Attached files
file | filename |
---|---|
EX-32 - EX-32 - CITY NATIONAL BANCSHARES CORP | y86231exv32.htm |
EX-31 - EX-31 - CITY NATIONAL BANCSHARES CORP | y86231exv31.htm |
Table of Contents
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
(Mark One) |
þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended June 30, 2010
o | 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 0-11535
CITY NATIONAL BANCSHARES CORPORATION
(Exact name of registrant as specified in its charter)
New Jersey | 22-2434751 | |
(State or other jurisdiction of | (I.R.S. Employer | |
incorporation or organization) | Identification No.) | |
900 Broad Street, | 07102 | |
Newark, New Jersey | (Zip Code) | |
(Address of principal executive offices) |
Registrants telephone number, including area code: (973) 624-0865
Securities Registered Pursuant to Section 12(b) of the Act: None
Securities Registered Pursuant to Section 12(g) of the Act:
Title of each class
Common stock, par value $10 per share
Common stock, par value $10 per share
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the Registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.
Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months
(or for such shorter period that the registrant was required to submit and post such files).
Yes
o No o
Indicate by check mark whether the registrant is a large
accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions
of large accelerated filer, accelerated filer and smaller reporting
company in Rule 12b-2 of the
Exchange Act. (Check one):
Large accelerated filer o | Accelerated filer o | Non-accelerated filer þ | Smaller reporting company o | |||
(Do not check if a smaller reporting company) |
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act).
Yes o No þ
The aggregate market value of voting stock held by non-affiliates of the Registrant as of August
16, 2010 was approximately $3,614,535.
There were 131,290 shares of common stock outstanding at August 16, 2010.
Index | Page | |||||||
Part I. Financial Information |
||||||||
Item 1. Financial Statements |
||||||||
3 | ||||||||
4 | ||||||||
5 | ||||||||
6 | ||||||||
16 | ||||||||
24 | ||||||||
24 | ||||||||
24 | ||||||||
26 | ||||||||
27 | ||||||||
EX-31 | ||||||||
EX-32 |
2
Table of Contents
CITY NATIONAL BANCSHARES CORPORATION AND SUBSIDIARY
Consolidated Balance Sheets
(Unaudited)
June 30, | December 31, | |||||||
Dollars in thousands, except per share data | 2010 | 2009 | ||||||
Assets |
||||||||
Cash and due from banks |
$ | 8,753 | $ | 6,808 | ||||
Federal funds sold |
32,580 | 5,500 | ||||||
Interest bearing deposits with banks |
582 | 609 | ||||||
Investment securities available for sale |
140,560 | 122,006 | ||||||
Investment securities held to maturity (Market value of
$41,782 at December 31, 2009) |
| 40,395 | ||||||
Loans held for sale |
| 190 | ||||||
Loans |
262,987 | 276,242 | ||||||
Less: Allowance for loan losses |
7,934 | 8,650 | ||||||
Net loans |
255,053 | 267,592 | ||||||
Premises and equipment |
3,195 | 2,949 | ||||||
Accrued interest receivable |
2,145 | 2,546 | ||||||
Bank-owned life insurance |
5,633 | 5,537 | ||||||
Other real estate owned |
1,813 | 2,352 | ||||||
Other assets |
7,295 | 9,855 | ||||||
Total assets |
$ | 457,609 | $ | 466,339 | ||||
Liabilities and Stockholders Equity |
||||||||
Deposits: |
||||||||
Demand |
$ | 30,909 | $ | 29,304 | ||||
Savings |
150,496 | 149,853 | ||||||
Time |
189,535 | 201,119 | ||||||
Total deposits |
370,940 | 380,276 | ||||||
Accrued expenses and other liabilities |
6,246 | 5,950 | ||||||
Short-term portion of long-term debt |
5,000 | 5,000 | ||||||
Short-term borrowings |
600 | 100 | ||||||
Long-term debt |
42,000 | 44,000 | ||||||
Total liabilities |
424,786 | 435,326 | ||||||
Commitments and contingencies |
||||||||
Stockholders equity |
||||||||
Preferred stock, no par value: Authorized 100,000 shares; |
||||||||
Series A , issued and outstanding 8 shares in 2010 and 2009 |
200 | 200 | ||||||
Series C , issued and outstanding 108 shares in 2010 and 2009 |
27 | 27 | ||||||
Series D , issued and outstanding 3,280 shares in 2010 and 2009 |
820 | 820 | ||||||
Preferred stock, no par value, perpetual noncumulative: Authorized 200 shares; |
||||||||
Series E, issued and outstanding 49 shares in 2010 and 2009 |
2,450 | 2,450 | ||||||
Preferred stock, no par value, perpetual noncumulative: Authorized 7,000 shares; |
||||||||
Series F, issued and outstanding 7,000 shares in 2010 and 2009 |
6,790 | 6,790 | ||||||
Preferred stock, no par value, perpetual cumulative: Authorized 9,439 shares; |
||||||||
Series G, issued and outstanding 9,439 shares in 2010 and 2009 |
9,740 | 9,499 | ||||||
Common stock, par value $10: Authorized 400,000 shares; |
||||||||
134,530 shares issued in 2010 and 2009 |
||||||||
131,290 shares outstanding in 2010 and 2009 |
1,345 | 1,345 | ||||||
Surplus |
1,115 | 1,115 | ||||||
Retained earnings |
8,339 | 8,462 | ||||||
Accumulated other comprehensive income |
2,225 | 533 | ||||||
Treasury stock, at cost - 3,240 common shares in 2010 and 2009, respectively |
(228 | ) | (228 | ) | ||||
Total stockholders equity |
32,823 | 31,013 | ||||||
Total liabilities and stockholders equity |
$ | 457,609 | $ | 466,339 | ||||
See accompanying notes to unaudited consolidated financial statements.
3
Table of Contents
CITY NATIONAL BANCSHARES CORPORATION AND SUBSIDIARY
Consolidated Statements of Operations
(Unaudited)
Three months ended | Six months ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
Dollars in thousands, except per share data | 2010 | 2009 | 2010 | 2009 | ||||||||||||
Interest income |
||||||||||||||||
Interest and fees on loans |
$ | 3,709 | $ | 3,976 | $ | 7,479 | $ | 7,864 | ||||||||
Interest on Federal funds sold and securities
purchased under agreements to resell |
13 | 14 | 21 | 43 | ||||||||||||
Interest on deposits with banks |
7 | 3 | 14 | 5 | ||||||||||||
Interest and dividends on investment securities: |
||||||||||||||||
Taxable |
1,304 | 1,719 | 2,758 | 3,528 | ||||||||||||
Tax-exempt |
240 | 324 | 523 | 657 | ||||||||||||
Total interest income |
5,273 | 6,036 | 10,795 | 12,097 | ||||||||||||
Interest expense |
||||||||||||||||
Interest on deposits |
1,472 | 1,943 | 3,041 | 4,030 | ||||||||||||
Interest on short-term borrowings |
| 2 | | 2 | ||||||||||||
Interest on long-term debt |
423 | 462 | 852 | 929 | ||||||||||||
Total interest expense |
1,895 | 2,407 | 3,893 | 4,961 | ||||||||||||
Net interest income |
3,378 | 3,629 | 6,902 | 7,136 | ||||||||||||
Provision for loan losses |
1,010 | 436 | 2,391 | 937 | ||||||||||||
Net interest income after provision
for loan losses |
2,368 | 3,193 | 4,511 | 6,199 | ||||||||||||
Other operating income |
||||||||||||||||
Service charges on deposit accounts |
340 | 370 | 702 | 730 | ||||||||||||
Agency fees on commercial loans |
4 | 59 | 18 | 134 | ||||||||||||
Award income |
1,025 | 51 | 1,050 | 25 | ||||||||||||
Other income |
275 | 328 | 564 | 797 | ||||||||||||
Net gains on sales of investment securities |
528 | 10 | 529 | 10 | ||||||||||||
Other than temporary impairment losses on securities |
| (2,183 | ) | | (2,315 | ) | ||||||||||
Portion of loss recognized in other comprehensive income, before tax |
| 1,128 | | 1,128 | ||||||||||||
Net impairment losses on securities recognized in earnings |
| (1,055 | ) | | (1,187 | ) | ||||||||||
Total other operating income |
2,172 | (237 | ) | 2,863 | 509 | |||||||||||
Other operating expenses |
||||||||||||||||
Salaries and other employee benefits |
1,559 | 1,626 | 3,143 | 3,225 | ||||||||||||
Occupancy expense |
470 | 326 | 837 | 652 | ||||||||||||
Equipment expense |
146 | 181 | 300 | 340 | ||||||||||||
Appraisal fees |
146 | 3 | 161 | 3 | ||||||||||||
Audit fees |
193 | 68 | 257 | 118 | ||||||||||||
Legal fees |
124 | 71 | 199 | 109 | ||||||||||||
Management consulting fees |
89 | 101 | 354 | 178 | ||||||||||||
FDIC insurance expense |
225 | 469 | 468 | 587 | ||||||||||||
Data processing expense |
86 | 73 | 177 | 144 | ||||||||||||
Other expenses |
627 | 740 | 1,292 | 1,394 | ||||||||||||
Total other operating expenses |
3,665 | 3,658 | 7,188 | 6,750 | ||||||||||||
Income (loss) before income tax expense |
875 | (702 | ) | 186 | (42 | ) | ||||||||||
Income tax expense |
53 | 119 | 68 | 281 | ||||||||||||
Net income (loss) |
$ | 822 | $ | (821 | ) | $ | 118 | $ | (323 | ) | ||||||
Net income (loss) per common share |
||||||||||||||||
Basic |
$ | 5.32 | $ | (8.21 | ) | $ | (0.94 | ) | $ | (7.18 | ) | |||||
Diluted |
5.32 | (8.21 | ) | (0.94 | ) | (7.18 | ) | |||||||||
Basic average common shares outstanding |
131,290 | 131,290 | 131,290 | 131,309 | ||||||||||||
Diluted average common shares outstanding |
131,290 | 131,290 | 131,290 | 131,309 | ||||||||||||
See accompanying notes to unaudited consolidated financial statements.
4
Table of Contents
CITY NATIONAL BANCSHARES CORPORATION AND SUBSIDIARY
Consolidated Statements of Cash Flows
(Unaudited)
Six Months Ended | ||||||||
June 30, | ||||||||
Dollars in thousands | 2010 | 2009 | ||||||
Operating activities |
||||||||
Net income (loss) |
$ | 118 | $ | (323 | ) | |||
Adjustments to reconcile net income (loss) to net cash from operating activities: |
||||||||
Depreciation and amortization |
210 | 276 | ||||||
Provision for loan losses |
2,391 | 937 | ||||||
Premium amortization (discount accretion) of investment securities |
61 | (2 | ) | |||||
Amortization of intangible assets |
75 | 102 | ||||||
Net impairment losses on securities |
| 1,187 | ||||||
Net gains on securities transactions |
(529 | ) | (10 | ) | ||||
Net gains on sales of loans held for sale |
(6 | ) | (5 | ) | ||||
Net gains on sales of other real estate owned |
(17 | ) | | |||||
Loans originated for sale |
| (122 | ) | |||||
Proceeds from sales and principal payments from loans held for sale |
196 | 272 | ||||||
Decrease (increase) in accrued interest receivable |
401 | (26 | ) | |||||
Deferred tax expense (benefit) |
1,195 | (531 | ) | |||||
Net increase in bank-owned life insurance |
(96 | ) | (96 | ) | ||||
Decrease (increase) in other assets |
205 | (1,211 | ) | |||||
Increase in accrued expenses and other liabilities |
296 | 1,500 | ||||||
Net cash provided by operating activities |
4,500 | 1,948 | ||||||
Investing activities |
||||||||
Decrease (increase) in loans, net |
10,148 | (8,178 | ) | |||||
Decrease in interest bearing deposits with banks |
27 | 122 | ||||||
Proceeds from maturities of investment securities available for sale,
including principal payments and early redemptions |
23,594 | 11,302 | ||||||
Proceeds from maturities of investment securities held to maturity,
including principal payments and early redemptions |
1,247 | 7,790 | ||||||
Proceeds from sales of investment securities available for sale |
14,502 | 1,985 | ||||||
Purchases of investment securities available for sale |
(14,257 | ) | (11,799 | ) | ||||
Purchases of investment securities held to maturity |
| (1,462 | ) | |||||
Proceeds from sales of other real estate owned |
556 | | ||||||
Purchases of premises and equipment |
(456 | ) | (102 | ) | ||||
Net cash provided by (used in) investing activities |
35,361 | (342 | ) | |||||
Financing activities |
||||||||
Decrease in deposits |
(9,336 | ) | (19,682 | ) | ||||
Increase (decrease) in short-term borrowings |
500 | (1,130 | ) | |||||
Decrease in long-term debt |
(2,000 | ) | (1,000 | ) | ||||
Issuance of preferred stock |
| 9,439 | ||||||
Purchases of treasury stock |
| (3 | ) | |||||
Dividends paid on preferred stock |
| (559 | ) | |||||
Dividends paid on common stock |
| (263 | ) | |||||
Net cash used by financing activities |
(10,836 | ) | (13,198 | ) | ||||
Net increase (decrease) cash and cash equivalents |
29,025 | (11,592 | ) | |||||
Cash and cash equivalents at beginning of period |
12,308 | 25,813 | ||||||
Cash and cash equivalents at end of period |
$ | 41,333 | $ | 14,221 | ||||
Cash paid during the year |
||||||||
Interest |
$ | 3,706 | $ | 4,711 | ||||
Income taxes |
10 | 1,248 | ||||||
Non-cash transactions |
||||||||
Transfer of held to maturity securities to available for sale |
39,144 | |||||||
Transfer of loans to other real estate owned |
| 438 |
See accompanying notes to unaudited consolidated financial statements.
5
Table of Contents
CITY NATIONAL BANCSHARES CORPORATION AND SUBSIDIARY
Notes to Consolidated Financial Statements (Unaudited)
1. Principles of consolidation
The accompanying consolidated financial statements include the accounts of City National Bancshares
Corporation (the Corporation) and its subsidiaries, City National Bank of New Jersey (the Bank
or CNB) and City National Bank of New Jersey Capital Trust II. All intercompany accounts and
transactions have been eliminated in consolidation.
2. Basis of presentation
The accompanying unaudited consolidated financial statements have been prepared in accordance with
U.S. generally accepted accounting principles for interim financial information. Accordingly, they
do not include all the information required by U.S. generally accepted accounting principles for
complete financial statements. These consolidated financial statements should be reviewed in
conjunction with the financial statements and notes thereto included in the Corporations December
31, 2009 Annual Report to Stockholders.
In the opinion of management, all adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation of the financial statements have been included. Operating
results for the three and six months ended June 30, 2010 are not necessarily indicative of the
results that may be expected for the year ended December 31, 2010. In preparing the financial
statements, management is required to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosures of contingent liabilities as of the date of the
balance sheet and revenues and expenses for related periods. Actual results could differ
significantly from those estimates.
3. Net income (loss) per common share
The following table presents the computation of net income (loss) per common share.
Three Months Ended | Six Months Ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
In thousands, except per share data | 2010 | 2009 | 2010 | 2009 | ||||||||||||
Net income (loss) |
$ | 822 | $ | (821 | ) | $ | 118 | $ | (323 | ) | ||||||
Dividends on preferred stock |
122 | 257 | 240 | 621 | ||||||||||||
Net income (loss) applicable to basic common shares |
700 | (1,078 | ) | (122 | ) | (944 | ) | |||||||||
Dividends applicable to convertible
preferred stock |
| | | 147 | ||||||||||||
Net income (loss) applicable to diluted
common shares |
$ | 700 | $ | (1,078 | ) | $ | (122 | ) | $ | (797 | ) | |||||
Number of average common shares |
||||||||||||||||
Basic |
131,290 | 131,290 | 131,290 | 131,309 | ||||||||||||
Diluted |
131,290 | 131,290 | 131,290 | 131,309 | ||||||||||||
Net income (loss) per common share |
||||||||||||||||
Basic |
$ | 5.32 | $ | (8.21 | ) | $ | (.94 | ) | $ | (7.18 | ) | |||||
Diluted |
5.32 | (8.21 | ) | (.94 | ) | (7.18 | ) |
Basic income (loss) per common share is calculated by dividing net income (loss) less
dividends paid on preferred stock by the weighted average number of common shares outstanding. On
a diluted basis, both net income (loss) and common shares outstanding are adjusted to assume the
conversion of the convertible preferred stock, if conversion is deemed dilutive. For the first
half of 2010 and 2009 the assumption of the conversion would have been antidilutive.
On April 10, 2009, the Corporation issued 9,439 shares of fixed rate cumulative perpetual preferred
stock to the U.S. Department of Treasury. These shares pay cumulative dividends at a rate of five
percent per annum until the fifth anniversary of the date of issuance, after which the rate
increases to nine percent per annum. Dividends are paid quarterly in arrears and unpaid dividends
are accrued over the period the preferred shares are outstanding.
In the first and second quarters of 2010, City National Bancshares Corporation deferred the payment
of its regular quarterly cash dividend on its Series G fixed-rate cumulative perpetual preferred
stock issued to the U.S. Treasury in connection with the Corporations participation in the
Treasurys TARP Capital Purchase Program. In addition, the Corporation deferred its regularly
scheduled quarterly interest payment on its junior subordinated debentures issued by the City
National Bank of New Jersey Capital Statutory Trust II (the Trust).
The Series G preferred stock and the junior subordinated debentures issued in favor of the Trust
provide for cumulative dividends and interest, respectively. Accordingly, the Corporation may not
pay dividends on any of its common or
preferred stock until the dividends on Series G preferred stock and the interest on such debentures
are paid-up currently.
6
Table of Contents
There were no dividend payments made on preferred stock during 2010,
although such dividends have been accrued because they are cumulative.
On May 1, 2009 the Corporation paid a cash dividend of $2.00 per share to common stockholders.
The Corporation is currently unable to determine when dividend payments may be resumed and does
not expect to pay a common stock dividend in 2010. Whether cash dividends will be paid in the
future depends upon various factors, including the earnings and financial condition of the Bank
and the Corporation at the time. Additionally, federal and state laws and regulations contain
restrictions on the ability of the Bank and the Corporation to pay dividends.
Subject to applicable law, the Board of Directors of the Bank and of the Corporation may provide
for the payment of dividends when it is determined that dividend payments are appropriate, taking
into account factors including net income, capital requirements, financial condition, alternative
investment options, tax implications, prevailing economic conditions, industry practices, and other
factors deemed to be relevant at the time. Because CNB is a national banking association, it is
subject to regulatory limitation on the amount of dividends it may pay to its parent corporation,
CNBC. Prior approval of the Office of the Comptroller of the Currency (OCC) is required if the
total dividends declared by the Bank in any calendar year exceeds net profit, as defined, for that
year combined with the retained net profits from the preceding two calendar years. Based upon this
limitation, no funds were available for the payment of dividends to the parent corporation at June
30, 2010.
4. Comprehensive income (loss)
Total comprehensive income (loss) includes net income and other comprehensive income or loss which
is comprised of unrealized gains and losses on investment securities available for sale, net of
taxes. The Corporations total comprehensive income (loss) for the three months ended June 30,
2010 and 2009 was $1,379,000 and $(684,000), respectively and for the six months ended June 30,
2010 and 2009 was $1,810,000 and $(917,000), respectively. The difference between the
Corporations net income and total comprehensive income (loss) for these periods relates to the
change in net unrealized gains and losses on investment securities available for sale during the
applicable period of time.
5. Reclassifications
Certain reclassifications have been made to the 2009 consolidated financial statements in order to
conform with the 2010 presentation.
6. Recent accounting pronouncements
ASC 810, Consolidation, replaces the quantitative-based risks and rewards calculation for
determining which enterprise, if any, has a controlling financial interest in a variable interest
entity with an approach focused on identifying which enterprise has the power to direct the
activities of a variable interest entity that most significantly effect the entitys economic
performance and (i) the obligation to absorb losses of the entity or (ii) the right to receive
benefits from the entity. The pronouncement was effective January 1, 2010, and did not have a
significant effect on the Corporations consolidated financial statements.
In May 2009, the Financial Accounting Standards Board (FASB) issued Statements No. 166,
Accounting for Transfers of Financial Assets and 167, Amendments to FASB Interpretation No.
46(R), as codified in ASC 860-10 and 810-10, respectively, which establish new criteria governing
whether transfers of financial assets are accounted for as sales and are expected to result in more
variable interest entities being consolidated. The Statements were effective for annual periods
beginning after November 15, 2009. The adoption of this pronouncement did not have a material
impact on the Corporations financial condition, results of operations or financial statement
disclosures.
In June 2009, the FASB issued ASC 860, an amendment to the accounting and disclosure requirements
for transfers of financial assets. The guidance defines the term participating interest to
establish specific conditions for reporting a transfer of a portion of a financial asset as a sale.
If the transfer does not meet those conditions, a transferor should account for the transfer as a
sale only if it transfers an entire financial asset or a group of entire financial assets and
surrenders control over the entire transferred asset(s). The guidance requires that a transferor
recognize and initially measure at fair value all assets obtained (including a transferors
beneficial interest) and liabilities incurred as a result of a transfer of financial assets
accounted for as a sale. This Statement is effective as of the beginning of each reporting entitys
first annual reporting period that begins after November 15, 2009, for interim periods within that
first annual reporting period, and for interim and annual reporting periods thereafter. The
adoption of ASC 860 did not have a material impact on the Corporations financial condition,
results of operations or financial statement disclosures.
In January 2010, the FASB issued Accounting Standards Update (ASU) 2010-06 to improve disclosures
about fair value measurements. This guidance requires new disclosures on transfers into and out of
Level 1 and 2 measurements of the
fair value hierarchy and requires separate disclosures about purchases, sales, issuances, and
settlements relating to
7
Table of Contents
Level 3 measurements. It also clarifies existing fair value disclosures
relating to the level of disaggregation and inputs and valuation techniques used to measure fair
value. It is effective for the first reporting period (including interim periods) beginning after
December 15, 2009, except for the requirement to provide the Level 3 activity of purchases, sales,
issuances, and settlements on a gross basis, which will be effective for fiscal years beginning
after December 15, 2010. The adoption of this pronouncement did not have a material impact on the
Corporations financial condition, results of operations or financial statement disclosures.
In February 2010, the FASB issued ASU 2010-09, which amended the subsequent events pronouncement
issued in May 2009. The amendment removed the requirement to disclose the date through which
subsequent events have been evaluated. This pronouncement became effective immediately upon
issuance and is to be applied prospectively. The adoption of this pronouncement did not have a
material impact on the Companys financial condition, results of operations or financial statement
disclosures.
In April 2010, the FASB issued ASU 2010-18, which states that modifications of loans that are
accounted for within a pool under ASC 310-30 do not result in the removal of those loans from the
pool even if the modification of those loans would otherwise be considered a troubled debt
restructuring. An entity will continue to be required to consider whether the pool of assets in
which the loan is included is impaired if expected cash flows for the pool change. The amendments
do not affect the accounting for loans under the scope of ASC 310-30 that are not accounted for
within pools. Loans accounted for individually under ASC 310-30 continue to be subject to the
troubled debt restructuring accounting provisions within ASC 310-40, ReceivablesTroubled Debt
Restructurings by Creditors. The amendments are effective for modifications of loans accounted for
within pools under Subtopic 310-30 occurring in the first interim or annual period ending on or
after July 15, 2010. The Company does not expect that the adoption of this pronouncement will have
a material impact on the Companys financial condition, results of operations or financial
statement disclosures.
In July 2010, the FASB issued ASU 2010-20 to provide financial statement users with greater
transparency about an entitys allowance for credit losses and the credit quality of its financing
receivables. The objective of the ASU is to provide disclosures that assist financial statement
users in their evaluation of (1) the nature of an entitys credit risk associated with its
financing receivables, (2) how the entity analyzes and assesses that risk in arriving at the
allowance for credit losses and (3) the changes in the allowance for credit losses and the reasons
for those changes. Disclosures provided to meet the objective above should be provided on a
disaggregated basis. The disclosures as of the end of a reporting period are effective for interim
and annual reporting periods ending on or after December 15, 2010. The disclosures about activity
that occurs during a reporting period are effective for interim and annual reporting periods
beginning on or after December 15, 2010. The Corporation does not expect that the adoption of this
pronouncement will have a material impact on the Corporations financial condition or results of
operations.
8
Table of Contents
7. Investment securities available for sale
The amortized cost and fair values at of investment securities available for sale were as follows:
Gross | Gross | |||||||||||||||
June 30, 2010 | Amortized | Unrealized | Unrealized | Fair | ||||||||||||
In thousands | Cost | Gains | Losses | Value | ||||||||||||
U.S. Treasury securities
and obligations of U.S.
government agencies |
$ | 15,864 | $ | 508 | $ | 43 | $ | 16,329 | ||||||||
Obligations of U.S.
government sponsored
entities |
15,999 | 223 | 26 | 16,196 | ||||||||||||
Obligations of state and
political subdivisions |
14,519 | 464 | 48 | 14,935 | ||||||||||||
Mortgage-backed
securities |
73,795 | 4,333 | 35 | 78,093 | ||||||||||||
Other debt securities |
12,693 | 303 | 1,969 | 11,027 | ||||||||||||
Equity securities: |
||||||||||||||||
Marketable securities |
731 | | 7 | 724 | ||||||||||||
Nonmarketable
securities |
115 | | | 115 | ||||||||||||
Federal Reserve Bank
and Federal Home
Loan Bank stock |
3,141 | | | 3,141 | ||||||||||||
Total |
$ | 136,857 | $ | 5,831 | $ | 2,128 | $ | 140,560 | ||||||||
Gross | Gross | |||||||||||||||
December 31, 2009 | Amortized | Unrealized | Unrealized | Fair | ||||||||||||
In thousands | Cost | Gains | Losses | Value | ||||||||||||
U.S. Treasury securities
and obligations of U.S.
government agencies |
$ | 12,518 | $ | 231 | $ | 49 | $ | 12,700 | ||||||||
Obligations of U.S.
government sponsored
entities |
17,289 | 222 | 187 | 17,324 | ||||||||||||
Obligations of state and
political subdivisions |
546 | 7 | | 553 | ||||||||||||
Mortgage-backed
securities |
74,417 | 2,797 | 76 | 77,138 | ||||||||||||
Other debt securities |
12,269 | 266 | 2,267 | 10,268 | ||||||||||||
Equity securities: |
||||||||||||||||
Marketable securities |
713 | | 18 | 695 | ||||||||||||
Nonmarketable
securities |
115 | | | 115 | ||||||||||||
Federal Reserve Bank
and Federal Home
Loan Bank stock |
3,213 | | | 3,213 | ||||||||||||
Total |
$ | 121,080 | $ | 3,523 | $ | 2,597 | $ | 122,006 | ||||||||
The amortized cost and the fair value of investment securities available for sale are distributed
by contractual maturity without regard to normal amortization, including mortgage-backed
securities, which will have shorter estimated lives as a result of prepayments of the underlying
mortgages.
9
Table of Contents
Amortized | Fair | |||||||
In thousands | Cost | Value | ||||||
Due within three months: |
||||||||
Obligations of U.S. government sponsored entities |
$ | 1,000 | $ | 1,000 | ||||
Other debt securities |
999 | 1,004 | ||||||
Due within one year: |
||||||||
Obligations of U.S. government sponsored entities |
230 | 234 | ||||||
Due after one year but within five years: |
||||||||
Obligations of state and political subdivisions |
3,511 | 3,696 | ||||||
Obligations of U.S. government sponsored entities |
2,077 | 2,136 | ||||||
Mortgage-backed securities |
831 | 874 | ||||||
Other debt securities |
2,467 | 2,355 | ||||||
Due after five years but within ten years: |
||||||||
U.S. Treasury securities and obligations of U.S. government agencies |
5,763 | 5,958 | ||||||
Obligations of state and political subdivisions |
5,739 | 5,963 | ||||||
Obligations of U.S. government sponsored entities |
3,083 | 3,145 | ||||||
Mortgage-backed securities |
1,362 | 1,415 | ||||||
Due after ten years: |
||||||||
U.S. Treasury securities and obligations of U.S. government agencies |
10,101 | 10,371 | ||||||
Obligations of state and political subdivisions |
5,269 | 5,276 | ||||||
Obligations of U.S. government sponsored
entities |
9,609 | 9,681 | ||||||
Mortgage-backed securities |
71,602 | 75,804 | ||||||
Other debt securities |
9,227 | 7,668 | ||||||
Total debt securities |
132,870 | 136,580 | ||||||
Equity securities |
3,987 | 3,980 | ||||||
Total |
$ | 136,857 | $ | 140,560 | ||||
Investment securities available for sale which have had continuous unrealized losses as of
June 30, 2010 and December 31, 2009 are set forth below.
June 30, 2010 | Less than 12 Months | 12 Months or More | Total | |||||||||||||||||||||
Gross | Gross | Gross | ||||||||||||||||||||||
Unrealized | Unrealized | Unrealized | ||||||||||||||||||||||
In thousands | Fair Value | Losses | Fair Value | Losses | Fair Value | Losses | ||||||||||||||||||
U.S. Treasury securities and
obligations of U.S. government
agencies |
$ | 2,265 | $ | 23 | $ | 2,177 | $ | 20 | $ | 4,442 | $ | 43 | ||||||||||||
Obligations of U.S. government
sponsored agencies |
875 | 6 | 2,231 | 20 | 3,106 | 26 | ||||||||||||||||||
Obligations of state and
political subdivisions |
989 | 10 | 685 | 38 | 1,674 | 48 | ||||||||||||||||||
Mortgage-backed securities |
4,463 | 34 | 16 | 1 | 4,479 | 35 | ||||||||||||||||||
Other debt securities |
| | 4,917 | 1,969 | 4,917 | 1,969 | ||||||||||||||||||
Marketable equity securities |
| | 724 | 7 | 724 | 7 | ||||||||||||||||||
Total |
$ | 8,592 | $ | 73 | $ | 10,750 | $ | 2,055 | $ | 19,342 | $ | 2,128 | ||||||||||||
10
Table of Contents
December 31, 2009 | Less than 12 Months | 12 Months or More | Total | |||||||||||||||||||||
Gross | Gross | Gross | ||||||||||||||||||||||
Unrealized | Unrealized | Unrealized | ||||||||||||||||||||||
In thousands | Fair Value | Losses | Fair Value | Losses | Fair Value | Losses | ||||||||||||||||||
U.S. Treasury securities and
obligations of U.S. government
agencies |
$ | 2,050 | $ | 14 | $ | 2,598 | $ | 35 | $ | 4,648 | $ | 49 | ||||||||||||
Obligations of U.S. Government
sponsored entities |
2,822 | 143 | 2,323 | 44 | 5,145 | 187 | ||||||||||||||||||
Mortgaged-backed securities |
4,947 | 73 | 248 | 3 | 5,195 | 76 | ||||||||||||||||||
Other debt securities |
43 | 1 | 4,352 | 2,266 | 4,395 | 2,267 | ||||||||||||||||||
Equity securities |
| | 713 | 18 | 713 | 18 | ||||||||||||||||||
Total |
$ | 9,862 | $ | 231 | $ | 10,234 | $ | 2,366 | $ | 20,096 | $ | 2,597 | ||||||||||||
The following table presents a rollforward of the credit loss component of
other-than-temporary investment losses (OTTI) on debt securities for which a non-credit component
of OTTI was recognized in other comprehensive income. OTTI recognized in earnings for
credit-impaired debt securities is presented as additions in two components, based upon
whether the current period is the first time a debt security was credit-impaired (initial credit
impairment) or is not the first time a debt security was credit impaired (subsequent credit
impairment).
For the Six Months | ||||
In thousands | Ended June 30, 2010 | |||
Balance, December 31, 2009 |
$ | 2,489 | ||
Add: Initial credit impairments |
| |||
Additional credit impairments |
| |||
Less: Sale of investment securities |
(2,489 | ) | ||
Balance, June 30, 2010 |
$ | | ||
In April 2009, FASB amended the impairment model for debt securities. The impairment model for
equity securities was not affected. Under the new guidance, an other-than-temporary impairment loss
must be fully recognized in earnings if an investor has the intent to sell the debt security or if
it is more likely than not that the investor will be required to sell the debt security before
recovery of its amortized cost basis. However, even if an investor does not expect to sell a debt
security, it must evaluate the expected cash flows to be received and determine if a credit loss
has occurred. In the event of a credit loss, only the amount of impairment associated with the
credit loss is recognized in earnings. Amounts relating to factors other than credit losses are
recorded in accumulated other comprehensive income. The guidance also requires additional
disclosures regarding the calculation of credit losses as well as factors considered in reaching a
conclusion that an investment is not other-than-temporarily impaired OTTI. The Corporation
adopted the new guidance effective April 1, 2009. The Corporation recorded a $1 million pre-tax
transition adjustment for the non-credit portion of OTTI on securities held at April 1, 2009 that
were previously considered other than temporarily impaired.
During the second quarter and first half of 2009, $1.1 million and $1.2 million, respectively, in
OTTI charges were recorded on two collateralized debt securities (CDOs), while there were no such
charges recorded in the first half of 2010. This OTTI was related to credit losses incurred on the
aforementioned investments and was determined through discounted cash flow analysis of expected
cash flows from the underlying collateral. Third-party consultants were used to obtain valuations
for certain CDOs, including the determination of both the credit and market components. One
consultant analyzes the default prospects of the CDOs underlying collateral and performs
discounted cash flow analyses, while the other projects default prospects based generally on
historical default rates. Both used discount rates based on what return an investor would require
on a risk-adjusted basis based on current economic conditions. Both CDOs were sold in the second
quarter of 2010 at an aggregate loss of $77,000.
The Corporation also owns a CDO with a carrying value of $996,000 and a fair market value of
$496,000 on which no impairment losses have been recorded because it is expected that this security
will perform in accordance with its original terms and that the carrying value is fully
recoverable. Based on valuations received from third-party consultants, management believes that
these carrying values will eventually be recovered and that no impairment exists.
Additionally, the Corporation owns a portfolio of seven single-issue trust preferred securities
with a carrying value of $6.3 million and a related unrealized loss of $876,000 compared to an
unrealized loss of $1.1 million at the end of 2009. None of these securities are considered
impaired as they are all fully performing. Finally, the Corporation also owns two corporate
securities with a carrying value of $1.9 million and a fair market value of $1.5 million that are
rated below investment grade. Neither of these securities is considered impaired as they are also
fully performing.
The Corporation concluded that these available for sale securities were only temporarily impaired
at June 30, 2010. In concluding that the impairments were only temporary, the Corporation
considered several factors in its analysis. The Corporation noted that each
issuer made all the contractually due payments when required. There were no defaults on
11
Table of Contents
principal
or interest payments and no interest payments were deferred. All of the financial institutions were
also considered well-capitalized under regulatory guidelines. Based on managements analysis of
each individual security, the issuers appear to have the ability to meet debt service requirements
for the foreseeable future. Furthermore, although these investment securities are available for
sale, the Corporation does not have the intent to sell these securities and it is more
likely than not that the Corporation will not be required to sell the securities.
The Corporation has held the securities continuously since 1999 and
expects to receive its full principal at maturity.
Management does not believe that any individual unrealized loss as of June 30, 2010 represents an
other-than-temporary impairment. Management has determined that such losses are temporary and that
the carrying value of these securities will be recovered.
Available for sale securities in unrealized loss positions are analyzed as part of the
Corporations ongoing assessment of OTTI. When the Corporation intends to sell available-for-sale
securities, the Corporation recognizes an impairment loss equal to the full difference between the
amortized cost basis and fair value of those securities. When the Corporation does not intend to
sell available for sale securities in an unrealized loss position, potential OTTI is considered
based on a
variety of factors, including the length of time and extent to which the fair value has been less
than cost; adverse conditions specifically related to the industry, the geographic area or
financial condition of the issuer or the underlying collateral of a security; the payment structure
of the security; changes to the rating of the security by rating agencies; the volatility of the
fair value changes; and changes in fair value of the security after the balance sheet date. For
debt securities, the Corporation estimates cash flows over the remaining lives of the underlying
collateral to assess whether credit losses exist and to determine if any adverse changes in cash
flows have occurred. The Corporations cash flow estimates take into account expectations of
relevant market and economic data as of the end of the reporting period.
Other factors considered in determining whether a loss is temporary include the length of time and
the extent to which fair value has been below cost; the severity of the impairment; the cause of
the impairment; the financial condition and near-term prospects of the issuer; activity in the
market of the issuer which may indicate adverse credit conditions; and the forecasted recovery
period using current estimates of volatility in market interest rates (including liquidity and risk
premiums).
Managements assertion regarding its intent not to sell or that it is not more likely than not that
the Corporation will be required to sell the security before its anticipated recovery considers a
number of factors, including a quantitative estimate of the expected recovery period (which may
extend to maturity), and managements intended strategy with respect to the identified security or
portfolio. If management does have the intent to sell or believes it is more likely than not that
the Corporation will be required to sell the security before its anticipated recovery, the gross
unrealized loss is charged directly to earnings in the Consolidated Statements of Operations.
As of June 30, 2010, the Corporation does not intend to sell the securities with an unrealized loss
position in accumulated other comprehensive income (AOCI), and it is not more likely than not
that the Corporation will be required to sell these securities before recovery of their amortized
cost basis. The Corporation believes that the securities with an unrealized loss in AOCI are not
other-than-temporarily impaired as of June 30, 2010.
8. Investment securities held to maturity
The Bank transferred its entire held to maturity (HTM) portfolio to available for sale (AFS)
during March 2010. This transfer was made in conjunction with a deleveraging program to reduce
total asset levels and improve capital ratios. As a result, purchases of securities may not be
classified as HTM for the next two years.
The amortized cost and fair values at of investment securities held to maturity at December 31,
2009 were as follows:
Gross | Gross | |||||||||||||||
Amortized | Unrealized | Unrealized | Fair | |||||||||||||
In thousands | Cost | Gains | Losses | Value | ||||||||||||
U.S. Treasury securities and obligations of U.S.
government agencies |
$ | 1,585 | $ | 62 | $ | | $ | 1,647 | ||||||||
Obligations of U.S.
government
sponsored entities |
2,459 | 19 | 73 | 2,405 | ||||||||||||
Obligations of state and
political subdivisions |
27,979 | 1,135 | 72 | 29,042 | ||||||||||||
Mortgage-backed
securities |
7,877 | 309 | | 8,186 | ||||||||||||
Other debt securities |
495 | 7 | | 502 | ||||||||||||
Total |
$ | 40,395 | $ | 1,532 | $ | 145 | $ | 41,782 | ||||||||
12
Table of Contents
The amortized cost and the fair value of investment securities held to maturity are distributed by
contractual maturity without regard to normal amortization, including mortgage-backed securities,
which will have shorter estimated lives as a result of prepayments of the underlying mortgages.
Investment securities held to maturity at December 31, 2009 which had continuous unrealized losses
are set forth below.
Less than 12 Months | 12 Months or More | Total | ||||||||||||||||||||||
Gross | Gross | Gross | ||||||||||||||||||||||
Unrealized | Unrealized | Unrealized | ||||||||||||||||||||||
In thousands | Fair Value | Losses | Fair Value | Losses | Fair Value | Losses | ||||||||||||||||||
Obligations of
state and political
subdivisions |
$ | 2,268 | $ | 22 | $ | 672 | $ | 50 | $ | 2,940 | $ | 72 | ||||||||||||
Obligations of U.S.
government
sponsored entities |
1,351 | 73 | | | 1,351 | 73 | ||||||||||||||||||
Total |
$ | 3,619 | $ | 95 | $ | 672 | $ | 50 | $ | 4,291 | $ | 145 | ||||||||||||
9. Fair value measurement of assets and liabilities
The following table represents the assets and liabilities on the Consolidated Balance Sheets at
their fair value at June 30, 2010 by level within the fair value hierarchy. The fair value
hierarchy established by ASC Topic 820, Fair Value Measurements and Disclosures prioritizes
inputs to valuation techniques used to measure fair value. The hierarchy gives the highest
priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1
measurement) and the lowest priority to unobservable inputs (level 3 measurements). The three
levels of the fair value hierarchy are described below.
Level 1 Unadjusted quoted prices in active markets that are accessible at the measurement date
for identical unrestricted assets or liabilities;
Level 2 Quoted prices in markets that are not active, or inputs that are observable either
directly or indirectly, for substantially the full term of the assets or liabilities;
Level 3 Prices or valuation techniques that require inputs that are both significant to the fair
value measurement and unobservable (i.e., supported by little or no market activity).
The following tables present the assets and liabilities that are measured at fair value hierarchy
at June 30, 2010 and December 31, 2009, respectively.
June 30, 2010 | ||||||||||||||||
(Dollars in thousands) | Total | Level 1 | Level 2 | Level 3 | ||||||||||||
Investment securities available for sale |
$ | 140,560 | $ | 16,329 | $ | 123,735 | $ | 496 | ||||||||
Loans held for sale |
| | | | ||||||||||||
Total assets |
$ | 140,560 | $ | 16,329 | $ | 123,735 | $ | 496 | ||||||||
December 31, 2009 | ||||||||||||||||
(Dollars in thousands) | Total | Level 1 | Level 2 | Level 3 | ||||||||||||
Investment securities available for sale |
$ | 122,006 | $ | 12,700 | $ | 108,804 | $ | 502 | ||||||||
Loans held for sale |
190 | | | 190 | ||||||||||||
Total assets |
$ | 122,196 | $ | 12,700 | $ | 108,804 | $ | 692 | ||||||||
The fair value of Level 3 investments at June 30, 2010 was $196,000 less than the related fair
value of $692,000 at December 31, 2009. The decrease was attributable to the sale of two
collateralized debt obligations (CDOs) and the loans held for sale.
Level 1 securities includes securities issued by the U.S. Treasury Department based upon quoted
market prices. Level 2 securities includes fair value measurements obtained from various sources
including the utilization of matrix pricing, dealer quotes, market spreads, live trading levels,
credit information and the bonds terms and conditions, among other
13
Table of Contents
things. Any investment security not valued based on the
aforementioned criteria are considered Level 3. Level 3 fair values are determined using
unobservable inputs and includes corporate debt obligations for which there are no readily
available quoted market values as discussed under Managements Discussion and Analysis of
Financial Condition and Results of Operations Investments. For such securities, market values
have been provided by the trading desk of an investment bank, which compares characteristics of the
securities with those of similar securities and evaluates credit events in underlying collateral or
obtained from an external pricing specialist which utilized a discounted cash flow model.
At June 30, 2010, the Corporation had impaired loans with outstanding principal balances of $24.1
million, of which $8.4 million were written down to fair value during the first half of 2010.
Impaired assets are valued utilizing current appraisals adjusted downward by management, as
necessary, for changes in relevant valuation factors subsequent to the appraisal date, as well as
costs to sell the underlying collateral.
10. Long-term debt
At June 30, 2010, long-term debt included a $5 million, 5.00% senior note due in February, 2022.
Interest is payable quarterly for the first ten years and payable thereafter at a fixed rate based
on the yield of the ten-year U.S. Treasury note plus 150 basis points in effect on the tenth
anniversary of the note agreement. Quarterly principal payments of $250,000 commence in the
eleventh year of the loan. As an additional condition for receiving the loan, the Bank is required
to contribute $100,000 annually for the first five years the loan is outstanding to a nonprofit
lending institution formed jointly by CNB and the lender to provide financing to small businesses
that would not qualify for bank loans.
The Corporation has been in violation of certain covenants of the loan agreement since December 31,
2008. Although the loan becomes immediately payable as a result of these violations, which are
considered an event of default, the lender has informally indicated that no action will be taken as
a result of these violations. The loan has been reclassified to short-term portion of long-term
debt on the accompanying Balance Sheet.
11. Fair value of financial instruments
The fair value of financial instruments is the amount at which an asset or obligation could be
exchanged in a current transaction between willing parties, other than in a forced liquidation.
Fair value estimates are made at a specific point in time based on the type of financial instrument
and relevant market information.
Because no quoted market price exists for a significant portion of the Corporations financial
instruments, the fair values of such financial instruments are derived based on the amount and
timing of future cash flows, estimated discount rates, as well as managements best judgment with
respect to current economic conditions. Many of these estimates involve uncertainties and matters
of significant judgment and cannot be determined with precision.
The fair value information provided is indicative of the estimated fair values of those financial
instruments and should not be interpreted as an estimate of the fair market value of the
Corporation taken as a whole. The disclosures do not address the value of recognized and
unrecognized nonfinancial assets and liabilities or the value of future anticipated business. In
addition, tax implications related to the realization of the unrealized gains and losses could have
a substantial impact on these fair value estimates and have not been incorporated into any of the
estimates.
The following methods and assumptions were used to estimate the fair values of significant
financial instruments at June 30, 2010 and December 31, 2009.
Cash, short-term investments and interest-bearing deposits with banks
These financial instruments have relatively short maturities or no defined maturities but are
payable on demand, with little or no credit risk. For these instruments, the carrying amounts
represent a reasonable estimate of fair value.
Investment securities
Investment securities are reported at their fair values based on prices obtained from a nationally
recognized pricing service, where available. Otherwise, fair value measurements are obtained from
various sources including dealer quotes, matrix pricing, market spreads, live trading levels,
credit information and the bonds terms and conditions, among other things. Management reviews all
prices obtained for reasonableness on a quarterly basis.
Loans
Fair values were estimated for performing loans by discounting the future cash flows using market
discount rates that reflect the credit and interest-rate risk inherent in the loans, reduced by the
allowance for loan losses. This method of estimating fair value does not incorporate the exit
price concept of fair value prescribed by the FASB ASC Topic for Fair Value Measuring and
Disclosure.
Loans held for sale
The fair value for loans held for sale is based on estimated secondary market prices.
14
Table of Contents
Deposit liabilities
The fair values of demand deposits, savings deposits and money market accounts were the amounts
payable on demand at June 30, 2010 and December 31, 2009. The fair value of time deposits was
based on the discounted value of contractual cash flows. The discount rate was estimated utilizing
the rates currently offered for deposits of similar remaining maturities.
These fair values do not include the value of core deposit relationships that comprise a
significant portion of the Banks deposit base. Management believes that the Banks core deposit
relationships provide a relatively stable, low-cost funding source that has a substantial value
separate from the deposit balances.
Short-term borrowings
For such short-term borrowings, the carrying amount was considered to be a reasonable estimate of
fair value.
Long-term debt
The fair value of long-term debt was estimated based on rates currently available to the
Corporation for debt with similar terms and remaining maturities.
Commitments to extend credit and letters of credit
The estimated fair value of financial instruments with off-balance sheet risk is not significant at
June 30, 2010 and December 31, 2009.
The following table presents the carrying amounts and fair values of financial instruments.
June 30, 2010 | December 31, 2009 | |||||||||||||||
Carrying | Fair | Carrying | Fair | |||||||||||||
In thousands | Value | Value | Value | Value | ||||||||||||
Financial assets |
||||||||||||||||
Cash and other short-term
Investments |
$ | 41,333 | $ | 41,333 | $ | 12,308 | $ | 12,308 | ||||||||
Interest-bearing deposits
with banks |
582 | 582 | 609 | 607 | ||||||||||||
Investment securities AFS |
140,560 | 140,560 | 122,006 | 122,006 | ||||||||||||
Investment securities HTM |
| | 40,395 | 41,782 | ||||||||||||
Loans |
262,987 | 257,301 | 276,242 | 270,054 | ||||||||||||
Financial liabilities |
||||||||||||||||
Deposits |
370,940 | 362,994 | 380,276 | 369,758 | ||||||||||||
Short-term borrowings |
600 | 600 | 100 | 100 | ||||||||||||
Long-term debt |
47,000 | 48,358 | 49,000 | 49,664 |
12. Formal Agreement
The Bank is subject to a Formal Agreement with the Comptroller of the Currency (the OCC), entered
into on June 29, 2009. The Agreement is based on the results of the most recent annual examination
of the Bank. The Agreement provides, among other things, the enhancement and implementation of
certain programs to reduce the Banks credit risk, along with the development of a capital and
profit plan, the development of a contingency funding plan and the correction of deficiencies in
its loan administration. The OCC also indicated that the Bank needs to improve its capital ratios
and seek outside capital.
The Agreement may significantly affect the operations of both the Bank and the parent holding
company, particularly in the event that the Bank fails to comply with the provisions of the
Agreement, which may also result in more severe enforcement actions and other restrictions. The
Bank is currently not in compliance with certain provisions of the Agreement; however, management
has taken steps to remedy these noncompliance matters. Management has communicated to the OCC
plans regarding compliance with the regulatory capital thresholds in the regulatory agreement. The
OCC is currently evaluating those plans. Although the Banks leverage ratio is less than 8%,
management expects to achieve an 8% leverage ratio by December 31, 2010.
13. Subsequent event
As defined in FASB ASC 855-10, Subsequent Events, subsequent events are events or transactions
that occur after the balance sheet date but before financial statements are issued or available to
be issued. Financial statements are considered issued when they are widely distributed to
shareholders and other financial statement users for general use and reliance in a form and format
that compiles with GAAP. The Corporation has evaluated subsequent events through August 17, 2010, which is the date that the Corporations financial statements are being issued.
15
Table of Contents
Based on the evaluation, the Corporation noted in August 2010, City National Bancshares Corporation
deferred the payment of its regular quarterly cash dividend on its Series G fixed-rate cumulative
perpetual preferred stock issued to the U.S. Treasury in connection with the Corporations
participation in the Treasurys TARP Capital Purchase Program
The Corporation also deferred its regularly scheduled quarterly interest payment on its junior
subordinated debentures issued by the City National Bank of New Jersey Capital Statutory Trust II
(the Trust).
The Series G preferred stock and the junior subordinated debentures issued in favor of the Trust
provide for cumulative dividends and interest, respectively. Accordingly, the Corporation may not
pay dividends on any of its common or preferred stock until the dividends on Series G preferred
stock and the interest on such debentures are paid-up currently.
Item 2
Managements Discussion and Analysis of Financial Condition and Results of Operations
The purpose of this analysis is to provide information relevant to understanding and assessing the
Corporations results of operations for the first quarter of the current and previous years and
financial condition at the end of the current quarter and previous year-end.
Cautionary statement concerning forward-looking statements
This managements discussion and analysis contains forward-looking statements within the meaning
of the Private Securities Litigation Reform Act of 1995. Such statements are not historical facts
and include expressions about managements expectations about new and existing programs and
products, relationships, opportunities, and market conditions. Such forward-looking statements
involve certain risks and uncertainties. These include, but are not limited to, unanticipated
changes in the direction of interest rates, effective income tax rates, loan prepayment
assumptions, deposit growth, the direction of the economy in New Jersey and New York, continued
levels of loan quality, continued relationships with major customers as well as the effects of
general economic conditions and legal and regulatory issues and changes in tax regulations.
Actual results may differ materially from such forward-looking statements. The Corporation
assumes no obligation for updating any such forward-looking statement at any time.
Executive summary
The primary source of the Corporations income comes from net interest income, which represents
the excess of interest earned on earning assets over the interest paid on interest-bearing
liabilities. This income is subject to interest rate risk resulting from changes in interest
rates. The most significant component of the Corporations interest-earning assets is the loan
portfolio. In addition to the aforementioned interest rate risk, the portfolio is subject to
credit risk. Certain components of the investment portfolio are subject to credit risk as well.
After incurring a $7.8 million loss in 2009, including a $7 million loss in the 2009 fourth
quarter, the Corporation recorded $822,000 in net income in the 2010 second quarter compared to an
$821,000 loss in the second quarter of 2009, and net income for the 2010 first half of $118,000
compared to a loss of $323,000 for the 2009 first half. Both earnings improvements were due to
the recognition of a $1 million award received from the U.S. Treasury under its CDFI program for
lending in lower-income communities along with a reduction in OTTI losses, partially offset by
higher loan loss provisions, and increased operating expenses.
The Corporation expects to record significantly reduced earnings during the remainder of 2010 due
to expected higher costs for consultants retained to achieve compliance with the provisions of a
Formal Agreement entered into with the Comptroller of the Currency discussed below. Also
contributing to the lower earnings are expected higher FDIC insurance expense and increased credit
costs associated with loan collection and carrying other real estate owned (OREO).
The Bank is subject to a Formal Agreement (the Agreement) with the Comptroller of the Currency
(the OCC), entered into on June 29, 2009. The Agreement is based on the results of the most
recent annual examination of the Bank. The Agreement provides, among other things, the enhancement
and implementation of certain programs to reduce the Banks credit risk, along with the development
of a profit plan and capital program, the development of a contingency funding plan and the
correction of deficiencies in its loan administration. The OCC also indicated that the Bank
improve its capital ratios and seek outside capital.
The Agreement may significantly affect the operations of both the Bank and the parent holding
company, particularly in the event that the Bank fails to comply with the provisions of the
Agreement, which may also result in more severe enforcement actions and other restrictions. The
Bank is currently not in compliance with certain provisions of the Agreement; however, management
has taken steps to remedy these noncompliance matters. Management has communicated to the OCC
plans regarding compliance with the regulatory capital thresholds in the regulatory agreement. The
OCC is currently evaluating those plans. Although the Banks leverage ratio is less than 8%,
management expects to achieve an 8% leverage ratio by December 31, 2010 by recognizing gains on
planned sales of investment securities along with continued deleveraging.
16
Table of Contents
Financial Condition
At June 30, 2010, total assets declined to $457.6 million from $486.8 at March 31, 2010 and $466.3
million at the end of 2009, while total deposits fell to $370.9 million from $400.1 million and
$380.3 million, respectively. Average assets also declined during the first half of 2010 to $476.8
million, from $531.2 million a year earlier. The June 30, 2010 asset decrease resulted from
reductions in both loans outstanding and investment securities in conjunction with a deleveraging
program. The lower average balance also resulted from a decline in such balances. Additionally,
the 2009 first half average balance included a short-term municipal deposit of approximately $60
million that was withdrawn in the second quarter of 2009.
Federal funds sold
Federal funds sold totaled $32.6 million at June 30, 2010 compared to $5.5 million at the end of
2009, while the related average balance fell to $30.3 million in the first half of 2010 from $52.3
million in the first half of 2009. Both changes resulted from the aforementioned changes in
deposit balances.
Investments
The Bank transferred its entire held to maturity (HTM) portfolio to available for sale (AFS) in
March 2010. This transfer was made in conjunction with the deleveraging program to reduce total
asset levels in order to improve capital ratios, and improve liquidity by allowing for the
disposition of securities, if necessary. The total investment portfolio declined to $140.6 million
at June 30, 2010 from $162.4 million at the end of 2009, while the net unrealized gain, net of tax
rose to $2.2 million from $533,000 million at the end of 2009 due primarily to the transfer because
of a pre-tax $1.4 million unrealized gain in the HTM portfolio. The decrease in the portfolio
resulted primarily from the sale of $13.8 million of tax-exempt securities for which the
Corporation did not expect to benefit from the tax-exempt income status. Additionally, the
Corporation sold two CDOs at a loss of $77,000. Both CDOs were nonperforming, had incurred
previous OTTI charges of $2.5 million and had only long-term prospects of recovering the carrying
values.
Loans
Loans declined to $263 million at June 30, 2010 from $276.2 million at December 31, 2009, while
average loans of $270 million in the 2010 first half was down from $276.7 million for the first six
months of 2009. The decline resulted primarily from the repurchase of $1.8 million in loans at par
by a third-party lender that had previously sold us the loans, and charge-offs totaling $3.1
million. Paydowns and principal payments comprised the balance of the reduction. The Bank is
presently originating very few loans, which are primarily to existing customers. Additionally, the
Bank closed its residential lending department and expects to originate few residential mortgage
loans, if any for the foreseeable future.
Provision and allowance for loan losses
Changes in the allowance for loan losses are set forth below.
Three Months | Six Months | |||||||||||||||
Ended June 30, | Ended June 30, | |||||||||||||||
(Dollars in thousands) | 2010 | 2009 | 2010 | 2009 | ||||||||||||
Balance at beginning of period |
$ | 8,000 | $ | 4,200 | $ | 8,650 | $ | 3,800 | ||||||||
Provision for loan losses |
1,010 | 436 | 2,391 | 937 | ||||||||||||
Recoveries of previous charge-offs |
37 | 15 | 46 | 15 | ||||||||||||
9,047 | 4,651 | 11,087 | 4,752 | |||||||||||||
Less: Charge-offs |
1,113 | 151 | 3,153 | 252 | ||||||||||||
Balance at end of period |
$ | 7,934 | $ | 4,500 | $ | 7,934 | $ | 4,500 | ||||||||
The allowance for loan losses is a critical accounting policy and is maintained at a level
determined by management to be adequate to provide for inherent losses in the loan portfolio. The
allowance is increased by provisions charged to operations and recoveries of loan charge-offs.
The allowance is based on managements evaluation of the loan portfolio and several other factors,
including past loan loss experience, general business and economic conditions, concentration of
credit and the possibility that there may be inherent losses in the portfolio that cannot
currently be identified. Although management uses the best information available, the level of the
allowance for loan losses remains an estimate that is subject to significant judgment and
short-term changes.
Management maintains the allowance for credit losses at a level estimated to absorb probable loan
losses of the loan portfolio at the balance sheet date. The allowance is based on ongoing
evaluations of the probable estimated losses inherent in the loan portfolio. The methodology for
evaluating the appropriateness of the allowance includes segmentation
17
Table of Contents
of the loan portfolio into its various components, tracking the historical levels of classified
loans and delinquencies, applying economic outlook factors, assigning specific incremental reserves
where necessary, providing specific reserves on impaired loans, and assessing the nature and trend
of loan charge-offs. Additionally, the volume of non-performing loans, concentration risks by size
and type, collateral adequacy and economic conditions are taken into consideration.
The allowance established for probable losses on specific loans is based on a regular analysis and
evaluation of classified loans. Loans are classified based on an internal credit risk grading
process that evaluates, among other things: (i) the obligors ability to repay; (ii) the underlying
collateral, if any; and (iii) the economic environment and the industry in which the borrower
operates. Specific valuation allowances are determined by analyzing the borrowers ability to
repay amounts owed, collateral deficiencies, the relative risk grade of the loan and economic
conditions affecting the borrowers industry, among other things.
Additionally, nonaccrual loans over a specific dollar amount are individually evaluated, along with
all troubled debt restructured loans, for impairment based on the underlying anticipated method of
payment consisting of either the expected future cash flows or the related collateral. If payment
is expected solely based on the underlying collateral, an appraisal is completed to assess the fair
value of the collateral. Collateral dependent impaired loan balances are written down to the
current fair value of each loans underlying collateral resulting in an immediate charge-off to the
allowance. If repayment is based upon future expected cash flows, the present value of the
expected future cash flows discounted at the loans original effective interest rate is compared to
the carrying value of the loan, and any shortfall is recorded as a specific valuation allowance in
the allowance for credit losses.
The allowance allocations for non-impaired loans are calculated by applying loss factors by
specific loan types to the applicable outstanding loans and unfunded commitments. Loss factors are
based on the Banks loss experience and may be adjusted for significant changes in the current loan
portfolio quality that, in managements judgment, affect the collectability of the portfolio as of
the evaluation date.
The allowance contains reserves identified as unallocated to cover inherent losses in the loan
portfolio which have not been otherwise reviewed or measured on an individual basis. Such reserves
include managements evaluation of the regional economy, loan portfolio volumes, the composition
and concentrations of credit, credit quality and delinquency trends. These reserves reflect
managements attempt to ensure that the overall allowance reflects a margin for judgmental factors
and the uncertainty that is inherent in estimates of probable credit losses.
The allowance represented 3.02% of total loans at June 30, 2010 compared to 3.13% at December 31,
2009, while the allowance represented 24.58% of total nonperforming loans at June 30, 2010
compared to 48.35% at the end of 2009 due to the substantial increase in nonperforming loans. An
increase in the allowance was not deemed necessary because most of the nonperforming loans were
reviewed for impairment, resulting in no specific reserve requirements. The allowance at June 30,
2010 declined to $7.9 million from $8.7 million at December 31, 2009 due to loan charge-offs in
excess of provisions because a portion of the charge-offs had previously been specifically
reserved for and therefore replenishment of the allowance was not required.
June 30, | March 31, | December 31, | ||||||||||
2010 | 2010 | 2009 | ||||||||||
Allowance for loan losses as a
percentage of: |
||||||||||||
Total loans |
3.02 | % | 2.99 | % | 3.13 | % | ||||||
Total nonperforming loans |
24.58 | % | 36.72 | % | 48.35 | % | ||||||
Year-to-date net charge-offs as
a percentage
of average loans (annualized) |
1.15 | % | 2.97 | % | 1.17 | % |
Nonperforming loans
Nonperforming loans include loans on which the accrual of interest has been discontinued or loans
which are contractually past due 90 days or more as to interest or principal payments on which
interest income is still being accrued. Delinquent interest payments are credited to principal
when received. The following table presents the principal amounts of nonperforming loans.
18
Table of Contents
June 30, | March 31, | December 31, | ||||||||||
(Dollars in thousands) | 2010 | 2010 | 2009 | |||||||||
Loans past due 90 days or more and still accruing |
||||||||||||
Commercial |
$ | 335 | $ | 112 | $ | 555 | ||||||
Real estate |
3,462 | 375 | 1,012 | |||||||||
Installment |
1 | 1 | | |||||||||
Total |
3,798 | 488 | 1,567 | |||||||||
Nonaccrual loans |
||||||||||||
Commercial |
3,047 | 3,349 | 1,237 | |||||||||
Real estate |
25,438 | 17,943 | 15,080 | |||||||||
Installment |
| 2 | 6 | |||||||||
Total |
28,485 | 21,294 | 16,323 | |||||||||
Total nonperforming loans |
32,283 | 21,782 | 17,890 | |||||||||
Other real estate owned |
1,813 | 2,352 | 2,352 | |||||||||
Total nonperforming assets |
$ | 34,096 | $ | 24,134 | $ | 20,242 | ||||||
Nonperforming assets continued to rise in the second quarter of 2010 due primarily to higher levels
of nonaccruing commercial real estate loans. This category of loans continues to be stressed by
the effects of the economic recession in the Banks trade area, which has been affected later than
the rest of the country and is expected to recover later as well. The deterioration in credit
quality has occurred primarily in two segments of the loan portfolio, comprised of loans acquired
from a third-party non-bank lender located in New York City and loans made to churches. Both
categories are considered commercial real estate loans.
Included in the portfolio are loans to churches totaling $63.9 million and loans acquired from the
third-party lender totaling $25.1 million. Nonaccrual loans includes $5.9 million of loans to
religious organizations, which management believes have been impacted by reductions in tithes and
collections from congregation members due to the deterioration in the economy, and $10.7 million of
loans acquired from the third-party non-bank lender. Church loans located in the State of New York
may require significantly longer to collect because approval is required by the state of New York
before the underlying property may be encumbered. Nonaccrual loans to churches located in New York
totaled $2.5 million at June 30, 2010.
Impaired loans totaled $24.1 million June 30, 2010 compared to $11.1 million at December 31, 2009.
The related allocation of the allowance for loan losses amounted to $665,000 due to a shortfall
in collateral values. Impaired loans totaling $21.3 million had no specific reserves at June 30,
2010 due to the net realizable value of the underlying collateral exceeding the carrying value of
the loan. Impaired loan charge-offs totaled $3.1 million in the first six months of 2010.
Included in impaired loans are loans to churches totaling $4.3 million with no related allowance
based on the value of the underlying collateral. Additionally, impaired loans includes $10.6
million of loan participations acquired from the third-party lender. Such loans were comprised
primarily of construction loans. Troubled debt restructured loans (TDRs) totaled $3.2 million,
with a related allowance of $160,000 at June 30, 2010 and were comprised of three church loans.
One TDR of $1.3 million is accruing interest. The remaining TDRs are on nonaccrual status and
reflected in the above table.
The average balance of impaired loans for the 2010 second quarter was $20.9 million and for the
first half amounted to $17.6 million, compared to $6.8 million for the second quarter of 2009 and
$6.4 million for the first half of 2009. All of the impaired loans are secured by commercial real
estate properties.
Deposits
The Banks deposit levels may change significantly on a daily basis because deposit accounts
maintained by municipalities represent a significant part of the Banks deposits and are more
volatile than commercial or retail deposits. These municipal accounts represent a substantial part
of the Banks deposits, and tend to have high balances and comprised most of the Banks accounts
with balances of $100,000 or more at June 30, 2010 and December 31, 2009. These accounts are used
for operating and short-term investment purposes by the municipalities. All the foregoing deposits
require collateralization with readily marketable U.S. Government securities or Federal Home Loan
Bank of New York municipal letters of credit. The Bank expects its municipal deposit account
balances to decline substantially in conjunction with its deleveraging program.
19
Table of Contents
While the collateral maintenance requirements associated with the Banks municipal and U.S.
Government account relationships might limit the ability to readily dispose of investment
securities used as such collateral, management does not foresee any need for such disposal, and in
the event of the withdrawal of any of these deposits, these securities are readily marketable.
Changes in all deposit categories discussed below were caused by fluctuations in municipal deposit
account balances unless otherwise indicated.
Total deposits declined to $370.9 million at June 30, 2010 from $380.3 million at the end of 2009,
while average deposits decreased to $390.5 million for the first six months of 2010 from $441.1
million for the first six months of 2009.
Total noninterest bearing demand deposits of $30.9 million at June 30, 2010 was relatively
unchanged from $29.3 million at the end of 2009 as were average demand deposits of $36.7 million
for the first six months of 2010, compared to $36.7 in the first six months of 2009.
Money market deposit accounts declined to $59.2 million at June 30, 2010 from $73.5 at the end of
2009, while the related average balance fell to $72.8 million for the first half of 2010 from
$135.2 million in the same period of 2009. This decrease was caused by the runoff in the second
quarter of 2009 of the aforementioned temporary municipal deposit account balance.
Interest-bearing demand deposit accounts account balances increased to $66.9 million at June 30,
2010 compared to $51.8 million at the end of 2009, and averaged $62 million for the first six
months of 2010 compared to $53.5 million for the first six months of 2009.
Passbook and statement savings accounts totaled $24.5 million at June 30, 2010, unchanged from
December 31, 2009 and averaged $25 million for the first six months of 2010, also unchanged from
the same period in 2009.
Time deposits totaled $189.5 million at June 30, 2010, down from $201.1 million at December 31,
2009, while average time deposits rose slightly to $194.3 million for the first six months of 2009
from $191.9 million for the similar 2009 period. The reduction in the June 30, 2010 balance was
due to the deleveraging program and could decline further for the same reason.
Short-term borrowings
Short-term borrowings at June 30, 2010 totaled $600,000 compared to $100,000 at December 31, 2009,
while the related average balances were $119,000 for the first six months of 2010 compared to
$891,000 for the first six months of 2009. The end-of-period increase was due to a higher balance
of retail repurchase agreements while the decline in the average balance resulted from lower U.S.
Treasury tax and loan account balances.
Long-term debt
Long-term debt was unchanged from $47 million at December 31, 2009, while the related average
balance was $47.7 million for the first six months of 2010 compared to $32.7 million for the same
period in 2009. The increase resulted from Federal Home Loan Bank advance transactions.
Capital
A significant measure of the strength of a financial institution is its shareholders equity, which
is comprised of three components: (1) core capital (common equity), (2) preferred stock, and (3)
accumulated other comprehensive income or loss. (AOCI). For regulatory purposes, capital is
defined differently, as are the ratios used to determine capital adequacy. Regulatory risk-based
capital ratios are expressed as a percentage of risk-adjusted assets, and relate capital to the
risk factors of a banks asset base, including off-balance sheet risk exposures. Various weights
are assigned to different asset categories as well as off-balance sheet exposures depending on the
risk associated with each. In general, less capital is required for less risk. Capital levels are
managed through asset size and composition, issuance of debt and equity instruments, treasury stock
activities, dividend policies and retention of earnings.
Risk-based capital ratios are expressed as a percentage of risk-adjusted assets, and relate capital
to the risk factors of a banks asset base, including off-balance sheet risk exposures. Various
weights are assigned to different asset categories as well as off-balance sheet exposures depending
on the risk associated with each. In general, less capital is required for less risk. Capital
levels are managed through asset size and composition, issuance of debt and equity instruments,
treasury stock activities, dividend policies and retention of earnings.
20
Table of Contents
Typically, the primary source of capital growth is through retention of earnings, reduced by
dividend payments. In February and May, 2010, City National Bancshares Corporation deferred the
payment of its regular quarterly cash dividend on its Series G fixed-rate cumulative perpetual
preferred stock issued to the U.S. Treasury in connection with the Corporations participation in
the Treasurys TARP Capital Purchase Program. In addition, the Corporation deferred its
regularly scheduled quarterly interest payment on its junior subordinated debentures issued by the
City National Bank of New Jersey Capital Statutory Trust II (the Trust).
The Series G preferred stock and the junior subordinated debentures issued in favor of the Trust
provide for cumulative dividends and interest, respectively. Accordingly, the Corporation may not
pay dividends on any of its common or preferred stock until the dividends on Series G preferred
stock and the interest on such debentures are paid-up currently, and no dividend payments were made
during the second quarter of 2010.
Set forth below are consolidated and bank-only capital ratios.
Consolidated | Bank Only | |||||||||||||||
June 30, | December 31, | June 30, | December 31, | |||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Risk-based capital ratios: |
||||||||||||||||
Tier 1 capital to risk-adjusted assets |
10.86 | % | 10.45 | % | 10.84 | % | 10.62 | % | ||||||||
Minimum to be considered well-capitalized |
6.00 | 6.00 | 6.00 | 6.00 | ||||||||||||
Total capital to risk-adjusted assets |
13.79 | 13.32 | 13.71 | 13.44 | ||||||||||||
Minimum to be considered well-capitalized |
10.00 | 10.00 | 10.00 | 10.00 | ||||||||||||
Leverage ratio |
7.27 | 6.96 | 7.25 | 7.08 | ||||||||||||
Minimum to be considered well-capitalized |
5.00 | 5.00 | 5.00 | 5.00 | ||||||||||||
Total stockholders equity
to total assets |
7.16 | 6.65 | 8.02 | 7.63 |
All the regulatory ratios at June 30, 2010 were higher than the ratios at December 31, 2009 because
of the reduction in assets. Both CNBC and CNB were considered well-capitalized for regulatory
purposes at June 30, 2010 and December 31, 2009.
On April 10, 2009, CNBC issued 9,439 shares of senior fixed rate cumulative perpetual preferred
stock, Series G, to the U.S. Department of Treasury under the Treasury Capital Purchase Program
administered by the U.S. Treasury under the Troubled Asset Relief Program (TARP). The shares
have an annual 5% cumulative preferred dividend rate for the first five years, payable quarterly,
after which the rate increases to 9%. The $9.4 million preferred stock issuance, is considered
Tier I capital, as is the $9 million of such capital that was downstreamed to the Bank.
While both the Corporation and the Bank were well-capitalized under the Prompt Corrective Action
Requirements at June 30, 2010, additional losses from higher loan loss provisions or investment
impairment charges could be incurred reducing capital levels, although management believes that
capital levels are sufficient to absorb additional losses and still remain well-capitalized.
Additionally, management may improve capital ratios, if necessary, by reducing its municipal
deposit levels or seeking additional capital from external sources.
The Bank is subject to a Formal Agreement with the Comptroller of the Currency (the OCC), entered
into on June 29, 2009. The Agreement is based on the results of the most recent annual examination
of the Bank. The Agreement provides, among other things, the enhancement and implementation of
certain programs to reduce the Banks credit risk, along with the development of a capital and
profit plan, the development of a contingency funding plan and the correction of deficiencies in
its loan administration. The OCC also indicated that the Bank needs to improve its capital ratios
and seek outside capital.
The Agreement may significantly affect the operations of both the Bank and the parent holding
company, particularly in the event that the Bank fails to comply with the provisions of the
Agreement, which may also result in more severe enforcement actions and other restrictions. The
Bank is currently not in compliance with certain provisions of the Agreement; however, management
has taken steps to remedy these noncompliance matters. Management has communicated to the OCC
plans regarding compliance with the regulatory capital thresholds in the regulatory agreement. The
OCC is currently evaluating those plans. Although the Banks leverage ratio is less than 8%,
management expects to achieve an 8% leverage ratio by December 31, 2010 by recognizing gains on
planned sales of investment securities along with continued deleveraging.
21
Table of Contents
Finally, the Corporation was required to deconsolidate its investment in the subsidiary trust
formed in connection with the issuance of trust preferred securities in 2004. The deconsolidation
of the subsidiary trust results in the Corporation reporting on its balance sheet the subordinated
debentures that have been issued by City National Bancshares Corporation to the subsidiary trust.
In March 2005, the Board of Governors of the Federal Reserve System issued a final rule allowing
bank holding companies to continue to include qualifying trust preferred capital securities in
their Tier 1 capital for regulatory capital purposes, subject to a 25 percent limitation to all
core (Tier 1) capital elements, net of goodwill less any associated deferred tax liability. The
amount of trust preferred securities and certain other elements in excess of the limit could be
included in total capital, subject to restrictions. The final rule originally provided a five-year
transition period, ending June 30, 2009, for application of the aforementioned quantitative
limitation, however, in March 2009, the Board of Governors of the Federal Reserve Board voted to
delay the effective date until March 2011. As of June 30, 2010 and December 31, 2009, 100 percent
of the trust preferred securities qualified as Tier I capital under the final rule adopted in March
2005. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 was signed into law on
July 21, 2010. Under the act, the Corporations outstanding trust preferred securities will
continue to count as Tier I capital but the Corporation will be unable to issue replacement or
additional trust preferred securities which would count as Tier I capital.
Results of Operations
The Corporation recorded net income of $822,000 for the 2010 second quarter compared to a net loss
of $821,000 for the 2009 second quarter and net income of $118,000 for the 2010 first half compared
to a net loss of $323,000 for the first half of 2009. The second quarter earnings improvement was
due to the recognition in 2010 of a $1 million award received from the U.S. Treasury compared to
$51,000 of award income recorded in the comparable 2009 period, along with $1.1 million of OTTI
charges recorded in the second quarter of 2009 compared to none in the similar 2010 period, offset
in part by substantially higher loan loss provisions and higher management consulting fees, credit
costs and FDIC insurance expense, all of which are expected to remain higher than in previous years
for the remainder of 2010. Also contributing to the improved earnings was a $528,000 gain on the
sale of securities in the second quarter of 2010 compared to $10,000 in the second quarter of 2009.
First half 2010 results were improved for the same reasons.
Net interest income
On a fully taxable equivalent (FTE) basis, net interest income declined to $7.2 million for the
2010 first half compared to $7.5 million in the first half of 2009, while the related net interest
margin rose 20 basis points, to 3.16% from 2.96%. The lower net interest income resulted from the
Corporations strategic decision to become more asset-sensitive by shortening investment maturities
and increasing Federal funds levels. While this decision has resulted in opportunity costs, the
Corporation believes that it is well positioned to benefit from an anticipated increase in interest
rates. Also contributing to the lower income level was an increase in nonaccrual loans, resulting
in foregone interest income. Additionally, reinvesting investment principal and interest payments
in short-term earning assets in a low interest rate environment along with variable-rate loans
repricing at lower rates at reset dates also had a negative impact. The increase in net interest
margin resulted primarily due to the large temporary municipal account balance on which the spread
was minimal compressing the net interest margin in the first half of 2009.
Interest income decreased 3.4% in the first half of 2010 compared to the first half of 2009 due
primarily to a decline in earning assets from $509 million to $452.9 million and income lost on
nonaccrual loans.
Interest income from Federal funds sold declined due to a decrease in the average balance resulting
from the withdrawal of the temporary municipal account balance in the second quarter of 2009. The
low yield resulted from the Federal Reserve Banks Federal Open Market Committees decision to
leave the Federal funds target rate at a range of 0% to .25%.
Interest income on taxable investment securities was lower in the first half of 2010 due to a lower
average rate, which declined from 4.87% to 4.40%, as well as a lower average balance. Tax-exempt
investment income declined for the same reasons, as both portfolios were subject to early
redemptions.
Interest income on loans declined due to a lower average rate earned, which declined from 5.73% to
5.54%, along with a decrease in loan volume, as originations declined and the portfolio was further
reduced by charge-offs and sales.
Interest expense declined 21.5% in the first half of 2010, as the average rate paid to fund
interest-earning assets decreased to 1.73% from 2.65%. This decline was due to the lower rates
paid on almost all interest-bearing liabilities. The most significant reduction occurred in
interest expense on certificates of deposit, which declined from $3.1 million to $2.5 million.
22
Table of Contents
Provision for loan losses
The provision rose in the second quarter of 2010 rose to $1 million from $436,000 for the similar
quarter in 2009, and increased to $2.4 million in the first half of 2010 from $937,000 in the
comparable 2009 period. Both increases occurred due to higher charge-offs as well as increased
levels of nonperforming loans.
Other operating income
Other operating income, excluding the results of investment securities transactions, rose to $1.6
million in the second quarter of 2010 compared to $808,000 in the similar 2009 period, while such
income increased to $2.3 million for the first half of 2010 compared to $1.7 million in similar the
year-earlier period. Both increases resulted primarily from the aforementioned $1 million award
recorded in the second quarter, offset in part by a significant decline in earnings from an
unconsolidated leasing company in which the Bank owns a minority interest.
Securities transactions
In June 2010, the Bank sold $13.9 million of investment securities, resulting in a net gain of
$528,000. $13.8 million consisted of municipal securities, which resulted in a gain of $605,000.
Two CDOs were also sold at an aggregate loss of $77,000. Such transactions were nominal during the
first half of 2009.
Other operating expenses
Other operating expenses of $3.7 million were unchanged in the second quarter of 2010 from the
second quarter of 2009 although there were significant changes in several expense categories.
Salary expense declined due primarily to the elimination of bonus accruals in the first quarter of
2010. Service contract costs were lower as contracts were renegotiated or vendors changed.
Management consulting fees dropped due to the reversal in the second quarter of 2010 of accruals
for Sarbanes-Oxley requirements that are no longer necessary for companies with market
capitalizations of less than $75 million, such as CNBC. FDIC insurance expense declined due to the
payment in the second quarter of 2009 of a $255,000 special assessment required to recapitalize the
insurance fund. Merchant card expenses were lower as such costs, which were previously absorbed by
the Bank, are now passed on to the customer. Finally, foreclosure expense declined due to less of
such activity during the 2010 second quarter.
These reductions were largely offset by increases in health insurance costs and rent expense, as
the Bank relocated a branch to a larger facility and made a one-time $115,000 settlement to avoid
opening another branch that had become less desirable. Also rising significantly during the
quarter were audit and legal fees, and credit costs, including legal, appraisal and OREO-related
expenses and management consulting fees resulting from the necessity to comply with the terms of
the regulatory agreement along with the outsourcing of the internal audit function.
First-half 2010 other operating expenses rose to $7.2 million from $6.8 million in the 2009 first
half for the same reasons as the quarterly increases along with sharply higher health insurance
costs, offset in part by the elimination of bonuses. Both the supplemental executive retirement
plan and the directors retirement plan were terminated effective June 30, 2010.
Income tax expense
The changes in income tax expense as a percentage of pretax income compared to 2009 resulted
primarily to tax strategies implemented during the 2010 second quarter, such as the sale of CDOs
that had been previously written down to a nominal value based on discounted cash flow analysis, in
order to trigger losses deductible for tax purposes and disposing of tax-exempt securities where
the tax benefits have been negatively impacted by operating losses.
Liquidity
The liquidity position of the Corporation is dependent on the successful management of its assets
and liabilities so as to meet the needs of both deposit and credit customers. Liquidity needs
arise primarily to accommodate possible deposit outflows and to meet borrowers requests for
loans. Such needs can be satisfied by investment and loan maturities and payments, along with the
ability to raise short-term funds from external sources.
The Bank depends primarily on deposits as a source of funds and also provides for a portion of its
funding needs through short-term borrowings, such as the Federal Home Loan Bank, Federal Funds
purchased, securities sold under repurchase agreements and borrowings under the U.S. Treasury tax
and loan note option program. The Bank also utilizes the Federal Home Loan Bank for longer-term
funding purposes.
23
Table of Contents
A significant part of the Banks deposit growth is from municipal deposits, which comprised $119
million, or 31.2% of total deposits at June 30, 2010, compared to $140.2 million, or 36.9% of
total deposits at December 31, 2009. These relationships arise due to the Banks urban market,
leading to municipal deposit relationships. $64.7 million of investment securities were pledged
as collateral for these deposits.
Illiquidity in certain segments of the investment portfolio may limit the Corporations ability to
dispose of various securities, although management believes that the Corporation has sufficient
resources to meet all its liquidity demands. Should the market for these and similar types of
securities, such as single issuer trust preferred securities, continue to deteriorate, or should
credit weakness develop, additional illiquidity could occur within the investment portfolio.
Municipal deposit levels may fluctuate significantly depending on the cash requirements of the
municipalities. The Bank has ready sources of available short-term borrowings in the event that
the municipalities have unanticipated cash requirements. Such sources include the Federal Reserve
Bank discount window, Federal funds lines, FHLB advances and access to the repurchase agreement
market, utilizing the collateral for the withdrawn deposits. In certain instances, however, these
lines may be reduced or not available in the event of a significant decline in the Banks credit
quality or capital levels.
There were no significant sources or uses of cash during the first quarter of 2010 from operating
activities. Net cash used in investing activities was primarily for investment purchases, while
sources of cash provided by investing activities were derived primarily from proceeds from
maturities, principal payments and early redemptions of investment securities available for sale.
The most significant use of funds was for the maturity of a FHLB advance while there no significant
sources of cash provided by financing activities.
As a result of the aforementioned Formal Agreement, the Corporation has implemented a contingency
funding plan which provides detailed procedures to be instituted in the event of a liquidity
crisis.
Item 3
Quantitative and Qualitative Disclosures about Market Risk
Due to the nature of the Corporations business, market risk consists primarily of its exposure to
interest rate risk. Interest rate risk is the impact that changes in interest rates have on
earnings. The principal objective in managing interest rate risk is to maximize net interest
income within the acceptable levels of risk that have been established by policy. There are
various strategies that may be used to reduce interest rate risk, including the administration of
liability costs, the reinvestment of asset maturities and the use of off-balance sheet financial
instruments. The Corporation does not presently utilize derivative financial instruments to manage
interest rate risk.
Interest rate risk is monitored through the use of simulation modeling techniques, which apply
alternative interest rate scenarios to periodic forecasts of changes in interest rates, projecting
the related impact on net interest income. The use of simulation modeling assists management in
its continuing efforts to achieve earnings growth in varying interest rate environments.
Key assumptions in the model include anticipated prepayments on mortgage-related instruments,
contractual cash flows and maturities of all financial instruments, deposit sensitivity and changes
in interest rates.
These assumptions are inherently uncertain, and as a result, these models cannot precisely estimate
the effect that higher or lower rate environments will have on net interest income. Actual results
may differ from simulated projections due to the timing, magnitude or frequency of interest rate
changes, as well as changes in managements strategies.
The most recently prepared model indicates that net interest income would increase 3.87% from base
case scenario if interest rates rise 200 basis points and decline 12.03% if rates decrease 200
basis points. Additionally, the economic value of equity would decrease 10.76% if rates rose 200
basis points and decline 13.27% if rates declined 200 basis points.
Management believes that the exposure to a 200 basis point, or more, falling rate environment is
nominal given the historically low interest rate environment. These results indicate that the
Corporation is asset-sensitive, meaning that the interest rate risk is higher if interest rates
fall, which management does not expect to occur during 2010 based on the current low interest rate
environment.
PART II Other information
Item 1. Legal Proceedings
In the normal course of business, the Corporation or its subsidiary may, from time to time, be
party to various legal
24
Table of Contents
proceedings relating to the conduct of its business. In the opinion of
management, the consolidated financial statements will not be materially affected by the outcome of
any pending legal proceedings.
Item 1a. Risk Factors
In February and May, 2010, City National Bancshares Corporation deferred the payment of its regular
quarterly cash dividend on its Series G fixed-rate cumulative perpetual preferred stock issued to
the U.S. Treasury in connection with the Corporations participation in the Treasurys TARP Capital
Purchase Program. In addition, the Corporation deferred its regularly scheduled quarterly
interest payment on its junior subordinated debentures issued by the City National Bank of New
Jersey Capital Statutory Trust II (the Trust). The Series G preferred stock and the junior
subordinated debentures issued in favor of the Trust provide for cumulative dividends and interest,
respectively. Accordingly, the Corporation may not pay dividends on any of its common or preferred
stock until the dividends on Series G preferred stock and the interest on such debentures are
paid-up currently. Additionally, the Corporation intends to defer third-quarter 2010 payments on
the aforementioned instruments and cannot presently determine when such payments will resume.
Financial reform legislation recently enacted will, among other things, create a new Consumer
Financial Protection Bureau, tighten capital standards and result in new laws and regulations that
are expected to increase our costs of operations.
On July 21, 2010 the President signed the Dodd-Frank Wall Street Reform and Consumer
Protection Act (the Dodd-Frank Act). This new law will significantly change the current bank
regulatory structure and affect the lending, deposit, investment, trading and operating activities
of financial institutions and their holding companies. The Dodd-Frank Act requires various federal
agencies to adopt a broad range of new implementing rules and regulations, and to prepare numerous
studies and reports for Congress. The federal agencies are given significant discretion in drafting
the implementing rules and regulations, and consequently, many of the details and much of the
impacts of the Dodd-Frank Act may not be known for many months or years.
The Dodd-Frank Act creates a new Consumer Financial Protection Bureau with broad powers to
supervise and enforce consumer protection laws. The Consumer Financial Protection Bureau has broad
rule-making authority for a wide range of consumer protection laws that apply to all banks and
savings institutions, including the authority to prohibit unfair, deceptive or abusive acts and
practices. The Consumer Financial Protection Bureau has examination and enforcement authority over
all banks with more than $10 billion in assets. Banks with $10 billion or less in assets will
continue to be examined for compliance with the consumer laws by their primary bank regulators. The
Dodd-Frank Act also weakens the federal preemption rules that have been applicable for national
banks and federal savings associations, and gives state attorneys general the ability to enforce
federal consumer protection laws.
The Dodd-Frank Act requires minimum leverage (Tier 1) and risk based capital requirements for
bank and savings and loan holding companies that are no less than those applicable to banks, which
will exclude certain instruments that previously have been eligible for inclusion by bank holding
companies as Tier 1 capital, such as trust preferred securities.
The new law provides that the Office of Thrift Supervision will cease to exist one year from
the date of the new laws enactment. The Office of the Comptroller of the Currency, which is
currently the primary federal regulator for national banks, will become the primary federal
regulator for federal thrifts. The Board of Governors of the Federal Reserve System will supervise
and regulate all savings and loan holding companies that were formerly regulated by the Office of
Thrift Supervision.
Effective one year after the date of enactment is a provision of the Dodd-Frank Act that
eliminates the federal prohibitions on paying interest on demand deposits, thus allowing businesses
to have interest bearing checking accounts. Depending on competitive responses, this significant
change to existing law could have an adverse impact on our interest expense.
The Dodd-Frank Act also broadens the base for Federal Deposit Insurance Corporation deposit
insurance assessments. Assessments will now be based on the average consolidated total assets less
tangible equity capital of a financial institution, rather than deposits. The Dodd-Frank Act also
permanently increases the maximum amount of deposit insurance for banks, savings institutions and
credit unions to $250,000 per depositor, retroactive to January 1, 2009, and non-interest bearing
transaction accounts have unlimited deposit insurance through December 31, 2012. The legislation
also increases the required minimum reserve ratio for the Deposit Insurance Fund, from 1.15% to
1.35% of insured deposits, and directs the FDIC to offset the effects of increased assessments on
depository institutions with less than $10 billion in assets.
The Dodd-Frank Act will require publicly traded companies to give stockholders a non-binding
vote on executive compensation and so-called golden parachute payments, and authorizes the
Securities and Exchange Commission to
promulgate rules that allow stockholders to nominate their own candidates using a companys proxy
materials. It also provides that the listing standards of the national securities exchanges shall
require listed companies to implement and
25
Table of Contents
disclose clawback policies mandating the recovery of
incentive compensation paid to executive officers in connection with accounting restatements. The
legislation also directs the Federal Reserve Board to promulgate rules prohibiting excessive
compensation paid to bank holding company executives.
It is difficult to predict at this time what specific impact the Dodd-Frank Act and the yet to
be written implementing rules and regulations will have on community banks. However, it is expected
that at a minimum they will increase our operating and compliance costs and could increase our
interest expense.
There have been no other material changes in the risk factors since December 31, 2009.
For a summary of risk factors relevant to the corporation and its subsidiarys operations, please
refer to Part I, Item 1a in the Corporations December 31, 2009 Annual Report to Stockholders.
Item 6. Exhibits
(a) Exhibits
Exhibits
(10.1) | Employment Agreement, dated as of May 18, 2010, by and among City National Bancshares Corporation, City National Bank of New Jersey and Louis E Prezeau (incorporated herein by reference to Exhibit 10.1 to the Corporations Current Report on Form 8-K dated May 18, 2010 and filed May 21, 2010). | ||
(31) | Certifications of Principal Executive Officer and Principal Financial Officer (Section 302 of the Sarbanes-Oxley Act of 2002) (filed herewith). | ||
(32) | Certifications of Principal Executive Officer and Principal Financial Officer under 18 U.S.C. Section 1350 (Section 906 of the Sarbanes-Oxley Act of 2002) (filed herewith). |
26
Table of Contents
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by the undersigned hereunto duly authorized.
CITY NATIONAL BANCSHARES CORPORATION
(Registrant)
(Registrant)
August 16, 2010
|
/s/ Edward R. Wright | |||
Senior Vice President and Chief Financial | ||||
Officer (Principal Financial and Accounting Officer) |
27