<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
X Quarterly Report Pursuant to Section 13 or 15(d) of the
---
Securities and Exchange Act of 1934
For the quarterly period ended September 30, 1999, or
Transition Report Pursuant to Section 13 or 15(d) of the
--- Securities Exchange Act of 1934
For the Transition Period from to
-------------- -----------------
Commission File No. 0-17000
COMMERCIAL NATIONAL FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
Michigan 38-2799780
(State of Incorporation) (IRS Employer Identification No.)
101 North Pine River Street, Ithaca, Michigan 48847
(address of principal executive offices) (ZIP Code)
Registrant's telephone number, including area code: (517) 875-4144
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO
--------------- ---------------
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding at November 1, 1999
----- -------------------------------
Common Stock 3,037,288
No Par Value
<PAGE> 2
COMMERCIAL NATIONAL FINANCIAL CORPORATION
INDEX
<TABLE>
<S> <C> <C>
PART I FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of September 30, 1999 and December 31, 1998 (Page 3)
Consolidated Statements of Income for the three and nine months ended September 30, (Page 4)
1999 and September 30,1998
Consolidated Statements of Shareholders' Equity for the periods ended September (Page 5)
30, 1999 and December 31, 1998
Consolidated Statements of Cash Flows for the nine months ended September 30, 1999 (Page 6)
and September 30, 1998
Notes to Consolidated Financial Statements (Page 7-10)
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (Page 11-17)
PART II OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
a) Exhibit 27-Financial Data Schedule (Page 20)
b) Reports on Form 8-K (Page 18)
SIGNATURES (Page 19)
</TABLE>
2
<PAGE> 3
COMMERCIAL NATIONAL FINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS
September 30, 1999 (Unaudited) and December 31, 1998
<TABLE>
<CAPTION>
September 30, December 31,
1999 1998
---- ----
(Unaudited)
<S> <C> <C>
ASSETS
Cash and due from banks $ 6,075,333 $ 8,555,428
Federal funds sold -- 4,000,000
------------- -------------
Total cash and cash equivalents 6,075,333 12,555,428
Securities available for sale 22,249,833 17,311,849
Securities held to maturity (fair value $9,769,366 -
September 30, 1999; $12,510,000 - December 31, 1998) 9,563,237 12,017,433
Federal Home Loan Bank stock, at cost 1,391,300 1,391,300
Loans receivable, net of allowance for loan losses
$2,690,571-September 30, 1999; $2,343,976- December 31, 1998 146,271,925 133,525,631
Premises and equipment, net 2,823,229 2,790,001
Accrued interest receivable and other assets 2,140,181 1,503,999
------------- -------------
Total assets $ 190,515,038 $ 181,095,641
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Deposits
Noninterest-bearing demand $ 19,692,745 $ 20,048,154
Interest-bearing demand 24,006,133 25,461,761
Savings 42,354,919 38,783,466
Time 59,966,704 56,881,316
------------- -------------
Total deposits 146,020,501 141,174,697
Securities sold under agreements to repurchase 5,134,027 6,965,058
Other Borrowings 1,860,919 1,552,997
Federal Home Loan Bank advances 17,500,000 11,500,000
Accrued expenses and other liabilities 1,431,226 2,242,787
------------- -------------
Total liabilities 171,946,673 163,435,539
Shareholders' equity
Common stock and paid in capital, no par value: 5,000,000 shares
authorized; shares issued and outstanding
September 30, 1999 - 3,021,896 and December 31,
1998 - 2,982,992 17,952,585 17,525,466
Retained earnings (deficit) 693,666 (8,483)
Accumulated other comprehensive income, net of tax (77,886) 143,119
------------- -------------
Total shareholders' equity 18,568,365 17,660,102
------------- -------------
Total liabilities and shareholders' equity $ 190,515,038 $ 181,095,641
============= =============
</TABLE>
See accompanying notes to consolidated financial statements.
3
<PAGE> 4
COMMERCIAL NATIONAL FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
Periods ended September 30, 1999 and 1998 (Unaudited)
<TABLE>
<CAPTION>
For Three Months For Nine Months
Ended September 30, Ended September 30,
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Interest and dividend income
Loans receivable, including fees $ 3,113,208 $ 2,857,483 $ 8,924,411 $ 8,450,111
Taxable securities 284,665 222,723 780,947 704,528
Nontaxable securities 154,839 187,861 482,042 553,245
Federal funds sold 26,479 103,019 94,277 304,937
Federal Home Loan Bank stock dividends 28,054 28,159 83,249 83,354
----------- ----------- ----------- -----------
Total interest and dividend income 3,607,245 3,399,245 10,364,926 10,096,175
Interest expense
Deposits 1,130,806 1,203,211 3,322,908 3,635,537
Securities sold under agreements to repurchase 75,516 80,779 240,940 225,188
Federal Home Loan Bank advances 249,518 190,915 608,846 612,551
Other 10,098 6,556 23,495 18,445
----------- ----------- ----------- -----------
Total interest expense 1,465,938 1,481,461 4,196,189 4,491,721
Net interest income 2,141,307 1,917,784 6,168,737 5,604,454
Provision for loan losses 90,000 90,000 270,000 270,000
----------- ----------- ----------- -----------
Net interest income after provision for loan losses 2,051,307 1,827,784 5,898,737 5,334,454
Noninterest income
Service charges and fees 124,460 123,773 350,870 359,297
Net gains on loan sales 47,869 88,232 172,437 289,154
Receivable financing fees 31,117 36,871 160,673 177,240
Other 54,269 70,518 193,082 185,930
----------- ----------- ----------- -----------
Total noninterest income 257,715 319,394 877,062 1,011,621
Noninterest expenses
Salaries and employee benefits 687,506 647,730 2,046,910 1,931,420
Occupancy and equipment 278,212 243,912 779,081 766,723
FDIC insurance 5,487 5,676 16,704 16,758
Printing, postage and supplies 61,174 63,522 185,895 176,566
Professional and outside services 74,050 62,571 251,628 197,973
Other 255,137 241,234 727,093 745,524
----------- ----------- ----------- -----------
Total noninterest expense 1,361,566 1,264,645 4,007,311 3,834,964
----------- ----------- ----------- -----------
Income before income tax expense 947,456 882,533 2,768,488 2,511,111
Income tax expense 269,906 238,000 783,000 652,000
----------- ----------- ----------- -----------
Net income $ 677,550 $ 644,533 $ 1,985,488 $ 1,859,111
=========== =========== =========== ===========
Per share information
Basic earnings $ 0.22 $ 0.21 $ 0.66 $ 0.62
Diluted earnings $ 0.22 $ 0.21 $ 0.66 $ 0.61
Dividends declared $ 0.14 $ 0.13 $ 0.43 $ 0.35
</TABLE>
See accompanying notes to consolidated financial statements.
4
<PAGE> 5
COMMERCIAL NATIONAL FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Periods ended September 30, 1999 (Unaudited) and December 31, 1998
<TABLE>
<CAPTION>
Common Other
Stock and Retained Comprehensive Total
Paid in Earnings Income Shareholders'
Capital (deficit) Net of Tax Equity
--------------------------------------------------------------------
<S> <C> <C> <C> <C>
Balance at December 31, 1997 $ 16,231,861 $ 647,697 $ 3,584 $ 16,883,142
Comprehensive income:
Net income 2,560,014 2,560,014
Net change in unrealized gains on
securities available for sale 211,418 211,418
Tax effect (71,883) (71,883)
--------- ------------
Total other comprehensive income 139,535 139,535
------------
Total comprehensive income 2,699,549
------------
Cash dividends declared, $.49 per share (1,476,518) (1,476,518)
Issued 143,337 shares in payment of
5% stock dividend 1,735,374 (1,739,676) (4,302)
Issued 49,866 shares under dividend
reinvestment program 548,186 548,186
Issued 14,829 shares under stock option plan 122,357 122,357
Repurchase of 89,991 shares (1,112,312) (1,112,312)
------------ ---------- --------- -----------
Balance at December 31, 1998 17,525,466 (8,483) 143,119 17,660,102
Comprehensive income:
Net income 1,985,488 1,985,488
Net change in unrealized gains on
securities available for sale (334,856) (334,856)
Tax effect 113,851 113,851
--------- ------------
Total other comprehensive income (221,005) (221,005)
------------
Total comprehensive income 1,764,483
Cash dividends declared, $.43 per share (1,283,339) (1,283,339)
Issued 42,830 shares under dividend
reinvestment program 505,056 505,056
Issued 9,333 shares under stock option plans 87,047 87,047
Repurchase of 16,035 shares (200,150) (200,150)
Issued 2,775 shares to employee stock
ownership plan 35,166 35,166
------------ ---------- --------- ------------
Balance at September 30, 1999 $ 17,952,585 $ 693,666 $ (77,886) $ 18,568,365
============ ========== ========= ============
</TABLE>
See accompanying notes to consolidated financial statements.
5
<PAGE> 6
COMMERCIAL NATIONAL FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Periods ended September 30, 1999 and 1998 (Unaudited)
<TABLE>
<CAPTION>
For Nine Months Ended
September 30,
1999 1998
---- ----
<S> <C> <C>
Cash flows from operating activities
Net income $ 1,985,488 $ 1,859,111
Adjustments to reconcile net income to net
cash from operating activities
Provision for loan loss 270,000 270,000
Net gains on loan sales (111,766) (298,140)
Originations of loans held for sale (8,260,335) (11,752,081)
Proceeds from sales of loans held for sale 8,436,561 12,740,720
Depreciation, amortization and accretion 579,869 509,767
Net change in accrued interest receivable and other assets (506,562) (438,742)
Net change in accrued expenses and other liabilities (811,561) (69,453)
------------ ------------
Net cash from operating activities 1,581,694 2,821,182
Cash flows from investing activities
Purchases of securities available for sale (8,280,410) (15,548,422)
Proceeds from maturities of securities available for sale 2,898,530 7,000,000
Proceeds from maturities of securities held to maturity 2,441,600 6,945,000
Purchases of securities held to maturity -- --
Net change in loans (13,107,294) (6,032,858)
Purchases of premises and equipment, net (480,690) (74,133)
------------ ------------
Net cash from investing activities (16,528,264) (7,710,413)
Cash flow from financing activities
Net change in deposits 4,845,804 1,391,665
Net change in securities sold under agreements to repurchase (1,831,031) 2,454,390
Net change in U.S. Treasury demand notes 307,922 (2,336,341)
Federal Home Loan Bank advances 19,000,000
Federal Home Loan Bank repayments (13,000,000) (2,000,000)
Repurchase of common stock shares (200,150) (682,336)
Dividends paid and fractional shares (1,283,339) (1,080,658)
Proceeds from sale of common stock 627,269 471,758
------------ ------------
Net cash from financing activities 8,466,475 (1,781,522)
------------ ------------
Net change in cash and cash equivalents (6,480,095) (6,670,753)
Cash and cash equivalents, at beginning of year 12,555,428 15,176,724
------------ ------------
Cash and cash equivalents, at end of period $ 6,075,333 $ 8,505,971
============ ============
Cash paid during the period for
Interest $ 4,233,069 $ 4,568,371
Federal income taxes 1,121,000 740,372
</TABLE>
See accompanying notes to consolidated financial statements.
6
<PAGE> 7
Notes to COnsolidated Financial Statements (Unaudited)
Note 1-Summary of Significant Accounting Policies
Basic Presentation
The accompanying unaudited condensed consolidated financial statements were
prepared in accordance with Rule 10-01 of regulation S-X and the instructions
for Form 10-Q and, therefore, do not include all disclosures required by
generally accepted accounting principles for complete presentation of financial
statements. In the opinion of management, the condensed consolidated financial
statements contain all adjustments (consisting of normal recurring accruals)
necessary to present fairly the financial condition of Commercial National
Financial Corporation as of September 30, 1999 and December 31, 1998, and the
results of its operations for the three and nine months ending September 30,
1999 and September 30, 1998. The results for the three and nine months ended
September 30, 1999 are not necessarily indicative of the results expected for
the full year.
Principals of Consolidation
The accompanying consolidated financial statements include the accounts of
Commercial National Financial Corporation (CNFC), Commercial Bank (Bank) and
CNFC Financial Services, Inc., a wholly owned subsidiary of the Bank. All
material intercompany accounts and transactions have been eliminated in
consolidation.
Nature of Operations, Industry Segments and Concentrations of Credit Risk
The Corporation is a one-bank holding company, which conducts limited business
activities. The Bank performs the majority of business activities.
The Bank provides a full range of banking services to individuals, agricultural
businesses, commercial businesses and light industries located in its service
area. It maintains a diversified loan portfolio, including loans to individuals
for home mortgages, automobiles and personal expenditures, and loans to business
enterprises for current operations and expansion. The Bank offers a variety of
deposit products, including checking, savings, money market, individual
retirement accounts and certificates of deposit. While the Corporation's chief
decision-makers monitor the revenue stream of various Corporate products and
services, operations are managed and financial performance is evaluated on a
Corporation-wide basis. Accordingly, all of the Corporation's banking operations
are considered by management to be aggregated into one operating segment.
The principal markets for the Bank's financial services are the Michigan
communities in which the Bank is located and the areas immediately surrounding
these communities. The Bank serves these markets through seven offices located
in Gratiot and Montcalm Counties in Michigan.
Use of Estimates
To prepare financial statements in conformity with generally accepted accounting
principles, management makes estimates and assumptions based on available
information. These estimates and assumptions affect the amounts reported in the
financial statements and the disclosures provided, and future results could
differ. The allowance for loan losses and fair values of securities and other
financial instruments are particularly subject to change.
Cash Flow Reporting
Cash and cash equivalents include cash on hand, demand deposits with other
financial institutions and federal funds sold. Cash flows are reported net for
customer loan and deposit transactions, securities sold under agreements to
repurchase with original maturity of 90 days or less and U.S. Treasury demand
notes.
Securities
Securities are classified as held to maturity and carried at amortized cost when
management has the positive intent and ability to hold them to maturity.
Securities are classified as available for sale when they might be sold before
maturity. Securities available for sale are carried at fair value, with net
7
<PAGE> 8
unrealized holding gains and losses reported separately in shareholders' equity,
net of tax. Trading securities are bought principally for sale in the near term,
and are reported at fair value with unrealized gains and losses included in
earnings. Securities are written down to fair value when a decline in fair value
is not temporary. CNFC did not classify securities for trading at any time
during 1999 or 1998.
Gains and losses on sales are determined using the amortized cost of the
specific security sold. Interest and dividend income, adjusted by amortization
of purchase premiums and discounts, is included in earnings.
Loans Held for Sale
Loans held for sale are reported at the lower of cost or market value in the
aggregate. Net unrealized losses are recorded in a valuation allowance by
charges to income.
Loans Receivable
Loans receivable are reported at the principal balance outstanding, net of
unearned interest, deferred loan fees and costs, and an allowance for loan
losses. Interest income is reported on the interest method and includes
amortization of net deferred loan fees and costs over the loan term.
Interest income is not reported when full loan repayment is in doubt, typically
when payments are past due over 90 days, unless the loan is both well secured
and in the process of collection. Payments received on such loans are reported
as principal reductions.
Allowance for Loan Losses
The allowance for loan losses is a valuation allowance for probable credit
losses, increased by the provision for loan losses and decreased by charge-offs
less recoveries. Estimating the risk of loss and the amount of loss on any loan
is necessarily subjective. Accordingly, management estimates the allowance
balance required based on past loan loss experience, known and inherent risks in
the portfolio, information about specific borrower situations and estimated
collateral values, economic conditions, and other factors. Allocations of the
allowance may be made for specific loans, but the entire allowance is available
for any loan that, in management's judgment, should be charged-off. A problem
loan is charged-off by management as a loss when deemed uncollectible, although
collection efforts continue and future recoveries may occur.
Loan impairment is reported when full payment under the loan terms is not
expected. Impairment is evaluated in total for smaller-balance loans of similar
nature such as residential mortgage and consumer loans and on an individual loan
basis for other loans. If a loan is impaired, a portion of the allowance is
allocated so that the loan is reported, net, at the present value of estimated
future cash flows using the loan's existing rate or at the fair value of
collateral if repayment is expected solely from the collateral. Loans are
evaluated for impairment when payments are delayed, typically 90 days or more,
or when it is probable that all principal and interest amounts will not be
collected according to the original terms of the loan.
Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation.
Depreciation is computed using a combination of straight-line and accelerated
methods with useful lives ranging from 10 to 40 years for buildings and
improvements, and 3 to 10 years for furniture and equipment. These assets are
reviewed for impairment when events indicate their carrying amount may not be
recoverable from future undiscounted cash flows. Maintenance, repairs and minor
alterations are charged to current operations as expenditures occur. Major
improvements are capitalized.
Servicing Rights
Servicing rights represent both purchased rights and the allocated value of
servicing rights retained on loans sold. Servicing rights are expensed in
proportion to, and over the period of, estimated net servicing revenues.
8
<PAGE> 9
Impairment is evaluated based on the fair value of the rights, using groupings
of the underlying loans as to interest rates and then, secondarily, as to
geographic and prepayment characteristics. Any impairment of a grouping is
reported as a valuation allowance.
Excess servicing receivable is reported when a loan sale results in servicing in
excess of normal amounts and is expensed over the life of the servicing on the
interest method.
Other Real Estate Owned
Real estate properties acquired in collection of a loan receivable are recorded
at fair value at acquisition. Any reduction to fair value from the carrying
value of the related loan is accounted for as a loan loss. After acquisition, a
valuation allowance reduces the reported amount to the lower of the initial
amount or fair value less costs to sell. Expenses, gains and losses on
disposition, and changes in the valuation allowance are reported in other
expense.
Goodwill and Identified Intangibles
Goodwill is the excess of purchase price over identified net assets in business
acquisitions. Goodwill is expensed on the straight-line method over no more than
25 years. Identified intangibles represent the value of depositor relationships
purchased and are expensed on accelerated methods over 10 years. Goodwill and
identified intangibles are assessed for impairment based on estimated
undiscounted cash flows, and written down if necessary.
Securities Sold Under Agreements to Repurchase
All of these liabilities represent amounts advanced by various customers and are
secured by securities owned, as they are not covered by general deposit
insurance.
Employee Benefits
A benefit plan with 401(k) features cover substantially all employees. The plan
allows participant compensation deferrals. The amount of any Corporation
matching contribution is based solely on the discretion of the board of
directors. Historically, the Corporation has matched up to 6% of such deferrals
at 100%.
Expense for employee compensation under stock option plans is reported only if
options are granted below market price at grant date.
Income Taxes
Income tax expense is the sum of the current year income tax due or refundable
and the change in deferred tax assets and liabilities. Deferred tax assets and
liabilities are the expected future tax consequences of temporary differences
between the carrying amounts and tax bases of assets and liabilities, computed
using enacted tax rates. A valuation allowance, if needed, reduces deferred tax
assets to the amount expected to be realized.
Earnings and Dividends Per Share
Basic earnings per common share is based on net income divided by the weighted
average number of common shares outstanding during the period. Diluted earnings
per common share shows the diluted effect of any additional potential common
shares. Earnings and dividends per common share are restated for all stock
splits and stock dividends. On July 21, 1999 the board of directors of the
Corporation approved a 3 for 1 stock split payable on September 1, 1999 to
shareholders of record on August 8, 1999. All earnings per common share and
dividends per common share have been restated to reflect this stock split.
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.
9
<PAGE> 10
Comprehensive Income
Comprehensive income consists of net income and other comprehensive income.
Other comprehensive income includes the change in unrealized appreciation and
depreciation on securities available for sale, net of tax, which is also
recognized as a separate component of shareholders' equity.
Financial Instruments with Off-Balance-Sheet Risk
The Corporation, in the normal course of business, makes commitments to make
loans, which are not recorded in the financial statements.
Fair Values of Financial Instruments
Fair values of financial instruments are estimated using relevant market
information and other assumptions, as more fully disclosed separately. Fair
value estimates involve uncertainties and matters of significant judgment
regarding interest rates, credit risk, prepayments, and other factors,
especially in the absence of broad markets for particular items. Changes in
assumptions or in market conditions could significantly affect the estimates.
The fair value estimates of existing on-and off-balance-sheet financial
instruments does not include the value of anticipated future business or values
of assets and liabilities not considered financial instruments.
Reclassifications
Some items in the prior year financial statements have been reclassified to
conform with the current year presentation.
10
<PAGE> 11
ITEM 2: MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Financial Condition
Total assets for the quarter ending September 30, 1999 increased to $190,515,000
from the $181,096,000 at the quarter ending December 31, 1998. Total loans were
$148,960,000 as of September 30, 1999. This is a $13,090,000 or 9.6% increase
from December 31, 1998 balance of $135,870,000. The increase was primarily a
result of demand for business and home mortgage loans. Investment securities
increased to $33,204,000 at September 30, 1999 compared to $29,329,000 at
December 31, 1998.
Deposits increased 3.4% during the period. Total deposits at September 30, 1999
were $146,020,000 compared to $141,175,000 at December 31, 1999. Included in the
deposit total are certificates of deposit obtained through an online certificate
of deposit network. The participants in this network are primarily banks, credit
unions, and savings and loans. Rates are posted on an electronic bulletin board
available to participants in the network. Certificate of deposits gathered
through this method are generally less than 1 year in term and are in increments
of $100,000 or less.
Federal Home Loan Bank (FHLB) advances increased to $17,500,000 from $11,500,000
at December 31, 1998. Of the $6,000,000 in additional advances, $2,000,000 is
scheduled to mature in January of 2000. These funds were invested in securities
scheduled to mature in October and November of 1999. The funds will then be
available for use as part of the Bank's Y2K liquidity contingency plan.
Liquidity
Management defines liquidity as the ability to fund appropriate levels of credit
worthy loans, meet the immediate cash withdrawal requirements of depositors, and
maintain access to sufficient resources to meet unexpected contingencies at a
reasonable cost and or with minimum losses.
While modest loan growth continues, the Bank's deposit base has not increased at
the same rate. The loan to deposit ratio calculated on September 30, 1999 ending
balances was 102.0% compared to 96.2% at December 31, 1998. Management is
confident that the combination of available FHLB advances, Federal funds lines
of credit, the available for sale investment portfolio, and our ability to sell
mortgage loans and the government guaranteed portion of commercial loans
provides adequate short and medium term sources of liquidity. At a minimum the
Bank has the following available to meet short term liquidity needs: $6,500,000
in available FHLB advances and $9,000,000 in short term lines of credit with
correspondent banks.
CNFC also needs cash to pay dividends to its shareholders. The primary source of
cash is the dividends paid to CNFC by the Bank. Management believes that cash
from operations is sufficient to supply the cash needed to continue paying a
reasonable dividend.
Asset Quality and the Allowance for Loan Loss
The allowance for loan losses was 1.81% of total loans at September 30, 1999
compared to 1.73% at December 31, 1998. At September 30, 1999 approximately
$978,000 in loans was placed on non-accrual. This balance relates to a single
business relationship. Management is evaluating this relationship for potential
loss exposure, and is in the process of restructuring the affected loans.
Management has specifically identified a portion of the allowance for loan
losses in the event that a portion of the loan is charged off.
Net year to date recoveries totaled $77,000 compared to net charge-offs of
$65,000 for the nine months ending September 30, 1999. During the quarter the
Bank expensed a provision of $90,000 to the allowance compared to $90,000 during
the same period in 1998. Management continues to systematically evaluate the
adequacy of the allowance such that the balance is commensurate with the
performance of the loan portfolio, general market conditions and other relevant
factors.
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Capital Resources
CNFC's capital ratios continue to exceed regulatory guidelines for a "well
capitalized" institution. A summary of CNFC's capital ratios follows:
<TABLE>
<CAPTION>
September 30, December 31, Minimum Required to be
1999 1998 Well Capitalized Under
---- ---- Prompt Corrective Action
Regulations
-----------
<S> <C> <C> <C>
Total capital to risk weighted 14.1% 14.3% 10.0%
===== ===== =====
assets
Tier 1 capital to risk weighted 12.9% 13.0% 6.0%
===== ===== =====
assets
Tier 1 capital to average assets 09.9% 9.9% 5.0%
===== ===== =====
</TABLE>
Results of Operations
Net income for the quarter ended September 30, 1999 was $678,000, an increase of
$33,000, or 5.1% compared to the same period in 1998. Net income year to date
was $1,985,000, an increase of $126,000 or 6.8%.
Net Interest Income
The following table illustrates the effect that changes in rates and volumes of
interest-earning assets and interest-bearing liabilities had on net interest
income for the three and nine months ending September 30, 1999 and 1998.
<TABLE>
<CAPTION>
Three Months Ending September 30, Nine Months Ending September 30,
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Interest Income (tax equivalent) $ 3,731,978 $ 3,533,705 $ 10,817,985 $ 10,603,209
Interest Expense 1,465,938 1,481,461 4,196,189 4,491,721
------------ ------------ ------------ ------------
Net Interest Income $ 2,266,040 $ 2,052,244 $ 6,621,796 $ 6,111,488
Average Volume
Interest-earning Assets $181,559,090 $166,610,098 $176,450,962 $166,520,246
Interest-bearing Liabilities 149,634,532 137,915,808 145,571,711 138,991,339
------------ ------------ ------------ ------------
Net Differential $ 31,924,558 $ 28,694,290 $ 30,879,251 $ 27,528,907
============ ============ ============ ============
Average Yields/Rates
Yield on Earning Assets 8.16% 8.41% 8.20% 8.51%
Rate Paid on Liabilities 3.89% 4.26% 3.85% 4.32%
---- ---- ---- ----
Interest Spread 4.27% 4.15% 4.35% 4.19%
==== ==== ==== ====
Net Interest Margin 4.95% 4.89% 5.02% 4.91%
==== ==== ==== ====
</TABLE>
12
<PAGE> 13
The change in net interest income is attributable to the following:
<TABLE>
<CAPTION>
Three Months Ending Nine Months Ending
September 30, 1999 September 30, 1999
Volume Rate Inc/(Dec) Volume Rate Inc/(Dec)
------ ---- --------- ------ ---- ---------
<S> <C> <C> <C> <C> <C> <C>
Interest
Earning $ 345,152 $(146,879) $ 198,273 $ 738,765 $(523,988) $ 214,776
Interest
Bearing
Liabi1ities 121,042 (136,565) (15,523) 138,061 (433,592) (295,532)
--------- --------- --------- --------- --------- ---------
Net Interest
Income $ 224,110 $ (10,314) $ 213,796 $ 600,704 $ (90,396) $ 510,308
========= ========= ========= ========= ========= =========
</TABLE>
The increase in net interest income for the three and nine months ending
September 30, 1999 is due to an increase in earning assets and an increase in
margin. Net interest margin for the three months ending September 30, 1999
increased to 4.95% compared to 4.89% for the three months ending September 30,
1998. Net interest margin for the nine months ending September 30, 1999
increased to 5.02% compared to 4.91% for the nine months ending September 30,
1998. Average earning assets for the three months ending September 30, 1999
increased $14,949,000 compared to the same period in 1998. The average earning
assets for the 9 months ending September 30, 1999 increased $9,931,000 compared
to same period in 1998. During 1999, the Federal Reserve has increase the Fed
Funds rate twice, each time by 25 basis points. This results in an almost
immediate increase in the Bank's prime lending rate. The interest rate on a
significant portion of the Bank's commercial loan portfolio is tied to the prime
lending rate. Therefore, the Bank receives an immediate short-term benefit to
the increase in prime. In general, local deposit interest rates do not respond
as quickly to changes in the prime lending rate.
Non-interest Income
Non-interest income for the three months ending September 30, 1999 was $258,000.
This represents a $62,000 or 19.1% decrease over the same period in 1998. For
the nine months ending September 30, 1999, non-interest income totaled $877,000.
This represents a $135,000 or 13.3% decrease. Rising interest rates has all but
eliminated the mortgage refinance activity. This has significantly reduced the
number of mortgage loans originated and, as a result, has also reduced the gain
on sale of mortgage loans.
Non-interest Expense
Non-interest expense for the three months ending September 30, 1999 totaled
$1,362,000. This represents a 7.7% increase over the same period in 1998.
Non-interest expense for the nine months ending September 30,1999 totaled
$4,007,000. This represents a $172,000 or a 4.5% increase compared to the same
period in 1998.
Salary and benefit expense for the three months ending September 30, 1999
totaled $687,000 compared to $648,000 an increase of $39,000 or 6.0%. The year
to date increase in salary and benefit expense was $116,000 or 6.0%. The
increase reflects normal base salary increases, and an 8.0% increase in the cost
of medical insurance. Full time equivalents have remained unchanged compared to
the period ending September 30, 1998.
Year to date professional and outside services increased $54,000 or 27.3% over
the same period in 1998. Professional and outside services increased $11,000 or
17.5% for the three months ended September 30, 1999 primarily related for
services rendered for remediating Y2K related programs, and the upgrade,
installation and service of PC's, networks and related periphials. Management
anticipates that these costs will continue to decline in the fourth quarter of
1999.
13
<PAGE> 14
Quantitative and Qualitative Disclosures about Market Risk
Commercial's primary market risk exposure is interest rate risk and, to a lesser
extent, liquidity risk. All of the Corporation's transactions are denominated in
U.S. dollars with no specific foreign exchange exposure. The Corporation has a
limited exposure to commodity prices related to agricultural loans. Any impacts
that changes in foreign exchange rate and commodity prices would have on
interest rates are assumed to be insignificant.
Interest rate risk ("IRR") is the exposure of a banking organization's financial
condition to adverse movements in interest rates. Accepting this risk can be an
important source of profitability and stockholder value, however, excessive
levels of IRR could pose a significant threat to the Corporation's earnings and
capital base. Accordingly, effective risk management that maintains IRR at
prudent levels is essential to the Corporation's safety and soundness.
Evaluating a financial institution's exposure to changes in interest rates
includes assessing both the adequacy of the management process used to control
IRR and the organization's quantitative level of exposure. When assessing the
IRR management process, the Corporation seeks to ensure that appropriate
policies, procedures, management information systems and internal controls are
in place to maintain IRR at prudent levels with consistency and continuity.
Evaluating the quantitative level of IRR exposure requires the Corporation to
assess the existing and potential future effects of changes in interest rates on
its consolidated financial condition, including capital adequacy, earnings,
liquidity, and, where appropriate, asset quality.
The Federal Reserve Board, together with the Office of the Comptroller of the
Currency and the Federal Deposit Insurance Corporation, adopted a Joint Agency
Policy Statement on IRR effective June 26, 1996. The policy statement provides
guidance to examiners and bankers on sound practices for managing IRR, which
will form the basis for ongoing evaluation of the adequacy of IRR management at
supervised institutions. The policy statement also outlines fundamental elements
of sound management that have been identified in prior Federal Reserve guidance
and discusses the importance of these elements in the context of managing IRR.
Specifically, the guidance emphasizes the need for active board of directors and
senior management oversight and a comprehensive risk management process that
effectively identifies, measures, and controls IRR.
Financial institutions derive their income primarily from the excess of interest
collected over interest paid. The rates of interest an institution earns on its
assets and owes on its liabilities generally are established contractually for a
period of time. Since market interest rates change over time, an institution is
exposed to lower profit margins (or losses) if it cannot adapt to interest rate
changes. For example, assume that an institution's assets carry intermediate or
long term fixed rates and that those assets are funded with short-term
liabilities. If market interest rates rise by the time the short-term
liabilities must be refinanced, the increase in the institution's interest
expense on its liabilities may not be sufficiently offset if assets continue to
earn at the long-term fixed rates. Accordingly, an institution's profits could
decrease on existing assets because the institution will either have lower net
interest income or, possibly, net interest expense. Similar risks exist when
assets are subject to contractual interest rate ceilings, or rate sensitive
assets are funded by longer-term, fixed-rate liabilities in a decreasing rate
environment.
Various techniques might be used by an institution to minimize IRR. One approach
used by the Corporation is to periodically analyze its assets and liabilities
and make future financing and investment decisions based on payment streams,
interest rates, contractual maturities, and estimated sensitivity to actual or
potential changes in market interest rates. Such activities fall under the broad
definition of asset/liability management.
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
14
<PAGE> 15
swaps, futures contracts, options on futures, and other such derivative
financial instruments often are used for this purpose. Because these instruments
are sensitive to interest rate changes, they require management expertise to be
effective. The Corporation has not purchased derivative financial instruments in
the past and does not presently intend to purchase such instruments.
Financial institutions are also subject to prepayment risk in falling rate
environments. For example, mortgage loans and other financial assets may be
prepaid by a debtor so that the debtor may refund its obligations at new, lower
rates. Prepayments of assets carrying higher rates reduce the Corporation's
interest income and overall asset yields. Certain portions of an institution's
liabilities may be short-term or due on demand, while most of its assets may be
invested in long-term loans or investments. Accordingly, the Corporation seeks
to have in place sources of cash to meet short-term demands. These funds can be
obtained by increasing deposits, borrowing, or selling assets. Also, Federal
Home Loan Bank advances and short-term borrowings provide additional sources of
liquidity for the Corporation.
The following table provides information about the Corporation's financial
instruments that are sensitive to changes in interest rates as of September 30,
1999. The Corporation had no derivative financial instruments, or trading
portfolio, as of that date. The expected maturity date values for loans
receivable, mortgage-backed securities, and investment securities were
calculated without adjusting the instrument's contractual maturity date for
expectations of prepayments. Expected maturity date values for interest-bearing
core deposits were not based upon estimates of the period over which the
deposits would be outstanding, but rather the opportunity for repricing.
Principal/Notional Amount Maturing in:
15
<PAGE> 16
<TABLE>
<CAPTION>
1999 2000 2001 2002 2003 Thereafter Total Fair Value
---- ---- ---- ---- ---- ---------- ----- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Rate Sensitive Assets:
Fixed interest rate loans $ 1,958 $8,761 $ 8,575 11,698 $18,813 $35,209 $85,014 $ 82,573
Average interest rate 8.31% 7.79% 8.75% 8.62% 8.32% 7.96% 8.20%
Variable interest rate loans 9,354 13,922 2,890 4,681 2,058 31,044 63,949 63,949
Average interest rate 8.94% 9.04% 9.15% 8.76% 8.99% 8.06% 8.53%
Fixed interest rate securities 1,665 4,530 5,810 4,760 5,690 9,420 31,875 32,019
Average interest rate 6.01% 6.23% 5.93% 6.25% 6.24% 6.65% 6.29%
FHLB stock 1,391 1,391 1,391
Average interest rate 8.00% 8.00%
Federal funds sold - - -
Average interest rate 0.00% 0.00%
Rate Sensitive Liabilities:
Non interest bearing demand 19,693 19,693 19,693
Interest bearing demand 24,006 24,006 24,006
Average interest rate 1.70% 1.70%
Savings 42,355 42,355 42,355
Average interest rate 2.59% 2.59%
Time deposits 18,598 32,287 6,524 2,497 1,416 844 62,166 61,678
Average interest rate 3.78% 4.17% 4.72% 4.54% 4.63% 4.77% 4.14%
Repurchase agreements 5,134 5,134 5,134
Average interest rate 4.80% 4.80%
U.S. treasury demand notes 1,611 1,611 1,611
Average interest rate 5.04% 5.04%
Fixed Rate FHLB advances - 7,000 1,000 1,500 1,000 10,500 9,221
Average interest rate 0.00% 5.94% 6.50% 5.48% 5.35% 5.98%
Variable rate FHLB advance 6,000 1,000 7,000 5,995
Average interest rate 5.47% 5.48% 5.06%
Federal funds purchased 250 250 250
Average interest rate 5.48% 5.48%
</TABLE>
Year 2,000 Issues
Commercial is aware of the issues associated with the programming code in
existing computer systems as the Year 2000 approaches. The Year 2000 will affect
virtually every computer operation in some way by the rollover of the two digit
value used to represent the year to 00. The issue is whether computer software
will properly recognize the date-sensitive information when the year changes to
2000. Systems that do not properly recognize such information could generate
erroneous data or cause a system failure.
Commercial recognizes the need to ensure that its operation will not be
adversely impacted by Year 2000 (Y2K) software failures. Commercial has
established a process for evaluating and managing risks associated with this
issue. A Technology Committee comprised of management and independent members of
the Board of Directors meet regularly to ensure that progress is made in
identifying non-compliant systems and developing appropriate responses to
correct the deficiencies.
The State Of Readiness
The process of addressing the Y2K issue includes seven phases: I-Awareness,
II-Inventory, III-Assessment, IV-Analysis, V-Conversion, VI-Implementation,
VII-Post Implementation.
The Bank has successfully completed Phases I-VI. Final remediation of critical
systems was completed by March 31, 1999. Management is confident that all
mission critical systems will perform on December 31, 1999.
16
<PAGE> 17
Cost To Address The Year 2000 Issue
Management has prepared a budget to estimate the cost of completing the seven
phases in our Y2K plan. The expenses associated with Y2K are compared to budget
and reported to the Technology Committee.
The largest cost element associated with the Y2K has been the opportunity cost
associated with management, board of directors and employee time developing our
plan, completing the seven phases and documenting our plan results.
During 1999 we will upgrade equipment and technology that may directly or
indirectly address Y2K issues totaling an estimated $480,000.
Risk Associated With The Year 2000 Issue
Management is confident that all mission critical systems will function
correctly on January 1, 2000. We are also confident that our large deposit and
loan customers are aware of, and are addressing Y2K.
However, there are several risks that management cannot fully control. These
risks include the ability of large institutional and government agencies to be
adequately prepared, the public's perception and response to the negative media
portrayal of the Y2K, and regulatory risk that the agencies responsible for the
Bank's oversight are not satisfied with our efforts to address the Y2K issue.
Large institutional entities include the Social Security Administration,
Internal Revenue Service, etc. These entities electronically deposit and gather
funds from our customers' accounts. We are unable to control or influence their
level of preparedness. Our customers may perceive their inability to properly
process and deliver transactions to the Bank as the Bank's Y2K failure.
The media is increasingly focused on the Y2K issue. Their focus has been on what
can go wrong, rather than what companies have done to address the issue. Some of
the "alleged" experts are advocating drastic preparedness plans for individuals,
including the withdrawal of all or most of their cash. The public's response to
this media information is difficult to predict. Though we are addressing the
anticipated need for additional liquidity and cash, we cannot accurately predict
the actual requirement. During the remainder of 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 problems.
The Bank is subject to regulatory examination related to the Y2K issue. The
Federal Depository Insurance Corporation (FDIC) examines the Bank to determine
if our plan appears adequate, we are making sufficient progress in addressing
our Y2K issues, and that we are adequately reporting the status of Y2K to the
Bank's board of directors. In the event that the regulators determine that we
are not meeting their expectations, they have the authority to enforce
compliance.
Contingency Plans
During the second 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. Modifications to the plan were completed by
September 30, 1999.
Management's contingency plan also establishes additional liquidity reserves and
an increase in the cash levels normally stored in Bank vaults. The liquidity
reserves includes obtaining additional FHLB advances structured to mature after
December 31, 1999, obtaining a Federal Reserve Discount Window line of credit,
systematically increasing cash reserves, monitoring customer activity for
unusual cash withdrawls, and implementing appropriate security measures to
protect the additional cash reserves.
17
<PAGE> 18
Forward Looking Statements
This discussion and analysis of financial condition and results of operations,
and other sections of this report contain forward looking statements that are
based on management's beliefs, assumptions, current expectations, estimates and
projections about the financial services industry, the economy, and about the
Corporation itself. Words such as "anticipates", "believes", "estimates",
"expects" "forecasts" "intends", "is likely", "plans", "product", "projects",
variations of such words and similar expressions are intended to identify such
forward-looking statements. These statements are not guarantees of future
performance and involve certain risks, uncertainties, and assumptions ("Future
Factors") that are difficult to predict with regard to timing, extent,
likelihood and degree of occurrence. Therefore, actual results and outcomes may
materially differ from what may be expressed or forecasted in such forward
looking statements. Furthermore, CNFC undertakes no obligation to update, amend
or clarify forward-looking statements, whether as a result of new information,
future events, or otherwise.
Future Factors include changes in interest rates and interest rate
relationships; demand for products and services; the degree of competition by
traditional and non-traditional competitors; changes in banking regulations and
tax laws; changes in prices, levies, and assessments; the impact of technology,
governmental and regulatory policy changes; the outcome of pending and future
litigation and contingencies; trends in customer behavior including their
ability to repay loans; and vicissitudes of the national and local economies.
These are representative of the Future Factors that could cause a difference
between an actual outcome and a forward-looking statement.
18
<PAGE> 19
COMMERCIAL NATIONAL FINANCIAL CORPORATION
PART II. OTHER INFORMATION
Item 6(a) Exhibit 27 Financial Data
Item 6(b) Reports on Form 8-K
None
19
<PAGE> 20
COMMERCIAL NATIONAL FINANCIAL CORPORATION
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Commercial National Financial Corporation
(Registrant)
Date: November 11 ,1999
/s/ Jeffrey S. Barker
President and Chief Executive Officer
/s/ Patrick G. Duffy
Executive Vice President and Chief Financial
Officer
20
<PAGE> 21
Exhibit Index
-------------
Exhibit No. Description
- ----------- -----------
27 Financial Data Schedule
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> SEP-30-1999
<CASH> 6075
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 22250
<INVESTMENTS-CARRYING> 9563
<INVESTMENTS-MARKET> 9769
<LOANS> 148962
<ALLOWANCE> 2691
<TOTAL-ASSETS> 190515
<DEPOSITS> 146021
<SHORT-TERM> 6995
<LIABILITIES-OTHER> 1431
<LONG-TERM> 17500
0
0
<COMMON> 17953
<OTHER-SE> 694
<TOTAL-LIABILITIES-AND-EQUITY> 190515
<INTEREST-LOAN> 3113
<INTEREST-INVEST> 440
<INTEREST-OTHER> 56
<INTEREST-TOTAL> 3607
<INTEREST-DEPOSIT> 1131
<INTEREST-EXPENSE> 1466
<INTEREST-INCOME-NET> 2141
<LOAN-LOSSES> 90
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 1362
<INCOME-PRETAX> 947
<INCOME-PRE-EXTRAORDINARY> 947
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 678
<EPS-BASIC> .22
<EPS-DILUTED> .22
<YIELD-ACTUAL> 5.02
<LOANS-NON> 978
<LOANS-PAST> 13
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 1342
<ALLOWANCE-OPEN> 2608
<CHARGE-OFFS> 12
<RECOVERIES> 5
<ALLOWANCE-CLOSE> 2691
<ALLOWANCE-DOMESTIC> 2142
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 549
</TABLE>
