UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
For the quarterly period ended September 30, 2005
or
For the transition period from to
Commission File Number 0-13396
CNB FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
County National Bank
1 South Second Street
P.O. Box 42
Clearfield, Pennsylvania 16830
(Address of principal executive offices)
Registrant’s 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. Yes x No ¨
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes x No ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
The number of shares outstanding of the issuer’s common stock as of November 3, 2005
COMMON STOCK: $1.00 PAR VALUE, 9,041,399 SHARES
INDEX
Sequential
Page Number
2
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
(unaudited)
September 30,
2005
December 31,
2004
ASSETS
Cash and due from banks
Interest bearing deposits with other financial institutions
TOTAL CASH AND CASH EQUIVALENTS
Securities available for sale
Loans held for sale
Loans
Less: unearned discount
Less: allowance for loan losses
NET LOANS
FHLB, FRB and other equity interests
Premises and equipment, net
Bank owned life insurance
Accrued interest receivable and other assets
Mortgage servicing rights
Goodwill
Intangible assets, net
TOTAL ASSETS
LIABILITIES
Deposits:
Non-interest bearing deposits
Interest bearing deposits
TOTAL DEPOSITS
Short-term borrowings
Federal Home Loan Bank advances
Accrued interest and other liabilities
Subordinated debentures
TOTAL LIABILITIES
SHAREHOLDERS’ EQUITY
Common stock $1.00 par value Authorized 10,000,000 shares Issued 9,233,750 shares
Additional paid in capital
Retained earnings
Treasury stock, at cost (187,267 shares for Sept 2005, and 123,240 shares for Dec 2004)
Accumulated other comprehensive income
TOTAL SHAREHOLDERS’ EQUITY
TOTAL LIABILITIES & SHAREHOLDERS’ EQUITY
3
CONSOLIDATED STATEMENTS OF INCOME (unaudited)
(Dollars in thousands, except per share data)
INTEREST AND DIVIDEND INCOME
Loans including fees
Deposits with other financial institutions
Securities:
Taxable
Tax-exempt
Dividends
TOTAL INTEREST AND DIVIDEND INCOME
INTEREST EXPENSE
Deposits
Borrowed funds
TOTAL INTEREST EXPENSE
Net interest income
Provision for loan losses
NET INTEREST INCOME AFTER PROVISION
OTHER INCOME
Trust & asset management fees
Service charges on deposit accounts
Other service charges and fees
Net security gains (losses)
Gains on sale of loans
Bank owned life insurance earnings
Wealth Management
Other
TOTAL OTHER INCOME
OTHER EXPENSES
Salaries
Employee benefits
Net occupancy expense of premises
Amortization of intangibles
TOTAL OTHER EXPENSES
Income before income taxes
Applicable income taxes
NET INCOME
EARNINGS PER SHARE, BASED ON WEIGHTED AVERAGE SHARES OUTSTANDING
Net income, basic
Net income, diluted
DIVIDENDS PER SHARE
Cash dividends per share
4
Net security gains
Loss on other-than-temporarily impaired securities
5
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Consolidated Statements of Comprehensive Income (unaudited)
(dollars in thousands)
Net Income
Other comprehensive income, net of tax
Unrealized gains/(losses) on securities:
Unrealized gains/(losses) arising during the period, net of tax
Reclassification adjustment for accumulated (gains)/losses included in net income, net of tax
Other comprehensive income (loss)
Comprehensive income (loss)
6
CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
Consolidated Statements of Cash Flows (unaudited)
Cash flows from operating activities:
Adjustments to reconcile net income to net cash provided by operations:
Depreciation and amortization
Amortization and accretion and deferred loan fees
Deferred Taxes
Security Gains
Gain on sale of loans
Net gains on dispositions of acquired property
Proceeds from sale of loans
Origination of loans for sale
Increase in Bank Owned Life Insurance
Changes in:
Interest receivable and other assets
Interest payable and other liabilities
Net cash provided by operating activities
Cash flows from investing activities:
Proceeds from maturities of:
Proceeds from sales of securities available for sale
Purchase of securities available for sale
Loan origination and payments, net
Purchase of FHLB, FRB & Other
Equity Interests
Net, purchase of premises and equipment
Proceeds from the sale of foreclosed assets
Net cash used in investing activities
Cash flows from financing activities:
Net change in:
Checking, money market and savings accounts
Certificates of deposit
Treasury stock purchased
Proceeds from sale of treasury stock
Proceeds from the exercise of stock options
Cash dividends paid
Net advances from long-term borrowings
Net advances from short-term borrowings
Net cash provided by financing activities
Net increase (decrease) in cash and cash equivalents
Cash and cash equivalents at beginning of year
Cash and cash equivalents at end of period
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest
Income Taxes
Supplemental non cash disclosures:
Transfers to other real estate owned
7
CNB FINANCIAL CORPORATION AND SUBSIDIARIES
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 September 30, 2005 and for the three and nine months ended September 30, 2005 and 2004 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. The financial performance reported for CNB Financial Corporation (the Corporation) for the three and nine month periods ended September 30, 2005 is not necessarily indicative of the results to be expected for the full year. This information should be read in conjunction with the Corporation’s Annual Report to shareholders and Form 10-K for the period ended December 31, 2004.
COMMON STOCK PLAN
The Corporation has a common stock plan for key employees and independent directors. The Stock Incentive Plan, which is administered by the Executive Compensation and Personnel Committee, comprised of independent members of the Board of Directors, provides for the issuance of up to 625,000 shares of common stock in the form of nonqualified options. The Corporation applies Accounting Principles Board Opinion 25 and related interpretations in accounting for its common stock plan. Accordingly, no compensation expense has been recognized for the plans. No stock options were granted during the first nine months of 2005 or 2004.
As required by SFAS No.123, “Accounting for Stock-Based Compensation” as amended by SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure,” the Corporation provides pro forma net income and pro forma earnings per share disclosures.
The following table illustrates the effects of stock options on pro forma net income and pro forma earnings per share at September 30, 2005 and 2004 (in thousands except per share data):
Net income, as reported
Pro forma compensation expense, net of tax
Pro forma net income
Earnings per share - basic
As reported
Pro forma
Earnings per share - diluted
8
As reported in a Form 8K dated May 16, 2005, the Corporation opted to accelerate the vesting of all unvested options with an exercise price greater than $15.00, the closing price of the Corporations common stock on the NASDAQ on May 10, 2005. As a result of the acceleration, all unvested shares granted in 2003 and 2004 became immediately exercisable resulting in the significant increase in pro forma compensation expense for the nine month period ended September 30, 2005 as compared to the prior year and noted in the preceding table.
EARNINGS PER SHARE
Basic earnings per share is computed by dividing net income by the weighted average number of shares outstanding during the period. 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 stock options. For the three and nine month periods ended September 30, 2005, 110,500 shares under option were excluded from the diluted earnings per share calculations as they were anti-dilutive. For the three and nine month periods ended September 30, 2004, 56,250 shares were anti-dilutive.
The computation of basic and diluted EPS is shown below (in thousands except per share data):
Net income
Weighted-average common shares outstanding (basic)
Effect of stock options
Weighted-average common shares outstanding (diluted)
Earnings per share:
Basic
Diluted
9
SECURITIES
Securities at September 30, 2005 and December 31, 2004 (in thousands) are as follows:
Amortized
Cost
Fair
Value
Securities available for sale:
U.S. Treasury
U.S. Government agencies and corporations
Obligations of States and Political Subdivisions
Mortgage-backed securities
Corporate notes and bonds
Marketable equity securities
Total Securities available for sale
At September 30, 2005, 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.
Securities with unrealized losses at September 30, 2005 and December 31, 2004, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, are as follows:
September 30, 2005
Description of Securities
U.S. Gov’t Agencies & Corps
Mortgage-Backed Sec.
Corporate Notes and Bonds
Marketable Equity Securities
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. Consideration is given to the length of time and extent to which fair value has been less than cost, the financial condition and near term prospects of the issuer, 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. In analyzing an issuer’s financial condition, the Corporation may consider whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuer’s financial condition. The following comments relate to those securities which have been in a continuous unrealized loss position for more than twelve months.
10
Included in the $552,000 of unrealized losses at September 30, 2005 on investment securities that have been in a continuous unrealized loss position for 12 months or more are $411,000 of unrealized losses on debt securities. Management does not believe any of the individual unrealized losses on debt securities represents an other-than-temporary impairment since these losses are primarily attributable to changes in interest rates and the Corporation has both the intent and ability to hold the debt securities to maturity.
Unrealized losses on equity securities, which compromise the remainder of the $552,000, were not individually significant and also considered to be temporary in nature.
FEDERAL HOME LOAN BANK (FHLB) BORROWINGS
Borrowings from the FHLB at September 30, 2005 and December 31, 2004 (in thousands) are as follows:
Interest Rate
(a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)
(i)
(j)
Total FHLB Borrowings
(a), (b), (c), (d), (e), (f), (h) – Items (a) through (f) and (h) are fixed rate borrowings at interest rates of 3.45%, 3.69%, 3.83%, 4.00%, 4.14%, 4.35% and 4.43%, respectively.
(g) FHLB has option to float the interest rate based on the 3 month LIBOR +.16, the interest rate was 6.09% at September 30, 2005.
(i) Interest rate is fixed for one year at which time FHLB has option to float the interest rate based on the 3 month LIBOR +.20, the interest rate was 4.95% at September 30, 2005.
(j) Interest rate is fixed for two years at which time FHLB will convert it to a floating interest rate based on the 3 month LIBOR +.18 if the 3 month LIBOR is equal to or greater than 8.0%, the interest rate was 4.52% as of September 30, 2005.
The terms of the above borrowings are interest only payments with principal due at maturity.
RECENT ACCOUNTING PRONOUNCEMENTS
In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment (FAS No. 123R). FAS No. 123R revised FAS No. 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for Stock
11
Issued to Employees, and its related implementation guidance. FAS No. 123R will require compensation costs related to share-based payment transactions to be recognized in the financial statement (with limited exceptions). The amount of compensation cost will be measured based on the grant-date fair value of the equity or liability instruments issued. Compensation cost will be recognized over the period that an employee provides service in exchange for the award.
In April, the Securities and Exchange Commission adopted a new rule that amends the compliance dates for FAS No. 123R. The Statement requires that compensation cost relating to share-based payment transactions be recognized in financial statements and that this cost be measured based on the fair value of the equity or liability instruments issued. FAS No. 123R covers a wide range of share-based compensation arrangements including share options, restricted share plans, performance-based awards, share appreciation rights, and employee share purchase plans. The Company will adopt FAS No. 123R on January 1, 2006 and is currently evaluating the impact the adoption of the standard will have on the Company’s results of operations.
In March 2005, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. 107 (“SAB No. 107”),Share-Based Payment, providing guidance on option valuation methods, the accounting for income tax effects of share-based payment arrangements upon adoption of FAS No. 123R, and the disclosures in MD&A subsequent to the adoption. The Company will provide SAB No. 107 required disclosures upon adoption of FAS No. 123R on January 1, 2006 and is currently evaluating the impact the adoption of the standard will have on the Company’s financial condition, results of operations, and cash flows. However, management does not believe the future expense of unvested stock options as of September 30, 2005 will have a material effect on the Corporation’s results of operations.
12
ITEM 2
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
FINANCIAL CONDITION
The following discussion and analysis of the consolidated financial statements of the Corporation is presented to provide insight into management’s assessment of financial results. The Corporation’s primary subsidiary County National Bank (the “Bank”) provides financial services to individuals and businesses within the Bank’s market area made up of the west central Pennsylvania counties of Clearfield, Cambria, Centre, Elk, Jefferson, McKean and Warren. County National Bank is a member of the Federal Reserve System and subject to regulation, supervision and examination by the Office of the Comptroller of the Currency (“OCC”).
The market area that County National Bank operates in is rural in nature. The customer makeup consists of small business and individuals. The health of the economy in the region is mixed with unemployment rates running high in most of our market areas except Centre County.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents totaled $37,200,000 at September 30, 2005 compared to $29,912,000 on December 31, 2004. The increase in cash is primarily the result of slight deposit growth and liquidity created by borrowings from the Federal Home Loan Bank as discussed in the Funding Sources section of this analysis.
Management believes 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 increased approximately $403,000 or 0.2% since December 31, 2004. The slight increase is the result of purchases made in variable rate corporate trust preferred securities to take advantage of the rising interest rate environment. 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.
Management monitors 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, the Corporation maintains sufficient liquidity to satisfy depositor requirements and various credit needs of its customers.
LOANS
The Corporation’s lending is focused on the west central Pennsylvania market and consists principally of commercial lending primarily to locally owned small businesses and retail lending which includes single-family residential mortgages and other consumer lending. At September 30, 2005, the Corporation had $497,839,000 in loans outstanding, net of unearned discount, an increase of $15,902,000 (or 3.3%) since December 31, 2004. The increase was primarily the result of demand for our commercial loan products including commercial mortgages. The Corporation sees commercial lending as its competitive advantage and continues to focus on this area by hiring and retaining experienced lenders and supporting them with quality credit analysis. The Corporation recently opened a loan production office in Erie, Pennsylvania and this new market area should begin to generate new loan growth in the near term.
13
CONSOLIDATED YIELD COMPARISONS
CNB Financial Corporation
Average Balances and Net Interest Margin
Assets
Interest-bearing deposits with banks
Federal funds sold and securities purchased under agreements to resell
Investment Securities:
Tax-Exempt (1)
Equity Investments (1)
Total Investments
Commercial (1)
Mortgage (1)
Installment
Leasing
Total loans (2)
Total earning assets
Non Interest Bearing Assets
Cash & Due From Banks
Premises & Equipment
Other Assets
Allowance for Possible Loan Losses
Total Non-interest earning assets
Total Assets
Liabilities and Shareholders’ Equity
Interest-Bearing Deposits
Demand - interest-bearing
Savings
Time
Total interest-bearing deposits
Long-term borrowings
Subordinated Debentures
Total interest-bearing liabilities
Demand - non-interest-bearing
Other liabilities
Total Liabilities
Shareholders’ equity
Total Liabilities and Shareholders’ Equity
Interest income/earning assets
Interest expense/interest bearing liabilities
Net Interest Spread
Interest Income/Interest Earning Assets
Interest expense/Interest Earning Assets
Net Interest Margin
14
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:
($’s in thousands)
Balance at beginning of Period
Charge-offs:
Commercial and financial
Commercial mortgages
Residential mortgages
Lease receivables
Overdrafts
Recoveries:
Net charge-offs:
Balance at end-of-period
Loans, net of unearned
Allowance to net loans
Net charge-offs to average loans
The adequacy of the allowance for loan and lease losses is subject to a formal analysis by the credit administrator of the Bank. 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 criticized loans that is given a specific reserve. The remaining loans are pooled, by category, into these segments:
Reviewed
Homogeneous
The reviewed loan pools are further segregated into three categories: 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:
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 inherent risk of loss within each pool.
15
The allowance coverage of net loans has decreased slightly over the past nine months. Through the analysis methodology detailed above, the coverage during the period was considered appropriate and adequate based on the Corporation’s current risk profile. The adequacy of the allowance for loan losses is subject to a formal analysis by an independent loan review analyst, as well as our internal credit administrator, and is deemed to be adequate to absorb probable incurred losses in the portfolio as of September 30, 2005.
Management continues to closely monitor loan delinquency and loan losses. Non-performing assets, which include loans 90 or more days past due, non-accrual loans and other real estate owned, were $3,497,000 or 0.47% of total assets on September 30, 2005 compared to $2,690,000 or 0.37% on December 31, 2004. The increase was primarily caused by one large commercial loan that management placed on nonaccrual due to the borrowers inability to make regular payments. The bank has a first lien on the commercial property and considers its risk of loss to be minimal.
FUNDING SOURCES
The Corporation considers deposits, short-term borrowings, and term debt when evaluating funding sources. Traditional deposits continue to be the main focus for source of funds in the Corporation, reaching $600,561,000 at September 30, 2005. Deposits have increased only 0.6% since year-end 2004. The Corporation is currently implementing strategies to decrease its cost of funds from interest bearing deposits by shifting more dollars into lower interest bearing deposits throughout 2005.
The Corporation utilizes term borrowings from the Federal Home Loan Bank (FHLB) to meet funding needs not accommodated by deposit growth. As discussed in the loans section of this analysis, the Corporation experienced demand for its commercial loan products during the first nine months of the year. As previously mentioned, deposits have increased only 0.6% since December 31, 2004 and during the second quarter management accessed $19,500,000 in FHLB borrowings to fund certain new loans. The borrowings are fixed rate and have maturity dates ranging from six months to five years. Management plans to maintain access to short and long-term FHLB borrowings as an available funding source when deemed appropriate.
The Corporation’s capital continues to provide a base for profitable growth. Total shareholders’ equity was $69,589,000 at September 30, 2005 compared to $68,710,000 at December 31, 2004, an increase of $879,000 or 1.3%. In the first nine months of 2005, the Corporation earned $6,676,000 and declared dividends of $3,782,000, a dividend payout ratio of 56.7% of net income. This growth was offset by an increase in treasury stock and a decline in the securities market value as discussed below.
During the first nine months of 2005, the Corporation continued to repurchase shares of its own stock under a publicly announced plan. This strategy is the primary reason for the increase in treasury stock of 64,027 shares or $903,000 since December 31, 2004.
The securities in the Corporation’s portfolio are classified as available for sale making the Corporation’s balance sheet more sensitive to the changing market value of investments. The Federal Open Market Committee raised the federal discount rate by 150 basis points in the first nine months of 2005. This situation affected the market value of various securities in the Corporation’s portfolio and caused a decrease in accumulated other comprehensive income, included in shareholders’ equity, of $1,020,000 since December 31, 2004.
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 Corporation’s total risk-based capital ratio of 12.57% at September 30, 2005 is above the well-capitalized standard of 10%. The Corporation’s Tier 1 capital ratio of 11.55% is above the well-capitalized minimum of 6%. The leverage ratio at September 30, 2005 was 9.15%, also above the well-capitalized standard of 5%. The Corporation is well capitalized as measured by the federal regulatory agencies. The ratios provide quantitative data demonstrating the strength and future opportunities for use of the Corporation’s capital base. Management continues to evaluate risk-based capital ratios and the capital position of the Corporation as part of its strategic decision making process.
16
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 of the accompanying unaudited financial statements provides analysis of the Corporation’s cash and cash equivalents. Additionally, management considers that portion of the loan and investment portfolio that matures within one year as part of the Corporation’s liquid assets. The Corporation’s liquidity is monitored by the ALCO Committee, which establishes and monitors ranges of acceptable liquidity. Management feels the Corporation’s 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 September 30, 2005:
Commitments to extend credit
Standby letters of credit
RESULTS OF OPERATIONS
OVERVIEW OF THE INCOME STATEMENT
The Corporation had net income of $2,285,000 and $6,676,000 for the third quarter and first nine months of 2005, respectively. The earnings per diluted share for the respective periods were $0.25 and $0.73. Net income was $2,032,000 and $6,063,000 for the third quarter and first nine months of 2004, which equates to earnings per diluted share of $0.22 and $0.66, respectively. The return on assets and the return on equity for the nine months of 2005 are 1.19% and 12.79% as compared to 1.14% and 12.01% for the first nine months of 2004.
INTEREST INCOME AND EXPENSE
Net interest income totaled $6,525,000 in the third quarter, an increase of $459,000 (or 7.6%) over the third quarter of 2004 and totaled $19,306,000 for the nine months of 2005, an increase of 6.7% as compared to the first nine months of 2004. Total interest and dividend income increased by $1,359,000 (or 14.6%) as compared to the third quarter of 2004 while total interest expense increased $900,000 (or 27.7%) as compared to the third quarter of 2004. The primary reason for the growth in interest income stems from an improved level of average earning assets and increasing yields. As noted on page 13 of this analysis, the Corporation’s average earning assets have increased by $33,978,000 from $647,980,000 for the nine months ended September 30, 2004 to $681,958,000 for the nine months ended September 30, 2005 while annual yields have increased from 5.97% to 6.22% for the same two periods.
PROVISION FOR LOAN LOSSES
The Corporation recorded a provision for loan and lease losses in the third quarter of $207,000 compared to $200,000 in the third quarter of 2004 and $546,000 for the first nine months of 2005 compared to $800,000 for 2004. As part of the in-depth analysis as previously described, it has been determined that the credit risk of the Corporation is showing positive trends and therefore a lesser year to date provision is required. The overall credit quality of existing assets is consistent and has improved slightly and as a result the Corporation has experienced a consistent and relatively low level of charge-offs over the past three years. In short, based on managements’ evaluation of problem loans, criticized assets and charge-offs in the loan portfolio and the overall effects of the economy in our markets, the analysis indicates that the provision appears adequate. The reduced provision in the current year has created a slight decrease in the Allowance for Loan Losses as a percentage of total loans, however, management believes the allowance provides adequate coverage of our current loan portfolio.
Other income increased $190,000 (or 11.1%) and $232,000 (or 4.7%) in the third quarter and nine months of 2005, respectively, when compared to the same periods in 2004.
17
A loss on other than temporarily impaired securities negatively affected other income for the nine months ended September 30, 2005. As mentioned in the Securities footnote on page 10, 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. During the second quarter evaluation, management determined that a preferred stock issuance of the FHLMC appeared to be other than temporarily impaired. The security had a cost basis of $1,500,000 and is indexed to the two year constant maturity treasury plus 20 basis points with a reset date that occurred June 30, 2005. As the security did not meet management’s expectation for recovery at the reset date, the Corporation recorded an impairment charge of $240,000 (before tax) during the second quarter.
A positive enhancement to other income for 2005 has been the growth of earnings from the Corporation’s wealth management services. The Corporation added these services to its product mix during the second quarter of 2004 and in a little more than a year the program has more than $15 million of assets under management which has provided $419,000 in other income to the Corporation for the nine months ended September 30, 2005 compared to $140,000 for the nine months ended September 30, 2004.
OTHER EXPENSE
Other expense increased $198,000 (or 4.0%) during the third quarter of 2005 and $772,000 (or 5.4%) in the nine months of 2005 when compared to the same two periods in 2004. The increases were not concentrated in any one area or line item but were primarily the result of the Corporations increasing costs for salaries, outside services and insurance.
FEDERAL INCOME TAX EXPENSE
Federal income tax expense was $781,000 in the third quarter of 2005 as compared to $590,000 in the third quarter of 2004 resulting in an effective tax rate of 25.5% and 22.5%, respectively. For the nine month period comparisons the effective tax rate was 24.1% in 2005 and 22.9% in 2004. The effective tax 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.
FUTURE OUTLOOK
The focus of management for 2005 is to maintain a favorable cost of funds. As mentioned in the “Funding Sources” section of this report, management is currently implementing certain strategies to accomplish this focus including reducing the cost of funds for our traditional certificates of deposit as well as deriving more funding from our lower cost deposit products. Deposit growth was minimal during the first three quarters and is expected to be flat throughout the remainder of 2005. In addition to deposits, the traditional funding source for the Corporation, we will continue to manage potential earnings enhancement opportunities using other borrowings such as those through the Federal Home Loan Bank of Pittsburgh (FHLB) as there are certain interest rate environments that allow for pricing opportunities from such borrowings. As mentioned previously in this analysis, the Corporation utilized borrowings from the FHLB during the second quarter of 2005 to fund certain new loans added to its portfolio.
The Corporation’s loan growth was moderate throughout the first nine months of 2005. Management expects this moderate trend to continue in the near term in our traditional market areas but has positive expectations due to anticipated demand for our commercial loan products as we enter the Erie Pennsylvania market area as discussed in the loans section of this analysis. To increase profitability management will continue to implement a loan pricing approach that projects a desired return on investment for each proposal.
The interest rate environment always plays an important role in the future earnings of the Corporation. Management continues to closely monitor the net interest margin as much of the earnings of the Corporation continue to be derived from interest income. As mentioned in the Income and Expense portion of this analysis, the Corporation has increasing levels of average earning assets as well as increasing yields. Although the future is uncertain, management believes that interest rates will continue to increase in the near term resulting in increased profitability from the Corporation’s variable rate earning assets.
Enhancing non-interest income and controlling non-interest expense are important factors in the success of the Corporation. One promising enhancement to non interest income was the introduction of wealth management services to the Corporation’s product mix during 2004 as discussed in the Other Income section of this analysis. Like many growing entities, the Corporation must continue to monitor and manage expenses. One of the tools the Corporation uses to monitor expenses is the efficiency ratio, calculated according to the following: non-interest expense (less amortization of intangibles) as a percentage of fully tax equivalent net interest income and non-interest
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income (less non-recurring income). For the nine months ended September 30, 2005, the Corporation’s efficiency ratio was 57.33% compared to 57.89% for the same period last year. The Corporation strives to manage expenses while recognizing that some such as increasing costs for salaries, occupancy, outside services and insurance are simply the result of continued growth. As reported in a Form 8K dated October 19, 2005, the Corporation is beginning the process of expanding its banking franchise into the Erie, Pennsylvania market. The Corporation realizes that expenses related to the new venture may out pace related revenues in the near term but believes the long term growth potential is more than worth the near term cost.
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, management feels the Corporation is positioned to enhance performance of normal operations through the remainder of 2005.
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 Corporation’s financial position or results of operations. Note 1 ( Summary of Significant Accounting Policies), Note 3 (Securities), and Note 5 (Allowance for Loan and Lease Losses), of the 2004 Annual Report and 10-K, provide detail with regard to the Corporation’s accounting for the allowance for loan and lease losses and fair value of securities. There have been no significant changes in the application of accounting policies since December 31, 2004.
“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” or “projected” and similar expressions as they relate to CNB Financial Corporation or its management are intended to identify such forward looking statements. CNB Financial Corporation’s 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.
ITEM 3
QUANTITATIVE & QUALITATIVE DISCLOSURES ABOUT MARKET RISK
In the course of conducting business activities, the Corporation is exposed to market risk, principally interest rate risk, through the operation of the Bank. Interest rate risk arises from market driven fluctuations in interest rates, which affect cash flows, income, expense and values of all financial instruments. Management and the ALCO Committee of the Board monitor the Corporation’s interest rate risk position. No material changes have occurred during the period in the Bank’s market risk strategy or position, a discussion of which can be found in the SEC Form-10K filed for the period ended December 31, 2004.
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ITEM 4
CONTROLS AND PROCEDURES
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 Corporation’s 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 Corporation’s 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 Corporation’s 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.
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS - None
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
ISSUER PURCHASES OF EQUITY SECURITIES
Period
Total Number
of Shares (or
Units)
Purchased
Average
Price Paid
per Share
(or Unit)
Total Number of
Shares (or Units)
Purchased as Part
of Publicly
Announced Plans
or Programs
Maximum Number (or
Approximate Dollar
Value) of Shares (or
Units) that May Yet Be
Purchased Under the
Plans or Programs
7/1/05 to 7/31/05
8/1/05 to 8/31/05
9/1/05 to 9/30/05
Total
Purchases not made in conjunction with the Publicly Announced Plan were made to facilitate employee benefit plans in the form of a 401(k).
ITEM 3. DEFAULTS UPON SENIOR SECURITIES - None
ITEM 4. SUBMISSION OF MATTERS FOR SECURITY HOLDERS VOTE - None
ITEM 5. OTHER INFORMATION - None
ITEM 6. EXHIBITS
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
/s/ William F. Falger
/s/ Joseph B. Bower, Jr.
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