 69,906 shares of Commercial National Financial Corporation common stock
authorized for issuance under the Plan have been granted to qualified directors,
officers and key employees of Commercial Bank. Consequently, there are currently
only 8,133 shares of Commercial National Financial Corporation common stock
available for option grants under the Plan. The Board of Directors would like to
increase the number of shares available under the Plan so that options may be
granted to a greater number of key employees. The Board of Directors believes
that additional shares should be available under the Plan in order to achieve
this goal and the other purposes behind the Plan.
DESCRIPTION OF THE PLAN
The following description of the Plan is a summary of its terms and is qualified
in its entirety by the Plan, a copy of which is available by contacting Patrick
Duffy. The following description incorporates the proposed amendment to the
Plan.
Purpose. The Purpose of the Plan is to attract and retain qualified directors,
officers, and key employees, and to recognize their contribution to the
long-term performance and growth of the Corporation and the Bank.
Shares Subject to the Plan. The Plan would permit stock options, stock
appreciation rights, and tax benefit rights to be issued with respect to an
aggregate of 119,906 shares of the Corporation's Common Stock (subject to
adjustment for stock dividends, stock splits, etc.).
Administration. The Plan is administered by the stock option committee (the
"Committee"). The Committee determines the persons to be granted options, stock
appreciation rights, and tax benefit rights; the amount of options or rights to
be granted to each such participant; the time at which options would be granted;
the terms of each option and right; the duration of each option and any exercise
limitations; and all other determinations necessary or advisable for
administration of the Plan.
The board of directors may terminate or amend the Plan at any time provided that
no amendment could, without the approval of the shareholders, materially
increase either the benefits to participants or the number of shares that may be
issued under the Plan, materially modify the eligibility requirements, or reduce
the option price, except pursuant to the
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adjustments provided or in the Plan. Unless previously terminated by the board
of directors, the Plan will terminate on April 22, 2001.
Eligibility. Options may be issued to directors, and both options and rights may
be issued to officers, and other individuals identified as key employees of the
Corporation and the Bank. Grants of options to directors of the Corporation and
the Bank are made only on June 1 of each year, in an amount equal to the amount
of the director's total cash compensation from the Corporation reported on IRS
Form 1099 for the preceding calendar year. While it is not possible to indicate
the number, names or positions of directors, officers or employees who may be
selected for the grant of options and rights, in 1997 options were granted to 5
key management employees and 11 directors. It is likely that grants in the
future will be to the same number of directors and to a greater number of
officers and other key employees.
Stock Options. Certain options that may be granted to employees under the Plan
may qualify as incentive stock options as defined in Section 422 of the Internal
Revenue Code of 1986, as amended (the "Code"). Options may also be granted that
do not qualify for incentive stock option treatment.
No participant may be granted incentive stock options that would result in the
aggregate fair market value of the stock (determined at the time of grant) with
respect to which participant's incentive stock options are exercisable for the
first time during any calendar year to exceed $100,000. There is no specified
maximum for options which are not incentive stock options.
The per share option price is the market value of the Common Stock at the time
the option is granted. There is no established market for the Common Stock, and
no published information with respect to its market value. Accordingly, market
value is the mean between the bid and asked prices obtained from an independent
broker for the date of grant, or for the last preceding date (within 30 days)
for which such information was available. If such information is not available,
or if the Committee determines that such information is for any reason not a
reliable determination of the fair market value of the Corporation's Common
Stock, the Committee determines the market value of the Common Stock as of the
date of grant. As of March 13, 1998, the market value of Common Stock so
determined was $36 per share.
The term of each option is determined by the Committee, but no option may be
exercisable after 15 years from the date granted, but no option designated as an
incentive stock option may be exercisable after the expiration of 10 years from
the date of grant. Options generally terminate in the event of retirement,
death, or any other termination of employment. Options granted to participants
under the Plan cannot be transferred except by will or the laws of descent and
distribution.
Appreciation and Tax Benefit Rights. Under the Plan, the Corporation may grant
stock appreciation rights or tax benefit rights with respect to specific stock
options to eligible participants other than directors. A stock appreciation
right would allow the participant to surrender the related option, in whole or
part, or cash, shares of Common Stock, or a combination of cash and shares, in
an amount not exceeding the excess of the market value of the shares covered by
the related option at exercise over the option price of the shares. A tax
benefit right provides the participant a cash payment upon exercise of an
option. The payment
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will not exceed the amount determined by multiplying the participant's income
realized upon exercise of an option by the maximum federal income tax rate for
corporations. The participant may use the cash realized from a tax benefit right
to pay a portion of the option price unless the Committee provides otherwise.
When exercising all or a portion of an option, a participant may, with the
Committee's consent, pay for stock with cash, shares of Common Stock, or other
consideration equivalent to cash. The Committee may also permit payment of all
or a portion of the option price through promissory notes or other installment
payments, with or without interest or security.
Federal Income Tax Consequences. A participant exercising an incentive stock
option would not recognize income at exercise. The difference between the market
value and the exercise price would be, however, a preference item for
calculating alternative minimum tax. Upon sale of the stock, so long as the
participant holds the stock for at least 1 year after the exercise of the option
and at least 2 years after the grant of the option, the participant's basis
would equal the option price, the participant would be taxed on the difference
between the sales proceeds and the option price as capital gain, and the
Corporation would receive no federal tax deduction.
If, prior to the expiration of either of the above holding periods, the
participant sells shares acquired under an incentive stock option, the tax
deferral would be lost and the participant would realize compensation income
equal to the difference between the option price and the fair market value as of
the sale. The Corporation would receive a corresponding deduction for federal
income tax purposes. If the participant exercises options which are not
incentive stock options, he or she would have compensation income in the year of
exercise equal to the difference between the option price and the fair market
value at the time of exercise, and the Corporation would receive a corresponding
deduction for federal income tax purposes
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EXHIBIT 10(e)
CHANGE IN CONTROL AGREEMENT
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COMMERCIAL BANK AGREEMENT
WITH EXECUTIVE REGARDING BENEFITS PAID
IN THE EVENT OF A CHANGE OF CONTROL
Commercial Bank (the "Bank") and the Executive (as named below) agree that the
Executive will be eligible for certain benefits in accordance with the
following.
I. Change of Control Defined.
- "Change of Control" for purposes hereof shall occur on or after
the date upon which more than 50% of the common stock of
Commercial National Financial Corporation or its successor or
successors is acquired by an entity, person or group.
II. Duration of Agreement.
- The Executive shall be eligible for benefits hereunder for a
period of 24 months beginning on the date upon which a "Change of
Control" occurs (the "Benefit Period").
III. Eligibility for Benefits.
- The Executive shall become eligible for benefits hereunder upon a
Change of Control followed by one or more of the following events
occurring during the Benefit Period:
- Termination of Executive's employment for reasons other than
"Good Cause." ("Good Cause" shall be deemed to exist if and
only if Executive engages in acts or omissions constituting
dishonesty, intentional breach of fiduciary obligation, or
intentional wrongdoing or malfeasance, in each case that
results in substantial harm to the business or property of
the Bank or the Executive is convicted of a criminal
violation involving fraud or dishonesty);
- There is a significant change in the nature or the scope of
the Executive's authority or in his overall working
environment;
- Executive is assigned duties materially inconsistent with his
present duties, responsibilities and status;
- There is a material reduction in the Executive's monthly rate
of base salary.
IV. Amount of Benefits to be Received by Executive.
- The amount payable to Executive shall be a single sum payment in
the amount of 18 months of Executive's pay.
- The 18 months of Executive's pay shall be determined as follows:
- A sum equal to the last 12 months of the Executive's base
salary plus an amount equal to the Executive's average bonus
over the last 3 years shall be divided by 12 and then
multiplied by 18.
V. Timing of Benefit.
- Any benefits payable hereunder shall be paid to the Executive in
the form of a single sum payment no later than 60 days after
becoming eligible for benefits as set forth in paragraph III
hereof.
VI. Other Benefits.
- No other benefits shall be payable under this document. Any other
benefits to which Executive is entitled, including but not limited
to health benefits, retirement benefits and the like shall be
determined pursuant to the terms and conditions of each other
separate respective plan.
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Effective Date of Document: October 21, 1998
COMMERCIAL BANK
By: /s/ Scott E. Sheldon
---------------------------------------
Scott E. Sheldon
Its: Chairman
EXECUTIVE:
/s/ Jeffrey S. Barker
---------------------------------------
Jeffrey S. Barker
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EXHIBIT 13
INCORPORATED PORTIONS FROM 1998 ANNUAL REPORT TO SHAREHOLDERS
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CONTENTS
Report from the President.......................................... 2
Selected Financial Data............................................ 3
Business of Commercial National Financial Corporation.............. 4
Management's Discussion and Analysis............................... 4 - 17
Report of Independent Auditors..................................... 18
Management's Responsibility for Financial Statements............... 19
Consolidated Balance Sheets........................................ 20
Consolidated Statements of Income.................................. 21
Consolidated Statements of Shareholders' Equity.................... 22
Consolidated Statements of Cash Flows.............................. 23
Notes to Consolidated Financial Statements......................... 24 - 37
Common Stock and Dividend Information.............................. 37
Directors and Officers............................................. 38
Locations, Transfer Agent and Market Makers........................ 40
Featured on the cover are Katie Duffy, a
Savasourus Club member since 1997, and Bonnie
Barrett, Ithaca Customer Service Representative.
The Savasourus Club is a special deposit program
for the next generation of Commercial Bank
customers. Members receive an I.D. membership
card, a dinosaur bank and other special features.
Dick's Studio located in Ithaca, Michigan took the
photographs. E&S Graphics of Ithaca, Michigan
created the cover. Local talent is not hard to
find!
<PAGE> 3
[JEFF'S PICTURE]
To Our Shareholders:
Certainly the highlight of 1998 was the substantial increase in net income.
Earnings reached $2,560,000, a 51% increase over the prior year, and the highest
level ever attained by Commercial National Financial Corporation. Significant
improvement in operating efficiency, combined with an increase in net interest
income and gains on sales of residential real estate mortgages, contributed to
the record earnings. The resulting return on average assets of nearly 1.5% and
return on average equity of 14.4% compare exceptionally well with those
performance ratios of our peers.
Earnings per share rose to $2.54 during 1998 compared to $1.72 per share last
year. Perhaps, more importantly 1998 cash dividends were $1.47 per share, up 25%
over the $1.18 per share paid during 1997. In addition, during November 1998 a
5% stock dividend was distributed to shareholders for the ninth consecutive
year. Along with the exceptional 4.3% cash dividend yield, shareholders
experienced a 23% increase in the common stock price, closing the year at $37.50
per share.
Total loans grew at a steady 9% rate during 1998 and loan quality remains very
strong. During 1998, $360,000 was provided for the allowance for loan losses,
while net charge-offs for the same period were only $80,000. Therefore, the
allowance at year-end totaled $2,344,000 or 1.73% of total loans. That amount is
twenty-five times the nonperforming assets total of $92,000 at December 31,
1998.
January 1, 2000 will soon be upon us and you can be assured that we are prepared
to handle any Y2K computer concerns without any disruption to customer service.
In fact to demonstrate our confidence we are planning to celebrate the new
millennium at our bank on New Year's Day by being open to serve our customers.
Management, along with the Board of Directors, has been working diligently to
thoroughly test every critical system within the bank as well as document the
readiness of our vendors and suppliers. Testing of our critical systems has been
successfully completed, including tests of simulated processing by our mainframe
computer well into the year 2001.
Throughout the year we will update all of our customers with a regularly
published newsletter to keep everyone fully informed regarding our Y2K plans and
preparations.
By every measure 1998 was a very successful year resulting from the hard work
and dedication of our talented employees. Our continuing strategy will focus on
the needs of our customers by maintaining the necessary flexibility that only a
local community bank brings to the marketplace.
Thank you for your continued confidence and support. We look forward to
rewarding that confidence by increasing the value of your investment in
Commercial National Financial Corporation.
My best regards,
Jeffrey S. Barker
President and Chief Executive Officer
"EARNINGS REACHED $2,560,000, A 51% INCREASE OVER THE PRIOR YEAR, AND THE
HIGHEST LEVEL EVER ATTAINED BY COMMERCIAL NATIONAL FINANCIAL CORPORATION."
Jeffrey S. Barker
<PAGE> 4
<TABLE>
<CAPTION>
SELECTED FINANCIAL DATA
1998 1997 1996 1995 1994
- -------------------------------------------------------------------------------------------------------------------
(In thousands except financial ratios and per share data)
<S> <C> <C> <C> <C> <C>
FOR THE YEAR
Net interest income $ 7,559 $ 7,354 $ 6,979 $ 6,870 $ 6,450
Provision for loan losses (360) (395) (230) (250) (230)
Noninterest income 1,458 1,099 683 665 718
Noninterest expense (5,173) (5,867) (5,684) (5,126) (4,925)
----------------------------------------------------------------------------------------------------------------------
Income before income tax expense 3,484 2,191 1,748 2,159 2,013
Income tax expense (924) (499) (316) (491) (481)
----------------------------------------------------------------------------------------------------------------------
Net income $ 2,560 $ 1,692 $ 1,432 $ 1,668 $ 1,532
======================================================================================================================
AT YEAR END
Total assets $ 181,096 $ 172,405 $ 166,190 $ 151,075 $ 142,875
Net loans 133,526 122,458 120,501 107,611 98,525
Total deposits 141,175 133,947 133,017 129,701 125,090
FHLB advances 11,500 13,000 10,000 -- --
Shareholders' equity 17,660 16,883 15,496 14,643 13,458
FINANCIAL RATIOS
Return on average assets 1.47% 1.03% 0.92% 1.15% 1.07%
Return on average shareholders' equity 14.39 10.49 9.41 11.73 11.76
Average shareholders' equity to average assets 10.19 9.81 9.76 9.79 9.12
Allowance for loan losses to loans 1.73 1.66 1.49 1.53 1.51
Tier 1 leverage 9.92 10.26 9.43 9.43 9.24
Total risk-based capital 14.26 14.73 14.29 14.29 15.23
Dividend pay-out 57.68 69.23 68.37 49.56 47.41
PER SHARE DATA(1)
Basic earnings(2) $ 2.54 $ 1.72 $ 1.50 $ 1.78 $ 1.67
Diluted earnings(2) 2.53 1.71 1.49 1.78 1.67
Dividends declared 1.47 1.18 1.03 .87 .80
Book value, end of year 17.76 16.81 16.06 15.49 14.52
</TABLE>
(1) All per share data adjusted to reflect stock splits and stock dividends.
(2) Restated to reflect adoption of SFAS No. 128 on December 31, 1997.
[NET INCOME BAR GRAPH] [RETURN ON AVERAGE EQUITY BAR GRAPH] [DIVIDENDS PER SHARE
BAR GRAPH]
<PAGE> 5
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
- --------------------------------------------------------------------------------
INTRODUCTION
- --------------------------------------------------------------------------------
The following discussion provides information about the financial condition and
results of operations of Commercial National Financial Corporation. It should be
read in conjunction with the consolidated financial statements included
elsewhere in this Annual Report.
- --------------------------------------------------------------------------------
BUSINESS OF COMMERCIAL NATIONAL FINANCIAL CORPORATION
- --------------------------------------------------------------------------------
Commercial National Financial Corporation (the Corporation or Commercial), a
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).
On July 16, 1997, the Bank acquired an inactive insurance agency, Commercial
National Financial Services Incorporated (the Agency). The Agency in turn
purchased a minority interest in Michigan Bankers Title of Northern Michigan,
LLC (the Title Agency). Except for the investment in the Title Agency, the
Agency is inactive. Management does not intend to offer insurance products to
retail customers. The investment in the Title Agency and the related dividends
earned during 1998 are not material to the Corporation.
The Bank's business is concentrated primarily 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 products, including checking,
savings, money market, 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 seven locations in or
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 75.92% of the Corporation's total revenue in 1998, 79.69% in 1997,
and 79.82% in 1996. Interest on investment securities accounted for 11.19% of
the Corporation's total revenues in 1998, 9.85% in 1997 and 13.03% in 1996.
- --------------------------------------------------------------------------------
1998 HIGHLIGHTS
- --------------------------------------------------------------------------------
Net income for the year ended December 31, 1998 was $2,560,000, 51.30% or
$868,000 more than the $1,692,000 earned during the year ended December 31,
1997. Basic earnings per share increased to $2.54 in 1998 from $1.72 in 1997.
The return on average equity improved to 14.39% from 10.49%. The return on
average assets improved to 1.47% in 1998 from 1.03% in 1997.
The primary reasons for the improved earnings are as follows: a $205,000 or
2.79% increase in net interest income, a $359,000 or 32.67% increase in
noninterest income, and a $694,000 or 11.83% decrease in non-interest expense.
Total assets increased to $181.1 million in 1998 from $172.4 million in 1997.
This represents a $8.7 million or 5.04% increase.
<PAGE> 6
NET INTEREST INCOME
<TABLE>
<CAPTION>
Average Balance Sheet and Analysis of Net Interest Income
Years ended December 31
----------------1 9 9 8------------- ---------------1 9 9 7-------------
AVERAGE YIELD/ Average Yield/
BALANCE INTEREST RATE Balance Interest Rate
- ------------------------------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans receivable (1)(2) $ 128,312 $ 11,385 8.87% $ 124,710 $ 11,352 9.10%
Investment securities
Taxable 16,048 935 5.83 11,689 668 5.71
Tax-exempt (2) 13,782 1,111 8.06 13,462 1,099 8.17
Federal funds sold 5,866 352 6.00 5,046 275 5.45
Federal Home Loan Bank stock 1,391 111 7.98 1,315 105 7.99
----------------------- -----------------------
Total interest-earning assets 165,399 13,894 8.40 156,222 13,499 8.64
Non-earning assets:
Cash and due from banks 6,612 4,828
Premises and equipment, net 2,968 3,658
Other assets 1,830 1,650
Allowance for loan losses (2,205) (1,932)
----------- ---------
Total assets $ 174,604 $ 164,426
========== =========
Interest-bearing liabilities:
Interest-bearing deposits
Interest-bearing demand $ 23,200 477 2.06 $ 21,713 486 2.24
Savings 37,855 1,062 2.81 37,639 1,109 2.95
Time 58,454 3,239 5.54 55,468 3,079 5.55
Securities sold under agreements
to repurchase 5,842 296 5.07 5,777 305 5.28
U.S. Treasury demand notes 456 24 5.26 557 30 5.39
Federal Home Loan Bank advances 12,849 790 6.15 11,225 680 6.06
----------------------- -----------------------
Total interest-bearing liabilities 138,656 5,888 4.25 132,379 5,689 4.30
Noninterest-bearing liabilities:
Noninterest-bearing demand 16,945 14,798
Other liabilities 1,209 1,111
Shareholders' equity 17,794 16,138
---------- ---------
Total liabilities and shareholders' equity $ 174,604 $ 164,426
========== ==========
Net interest income/interest rate spread $ 8,006 4.15% $ 7,810 4.34%
========= ==== =========== ====
Net interest margin (3) 4.84% 5.00%
==== ====
</TABLE>
(1) Average outstanding balances include non-accruing loans. Interest on loans
receivable include fees. The inclusion of non-accruing loans and fees does
not have material effect on either the average outstanding balance or the
average yield.
(2) Yields on tax-exempt loans and securities are computed on a fully
taxable-equivalent basis using a federal income tax rate of 34%.
(3) Net interest earnings divided by average interest-earnings assets.
The largest component of Commercial's operating income is net interest income.
Net interest income is the difference between interest and fees earned on
earning assets and the interest paid on deposits and other borrowings. A number
of factors influence net interest income. These factors include: changes in
volume and mix of interest-earning assets and interest-bearing liabilities,
governmental
<PAGE> 7
monetary and fiscal policies, national and local market interest rates and
customer preference.
Net interest income on a tax equivalent basis was $8.0 million in 1998, an
increase of $196,000 or 2.5%. Tax-equivalent net interest income increased
$311,000 or 4.15% in 1997 compared to 1996. Commercial's annual increases in net
interest income were the result of an increased volume of earning assets.
Net interest margin is net interest income (fully tax equivalent) divided by
average earning assets. The net interest margin has decreased from 5.09% to
5.00% to 4.84% in 1996, 1997 and 1998, respectively. Commercial continues to
experience competitive pressures on loan and deposit product pricing. This
pressure has negatively impacted the Bank's interest margin.
During 1996, the Bank aggressively priced indirect automobile lending and
shortened the average life of the U.S. Treasury and Agency securities to meet
short-term liquidity needs. The general low interest rate environment and flat
yield curve continued from the fourth quarter of 1997 through out 1998 making it
difficult to replace maturing investment securities and loans with comparable or
higher yielding investments.
We have attempted to obtain interest bearing deposits and other interest bearing
liabilities at lower cost, however, we have been unable to reduce our cost of
funds as quickly as our yield on earning assets has decreased.
The following table analyzes the effect of volume and rate changes on interest
income and expense for the periods indicated.
<TABLE>
<CAPTION>
Years ended December 31,
1 9 9 8 1 9 9 7
-----------COMPARED TO 1997---------- -----------Compared to 1996----------
NET AMOUNT AMOUNT Net Amount Amount
INCREASE DUE TO DUE TO Increase Due to Due to
(DECREASE) VOLUME RATE (Decrease) Volume Rate
- -------------------------------------------------------------------------------------------------------------------
(In thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest income:
Loans receivable (1) (2) $ 33 $ 320 $ (287) $ 881 $ 973 $ (92)
Investment securities:
Taxable 267 254 13 (288) (212) (76)
Tax-exempt (2) 12 26 (14) (7) (32) 25
Federal funds sold 77 49 28 89 89 -
Federal Home Loan Bank stock 6 6 - 48 47 1
----------------------------------------------------------------------------------------------------------------
Total interest income 395 655 (260) 723 865 (142)
Interest expense:
Interest-bearing deposits
Interest-bearing demand (9) 31 (40) (20) 1 (21)
Savings (47) 7 (54) 42 6 36
Time 161 165 (4) (13) 29 (42)
Securities sold under
agreements to repurchase (10) 3 (13) 6 (7) 13
U.S. Treasury demand notes (6) (5) (1) - (1) 1
Federal Home Loan Bank advances 110 100 10 397 371 26
----------------------------------------------------------------------------------------------------------------
Total interest expense 199 301 (102) 412 399 13
- -------------------------------------------------------------------------------------------------------------------
Net interest income $ 196 $ 354 $ (158) $ 311 $ 466 $ (155)
===================================================================================================================
</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 balance.
(2) Yields on tax-exempt loans and investment securities are computed on a
fully taxable-equivalent basis using a federal income tax rate of 34%.
(3) For purposes of these tables, changes in interest due to volume and rate
were determined as follows: Volume Variance = Change in volume times old
rate; Rate Variance = change in rate times old volume; Rate/ Volume
Variance =Change in rate times change in volume allocated to volume and
rate changes in proportion to the relationship of the absolute dollar
amounts of the change in each.
<PAGE> 8
PROVISION FOR LOAN LOSSES
The provision for loan losses is the amount added to the allowance for loan
losses to absorb losses that are currently anticipated.
The loan loss provision is based on historical loss experience and such other
factors, which, in management's judgment, deserve current recognition in
maintaining an adequate allowance for loan losses.
The provision for loan losses was $360,000 in 1998 compared to $395,000 and
$230,000 in 1997 and 1996, respectively. The provision was increased during 1997
to recognize weaknesses in the Bank's indirect auto loan portfolio. Those
weaknesses have since been addressed, and the Bank no longer participates in the
indirect auto loan market. The allowance for loan losses to total loan ratio was
1.73%, 1.66% and 1.49% for 1998, 1997 and 1996 respectively.
The Bank's loan portfolio continued to perform well during 1998. Net charge-offs
during 1998 were $80,000 compared to $155,000 in 1997.
NONINTEREST INCOME
Noninterest income was $1,458,000 for the year ended December 31, 1998. This
represents a $359,000 or 32.67% increase over 1997. The Bank benefited from a
full year's effect of deposit fee increases instituted during the second quarter
of 1997.
The low interest rate environment contributed to a heavy volume of mortgage loan
refinancing. Net gain on mortgage loan sales increased $205,000 or 115.17%. A
receivable financing program implemented during 1997 also contributed to the
increase in fee income during 1998. The Bank's other fee and service charge
structure remained unchanged during 1998.
In 1997, noninterest income increased $416,000 or 60.89% compared to 1996. The
increase in noninterest income was primarily attributed to three factors: a
general increase in service charges on deposit accounts, the addition of several
new deposit account service charges, increased gains on sales of mortgage loans
sold to the Federal Home Loan Mortgage Corporation (Freddie Mac) and the
addition of gains on sales of government guaranteed loans.
The increase in other deposit related service charges and fees aligned the
Bank's service charge structure with local competitors. The new fees included
activity charges on high volume, low balance corporate accounts, and the
surcharging of foreign ATM transactions. The improvement in Freddie Mac loan
sale gains was the result of better pricing of mortgage products and increased
origination volume.
The Bank also tested the secondary market for government guaranteed commercial
loans during 1997. These sales were conducted to identify an additional source
of liquidity and fee income.
The following table identifies the major sources of noninterest income and the
change for 1998, 1997 and 1996.
<TABLE>
<CAPTION>
Years ended December 31,
1998 1997 1996
- ----------------------------------------------------------------
(In thousands)
<S> <C> <C> <C>
Service charge and fees $ 485 $ 429 $ 292
Net gains on mortgage loan sales 383 178 21
Receivable financing fees 327 123 -
Net gains on government
guaranteed loan sales 12 42 -
Other 251 327 370
- ---------------------------------------------------------------
Total noninterest income $ 1,458 $ 1,099 $ 683
===============================================================
</TABLE>
<PAGE> 9
NONINTEREST EXPENSE
In the second quarter of 1997, management restructured the Bank to improve
efficiency and performance. Part of this process included:
reviewing branch performance, reducing full time equivalents and instituting
tighter controls over overhead costs. Nineteen ninety-eight benefited from this
process.
Noninterest expense decreased $694,000 or 11.83% compared to 1997. After
adjusting for the $547,000 related to the 1997 branch closings, noninterest
expense decreased $147,000 or 2.76%.
A small increase in 1997 noninterest expense compared to 1996 occurred despite
$547,000 in expenses associated with closing two supermarket branches and
expenses associated with severance packages paid in conjunction with a
management restructuring. Without the branch closing expense, 1997 noninterest
expense decreased $365,000 or 6.41% compared to 1996.
Full time equivalents (FTE's) increased to 71 at December 31, 1998 from 69 at
December 31, 1997. This increase represented the hiring of several employees for
positions that were vacant at December 31, 1997. The Bank received a full year's
benefit from the staff reduction in 1997. This helped control 1998 salary
expense.
FTE's were decreased from 95 at December 31, 1996 to 69 at December 31, 1997.
This reduction was the result of a general staff reduction, and the closing of
two supermarket branches. The reduction in FTE's helped decrease salaries and
employee benefits expense as a percentage of average assets to 1.46% in 1998
from 1.53% in 1997 and 1.84% in 1996.
Management reviewed fixed assets for impairment in 1997. As a result of this
review, approximately $40,000 in fixed assets were deemed impaired and disposed
of or written off. Management also reduced the estimated useful life of several
technology-related assets. The effects of these changes in useful lives
negatively impacted depreciation expense by approximately $70,000 in 1998. The
effect of the useful life changes occurred in the fourth quarter of 1997 and is
reflected in the increase of $128,000 or 21.44% increase in 1997 furniture and
equipment expense over 1996. Management sold the Bank's credit card portfolio in
the first quarter of 1998 and the merchant VISA program during the fourth
quarter of 1997. This reduced 1998 credit card processing fees by $97,000 or
75.78%.
Printing, postage and supplies expense decreased by $52,000 or 24.41% as a
result of better ordering practices, improved inventory management and a general
decrease in the need for supplies due to the closing of the two branches and the
general staff reduction.
During 1998, the Bank contracted with third parties for independent loan review
and compliance testing. The Bank also utilized the services of third parties to
assist with the assessment and remediation of Y2K related systems. As a result,
professional fees increased $36,000 or 16.74%.
<TABLE>
<CAPTION>
Years ended December 31,
1998 1997 1996
- -------------------------------------------------------------------
(In thousands)
<S> <C> <C> <C>
Salaries $ 2,057 $ 2,058 $ 2,283
Employee benefits 501 459 583
Occupancy 278 264 289
Furniture and equipment 722 725 597
Credit card processing 31 128 109
FDIC insurance 22 10 126
Other taxes 117 87 82
Printing and supplies 161 213 367
Postage 87 96 93
Telephone 113 110 121
Advertising 67 64 69
Other insurance 38 44 55
Branch closing costs - 547 -
Professional fees 251 215 220
Other expenses 728 847 691
- -------------------------------------------------------------------
Total noninterest expense $ 5,173 $ 5,867 $ 5,685
===================================================================
Efficiency Ratio 54.66% 65.88% 69.48%
===================================================================
Noninterest expense as percentage
of average assets 2.96% 3.57% 3.65%
==================================================================
Salaries and employee benefits as
a percentage of average assets 1.46% 1.53% 1.84%
==================================================================
</TABLE>
<PAGE> 10
INCOME TAX EXPENSE
Commercial's income tax expense was $924,000 in 1998 compared to $500,000 in
1997 and $316,000 in 1996. The increase from 1998 to 1997 was primarily the
result of increased income before income tax and a decrease in tax-exempt
interest income in relation to total pretax income.
The statutory federal tax rate during 1998, 1997 and 1996 was 34%. The
Corporation's effective tax rate was lower than the statutory rate in all three
years, primarily due to tax-exempt interest income. The reduction in tax-exempt
income in relation to taxable income caused the effective tax rate to increase
to 26.51% in 1998 from 22.80% in 1997. The effective tax rate in 1996 was
18.08%.
INVESTMENT PORTFOLIO
The following table shows, securities by classification as of December 31, 1998,
the amounts and weighted-average yields by maturity period:
<TABLE>
<CAPTION>
- --------------------------------------------------------------MATURING------------------------------------------------------------
Within After One But After Five But After
One Within Five Within Ten Ten
Year Years Years Years Total
(Dollars in thousands)
Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield
- ----------------------------------------------------------------------------------------------------------------------------------
AVAILABLE FOR SALE
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
U.S. Treasuries $1,012,813 5.40% $ - $ - $ - $ 1,012,813 5.40%
U.S. Government
agencies 3,566,093 5.83% 9,248,874 5.78% - 12,814,969 5.79%
State and municipal(1) 1,803,638 6.06% 768,369 6.52% 2,572,005 6.20%
Other securities 404,250 6.18% 507,812 5.92% - - 912,062 6.04%
- ----------------------------------------------------------------------------------------------------------------------------------
Total $4,983,156 $11,560,324 $ 768,369 $ $17,311,849
==================================================================================================================================
HELD TO MATURITY
U.S. Treasuries $ - $ - $ - $ - $ -
U.S. Government
agencies 1,000,125 5.80% - - - 1,000,125 5.80%
State and municipal(1) 1,613,789 7.57% 5,471,831 6.06% 3,836,688 7.80% 95,000 9.16% 11,017,308 7.63%
Other securities - - - - -
- ----------------------------------------------------------------------------------------------------------------------------------
Total $2,613,914 $ 5,471,831 $ 3,836,688 $ 95,000 $12,017,433
==================================================================================================================================
</TABLE>
(1) Yields on tax-exempt securities are computed on a fully taxable-equivalent
basis.
The Bank's Asset/Liability Management Committee (Committee) is responsible for
developing investment guidelines and strategies. The Committee relies on the
expertise of an investment advisor to select appropriate investments for the
portfolio.
The Committee does not invest in derivative securities. Commercial holds no
impaired securities at December 31, 1998. As of December 31, 1998, the aggregate
book value of investment securities issued by the State of Michigan and all its
political subdivisions totaled $9.9 million with an aggregate market value of
$10.4 million.
During 1997, the Committee elected to identify securities purchased as available
for sale. The available for sale classification allows management more
flexibility in managing interest rate risk and liquidity. Under most
<PAGE> 11
interest rate environments, management should be able to lengthen the maturities
of securities to improve yields without sacrificing liquidity. Previous
management identified all securities as held to maturity.
The U.S. Government Treasury and agency securities identified as available for
sale are laddered to mature more evenly over five years with a three year
average life. The goal is to reduce the volatility of the investment portfolio.
Management is currently faced with the challenge of replacing maturing
securities in a low rate environment with a historically flat yield curve. The
high percentage of securities maturing during 1998 made it difficult to maintain
the current yield on the investment portfolio, despite shifting the composition
of the portfolio from treasury securities to agency securities.
The book value of investment securities, as of the dates indicated, are
summarized as follows:
<TABLE>
<CAPTION>
December 31,
1 9 9 8 1 9 9 7
AVAILABLE HELD TO Available Held to
FOR SALE MATURITY for Sale Maturity
- -----------------------------------------------------------------
(In thousands)
<S> <C> <C> <C> <C>
U.S. Treasuries $ 1,013 $ - $1,999 $ 3,981
U.S. Government
agencies 12,815 1,000 5,034 2,016
State and municipal 2,572 11,017 - 12,417
Other 912 - 1,403 1,969
- -----------------------------------------------------------------
Total $ 17,312 $ 12,017 $8,436 $ 20,383
=================================================================
</TABLE>
LOAN PORTFOLIO
Commercial's management understands that credit risk is a fundamental element of
its business. Conservative lending philosophies supported by comprehensive
policies and administrative functions help the Bank's lenders adhere to strict
credit underwriting standards. Lending efforts are concentrated primarily in the
Michigan communities in which Commercial's branches are located. The Bank has no
foreign loans. Management continually monitors exposures to any single borrower,
as well as industry concentrations.
Total loans increased $11.3 million or 9.11% from year-end 1997 to 1998.
Commercial, real estate-construction and real estate-mortgage all increased
during 1998 as a result of strong demand and a stable economy. Commercial,
financial and agricultural loans increased $2.7 million or 3.94% in 1998. Real
estate-construction and real estate-mortgage loans increased $5.3 million or
89.75% and $7.8 million or 22.32% in 1998, respectively. The relatively low
interest rate environment experienced throughout 1997 and 1998 made it
advantageous to sell the majority of all fixed rate loans originated during the
year to the secondary market. The Bank originated approximately $16.1 million of
mortgage loans for sale to the secondary market in 1998, which compared to
approximately $11.0 million in 1997.
Consumer and other loans decreased $4.4 million or 27.81%. Previous management
aggressively priced and marketed indirect automobile paper. This lead to strong
growth in the consumer loan portfolio in prior years. An analysis of the quality
and profitability of the indirect paper in the second quarter of 1997 resulted
in the conclusion that the indirect market was both not profitable and posed
unnecessary underwriting risk to the Bank. The Bank's exit from this market
contributed to the decline in the consumer and other loan totals. The Bank has
also reduced lending authorities and tightened underwriting standards to
maintain credit quality.
The following table presents the amount of loans outstanding by loan type:
<TABLE>
<CAPTION>
December 31,
1998 1997
- --------------------------------------------------------
(In thousands)
<S> <C> <C>
Commercial, financial and
agricultural $ 70,272 $ 67,606
Real estate - construction 11,127 5,864
Real estate - mortgage 42,988 35,144
Consumer and other 11,483 15,907
- --------------------------------------------------------
Total loans $ 135,870 $ 124,521
========================================================
</TABLE>
<PAGE> 12
The following table shows the maturity of loans (excluding real estate-mortgage
and consumer and other loans) outstanding at December 31, 1998. Also provided
are the amounts due after one year classified according to their sensitivity to
changes in interest rates.
<TABLE>
<CAPTION>
Due Due
Due After One After Five Due
Within But Within But Within After
One Year Five Years Ten Years Ten Years Total
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Commercial, financial and agricultural $ 21,174 $ 39,020 $ 8,562 $ 1,516 $ 70,272
Real estate - construction 4,874 3,731 2,144 378 11,127
- -------------------------------------------------------------------------------------------------------------------
Total $ 26,048 $ 42,751 $ 10,706 $ 1,894 $ 81,399
===================================================================================================================
</TABLE>
<TABLE>
<S> <C>
Loans due after one year:
Fixed rate $ 35,799
Floating or adjustable rate 19,552
- ------------------------------------------------
Total $ 55,351
================================================
</TABLE>
ASSET QUALITY
Management believes that a conservative credit culture is critical to successful
Bank performance. Through Officer and Director Loan Committees, management
reviews and monitors the quality of the various loan portfolios. Low interest
rates and a strong local economy have contributed to an ideal lending
environment. Management also took steps to reduce credit risk during 1997 by
exiting the indirect automobile market and by restructuring credit authorities.
Loan performance is reviewed regularly by loan review personnel, loan officers
and senior management. During 1998 the Bank contracted with a third party for
periodic independent loan review services. Loans are placed on non-accrual
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, 1998 the Bank had $1,268,000 in domestic loans for which
payments are presently current, but the borrowers are experiencing financial
difficulties. Those loans are subject to ongoing management attention and their
classification is reviewed on a regular basis. As of December 31, 1998 there
were no concentrations of loans exceeding 10% of total loans.
The following table summarizes non-accrual, past due and restructured loans:
<TABLE>
<CAPTION>
December 31,
1998 1997
(In thousands)
- ------------------------------------------------------------------
<S> <C> <C>
Non-accrual loans $ 25 $ -
Accruing loans past due 90 days or more 30 -
Other real estate owned - -
Restructured loans 37 15
- ------------------------------------------------------------------
Total non-performing assets $ 92 $ 15
==================================================================
Total non-performing assets
as a percentage of total loans 0.07% .01%
==================================================================
</TABLE>
<PAGE> 13
ALLOWANCE FOR LOAN LOSSES
The following table summarizes changes in the allowance for possible loan
losses.
<TABLE>
<CAPTION>
Years ended December 31,
1998 1997
- ---------------------------------------------------------------------
(In thousands)
<S> <C> <C>
Loans
Amount of loans outstanding at
end of year $ 135,870 $ 124,521
=====================================================================
Daily average of loans
outstanding for the year $ 128,312 $ 124,710
=====================================================================
Balance of allowance at beginning of year $ 2,064 $ 1,824
Loans charged off:
Commercial, financial and agricultural (33) (44)
Real estate - mortgage -- --
Consumer and other (139) (234)
- ---------------------------------------------------------------------
Total loans charged off (172) (278)
Recoveries of loans previously charged off:
Commercial, financial, and agricultural 33 50
Real estate - mortgage 10 9
Consumer and other 49 64
- ---------------------------------------------------------------------
Total recoveries 92 123
- ---------------------------------------------------------------------
Net charge-offs (80) (155)
Provision for loan losses (1) 360 395
- ---------------------------------------------------------------------
Allowance at end of period $ 2,344 $ 2,064
=====================================================================
Ratio of net charge-offs during period to
average loans outstanding during
the period .06% .12%
=====================================================================
Ratio of allowance for loan losses to
loans outstanding at end of period 1.73% 1.66%
=====================================================================
</TABLE>
(1) The provision for loan losses charged to expense is based on loan loss
experience and other factors which, in management's judgment, deserve
current recognition in maintaining an adequate allowance for loan losses.
These other factors include, but are not limited to, a review of current
economic conditions as they relate to loan collectibility and reviews of
specific loans to evaluate their collectibility.
The allowance for loan losses has been allocated according to the amount deemed
to be reasonably necessary to provide for the probability of losses being
incurred as follows:
<TABLE>
<CAPTION>
December 31,
1 9 9 8 1 9 9 7
PERCENT Percent
OF LOANS of Loans
TO TOTAL to Total
ALLOWANCE LOANS Allowance Loans
- ---------------------------------------------------------------------
(In thousands)
<S> <C> <C> <C> <C>
Commercial, financial
and agricultural $ 596 51.72% $ 704 54.29%
Real estate - construction -- 8.19 -- 4.71
Real estate - mortgage 96 31.64 89 28.22
Consumer and other 362 8.45 512 12.78
Unallocated 1,290 -- 759 --
- ---------------------------------------------------------------------
Total $ 2,344 100.00% $2,064 100.00%
=====================================================================
</TABLE>
[BONNIE AND KATIE]
LIQUIDITY
Liquidity is generally defined as the ability to meet cash flow needs of
customers for loans and deposit withdrawals. To meet cash flow requirements,
sufficient resources of liquid funds must be available. These sources include
short-term investments, repayments of loans, maturing and called securities,
sales of assets, growth in deposits and other liabilities and Bank profits.
<PAGE> 14
At December 31, 1998, the Bank had $4 million in federal funds sold and $17.3
million in securities classified as available for sale. The Bank also has $12.5
million of additional borrowing capacity at the Federal Home Loan Bank and $6.0
million of borrowing capacity with correspondent banks. During 1998, the Banks
also generated $4.8 million in cash from operating activities. All of these
sources are available to meet cash flow needs of loan and deposit customers.
The Corporation also needs cash to pay dividends to its shareholders. The
primary source of cash is the dividends paid to the parent by the Bank.
Management believes that cash from operations is sufficient to supply the cash
needed to continue paying a reasonable dividend.
CAPITAL RESOURCES
At December 31, 1998, the capital of the Corporation totaled $17,660,000.
Management monitors the capital levels of the Corporation and the Bank to
provide for current and future business opportunities and to meet regulatory
guidelines for "well capitalized" institutions. "Well capitalized" institutions
are eligible for reduced FDIC premiums, and also enjoy other reduced regulatory
restrictions.
At December 31, 1998, the Corporation and the Bank exceeded all regulatory
minimum capital requirements and are considered to be "well capitalized".
ASSET LIABILITY MANAGEMENT
Commercial's static gap position at December 31, 1998 is illustrated in the
following table:
<TABLE>
<CAPTION>
0-90 days 91-365 days 1-5 years Over 5 years Total
- --------------------------------------------------------------------------------------------------------------
(In thousands)
<S> <C> <C> <C> <C> <C>
INTEREST-EARNING ASSETS:
Federal funds sold $ 4,000 $ - $ - $ - $ 4,000
Securities 1,705 5,790 16,790 4,670 28,955
Loans receivable 11,303 18,788 66,882 38,896 135,869
Federal Home Loan Bank stock 1,391 - - - 1,391
- ----------------------------------------------------------------------------------------------------------------
Total interest-earning assets 18,399 24,578 83,672 43,566 170,215
INTEREST-BEARING LIABILITIES:
Demand deposits 25,462 - - - 25,462
Savings deposits 38,783 - - - 38,783
Time deposits 16,024 24,124 16,484 249 56,881
Securities sold under agreements
to repurchase 6,965 - - - 6,965
U.S. Treasury demand notes 1,553 - - - 1,553
Federal Home Loan Bank advances 2,000 2,000 6,500 1,000 11,500
- ----------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 90,787 26,124 22,984 1,249 141,144
- ----------------------------------------------------------------------------------------------------------------
Asset (liability) gap $ (72,388) $ ( 1,546) $ 60,688 $ 42,317 $ 29,071
================================================================================================================
Cumulative asset (liability) gap $ (72,388) $ (73,934) $ (13,246) $ 29,071
=================================================================================================
</TABLE>
Asset liability management involves developing, implementing and monitoring
strategies to maintain sufficient liquidity, maximize net interest income and
minimize the impact that significant fluctuations in market interest rates would
have on earnings. Commercial's Asset/Liability Committee is responsible for
managing the process.
<PAGE> 15
As shown, Commercial had a $72.4 million cumulative liability gap position
within the one year timeframe. This implies that if interest rates drop, the
Bank has the potential to earn more net interest income. However, there are
significant limitations to the static gap model.
The static gap does not consider the timing or magnitude of non-contractual
repricing. As a general rule, residential real estate, consumer and most
business loan contracts do not include prepayment penalties. In a falling rate
environment, loan customers will refinance existing loans at lower rates without
regard for the contractual maturity of the loan agreement. Taking into account
the effect of interest rate sensitivity and other factors, management believes
that the Bank's margin is exposed to decreases in interest rates. Margin has
decreased since 1996 from 5.09% to 5.00% in 1997 to 4.84% in 1998. This decrease
occurred in a generally falling rate environment.
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 director 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.
<PAGE> 16
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 are often used for
this purpose. Because these instruments are sensitive to interest rate changes,
they require management's 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 repayment risk in falling rate
environments. For example, mortgage loans and other financial assets may be
prepaid by a debtor so that the debtor may refinance their obligations at new,
lower rates. Prepayments of assets carrying higher rates reduce the
Corporation's interest income and overall asset yields.
Principal/notional amount as of December 31, 1998 maturing in:
<TABLE>
<CAPTION>
Fair
1999 2000 2001 2002 2003 Thereafter Total Value
- ------------------------------------------------------------------------------------------------------------------------------------
(In thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
RATE SENSITIVE ASSETS
Federal funds sold $ 4,000 $ -- $ -- $ -- $ -- $ -- $ 4,000 $ 4,000
Average interest rate 5.00% -- -- -- -- -- 5.00%
Fixed interest rate securities 5,495 5,030 4,810 3,760 3,190 6,670 28,955 29,821
Average interest rate 6.44% 6.20% 6.04% 6.29% 6.67% 7.12% 6.49%
FHLB stock 1,391 -- -- -- -- -- 1,391 1,391
Average interest rate 8.00% -- -- -- -- -- 8.00%
Fixed interest rate loans 8,709 8,960 14,152 8,870 2,125 18,263 81,079 81,327
Average interest rate 12.12% 9.50% 8.81% 8.71% 8.50% 7.73% 8.90%
Variable interest rate loans 21,679 2,806 2,381 4,881 2,410 20,633 54,790 54,790
Average interest rate 9.00% 8.97% 8.86% 8.75% 8.80% 7.63% 8.45%
RATE SENSITIVE LIABILITIES
Interest-bearing demand 25,462 -- -- -- -- -- 25,462 25,462
Average interest rate 1.79% -- -- -- -- -- 1.79%
Savings 38,783 -- -- -- -- -- 38,783 38,783
Average interest rate 2.59% -- -- -- -- -- 2.59%
Time deposits 40,148 10,511 3,129 1,591 1,252 250 56,881 57,577
Average interest rate 4.76% 4.88% 5.14% 4.66% 4.91% 5.29% 4.75%
Variable interest rate securities
sold under agreements
to repurchase 6,965 -- -- -- -- -- 6,965 6,965
Average interest rate 4.66% -- -- -- -- -- 4.66%
Variable interest rate U.S.
Treasury demand notes 1,553 -- -- -- -- -- 1,553 1,553
Average interest rate 4.42% -- -- -- -- -- 4.42%
Fixed interest rate FHLB advances 3,000 4,000 1,000 -- 2,500 -- 10,500 10,248
Average interest rate 6.11% 6.40% 6.50% -- 5.30% -- 6.01%
Variable interest rate FHLB advances 1,000 -- -- -- -- -- 1,000 1,000
Average interest rate 4.95% -- -- -- -- -- 4.95%
</TABLE>
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
<PAGE> 17
borrowings provide additional sources of liquidity for the Corporation.
The above table provides information about the Corporation's financial
instruments that are sensitive to changes in interest rates as of December 31,
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.
YEAR 2000 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
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-IV. Phase V and VI are
substantially complete. Final remediation of critical systems should be
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.
During 1998 we purchased and upgraded software and hardware specifically to
address the Y2K issue of $15,000. In addition, we have contracted with third
parties to test and remediate various systems within the Bank. This includes,
but is not limited to, the testing of personal computers, software and hardware
used to maintain customers records, imaging software and hardware, etc. The cost
of using these third parties was $19,000.
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.
<PAGE> 18
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 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.
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.
Included in the modified disaster plan are purchasing an emergency electrical
generator, and increasing available sources of liquidity. Modifications to the
plan should be completed by March 31, 1999.
FORWARD LOOKING STATEMENT
This discussion and analysis of financial condition and results of operations
and other sections of this Annual Report contain forward looking statements that
are based on management's beliefs, assumptions, current expectations, estimates
and projections about the financial services industry, the economy and about the
Corporation itself.
Words such as "anticipates", "believes", "estimates", "expects", "forecasts",
"foresee", "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, Commercial undertakes no obligation to update, amend or clarify
forward-looking statements, whether as a result of new information, future
events or otherwise.
Future Factors include:
- - changes in interest rates and interest rate relationships; demand for
products and services;
- - the degree of competition by traditional and non-traditional competitors;
- - changes in banking regulations;
- - changes in tax laws;
- - changes in prices, levies and assessments;
- - the impact of technology, governmental and regulatory policy changes;
- - the outcome of pending and future litigation and contingencies;
- - trends in customer behavior as well as their ability to repay loans; and
- - changes in 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.
<PAGE> 19
COMMERCIAL NATIONAL FINANCIAL CORPORATION
REPORT OF INDEPENDENT AUDITORS
[CROWE LOGO]
Board of Directors and Shareholders
Commercial National Financial Corporation
Ithaca, Michigan
We have audited the accompanying consolidated balance sheets of Commercial
National Financial Corporation as of December 31, 1998 and 1997, and the related
consolidated statements of income, shareholders' equity and cash flows for each
of the years ended December 31, 1998, 1997 and 1996. These financial statements
are the responsibility of the Corporation's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with 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 audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Commercial National
Financial Corporation as of December 31, 1998 and 1997, and the results of its
operations, and its cash flows for each of the years ended December 31, 1998,
1997 and 1996 in conformity with generally accepted accounting principles.
Crowe, Chizek and Company LLP
South Bend, Indiana
February 4, 1999
<PAGE> 20
COMMERCIAL NATIONAL FINANCIAL CORPORATION
MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL STATEMENTS
Management is responsible for the preparation of the Commercial National
Financial Corporation's consolidated financial statements and related
information appearing in this Annual Report. Management believes that the
consolidated financial statements fairly reflect the form and substance of
transactions and reasonably present Commercial National Financial Corporation's
financial position and results of operations and were prepared in conformity
with generally accepted accounting principles. Management also has included in
the Corporation's financial statements, amounts that are based on estimates and
judgments which it believes are reasonable under the circumstances.
Commercial National Financial Corporation maintains a system of internal
controls designed to provide reasonable assurance that all assets are
safeguarded and financial records are reliable for preparing the consolidated
financial statements. The Corporation complies with laws and regulations
relating to safety and soundness which are designated by the FDIC and other
appropriate federal banking agencies. The selection and training of qualified
personnel and the establishment and communication of accounting and
administrative policies and procedures are elements of this control system. The
effectiveness of internal controls is monitored by a program of internal audit
and by independent certified public accountants. Management recognizes that the
cost of a system of internal controls should not exceed the benefits derived and
that there are inherent limitations to be considered in the potential
effectiveness of any system. Management believes that Commercial National
Financial Corporation's system provides the appropriate balance between costs of
controls and the related benefits.
The independent auditors have audited the Corporation's consolidated financial
statements in accordance with generally accepted auditing standards and provide
an objective, independent review of the fairness of the reported operating
results and financial position. The Board of Directors of Commercial National
Financial Corporation has an Audit Committee composed of six non-management
Directors. The Committee meets periodically with the internal auditors and the
independent auditors.
Jeffrey S. Barker
President and
Chief Executive Officer
Patrick G. Duffy
Vice President and
Chief Financial Officer
<PAGE> 21
COMMERICAL NATIONAL FINANCIAL CORPORATION
<TABLE>
<CAPTION>
CONSOLIDATED BALANCE SHEETS
December 31
1998 1997
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
Cash and due from banks $ 8,555,428 $ 5,576,724
Federal funds sold 4,000,000 9,600,000
- ------------------------------------------------------------------------------------------------------------------------
Total cash and cash equivalents 12,555,428 15,176,724
Securities available for sale 17,311,849 8,436,349
Securities held to maturity (fair value $12,510,000 - 1998, $20,847,000 - 1997) 12,017,433 20,383,446
Federal Home Loan Bank stock, at cost 1,391,300 1,391,300
Loans receivable, net of allowance for loan losses $2,343,976 - 1998,
$2,063,668 - 1997 133,525,631 122,457,789
Premises and equipment, net 2,790,001 3,188,743
Accrued interest receivable and other assets 1,503,999 1,370,472
- ------------------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $ 181,095,641 $ 172,404,823
========================================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Deposits
Noninterest-bearing demand $ 20,048,154 $ 17,102,386
Interest-bearing demand 25,461,761 22,076,363
Savings 38,783,466 35,523,362
Time 56,881,316 59,244,780
- ------------------------------------------------------------------------------------------------------------------------
Total deposits 141,174,697 133,946,891
Securities sold under agreements to repurchase 6,965,058 4,151,844
U.S. Treasury demand notes 1,552,997 2,753,486
Federal Home Loan Bank advances 11,500,000 13,000,000
Accrued expenses and other liabilities 2,242,787 1,669,460
- ------------------------------------------------------------------------------------------------------------------------
Total liabilities 163,435,539 155,521,681
Shareholders' equity
Common stock and paid-in-capital, no par value-1998, $1 par -1997:
1,750,000 shares authorized; shares issued
and outstanding 1998 - 994,331 and 1997 - 954,322 17,525,466 16,231,861
Retained earnings (deficit) (8,483) 647,697
Accumulated other comprehensive income, net of tax 143,119 3,584
- ------------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 17,660,102 16,883,142
- ------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 181,095,641 $ 172,404,823
========================================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE> 22
================================================================================
COMMERCIAL NATIONAL FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
Years ended December 31
1998 1997 1996
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Interest and dividend income
Loans receivable, including fees $ 11,315,309 $ 11,269,750 $ 10,328,228
Taxable securities 934,747 667,930 956,006
Nontaxable securities 733,098 725,491 729,396
Federal funds sold 351,723 274,965 185,564
Federal Home Loan Bank stock dividends 111,409 105,098 56,982
- -------------------------------------------------------------------------------------------------------------------
Total interest and dividend income 13,446,286 13,043,234 12,256,176
Interest expense
Deposits 4,778,263 4,674,419 4,665,374
Securities sold under agreements to repurchase 295,611 305,330 293,689
Federal Home Loan Bank advances 789,975 680,023 283,428
Other 23,704 29,504 34,715
- -------------------------------------------------------------------------------------------------------------------
Total interest expense 5,887,553 5,689,276 5,277,206
- -------------------------------------------------------------------------------------------------------------------
NET INTEREST INCOME 7,558,733 7,353,958 6,978,970
Provision for loan losses 360,000 395,000 230,000
- -------------------------------------------------------------------------------------------------------------------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 7,198,733 6,958,958 6,748,970
- -------------------------------------------------------------------------------------------------------------------
Noninterest income
Service charges and fees 484,521 429,349 291,903
Net gains on loan sales 394,762 219,935 21,307
Receivable financing fees 327,161 123,363 -
Other 251,687 326,783 370,130
- -------------------------------------------------------------------------------------------------------------------
Total noninterest income 1,458,131 1,099,430 683,340
- -------------------------------------------------------------------------------------------------------------------
Noninterest expense
Salaries and employee benefits 2,557,625 2,516,696 2,865,591
Occupancy and equipment 1,000,482 989,213 886,080
FDIC insurance 22,047 9,925 125,619
Branch closing costs - 546,614 -
Printing, postage and supplies 247,876 309,718 460,220
Professional and outside services 251,417 214,636 219,615
Other 1,093,866 1,279,826 1,127,433
- -------------------------------------------------------------------------------------------------------------------
Total noninterest expense 5,173,313 5,866,628 5,684,558
- -------------------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAX EXPENSE 3,483,551 2,191,760 1,747,752
Income tax expense 923,537 499,650 316,000
- -------------------------------------------------------------------------------------------------------------------
NET INCOME $ 2,560,014 $ 1,692,110 $ 1,431,752
===================================================================================================================
Per share information
Basic earnings $ 2.54 $ 1.72 $ 1.50
Diluted earnings $ 2.53 $ 1.71 $ 1.49
Dividends declared $ 1.47 $ 1.18 $ 1.03
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE> 23
COMMERCIAL NATIONAL FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Years ended December 31, 1998, 1997and 1996
<TABLE>
<CAPTION>
Accumulated
Other Total
Common Retained Comprehensive Shareholders'
Stock and Paid Earnings Income Net Equity
In Capital (Deficit) of Tax
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
BALANCE AT JANUARY 1, 1996 $ 12,439,407 $ 2,203,281 $ 14,642,688
Net income 1,431,752 1,431,752
Cash dividends declared, $1.03 per share (978,958) (978,958)
Issued 41,457 shares in payment of 5% stock dividend 1,153,324 (1,156,653) (3,329)
Issued 11,852 shares under dividend reinvestment program 296,530 296,530
Issued 4,995 shares under stock option plans 107,144 107,144
Repurchase of 6 shares (164) (164)
- -----------------------------------------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 1996 13,996,241 1,499,422 15,495,663
Comprehensive income:
Net income 1,692,110 1,692,110
Net change in unrealized gains on securities
available for sale $ 5,430 5,430
Tax effect (1,846) (1,846)
--------------------------------
Total other comprehensive income 3,584 3,584
-------------------------------
Total comprehensive income 1,695,694
Cash dividends declared, $1.18 per share (1,171,442) (1,171,442)
Issued 45,246 shares in payment of 5% stock dividend 1,368,669 (1,372,393) (3,724)
Issued 14,839 shares under dividend reinvestment program 390,739 390,739
Issued 21,255 shares under stock option plans 476,212 476,212
- -----------------------------------------------------------------------------------------------------------------------
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
=======================================================================================================================
</TABLE>
See financial notes to consolidated financial statements.
<PAGE> 24
COMMERCIAL NATIONAL FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31, 1998, 1997 and 1996
<TABLE>
<CAPTION>
1998 1997 1996
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 2,560,014 $ 1,692,110 $ 1,431,752
Adjustments to reconcile net income to net
cash from operating activities
Provision for loan losses 360,000 395,000 230,000
Net gains on loan sales (394,762) (219,935) (21,307)
Originations of loans held for sale (16,139,058) (11,069,099) (4,164,440)
Proceeds from sales of loans held for sale 17,234,909 10,898,784 4,185,747
Depreciation, amortization and accretion 728,296 404,668 579,699
Net change in accrued interest receivable and other assets (129,818) 488,214 (239,718)
Net change in accrued expenses and other liabilities 490,275 482,802 225,963
- -----------------------------------------------------------------------------------------------------------------------
Net cash from operating activities 4,709,856 3,072,544 2,227,696
- -----------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of securities available for sale (15,729,554) (8,422,708) -
Purchases of securities held to maturity - (4,454,227) (6,433,248)
Proceeds from maturities of securities held to maturity 8,385,000 9,560,000 10,430,000
Proceeds from maturities of securities available for sale 7,000,000 - -
Purchases of Federal Home Loan Bank stock - (128,900) (825,900)
Net change in loans (12,307,032) (1,980,964) (13,120,723)
Purchases of premises and equipment, net (180,560) 344,157 (1,159,833)
- ------------------------------------------------------------------------------------------------------------------------
Net cash from investing activities (12,832,146) (5,082,642) (11,109,704)
- ------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net change in deposits 7,227,806 930,069 3,315,543
Net change in securities sold under agreements to repurchase 2,813,214 (1,450,402) 296,811
Net change in U.S. Treasury demand notes (1,200,489) 1,811,518 381,977
Proceeds from Federal Home Loan Bank advances 10,500,000 7,000,000 10,000,000
Repayment of Federal Home Loan Bank advances (12,000,000) (4,000,000) -
Dividends paid and fractional shares (1,397,768) (1,122,158) (940,346)
Proceeds from sale of common stock 670,543 866,951 403,674
Repurchase of shares of common stock (1,112,312) - (164)
- ------------------------------------------------------------------------------------------------------------------------
Net cash from financing activities 5,500,994 4,035,978 13,457,495
- -----------------------------------------------------------------------------------------------------------------------
Net change in cash and cash equivalents (2,621,296) 2,025,880 4,575,487
Cash and cash equivalents, at beginning of year 15,176,724 13,150,844 8,575,357
- -----------------------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS, AT END OF YEAR $ 12,555,428 $ 15,176,724 $ 13,150,844
=======================================================================================================================
Cash paid during the year for
Interest $ 5,937,086 $ 5,624,266 $ 5,448,854
Federal income taxes 740,000 469,250 286,455
- -----------------------------------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE> 25
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998, 1997 and 1996
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accounting and reporting policies of Commercial National Financial
Corporation (the Corporation) and its wholly-owned subsidiary,
Commercial Bank (the Bank) (together referred to as the Corporation), 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, the Bank and CNFC Financial Services Inc., a
wholly-owned subsidiary of the Bank. Intercompany accounts and transactions are
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 maturities of 90 days or less and
U.S. Treasury demand notes.
SECURITIES Securities are classified as held to maturity and carried at
amortized cost when management has the positive intent and ability to hold them
to maturity. Securities are classified as available for sale when they might be
sold before maturity. Securities available for sale are carried at fair value,
with net unrealized holding gains and losses reported in other comprehensive
income and shareholder 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.
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
<PAGE> 26
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
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.
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. Other real estate owned amounted to $0 and $0 at
December 31, 1998 and 1997, respectively.
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. Goodwill and
identified intangibles amounted to $0 and $25,841 at December 31, 1998 and 1997,
respectively.
<PAGE> 27
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
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. Proforma disclosures of
net income and earnings per share are provided as if the option's fair value had
been recorded using an option pricing model.
INCOME TAXES Income tax expense is the sum of the current year income tax due or
refundable and the change in deferred tax assets and liabilities. Deferred tax
assets and liabilities are the expected future tax consequences of temporary
differences between the carrying amounts and tax bases of assets and
liabilities, computed using enacted tax rates. A valuation allowance, if needed,
reduces deferred tax assets to the amount expected to be realized.
EARNINGS AND DIVIDENDS PER SHARE Basic earnings per common share is based on net
income divided by the weighted average number of common shares outstanding
during the period. Diluted earnings per common share shows the dilutive effect
of any additional potential common shares. Earnings and dividends per common
share are restated for all stock splits and stock dividends, including the 5%
stock dividends paid in November 1998, 1997 and 1996.
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 Comprehensive income consists of net income and other
comprehensive income. Other comprehensive income includes the net change in
unrealized appreciation (depreciation) on securities available for sale, net of
tax, which is also recognized as a separate component of shareholders' equity.
The accounting standard that requires reporting comprehensive income first
applies for 1998, with prior information restated to be comparable.
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.
<PAGE> 28
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
NOTES 2 - SECURITIES
The amortized cost and fair value of securities identified as available for sale
are as follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1998
- ---------------------------------------------------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
U.S. TREASURIES $ 1,007,974 $ 4,839 $ - $ 1,012,813
U.S. GOVERNMENT AGENCIES 12,654,920 160,049 12,814,969
STATE AND MUNICIPALS 2,529,666 42,339 2,572,005
CORPORATE 902,441 9,621 912,062
- ----------------------------------------------------------------------------------------------------------
TOTAL $ 17,095,001 $ 216,848 $ - $ 17,311,849
==========================================================================================================
</TABLE>
<TABLE>
<CAPTION>
December 31, 1997
- ----------------------------------------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
U.S. Treasuries $ 1,995,580 $ 3,482 $ - $ 1,999,062
U.S. Government agencies 5,029,062 7,902 (2,519) 5,034,445
State and municipals - - - -
Corporate 999,321 - (4,729) 994,592
Other securities 406,956 1,294 - 408,250
- ----------------------------------------------------------------------------------------------------------
Total $ 8,430,919 $ 12,678 $ (7,248) $ 8,436,349
==========================================================================================================
</TABLE>
The amortized cost and fair value of securities identified as held to maturity
are as follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1998
- ----------------------------------------------------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
U.S. GOVERNMENT AGENCIES $ 1,000,125 $ 875 $ - $ 1,001,000
STATE AND MUNICIPALS 11,017,308 491,692 - 11,509,000
CORPORATE - - - -
- ----------------------------------------------------------------------------------------------------------
TOTAL $ 12,017,433 $ 492,567 $ - $ 12,510,000
==========================================================================================================
<CAPTION>
December 31, 1997
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
U.S. Treasuries $ 3,980,642 $ 15,358 $ - $ 3,996,000
U.S. Government agencies 2,015,945 777 (9,722) 2,007,000
State and municipals 12,417,335 463,665 - 12,881,000
Other securities 1,969,524 - (6,524) 1,963,000
- ----------------------------------------------------------------------------------------------------------
Total $ 20,383,446 $ 479,800 $ (16,246) $ 20,847,000
==========================================================================================================
</TABLE>
<PAGE> 29
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
The amortized cost and fair value of debt securities at year-end 1998, by
contractual maturity are shown below.
<TABLE>
<CAPTION>
Available for Sale Held to Maturity
- ----------------------------------------------------------------------------------------------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Due in one year or less $ 4,955,173 $ 4,983,156 $ 2,613,914 $ 2,635,000
Due from one to five years 11,389,768 11,560,324 5,471,831 5,693,000
Due from five to ten years 750,060 768,369 3,836,688 4,079,000
Due after ten years - - 95,000 103,000
- ----------------------------------------------------------------------------------------------------------
Total $ 17,095,001 $ 17,311,849 $ 12,017,433 $ 12,510,000
==========================================================================================================
</TABLE>
There were no sales of securities during 1998, 1997 and 1996.
In addition to Federal Home Loan Bank (FHLB) stock, securities having an
amortized cost of approximately $18,400,000 and $15,198,000 at year end 1998 and
1997 were pledged to secure FHLB advances, public deposits, securities sold
under agreements to repurchase and U.S. Treasury demand notes.
Except as indicated, total securities of any state (including all its political
subdivisions) were less than 10% of shareholders' equity. At year-end 1998 and
1997, the amortized cost of securities issued by the state of Michigan and all
its political subdivisions totaled $9,892,000 and $9,546,000 with an estimated
market value of $10,350,000 and $9,933,000, respectively.
NOTE 3 - LOANS RECEIVABLE
Year-end loans receivable are as follows:
<TABLE>
<CAPTION>
1998 1997
- -------------------------------------------------------------------
<S> <C> <C>
Real estate
Secured by single family
residential properties $42,988,361 $ 35,144,378
Secured by non-farm
nonresidential properties 41,199,791 40,745,864
Secured by farmland 4,796,595 4,740,489
Secured by multi-family
residential properties 5,607,091 5,509,556
Construction and land development 11,126,942 5,864,433
Consumer
Installment loans 11,482,473 15,172,025
Credit card and related plans - 734,634
Commercial 18,668,354 16,610,078
- -------------------------------------------------------------------
Gross loans receivable 135,869,607 124,521,457
Allowance for loan losses (2,343,976) (2,063,668)
- -------------------------------------------------------------------
Net loans receivable $133,525,631 $122,457,789
===================================================================
</TABLE>
Loans held for sale, included in real estate secured by single family
residential properties, were $809,000 and $390,000 at year-end 1998 and 1997.
Certain directors and executive officers of the Corporation, including
associates of such persons, were loan customers of the Corporation during 1998
and 1997. A summary of aggregate related party loan activity for loans
aggregating $60,000 or more to any related party is as follows:
<TABLE>
<CAPTION>
1998 1997
- -----------------------------------------------------------
<S> <C> <C>
Balance at beginning of year $ 4,149,000 $ 3,998,000
New loans 11,578,000 12,859,000
Repayments (11,361,000) (12,725,000)
Other changes, net (188,000) 17,000
- -----------------------------------------------------------
Balance at end of year $ 4,178,000 $ 4,149,000
===========================================================
</TABLE>
Other changes include adjustments for persons included in one reporting period
that are not reported in the other reporting period.
<PAGE> 30
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
Activity in the allowance for loan losses was as follows:
<TABLE>
<CAPTION>
1998 1997 1996
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Beginning balance $ 2,063,668 $ 1,824,080 $ 1,668,555
Loan charge-offs (171,467) (278,129) (175,051)
Loan recoveries 91,775 122,717 100,576
- -----------------------------------------------------------------------------
Net loan charge-offs (79,692) (155,412) (74,475)
Provision for loan losses 360,000 395,000 230,000
- -----------------------------------------------------------------------------
Ending balance $ 2,343,976 $ 2,063,668 $ 1,824,080
=============================================================================
</TABLE>
Impaired loans were as follows:
<TABLE>
<CAPTION>
1998 1997
- --------------------------------------------------------------
<S> <C> <C>
Year-end loans with allowance for
loan losses allocated $ 54,694 $ --
Year-end loans with no allowance
for loan losses allocated -- --
- --------------------------------------------------------------
Total impaired loans $ 54,694 $ --
==============================================================
Amount of the allowance allocated $ -- $ --
Average balance of impaired loans
during the year 50,640 60,580
Interest income recognized during
impairment 2,115 2,542
Cash-basis interest income
recognized -- 5,574
</TABLE>
At year-end 1998 and 1997, there were no nonaccrual loans.
NOTE 5 - LOAN SERVICE
Mortgage loans serviced for others are not reported as assets. These loans
totaled $36,156,000 and $31,689,000 at year-end 1998 and 1997. Related escrow
deposit balances were approximately $(7,000) and $(20,000) at year-end 1998 and
1997.
NOTE 6 - PREMISES AND EQUIPMENT, NET
Year-end premises and equipment consist of:
<TABLE>
<CAPTION>
1998 1997
- -----------------------------------------------------------
<S> <C> <C>
Land $ 310,689 $ 310,689
Buildings and improvements 2,937,780 2,889,651
Equipment 3,310,811 3,455,082
- ------------------------------------------------------------
Total cost 6,559,280 6,655,422
Less accumulated depreciation (3,769,279) (3,466,679)
Net premises and equipment $ 2,790,001 $ 3,188,743
============================================================
</TABLE>
Depreciation expense was $578,045, $514,474 and $431,784 in 1998, 1997 and 1996,
respectively.
<PAGE> 31
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
NOTE 7 - DEPOSITS
At year-end 1998, stated maturities of time deposits were as follows, for the
years ending December 31:
<TABLE>
<S> <C>
1999 $ 40,148,258
2000 10,511,320
2001 3,129,121
2002 1,591,076
2003 1,252,103
Thereafter 249,438
- -------------------------------------------------------
Total time deposits $ 56,881,316
=======================================================
</TABLE>
Time deposits in denominations of $100,000 or more were $12,871,000 and
$13,930,000 at year-end 1998 and 1997.
At year-end 1998, stated maturities of time deposits in denominations of
$100,000 or more were as follows:
<TABLE>
<S> <C>
In 3 months or less $ 6,580,000
Over 3 through 6 months 2,375,000
Over 6 through 12 months 2,643,000
Over 12 months 1,273,000
- -----------------------------------------------------
Total deposits > $100,000 $ 12,871,000
=====================================================
</TABLE>
Related party deposits were $1,716,000 and $1,522,000 at year-end 1998 and 1997.
NOTE 8 - BORROWINGS
SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
Information concerning securities sold under agreements to repurchase is
summarized as follows:
<TABLE>
<CAPTION>
1998 1997
- --------------------------------------------------------
<S> <C> <C>
Amount outstanding at
year-end $ 6,965,058 $ 4,151,844
Weighted average interest
rate at year-end 4.55% 5.29%
Average daily balance
during the year $ 5,842,000 $ 5,777,000
Weighted average interest
rate during the year 5.07% 5.28%
Maximum month end
balance during the year $ 7,244,000 $ 8,987,000
</TABLE>
FEDERAL HOME LOAN BANK ADVANCES
Federal Home Loan Bank (FHLB) advances totaled $11,500,000 at year-end 1998. A
majority of the advances have fixed interest rates ranging from 5.04% to 6.66%.
The advance with a variable rate is based on the FHLB overnight discount rate
plus 30 basis points.
Pursuant to collateral agreements with the Federal Home Loan Bank, in addition
to Federal Home Loan Bank stock, advances are secured under a blanket lien
arrangement by qualified 1-to-4 family mortgage loans and U.S. Government agency
securities with a carrying value of approximately $42,681,000 at year-end 1998.
At year-end 1998, scheduled principal reductions on these advances were as
follows for the years ending December 31:
<TABLE>
<S> <C>
1999 $ 4,000,000
2000 4,000,000
2001 1,000,000
2002 -
2003 1,500,000
Thereafter 1,000,000
- -------------------------------------------------------
Total FHLB advances $ 11,500,000
=======================================================
</TABLE>
<PAGE> 32
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
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
Corporation's annual contribution to the plan is based solely on the discretion
of the Corporation's board of directors. Historically, the Corporation has
matched 100% of the elective deferrals on the first 6% of the participant's
compensation. Employee and employer contributions are vested immediately. The
plan covers substantially all employees of the Corporation.
Contributions attributable to the plan were approximately $88,000, $72,000 and
$92,000 in 1998, 1997 and 1996. Expense related to the plan was approximately
$86,000, $51,000 and $113,000 in 1998, 1997 and 1996.
STOCK OPTION PLANS SFAS No. 123, Accounting for Stock-Based Compensation, 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 basic and diluted 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, no compensation cost was actually recognized for stock
options in 1998, 1997 and 1996.
The fair value of options granted during 1998, 1997 and 1996 is estimated using
the following weighted-average information: risk-free interest rate of 4.52%,
6.00% and 6.15%, respectively, expected life of 5.4, 4.0 and 3.9 years,
respectively, expected dividends of 4.0% per year, and nominal expected stock
price volatility.
<TABLE>
<CAPTION>
1998 1997 1996
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Net income as reported $ 2,560,014 $ 1,692,110 $ 1,431,752
Proforma net income 2,528,496 1,674,677 1,420,533
- --------------------------------------------------------------------------------
Basic earnings per share
as reported $ 2.54 $ 1.72 $ 1.50
Proforma basic earnings
per share 2.51 1.70 1.49
- --------------------------------------------------------------------------------
Diluted earnings per
share as reported 2.53 1.71 1.49
Proforma diluted
earnings per share 2.50 1.70 1.48
- --------------------------------------------------------------------------------
</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 1998, 54,201
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 1996 25,013 $ 18.87
Granted 12,380 24.19
Exercised (5,773) 18.55
Forfeited (243) 20.56
- -------------------------------------------------------
Outstanding, end of 1996 31,376 21.02
Granted 10,697 24.94
Exercised (23,248) 20.48
Forfeited (846) 22.78
- -------------------------------------------------------
OUTSTANDING, END OF 1997 17,979 24.11
GRANTED 9,928 36.49
EXERCISED (4,943) 24.75
- -------------------------------------------------------
OUTSTANDING, END OF 1998 22,964 $ 29.37
=======================================================
</TABLE>
The weighted-average fair value of options granted in 1998, 1997 and 1996 was
$3.17, $1.63 and $1.92, respectively. At year end 1998, options outstanding had
a weighted-average remaining life of 5.2 years and a range of exercise price
from $20.56 to $36.49.
Options exerciseable at year-end are as follows.
<TABLE>
<CAPTION>
Number Weighted Average
of Options Exercise Price
- -----------------------------------------
<S> <C> <C>
1996 18,996 $ 18.96
1997 17,979 24.11
1998 22,964 29.37
</TABLE>
<PAGE> 33
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
NOTE 10-FEDERAL INCOME TAXES
Income tax expense consists of:
<TABLE>
<CAPTION>
1998 1997 1996
- -------------------------------------------------------
<S> <C> <C> <C>
Current $1,029,420 $ 512,496 $ 326,000
Deferred (105,883) (12,846) (10,000)
- -------------------------------------------------------
$ 923,537 $ 499,650 $ 316,000
=======================================================
</TABLE>
Income tax expense calculated at the statutory federal income tax rate of 34%
differs from actual income tax expense as follows:
<TABLE>
<CAPTION>
1998 1997 1996
- -------------------------------------------------------------
<S> <C> <C> <C>
Statutory rates $1,184,000 $ 745,000 $ 594,000
Increase (decrease) from
Tax-exempt interest income (257,000) (262,000) (299,000)
Goodwill amortization 9,000 14,000 14,000
Other, net (12,463) 2,650 7,000
- --------------------------------------------------------------
$ 923,537 $ 499,650 $ 316,000
==============================================================
</TABLE>
Year-end deferred tax assets and liabilities consist of:
<TABLE>
<CAPTION>
1998 1997
- ---------------------------------------------------------
<S> <C> <C>
Allowance for loan losses $ 421,000 $ 326,000
Accumulated depreciation (225,000) (276,000)
Mortgage servicing rights (51,000) (17,000)
Net unrealized gain on
securities available for sale (73,729) (1,846)
Other 3,729 9,846
- ---------------------------------------------------------
75,000 41,000
Valuation allowance -- --
- ---------------------------------------------------------
Net deferred tax asset $ 75,000 $ 41,000
=========================================================
</TABLE>
NOTE 11 - EARNINGS PER SHARE
A reconciliation of the numerators and denominators of the basic earnings per
share and diluted earnings per share computations for the years ended is
presented below:
<TABLE>
<CAPTION>
1998 1997 1996
- -----------------------------------------------------------------
<S> <C> <C> <C>
BASIC EARNINGS PER SHARE:
Net income available to
common shareholders $2,560,014 $1,692,110 $1,431,752
- ------------------------------------------------------------------
Weighted-average common
shares outstanding for
basic earnings per share 1,007,811 985,954 955,659
- ------------------------------------------------------------------
BASIC EARNINGS PER SHARE $ 2.54 $ 1.72 $ 1.50
==================================================================
1998 1997 1996
- ------------------------------------------------------------------
DILUTED EARNINGS PER SHARE:
Net income available to
common shareholders $2,560,014 $1,692,110 $1,431,752
==================================================================
Weighted-average common
shares outstanding for
basic earnings per share 1,007,811 985,954 955,659
Add:
Dilutive effect of assumed
exercise of stock options 5,000 1,293 2,045
- ------------------------------------------------------------------
Weighted-average common
and dilutive additional
potential common shares
outstanding 1,012,811 987,247 957,704
==================================================================
Diluted earnings per share $ 2.53 $ 1.71 $ 1.49
==================================================================
</TABLE>
<PAGE> 34
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
NOTE 12 - COMMITMENTS, OFF-BALANCE-SHEET RISK AND CONTINGENCIES
There are various contingent liabilities that are not reflected in the
consolidated financial statements, including claims and legal actions arising in
the ordinary course of business. In the opinion of management, after
consultation with legal counsel, the ultimate disposition of these matters is
not expected to have a material effect on the Corporation's consolidated
financial condition or results of operations.
CASH RESERVE AND CLEARING BALANCES
At year-end 1998 and 1997, cash reserve and clearing balance requirements of
$1,191,000 and $1,127,000 were required as deposits with the Federal Reserve or
as cash on hand. These balances do not earn interest.
LEASES
The Corporation leases certain branch facilities under lease agreements expiring
through 2018, with optional renewal periods through 2028. During 1997 and 1996,
two of the leases were with a related party. Both of the related party leases
were terminated during 1997 in conjunction with the closing of two branches.
Rental expense on all leases totaled $16,000, $84,000 and $32,000 in 1998, 1997
and 1996, including $0 in 1998, $68,000 in 1997 and $16,000 in 1996 paid to the
related party. Included in the 1997 expense to the related party were costs of
$60,000 related to the termination of the leases. As of year-end 1998, there
were no significant future rental commitments.
LOAN COMMITMENTS
The Corporation is a party to financial instruments with off-balance-sheet risk
in the normal course of business to meet financing needs of its customers. These
financial instruments include commitments to make loans, unused lines of credit
and standby letters of credit. The Corporation's exposure to credit loss in the
event of non-performance by the other party to financial instruments for
commitments to make loans, unused lines of credit and standby letters of credit
is represented by the contractual amount of those instruments. The Corporation
follows the same credit policy to make such commitments as it uses for
on-balance-sheet items.
Since many commitments to make loans expire without being used, the amount of
commitments shown below do not necessarily represent future cash commitments. No
losses are anticipated as a result of these transactions. Collateral obtained
upon exercise of commitments is determined using management's credit evaluation
of the borrowers and may include real estate, business assets, deposits and
other items.
Commitments at year-end are as follows:
<TABLE>
<CAPTION>
1998 1997
- -----------------------------------------------------------
<S> <C> <C>
Commitments to extend credit $ 21,683,000 $ 21,769,000
Standby letters of credit 850,000 815,000
- -----------------------------------------------------------
Total commitments $ 22,533,000 $ 22,584,000
===========================================================
</TABLE>
NOTE 13 - FAIR VALUES ON FINANCIALS INSTRUMENTS
The following methods and assumptions were used to estimate fair values for
financial instruments:
- - Carrying amount is considered to estimate fair value for cash and cash
equivalents, Federal Home Loan Bank (FHLB) stock, demand and savings
deposits, securities sold under agreements to repurchase, U.S. Treasury
demand notes, 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.
- - Fixed rate loans and deposits, and variable rate loans and deposits with
infrequent repricing or repricing limits fair value, is estimated using
discounted cash flow analyses or underlying collateral values, where
applicable.
<PAGE> 35
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
- - Fair value of Federal Home Loan Bank advances is based on currently
available rates for similar financing.
- - Fair value of other financial instruments and off-balance-sheet items
approximate cost and are not considered significant to this presentation.
While these estimates of fair value are based on management's judgment of the
most appropriate factors, there is no assurance that if the Corporation had
disposed of such items at December 31, 1998 and 1997, the estimated fair values
would have been achieved. Market values may differ depending on various
circumstances not taken into consideration in this methodology. The estimated
fair values at December 31, 1998 and 1997 should not necessarily be considered
to apply at subsequent dates.
In addition, other assets and liabilities that are not defined as financial
instruments are not included in the following disclosures, such as property and
equipment. Also, non-financial instruments typically not recognized in financial
statements may have value but are not included in the following disclosures.
These include, among other items, the estimated earnings power of core deposit
accounts, the trained work force, customer goodwill and similar items.
Financial instruments at year-end are as follows, in thousands:
<TABLE>
<CAPTION>
1 9 9 8 1 9 9 7
- -------------------------------------------------------------------------------------------------------------------
CARRYING FAIR Carrying Fair
VALUE VALUE Value Value
- --------------------------------------------------------------------------------------------------------------------
FINANCIAL ASSETS
<S> <C> <C> <C> <C>
Cash and cash equivalents $ 12,555 $ 12,555 $ 15,177 $ 15,177
Securities 29,329 29,822 28,820 29,283
FHLB stock 1,391 1,391 1,391 1,391
Loans, net of allowance 133,526 133,774 122,458 122,613
- ------------------------------------------------------------------------------------------------------------------
Total financial assets $ 176,801 $ 177,542 $ 167,846 $ 168,464
==================================================================================================================
FINANCIAL LIABILITIES
Demand and savings deposits $ (84,293) $ (84,293) $ (74,702) $ (74,702)
Time deposits (56,881) (57,577) (59,245) (59,414)
Securities sold under agreements
to repurchase (6,965) (6,965) (4,152) (4,152)
U.S. Treasury demand notes (1,553) (1,553) (2,753) (2,753)
Federal Home Loan Bank advances (11,500) (11,248) (13,000) (12,968)
- ------------------------------------------------------------------------------------------------------------------
Total financial liabilities $ (161,192) $ (161,636) $ (153,852) $ (153,989)
==================================================================================================================
</TABLE>
NOTE 14 - REGULATORY MATTER
The Corporation and Bank are subject to regulatory capital requirements
administered by federal banking agencies. Capital adequacy guidelines and prompt
corrective action regulations involve quantitative and qualitative measures of
assets, liabilities, and certain off-balance-sheet items calculated under
regulatory accounting practices. Capital amounts and classifications are also
subject to qualitative judgments by regulators about components, risk
weightings, and other factors. The regulators can lower classifications in
certain cases. Failure to meet various capital requirements can initiate
regulatory action that could have a direct material effect on the financial
statements.
The prompt corrective action regulations provide five classifications, including
well capitalized, adequately capitalized, undercapitalized, significantly
undercapitalized, and critically undercapitalized. These terms are not used to
represent overall financial condition.
<PAGE> 36
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
If only adequately capitalized, regulatory approval is required to accept
brokered deposits. If undercapitalized, capital distributions, asset growth and
expansion are limited. Plans for capital restoration are also required. The
Corporation and Bank were categorized as well capitalized at year-end 1998 and
1997.
Actual capital levels (in millions) and minimum required levels were:
<TABLE>
<CAPTION>
Minimum Required
To Be Well
Capitalized
Minimum Required Under Prompt
For Capital Corrective
Actual Adequacy Purposes Action Regulations
Amount Ratio Amount Ratio Amount Ratio
1998
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
TOTAL CAPITAL (TO RISK WEIGHTED ASSETS)
CONSOLIDATED $ 19.1 14.3% $ 10.7 8.0% $ 13.4 10.0%
BANK 16.2 12.1 10.7 8.0 13.4 10.0
TIER 1 CAPITAL (TO RISK WEIGHTED ASSETS)
CONSOLIDATED 17.4 13.0 5.4 4.0 8.0 6.0
BANK 14.6 10.9 5.3 4.0 8.0 6.0
TIER 1 CAPITAL (TO AVERAGE ASSETS)
CONSOLIDATED 17.4 9.9 7.0 4.0 8.8 5.0
BANK 14.6 8.3 7.0 4.0 8.7 5.0
1997
- ------------------------------------------------------------------------------------------------------------------
Total capital (to risk weighted assets)
Consolidated $ 18.4 14.7% $ 10.0 8.0% $ 12.5 10.0%
Bank 16.3 13.1 10.0 8.0 12.5 10.0
Tier 1 capital (to risk weighted assets)
Consolidated 16.9 13.5 5.0 4.0 7.5 6.0
Bank 14.8 11.8 5.0 4.0 7.5 6.0
Tier 1 capital (to average assets)
Consolidated 16.9 10.3 6.6 4.0 8.2 5.0
Bank 14.8 8.6 6.8 4.0 8.6 5.0
</TABLE>
NOTE 15- PARENT CORPORATION CONDENSED
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 1999, the Bank may distribute to the Corporation, in
addition to 1999 net profits, approximately $2,167,000 in dividends without
prior approval from regulatory agencies.
Following are condensed parent corporation financial statements.
<PAGE> 37
COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
<TABLE>
<CAPTION>
CONDENSED BALANCE SHEETS
December 31,
1998 1997
- --------------------------------------------------------
<S> <C> <C>
ASSETS
Cash $ 2,013,394 $ 2,338,746
Securities available for sale 1,226,341 -
Investment in subsidiary 14,770,125 14,814,179
Other 48,196 45,119
- --------------------------------------------------------
Total assets $ 18,058,056 $17,198,044
========================================================
LIABILITIES AND SHAREHOLDERS'
EQUITY
Dividends payable $ 397,954 $ 314,902
Shareholders' equity 17,660,102 16,883,142
- --------------------------------------------------------
Total liabilities and
shareholders' equity $ 18,058,056 $17,198,044
========================================================
</TABLE>
CONDENSED STATEMENTS OF INCOME
Years ended December 31,
<TABLE>
<CAPTION>
1998 1997 1996
- -----------------------------------------------------------------------
<S> <C> <C> <C>
Dividends from subsidiary $ 2,730,000 $ 1,199,460 $ 1,059,300
Interest on securities 36,495 3,334 12,019
Other income 500 -- --
- ----------------------------------------------------------------------
Total income 2,766,995 1,202,794 1,071,319
Other expense 45,722 71,865 18,538
- ----------------------------------------------------------------------
Income before income
taxes and equity in
undistributed net income
of subsidiary 2,721,273 1,130,929 1,052,781
Income tax benefit 9,000 17,350 --
Equity in undistributed
(excess distribution)
net income of subsidiary (170,259) 543,831 378,971
- ----------------------------------------------------------------------
NET INCOME $ 2,560,014 $ 1,692,110 $ 1,431,752
======================================================================
</TABLE>
CONDENSED STATEMENTS OF CASH FLOWS
Years ended December 31,
<TABLE>
<CAPTION>
1998 1997 1996
- -----------------------------------------------------------------------------
<S> <C> <C> <C>
CASH FLOWS FROM
OPERATING ACTIVITIES
Net income $ 2,560,014 $ 1,692,110 $ 1,431,752
Adjustment:
Equity in (undistributed net
income)/excess distribution
of subsidiary 170,259 (543,831) (378,971)
Amortization 10,350
Change in other assets (9,943) 378,045 (358,283)
- -----------------------------------------------------------------------------
Net cash from
operating activities 2,730,680 1,526,324 694,498
CASH FLOW FROM
INVESTING ACTIVITIES
Purchase of securities
available for sale (1,216,495)
CASH FLOWS FROM
FINANCING ACTIVITIES
Dividends and fractional
shares paid (1,397,768) (1,122,158) (940,346)
Sale of common stock 670,543 866,951 403,674
Repurchase of common stock (1,112,312) -- (164)
- -----------------------------------------------------------------------------
Net cash from
financing activities (3,056,032) (255,207) (536,836)
- -----------------------------------------------------------------------------
Net change in cash
and cash equivalents (325,352) 1,271,117 157,662
Cash and cash equivalents
at the beginning of year 2,338,746 1,067,629 909,967
- -----------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS
AT END OF YEAR $ 2,013,394 $ 2,338,746 $ 1,067,629
=============================================================================
</TABLE>
NOTE 16 - DIVIDEND REINVESTMENT PLAN
The Corporation established a Dividend Reinvestment Plan for its shareholders in
1992. The Plan permits the issuance of previously authorized and unissued
shares. As of December 31, 1998 7,574 shares of authorized but unissued common
stock were reserved for Plan requirements.
NOTE 17 - STOCK REPURCHASE PLAN
The Corporation announced a stock repurchase plan in 1998. The Plan permits the
repurchase of up to 52,500 shares of the Corporation's outstanding shares of
common stock. As of December 31, 1998 the Corporation had repurchased 29,997
shares, in accordance with the program.
<PAGE> 38
NOTE 18 - IMPACT OF NEW ACCOUNTING STANDARDS
Beginning January 1, 2000 a new accounting standard will require all derivatives
to be recorded at fair value. Unless designated as hedges, changes in these fair
values will be recorded in the income statement. Fair value changes involving
hedges will generally be recorded by offsetting gains and losses on the hedge
and on the hedged item, even if the fair value of the hedged item is not
otherwise recorded. This is not expected to have a material effect but the
effect will depend on derivative holdings when this standard applies.
Mortgage loans originated in mortgage banking are converted into securities on
occasion. A new accounting standard for 1999 will allow classifying these
securities as available for sale, trading, or held to maturity, instead of the
current requirement to classify as trading. This is not expected to have a
material effect but the effect will vary depending on the level and designation
of securitizations as well as on market price movements.
COMMON STOCK INFORMATION
Commercial National Financial Corporation common stock is listed on the NASD
Over the Counter Bulletin Board under the symbol CEFC. Several brokers provide a
market for the stock. There were approximately 630 shareholders of record and
994,331 common shares outstanding at December 31, 1998.
Management is aware of 56 sales involving a total of 111,875 shares of stock
during 1998. The price was reported to management for only some of these
transactions. All prices have been adjusted for the 5% stock dividends issued in
November 1998 and November 1997.
During 1998 and 1997 the price ranges of transactions reported were:
<TABLE>
<CAPTION>
Shares Actual Price
Traded Range
- ---------------------------------------------------------------
1998 Low High
- ---------------------------------------------------------------
<S> <C> <C> <C>
FIRST QUARTER 27,597 $28.57 $36.19
SECOND QUARTER 25,600 33.33 37.85
THIRD QUARTER 27,708 34.76 37.14
FOURTH QUARTER 30,970 35.23 38.50
- ---------------------------------------------------------------
1997
- ---------------------------------------------------------------
First Quarter 25,578 $22.91 $26.31
Second Quarter 11,687 23.58 27.90
Third Quarter 12,458 26.98 28.34
Fourth Quarter 3,717 25.85 30.48
</TABLE>
DIVIDEND INFORMATION
The holders of Commercial National Financial Corporation common stock are
entitled to dividends when, and if, declared by the Board of Directors of 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 nine years.
The following table sets forth the dividends per share declared during 1998 and
1997. The dividends per share have been adjusted for the 5% stock dividends
issued in November 1998 and November 1997.
<TABLE>
<CAPTION>
1998 1997
- --------------------------------------------------------------
<S> <C> <C>
First Quarter $ .34 $.27
Second Quarter .35 .30
Third Quarter .38 .30
Fourth Quarter .40 .31
- --------------------------------------------------------------
Total dividend per share $1.47 $1.18
==============================================================
</TABLE>
<PAGE> 39
<TABLE>
<CAPTION>
EXECUTIVE OFFICERS
<S> <C>
Jeffrey S. Barker President and Chief Executive Officer
Patrick G. Duffy Vice President and Chief Financial Officer
BOARD OF DIRECTORS
Howard D. Poindexter Chairperson of the Board, Manager of Poindexter Farms
Richard F. Abbott Vice Chairperson of the Board, Retired EVP of the Corporation and Bank
Jefferson P. Arnold Attorney, Arnold Law Office
Jeffrey S. Barker President and CEO of the Corporation and Bank
Don J. Dewey President and Funeral Director, Dewey Funeral Homes, Inc.
David A. Ferguson Member, Chodoka LLC
Kenneth R. Luneack President, Ken Luneack Construction, Inc.
Kim C. Newson President, Alma Hardware Corporation
Scott E. Sheldon Owner, Kernen-Sheldon, Shepherd and LaDu-Brundage Insurance Agencies
Russell M. Simmet President, Simmet Insurance Agency, Inc.
COMMERCIAL BANK OFFICERS
Scott E. Sheldon Chairperson of the Board
Howard D. Poindexter Vice Chairperson of the Board
Jeffrey S. Barker President and Chief Executive Officer
Patrick G. Duffy Vice President and Chief Financial Officer
Daniel E. Raleigh Vice President - Marketing and Branch Administration
Andrew P. Shafley Vice President - Senior Loan Officer
Kevin D. Collison Vice President - Commercial Lending-Ithaca
Thomas D. Cooper Vice President - Commercial Lending-Middleton
Sheryl L. Allen Assistant Vice President - Human Resources
Corey S. Bailey Assistant Vice President - Consumer Lending-Alma
Janet M. Davison Assistant Vice President - Manager/Information Systems
Donna L. Kelley Assistant Vice President - Branch Supervisor-St. Louis
Wendy M. Lombard Assistant Vice President - Mortgage Lending
Vicki L. Nelson Assistant Vice President - Mortgage Lending
Karen M. Taylor Assistant Vice President - Mortgage Lending
Carol L. Vallance Assistant Vice President - Customer Relations
Kathryn K. Greening Loan Officer
Dawn K. Riley Loan Officer
Rebecca A. Smith Administrative Assistant - Transfer Agent
</TABLE>
<PAGE> 40
[PICTURES]
[Scott Jeff and Howard]
[Duffy]
[PicturesRaleigh]
[Shafley]
[Lenders]
<PAGE> 41
<TABLE>
<CAPTION>
COMMERCIAL BANK LOCATIONS
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
ALMA ITHACA POMPEII GREENVILLE ST. LOUIS MIDDLETON
301 NORTH STATE ST. 101 N. PINE RIVER* 105 E. FULTON STREET 101 NORTH LAFAYETTE 104 N. MILL STREET* 101 NORTH NEWTON STREET*
STREET*
Ph. (517) 463-2185 Ph. (517) 875-4144 Ph. (517) 838-2525 Ph. (616) 754-7166 Ph. (517) 681-5738 Ph. (517) 236-7236
Fax (517) 463-5996 Fax (517) 875-4534 Fax (616) 754-2118 Fax (517) 681-3509 Fax (517) 236-7732
119 WEST CENTER*
Ph. (517) 463-3120
1500 WRIGHT AVENUE*
Ph. (517) 463-3901
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
* Denotes Bank locations with ATMs on site.
DIVIDEND REINVESTMENT PLAN
As a service to its shareholders, Commercial National Financial Corporation
sponsors a Dividend Reinvestment Plan. The Plan allows a shareholder to purchase
this stock without brokerage commissions using dividends. For information about
this plan, contact the Corporation's Transfer Agent.
TRANSFER AGENT
Commercial National Financial Corporation
Care of Mrs. Rebecca A. Smith
101 North Pine River, P.O. Box 280
Ithaca, Michigan 48847
CORPORATE HEADQUARTERS
101 North Pine River
Ithaca, Michigan 48847
Phone (517) 875-4144
Fax (517) 875-4534
10-K AVAILABILITY
Commercial National's Annual report on Form 10-K is available upon written
request without charge from:
Commercial National Financial Corporation,
Care of Mr. Patrick G. Duffy, Vice President and Chief Financial Officer,
101 North Pine River, P.O. Box 280
Ithaca, Michigan 48847
Phone (517) 875-4144
<TABLE>
<CAPTION>
Market Makers
<S> <C> <C> <C> <C>
WILLIAM KAHL MICHAEL T. SEEKELL PETER VANDERSCHAAF CHRISTOPHER TURNER JAMES CRAWFORD
- ----------------------------------------------------------------------------------------------------------------------------
Everen Securities Robert W. Baird & Co. Stifel, Nicolaus & Co. McDonald & Co. Roney & Co.
East Lansing, MI Grand Rapids, MI Grand Rapids, MI Grand Rapids, MI Flint, MI
1-800-292-1960 1-800-888-6200 1-800-676-0477 1-800-548-6011 1-800-521-9767
- ----------------------------------------------------------------------------------------------------------------------------
</TABLE>
[LOGO]
[COMMERCIAL NATIONAL FINANCIAL CORPORATION LETTERHEAD]
<PAGE> 1
EXHIBIT 23
[CROWE CHIZEK LOGO]
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference and use of our report dated
February 4, 1999, which appears in Commercial National Financial Corporation's
annual report on Form 10-K for 1998, 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).
/s/ Crowe, Chizek and Company
Crowe, Chizek and Company LLP
March 19, 1999
South Bend, Indiana
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 8555
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 4000
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 18703
<INVESTMENTS-CARRYING> 12017
<INVESTMENTS-MARKET> 12510
<LOANS> 135870
<ALLOWANCE> 2344
<TOTAL-ASSETS> 181096
<DEPOSITS> 141175
<SHORT-TERM> 8518
<LIABILITIES-OTHER> 2243
<LONG-TERM> 11500
0
0
<COMMON> 17525
<OTHER-SE> 135
<TOTAL-LIABILITIES-AND-EQUITY> 181096
<INTEREST-LOAN> 11315
<INTEREST-INVEST> 1779
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</TABLE>
