UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
x | QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended June 30, 2009
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 0-13396
CNB FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
Pennsylvania | 25-1450605 | |
(State or other jurisdiction of incorporation or organization) |
(I.R.S. Employer Identification No.) |
1 South Second Street
P.O. Box 42
Clearfield, Pennsylvania 16830
(Address of principal executive offices)
Registrants telephone number, including area code, (814) 765-9621
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 periods that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. x Yes ¨ No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨ No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer, or a smaller reporting company. See definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer | ¨ | Accelerated filer | x | |||
Non-accelerated filer | ¨ | Smaller reporting company | ¨ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). ¨ Yes x No
The number of shares outstanding of the issuers common stock as of August 3, 2009
COMMON STOCK: $0 PAR VALUE, 8,666,766 SHARES
PART I.
FINANCIAL INFORMATION
2
CONSOLIDATED BALANCE SHEETS
Dollars in thousands
(unaudited) June 30, 2009 |
December 31, 2008 |
|||||||
ASSETS | ||||||||
Cash and due from banks |
$ | 38,380 | $ | 28,414 | ||||
Interest bearing deposits with other banks |
2,266 | 2,783 | ||||||
Federal funds sold |
| 59 | ||||||
Total cash and cash equivalents |
40,646 | 31,256 | ||||||
Interest bearing time deposits with other banks |
5,737 | 6,515 | ||||||
Securities available for sale |
255,341 | 237,289 | ||||||
Trading securities |
835 | 892 | ||||||
Loans held for sale |
7,449 | 3,332 | ||||||
Loans |
678,309 | 676,152 | ||||||
Less: unearned discount |
(4,127 | ) | (4,596 | ) | ||||
Less: allowance for loan losses |
(9,230 | ) | (8,719 | ) | ||||
Net loans |
664,952 | 662,837 | ||||||
FHLB and other equity interests |
7,062 | 5,815 | ||||||
Premises and equipment, net |
22,821 | 23,578 | ||||||
Bank owned life insurance |
16,080 | 15,720 | ||||||
Mortgage servicing rights |
732 | 552 | ||||||
Goodwill |
10,821 | 10,821 | ||||||
Other intangible assets |
135 | 185 | ||||||
Assets held for sale |
699 | | ||||||
Accrued interest receivable and other assets |
17,416 | 17,726 | ||||||
TOTAL |
$ | 1,050,726 | $ | 1,016,518 | ||||
LIABILITIES AND SHAREHOLDERS EQUITY | ||||||||
Non-interest bearing deposits |
$ | 104,736 | $ | 97,999 | ||||
Interest bearing deposits |
740,251 | 716,597 | ||||||
Total deposits |
844,987 | 814,596 | ||||||
Treasury, tax and loan borrowings |
1,710 | 719 | ||||||
FHLB and other borrowings |
107,558 | 107,478 | ||||||
Subordinated debentures |
20,620 | 20,620 | ||||||
Accrued interest payable and other liabilities |
11,801 | 10,638 | ||||||
Total liabilities |
986,676 | 954,051 | ||||||
Common stock, $0 par value; authorized 50,000,000 shares; issued 9,233,750 shares |
| | ||||||
Additional paid in capital |
12,811 | 12,913 | ||||||
Retained earnings |
67,756 | 65,890 | ||||||
Treasury stock, at cost (581,907 shares at June 30, 2009 and 637,694 shares at December 31, 2008) |
(8,546 | ) | (9,332 | ) | ||||
Accumulated other comprehensive loss |
(7,971 | ) | (7,004 | ) | ||||
Total shareholders equity |
64,050 | 62,467 | ||||||
TOTAL |
$ | 1,050,726 | $ | 1,016,518 | ||||
See Notes to Consolidated Financial Statements
3
CONSOLIDATED STATEMENTS OF INCOME (unaudited)
Dollars in thousands, except per share data
Three months ended June 30, |
||||||||
2009 | 2008 | |||||||
INTEREST AND DIVIDEND INCOME: |
||||||||
Loans including fees |
$ | 11,404 | $ | 11,594 | ||||
Deposits with banks |
60 | 79 | ||||||
Federal funds sold |
| 81 | ||||||
Securities: |
||||||||
Taxable |
1,872 | 1,799 | ||||||
Tax-exempt |
489 | 308 | ||||||
Dividends |
8 | 62 | ||||||
Total interest and dividend income |
13,833 | 13,923 | ||||||
INTEREST EXPENSE: |
||||||||
Deposits |
3,120 | 3,610 | ||||||
Borrowed funds |
1,127 | 1,095 | ||||||
Subordinated debentures |
219 | 219 | ||||||
Total interest expense |
4,466 | 4,924 | ||||||
NET INTEREST INCOME |
9,367 | 8,999 | ||||||
PROVISION FOR LOAN LOSSES |
1,008 | 756 | ||||||
Net interest income after provision for loan losses |
8,359 | 8,243 | ||||||
OTHER INCOME: |
||||||||
Trust and asset management fees |
236 | 265 | ||||||
Service charges on deposit accounts |
1,081 | 1,046 | ||||||
Other service charges and fees |
372 | 354 | ||||||
Net realized losses from sales of securities for which fair value was elected |
| (79 | ) | |||||
Net unrealized gains (losses) on securities for which fair value was elected |
93 | (379 | ) | |||||
Mortgage banking |
344 | 102 | ||||||
Bank owned life insurance |
180 | 160 | ||||||
Wealth management |
173 | 208 | ||||||
Other |
272 | 173 | ||||||
2,751 | 1,850 | |||||||
Total other-than-temporary impairment losses on available-for-sale securities |
(1,420 | ) | | |||||
Portion of loss recognized in other comprehensive loss |
1,180 | | ||||||
Net impairment losses recognized in earnings |
(240 | ) | | |||||
Net realized gains on securities available for sale |
291 | | ||||||
Net impairment losses recognized in earnings and realized gains on available-for-sale securities |
51 | | ||||||
Total other income |
2,802 | 1,850 | ||||||
OTHER EXPENSES: |
||||||||
Salaries and benefits |
3,498 | 3,763 | ||||||
Net occupancy expense of premises |
969 | 861 | ||||||
Amortization of intangibles |
25 | 25 | ||||||
Other |
3,318 | 2,457 | ||||||
Total other expenses |
7,810 | 7,106 | ||||||
INCOME BEFORE INCOME TAXES |
3,351 | 2,987 | ||||||
INCOME TAX EXPENSE |
863 | 811 | ||||||
NET INCOME |
$ | 2,488 | $ | 2,176 | ||||
EARNINGS PER SHARE: |
||||||||
Basic |
$ | 0.29 | $ | 0.25 | ||||
Diluted |
$ | 0.29 | $ | 0.25 | ||||
DIVIDENDS PER SHARE, |
||||||||
Cash dividends per share |
$ | 0.165 | $ | 0.16 |
See Notes to Consolidated Financial Statements
4
CONSOLIDATED STATEMENTS OF INCOME (unaudited)
Dollars in thousands, except per share data
Six months ended June 30, |
||||||||
2009 | 2008 | |||||||
INTEREST AND DIVIDEND INCOME: |
||||||||
Loans including fees |
$ | 22,834 | $ | 23,203 | ||||
Deposits with banks |
132 | 160 | ||||||
Federal funds sold |
| 232 | ||||||
Securities: |
||||||||
Taxable |
3,778 | 3,573 | ||||||
Tax-exempt |
1,026 | 613 | ||||||
Dividends |
18 | 172 | ||||||
Total interest and dividend income |
27,788 | 27,953 | ||||||
INTEREST EXPENSE: |
||||||||
Deposits |
6,451 | 7,152 | ||||||
Borrowed funds |
2,318 | 2,227 | ||||||
Subordinated debentures |
449 | 533 | ||||||
Total interest expense |
9,218 | 9,912 | ||||||
NET INTEREST INCOME |
18,570 | 18,041 | ||||||
PROVISION FOR LOAN LOSSES |
1,870 | 1,265 | ||||||
Net interest income after provision for loan losses |
16,700 | 16,776 | ||||||
OTHER INCOME: |
||||||||
Trust and asset management fees |
446 | 605 | ||||||
Service charges on deposit accounts |
2,014 | 2,048 | ||||||
Other service charges and fees |
721 | 650 | ||||||
Net realized losses from sales of securities for which fair value was elected |
| (254 | ) | |||||
Net unrealized losses on securities for which fair value was elected |
(58 | ) | (1,025 | ) | ||||
Mortgage banking |
497 | 195 | ||||||
Bank owned life insurance |
360 | 334 | ||||||
Wealth management |
333 | 420 | ||||||
Other |
405 | 306 | ||||||
4,718 | 3,279 | |||||||
Total other-than-temporary impairment losses on available-for-sale securities |
(1,420 | ) | | |||||
Portion of loss recognized in other comprehensive loss |
1,180 | | ||||||
Net impairment losses recognized in earnings |
(240 | ) | | |||||
Net realized gains on securities available for sale |
275 | 117 | ||||||
Net impairment losses recognized in earnings and realized gains on available-for-sale securities |
35 | 117 | ||||||
Total other income |
4,753 | 3,396 | ||||||
OTHER EXPENSES: |
||||||||
Salaries and benefits |
7,063 | 7,652 | ||||||
Net occupancy expense of premises |
2,073 | 1,836 | ||||||
Amortization of intangibles |
50 | 50 | ||||||
Other |
5,983 | 4,921 | ||||||
Total other expenses |
15,169 | 14,459 | ||||||
INCOME BEFORE INCOME TAXES |
6,284 | 5,713 | ||||||
INCOME TAX EXPENSE |
1,570 | 1,535 | ||||||
NET INCOME |
$ | 4,714 | $ | 4,178 | ||||
EARNINGS PER SHARE: |
||||||||
Basic |
$ | 0.55 | $ | 0.49 | ||||
Diluted |
$ | 0.55 | $ | 0.49 | ||||
DIVIDENDS PER SHARE, |
||||||||
Cash dividends per share |
$ | 0.33 | $ | 0.32 |
See Notes to Consolidated Financial Statements
5
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (unaudited)
Dollars in thousands
Three months ended June 30, |
Six months ended June 30, |
|||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
NET INCOME |
$ | 2,488 | $ | 2,176 | $ | 4,714 | $ | 4,178 | ||||||||
Other comprehensive income (loss), net of tax: |
||||||||||||||||
Change in fair value of interest rate swap agreement designated as a cash flow hedge, net of tax of ($106) and ($119) for the three and six months ended June 30, 2009 |
200 | | 223 | | ||||||||||||
Unrealized gains (losses) on securities available for sale: |
||||||||||||||||
Unrealized gains (losses) arising during the period, net of tax of ($3) and $1,805 for the three months ended June 30, 2009 and 2008, and $628 and $2,491 for the six months ended June 30, 2009 and 2008 |
6 | (3,353 | ) | (1,167 | ) | (4,626 | ) | |||||||||
Reclassification adjustment for accumulated (gains) losses included in net income, net of tax of $17 for the three months ended June 30, 2009, and $12 and $41 for the six months ended June 30, 2009 and 2008 |
(34 | ) | | (23 | ) | (76 | ) | |||||||||
Other comprehensive income (loss) |
172 | (3,353 | ) | (967 | ) | (4,702 | ) | |||||||||
COMPREHENSIVE INCOME (LOSS) |
$ | 2,660 | $ | (1,177 | ) | $ | 3,747 | $ | (524 | ) | ||||||
See Notes to Consolidated Financial Statements
6
CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
Dollars in thousands
Six months ended June 30, |
||||||||
2009 | 2008 | |||||||
CASH FLOWS FROM OPERATING ACTIVITIES: |
||||||||
Net income |
$ | 4,714 | $ | 4,178 | ||||
Adjustments to reconcile net income to net cash provided by operations: |
||||||||
Provision for loan losses |
1,870 | 1,265 | ||||||
Depreciation and amortization |
993 | 908 | ||||||
Amortization, accretion and deferred loan fees and costs |
549 | (317 | ) | |||||
Net impairment losses realized in earnings and gains on available-for-sale securities |
(35 | ) | (117 | ) | ||||
Net realized and unrealized losses on securities for which fair value was elected |
58 | 1,279 | ||||||
Gain on sale of loans |
(435 | ) | (137 | ) | ||||
Proceeds from sale of loans |
27,605 | 4,811 | ||||||
Origination of loans held for sale |
(31,555 | ) | (7,285 | ) | ||||
Increase in bank owned life insurance |
(360 | ) | (333 | ) | ||||
Stock-based compensation expense |
56 | 77 | ||||||
Changes in: |
||||||||
Accrued interest receivable and other assets |
700 | 282 | ||||||
Accrued interest payable and other liabilities |
1,589 | (1,803 | ) | |||||
NET CASH PROVIDED BY OPERATING ACTIVITIES |
5,749 | 2,808 | ||||||
CASH FLOWS FROM INVESTING ACTIVITIES: |
||||||||
Net decrease (increase) in interest bearing time deposits with other banks |
778 | (897 | ) | |||||
Proceeds from maturities, prepayments and calls of securities |
44,749 | 19,589 | ||||||
Proceeds from sales of securities |
51,227 | 13,003 | ||||||
Purchase of securities |
(116,201 | ) | (49,498 | ) | ||||
Loan origination and payments, net |
(4,176 | ) | (61,589 | ) | ||||
Redemption (purchase) of FHLB and other equity interests |
(1,247 | ) | 608 | |||||
Purchase of premises and equipment |
(797 | ) | (3,314 | ) | ||||
Proceeds from the sale of premises and equipment and foreclosed assets |
66 | 47 | ||||||
NET CASH USED IN INVESTING ACTIVITIES |
(25,601 | ) | (82,051 | ) | ||||
CASH FLOWS FROM FINANCING ACTIVITIES: |
||||||||
Net change in: |
||||||||
Checking, money market and savings accounts |
57,359 | 91,590 | ||||||
Certificates of deposit |
(26,968 | ) | 5,096 | |||||
Treasury stock purchased |
| (611 | ) | |||||
Proceeds from sale of treasury stock |
606 | 572 | ||||||
Proceeds from exercise of stock options |
22 | | ||||||
Cash dividends paid |
(2,848 | ) | (2,739 | ) | ||||
Advances from long-term borrowings |
625 | 5,000 | ||||||
Repayment of long-term borrowings |
(4,545 | ) | (4,000 | ) | ||||
Net change in short-term borrowings |
4,991 | (1,559 | ) | |||||
NET CASH PROVIDED BY FINANCING ACTIVITIES |
29,242 | 93,349 | ||||||
NET INCREASE IN CASH AND CASH EQUIVALENTS |
9,390 | 14,106 | ||||||
CASH AND CASH EQUIVALENTS, Beginning |
31,256 | 26,587 | ||||||
CASH AND CASH EQUIVALENTS, Ending |
$ | 40,646 | $ | 40,693 | ||||
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: |
||||||||
Cash paid (refunded) during the period for: |
||||||||
Interest |
$ | 9,411 | $ | 9,990 | ||||
Income taxes |
$ | 630 | $ | 2,450 | ||||
SUPPLEMENTAL NONCASH DISCLOSURES: |
||||||||
Transfers to other real estate owned |
$ | 19 | $ | 126 | ||||
Transfers to assets held for sale |
$ | 699 | $ | | ||||
Grant of restricted stock awards from treasury stock |
$ | | $ | 173 | ||||
Adoption of FASB Statement No. 159, transfer of securities available for sale to trading securities |
$ | | $ | 7,018 |
See Notes to Consolidated Financial Statements
7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
BASIS OF PRESENTATION
The accompanying consolidated financial statements have been prepared pursuant to rules and regulations of the Securities and Exchange Commission (SEC) and in compliance with accounting principles generally accepted in the United States of America. Because this report is based on an interim period, certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted.
In the opinion of management of the registrant, the accompanying consolidated financial statements as of June 30, 2009 and for the quarters and six months ended June 30, 2009 and 2008 include all adjustments, consisting of only normal recurring adjustments, necessary for a fair presentation of the financial condition and the results of operations for the period. Management has evaluated events occurring subsequent to the balance sheet date through August 7, 2009, the financial statement issuance date, determining no events require adjustment to or additional disclosure in the consolidated financial statements. The financial performance reported for CNB Financial Corporation (the Corporation) for the three and six month periods ended June 30, 2009 is not necessarily indicative of the results to be expected for the full year. This information should be read in conjunction with the Corporations Annual Report to shareholders and Form 10-K for the period ended December 31, 2008.
STOCK COMPENSATION
The Corporation has a stock incentive plan for key employees and independent directors. The Stock incentive plan, which is administered by a committee of the Board of Directors, provides for up to 500,000 shares of common stock in the form of nonqualified options or restricted stock. For key employees, the plan vesting is one-fourth of the granted options or restricted stock per year beginning one year after the grant date, with 100% vested on the fourth anniversary of the grant. For independent directors, the vesting schedule is one-third of the granted options per year beginning one year after the grant date, with 100% vested on the third anniversary of the grant.
Compensation expense for the restricted stock awards is recognized over the requisite service period noted above based on the fair value of the shares at the date of grant. Unearned restricted stock awards are recorded as a reduction of shareholders equity until earned. Compensation expense resulting from these restricted stock awards was $31,000 and $56,000 for the three and six months ended June 30, 2009 and $46,000 and $77,000 for the three and six months ended June 30, 2008. As of June 30, 2009, there was $188,000 of total unrecognized compensation cost related to unvested restricted stock awards. A summary of changes in unvested restricted stock awards for the three months ended June 30, 2009 and 2008 follows:
June 30, 2009 | June 30, 2008 | ||||||||||
Shares | Weighted Average Grant Date Fair Value |
Shares | Weighted Average Grant Date Fair Value | ||||||||
Nonvested at beginning of period |
17,238 | $ | 13.93 | 28,766 | $ | 14.03 | |||||
Granted |
| | | | |||||||
Vested |
| | (825 | ) | 14.10 | ||||||
Forfeited |
| | | | |||||||
Nonvested at end of period |
17,238 | $ | 13.93 | 27,941 | $ | 14.03 | |||||
8
A summary of changes in unvested restricted stock awards for the six months ended June 30, 2009 and 2008 follows:
June 30, 2009 | June 30, 2008 | |||||||||||
Shares | Weighted Average Grant Date Fair Value |
Shares | Weighted Average Grant Date Fair Value | |||||||||
Nonvested at beginning of period |
27,197 | $ | 14.03 | 22,688 | $ | 14.12 | ||||||
Granted |
400 | 9.70 | 12,433 | 13.91 | ||||||||
Vested |
(8,658 | ) | 14.03 | (7,180 | ) | 14.10 | ||||||
Forfeited |
(1,701 | ) | 14.05 | | | |||||||
Nonvested at end of period |
17,238 | $ | 13.93 | 27,941 | $ | 14.03 | ||||||
FAIR VALUE
Fair Value Option
Management elected to adopt Financial Accounting Standards Board (FASB) Statement No. 159 for its investment in perpetual preferred equity securities issued by the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation as well as its investment in certain other equity securities. Management elected the fair value option for these securities to provide financial statement users with greater visibility into the Corporations financial instruments that do not have a defined maturity date.
Fair value changes attributable to unrealized gains (losses) that were included in earnings for the three and six months ended June 30, 2009 were $93,000 and ($58,000). Fair value changes included in earnings for the three and six months ended June 30, 2008 were ($379,000) and ($1,025,000) for unrealized losses and ($79,000) and ($254,000) for realized losses on sales. There were no sales of securities for which the fair value option was elected during the three and six months ended June 30, 2009.
Dividend income is recorded based on cash dividends and comprises the Dividends line item in the accompanying consolidated statement of income. Dividend income was $8,000 and $18,000 for the three and six months ended June 30, 2009 and $62,000 and $172,000 for the three and six months ended June 30, 2008.
Fair Value Measurement
FASB Statement No. 157 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Statement No. 157 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:
Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
Level 3: Significant unobservable inputs that reflect a companys own assumptions about the assumptions that market participants would use in pricing an asset or liability.
9
The fair values of most trading securities and securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs) or matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather relying on the securities relationship to other benchmark quoted securities (Level 2 inputs). The fair values of certain mortgage-backed securities classified as available for sale have been determined by using Level 3 inputs. The Corporation has engaged a valuation expert to price these securities using a proprietary model, which incorporates assumptions that market participants would use in pricing the securities, including bid/ask spreads and liquidity and credit premiums.
Trust preferred securities which are issued by financial institutions and insurance companies are priced using Level 3 inputs. The decline in the level of observable inputs and market activity in this class of investments by the measurement date has been significant and resulted in unreliable external pricing. Broker pricing and bid/ask spreads, when available, vary widely, and the once active market has become comparatively inactive.
The Corporation engaged a third party consultant who has developed an internal model for pricing these securities. Information such as historical and current performance of the underlying collateral, deferral and default rates, collateral coverage ratios, break in yield calculations, cash flow projections, liquidity and credit premiums required by a market participant, and financial trend analysis with respect to the individual issuing financial institutions and insurance companies are utilized in determining individual security valuations. Due to the current market conditions as well as the limited trading activity of these securities, the market value of the securities is highly sensitive to assumption changes and market volatility.
Our derivative instrument is an interest rate swap that trades in liquid markets. As such, significant fair value inputs can generally be verified and do not typically involve significant management judgments (Level 2 inputs).
The fair value of impaired loans is determined using the fair value of collateral for collateral dependent loans and the estimated present value of future cash flows for non-collateral dependent loans. The Corporation uses appraisals prepared by valuation specialists and other available data such as comparable sales and industry data to estimate the fair value of collateral and present value of future cash flows (Level 3 inputs).
Assets and Liabilities Measured on a Recurring Basis
June 30, 2009 |
Fair Value Measurements at Reporting Date Using | |||||||||||||
Description |
Quoted Prices in Active Markets for Identical Assets (Level 1) |
Significant Other Observable Inputs (Level 2) |
Significant Unobservable Inputs (Level 3) | |||||||||||
Assets: |
||||||||||||||
Securities Available For Sale: |
||||||||||||||
U.S. Treasury |
$ | 11,184 | $ | 11,184 | ||||||||||
U.S. Government sponsored entities |
28,326 | $ | 6,000 | 22,326 | ||||||||||
States and political subdivisions |
63,532 | 6,025 | 57,507 | |||||||||||
Mortgage and asset backed |
125,634 | 11,069 | 111,752 | $ | 2,813 | |||||||||
Corporate notes and bonds |
16,019 | 16,019 | ||||||||||||
Pooled trust preferred |
2,778 | 2,778 | ||||||||||||
Pooled SBA |
6,202 | 4,254 | 1,948 | |||||||||||
Other securities |
1,666 | 1,666 | ||||||||||||
Total Securities Available For Sale |
$ | 255,341 | $ | 29,014 | $ | 220,736 | $ | 5,591 | ||||||
Trading securities equity securities |
$ | 835 | $ | 835 | ||||||||||
Liabilities, |
||||||||||||||
Interest rate swap |
$ | (673 | ) | $ | (673 | ) | ||||||||
10
December 31, 2008 |
Fair Value Measurements at Reporting Date Using | |||||||||||||
Description |
Quoted Prices in Active Markets for Identical Assets (Level 1) |
Significant Other Observable Inputs (Level 2) |
Significant Unobservable Inputs (Level 3) | |||||||||||
Assets: |
||||||||||||||
Securities Available For Sale: |
||||||||||||||
U.S. Treasury |
$ | 10,316 | $ | 10,316 | ||||||||||
U.S. Government sponsored entities |
41,264 | $ | 13,059 | 28,205 | ||||||||||
States and political subdivisions |
54,415 | 7,295 | 47,120 | |||||||||||
Mortgage-backed |
104,418 | 5,018 | 95,082 | $ | 4,318 | |||||||||
Corporate notes and bonds |
22,162 | 22,162 | ||||||||||||
Pooled trust preferred |
3,079 | 3,079 | ||||||||||||
Other securities |
1,635 | 1,635 | ||||||||||||
Total Securities Available For Sale |
$ | 237,289 | $ | 27,007 | $ | 202,885 | $ | 7,397 | ||||||
Trading securities equity securities |
$ | 892 | $ | 892 | ||||||||||
Liabilities, |
||||||||||||||
Interest rate swap |
$ | (1,015 | ) | $ | (1,015 | ) | ||||||||
The table below presents a reconciliation and income statement classification of gains and losses for all securities available for sale measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three months ended June 30, 2009 (in thousands):
Beginning balance, April 1, 2009 |
$ | 6,066 | ||
Total gains or losses (realized/unrealized): |
||||
Included in earnings |
(240 | ) | ||
Included in other comprehensive loss |
647 | |||
Purchases, issuances, and settlements |
(882 | ) | ||
Transfers in and/or out of Level 3 |
| |||
Ending balance, June 30, 2009 |
$ | 5,591 | ||
The table below presents a reconciliation and income statement classification of gains and losses for all securities available for sale measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the six months ended June 30, 2009 (in thousands):
Beginning balance, January 1, 2009 |
$ | 7,397 | ||
Total gains or losses (realized/unrealized): |
||||
Included in earnings |
(240 | ) | ||
Included in other comprehensive loss |
3 | |||
Purchases, issuances, and settlements |
(1,638 | ) | ||
Transfers in and/or out of Level 3 |
69 | |||
Ending balance, June 30, 2009 |
$ | 5,591 | ||
11
The table below presents a reconciliation and income statement classification of gains and losses for all securities available for sale measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the year ended December 31, 2008 (in thousands):
Beginning balance, January 1, 2008 |
$ | 1,526 | ||
Total gains or losses (realized/unrealized): |
||||
Included in earnings |
(2,000 | ) | ||
Included in other comprehensive loss |
(2,770 | ) | ||
Purchases, issuances, and settlements |
3,494 | |||
Transfers in and/or out of Level 3 |
7,147 | |||
Ending balance, December 31, 2008 |
$ | 7,397 | ||
The unrealized loss reported in earnings for the year ended December 31, 2008 for Level 3 assets that are still held at December 31, 2008 relates to a pooled trust preferred security deemed to be other-than-temporarily impaired.
Assets and Liabilities Measured on a Non-Recurring Basis
Assets measured at fair value on a non-recurring basis are summarized below (in thousands):
June 30, 2009 |
Fair Value Measurements at Reporting Date Using | |||||||||
Description |
Quoted Prices in Active Markets for Identical Assets (Level 1) |
Significant Other Observable Inputs (Level 2) |
Significant Unobservable Inputs (Level 3) | |||||||
Assets, |
||||||||||
Impaired loans |
$ | 4,505 | $ | 4,505 | ||||||
December 31, 2008 |
Fair Value Measurements at Reporting Date Using | |||||||||
Description |
Quoted Prices in Active Markets for Identical Assets (Level 1) |
Significant Other Observable Inputs (Level 2) |
Significant Unobservable Inputs (Level 3) | |||||||
Assets, |
||||||||||
Impaired loans |
$ | 3,222 | $ | 3,222 |
Impaired loans, which are measured for impairment using the fair value of collateral for collateral dependent loans, had a principal balance of $6,194, with a valuation allowance of $1,686 as of June 30, 2009, resulting in an additional provision for loan losses of $299 and $185 for the three and six months then ended. Impaired loans had a principal balance of $4,850, with a valuation allowance of $1,628 as of December 31, 2008, resulting in an additional provision for loan losses of $1,292 for the year then ended.
Fair Value of Financial Instruments
Carrying amount is the estimated fair value for cash and cash equivalents, accrued interest receivable and payable, demand deposits, other borrowings, and variable rate loans, deposits or borrowings that reprice frequently and fully. For fixed rate loans or deposits and for variable rate loans or deposits with infrequent repricing or repricing limits, fair value is based on discounted cash flows using current market rates applied to the estimated life and credit risk. Fair value of loans held for sale is based on market quotes. Fair value of debt is based on current rates for similar financing. It is not practical to determine the fair value of FHLB stock and other equity interests due to restrictions placed on the transferability of these instruments. The fair value of off balance sheet items is based on the current fees or cost that would be charged to enter into or terminate such arrangements. The fair value of off balance sheet items is not material.
12
While these estimates of fair value are based on managements judgment of the most appropriate factors as of the balance sheet date, there is no assurance that the estimated fair values would have been realized if the assets had been disposed of or the liabilities settled at that date, since market values may differ depending on various circumstances. The estimated fair values would also not apply to subsequent dates.
In addition, other assets and liabilities that are not financial instruments, such as premises and equipment, are not included in the disclosures. Also, non-financial instruments typically not recognized on the balance sheet may have value but are not included in the fair value disclosures. These include, among other items, the estimated earnings power of core deposits, the earnings potential of trust accounts, the trained workforce, customer goodwill, and similar items.
June 30, 2009 | December 31, 2008 | |||||||||||||||
Carrying Amount |
Fair Value |
Carrying Amount |
Fair Value |
|||||||||||||
ASSETS |
||||||||||||||||
Cash and cash equivalents |
$ | 40,646 | $ | 40,646 | $ | 31,256 | $ | 31,256 | ||||||||
Interest bearing time deposits with other banks |
5,737 | 5,993 | 6,515 | 6,658 | ||||||||||||
Securities available for sale |
255,341 | 255,341 | 237,289 | 237,289 | ||||||||||||
Trading securities |
835 | 835 | 892 | 892 | ||||||||||||
Loans held for sale |
7,449 | 7,479 | 3,332 | 3,339 | ||||||||||||
Net loans |
664,952 | 693,369 | 662,837 | 682,741 | ||||||||||||
FHLB and other equity interests |
7,062 | N/A | 5,815 | N/A | ||||||||||||
Accrued interest receivable |
4,243 | 4,243 | 4,470 | 4,470 | ||||||||||||
LIABILITIES |
||||||||||||||||
Deposits |
$ | (844,987 | ) | $ | (834,569 | ) | $ | (814,596 | ) | $ | (816,456 | ) | ||||
Borrowings |
(129,888 | ) | (138,998 | ) | (128,817 | ) | (135,760 | ) | ||||||||
Interest rate swap |
(673 | ) | (673 | ) | (1,015 | ) | (1,015 | ) | ||||||||
Accrued interest payable |
(1,797 | ) | (1,797 | ) | (2,107 | ) | (2,107 | ) |
SECURITIES
Securities available for sale at June 30, 2009 and December 31, 2008 were as follows (in thousands):
June 30, 2009 | December 31, 2008 | |||||||||||||||||||||||||
Amortized Cost |
Unrealized | Fair Value |
Amortized Cost |
Unrealized | Fair Value | |||||||||||||||||||||
Gains | Losses | Gains | Losses | |||||||||||||||||||||||
U.S. Treasury |
$ | 11,043 | $ | 141 | $ | | $ | 11,184 | $ | 10,059 | $ | 257 | $ | | $ | 10,316 | ||||||||||
U.S. Govt sponsored entities |
28,399 | 71 | (144 | ) | 28,326 | 40,779 | 486 | (1 | ) | 41,264 | ||||||||||||||||
States & political subdivisions |
63,369 | 806 | (643 | ) | 63,532 | 54,467 | 667 | (719 | ) | 54,415 | ||||||||||||||||
Mortgage & asset backed |
127,020 | 1,085 | (2,471 | ) | 125,634 | 105,623 | 580 | (1,785 | ) | 104,418 | ||||||||||||||||
Corporate notes & bonds |
22,771 | 39 | (6,791 | ) | 16,019 | 27,735 | 31 | (5,604 | ) | 22,162 | ||||||||||||||||
Pooled trust preferred |
6,777 | | (3,999 | ) | 2,778 | 7,080 | 37 | (4,038 | ) | 3,079 | ||||||||||||||||
Pooled SBA |
6,246 | 1 | (45 | ) | 6,202 | | | | | |||||||||||||||||
Other securities |
1,670 | 16 | (20 | ) | 1,666 | 1,670 | | (35 | ) | 1,635 | ||||||||||||||||
$ | 267,295 | $ | 2,159 | $ | (14,113 | ) | $ | 255,341 | $ | 247,413 | $ | 2,058 | $ | (12,182 | ) | $ | 237,289 | |||||||||
At June 30, 2009, there were no holdings of securities of any one issuer, other than the U.S. Government and its agencies, in an amount greater than 10% of shareholders equity.
13
Securities with unrealized losses at June 30, 2009 and December 31, 2008, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, are as follows (in thousands):
June 30, 2009 |
|||||||||||||||||||||
Less than 12 Months | 12 Months or More | Total | |||||||||||||||||||
Description of Securities |
Fair Value |
Unrealized Loss |
Fair Value |
Unrealized Loss |
Fair Value |
Unrealized Loss |
|||||||||||||||
U.S. Treasury |
$ | | $ | | $ | | $ | | $ | | $ | | |||||||||
U.S. Govt sponsored entities |
7,855 | (144 | ) | | | 7,855 | (144 | ) | |||||||||||||
States & political subdivisions |
15,000 | (347 | ) | 7,108 | (296 | ) | 22,108 | (643 | ) | ||||||||||||
Mortgage & asset backed |
41,537 | (822 | ) | 7,465 | (1,649 | ) | 49,002 | (2,471 | ) | ||||||||||||
Corporate notes & bonds |
| | 15,848 | (6,791 | ) | 15,848 | (6,791 | ) | |||||||||||||
Pooled trust preferred |
| | 2,778 | (3,999 | ) | 2,778 | (3,999 | ) | |||||||||||||
Pooled SBA |
1,948 | (45 | ) | | | 1,948 | (45 | ) | |||||||||||||
Other securities |
129 | (20 | ) | | | 129 | (20 | ) | |||||||||||||
$ | 66,469 | $ | (1,378 | ) | $ | 33,199 | $ | (12,735 | ) | $ | 99,668 | $ | (14,113 | ) | |||||||
December 31, 2008 |
|||||||||||||||||||||
U.S. Treasury |
$ | | $ | | $ | | $ | | $ | | $ | | |||||||||
U.S. Govt sponsored entities |
468 | (1 | ) | | | 468 | (1 | ) | |||||||||||||
States & political subdivisions |
18,217 | (599 | ) | 3,894 | (120 | ) | 22,111 | (719 | ) | ||||||||||||
Mortgage & asset backed |
35,572 | (312 | ) | 9,695 | (1,473 | ) | 45,267 | (1,785 | ) | ||||||||||||
Corporate notes & bonds |
2,985 | (71 | ) | 17,154 | (5,533 | ) | 20,139 | (5,604 | ) | ||||||||||||
Pooled trust preferred |
849 | (2,008 | ) | 970 | (2,030 | ) | 1,819 | (4,038 | ) | ||||||||||||
Other securities |
1,134 | (35 | ) | | | 1,134 | (35 | ) | |||||||||||||
$ | 59,225 | $ | (3,026 | ) | $ | 31,713 | $ | (9,156 | ) | $ | 90,938 | $ | (12,182 | ) | |||||||
The Corporation evaluates securities for other-than-temporary impairment on a quarterly basis, or more frequently when economic or market conditions warrant such an evaluation.
At June 30, 2009, management evaluated the structured pooled trust preferred securities for other-than-temporary impairment by estimating the cash flows expected to be received from each security within the collateral pool, taking into account estimated levels of deferrals and defaults by the underlying issuers. Management also assumed that all issuers in deferral will default prior to their next payment date. Trust preferred collateral is deeply subordinated within issuers capital structures, so large recoveries are unlikely. Accordingly, management assumed 10% recoveries on bank collateral and none on collateral issued by other companies. Due to the current crisis in the U.S. economy, management also added a baseline default rate of 2% annually for the next two years to our default projections for specific issuers. This percentage represents the peak, post-war bank default rate that occurred at the height of the savings and loan crisis, which we believe is an accurate proxy for the current environment. Within the next two years, management expects that credit markets will normalize and that banks with the financial strength to survive will default at a .36% average annual rate, which represents Moodys idealized default probability for BBB corporate credits, and is in line with historical bank failure rates.
Using this methodology, one of the Corporations structured pooled trust preferred securities was deemed to become other-than-temporarily impaired during the quarter ended June 30, 2009. As described in the Recent Accounting Pronouncements disclosure, the Corporation adopted FSP FAS 115-2 and FAS 124-2 effective April 1, 2009. As a result, the Corporation separated the other-than-temporary impairment related to this structured pooled trust preferred security into (a) the amount of the total impairment related to credit loss, which is recognized in the income statement, and (b) the amount of the total impairment related to all other factors, which is recognized in other comprehensive income. The Corporation measured the credit loss component of other-than-temporary impairment based on the difference between the cost basis and the present value of cash flows expected to be collected. As a result of implementing this standard, the amount of other-than-temporary impairment recognized in income for the three months ended June 30, 2009 was $240,000. Had the standard not been issued, the amount of other-than-temporary impairment that would have been recognized in income for the period would have been $1,420,000.
14
A roll-forward of the other-than-temporary impairment amount related to credit losses for the three months ended June 30, 2009 is as follows (in thousands):
Balance of credit losses on debt securities for which a portion of other-than-temporary impairment was recognized in other comprehensive income, beginning of period (as measured effective April 1, 2009 upon adoption of FSP FAS 115-2 and FAS 124-2) |
$ | | |
Additional credit loss for which other-than-temporary impairment was not previously recognized |
240 | ||
Balance of credit losses on debt securities for which a portion of other-than-temporary impairment was recognized in other comprehensive income, end of period |
$ | 240 | |
At June 30, 2009, approximately 28% of the total unrealized losses relate to structured pooled trust preferred securities, primarily from issuers in the financial services industry, which are not currently trading in an active, open market with readily observable prices. As a result, these securities were classified within Level 3 of the valuation hierarchy. The fair values of these securities have been calculated using a discounted cash flow model and market liquidity premium as permitted by FASB Statement No. 157, as amended. With the current market conditions, the assumptions used to determine the fair value of Level 3 securities has greater subjectivity due to the lack of observable market transactions. The fair values of these securities have declined due to the fact that subsequent offerings of similar securities pay a higher market rate of return. This higher rate of return reflects the increased credit and liquidity risks in the marketplace. Except as described above, based on managements evaluation of the structured pooled trust preferred securities, the present value of the projected cash flows is sufficient for full repayment of the amortized cost of the securities and, therefore, it is believed that the decline in fair value is temporary due to current market conditions. However, without recovery of these securities, other-than-temporary impairments may occur in future periods.
For all of the securities that comprise corporate notes and bonds, the Corporations management follows the guidance in FASB Statement No. 115, SEC Staff Accounting Bulletin No. 59, and SEC Staff Accounting Topic 5.M while performing its analysis of other-than-temporary impairment. For each security issuer, management monitors publicly available financial information such as filings with the Securities and Exchange Commission. For financial institution issuers, management also monitors information from quarterly call report filings that are used to generate Uniform Bank Performance Reports. When reviewing this information, management considers the financial condition and near term prospects of the issuer and whether downgrades by bond rating agencies have occurred. Management also considers the length of time and extent to which fair value has been less than cost and the intent and ability of the Corporation to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. As of June 30, 2009 and December 31, 2008, management concluded that the previously mentioned securities were not other-than-temporarily impaired for the following reasons:
| There is no indication of any significant deterioration of the creditworthiness of the institutions who issued the securities. |
| The unrealized losses are predominantly attributable to liquidity disruptions within the credit markets and the generally stressed condition of the financial services industry. |
| All contractual interest payments on the securities have been received as scheduled, and no information has come to managements attention through the processes previously described which would lead to a conclusion that future contractual payments will not be received timely. |
The Corporation does not intend to sell and it is not more likely than not that it will be required to sell the securities in an unrealized loss position before recovery of its amortized cost basis.
Information pertaining to security sales is as follows:
Proceeds | Gross Gains | Gross Losses | ||||||||
Three months ended June 30, 2009 |
$ | 19,215 | $ | 357 | $ | (66 | ) | |||
Six months ended June 30, 2009 |
51,227 | 1,121 | (846 | ) |
15
The following is a schedule of the contractual maturity of securities available for sale, excluding equity securities, at June 30, 2009 and December 31, 2008:
June 30, 2009 | December 31, 2008 | |||||
1 year or less |
$ | 32,694 | $ | 17,791 | ||
1 year 5 years |
33,011 | 44,062 | ||||
5 years 10 years |
35,200 | 31,971 | ||||
After 10 years |
27,136 | 37,412 | ||||
128,041 | 131,236 | |||||
Mortgage & asset backed securities |
125,634 | 104,418 | ||||
Total debt securities |
$ | 253,675 | $ | 235,654 | ||
Mortgage and asset backed securities are not due at a single date; periodic payments are received based on the payment patterns of the underlying collateral.
FEDERAL HOME LOAN BANK (FHLB) STOCK
CNB Bank is a member of the FHLB system. Members are required to own a certain amount of stock based on the level of borrowings and other factors, and may invest in additional amounts. FHLB stock is carried at cost, classified as a restricted security, and periodically evaluated for impairment. Because this stock is viewed as a long term investment, impairment is based on ultimate recovery of par value.
As of June 30, 2009, the Corporation holds $5,401 of stock in FHLB. In December 2008, FHLB announced that due largely to a decline in the fair value of a segment of its mortgage-backed securities portfolio, it had suspended payment of dividends on the stock and made a decision to no longer purchase excess stock from its members. The Corporations stock is not transferable and can only be redeemed by FHLB. Further deterioration in the financial condition of FHLB may lead management to a conclusion that the cost of the Corporations stock in FHLB is not recoverable, which would result in a charge to earnings for impairment of the Corporations holdings of the stock. The amount of such a charge, if any, cannot be estimated at this time.
ASSETS HELD FOR SALE
Effective June 30, 2009, the Corporation transferred land and a building with a carrying amount of $699,000 from premises and equipment to assets held for sale in anticipation of the sale of the property in the third quarter of 2009. Since this property includes one of the Corporations branch locations, it will be leased back from the buyer.
DEPOSITS
Total deposits at June 30, 2009 and December 31, 2008 are summarized as follows (in thousands):
Percentage Change |
June 30, 2009 | December 31, 2008 | |||||||
Checking, non-interest bearing |
6.9 | % | $ | 104,736 | $ | 97,999 | |||
Checking, interest bearing |
3.5 | % | 243,918 | 235,611 | |||||
Savings accounts |
30.8 | % | 179,659 | 137,344 | |||||
Certificates of deposit |
(7.8 | )% | 316,674 | 343,642 | |||||
3.7 | % | $ | 844,987 | $ | 814,596 | ||||
16
EARNINGS PER SHARE
Effective January 1, 2009, the Corporation adopted Financial Accounting Standards Board (FASB) Staff Position (FSP) No. EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities. FSP EITF 03-6-1 provides that unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of earnings per share pursuant to the two-class method. The Corporation has determined that its outstanding non-vested stock awards are participating securities. Accordingly, effective January 1, 2009, earnings per share is computed using the two-class method prescribed by FASB Statement No. 128, Earnings Per Share. All previously reported earnings per share data has been retrospectively adjusted to conform to the new computation method.
Basic earnings per share is computed by dividing net income by the weighted average number of shares outstanding during the applicable period, excluding outstanding participating securities. Diluted earnings per share is computed using the weighted average number of shares determined for the basic computation plus the dilutive effect of potential common shares issuable under certain stock compensation plans. For the three and six month periods ended June 30, 2009, 134,875 and 152,337 shares under option were excluded from the diluted earnings per share calculations as they were anti-dilutive. For the three and six month periods ended June 30, 2008, 110,500 shares under option were excluded from the diluted earnings per share calculations as they were anti-dilutive.
The computation of basic and diluted EPS is shown below (in thousands except per share data):
Three months ended June 30, |
Six months ended June 30, |
|||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Basic earnings per common share computation: |
||||||||||||||||
Distributed earnings allocated to common stock |
$ | 1,423 | $ | 1,365 | $ | 2,841 | $ | 2,729 | ||||||||
Undistributed earnings allocated to common stock |
1,060 | 804 | 1,864 | 1,436 | ||||||||||||
Net earnings allocated to common stock |
$ | 2,483 | $ | 2,169 | $ | 4,705 | $ | 4,165 | ||||||||
Weighted average common shares outstanding, including shares considered participating securities |
8,640 | 8,566 | 8,624 | 8,566 | ||||||||||||
Less: Average participating securities |
(14 | ) | (25 | ) | (15 | ) | (24 | ) | ||||||||
Weighted average shares |
8,626 | 8,541 | 8,609 | 8,542 | ||||||||||||
Basic earnings per common share |
$ | 0.29 | $ | 0.25 | $ | 0.55 | $ | 0.49 | ||||||||
Diluted earnings per common share computation: |
||||||||||||||||
Net earnings allocated to common stock |
$ | 2,483 | $ | 2,169 | $ | 4,705 | $ | 4,165 | ||||||||
Weighted average common shares outstanding for basic earnings per common share |
8,626 | 8,541 | 8,609 | 8,542 | ||||||||||||
Add: Dilutive effects of assumed exercises of stock options |
15 | 24 | 11 | 23 | ||||||||||||
Weighted average shares and dilutive potential common shares |
8,641 | 8,565 | 8,620 | 8,565 | ||||||||||||
Diluted earnings per common share |
$ | 0.29 | $ | 0.25 | $ | 0.55 | $ | 0.49 | ||||||||
17
DERIVATIVE INSTRUMENTS
FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended and interpreted, establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. As required by Statement No. 133, the Corporation records all derivatives on the balance sheet at fair value. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative and the resulting designation. Derivatives used to hedge the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges. Derivatives used to hedge the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges.
For derivatives designated as cash flow hedges, the effective portion of the changes in the fair value of the derivative is initially reported in other comprehensive income (outside of earnings) and subsequently reclassified into earnings when the hedged transaction affects earnings, and the ineffective portion of changes in the fair value of the derivative is recognized directly in earnings. The Corporation assesses the effectiveness of each hedging relationship by comparing the changes in cash flows of the derivative hedging instrument with the changes in cash flows of the designated hedged item or transaction.
On August 1, 2008, the Corporation executed an interest rate swap agreement with a 5 year term to hedge $10 million of a subordinated note that was entered into by the Corporation during 2007 and elected cash flow hedge accounting for the agreement. The Corporations objective in using this derivative is to add stability to interest expense and to manage its exposure to interest rate risk. The interest rate swap involves the receipt of variable-rate amounts in exchange for fixed-rate payments over the life of the agreement without exchange of the underlying notional amount. At June 30, 2009, the variable rate on the subordinated debt was 2.18% (LIBOR plus 155 basis points) and the Corporation was paying 5.84% (4.29% fixed rate plus 155 basis points).
As of June 30, 2009, no derivatives were designated as fair value hedges or hedges of net investments in foreign operations. Additionally, the Corporation does not use derivatives for trading or speculative purposes and currently does not have any derivatives that are not designated as hedges.
The following tables provide information about the amounts and locations of activity related to the interest rate swap designated as a cash flow hedge within the Corporations consolidated balance sheet and statement of income as of June 30, 2009 and for the three and six month periods then ended:
As of June 30, 2009 | Liability Derivative | ||||||||||||||
Balance Sheet Location |
Fair Value |
||||||||||||||
Interest rate contract |
|
Accrued interest payable and other liabilities |
$ | 673 | |||||||||||
For the Three Months Ended June 30, 2009 |
(a) | (b) | (c) | (d) | (e) | ||||||||||
Interest rate contract |
$ | 200 | |
Interest expense subordinated debentures |
$ | (78 | ) | Other income |
$ | | |||||
For the Six Months Ended June 30, 2009 |
|||||||||||||||
Interest rate contract |
$ | 223 | |
Interest expense subordinated debentures |
$ | (138 | ) | Other income |
$ | |
(a) | Amount of Gain or (Loss) Recognized in Other Comprehensive Loss on Derivative (Effective Portion), net of tax |
(b) | Location of Gain or (Loss) Reclassified from Accumulated Other Comprehensive Loss into Income (Effective Portion) |
18
(c) | Amount of Gain or (Loss) Reclassified from Accumulated Other Comprehensive Loss into Income (Effective Portion) |
(d) | Location of Gain or (Loss) Recognized in Income on Derivative (Ineffective Portion and Amount Excluded from Effectiveness Testing) |
(e) | Amount of Gain or (Loss) Recognized in Income on Derivative (Ineffective Portion and Amount Excluded from Effectiveness Testing) |
Amounts reported in accumulated other comprehensive loss related to the interest rate swap will be reclassified to interest expense as interest payments are made on the subordinated debentures. Such amounts reclassified from accumulated other comprehensive loss to interest expense in the next 12 months are expected to approximate $366,000.
RECENT ACCOUNTING PRONOUNCEMENTS
In April 2009, the FASB issued three final FSPs intended to provide additional application guidance and enhance disclosures regarding fair value measurements and impairments of securities. FSP FAS 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly, provides guidelines for making fair value measurements more consistent with the principles presented in Statement No. 157. FSP FAS 107-1 and APB 28-1, Interim Disclosures about Fair Value of Financial Instruments, enhances consistency in financial reporting by increasing the frequency of fair value disclosures. FSP FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments, provides additional guidance designed to create greater clarity and consistency in accounting for and presenting impairment losses on securities and requires impairment of debt securities to be separated into (a) the amount of the total impairment related to credit loss, which is recognized in earnings, and (b) the amount of the total impairment related to all other factors, which is recognized in comprehensive income. The total other-than-temporary impairment is presented in the income statement with an offset for the amount of total other-than-temporary impairment recognized in other comprehensive income. The FSPs are effective for interim and annual periods ending after June 15, 2009, but entities may adopt the FSPs for the interim and annual periods ending after March 15, 2009. The Corporation adopted these FSPs for its quarter ended June 30, 2009. As a result of implementing FSP FAS 115-2 and FAS 124-2, the amount of other-than-temporary impairment recognized in income for the three months ended June 30, 2009 was $240,000. Had the standard not been issued, the amount of other-than-temporary impairment that would have been recognized in income for the period would have been $1,420,000.
In May 2009, the FASB issued Statement No. 165, Subsequent Events. This statement is intended to establish general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. This statement is effective for interim and annual periods ending after June 15, 2009. During the second quarter of 2009, the Corporations subsequent events period extended to August 7, 2009, the date of filing of Form 10-Q. The impact of adoption was not material.
In June 2009, the FASB issued Statement No. 166, Accounting for Transfers of Financial Assets, and Statement No. 167, Amendments to FASB Interpretation No. 46(R). Statement No. 166 is a revision to Statement No. 140 and will require more information about transfers of financial assets, including securitization transactions, and where companies have continuing exposure to the risks related to transferred financial assets. Statement No. 167 changes how a company determines when an entity that is insufficiently capitalized or is not controlled through voting or similar rights should be consolidated. These statements will be effective at the start of a companys first fiscal year beginning after November 15, 2009, or January 1, 2010 for companies reporting on a calendar-year basis. The adoption of these standards is not expected to have a material effect on the Corporations results of operations or financial position.
19
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following discussion and analysis of the consolidated financial statements of CNB Financial Corporation (the Corporation) is presented to provide insight into managements assessment of financial results. The Corporations subsidiary CNB Bank (the Bank) provides financial services to individuals and businesses within the Banks market area which is primarily made up of the west central Pennsylvania counties of Cambria, Clearfield, Centre, Elk, Jefferson and McKean. During 2005, the Bank entered the northwestern Pennsylvania county of Erie and began doing business as ERIEBANK. The Bank is subject to regulation, supervision and examination by the Pennsylvania State Department of Banking as well as the Federal Deposit Insurance Corporation. The financial condition and results of operations are not intended to be indicative of future performance. One of the Corporations subsidiaries, CNB Securities Corporation, is incorporated in Delaware and currently maintains investments in debt and equity securities. County Reinsurance Company, also a subsidiary, is a Corporation of Arizona, and provides credit life and disability for customers of CNB Bank. CNB Insurance Agency, incorporated in Pennsylvania, provides for the sale of nonproprietary annuities and other insurance products. Finally, Holiday Financial Services Corporation (Holiday) was formed in 2005 to facilitate the Corporations entry into the consumer discount loan and finance business. Managements discussion and analysis should be read in conjunction with the consolidated financial statements and related notes.
Risk identification and management are essential elements for the successful management of the Corporation. In the normal course of business, the Corporation is subject to various types of risk, including interest rate, credit, and liquidity risk. These risks are controlled through policies and procedures established throughout the Corporation.
Interest rate risk is the sensitivity of net interest income and the market value of financial instruments to the direction and frequency of changes in interest rates. Interest rate risk results from various repricing frequencies and the maturity structure of the financial instruments owned by the Corporation. The Corporation uses its asset/liability management policy and systems to control, monitor and manage interest rate risk.
Credit risk represents the possibility that a customer may not perform in accordance to contractual terms. Credit risk results from loans with customers and the purchase of securities. The Corporations primary credit risk is in the loan portfolio. The Corporation manages credit risk by following an established credit policy and through a disciplined evaluation of the adequacy of the allowance for loan losses. Also, the investment policy limits the amount of credit risk that may be taken in the securities portfolio.
Liquidity risk represents the inability to generate or otherwise obtain funds at reasonable rates to satisfy commitments to borrowers and obligations to depositors. The Corporation has established guidelines within its asset liability management policy to manage liquidity risk. These guidelines include contingent funding alternatives.
GENERAL OVERVIEW
The Corporation continues to seek out growth opportunities, with plans to develop its Meadville, Pennsylvania loan production office to a full service store at a future date. Management believes that our ERIEBANK division, along with our traditional CNB Bank market areas, should provide the Bank with sustained loan and deposit growth during 2009.
The Corporation began 2009 with a total of eight offices within Holiday Financial Services Corporation. Although the consumer discount loan business is relatively new to the Corporation, management has made the necessary investments in experienced personnel and technology which has facilitated the growth of Holiday into a successful and profitable subsidiary of the Corporation.
20
While non-interest costs are expected to increase with the growth of the Corporations banking and consumer discount loan franchises, these new ventures will continue to provide growth in earning assets as well as enhanced non-interest income which we believe will more than offset these costs in 2009 and beyond. In addition, during the latter part of 2008 and continuing into 2009, the Corporation began a cost management study covering all areas of non-interest expense. Cost savings as a result of this study have begun to be recognized in 2009 with benefits continuing into subsequent years.
The interest rate environment will continue to play an important role in the future earnings of the Corporation. Although we have seen some slight compression of our net interest margin in 2009 as a result of the current interest rate environment, management will continue to apply a disciplined approach to managing our balance sheet in these uncertain times. We have taken measures such as instituting rate floors on our commercial lines of credit and home equity lines as a result of the historic lows on various key interest rates such as the Prime Rate and 3-month LIBOR. Due to our continued growth, non-interest income should be enhanced in several areas including service charges and other fees. In addition, mortgage banking income is expected to continue increasing in 2009 due to an expanded volume of refinancing activity resulting from projected historically low borrowing rates. While our business plan continues to focus on commercial lending, we now offer a full service approach to servicing the needs of high net worth individuals through our Private Banking groups in both our CNB Bank and ERIEBANK franchises.
Management concentrates on return on average equity and earnings per share evaluations, plus other methods to measure and direct the performance of the Corporation. While past results are not an indication of future earnings, we feel the Corporation is well positioned to enhance core earnings through the remainder of 2009.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents totaled $40.6 million at June 30, 2009 compared to $31.3 million at December 31, 2008. Cash and cash equivalents will fluctuate based on the timing and amount of liquidity events that occur in the normal course of business. We believe the liquidity needs of the Corporation are satisfied by the current balance of cash and cash equivalents, readily available access to traditional funding sources, and the portion of the investment and loan portfolios that mature within one year. These sources of funds will enable the Corporation to meet cash obligations and off-balance sheet commitments as they come due.
SECURITIES
Securities available for sale and trading securities have combined to increase $18.0 million or 7.6% since December 31, 2008. The increase is primarily the result of purchases of structured collateralized mortgage obligations, mortgage-backed securities, and tax-exempt securities from excess deposit growth not reinvested in loans. In addition, as more fully described below, the Corporation also had a higher than normal volume of sales and purchases of securities available for sale during the first six months of 2009.
The Corporations structured pooled trust preferred securities currently do not trade in an active, open market with readily observable prices and are therefore classified within Level 3 of the valuation hierarchy. The fair value of these securities has been calculated using a discounted cash flow model and market liquidity premium as permitted by FSP 157-3. With the current market conditions, the assumptions used to determine the fair value of Level 3 securities has greater subjectivity due to the lack of observable market transactions. The fair values of these securities have declined due to the fact that the subsequent offerings of similar securities pay a higher market rate of return. This higher rate of return reflects the increased credit and liquidity risks in the marketplace.
When the structured pooled trust preferred securities were purchased, they were considered to be investment grade based on ratings assigned by Moodys. As a result of liquidity disruptions within the credit markets and the generally stressed conditions within the
21
financial services industry, Moodys has downgraded the rating of these securities since they were purchased by the Corporation. As of June 30, 2009, the Corporation held three structured pooled trust preferred securities rated Ca by Moodys having an amortized cost of $4,626,000 and fair value of $1,300,000, one structured pooled trust preferred security rated Baa2 by Moodys having an amortized cost of $1,166,000 and fair value of $1,142,000, and one structured pooled trust preferred security rated B3 by Moodys having an amortized cost of $985,000 and fair value of $335,000.
Based on our evaluation of certain structured pooled trust preferred securities, the present value of the projected cash flows is sufficient for full repayment of the amortized cost of the securities and, therefore, it is believed the decline in fair value is temporary due to current market conditions. However, without recovery of these securities, other-than-temporary impairments may occur in future periods.
During the first quarter of 2009, management identified its corporate debt investments as a potential credit risk to the Corporation based upon the continued downturn in the economy and the resulting effect on the financial services industry. As a result of a thorough evaluation process which included risk profiling of individual issuers and comparisons of corporate debt exposure to peer institutions, management elected to liquidate a portion of its investments in mid-tier financial institution corporate debt. The decision to sell specific securities was based upon news and events that occurred in the first quarter of 2009 which were indicators of deterioration of the issuers creditworthiness, including earnings releases which were significantly less than expectations, declines in common stock prices, and decreases in the fair value of debt securities from December 31, 2008 through the date of sale.
The total reduction in corporate debt of approximately $2.0 million brought the Corporations exposure below the median of its peers based on data obtained from quarterly Uniform Bank Performance Reports. Proceeds from the sale of these corporate securities totaled $1,694,000 resulting in gross realized losses of $780,000. To offset this loss, the Corporation sold obligations of U.S. Government sponsored entities, state and political subdivisions, and mortgage-backed securities resulting in total proceeds of $30,318,000 and gross gains of $764,000. Management will continue to closely monitor its corporate debt portfolio and reduce identified risks based on changes in the economic environment and the fundamental financial health of individual institutions in which the Corporation is invested.
During the second quarter of 2009, management sold additional debt securities in an attempt to re-position a portion of its portfolio into lower risk-weighted assets. Proceeds from the sales were reinvested in other available for sale securities. None of these sales resulting in the realization of a significant loss.
The Corporation generally buys into the market over time and does not attempt to time its transactions. In doing this, the highs and lows of the market are averaged into the portfolio and minimize the overall effect of different rate environments. We monitor the earnings performance and the effectiveness of the liquidity of the securities portfolio on a regular basis through Asset/Liability Committee (ALCO) meetings. The ALCO also reviews and manages interest rate risk for the Corporation. Through active balance sheet management and analysis of the securities portfolio, we maintain a sufficient level of liquidity to satisfy depositor requirements and various credit needs of our customers.
LOANS
The Corporation experienced a slight increase in loan demand during the first six months of 2009. Our lending is primarily focused in the west, central and northwest Pennsylvania markets and consists principally of commercial and retail lending, which includes single family residential mortgages and other consumer loans. The Corporation views commercial lending as its competitive advantage and continues to focus on this area by hiring and retaining experienced loan officers and supporting them with quality credit analysis. The Corporation expects moderate loan demand throughout 2009 primarily as a result of the continued growth of our ERIEBANK division.
22
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is established by provisions for losses in the loan portfolio as well as overdrafts in deposit accounts. These provisions are charged against current income. Loans and overdrafts deemed not collectible are charged off against the allowance while any subsequent collections are recorded as recoveries and increase the allowance. The table below shows activity within the allowance account (in thousands):
Six months ending June 30, 2009 |
Year ending December 31, 2008 |
Six months ending June 30, 2008 |
||||||||||
Balance at beginning of period |
$ | 8,719 | $ | 6,773 | $ | 6,773 | ||||||
Charge-offs: |
||||||||||||
Commercial, industrial, and agricultural |
153 | 33 | | |||||||||
Commercial mortgages |
78 | 178 | 95 | |||||||||
Residential mortgages |
228 | 330 | 204 | |||||||||
Consumer |
900 | 1,169 | 275 | |||||||||
Overdraft deposit accounts |
108 | 334 | 122 | |||||||||
1,467 | 2,044 | 696 | ||||||||||
Recoveries: |
||||||||||||
Commercial, industrial, and agricultural |
1 | 2 | | |||||||||
Commercial mortgages |
| | 2 | |||||||||
Residential mortgages |
| 6 | 5 | |||||||||
Consumer |
45 | 84 | 41 | |||||||||
Overdraft deposit accounts |
62 | 111 | 52 | |||||||||
108 | 203 | 100 | ||||||||||
Net charge-offs |
(1,359 | ) | (1,841 | ) | (596 | ) | ||||||
Provision for loan losses |
1,870 | 3,787 | 1,265 | |||||||||
Balance at end of period |
$ | 9,230 | $ | 8,719 | $ | 7,442 | ||||||
Loans, net of unearned |
$ | 674,182 | $ | 671,556 | $ | 660,859 | ||||||
Allowance to net loans |
1.37 | % | 1.30 | % | 1.13 | % | ||||||
Net charge-offs to average loans |
0.40 | % | 0.28 | % | 0.19 | % | ||||||
Nonperforming assets |
$ | 7,185 | $ | 4,250 | $ | 3,684 | ||||||
Nonperforming % of total assets |
0.68 | % | 0.42 | % | 0.39 | % |
The adequacy of the allowance for loan losses is subject to a formal analysis by the credit administrator of the Corporation. As part of the formal analysis, delinquencies and losses are monitored monthly. The loan portfolio is divided into several categories in order to better analyze the entire pool. First is a selection of classified loans that is given a specific reserve. The remaining loans are pooled, by category, into these segments:
Reviewed
| Commercial, industrial, and agricultural |
| Commercial mortgages |
Homogeneous
| Residential real estate |
| Consumer |
| Credit cards |
| Overdrafts |
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The reviewed loan pools are further segregated into four categories: special mention, substandard, doubtful, and unclassified. Historical loss factors are calculated for each pool excluding overdrafts based on the previous eight quarters of experience. The homogeneous pools are evaluated by analyzing the historical loss factors from the most previous quarter end and the two most recent year ends. The historical loss factors for both the reviewed and homogeneous pools are adjusted based on these six qualitative factors:
| Levels of and trends in delinquencies, non-accrual loans, and classified loans |
| Trends in volume and terms of loans |
| Effects of any changes in lending policies and procedures |
| Experience, ability and depth of management |
| National and local economic trends and conditions |
| Concentrations of credit |
The methodology described above was created using the experience of our credit administrator, guidance from the regulatory agencies, expertise of our loan review partner, and discussions with our peers. The resulting factors are applied to the pool balances in order to estimate the probable risk of loss within each pool.
Prudent business practices dictate that the level of the allowance, as well as corresponding charges to the provision for loan losses, should be commensurate with identified areas of risk within the loan portfolio and the attendant risks inherent therein. The quality of the credit risk management function and the overall administration of this vital segment of the Corporations assets are critical to the ongoing success of the Corporation.
The previously mentioned analysis considered numerous historical and other factors to analyze the adequacy of the allowance and current period charges against the provision for loan losses. Management paid special attention to a section of the analysis that compared and plotted the actual level of the allowance against the aggregate amount of loans adversely classified in order to compute the estimated potential losses associated with those loans. By noting the spread at the present time, as well as prior periods, management can determine the current adequacy of the allowance as well as evaluate trends that may be developing. The volume and composition of the Corporations loan portfolio continue to reflect growth in commercial credits including commercial real estate loans.
As mentioned in the Loans section of this analysis, management considers commercial lending a competitive advantage and continues to focus on this area as part of its strategic growth initiatives. However, management must also consider the fact that the inherent risk is more pronounced in these types of credits and is also driven by the economic environment of its market areas.
During the six month period ended June 30, 2009, the Corporation increased its provision for loan losses and allowance as compared to the six month period ended June 30, 2008. The increase was a result of increases in net charge-offs, primarily in the consumer discount portfolio, as well as growth in loans oustanding and nonperforming loans from June 30, 2008 to June 30, 2009. Due to the addition of Holiday Financial Services in 2005, the Corporation has grown a portfolio of consumer finance and discount loans with different risk characteristics than its consumer loan portfolio in its banking subsidiary. Holiday originates small balance unsecured loans and secured loans, primarily collateralized by automobiles and equipment, to borrowers with higher credit risk characteristics than are typical in its bank consumer loan portfolio. Although such loans only represent 2.5% of the Corporations total outstanding loans at June 30, 2009, the characteristics of this higher credit risk portfolio were considered, resulting in increases to our provision and allowance for the six months ended June 30, 2009.
Nonperforming loans and net charge-offs have increased during the first six months of 2009, primarily as a result of the effect of rising costs and the overall challenging economic environment on certain borrowers. Management believes that both its current period provision and allowance for loan losses are reasonable and adequate to absorb probable incurred losses in its portfolio at June 30, 2009.
24
FUNDING SOURCES
The Corporation considers deposits, short-term borrowings, and term debt when evaluating funding sources. Traditional deposits continue to be the main source of funds in the Corporation increasing $30.4 million from $814.6 million at December 31, 2008 to $845.0 million at June 30, 2009. The growth in deposits was the result of increases in savings accounts of $42.3 million, offset by a decrease in certificates of deposit of $27.0 million. Non-interest bearing checking and interest bearing checking accounts increased $6.7 million and $8.3 million, respectively. The increase in savings accounts occurred as a result of the Corporations continued offering of competitive rates and growth of its ERIEBANK franchise.
Periodically, the Corporation utilizes term borrowings from the Federal Home Loan Bank (FHLB) and other lenders to meet funding needs. During the quarter ended June 30, 2009, the Corporation entered into a term borrowing with the FHLB at a fixed rate of 5.24%, with monthly principal and interest payments and a balloon payment due at maturity in June 2024. Management plans to maintain access to short and long-term borrowings as an available funding source when deemed appropriate.
SHAREHOLDERS EQUITY
The Corporations capital continues to provide a base for profitable growth. Total shareholders equity was $64.1 million at June 30, 2009 and $62.5 million at December 31, 2008. In the first six months of 2009, the Corporation earned $4.7 million and declared dividends of $2.8 million, a dividend payout ratio of 60.4% of net income. The Corporation has also complied with the standards of capital adequacy mandated by the banking regulators. Bank regulators have established risk-based capital requirements designed to measure capital adequacy. Risk-based capital ratios reflect the relative risks of various assets banks hold in their portfolios. A weight category of 0% (lowest risk assets), 20%, 50%, or 100% (highest risk assets), is assigned to each asset on the balance sheet. The Banks total risk-based capital ratio of 11.27% at June 30, 2009 is above the well-capitalized standard of 10%. The Banks Tier 1 capital ratio of 10.16% at June 30, 2009 is above the well-capitalized minimum of 6%. The Banks leverage ratio at June 30, 2009 was 7.54%, also above the well-capitalized standard of 5%. The Corporations total risk-based capital, Tier 1 capital and leverage ratios all exceed well-capitalized standards as well. The ratios provide quantitative data demonstrating the strength and future opportunities for use of the Corporations capital base. An evaluation of risk-based capital ratios and the capital position of the Corporation is part of its budgeting and strategic planning processes.
LIQUIDITY AND INTEREST RATE SENSITIVITY
Liquidity measures an organizations ability to meet cash obligations as they come due. The consolidated statement of cash flows presented on page 7 provides analysis of the Corporations cash and cash equivalents. Additionally, management considers that portion of the loan and investment portfolio that matures within one year as part of the Corporations liquid assets. The Corporations liquidity is monitored by the ALCO Committee, which establishes and monitors ranges of acceptable liquidity. Management believes the Corporations current liquidity and interest rate position is acceptable.
OFF BALANCE SHEET ACTIVITIES
Some financial instruments, such as loan commitments, credit lines, letters of credit and overdraft protection, are issued to meet customer financing needs. The contractual amount of financial instruments with off-balance sheet risk was as follows at June 30, 2009 (in thousands):
Commitments to extend credit |
$ | 213,085 | |
Standby letters of credit |
10,943 | ||
$ | 224,028 | ||
25
CNB FINANCIAL CORPORATION
CONSOLIDATED YIELD COMPARISONS
AVERAGE BALANCES AND NET INTEREST MARGIN
Dollars in thousands
June 30, 2009 | June 30, 2008 | |||||||||||||||||||
Average Balance |
Annual Rate |
Interest Inc./Exp. |
Average Balance |
Annual Rate |
Interest Inc./Exp. | |||||||||||||||
ASSETS: |
||||||||||||||||||||
Interest-bearing deposits with other banks |
$ | 9,054 | 2.92 | % | $ | 132 | $ | 6,561 | 4.88 | % | $ | 160 | ||||||||
Federal funds sold and securities purchased under agreements to resell |
2 | 0.00 | % | | 13,744 | 3.38 | % | 232 | ||||||||||||
Securities: |
||||||||||||||||||||
Taxable (1) |
195,154 | 3.65 | % | 3,778 | 146,603 | 4.80 | % | 3,573 | ||||||||||||
Tax-Exempt (1,2) |
52,316 | 5.79 | % | 1,483 | 27,699 | 6.63 | % | 890 | ||||||||||||
Equity Securities (1,2) |
1,428 | 3.36 | % | 24 | 6,440 | 6.22 | % | 227 | ||||||||||||
Total |
257,954 | 4.04 | % | 5,417 | 201,047 | 5.55 | % | 5,082 | ||||||||||||
Loans: |
||||||||||||||||||||
Commercial (2) |
240,537 | 5.75 | % | 6,920 | 237,736 | 6.64 | % | 7,896 | ||||||||||||
Mortgage (2) |
388,487 | 6.51 | % | 12,646 | 341,558 | 7.11 | % | 12,149 | ||||||||||||
Consumer |
47,526 | 14.96 | % | 3,556 | 46,973 | 14.32 | % | 3,363 | ||||||||||||
Total loans (3) |
676,550 | 6.84 | % | 23,122 | 626,267 | 7.48 | % | 23,408 | ||||||||||||
Total earning assets |
934,504 | 6.04 | % | $ | 28,539 | 827,314 | 6.87 | % | $ | 28,490 | ||||||||||
Non interest-bearing assets: |
||||||||||||||||||||
Cash and due from banks |
36,135 | 20,292 | ||||||||||||||||||
Premises and equipment |
23,424 | 21,607 | ||||||||||||||||||
Other assets |
49,327 | 38,875 | ||||||||||||||||||
Allowance for loan losses |
(9,047 | ) | (7,084 | ) | ||||||||||||||||
Total non interest-bearing assets |
99,839 | 73,690 | ||||||||||||||||||
TOTAL ASSETS |
$ | 1,034,343 | $ | 901,004 | ||||||||||||||||
LIABILITIES AND SHAREHOLDERS EQUITY: |
||||||||||||||||||||
Demand - interest-bearing |
242,389 | 0.87 | % | 1,052 | 185,564 | 1.47 | % | 1,368 | ||||||||||||
Savings |
163,810 | 1.72 | % | 1,408 | 75,140 | 1.56 | % | 586 | ||||||||||||
Time |
323,349 | 2.47 | % | 3,991 | 350,145 | 2.97 | % | 5,198 | ||||||||||||
Total interest-bearing deposits |
729,548 | 1.77 | % | 6,451 | 610,849 | 2.34 | % | 7,152 | ||||||||||||
Short-term borrowings |
2,375 | 0.34 | % | 4 | 1,298 | 1.54 | % | 10 | ||||||||||||
Long-term borrowings |
106,656 | 4.34 | % | 2,314 | 98,333 | 4.51 | % | 2,217 | ||||||||||||
Subordinated debentures |
20,620 | 4.35 | % | 449 | 20,620 | 5.17 | % | 533 | ||||||||||||
Total interest-bearing liabilities |
859,199 | 2.15 | % | $ | 9,218 | 731,100 | 2.71 | % | $ | 9,912 | ||||||||||
Demand - non interest-bearing |
100,322 | 94,363 | ||||||||||||||||||
Other liabilities |
11,100 | 6,145 | ||||||||||||||||||
Total liabilities |
970,621 | 831,608 | ||||||||||||||||||
Shareholders equity |
63,722 | 69,396 | ||||||||||||||||||
TOTAL LIABILITIES AND SHAREHOLDERS EQUITY |
$ | 1,034,343 | $ | 901,004 | ||||||||||||||||
Interest income/Earning assets |
6.04 | % | $ | 28,539 | 6.87 | % | $ | 28,490 | ||||||||||||
Interest expense/Interest-bearing liabilities |
2.15 | % | 9,218 | 2.71 | % | 9,912 | ||||||||||||||
Net interest spread |
3.89 | % | $ | 19,321 | 4.16 | % | $ | 18,578 | ||||||||||||
Interest income/Interest-bearing assets |
6.04 | % | 28,539 | 6.87 | % | 28,490 | ||||||||||||||
Interest expense/Interest-bearing assets |
1.97 | % | 9,218 | 2.40 | % | 9,912 | ||||||||||||||
Net interest margin |
4.07 | % | $ | 19,321 | 4.47 | % | $ | 18,578 | ||||||||||||
(1) | Includes unamortized discounts and premiums. Average balance is computed using the carrying value of securities. The average yield has been computed using the historical amortized cost average balance for available for sale securities. |
(2) | Average yields are stated on a fully taxable equivalent basis. |
(3) | Average outstanding includes the average balance outstanding of all non-accrual loans. Loans consist of the average of total loans less average unearned income. The amount of loan fees included in the interest income on loans is not material. |
26
RESULTS OF OPERATIONS
Three Months Ended June 30, 2009 and 2008
OVERVIEW OF THE INCOME STATEMENT
The Corporation had net income of $2.5 million for the second quarter of 2009 compared to $2.2 million for the same period of 2008. The earnings per diluted share increased from $0.25 in the second quarter of 2008 to $0.29 for the second quarter of 2009.
INTEREST INCOME AND EXPENSE
Net interest income totaled $9.4 million in the second quarter, an increase of $368 thousand (or 4.1%) over the second quarter of 2008. Total interest and dividend income decreased by $90 thousand (or 0.6%) as compared to the second quarter of 2008. Although the Corporations earning assets continue to grow, these increases have been offset by decreases in the yield on earning assets due to the current interest rate environment. However, our total interest expense decreased $458 thousand (or 9.3%) as compared to the second quarter of 2008. The Corporations deposits continue to grow; however, interest expense has been positively impacted by decreases in rates paid on deposit accounts, primarily as a result of decreases in short-term interest rates by the Federal Reserve throughout 2008.
PROVISION FOR LOAN LOSSES
The Corporation recorded a provision for loan losses of $1.0 million in the second quarter of 2009 compared to $756 thousand in the second quarter of 2008. As noted in the allowance for loan loss table on page 23, the Corporation has experienced an increased level of charge-offs over the prior year even though net charge-offs as a percentage of average loans remains at a modest level in comparison to our peer group. However, because of the increase in net charge-offs and the increasing level of nonperforming loans, as well as managements detailed evaluation of problem loans, criticized assets, and the overall effects of the economy in our markets, an increase in the provision was deemed necessary. Management believes the charges to the provision in the second quarter are appropriate and the allowance for loan losses is adequate to absorb probable incurred losses in our portfolio as of June 30, 2009.
OTHER INCOME
Other income increased $952 thousand (or 51.5%) in the three months ended June 30, 2009 as compared to the same period in 2008. However, a substantial portion of the increase is a result of the Corporations net securities losses incurred during the second quarter of 2008, which resulted in a pretax charge of $379 thousand for net unrealized loses on securities and $79 thousand for realized losses on securities sold for which fair value was elected.
Excluding the effects of securities transactions, the Corporations other income increased $350 thousand (or 15.2%) in the second quarter of 2009 as compared to the same period in 2008. The most significant increase of $242 thousand occurred in mortgage banking income, which is a result of the volume of refinancing transactions processed by the Corporations mortgage banking department in the second quarter of 2009 compared to the second quarter of 2008. The principal balances of mortgage loans sold to Freddie Mac increased from $3.6 million in the second quarter of 2008 to $17.3 million in the second quarter of 2009.
NON-INTEREST EXPENSE
Non-interest expense increased 9.9% to $7.8 million in the second quarter of 2009 compared to $7.1 million in the second quarter 2008. The Corporations insurance premiums due to the Federal Deposit Insurance Corporation (FDIC) increased by $697 thousand primarily as a result of increases in the deposits on which the premium assessment is based, higher assessment rates in 2009, and the 2009 special assessment described below.
27
As an institution insured by the Federal Deposit Insurance Corporation (FDIC), the Corporation is required to pay deposit insurance premiums to the FDIC. Because the FDICs deposit insurance fund fell below prescribed levels in 2008, the FDIC has announced increased premiums for all insured depository institutions, including the Corporation, in order to begin recapitalizing the fund. In addition, in the second quarter of 2009, the FDIC imposed a 5 basis point emergency assessment on insured depository institutions to be paid on September 30, 2009, based on total assets less Tier 1 capital at June 30, 2009. The Corporation estimates its expense attributable to this special assessment to be $475 thousand which is reflected in other expenses.
Salaries and benefits expenses decreased $265 thousand, primarily due to a decrease in health insurance costs of $190 thousand and a decrease in supplemental executive retirement plan expenses of $99 thousand.
Beginning in the latter part of 2008, management began conducting a cost control study with savings expected to be realized throughout the remainder of 2009 and subsequent years. As a result of this ongoing evaluation, the Corporation will strive to manage expenses while recognizing that certain increasing costs are simply the function of continued growth.
INCOME TAX EXPENSE
Income tax expense was $863 thousand in the second quarter of 2009 as compared to $811 thousand in the second quarter of 2008, resulting in an effective tax rate of 25.8% and 27.2%, respectively. The effective rate for the periods differed from the federal statutory rate of 35.0% principally as a result of tax exempt income from securities and loans as well as earnings from bank owned life insurance. The decrease in the effective tax rate is attributable to a higher percentage of tax-exempt income compared to pre-tax income.
Six Months Ended June 30, 2009 and 2008
OVERVIEW OF THE INCOME STATEMENT
The Corporation had net income of $4.7 million for the first six months of 2009 compared to $4.2 million for the same period of 2008. The earnings per diluted share increased from $0.49 in the first six months of 2008 to $0.55 for the same period of 2009. The return on assets and the return on equity for the first six months of 2009 are 0.92% and 14.92% as compared to 0.93% and 12.11% for the first six months of 2008.
INTEREST INCOME AND EXPENSE
Net interest income totaled $18.6 million in the first six months of 2009, an increase of $529 thousand (or 2.9%) over the first six months of 2008. Total interest and dividend income decreased by $165 thousand (or 0.6%) as compared to the first six months of 2008. Although the Corporations earning assets continue to grow, these increases have been offset by slight decreases in the yield on earning assets as a result of the current interest rate environment. As noted in the table on page 26, the Corporations average earning assets have grown by $107.2 million since June 30, 2008 while the yield has decreased by 83 basis points from 6.87% to 6.04%. Total interest expense, however, decreased $694 thousand (or 7.0%) as compared to the first six months of 2008. The Corporations deposits continue to grow; however, interest expense has been positively impacted by decreases in rates paid on deposit accounts, primarily as a result of decreases in short-term interest rates by the Federal Reserve throughout 2008. As a result, the cost of interest bearing liabilities decreased by 56 basis points which more than offset the increase in average interest bearing liabilities of $128.1 million.
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PROVISION FOR LOAN LOSSES
The Corporation recorded a provision for loan losses of $1.9 million in the first six months of 2009 compared to $1.3 million in the first six months of 2008. As noted in the allowance for loan loss table on page 23, the Corporation has experienced an increased level of charge-offs over the prior year even though net charge-offs as a percentage of average loans remains at a modest level in comparison to our peer group. However, because of the increase in net charge-offs and the increasing level of nonperforming loans, as well as managements detailed evaluation of problem loans, criticized assets, and the overall effects of the economy in our markets, an increase in the provision was deemed necessary. Management believes the charges to the provision in the current year are appropriate and the allowance for loan losses is adequate to absorb probable incurred losses in our portfolio as of June 30, 2009.
OTHER INCOME
Other income increased $1.4 million (or 40.0%) in the first six months of 2009 as compared to the same period in 2008. However, a substantial portion of the increase is a result of the Corporations net securities losses incurred during the first six months of 2008, which resulted in a pretax charge of $1.0 million for net unrealized loses on securities and $254 thousand for realized losses on securities sold for which fair value was elected.
Excluding the effects of securities transactions, the Corporations other income increased $218 thousand (or 4.8%) in the first six months of 2009 as compared to the same period in 2008. The most significant increase of $302 thousand occurred in mortgage banking income, which is a result of the volume of refinancing transactions processed by the Corporations mortgage banking department in 2009. The principal balances of mortgage loans sold to Freddie Mac increased from $6.0 million in the first six months of 2008 to $27.4 million in the first six months of 2009.
NON-INTEREST EXPENSE
Non-interest expense increased 4.9% to $15.2 million in the first six months of 2009 compared to $14.5 million in the first six months of 2008. The Corporations insurance premiums due to the Federal Deposit Insurance Corporation (FDIC) increased by $901 thousand primarily as a result of increases in the deposits on which the premium assessment is based, higher assessment rates, and the special assessment described in the second quarter results of operations analysis on pages 27 and 28. Salaries and benefits expenses decreased $589 thousand, primarily due to a decrease in health insurance costs of $314 thousand and a decrease in supplemental executive retirement plan expenses of $271 thousand.
Beginning in the latter part of 2008, management began conducting a cost control study with savings expected to be realized throughout the remainder of 2009 and subsequent years. As a result of this ongoing evaluation, the Corporation will strive to manage expenses while recognizing that certain costs are the result of continued growth.
INCOME TAX EXPENSE
Income tax expense was $1.6 million in the first six months of 2009 as compared to $1.5 million in the first six months of 2008, resulting in an effective tax rate of 25.0% and 26.9%, respectively. The effective rate for the periods differed from the federal statutory rate of 35.0% principally as a result of tax exempt income from securities and loans as well as earnings from bank owned life insurance. The decrease in the effective tax rate is attributable to a higher percentage of tax-exempt income compared to pre-tax income.
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CRITICAL ACCOUNTING POLICIES
The accounting and reporting policies of CNB Financial Corporation are in accordance with accounting principles generally accepted in the United States of America and conform to general practices within the financial services industry. Accounting and reporting practices for the allowance for loan losses and fair value of securities are deemed critical since they involve the use of estimates and require significant management judgments. Application of assumptions different than those used by management could result in material changes in CNB Financial Corporations financial position or results of operations. Note 1 (Summary of Significant Accounting Policies), Note 3 (Securities), and Note 5 (Allowance for Loan Losses), of the 2008 Annual Report and 10-K, provide detail with regard to the Corporations accounting for the allowance for loan losses and fair value of securities. There have been no significant changes in the application of accounting policies since December 31, 2008.
SAFE HARBOR STATEMENT UNDER THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995
Certain statements contained in the report that are not historical facts are forward looking statements that are subject to certain risks and uncertainties. When used herein, the terms anticipates, plans, expects, believes, estimate, projected, forecast, should, or gravitate to and similar expressions as they relate to CNB Financial Corporation or its management are intended to identify such forward looking statements. CNB Financial Corporations actual results, performance or achievements may materially differ from those expressed or implied in the forward-looking statements. Risks and uncertainties that could cause or contribute to such material differences include, but are not limited to, general economic conditions, interest rate environment, competitive conditions in the financial services industry, changes in law, governmental policies and regulations, and rapidly changing technology affecting financial services.
QUANTITATIVE & QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the risk of loss arising from adverse changes in the fair value of financial instruments due to changes in interest rates, exchange rates, and equity prices. As a financial institution, the Corporation is primarily sensitive to the interest rate risk component. Changes in interest rates will affect the levels of income and expense recorded on a large portion of the Banks assets and liabilities. Additionally, such fluctuations in interest rates will impact the market value of all interest sensitive assets. The Asset/Liability Committee (ALCO) is responsible for reviewing the interest rate sensitivity position and establishing policies to control exposure to interest rate fluctuations. The primary goal established by this policy is to increase total income within acceptable risk limits.
The Corporation monitors interest rate risk through the use of two models: earnings simulation and static gap. Each model standing alone has limitations; however taken together they represent a reasonable view of the Corporations interest rate risk position.
STATIC GAP: Gap analysis is intended to provide an approximation of projected repricing of assets and liabilities at a point in time on the basis of stated maturities, prepayments, and scheduled interest rate adjustments within selected time intervals. A gap is defined as the difference between the principal amount of assets and liabilities which reprice within those time intervals. The cumulative one year gap at June 30, 2009 was 0.37% of total earning assets compared to policy guidelines of plus or minus 15.0%.
Fixed rate securities, loans and CDs are included in the gap repricing based on time remaining until maturity. Mortgage prepayments are included in the time frame in which they are expected to be received.
Certain shortcomings are inherent in the method of analysis presented in Static Gap. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may not react correspondingly to changes in market interest rates.
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Also, the interest rates on certain types of assets and liabilities may fluctuate with changes in market interest rates, while interest rates on other types of assets may lag behind changes in market rates. Additionally, certain assets, such as adjustable-rate loans, have features, like annual and lifetime rate caps, which restrict changes in interest rates both on a short-term basis and over the life of the asset. Further, in the event of a change in interest rates, prepayment and early withdrawal levels would likely deviate from those assumed in the table. Finally, the ability of certain borrowers to make scheduled payments on their adjustable-rate loans may decrease in the event of an interest rate increase.
EARNINGS SIMULATION: This model forecasts the projected change in net income resulting from an increase or decrease in the level of interest rates. The model assumes a one time shock of plus or minus 200 basis points or 2%.
The model makes various assumptions about cash flows and reinvestments of these cash flows in the different rate environments. Generally, repayments, maturities and calls are assumed to be reinvested in like instruments and no significant change in the balance sheet mix is assumed. Actual results could differ significantly from these estimates which would produce significant differences in the calculated projected change in income. The limits stated above do not necessarily represent measures that would be taken by management in order to stabilize income results. The instruments on the balance sheet do react at different speeds to various changes in interest rates as discussed under Static Gap. In addition, there are strategies available to management that minimize the decline in income caused by a rapid rise in interest rates.
The following table below summarizes the information from the interest rate risk measures reflecting rate sensitive assets to rate sensitive liabilities at June 30, 2009 and December 31, 2008:
June 30, 2009 | December 31, 2008 | |||||
Static 1-Yr. Cumulative Gap |
0.37 | % | 1.42 | % | ||
Earnings Simulation: |
||||||
-200 bps vs. Stable Rate |
12.52 | % | 6.28 | % | ||
+200 bps vs. Stable Rate |
(5.54 | )% | (10.59 | )% |
The interest rate sensitivity position at June 30, 2009 was asset sensitive in the short-term, which is consistent with December 31, 2008. Management measures the potential impact of significant changes in interest rates on both earnings and equity. By the use of computer generated models, the potential impact of these changes has been determined to be acceptable with modest effects on net income and equity given an interest rate shock of an increase or decrease in rates of 2.0%. We continue to monitor the interest rate sensitivity through the ALCO and use the data to make strategic decisions.
As of the end of the period covered by this quarterly report, an evaluation was carried out under the supervision and with the participation of the Corporations management, including our Chief Executive Officer and Principal Financial Officer, of the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934). Based on their evaluation, our Chief Executive Officer and Principal Financial Officer have concluded that the Corporations disclosure controls and procedures are, to the best of their knowledge, effective to ensure that information required to be disclosed by the Corporation in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. Subsequent to the date of their evaluation, our Chief Executive Officer and Principal Financial Officer have concluded that there were no significant changes in the Corporations internal controls or in other factors that could significantly affect its internal controls, including any corrective actions with regard to significant deficiencies and material weaknesses.
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PART II OTHER INFORMATION
ITEM 1. | LEGAL PROCEEDINGS None |
ITEM 1A. | RISK FACTORS There have been no material changes to the factors disclosed in Item 1A. Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2008. |
ITEM 3. | DEFAULTS UPON SENIOR SECURITIES None |
Results of shareholder voting on the directors were as follows:
Joseph B. Bower, Jr. |
Robert E. Brown |
Michael F. Lezzer |
Robert W. Montler |
William C. Polacek | ||||||
For |
5,967,619 | 6,017,040 | 5,941,659 | 5,941,995 | 6,007,914 | |||||
Against or Withheld |
130,332 | 80,911 | 156,292 | 155,956 | 90,037 |
The following directors terms of office as director continued after the meeting: William F. Falger, Dennis L. Merrey, Deborah Dick Pontzer, Jeffrey S. Powell, James B. Ryan, Charles H. Reams, and Peter F. Smith.
Results of ratification of appointment of Crowe Horwath LLP as independent auditors were as follows:
For |
5,938,412 | |
Against or Withheld |
159,539 |
Results of ratification of the Stock Incentive Plan were as follows:
For |
4,269,446 | |
Against or Withheld |
1,828,505 |
The total shares voted at the Annual Meeting were 6,097,951.
ITEM 5. | OTHER INFORMATION None |
ITEM 6. | EXHIBITS |
EXHIBIT 31.1 | Principal Executive Officer Certification | |
EXHIBIT 31.2 | Principal Financial Officer Certification | |
EXHIBIT 32 | Certifications |
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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.
CNB FINANCIAL CORPORATION (Registrant) | ||
DATE: August 7, 2009 | /s/ William F. Falger | |
William F. Falger | ||
President and Director | ||
(Principal Executive Officer) | ||
DATE: August 7, 2009 | /s/ Charles R. Guarino | |
Charles R. Guarino | ||
Treasurer | ||
(Principal Financial Officer) |
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