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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
ANNUAL REPORT PURSUANT TO SECTION 13
OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Form 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2003
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 0-30665
CNB Financial Services, Inc.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
United States of America 55 - 0773918
- ------------------------------- ------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
101 S. Washington Street, Berkeley Springs, WV 25411
- ---------------------------------------------- ---------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, ( 304 ) 258 - 1520
Securities to be registered under Section 12(b) of the Act:
None
Securities to be registered under Section 12(g) of the Act:
Common Stock, Par Value $1.00 per share
- --------------------------------------------------------------------------------
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for 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 if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2).
Yes [ ] No [X]
The aggregate value of the common stock of the Registrant that was held by
non-affiliates as of the most recently completed second fiscal quarter (June 30,
2003), was approximately $38.5 million. This amount was based on the last
closing sale price of a share of common stock of $100.00 as of the same date.
As of March 24, 2004, there were 458,048 shares of Common Stock, Par Value $1.00
per share, outstanding.
DOCUMENTS INCORPORATED BY REFERENCE:
None
CNB FINANCIAL SERVICES, INC. AND SUBSIDIARY
TABLE OF CONTENTS
PAGE
----
PART I
Item 1. Business................................................................................. 3
Item 2. Properties............................................................................... 7
Item 3. Legal Proceedings........................................................................ 7
Item 4. Submission of Matters to a Vote of Security Holders...................................... 7
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.................... 8
Item 6. Selected Financial Data.................................................................. 9
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.... 10
Item 7A. Quantitative and Qualitative Disclosures About Market Risk............................... 28
Item 8. Financial Statements and Supplementary Data.............................................. 29
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures.... 59
Item 9A. Controls and Procedures.................................................................. 59
PART III
Item 10. Directors and Executive Officers of the Registrant....................................... 60
Item 11. Executive Compensation................................................................... 62
Item 12. Security Ownership of Certain Beneficial Owners and Management........................... 63
Item 13. Certain Relationships and Related Transactions........................................... 64
Item 14. Principal Accountant's Fees and Services................................................. 64
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K.......................... 65
SIGNATURES ............................................................................................ 66
FORWARD LOOKING STATEMENTS
In our Annual Report and Form 10-K, we include forward-looking
statements relating to such matters as anticipated financial performance,
business prospects, technological developments, new products and similar
matters. You can identify these statements by forward-looking words such as
"may," "will," "expect," "anticipate," "believe," "estimate," "plans,"
"intends," or similar words or expressions. You should read statements that
contain these words carefully because they discuss our future expectations or
state other "forward-looking" information. We believe that it is important to
communicate our future expectations to our shareholders. However, there may be
events in the future that we are not able to predict accurately or control. The
Private Securities Litigation Reform Act of 1995 provides a safe harbor for
forward-looking statements. In order to comply with the terms of the safe
harbor, we must inform you that a variety of factors could cause CNB Financial
Services, Inc.'s actual results and experiences to differ materially from the
anticipated results or other expectations expressed in these forward-looking
statements. Our ability to predict the results of the effect of future plans and
strategies is inherently uncertain. Some of the risks and uncertainties that may
affect the operations, performance, development and results of CNB Financial
Services, Inc.'s business include:
- - Changes in market interest rates;
- - Local and national economic trends and conditions;
- - Competition for products and services among community, regional and
national financial institutions;
- - New services and product offerings by competitors;
- - Changes in customer preferences;
- - Changes in technology;
- - Legislative and regulatory changes;
- - Delinquency rates on loans; and
- - Changes in accounting principles, policies or guidelines;
You should consider these factors in evaluating any forward-looking
statements and not place undue reliance on such statements. We are not obligated
to publicly update any forward looking statements we may make in this Form 10-K
or our Annual Report to reflect the impact of subsequent events.
2
PART I
ITEM 1. DESCRIPTION OF BUSINESS
ORGANIZATIONAL HISTORY AND SUBSIDIARIES
CNB Financial Services, Inc. (the "Company") was organized under the
laws of West Virginia in March 2000 at the direction of the Board of Directors
of Citizens National Bank (the "Bank" or "Citizens National Bank") for the
purpose of becoming a financial services holding company. The Company and its
subsidiary are collectively referred to herein as "CNB".
A special meeting of the Bank's shareholders was held on August 4,
2000, and the shareholders approved the Agreement and Plan of Merger between the
Bank and the Company, whereby the Bank became a wholly-owned subsidiary of the
Company and the shareholders of the Bank became shareholders of the Company. The
merger became effective on August 31, 2000. Each Bank shareholder received two
shares of the Company stock for each share of the Bank's common stock. On August
31, 2000, the Company consummated its merger with the Bank and subsidiary, in a
tax-free exchange of stock. Shareholders of the Bank received two shares of CNB
Financial Services, Inc. common stock for each of the 229,024 shares of the
Bank's common stock. The merger was accounted for as a pooling of interests.
CNB became a 50% member of a limited liability company, Morgan County
Title Insurance Agency, LLC in February 2001, for the purpose of selling title
insurance. As of January 2003, CNB's percentage of ownership in Morgan County
Title Insurance Agency, LLC decreased to 33%.
The Bank was organized on June 20, 1934 and has operated as a national
banking association continuously since that time. The Bank formed CNB Insurance
Services, Inc., a wholly owned subsidiary, which is a property and casualty
insurance agency selling primarily personal lines of insurance.
EMPLOYEES
As of December 31, 2003 and 2002, CNB employed 87 and 81 full-time
equivalent employees, respectively.
BUSINESS OF CNB FINANCIAL SERVICES, INC. AND CITIZENS NATIONAL BANK
The Company's primary function is to direct, plan and coordinate the
business activities of the Bank and its subsidiary.
Citizens National Bank is a full-service commercial bank conducting
general banking and trust activities through four full-service offices and five
automated teller machines located in Morgan and Berkeley Counties, West
Virginia. The Bank exercised an option to purchase a parcel of land in Falling
Waters, Berkeley County, West Virginia for the future site of an additional
full-service branch. On January 26, 2004, CNB entered into a Purchase and
Assumption Agreement with Fidelity Bank to acquire its full service branch in
Hancock, Maryland.
Citizens National Bank accepts time, demand and savings deposits
including NOW accounts, regular savings accounts, money market accounts,
fixed-rate certificates of deposit and club accounts. In addition, the Bank
provides safe deposit box rentals, wire transfer services and 24-hour ATM
services through a regional network known as STAR. STAR is a participant in the
nationwide Cirrus network.
The Bank offers a full spectrum of lending services to its customers,
including commercial loans and lines of credit, residential real estate loans,
consumer installment loans and other personal loans. Commercial loans are
generally secured by various collateral, including commercial real estate,
accounts receivable and business machinery and equipment. Residential real
estate loans consist primarily of mortgages on the borrower's personal
residence, and are typically secured by a first lien on the subject property.
Consumer and personal loans are generally secured, often by first liens on
automobiles, consumer goods or depository accounts. A special effort is made to
keep loan products as flexible as possible within the guidelines of prudent
banking practices in terms of interest rate risk and credit risk. Bank lending
personnel adhere to established lending limits and authorities based on each
individual's lending expertise and experience.
The Bank's trust department acts as trustee under trusts and wills, as
executor of wills and administrator of estates, as guardian for estates of
minors and incompetents and serves in various corporate trust capacities.
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COMPETITION
Citizens National Bank faces a high degree of competition for all its
services from local banks. Within its market area of Morgan and Berkeley
Counties in West Virginia and Washington County in Maryland, numerous competing
commercial banks exist.
Nonbank competition has also increased in recent years locally by the
establishment of finance and mortgage companies and the expansion of insurance
operations and credit unions, as well as from mutual funds located throughout
the country.
West Virginia banks are allowed unlimited branch banking throughout the
State. The Interstate Banking and Branch Efficiency Act of 1994 also authorizes
interstate branching by acquisition and consolidation nationwide. These and
similar provisions impacting both the banking and thrift industries may serve to
intensify future competition within the Bank's market.
AVAILABLE INFORMATION
Our Internet address is WWW.CNBWV.COM. The SEC maintains an Internet
website at http://www.sec.gov that contains reports, proxy and information
statements, and other information regarding issuers that file electronically
with the SEC, and our annual report on Form 10-K, quarterly reports on Form
10-Q, current reports on Form 8-K and amendments to those reports filed or
furnished pursuant to Section 13(a) or 15(d) of the Exchange Act are available,
free of charge, as soon as reasonably practicable after we electronically file
such material with, or furnish it to, the SEC.
SUPERVISION AND REGULATION
The following is a summary of certain statutes and regulations
affecting the Company and its subsidiaries and is qualified in its entirety by
reference to such statutes and regulations:
BANK HOLDING COMPANY REGULATION. The Company is a bank holding company
under the Bank Holding Company Act of 1956 ("BHCA"), which restricts the
activities of the Company and any acquisition by the Company of voting stock or
assets of any bank, savings association or other company. The Company is subject
to the reporting requirements of, and examination and regulation by, the Federal
Reserve Board. The Company's subsidiary bank is subject to restrictions imposed
by the Federal Reserve Act on transactions with affiliates, including any loans
or extensions of credit to the Company or its subsidiaries, investments in the
stock or other securities thereof and the taking of such stock or securities as
collateral for loans to any borrower; the issuance of guarantees, acceptances or
letters of credit on behalf of the Company and its subsidiaries; purchases or
sales of securities or other assets; and the payment of money or furnishing of
services to the Company and other subsidiaries. The Bank is prohibited from
acquiring direct or indirect control of more than 5% of any class of voting
stock or substantially all of the assets of any bank holding company without the
prior approval of the Federal Reserve Board. The Company and its subsidiaries
are prohibited from engaging in certain tying arrangements in connection with
extensions of credit and/or the provision of other property or services to a
customer by the Company or its subsidiaries.
The BHCA also permits the Company to purchase or redeem its own
securities. However, Regulation Y provides that prior notice must be given to
the Federal Reserve Board if the gross consideration for such purchase or
consideration, when aggregated with the net consideration paid by the Company
for all such purchases or redemptions during the preceding 12 months, is equal
to 10 percent or more of the Company's consolidated net worth. Prior notice is
not required if (i) both before and immediately after the redemption, the bank
holding company is well-capitalized; (ii) the financial holding company is
well-managed and (iii) the bank holding company is not the subject of any
unresolved supervisory issues.
The Gramm-Leach-Bliley Act (also known as the Financial Services
Modernization Act of 1999) permits bank holding companies to become financial
holding companies. This allows them to affiliate with securities firms and
insurance companies and to engage in other activities that are financial in
nature. A bank holding company may become a financial holding company if each of
its subsidiary banks is well capitalized, is well managed and has at least a
satisfactory rating under the Community Reinvestment Act. No regulatory approval
will be required for a financial holding company to acquire a company, other
than a bank or savings association, engaged in activities that are financial in
nature or incidental to activities that are financial in nature, as determined
by the Federal Reserve Board.
4
The Financial Services Modernization Act defines "financial in nature"
to include: securities underwriting, dealing and market making; sponsoring
mutual funds and investment companies; insurance underwriting and agency;
merchant banking activities; and activities that the Federal Reserve Board has
determined to be closely related to banking. A bank also may engage, subject to
limitations on investment, in activities that are financial in nature, other
than insurance underwriting, insurance company portfolio investment, real estate
development and real estate investment, through a financial subsidiary of the
bank, if the bank is well capitalized, well managed and has at least a
satisfactory Community Reinvestment Act rating.
BANK SUBSIDIARY REGULATION. The Bank, as a national banking
association, is subject to supervision, examination and regulation by the Office
of the Comptroller of the Currency ("OCC"). It is also a member of the Federal
Reserve System, and as such is subject to applicable provisions of the Federal
Reserve Act and regulations issued thereunder.
The deposits of the Bank are insured by the Federal Deposit Insurance
Corporation ("FDIC") to the extent provided by law. Accordingly, the Bank is
also subject to regulation by the FDIC. The FDIC may terminate a bank's deposit
insurance upon finding that the institution has engaged in unsafe or unsound
practices, is in an unsafe or unsound condition to continue operations, or has
violated any applicable law, regulation, rule, order or condition enacted or
imposed by the bank's regulatory agency.
CAPITAL REQUIREMENTS
As a bank holding company, the Company is subject to Federal Reserve
Board risk-based capital guidelines. The guidelines establish a systematic
framework that makes regulatory capital requirements more sensitive to
differences in risk profiles among banking organizations, takes off-balance
sheet exposures into account and minimizes disincentives to holding liquid,
low-risk assets. Under the guidelines bank holding companies must maintain
capital sufficient to meet both a risk-based asset ratio test and leverage ratio
test on a consolidated basis. The risk-based ratio is determined by allocating
assets and specified off-balance-sheet commitments into four weighted
categories, with higher levels of capital being required for categories
perceived as representing greater risk. The Bank is subject to substantially
similar capital requirements adopted by its applicable regulatory agencies. In
addition, the Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA") established a regulatory framework which ties the level of
supervisory intervention by bank regulatory authorities primarily to a
depository institution's capital category. Among other things, FDICIA authorized
regulatory authorities to take "prompt corrective action" with respect to
depository institutions that do not meet minimum capital requirements. FDICIA
established five capital tiers: well capitalized, adequately capitalized,
undercapitalized, significantly undercapitalized and critically
undercapitalized. The Company is well capitalized as detailed in Note 19 to the
accompanying consolidated financial statements.
FEDERAL AND STATE LAWS
The Bank is subject to regulatory oversight under various consumer
protection and fair lending laws. These laws govern, among other things,
truth-in-lending disclosure, equal credit opportunity, fair credit reporting and
community reinvestment. Failure to abide by federal laws and regulations
governing community reinvestment could limit the ability of a bank to open a new
branch or engage in a merger transaction. Community reinvestment regulations
evaluate how well and to what extent a bank lends and invests in its designated
service area, with particular emphasis on low-to-moderate income communities and
borrowers in such areas.
MONETARY POLICY AND ECONOMIC CONDITIONS
The business of financial institutions is affected not only by general
economic conditions, but also by the policies of various governmental regulatory
agencies, including the Federal Reserve Board. The Federal Reserve Board
regulates money and credit conditions and interest rates to influence general
economic conditions primarily through open market operations in U.S. government
securities, changes in the discount rate on bank borrowings and changes in the
reserve requirements against depository institutions' deposits. These policies
and regulations significantly affect the overall growth and distribution of
loans, investments and deposits, and the interest rates charged on loans, as
well as the interest rates paid on deposits and accounts.
The monetary policies of the Federal Reserve Board have had a
significant effect on the operating results of financial institutions in the
past and are expected to continue to have significant effects in the
5
future. In view of the changing conditions in the economy and the money markets
and the activities of monetary and fiscal authorities, the Company cannot
definitely predict future changes in interest rates, credit availability or
deposit levels.
EFFECT OF ENVIRONMENTAL REGULATION
The Bank's primary exposure to environmental risk is through its
lending activities. In cases when management believes environmental risk
potentially exists, the Bank mitigates its environmental risk exposures by
requiring environmental site assessments at the time of loan origination to
confirm collateral quality as to commercial real estate parcels posing higher
than normal potential for environmental impact, as determined by reference to
present and past uses of the subject property and adjacent sites. Environmental
assessments are typically required prior to any foreclosure activity involving
non-residential real estate collateral.
With regard to residential real estate lending, management reviews
those loans with inherent environmental risk on an individual basis and makes
decisions based on the dollar amount of the loan and the materiality of the
specific credit.
The Company anticipates no material effect on anticipated capital
expenditures, earnings or competitive position as a result of compliance with
federal, state or local environmental protection laws or regulations.
INTERNATIONAL MONEY LAUNDERING ABATEMENT AND
ANTI-TERRORIST FINANCING ACT OF 2001 (USA PATRIOT ACT)
The International Money Laundering Abatement and Anti-Terrorist
Financing Act of 2001 (the "Patriot Act") was adopted in response to the
September 11, 2001 terrorist attacks. The Patriot Act provides law enforcement
with greater powers to investigate terrorism and prevent future terrorist acts.
Among the broad-reaching provisions contained in the Patriot Act are several
designed to deter terrorists' ability to launder money in the United States and
provide law enforcement with additional powers to investigate how terrorists and
terrorist organizations are financed. The Patriot Act creates additional
requirements for banks, which were already subject to similar regulations. The
Patriot Act authorizes the Secretary of the Treasury to require financial
institutions to take certain "special measures" when the Secretary suspects that
certain transactions or accounts are related to money laundering. These special
measures may be ordered when the Secretary suspects that a jurisdiction outside
of the United States, a financial institution operating outside of the United
States, a class of transactions involving a jurisdiction outside of the United
States or certain types of accounts are of "primary money laundering concern."
The special measures include the following: (a) require financial institutions
to keep records and report on the transactions or accounts at issue; (b) require
financial institutions to obtain and retain information related to the
beneficial ownership of any account opened or maintained by foreign persons; (c)
require financial institutions to identify each customer who is permitted to use
a payable-through or correspondent account and obtain certain information from
each customer permitted to use the account; and (d) prohibit or impose
conditions on the opening or maintaining of correspondent or payable-through
accounts.
CRITICAL ACCOUNTING POLICIES
CNB's financial position and results of operations are impacted by
management's application of accounting policies involving judgments made to
arrive at the carrying value of certain assets. Management's greatest challenge
in implementing its policies is the need to make estimates about the effect of
matters that are inherently less than certain. For a detailed discussion of
CNB's significant accounting policies, see Note 1: Summary of Significant
Accounting Policies in the Notes to Consolidated Financial Statements. A
material estimate that is susceptible to significant change is the determination
of the allowance for loan losses. Both the estimates of the amount of the
allowance for loan losses and the placement of loans on non-accrual status
affect the carrying amount of the loan portfolio.
The allowance for loan losses is a subjective judgment that management
must make regarding the loan portfolio, and is established and maintained at
levels that management believes are adequate to cover losses resulting from the
inability of borrowers to make required payments on loans. Where there is a
question as to the impairment of a specific loan, management obtains valuations
of the property or collateral securing the loan, and current financial
information of the borrower, including financial statements, when available.
Since the calculation of appropriate loan loss allowances relies on management's
estimates and judgments relating to inherently uncertain events, actual results
may differ from these estimates. The
6
American Institute of Certified Public Accountants is preparing further guidance
for calculating the allowance for loan losses. Implementation of that guidance
could result in an adjustment to the allowance. For a more detailed discussion
on the allowance for loan losses, see Nonperforming Loans and Allowance For Loan
Losses in this Management's Discussion and Analysis and Allowance for Loan
Losses in Note 1: Summary of Significant Accounting Policies and Note 4: Loans
and Leases Receivable in the Notes to Consolidated Financial Statements.
ITEM 2. PROPERTIES
CNB Financial Services, Inc.
CNB's headquarters are located at the main office of Citizens National
Bank located at 101 South Washington Street, Berkeley Springs, West Virginia.
Citizens National Bank
The principal executive office and main banking office is located at
101 South Washington Street, Berkeley Springs, West Virginia. In addition, the
bank has owned and operated a full service branch bank located at 2450 Valley
Road, Berkeley Springs, West Virginia since 1991. In October 1998, the bank
opened a full service branch located at 2646 Hedgesville Road, Martinsburg, West
Virginia. In March 2002, the bank opened an additional full service branch
located at 14994 Apple Harvest Drive, Martinsburg, West Virginia. The main
banking office and each location in Berkeley County provides ATM services, in
addition to traditional lobby and drive-in services. In December 2003, the Bank
exercised an option to purchase a parcel of land in Falling Waters, Berkeley
County West Virginia for the future site of a full-service branch. The
construction of the branch is expected to be completed during the fourth quarter
2004. On January 26, 2004, CNB entered into a Purchase and Assumption Agreement
with Fidelity Bank to acquire its full service branch in Hancock, Maryland.
During 1998, the bank purchased two cash machines and placed them at Cacapon
State Park Lodge and the Woods Resort. In November of 1998, the bank acquired
CNB Insurance Services, Inc. which is operated out of the main office in
Berkeley Springs. The main office and branches are owned free and clear of any
indebtedness. The net book value of the bank's premises and equipment as of
December 31, 2003 is $5.3 million.
ITEM 3. LEGAL PROCEEDINGS
In the ordinary course of business, the company and its subsidiary are
involved in various legal proceedings.
In the opinion of the management of CNB, there are no proceedings
pending to which CNB is a party or to which its property is subject, which, if
determined adversely to CNB, would be material in relation to CNB's financial
condition. There are no proceedings pending other than ordinary routine
litigation incident to the business of CNB. In addition, no material proceedings
are pending or are known to be threatened or contemplated against CNB by
government authorities.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of security holders, through the
solicitation of proxies or otherwise, during the fourth quarter of 2003.
7
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The price of CNB's common stock ranged from $67.50 to $100.00 in 2003
and from $63.50 to $90.00 in 2002. The prices listed below represent the high
and low market prices for stock trades reported during each quarter.
PER SHARE
HIGH LOW DIVIDEND
---- --- --------
2003
First quarter $ 100.00 $ 100.00
Second quarter $ 100.00 $ 70.00 $ 0.39
Third quarter $ 80.00 $ 67.50
Fourth quarter $ - $ - $ 0.81
2002
First quarter $ 90.00 $ 63.50
Second quarter $ 85.00 $ 85.00 $ 0.36
Third quarter $ 70.50 $ 73.50
Fourth quarter $ 70.00 $ 70.00 $ 0.66
CNB's stock is not traded on an established exchange and there are no
known market makers, therefore there is no established public trading market for
CNB's stock. The prices listed above are based upon information available to
management through discussions with shareholders, and to the best of
management's knowledge, accurately represent the amount at which its stock was
traded during the periods indicated. Prices reflect amounts paid by purchasers
of the stock and, therefore, may include commissions or fees. The amounts of
such commissions or fees, if any, are not known to management. No attempt was
made by management to ascertain the prices for every sale made during these
periods.
The ability of CNB to pay dividends is subject to certain limitations
imposed by national banking laws. As of March 5, 2004, the number of record
holders was 612.
8
ITEM 6. SELECTED FINANCIAL DATA
TABLE 1. FIVE YEAR SELECTED CONSOLIDATED FINANCIAL DATA
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
In thousands except for per share data
AT YEAR-END
Total assets $ 201,056 $ 191,602 $ 171,541 $ 149,982 $ 138,648
Securities available for sale 39,362 43,430 49,668 35,374 31,187
Loans and lease, net of
unearned income 146,273 129,815 111,874 105,220 98,272
Deposits 180,899 173,063 154,381 133,996 124,510
Shareholders' equity 16,569 16,270 14,926 13,864 12,249
SIGNIFICANT RATIOS
Return on average assets 0.89% 0.71% 0.77% 0.91% 0.90%
Return on average
shareholders' equity 10.44 8.38 8.49 10.16 9.66
Average shareholders' equity
to average assets 8.48 8.49 9.12 9.00 9.35
Net interest margin 3.83 3.36 3.73 4.03 4.01
SUMMARY OF OPERATIONS
Interest income $ 11,569 $ 11,489 $ 11,868 $ 11,035 $ 9,945
Interest expense 4,152 5,342 5,937 5,365 4,597
Net interest income 7,417 6,147 5,931 5,670 5,348
Provision for loan losses 312 261 226 170 118
Net interest income after
provision for loan losses 7,105 5,886 5,705 5,500 5,230
Non-interest income 1,728 1,403 1,025 843 565
Non-interest expense 6,007 5,300 4,794 4,279 3,954
Income before income taxes 2,826 1,989 1,936 2,064 1,841
Income tax expense 1,083 681 700 758 621
Net income 1,743 1,308 1,236 1,306 1,220
PER SHARE DATA (1)
Net income $ 3.80 $ 2.86 $ 2.70 $ 2.85 $ 2.66
Cash dividends 1.20 1.02 1.02 1.02 1.00
Net book value 36.17 35.52 32.59 30.27 26.74
(1) Restated to reflect the formation of CNB Financial Services, Inc. and the
acquisition of Citizens National Bank and subsidiary on August 31, 2000 and
accounted for as a pooling of interests.
9
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis presents the significant changes
in financial condition and results of operations of CNB, for the years ended
December 31, 2003 and 2002. This discussion and analysis should be read in
conjunction with the audited, consolidated financial statements and accompanying
notes. This discussion includes forward-looking statements based upon
management's expectations; actual results may differ. Amounts and percentages
used in this discussion have been rounded. All average balances are based on
monthly averages.
EARNINGS SUMMARY
CNB had net income totaling $1.7 million or $3.80 per share, $1.3
million or $2.86 per share and $1.2 million or $2.70 per share for fiscal years
2003, 2002 and 2001, respectively. Annualized return on average assets and
average equity were .9% and 10.4%, respectively for 2003 compared to .7% and
8.4% for 2002 and .8% and 8.5% for 2001.
Growth in net income for the year 2004 is projected to slow down
compared to the growth in net income for 2003 due to the additional expenses
related to the projected opening of a new branch facility in Falling Waters,
West Virginia and the acquisition of Fidelity Bank's branch office in Hancock,
Maryland. Additionally, the slowing of the maturities of the higher interest
bearing 36 month Certificate of Deposits will cause interest expense to level
out. The steady loan growth is expected to continue through 2004 although not at
the level experienced recently. As a result of lower interest rates and slower
loan growth, interest income on loans will be impacted.
NET INTEREST INCOME
Net interest income represents the primary component of the Bank's
earnings. It is the difference between interest and fee income related to
earning assets and interest expense incurred to carry interest-bearing
liabilities. Net interest income is impacted by changes in the volume and mix of
interest-earning assets and interest-bearing liabilities, as well as by changing
interest rates. In order to manage these changes, their impact on net interest
income and the risk associated with them, the Bank utilizes an ongoing
asset/liability management program. This program includes analysis of the
difference between rate sensitive assets and rate sensitive liabilities,
earnings sensitivity to rate changes, and source and use of funds. A discussion
of net interest income and the factors impacting it is presented below.
Net interest income in 2003 increased by $1.3 million or 20.7% over
2002. Interest income in 2003 increased by $80,000 or 0.7% compared to 2002,
while interest expense decreased by $1.2 million or 22.3% during 2003 as
compared to 2002. Interest income increased during 2003 compared to 2002 as a
result of an increase in the average balances of loans offset by a decrease in
the average rates earned on loans, investment securities and federal funds sold.
Interest expense decreased during 2003 compared to 2002 as a result of a
decrease in the average rates paid on NOW, money market, savings and time
deposits offset by an increase in the average balances of the interest bearing
liabilities.
Net interest income in 2002 increased by $217,000 or 3.7% over 2001.
Interest income in 2002 decreased by $379,000 or 3.2% compared to 2001, while
interest expense decreased by $596,000 or 10.0% during 2002 as compared to 2001.
Interest income decreased during 2002 compared to 2001 as a result of a decrease
in the average rates earned on loans, securities and federal funds sold offset
by an increase in the average balances of the earning assets. Interest expense
decreased during 2002 compared to 2001 as a result of a decrease in the average
rates paid on NOW, money market, savings and time deposits offset by an increase
in the average balances of the interest bearing liabilities.
During 2003, the Bank used funds generated from deposit account growth
and FHLB borrowings to fund loan commitments. During 2002, the Bank solely used
funds generated from deposit account growth to fund loan commitments and to
increase the average balance of investment securities, especially high quality
U.S. government agency securities.
The net interest margin is impacted by the change in the spread between
yields on earning assets and rates paid on interest bearing liabilities. Net
interest margin increased from 2002 to 2003. See Table 2 - Distribution of
Assets, Liabilities and Shareholders' Equity; Interest Rates and Interest
Differential.
10
TABLE 2. DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY;
INTEREST RATES AND INTEREST DIFFERENTIAL
DECEMBER 31, 2003 DECEMBER 31, 2002 DECEMBER 31, 2001
----------------- ----------------- -----------------
YTD YTD YTD
AVERAGE YTD YIELD/ AVERAGE YTD YIELD/ AVERAGE YTD YIELD/
BALANCE INTEREST RATE BALANCE INTEREST RATE BALANCE INTEREST RATE
-------- --------- ------ --------- -------- ------ -------- -------- ------
In thousands
Interest earning assets:
Federal funds sold $ 1,521 $ 17 1.02 % $ 4,720 $ 82 1.57 % $ 4,298 $ 160 3.79 %
Securities:
Taxable 42,602 1,887 4.43 47,955 2,307 4.81 38,385 2 312 6.02
Tax-exempt (1) 1,718 59 5.20 695 28 6.10 302 14 7.02
Loans (net of unearned
interest) (2) (4) (5) 136,658 9,187 6.72 118,530 8,708 7.35 108,526 9 096 8.38
-------- --------- ----- --------- -------- ----- -------- -------- -----
Total interest
earning assets (1) $182,499 $ 11,150 6.11 % $ 171,900 $ 11,125 6.47 % $151,511 $ 11 582 7.64 %
-------- --------- ----- --------- -------- ----- -------- -------- -----
Nonearning assets:
Cash and due
from banks $ 6,934 $ 6,592 $ 3,609
Bank premises and
equipment, net 4,734 4,624 3,700
Other assets 4,193 2,240 2,202
Allowance for
loan losses (1543) (1,403) (1,277)
-------- --------- --------
Total assets $196,817 $ 183,953 $159,745
======== ========= ========
Interest bearing
liabilities:
Savings deposits $ 22,876 $ 114 0.50 % $ 19,629 $ 117 0.60 % $ 16,614 $ 272 1.64 %
Time deposits 94,497 3,685 3.90 94,889 4,854 5.12 84,987 5 094 5.99
NOW accounts 25,432 290 1.14 23,242 318 1.37 19,321 476 2.46
Money market
accounts 6,836 53 0.78 5,295 52 0.98 4,802 93 1.94
Borrowings 728 10 1.37 - - - 44 2 4.55
-------- --------- ----- --------- -------- ----- -------- -------- -----
Total interest bearing
liabilities $150,369 $ 4,152 2.76 % $ 143,055 $ 5,341 3.73 % $125,768 $ 5 937 4.72 %
-------- --------- ----- --------- -------- ----- -------- -------- -----
Noninterest bearing
liabilities:
Demand deposits $ 27,319 $ 23,278 $ 17,469
Other liabilities 2,431 2,009 1,944
Shareholders' equity 16,698 15,611 14,564
-------- --------- --------
Total liabilities and
shareholders' equity $196,817 $ 183,953 $159,745
======== ========= ========
--------- -------- --------
Net interest income (1) $ 6,998 $ 5,784 $ 5,645
========= ======== ========
Net interest spread (3) 3.35 % 2.74 % 2.92 %
==== ==== ====
Net interest income to
average interest earning
assets (1) 3.83 % 3.36 % 3.73 %
==== ==== ====
(1) Yields are expressed on a tax equivalent basis using a 34% tax rate.
(2) For the purpose of these computations, nonaccruing loans are included in
the amounts of average loans outstanding.
(3) Net interest spread is the difference between the weighted average yield on
interest-earning assets and the weighted average cost of interest-bearing
liabilities.
(4) Interest income on loans excludes fees of $419,000 in 2003, $365,000 in
2002 and $285,000 in 2001.
(5) Interest income on loans includes fees of $155,942 in 2003, $158,085 in
2002 and $200,039 in 2001 from the Business Manager Program, student loans
and lease receivables.
11
Table 3 sets forth a summary of the changes in interest earned and
interest expense detailing the amounts attributable to (i) changes in volume
(change in average volume times the prior year's average rate), (ii) changes in
rate (change in the average rate times the prior year's average volume). The
changes in rate/volume (change in the average volume times the change in the
average rate), had been allocated to the changes in volume and changes in rate
in proportion to the relationship of the absolute dollar amounts of the change
in each. During 2003, net interest income increased $959,000 due to changes in
volume and $255,000 due to changes in interest rates. Also, net interest income
was affected by a $53,000 increase in loan fees. In 2002, net interest income
increased $648,000 due to changes in volume and decreased $509,000 due to
changes in interest rates. Also, net interest income was affected by a $80,000
increase in loan fees.
TABLE 3. VOLUME AND RATE ANALYSIS OF CHANGES IN INTEREST INCOME
(Taxable equivalent basis)
2003 OVER 2002 2002 OVER 2001
-------------- --------------
CHANGE DUE TO CHANGE DUE TO
------------- TOTAL ---------------- TOTAL
VOLUME RATE CHANGE VOLUME RATE CHANGE
------ ---- ------ ------ ---- ------
In thousands
Interest earned on:
Federal funds sold $ (43) $ (22) $ (65) $ 15 $ (93) $ (78)
Taxable securities (246) (174) (420) 512 (517) (5)
Tax-exempt securities 36 (5) 31 16 (2) 14
Loans 1,263 (784) 479 794 (1,182) (388)
------- ------- ------- ------- ------- ------
Total interest earned $ 1,010 $ (985) $ 25 $ 1,337 $(1,794) $ (457)
------- ------- ------- ------- ------- ------
Interest expense on:
Savings deposits $ 18 $ (21) $ (3) $ 43 $ (198) $ (155)
Time deposits (19) (1,150) (1,169) 555 (795) (240)
NOW accounts 29 (57) (28) 83 (241) (158)
Money market accounts 13 (12) 1 9 (50) (41)
Other borrowing 10 - 10 (1) (1) (2)
------- ------- ------- ------- ------- ------
Total interest expense $ 51 $(1,240) $(1,189) $ 689 $(1,285) $ (596)
------- ------- ------- ------- ------- ------
Net interest income $ 959 $ 255 $ 1,214 $ 648 $ (509) $ 139
======= ======= ======= ======= ======= ======
Another method of analyzing the change in net interest income is to
examine the changes between interest rate spread and the net interest margin on
earning assets. The interest rate spread as shown in Table 4 is the difference
between the average rate earned on earning assets and the average rate on
interest bearing liabilities. The net interest margin takes into account the
benefit derived from assets funded by interest free sources such as non-interest
bearing demand deposits and capital.
12
TABLE 4. INTEREST RATE SPREAD AND NET INTEREST MARGIN ON EARNING ASSETS
(Taxable equivalent basis)
2003 2002 2001
---- ---- ----
AVERAGE AVERAGE AVERAGE
BALANCE RATE BALANCE RATE BALANCE RATE
------- ---- ------- ---- ------- ----
In thousands
Earning assets $182,499 6.11% $171,900 6.47% $151,511 7.64%
======== ======== ========
Interest bearing liabilities $150,369 2.76% $143,055 3.73% $125,768 4.72%
---- ---- ----
Interest rate spread 3.35% 2.74% 2.92%
Interest free sources used
to fund earning assets(1) 32 130 0.48% 28 845 0.62% 25,743 0.81%
-------- ---- -------- ---- ------ ----
Total sources of funds $182,499 $171,900 $151,511
======== ======== ========
Net interest margin 3.83% 3.36% 3.73%
==== ==== ====
(1) Non-interest bearing liabilities and shareholders' equity less non-interest
earning assets.
The following discussion analyzes changes in the Bank's spreads and
margins in terms of basis points. A basis point is a unit of measure for
interest rates equal to .01%. One hundred basis points equals 1%.
Interest rate spread increased 61 basis points in 2003 while the net
interest margin increased 47 basis points. Both the interest rate spread and
margin were positively impacted by a 97 basis point decrease in interest bearing
liability costs offset by a 36 basis point decrease in earning asset yields.
Interest rate spread decreased 18 basis points in 2002 while the net interest
margin decreased 37 basis points. Both the interest rate spread and margin were
negatively impacted by a 117 basis point decrease in earning asset yields and
offset by a 99 basis point decrease in interest bearing liability costs.
Although the prime rate only decreased 25 basis points in 2003 and 50
basis points in 2002, loan yields decreased 63 basis points in 2003 and 103
basis points in 2002 due to a significant portion of the loan portfolio repriced
at lower rates through refinancing or variable rate loans. In both 2003 and
2002, the decrease in liability costs is primarily the result of the lower cost
of funds on savings, NOW, money market and time deposit accounts during the
year.
PROVISION FOR LOAN LOSSES
The amount charged to the provision for loan losses is based on
Management's evaluation of the loan portfolio. Management determines the
adequacy of the allowance for loan losses based on past loan loss experience,
current economic conditions and composition of the loan portfolio. The allowance
for loan losses is the best estimate by Management of the probable losses which
have been incurred as of the balance sheet date. See Nonperforming Loans and
Allowance for Loan Losses for a comprehensive analysis.
NONINTEREST INCOME
Noninterest income increased $325,000 or 23.2% during 2003 over the
prior comparable period. The increase in 2003 was attributable to fees generated
from the Bounce Protection program, debit card income and gain on sale of
securities. These increases were offset by a decrease in overdraft fees and
trust fees. Income from CNB's insurance operations increased due to additional
new written business, rate increases by companies and a large group health plan
written in September 2003. Bounce Protection, and debit card fees increased due
to the Bank's increased number of checking accounts and volume of activity on
these accounts.
Although the level of trust assets being managed increased from $22.7
million at December 31, 2002 to $24.6 million at December 31, 2003, the fees
earned on these assets decreased in 2003. The decrease
13
in trust fees was a direct result of the fees of $27,000 earned from the
settlement of an estate in 2002 offset by fees of $10,000 earned from the
settlement of an estate in 2003.
Noninterest income increased $377,000 or 36.8% during 2002 over the
prior comparable period. The increase in 2002 was attributable to fees generated
from the Bounce Protection program, overdraft fees, debit cards, gain on sale of
securities and trust fees. Income from CNB's insurance operations decreased.
Bounce Protection is a form of overdraft protection which enables the customer
to have insufficient funds checks paid instead of returned. The customer is
charged a fee for each check paid. Bounce Protection, overdraft fees and debit
card fees increased due to the Bank's increased number of checking accounts and
volume of activity on these accounts.
There was also an increase in other fees, which included trust fees.
Fees generated from trust assets under management increased even though the
level of assets being managed decreased from $24.1 million at December 31, 2001
to $22.7 million at December 31, 2002. The trust fees increased due to a large
estate being settled in 2002. Another factor contributing to the increase in
noninterest income was in March 2002, one of the Bank's Board of Directors
passed away and the Bank was the beneficiary of a life insurance policy on the
director. The Bank received $43,379 in a death benefit, $21,645 of which was
recorded in assets as cash surrender value. The difference of $21,734 is
reflected in other operating income.
NONINTEREST EXPENSES
Noninterest expenses increased $706,000 or 13.3% during 2003 over the
prior comparable period. The increase was primarily due to an increase in
occupancy expense, furniture and equipment expense, salaries and employee
benefits and other operating expenses. Normal recurring merit increases and
remuneration in connection with the conversion of the Bank's core processing
system accounted for the additional costs of salaries in 2003. Higher health
insurance costs and pension costs contributed to the increased employee benefit
costs in 2003. Additional depreciation and amortization related to the new
computer equipment, software and peripherals associated with the upgrade of the
Bank's technology systems caused furniture and equipment expense to increase.
Another factor relating to the increase in furniture and equipment expense was
an increase in the cost and number of equipment maintenance contracts the Bank
entered into in 2003. Occupancy expense increased due to the cost of real estate
property taxes and property insurance rising.
Components of other operating expense, which significantly increased
during 2003, included stationary, supplies and printing, postage, employee
training, Bounce protection, mortgage servicing rights expense and amortization
of business assets purchased. These increases were offset by decreases to
advertising, data processing expense, telephone, miscellaneous NSF check and
other losses expense. The increase in stationary, supplies and printing and
employee training were a direct result of the Bank's conversion to the new
technology systems. Expenses related to the Bounce Protection Program increased
due to the usage volume continuing to increase.
The Company performed an analysis of the predominant risk
characteristics of the previously capitalized mortgage servicing rights on
December 31, 2003. This analysis indicated prepayment risk for the underlying
loans is higher due to lower current interest rates and thus a write-down of the
remaining balance was necessary. Management recognized a direct write off of
$27,674 included in other expenses on the income statement.
The Company performed its annual test of impairment of acquired
customer lists on December 31, 2003. Based on the results of these tests, the
Company concluded that there was an impairment of the amortizable intangible
assets as a result of the rate of attrition of the acquired customers.
Management determined the fair value of the intangible assets based on a
multiple of commission income to determine the amount of impairment. The
impairment recorded in 2003 was $64,003, which is included in other expenses on
the income statement.
Advertising expense decreased due to the bank canceling their contract
with a third party vendor for certain advertising services in 2003. Telephone
expense decreased in 2003 due to the Bank receiving a credit from the telephone
company for double billing of telephone lines in prior years. There was a
decrease in miscellaneous NSF check and other losses expense for 2003.
14
Noninterest expenses increased $507,000 or 10.6% during 2002 over the
prior comparable period. The increase was primarily due to an increase in
occupancy expense, furniture and equipment expense, salaries and employee
benefits and other operating expenses. Higher health insurance costs, normal
recurring merit increases and additional staffing at the south Martinsburg
branch facility accounted for the additional costs of salaries and benefits in
2002. Additional depreciation related to the Bank's new technology systems and
south Martinsburg branch facility caused occupancy expense and furniture and
equipment expense to increase.
Components of other operating expense, which significantly increased
during 2002, included telephone, advertising, conventions and meetings, and NSF
check and other losses. These increases were offset by decreases to stationary,
supplies and printing, Bounce Protection expenses, Business Manager expenses,
other outside service fees and miscellaneous other operating expenses. Expenses
related to the first full year of operation of the new branch facility in south
Martinsburg, Berkeley County West Virginia attributed to the increase in other
operating expenses. Expenses related to the Bounce Protection Program decreased
due to a contract revision reducing the percentage of income shared with the
vendor. Advertising expense increased due to the bank contracting a third party
vendor for additional advertising services. A decrease in the volume of the
Business Manager program caused the expenses related to this program to
decrease.
INCOME TAXES
Provision for income tax totaled $1.1 million in 2003, $681,000 in 2002
and $700,000 in 2001. The effective tax rate was 38.3% in 2003 compared to 34.2%
and 36.1% in 2002 and 2001, respectively. The Bank's income tax expense differs
from the amount computed at statutory rates primarily due to the tax-exempt
earnings from certain investment securities. See Note 15 of the Notes to
Consolidated Financial Statements for a comprehensive analysis of income tax
expense.
FINANCIAL CONDITION
Table 5 examines Citizens National Bank's financial condition in terms
of its sources and uses of funds. Average funding sources and uses increased
$10.6 million or 6.2% in 2003 compared with an increase of $20.4 million or
13.5% in 2002.
15
TABLE 5. SOURCES AND USES OF FUNDS
2003 2002 2001
-------------------------------- ------------------------------ ----
INCREASE (DECREASE) INCREASE (DECREASE)
AVERAGE ------------------- AVERAGE ------------------- AVERAGE
BALANCE AMOUNT % BALANCE AMOUNT % BALANCE
-------- -------- -------- -------- -------- ------- -------
In thousands
Funding uses:
Federal funds
sold $ 1,521 $ (3,199) (67.8)% $ 4,720 $ 422 9.8 % $ 4,298
Securities available
for sale 44,320 (4,330) (8.9) 48,650 9,963 25.8 38,687
Loans 136,658 18,128 15.3 118,530 10,004 9.2 108,526
-------- -------- ------- -------- -------- ------ --------
Total uses $182,499 $ 10,599 6.2 % $171,900 $ 20,389 13.5 $151,511
======== ======== ======= ======== ======== ====== ========
Funding sources:
Interest-bearing
demand deposits $ 32,268 $ 3,731 13.1 % $ 28,537 $ 4,414 18.3 % $ 24,123
Savings deposits 22,876 3,247 16.5 19,629 3,015 18.1 16,614
Time deposits 94,497 (392) (0.4) 94,889 9,902 11.7 84,987
Short-term
borrowings 728 728 100.0 - (44) (100.0) 44
Noninterest bearing
funds, net(1) 32,130 3,285 11.4 28,845 3,102 12.0 25,743
-------- -------- ------- -------- -------- ------ --------
Total sources $182,499 $ 10,599 6.2 % $171,900 $ 20,389 13.5 % $151,511
======== ======== ======= ======== ======== ====== ========
(1) Noninterest bearing liabilities and shareholders' equity less noninterest
earning assets.
Total assets increased $9.5 million or 4.9% to $201.1 million from
December 31, 2002 to December 31, 2003, due primarily to a $16.3 million
increase in loans and a $488,000 increase in premises and equipment, net, which
were partially offset by a $4.1 million decrease in federal funds sold, a $4.1
million decrease in securities available for sale.
Total liabilities increased $9.2 million or 5.2% to $184.5 million from
December 31, 2002 to December 31, 2003 substantially due to the increase in
deposits. Shareholders' equity increased $299,000 to $16.6 million at December
31, 2003 primarily due to net income of $1.7 million, offset by a $894,000
decrease in accumulated other comprehensive income and cash dividends of
$550,000.
The decrease in accumulated other comprehensive income was due to the
unrealized market value depreciation of the available for sale investment
security portfolio and additional minimum pension liability. The components of
accumulated other comprehensive income at December 31, 2003, were unrealized
gains and losses on available for sale securities, net of deferred income taxes
and additional minimum pension liability, net of deferred income taxes. The
unrealized gains and losses are primarily a function of available market
interest rates relative to the yield being generated on the available for sale
portfolio. No earnings impact results, however, unless the securities are
actually sold. The additional minimum pension liability adjustment results from
the accumulated benefit obligation exceeding the fair value of plan assets.
16
LOAN PORTFOLIO
At December 31, 2003, total loans increased $16.3 million or 12.7% to
$144.7 million from $128.3 million at December 31, 2002. The loan mix changed
slightly compared with December 31, 2002. The loan portfolio change is primarily
due to the reclassification of loans within the loan portfolio during the Bank's
recent mainframe computer conversion. The Bank's real estate loans grew as a
direct result of new construction loans and refinancing of existing loans at
lower rates. The Bank's programs targeting purchases and home construction loans
continue to generate additional growth. The Bank's commercial real estate and
business loans grew as a direct result of the Bank's continued efforts to
develop new commercial lending relationships especially in the Berkeley County,
West Virginia market. The Bank's management believes additional growth in all
lending areas is possible into year 2004. Management's intent is to control the
loan volume in a manner which would produce a loan to deposit ratio between 75%
and 80% and maintain credit quality. The loan to deposit ratio was 80.0% at
December 31, 2003 and 74.2% at December 31, 2002. The ratio of net charge-offs
to average loans outstanding was .14% in 2003 and .10% in 2002.
Table 6 sets forth the amount of loans outstanding (net of unearned
income) as of the dates shown:
TABLE 6. LOANS AND LEASES OUTSTANDING
DECEMBER 31,
-------------------------------------------------------------------
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
In thousands
Real estate $ 98,405 $ 83,239 $ 67,860 $ 65,278 $ 61,625
Commercial real estate 21,521 13,935 12,459 9,944 9,569
Consumer 16,853 22,575 24,198 23,708 21,778
Commercial 8,934 9,685 6,978 6,037 5,185
Overdrafts 136 73 87 20 28
--------- --------- --------- --------- --------
$ 145,849 $ 129,507 $ 111,582 $ 104,987 $ 98,185
Leases: 186 135 139 143 -
--------- --------- --------- --------- --------
$ 146,035 $ 129,642 $ 111,721 $ 105,130 $ 98,185
Net deferred loan fees,
premiums and discounts 238 172 153 90 88
Allowance for loan losses (1,608) (1,484) (1,337) (1,216) (1,148)
--------- --------- --------- --------- --------
$ 144,665 $ 128,330 $ 110,537 $ 104,004 $ 97,125
========= ========= ========= ========= ========
The commercial loan portfolio consisting of commercial business and
commercial real estate loans showed an increase in outstanding loans of $6.9
million from $23.6 million at December 31, 2002 to $30.5 million at December 31,
2003. The commercial loan portfolio is approximately 21% of the total loan
portfolio at December 31, 2003 compared to 18% at December 31, 2002. The Bank's
market area was expanded to Berkeley County, West Virginia in 1999 which
provides a much larger area for commercial lending. Additional growth in both
commercial business and commercial real estate loans is possible in 2004.
Real estate mortgage loans comprised mainly of one to four family
residences continued to be the Bank's dominant loan category. Mortgage lending
comprises approximately 67% or $98.4 million of the total loan portfolio at
December 31, 2003 compared to 64% or $83.2 million at December 31, 2002.
Table 7 summarizes the approximate contractual maturity and sensitivity
of certain loan types to changes in interest rates as of December 31, 2003:
17
TABLE 7. LOAN MATURITIES AND INTEREST SENSITIVITY
DECEMBER 31, 2003
---------------------------------------------------
ONE YEAR ONE THROUGH OVER
OR LESS FIVE YEARS FIVE YEARS TOTAL
------- ---------- ---------- -----
In thousands
Commercial, financial and agricultural:
Floating rate $ 19,352 $ 3,030 $ 34 $ 22,416
Fixed rate 1,696 2,958 3,385 8,039
-------- -------- -------- --------
Total $ 21,048 $ 5,988 $ 3,419 $ 30,455
======== ======== ======== ========
Real estate - mortgage:
Floating rate $ 10,625 $ 38,413 $ 472 $ 49,510
Fixed rate 981 5,275 39,181 45,437
-------- -------- -------- --------
Total $ 11,606 $ 43,688 $ 39,653 $ 94,947
======== ======== ======== ========
Real estate - construction:
Floating rate $ 1,691 $ - $ - $ 1,691
Fixed rate 1,767 - - 1,767
-------- -------- -------- --------
Total $ 3,458 $ - $ - $ 3,458
======== ======== ======== ========
Consumer:
Floating rate $ 80 $ 37 $ - $ 117
Fixed rate 1,218 14,345 1,173 16,736
-------- -------- -------- --------
Total $ 1,298 $ 14,382 $ 1,173 $ 16,853
======== ======== ======== ========
Lease financing:
Floating rate $ - $ - $ - $ -
Fixed rate - 55 131 186
-------- -------- -------- --------
Total $ - $ 55 $ 131 $ 186
======== ======== ======== ========
Demand for the Bank's primary mortgage products, variable rate loans
carrying annual interest rate adjustments based on one, three and five year
Treasury rates, continues to remain attractive to the Bank's customers because
these loans usually have lower rates, lower closing costs and quicker
settlement. The Bank continues to see demand for fixed rate mortgage products,
and for all loan products, as the Bank penetrates the Berkeley County, West
Virginia real estate market. As of December 31, 2003, 58.6% of the Bank's
mortgage loans were adjustable rate loans and 41.4% were fixed rate loans.
Currently, the Bank has approximately $4.3 million in fixed rate loans in the
portfolio which were originated under terms that would allow them to be sold on
the secondary market, although there is no intent to sell these loans.
The consumer loan portfolio showed a decrease of $5.7 million. The
primary factor causing the decrease was a shift by the Bank's customers to
consolidate higher interest consumer loans into lower interest mortgage and home
equity loans. In the third quarter of 2002, the Bank adopted a managed risk
pricing structure for its consumer loans which significantly reduced loan rates
for borrowers with excellent credit. The Bank has realized more business from
the automobile dealers through indirect loan contracts with the new pricing
structure. Since the inception of the new pricing structure, in lieu of a formal
loan sale, the lower rates in conjunction with the managed risk pricing were
advertised.
Bank policy requires those loans which are past due 90 days or more be
placed on nonaccrual status unless they are both well secured and in the process
of collection. As of December 31, 2003 and 2002, nonaccrual loans approximated
..24% and .01% of total loans (net), respectively.
18
TABLE 8. LOANS AND LEASES RECEIVABLE
DECEMBER 31,
-----------------------------------------------------------
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
In thousands
Real estate $ 98,405 $ 83,239 $ 67,860 $ 65,278 $ 61,625
Commercial real estate 21,521 13,935 12,459 9,944 9,569
Consumer 16,853 22,575 24,198 23,708 21,778
Commercial 8,934 9,685 6,978 6,037 5,185
Overdrafts 136 73 87 20 28
--------- --------- --------- --------- --------
$ 145,849 $ 129,507 $ 111,582 $ 104,987 $ 98,185
Leases: 186 135 139 143 -
--------- --------- --------- --------- --------
$ 146,035 $ 129,642 $ 111,721 $ 105,130 $ 98,185
Net deferred loan fees,
premiums and discounts 238 172 153 90 88
Allowance for loan losses (1,608) (1,484) (1,337) (1,216) (1,148)
--------- --------- --------- --------- --------
$ 144,665 $ 128,330 $ 110,537 $ 104,004 $ 97,125
========= ========= ========= ========= ========
NONPERFORMING LOANS AND ALLOWANCE FOR LOAN LOSSES
Nonperforming loans consist of loans in nonaccrual status and loans
which are past due 90 days or more and still accruing interest. The Bank has no
loans which are considered to be impaired as of December 31, 2003 and 2002. As
of December 31, 2003, management is aware of two borrowers who have exhibited
weaknesses. Their loans have aggregate uninsured balances of $698,000. A
specific allowance of $50,000 related to these loans has been established as
part of the allowance for loan losses. The loans are collateralized primarily by
real estate and management anticipates that any additional potential loss would
be minimal.
Table 9 sets forth the amounts of nonperforming loans as of the dates
indicated:
TABLE 9. NONPERFORMING ASSETS
DECEMBER 31
--------------------------------------------------------------
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
In thousands
Nonaccrual loans $ 349 $ 13 $ 25 $ 22 $ 22
Loans past due 90 days or more still accruing interest 27 553 450 360 79
Other real estate - 2 15 - 67
------ ------ ------ ------ -------
Total $ 376 $ 568 $ 490 $ 382 $ 168
====== ====== ====== ====== =======
19
The allowance for loan losses is the best estimate by management of the
probable losses which have been incurred as of the respective balance sheet
date. Management makes a determination quarterly by analyzing overall loan
quality, changes in the mix and size of the loan portfolio, previous loss
experience, general economic conditions, information about specific borrowers
and other factors. The Bank's methodology for determining the allowance for loan
losses establishes both an allocated and an unallocated component. The allocated
portion of the allowance represents the results of analyses of individual loans
that are being monitored for potential credit problems and pools of loans within
the portfolio. The allocated portion of the allowance for loans is based
principally on current loan risk ratings, historical loan loss rates adjusted to
reflect current conditions, as well as analyses of other factors that may have
affected the collectibility of loans in the portfolio. The Bank analyzes all
commercial loans that are being monitored as potential credit problems to
determine whether such loans are impaired, with impairment measured by reference
to the borrowers' collateral values and cash flows. The unallocated portion of
the allowance for loan losses represents the results of analyses that measure
probable losses inherent in the portfolio that are not adequately captured in
the allocated allowance analyses. These analyses include consideration of
unidentified losses inherent in the portfolio resulting from changing
underwriting criteria, changes in the types and mix of loans originated,
industry concentrations and evaluations, allowance levels relative to selected
overall credit criteria and other economic indicators used to estimate probable
incurred losses. At December 31, 2003 and 2002, the allowance for loan losses
totaled $1.6 million and $1.5 million, respectively. The allowance for loan
losses as a percentage of loans was 1.1% and 1.2% as of December 31, 2003 and
2002. The provision for loan losses exceeded net charge-offs by $124,000 and
$147,000 in 2003 and 2002.
20
Table 10 shows a summary of the Company's loan loss experience:
TABLE 10. ALLOWANCE FOR LOAN LOSSES
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
In thousands
Loans outstanding at end of year $ 144,665 $ 128,330 $ 110,537 $ 104,004 $ 97,125
========= ========= ========= ========= =========
Daily average balance of loans and leases $ 136,658 $ 118,530 $ 108,526 $ 102,096 $ 91,717
========= ========= ========= ========= =========
Balance of allowance for loan losses
at beginning of year $ 1,484 $ 1,337 $ 1,216 $ 1,148 $ 1,122
--------- --------- --------- --------- ---------
Loans charged off:
Commercial, financial and agricultural $ 7 $ 1 $ 3 $ 6 $ 7
Real estate - mortgage - 5 - - 14
Consumer 262 145 132 115 97
--------- --------- --------- --------- ---------
Total loans charged off $ 269 $ 151 $ 135 $ 121 $ 118
--------- --------- --------- --------- ---------
Recoveries:
Commercial, financial and agricultural $ 2 $ 2 $ 2 $ 1 $ 5
Consumer 79 35 28 18 21
--------- --------- --------- --------- ---------
Total recoveries $ 81 $ 37 $ 30 $ 19 $ 26
--------- --------- --------- --------- ---------
Net charge-offs $ 188 $ 114 $ 105 $ 102 $ 92
Provision charged to expense $ 312 $ 261 $ 226 $ 170 $ 118
--------- --------- --------- --------- ---------
Balance, end of year $ 1,608 $ 1,484 $ 1,337 $ 1,216 $ 1,148
========= ========= ========= ========= =========
SELECTED ASSET QUALITY RATIOS:
Net charge-offs to average loans 0.14 % 0.10 % 0.10 % 0.10 % 0.10 %
Allowance for loan losses to loans
outstanding at end of year 1.11 % 1.16 % 1.21 % 1.17 % 1.18 %
Non-performing assets (1) to total assets 0.19 % 0.30 % 0.29 % 0.25 % 0.12 %
Non-accrual loans to total loans 0.24 % 0.01 % 0.02 % 0.02 % 0.02 %
(1) Includes accruing loans past due 90 days or more
Table 11 summarizes the allocation of the allowance for loan losses by
loan type:
TABLE 11. LOAN LOSS HISTORY
DECEMBER 31,
------------------------------------------------------------------------------------------------------
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
% OF % OF % OF % OF % OF
LOANS IN LOANS IN LOANS IN LOANS IN LOANS IN
EACH EACH EACH EACH EACH
AMOUNT CATEGORY AMOUNT CATEGORY AMOUNT CATEGORY AMOUNT CATEGORY AMOUNT CATEGORY
------ -------- ------ -------- ------ -------- ------ -------- ------ --------
In thousands
Commercial, financial
and agriculture $ 782 21% $ 330 8% $ 363 6% $ 206 6% $ 89 5%
Real estate-
construction and
mortgages 401 67 391 75 294 72 257 72 284 73
Consumer, leasing
and other 274 12 364 17 370 22 351 22 558 22
Unallocated 151 N/A 399 N/A 310 N/A 402 N/A 217 N/A
-------- --- -------- --- -------- --- -------- --- -------- ---
Total $ 1,608 100% $ 1,484 100% $ 1,337 100% $ 1,216 100% $ 1,148 100%
======== === ======== === ======== === ======== === ======== ===
21
The provision for loan losses is a charge to earnings which is made to
maintain the allowance for loan losses at a sufficient level. In 2003, 2002 and
2001, the provision totaled $312,000, $261,000 and $226,000, respectively. While
loan quality remains good and past due and nonaccrual loans are minimal,
management increased the provision for loan losses in 2003 based on the general
economic conditions as evidenced by the continued slowdown in the economy and an
increased concentration of real estate development lending by the Bank. Having
increased the provision for loan losses, management believes the allowance for
loan losses to be adequate and is not aware of any information relating to the
loan portfolio which it expects will materially impact future operating results,
liquidity or capital resources. In addition, federal regulators may require
additional reserves as a result of their examination of the Bank. The allowance
for loan losses reflects what management currently believes is an adequate level
of allowance, although there can be no assurance that future losses will not
exceed the estimated amounts, thereby adversely affecting future results of
operations.
SECURITIES PORTFOLIO AND FEDERAL FUNDS SOLD
The Bank's securities portfolio consists of available for sale
securities and restricted investments. Classifying the securities portfolio as
available for sale provides management with increased ability to manage the
balance sheet structure and address asset/liability management issues when
needed. The fair value of the investment portfolio has decreased $3.6 million to
$40.4 million at December 31, 2003 from 2002.
The composition of the portfolio continues to reflect the Bank's
conservative philosophy which places greater importance on safety and liquidity
than on yield. At December 31, 2003, approximately 62.5% of the portfolio is
comprised of US Treasury and Agency securities, 23.5% in Mortgage Backed
securities, 11.5% in State and Political Subdivision securities and 2.5% in
restricted investments. The term to maturity is limited to seven years for
Treasury and Agency bonds and 10 years for Municipal bonds. Typically,
investments in Agency bonds contain a call feature. These bonds generally have a
somewhat higher yield. The average term to maturity of the portfolio as of
December 31, 2003 was 4.7 years.
Table 12 sets forth the carrying amount of investment securities as of
the dates shown:
TABLE 12. INVESTMENT SECURITIES
DECEMBER 31
----------------------------------------------
2003 2002 2001
---- ---- ----
In thousands
Available for sale:
US government and agency securities $ 25,219 $ 28,028 $ 48,367
State and municipal securities 4,655 1,157 546
Mortgage-backed securities 9,488 14,245 -
Restricted securities 995 559 755
-------- -------- --------
Total $ 40,357 $ 43,989 $ 49,668
======== ======== ========
The Bank generally participates in the overnight federal funds sold
market. Depending upon specific investing or funding strategies and/or normal
fluctuations in loan and deposit balances, the Bank may need, on occasion, to
purchase funds on an overnight basis. In 2003 and 2002, the average balance in
federal funds sold was $1.5 million and $4.7 million, respectively.
See Note 3 of the Notes to Consolidated Financial Statements for a
comprehensive analysis of the securities portfolio.
22
DEPOSITS AND OTHER FUNDING SOURCES
Total deposits were $180.9 million at December 31, 2003, an increase of
$7.8 million or 4.5% over deposits at December 31, 2002. Average deposits,
however, showed a $10.6 million, or 6.4% growth, to $177.0 million in 2003.
Deposits at the Hedgesville branch totaled $22.2 million at December 31, 2003,
an increase of $1.0 million over December 31, 2002. Deposits at the Martinsburg
branch totaled $8.6 million at December 31, 2003, an increase of $3.0 million
over December 31, 2002. The Bank has experienced a change in the deposit account
mix during 2003. A shift from time deposits and jumbo certificates of deposit to
demand, interest bearing demand and savings is a direct result of customers
temporarily placing their money in readily accessible accounts due to customer
concerns with the weak economy and stock market. Another factor contributing to
the increase in demand, interest bearing demand and savings accounts is the
continued customer growth in the Bank's market area of Morgan and Berkeley
Counties, West Virginia. The 36-month Ultimate Certificate of Deposit continues
to be the deposit alternative of choice for customers who are willing to have
their money held for one year. The Bank's 36-month Ultimate Certificate of
Deposit allows the customer to withdraw all or a portion of the CD on the first
or second year anniversary date without penalty. Deposits may also be made to
this CD at any time.
Noninterest-bearing deposits also grew by $2.8 million or 10.6%, during
2003, from $26.7 million at December 31, 2002, to $29.5 million at December 31,
2003. At December 31, 2003, noninterest-bearing deposits represented 16.3% of
total deposits, compared to 15.4% for 2002. Average noninterest-bearing deposits
increased 17.4% from $23.3 million in 2002 to $27.3 million in 2003. The Bank's
noninterest-bearing deposit account with no minimum balance and check truncation
continues to grow since its introduction in 1999.
Interest-bearing deposits increased by $5.0 million or 3.4% to $151.4
million at December 31, 2003. Interest-bearing checking increased by $3.9
million in 2003. Included in this category are NOW accounts and Money Market
accounts. Although, the average savings deposits increased $3.2 million or 16.5%
to $22.9 million in 2003, savings accounts only increased $2.9 million at
December 31, 2003 to $24.4 million. The Bank's largest source of
interest-bearing funds is certificates of deposit. These accounts totaled $93.0
million at December 31, 2003, a decrease of $1.8 million or 1.9%. The decrease
is primarily due to customers temporarily placing their money in demand,
interest bearing demand and savings accounts due to customer concerns with the
weak economy and stock market.
Table 13 is a summary of the maturity distribution of certificates of
deposit in amounts of $100,000 or more as of December 31, 2003:
TABLE 13. MATURITY OF TIME DEPOSITS OF $100,000 OR MORE
AMOUNT PERCENT
------ -------
In thousands
Three months or less $ 3,354 9.15%
Three through six months 3,721 10.15
Six through twelve months 5,100 13.92
Over twelve months 24,468 66.78
--------- -----
Total $ 36,643 100%
========= =====
23
CONTRACTUAL OBLIGATIONS
Table 14 shows the Company's significant contractual obligations as of
December 31, 2003:
TABLE 14. CONTRACTUAL OBLIGATIONS
Payments due by period
Less than More than
Total 1 year 1-3 years 4-5 years 5 years
----- ------ --------- --------- -------
Purchase obligations $ 65,507 $ 65,507 $ - $ - $ -
Other long-term liabilities
reflected on the registrant's
balance sheet under GAAP
Pension liability 489,884 - - - 489,884
401k liability 47,270 47,270 - - -
Deferred compensation 633,646 22,923 20,676 10,608 579,439
Post retirement liability 183,118 24,884 49,240 52,260 56,734
---------- --------- ------- -------- ----------
Total contractual obligations $1,419,425 $ 160,584 $69,916 $ 62,868 $1,126,057
========== ========= ======= ======== ==========
See Note 6 of the Notes to Consolidated Financial Statements for
additional information on the purchase obligations.
CAPITAL RESOURCES
The Bank remains well capitalized. Total shareholders' equity at
December 31, 2003 of $16.6 million represents 8.2% of total assets. This
compares to $16.3 million or 8.5%, at December 31, 2002. Included in capital at
December 31, 2003 is $57,000 of unrealized gains on available for sale
securities and $270,000 minimum pension liability adjustment, both net of
deferred income taxes. At December 31, 2002, the Bank had unrealized gains on
available for sale securities, net of deferred income taxes of $681,000. Such
unrealized gains and losses are recorded net of related deferred taxes and are
primarily a function of available market interest rates relative to the yield
being generated on the available for sale portfolio. No earnings impact will
result, however, unless the securities are actually sold.
The stock of CNB Financial Services, Inc., and prior to the formation
of CNB, the Bank, is not listed on an exchange and is not heavily traded. The
trades that have occurred are those that, to management's knowledge, have been
individually arranged. Based on information that management is aware of, the
majority of shares sold during 2003 were at a price that ranged from $68 to $100
per share. During 2002, information available to management indicates that stock
trades ranged from $64 to $90 per share. Book value per share increased from
$35.52 at December 31, 2002 to $36.17 at December 31, 2003.
Dividends which have been declared by the Board of Directors
semiannually, increased from $1.02 per share in 2002 to $1.20 per share in 2003,
a 17.7% increase.
The Federal Reserve's risk-based capital guidelines provide for the
relative weighting of both on-balance-sheet and off-balance-sheet items based on
their degree of risk. The Bank continues to exceed all regulatory capital
requirements, and is unaware of any trends or uncertainties, nor do any plans
exist, which may materially impair or alter its capital position.
24
RETURN ON EQUITY AND ASSETS
Table 15 shows consolidated operating and capital ratios for the
periods indicated:
TABLE 15. OPERATING AND CAPITAL RATIOS
YEARS ENDED DECEMBER 31,
------------------------------
2003 2002
---- ----
Return on average assets .89% .71%
Return on average equity 10.44 8.38
Dividend payout ratio 31.54 35.72
Average equity to average assets ratio 8.48 8.49
LIQUIDITY AND INTEREST RATE SENSITIVITY
The objective of the Bank's liquidity management program is to ensure
the continuous availability of funds to meet the withdrawal demands of
depositors and the credit needs of borrowers. The basis of the Bank's liquidity
comes from the stability of its core deposits. Liquidity is also available
through the available for sale securities portfolio and short-term funds such as
federal funds sold. At December 31, 2003, these sources totaled $39.4 million,
or 19.6% of total assets. In addition, liquidity may be generated through loan
repayments and over $3.0 million of available borrowing arrangements with
correspondent banks. At December 31, 2003, management considered the Bank's
ability to satisfy its anticipated liquidity needs over the next twelve months.
Management believes that the Bank is well positioned and has ample liquidity to
satisfy these needs. The Bank generated $2.5 million of cash from operations in
2003, which compares to $2.2 million in 2002 and $1.5 million in 2001.
Additional cash of $8.5 million, $18.2 million and $19.9 million was generated
through net financing activities in 2003, 2002 and 2001, respectively. These
proceeds along with proceeds from the sales and maturities of investment
securities were used to fund loans and purchase securities during each year. Net
cash used in investing activities totaled $11.1 million in 2003 compared to
$16.8 million in 2002 and $20.9 million in 2001. Details on both the sources and
uses of cash are presented in the Consolidated Statements of Cash Flows
contained in the financial statements.
The objective of the Bank's interest rate sensitivity management
program, also known as asset/liability management, is to maximize net interest
income while minimizing the risk of adverse effects from changing interest
rates. This is done by controlling the mix and maturities of interest-sensitive
assets and liabilities. The Bank has established an asset/liability committee
for this purpose. Daily management of the Bank's sensitivity of earnings to
changes in interest rates within the Bank's policy guidelines are monitored by
using a combination of off-balance sheet and on-balance sheet financial
instruments. The Bank's Chief Executive Officer, Senior Lending Officer, Chief
Financial Officer and the Chief Operations Officer monitor day to day deposit
flows, lending requirements and the competitive environment. Rate changes occur
within policy guidelines if necessary to minimize adverse effects. Also, the
Bank's policy is intended to ensure that the Bank measures a range of rate
scenarios and patterns of rate movements that are reasonably possible.
In analyzing interest rate sensitivity for policy measurement, the Bank
compares its forecasted earnings in both a "high rate" and "low rate" scenario
to a base-line scenario. The Bank's base-line scenario is that short-term
interest rates over the next 12 months remain at the current rate. The "high
rate" and "low rate" scenarios assume a 200 basis point increase or decrease in
the prime rate from beginning point of the base-line scenario over the most
current 12-month period. The Bank's policy limit for the maximum negative impact
on earnings resulting from "high rate" or "low rate" scenarios is 10 percent.
The policy measurement period is 12 months in length, beginning with the first
month of the forecast.
The Bank's base-line scenario holds the prime rate constant at 4.00
percent through December 2004. Based on the January 2004 outlook, the model
indicates that earnings during the policy measurement period would be affected
by less than 10 percent, in both an increasing or decreasing interest rate
scenario.
One common interest rate risk measure is the gap, or the difference
between rate sensitive assets and rate sensitive liabilities. A positive gap
occurs when rate-sensitive assets exceed rate-sensitive liabilities. This tends
to be beneficial in rising interest rate environments. A negative gap refers to
the opposite situation and tends to be beneficial in declining interest rate
environments. However, the gap does not consider future changes in the volume of
rate sensitive assets or liabilities or the possibility that interest rates of
various products may not change by the same amount or at the same time. In
addition, certain assumptions must be made in constructing the gap. For example,
the Bank considers administered rate deposits, such as savings
25
accounts, to be immediately rate sensitive although their actual rate
sensitivity could differ from this assumption. The Bank monitors its gap on a
quarterly basis.
TABLE 16. INTEREST SENSITIVITY ANALYSIS
DECEMBER 31, 2003
------------------------------------------------------------------------------------------
INTEREST SENSITIVITY PERIOD
------------------------------------------------------------------------------------------
2004 2005 2006 2007 2008 THEREAFTER TOTAL FAIR VALUE
-------- -------- -------- -------- -------- ---------- --------- ----------
In thousands
Rate sensitive assets
Loans, net of unearned interest $ 65,858 $ 15,707 $ 16,782 $ 7,419 $ 8,318 $ 30,582 $ 144,665 $ 145,075
Average interest rate 6.36% 6.70% 7.00% 7.25% 7.50% 7.75% 6.72%
Securities 13,764 1,118 1,610 1,348 1,055 20,467 39,362 39,362
Average interest rate 4.50% 4.65% 4.75% 4.28% 4.75% 4.15% 4.25%
-------- -------- -------- -------- -------- ---------- ---------
Total interest sensitive assets $ 79,622 $ 16,825 $ 18,392 $ 8,767 $ 9,373 $ 51,049 $ 184,027
======== ======== ======== ======== ======== ========== =========
Interest sensitive liabilities
Non-interest-bearing deposits $ 2,949 $ 2,949 $ 2,949 $ 2,949 $ 2,949 $ 14,740 29,485 $ 29,485
Average interest rate -% -% -% -% -% -% -%
Savings and interest-bearing checking 5,840 5,840 5,840 5,840 5,840 29,203 58,403 58,403
Average interest rate 0.83% 0.83% 0.83% 0.83% 0.83% 0.83% 0.83%
Time deposits 29,719 14,561 36,877 5,222 6,631 - 93,010 95,057
Average interest rate 1.96% 2.30% 2.60% 2.95% 3.10% -% 2.56%
-------- -------- -------- -------- -------- ---------- ---------
Total interest sensitive liabilities $ 38,508 $ 23,350 $ 45,666 $ 14,011 $ 15,420 $ 43,943 $ 180,898
======== ======== ======== ======== ======== ========== =========
GAP $ 41,114 $ (6,525) $(27,274) $ (5,244) $ (6,047) $ 7,106
Cumulative GAP $ 41,114 $ 34,589 $ 7,315 $ 2,071 $ (3,977) $ 3,129
GAP to sensitive assets ratio 22.34% (3.55)% (14.82)% (2.85)% (3.29)% 3.86%
Cumulative GAP to sensitive
assets ratio 22.34% 18.80% 3.97% 1.13% (2.16)% 1.70%
GAP to total assets ratio 20.45% (3.25)% (13.57)% (2.61)% (3.01)% 3.53%
Cumulative GAP to total assets ratio 20.45% 17.20% 3.64% 1.03% (1.98)% 1.56%
26
RECENTLY ISSUED ACCOUNTING STANDARDS
In November 2002, the FASB issued Interpretation No. 45, Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others (FIN 45), which covers guarantees such as
standby letters of credit, performance guarantees, and direct or indirect
guarantees of the indebtedness of others, but not guarantees of funding. FIN 45
requires a guarantor to recognize, at the inception of a guarantee, a liability
in an amount equal to the fair value of the obligation undertaken in issuing the
guarantee, and requires disclosure about the maximum potential payments that
might be required, as well as the collateral or other recourse obtainable. The
recognition and measurement provisions of FIN 45 were effective on a prospective
basis after December 31, 2002, and its adoption by the Company on January 1,
2003 has not had a significant effect on the Company's consolidated financial
statements.
In January 2003, the FASB issued Interpretation No. 46, Consolidation
of Variable Interest Entities (FIN 46), which establishes guidance for
determining when an entity should consolidate another entity that meets the
definition of a variable interest entity. FIN 46 requires a variable interest
entity to be consolidated by a company if that company will absorb a majority of
the expected losses, will receive a majority of the expected residual returns,
or both. Transferors to qualified special-purpose entities ("QSPEs") and certain
other interests in a QSPE are not subject to the requirements of FIN 46. On
December 17, 2003, the FASB revised FIN 46 (FIN 46R) and deferred the effective
date of FIN 46 to no later than the end of the first reporting period that ends
after March 15, 2004, however, for special-purpose entities the Company would be
required to apply FIN 46 as of December 31, 2003. The Interpretation had no
effect on the Company's consolidated financial statements.
In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133
on Derivative Instruments and Hedging Activities. This Statement amends SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities" and
clarified accounting for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities under SFAS
No. 133. This Statement is effective for contracts entered into or modified
after June 30, 2003, except in certain circumstances, and for hedging
relationships designated after June 30, 2003. This Statement had no effect on
the Company's consolidated financial statements.
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity. This
Statement provides new rules on the accounting for certain financial instruments
that, under previous guidance, issuers could account for as equity. Such
financial instruments include mandatorily redeemable shares, instruments that
require the issuer to buy back some of its shares in exchange for cash or other
assets, or obligations that can be settled with shares, the monetary value of
which is fixed. Most of the guidance in SFAS No. 150 is effective for financial
instruments entered into or modified after May 31, 2003, and otherwise is
effective at the beginning of the first interim period beginning after June 30,
2003. This Statement had no effect on the Company's consolidated financial
statements.
In December 2003, the FASB issued SFAS No. 132 (revised 2003),
Employers' Disclosures about Pensions and Postretirement Benefits. This
statement requires additional disclosures about the assets, obligations and cash
flows of defined benefit pension and postretirement plans, as well as the
expense recorded for such plans. As of December 31, 2003, the Company has
disclosed the required elements related to its defined benefit pension plan in
Note 12 to these consolidated financial statements.
IMPACT OF INFLATION
The results of operations and financial position of the Bank have been
presented based on historical cost, unadjusted for the effects of inflation,
except for the recording of unrealized gains and losses on securities available
for sale. Inflation could significantly impact the value of the Bank's interest
rate-sensitive assets and liabilities and the cost of noninterest expenses, such
as salaries, benefits and other operating expenses. Management of the money
supply by the Federal Reserve to control the rate of inflation may have an
impact on the earnings of the Bank. Further, changes in interest rates to
control inflation may have a corresponding impact on the ability of certain
borrowers to repay loans granted by the Bank.
As a financial intermediary, the Bank holds a high percentage of
interest rate-sensitive assets and liabilities. Consequently, the estimated fair
value of a significant portion of the Bank's assets and liabilities change more
frequently than those of non-banking entities. The Bank's policies attempt to
structure its mix of financial instruments and manage its interest rate
sensitivity in order to minimize the potential adverse effects of market forces
on its net interest income, earnings and capital.
27
A comparison of the carrying value of the Bank's financial instruments
to their estimated fair value as of December 31, 2003 and December 31, 2002 is
disclosed in Note 21 of the Notes to the Consolidated Financial Statements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Liquidity and Interest Rate Sensitivity" in Item 7
hereof.
28
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following audited consolidated financial statements are set forth
in this Annual Report of Form 10-K on the following pages:
CNB Financial Services, Inc. and Subsidiary
Independent Auditors' Report ........................................... 30
Consolidated Balance Sheets ............................................. 31
Consolidated Statements of Income........................................... 32
Consolidated Statements of Stockholders' Equity............................. 33
Consolidated Statements of Cash Flows....................................... 34
Notes to Consolidated Financial Statements.................................. 35
29
INDEPENDENT AUDITOR'S REPORT
Shareholders and Board of Directors
CNB Financial Services, Inc.
Berkeley Springs, West Virginia
We have audited the accompanying consolidated statements of
financial condition of CNB Financial Services, Inc. and subsidiary as of
December 31, 2003 and 2002, and the related consolidated statements of income,
changes in shareholders' equity, and cash flows for each of the three years in
the period ended December 31, 2003. These financial statements are the
responsibility of CNB Financial Services, Inc.'s management. Our responsibility
is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards
generally accepted in the United States of America. Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred
to above present fairly, in all material respects, the financial position of CNB
Financial Services, Inc. and subsidiary as of December 31, 2003 and 2002, and
the results of their operations and their cash flows for each of the three years
in the period ended December 31, 2003 in conformity with accounting principles
generally accepted in the United States of America.
/s/ SMITH ELLIOTT KEARNS & COMPANY, LLC
Hagerstown, Maryland
January 23, 2004
30
CNB FINANCIAL SERVICES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31, 2003 AND 2002
2003 2002
------------- -------------
ASSETS
Cash and due from banks $ 7,641,280 $ 7,832,735
Federal funds sold 3,000 4,127,299
Securities available for sale
(at approximate market value) 39,361,934 43,429,902
Federal Home Loan Bank stock, at cost 865,700 429,000
Federal Reserve Bank stock, at cost 129,650 129,650
Loans and leases receivable, net 144,665,208 128,330,303
Accrued interest receivable 838,659 921,907
Foreclosed real estate (held for sale), net -- 1,800
Premises and equipment, net 5,288,633 4,800,135
Deferred income taxes 352,405 --
Cash surrender value of life insurance 1,065,435 964,179
Intangible assets 23,795 96,483
Other assets 820,052 538,687
------------- -------------
TOTAL ASSETS $ 201,055,751 $ 191,602,080
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Deposits:
Demand $ 29,485,097 $ 26,663,469
Interest-bearing demand 34,042,317 30,087,763
Savings 24,360,890 21,489,855
Time, $100,000 and over 36,642,560 37,433,561
Other time 56,367,865