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UNITED STATES
 SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
 
FORM 10-Q

 
 
(Mark One)

ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2012

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 0-18676

COMMERCIAL NATIONAL FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)


 
PENNSYLVANIA
25-1623213
 
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)


900 LIGONIER STREET LATROBE, PA
15650
(Address of principal executive offices)
(Zip Code)


Registrant's telephone number, including area code:                                                                                                (724) 539-3501


Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes [X]    No [   ]

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes [X]    No [   ]

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 definition of “large accelerated filer”, “accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (Check one):

Large Accelerated filer [  ]    Accelerated filer   [   ] Non-accelerated filer [   ]   Smaller Reporting Company [X]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
[  ] Yes                      [X] No

Indicate the number of shares outstanding of each of the issuer's classes of common stock.


CLASS
OUTSTANDING AT MAY 1, 2012
Common Stock, $2 Par Value
2,860,953 Shares

 
1

 


PART I - FINANCIAL INFORMATION



ITEM 1.         FINANCIAL STATEMENTS


 
Page
 
 
         Consolidated Statements of Financial Condition
 
3
         Consolidated Statements of Income
 
4
         Consolidated Statements of Comprehensive Income
 
5
         Consolidated Statements of Changes in Shareholders’ Equity
 
6
         Consolidated Statements of Cash Flows
 
7
         Notes to Consolidated Financial Statements
 
8
 
 
 
 

ITEM 2.Management's Discussion and Analysis of Financial Condition and Results of Operations
 
 
222


 
ITEM 3.Quantitative and Qualitative Disclosures about Market Risk
 
 
266
 
 
ITEM 4.Controls and Procedures
 
 
266


PART II - OTHER INFORMATION

 
 
 
 
ITEM 1.Legal Proceedings
 
266
ITEM 1A.Risk Factors
 
277
ITEM 2.Unregistered Sales of Equity Securities and Use of Proceeds
 
277
ITEM 3.Defaults Upon Senior Securities
 
277
ITEM 4.Mine Safety Disclosures
 
277
ITEM 5.Other Information
 
277
ITEM 6.Exhibits
 
288
     
Signatures
 
290
     
     


 
2

 


COMMERCIAL NATIONAL FINANCIAL CORPORATION
 
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
 
(Dollars in thousands, except share amounts)
 
             
   
March 31,
   
December 31,
 
   
2012
   
2011
 
   
(unaudited)
       
   
ASSETS
 
Cash and due from banks
  $ 6,204     $ 6,275  
Interest bearing deposits with banks
    41,121       185  
Total cash and cash equivalents
    47,325       6,460  
   
   
Investment securities available for sale
    128,271       189,898  
Restricted investments in bank stock
    3,357       3,534  
   
   
Loans receivable
    172,730       179,386  
Allowance for loan losses
    (1,679 )     (1,673 )
Net loans
    171,051       177,713  
   
Premises and equipment, net
    3,066       3,085  
Accrued interest receivable
    1,615       2,545  
Investment in life insurance
    16,140       16,021  
Other assets
    2,209       1,790  
   
Total assets
  $ 373,034     $ 401,046  
   
LIABILITIES AND SHAREHOLDERS' EQUITY
 
Deposits (all domestic):
 
Non-interest bearing
  $ 96,687     $ 89,690  
Interest bearing
    216,871       214,126  
Total deposits
    313,558       303,816  
   
Short-term borrowings
    0       29,450  
Long-term borrowings
    0       10,000  
      Other liabilities
    4,917       5,231  
Total liabilities
    318,475       348,497  
   
Shareholders' equity:
 
Common stock, par value $2 per share; 10,000,000
 
shares authorized; 3,600,000 issued; 2,860,953
 
shares outstanding in 2012 and 2011
    7,200       7,200  
Retained earnings
    54,227       51,175  
Accumulated other comprehensive income
    5,676       6,718  
Treasury stock, at cost, 739,047 shares in 2012 and 2011
    (12,544 )     (12,544 )
Total shareholders' equity
    54,559       52,549  
   
Total liabilities and
 
shareholders' equity
  $ 373,034     $ 401,046  
   
The accompanying notes are an integral part of these consolidated financial statements.


 
3

 
 
 
 

 
COMMERCIAL NATIONAL FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands, except per share data)
   
               Three Months Ended
                         March 31
          2012                                 2011
    
 
 
   
(unaudited)
 
 
         
INTEREST INCOME:
       
Interest and fees on loans
  $ 2,429     $ 2,717  
Interest and dividends on investments:
                 
Taxable
    1,158       923  
Exempt from federal income tax
    963       728  
Other
    10       0  
Total interest income
    4,560       4,368  
                   
INTEREST EXPENSE
                 
Interest on deposits
    343       485  
Interest on short-term borrowings
    14       18  
Interest on long-term borrowings
    1       59  
Total interest expense
    358       562  
                   
NET INTEREST INCOME
    4,202       3,806  
PROVISION FOR LOAN LOSSES
    0       0  
                   
NET INTEREST INCOME AFTER
                 
PROVISION FOR LOAN LOSSES
    4,202       3,806  
                   
OTHER INCOME
                 
Trust department income
    240       252  
Service charges on deposit accounts
    262       255  
Income from investment in life insurance
    119       123  
   Net security gains
    3,186       0  
Other income
    114       64  
Total other income
    3,921       694  
                   
OTHER EXPENSES
                 
Salaries and employee benefits
    1,654       1,585  
Net occupancy expense
    218       214  
Furniture and equipment expense
    91       109  
Pennsylvania shares tax
    126       126  
Legal and professional
    81       93  
   FDIC Insurance
    48       87  
Other expense
    714       675  
Total other expenses
    2,932       2,889  
                   
INCOME BEFORE INCOME TAXES
    5,191       1,611  
Income tax expense
    1,395       251  
                   
NET INCOME
  $ 3,796     $ 1,360  
                   
Average shares outstanding
    2,860,953       2,860,953  
                   
EARNINGS PER SHARE, BASIC
  $ 1.33     $ 0.48  
                   
Dividend paid per share
  $ 0.26     $ 0.22  

 
4

 



COMMERCIAL NATIONAL FINANCIAL CORPORATION
 
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
 
(Dollars in thousands)
 
   
Three Months Ended
   
Three Months Ended
 
   
March 31
   
March 31
 
   
2012
   
2011
 
 
 
(unaudited)
   
(unaudited)
 
 
           
Net Income
  $ 3,796     $ 1,360  
Other comprehensive income (loss), net of tax:
               
Unrealized net gains on securities
               
              Unrealized holding gains arising during period
    1,060       286  
              Less: Reclassification adjustment for
               
              gains included in net income
    (2,102 )     0  
 Other comprehensive income (loss)
    (1,042 )     286  
   Total Comprehensive Income
  $ 2,754     $ 1,646  
                 
                 

The accompanying notes are an integral part of these consolidated financial statements.




 




 
5

 



COMMERCIAL NATIONAL FINANCIAL CORPORATION
 
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
 
(Dollars in thousands, except per share data)
 
   
   
                     
Accumulated
       
                     
Other
   
Total
 
   
Common
   
Retained
   
Treasury
   
Comprehensive
   
Shareholders’
 
   
Stock
   
Earnings
   
Stock
   
Income
   
Equity
 
(unaudited)
                             
Balance at December 31, 2011
  $ 7,200     $ 51,175     $ (12,544 )   $ 6,718     $ 52,549  
                                         
     Net income
    0       3,796       0       0       3,796  
                                         
Other comprehensive income (loss)
    0       0       0       (1,042 )     (1,042 )
                                         
Cash dividends paid
                                       
        $0.26 per share
    0       (744 )     0       0       (744 )
                                         
Balance at March 31, 2012
  $ 7,200     $ 54,227     $ (12,544 )   $ 5,676     $ 54,559  
                                         
(unaudited)
                                       
Balance at December 31, 2010
  $ 7,200     $ 47,207     $ (12,544 )   $ 4,149     $ 46,012  
                                         
     Net income
    0       1,360       0       0       1,360  
                                         
Other comprehensive income
    0       0       0       286       286  
                                         
Cash dividends paid
                                       
         $0.22 per share
    0       (630 )     0       0       (630 )
                                         
Balance at March 31, 2011
  $ 7,200     $ 47,937     $ (12,544 )   $ 4,435     $ 47,028  



The accompanying notes are an integral part of these consolidated financial statements.

 
6

 


COMMERCIAL NATIONAL FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)
(unaudited)
   
                                      For Three Months
   
                                       Ended March 31
   
                           2012                                2011
 
         
OPERATING ACTIVITIES
       
Net income
  $ 3,796     $ 1,360    
Adjustments to reconcile net income to net cash provided by
             
operating activities:
                 
Net security gains
    (3,186 )     0    
Depreciation and amortization
    72       83    
Amortization of intangibles
    24       24    
Net accretion of loans and securities
    0       (12 )  
Gain on sale of OREO
    (8 )     0    
Income from investment in life insurance
    (119 )     (123 )  
Decrease in other assets
    476       1,152    
Increase (decrease) in other liabilities
    224       (2,054 )  
Net cash provided by operating activities
    1,279       430    
                   
INVESTING ACTIVITIES
                 
     Purchase of securities
    (2,518 )     (9,281 )  
Sale of securities
    60,395       0    
Maturities and calls of securities
    5,353       4,096    
Redemption of restricted investments in bank stock
    177       217    
Net decrease in loans
    6,666       1,837    
Proceeds from sale of foreclosed real estate
    17       1    
Purchase of premises and equipment
    (51 )     (19 )  
Net cash provided by (used in) investing activities
    70,039       (3,149 )  
                   
FINANCING ACTIVITIES
                 
Net increase in deposits
    9,741       13,501    
Decrease in short-term borrowings
    (29,450 )     (10,425 )  
Decrease in long-term borrowings
    (10,000 )     0    
Dividends paid
    (744 )     (630 )  
Net cash (used in) provided by financing activities
    (30,453 )     2,446    
Increase (decrease) in cash and cash equivalents
    40,865       (273 )  
                   
Cash and cash equivalents at beginning of year
    6,460       5,594    
                   
Cash and cash equivalents at end of quarter
  $ 47,325     $ 5,321    
                   
Supplemental disclosures of cash flow information:
                 
                   
Cash paid during the period for:
                 
Interest
  $ 418     $ 585    
                   
Income Taxes
  $ 650     $ 375    
                   
Non-cash investing activities
                 
     Purchase of investment securities not settled until April 2011
               
 
          included in other assets and other liabilities
  $ 0     $ 8,026    
                 
 
                   
                   
                   
                   
The accompanying notes are an integral part of these consolidated financial statements.

 
7

 

COMMERCIAL NATIONAL FINANCIAL CORPORATION
                          NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2012

Note 1    Basis of Presentation

The accompanying consolidated financial statements include the accounts of Commercial National Financial Corporation (the Corporation) and its wholly owned subsidiaries, Commercial Bank & Trust of PA (the Bank) and Ridge Properties, Inc. All material intercompany transactions have been eliminated.

The accompanying unaudited consolidated interim financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information.  However, they do not include all information and footnote disclosures required by generally accepted accounting principles for complete financial statements and should be read in conjunction with the annual consolidated financial statements of the Corporation for the year ended December 31, 2011, including the notes thereto. In the opinion of management, the unaudited interim consolidated financial statements include all adjustments (consisting of only normal recurring adjustments) necessary for a fair presentation of financial position as of March 31, 2012 and the results of operations for the three-month period ended March 31, 2012 and 2011. The results of operations for the three-months ended March 31, 2012 are not necessarily indicative of the results to be expected for the entire year.

The consolidated balance sheet at December 31, 2011 has been derived from the audited consolidated financial statements at that date, but does not include all of the information and footnotes required by GAAP for complete consolidated financial statements.

Reclassifications
Certain comparative amounts for the prior year have been reclassified to conform to current year classifications.  Such classifications had no effect on consolidated net income or changes in shareholders’ equity.

Note 2   Allowance for Loan Loss
 
The allowance for loan losses represents management’s estimate of losses inherent in the loan portfolio as of the balance sheet date and is recorded as a reduction to loans.  The allowance for loan losses is increased by the provision for loan losses, and decreased by charge-offs, net of recoveries. Loans deemed to be uncollectible are charged against the allowance for loan losses, and subsequent recoveries, if any, are credited to the allowance. All, or part, of the principal balance of loans receivable is charged off to the allowance as soon as it is determined that the repayment of all, or part, of the principal balance is highly unlikely.  Non-residential consumer loans are generally charged off no later than 90 days past due on a contractual basis, earlier in the event of Bankruptcy, or if there is an amount deemed uncollectible.  Because all identified losses are immediately charged off, no portion of the allowance for loan losses is restricted to any individual loan or groups of loans, and the entire allowance is available to absorb any and all loan losses.

The following discusses key risk within each portfolio segment:
 
Commercial, industrial and other financing – these loans are made to operating companies or manufacturers for the purpose of production, operating capacity, accounts receivable, inventory or equipment financing. Cash flow from the operations of the company is the primary source of repayment for these loans. The condition of the local economy is an important indicator of risk, but there are also more specific risks depending on the industry of the company. Collateral for these types of loans often do not have sufficient value in a distressed or liquidation scenario to satisfy the outstanding debt.
 
Commercial real estate – These loans are secured by commercial purpose real estate, including both owner occupied properties and investment properties for various purposes such as strip malls and apartment buildings. Individual projects as well as global cash flows are the primary sources of repayment for these loans. The condition of the local economy is an important indicator of risk, but there are also more specific risks depending on the collateral type as well as the business prospects of the lessee, if the project is not owner occupied.
 
Residential mortgages – These are loans secured by 1-4 family residences, including purchase money mortgages. We currently originate fixed-rate, fully amortizing mortgage loans with maturities of 15 to 30 years.  The primary source of repayment for these loans is the income and assets of the borrower. The condition of the local economy, in particular the unemployment rate, is an important indicator of risk for this segment. The state of the local housing market can also have a significant impact on this portfolio, since low demand and/or declining home values can limit the ability of borrowers to sell a property and satisfy the debt.
 
 
 
8

 
 
Loans to individuals – Loans made to individuals may be secured by junior lien positions on a borrower’s primary residence or other assets of the borrower, as well as unsecured loans. This segment includes home equity loans, auto loans, and secured or unsecured lines.  The primary source of repayment for these loans is the income and assets of the borrower. The condition of the local economy, in particular the unemployment rate, is an important indicator of risk for this segment. The value of the collateral, if there is any, is less likely to be a source of repayment due to less certain collateral values.
 
An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.
 
A loan is considered impaired when, based on current information and events, it is probable that the Corporation will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial and industrial loans and commercial real estate loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the collateral if the loan is collateral dependent.
 
An allowance for loan losses is established for an impaired loan if its carrying value exceeds its estimated fair value. The estimated fair values of substantially all of the Corporation’s impaired loans are measured based on the estimated fair value of the loan’s collateral.
 
For commercial loans secured by real estate, estimated fair values are determined primarily through third-party appraisals. When a real estate secured loan becomes impaired, a decision is made regarding whether an updated certified appraisal of the real estate is necessary. This decision is based on various considerations, including the age of the most recent appraisal, the loan-to-value ratio based on the original appraisal and the condition of the property. Appraised values are discounted to arrive at the estimated selling price of the collateral, which is considered to be the estimated fair value. The discounts also include estimated costs to sell the property.
 
For commercial and industrial loans secured by non-real estate collateral, such as accounts receivable, inventory and equipment, estimated fair values are determined based on the borrower’s financial statements, inventory reports, accounts receivable agings or equipment appraisals or invoices. Indications of value from these sources are generally discounted based on the age of the financial information or the quality of the assets.
 
Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Corporation does not separately identify individual residential mortgage loans and loans to individuals for impairment disclosures, unless such loans are the subject of a troubled debt restructuring agreement.
 
Loans whose terms are modified are classified as troubled debt restructurings if the Corporation grants such borrowers concessions and it is deemed that those borrowers are experiencing financial difficulty. Concessions granted under a troubled debt restructuring generally involve a temporary reduction in interest rate or an extension of a loan’s stated maturity date. Non-accrual troubled debt restructurings are restored to accrual status if principal and interest payments, under the modified terms, are current for twelve consecutive months after modification.   Loans classified as troubled debt restructurings are designated as impaired.
 
The allowance for loan loss calculation methodology includes further segregation of loan classes into risk rating categories. The borrower’s overall financial condition, repayment sources, guarantors and value of collateral, if appropriate, are evaluated annually for commercial loans.  Such evaluations for commercial and consumer loans are also made when credit deficiencies arise, such as delinquent loan payments.  Credit quality risk ratings include categories of “pass,” “special mention,” “substandard” and “doubtful.” Assets which do not currently expose the insured institution to sufficient risk, warrant classification as pass.  Assets that are not classified as pass and possess weaknesses are required to be designated “special mention.”  If uncorrected, the potential weaknesses may result in deterioration of the repayment prospects.  An asset is considered “substandard” if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any.   “Substandard” assets include those characterized by the “distinct possibility” that the insured institution will sustain “some loss” if the deficiencies are not corrected.   Assets classified as “doubtful” have all of the weaknesses inherent in those classified “substandard” with the added characteristic that the weaknesses present make “collection or liquidation in full,” on the basis of currently existing facts, conditions, and values, “highly questionable and improbable.”   In addition, Federal regulatory agencies, as an integral part of their examination process, periodically review the Corporation’s allowance for loan losses and may require the Corporation to recognize additions to the allowance based on their judgments about information available to them at the time of their examination, which may not be currently available to management. Based on management’s comprehensive analysis of the loan portfolio, management believes the current level of the allowance for loan losses is adequate.
 
 
9

 
 
 
The following table presents the classes of the loan portfolio summarized by the aggregate pass rating and the classified ratings of special mention, substandard and doubtful within the Corporation's internal risk rating system as of March 31, 2012:
(Dollars in Thousands)

                               
   
Pass
   
Special Mention
   
Substandard
   
Doubtful
   
Total
 
                               
                               
Commercial
 
 
   
 
   
 
   
 
   
 
 
    Commercial,
                             
       Industrial & Other
  $ 34,864     $ 123     $ 143     $ 0     $ 35,130  
    Commercial real estate
    50,649       10,041       3,950       0       64,640  
Residential mortgages
    52,426       404       131       0       52,961  
Loans to Individuals
    19,843       156       0       0       19,999  
                                         
        Total
  $ 157,782     $ 10,724     $ 4,224     $ 0     $ 172,730  
                                         

The following table presents the classes of the loan portfolio summarized by the aggregate pass rating and the classified ratings of special mention, substandard and doubtful within the Corporation's internal risk rating system as of December 31, 2011:

(Dollars in Thousands)

                               
   
Pass
   
Special Mention
   
Substandard
   
Doubtful
   
Total
 
                               
                               
Commercial
 
 
   
 
   
 
   
 
   
 
 
    Commercial,
                             
       Industrial & Other
  $ 35,560     $ 126     $ 65     $ 0     $ 35,751  
    Commercial real estate
    49,470       10,749       3,983       0       64,202  
Residential mortgages
    58,450       407       135       0       58,992  
Loans to Individuals
    20,283       158       0       0       20,441  
                                         
        Total
  $ 163,763     $ 11,440     $ 4,183     $ 0     $ 179,386  
                                         





Past due loans are reviewed on a monthly basis to identify loans for non-accrual status.  The Corporation places a loan on non-accrual status and discontinues interest accruals when principal or interest is due and has remained unpaid for 90 days. When a loan is placed on non-accrual status, all unpaid interest recognized in the current year is reversed and interest accrued in prior years is charged to the allowance for loan losses.  Non-accrual loans may not be restored to accrual status until all delinquent principal and interest have been paid and the ultimate collectability of the remaining principal and interest is reasonably assured.





 
10

 





The performance and credit quality of the loan portfolio is also monitored by analyzing the age of the receivable as determined by the length of time a recorded payment is past due.  The following table presents the classes of the loan portfolio summarized by the past due status as of March 31, 2012:

(Dollars in Thousands)
     
   
30-89 Days
Past Due
   
>90 Days Past Due and Still Accruing
   
Non-Accrual
   
Total Past Due
   
 
Current
   
 
              Total Loans
 
                                     
Commercial
 
 
   
 
   
 
   
 
   
 
   
 
 
 Commercial,
                                   
     Industrial & Other
  $ 19     $ 0     $ 0     $ 19     $ 35,111     $ 35,130  
Commercial real estate
    0       0       0       0       64,640       64,640  
Residential mortgages
    47       0       0       47       52,914       52,961  
Loans to individuals
    6       0       27       33       19,966       19,999  
 
                                               
        Total
  $ 72     $ 0     $ 27     $ 99     $ 172,631     $ 172,730  
 
 


The following table presents the classes of the loan portfolio summarized by the past due status as of December 31, 2011:

(Dollars in Thousands)
     
   
30-89 Days
Past Due
   
>90 Days Past Due and Still Accruing
   
Non-Accrual
   
Total Past Due
   
 
Current
   
 
             Total Loans
 
                                     
Commercial
 
 
   
 
   
 
   
 
   
 
   
 
 
 Commercial,
                                   
     Industrial & Other
  $ 60     $ 0     $ 0     $ 60     $ 35,691     $ 35,751  
Commercial real estate
    258       0       0       258       63,944       64,202  
Residential mortgages
    0       0       76       76       58,916       58,992  
Loans to individuals
    7       0       27       34       20,407       20,441  
 
                                               
        Total
  $ 325     $ 0     $ 103     $ 428     $ 178,958     $ 179,386  


 

 
 
11

 

 


 
 
The following table summarizes information in regards to impaired loans by loan portfolio class as of March 31, 2012.
 
(Dollars in Thousands)

   
 
Recorded Investment
   
Unpaid Principal Balance
   
 
Related Allowance
   
Average Recorded Investment
   
Interest Income Recognized
 
                               
With no related allowance recorded:
                             
Commercial
 
 
   
 
   
 
   
 
   
 
 
  Commercial,
                             
       Industrial & Other
  $ 28     $ 28     $ 0     $ 28     $ 1  
  Commercial real estate
    268       268       0       272       4  
Residential mortgages
    27       27       0       28       1  
Loans to Individuals
    0       0       0       0       0  
        Subtotal
    323       323       0       328       6  
With an allowance recorded:
                                       
Commercial
                                       
  Commercial,
                                       
       Industrial & Other
    0       0       0       0       0  
  Commercial real estate
    0       0       0       0       0  
Residential mortgages
    0       0       0       0       0  
Loans to Individuals
    0       0       0       0       0  
        Subtotal
    0       0       0       0       0  
 Total
  $ 323     $ 323     $ 0     $ 328     $ 6  


The following table summarizes information in regards to impaired loans by loan portfolio class as of December 31, 2011.
 
(Dollars in Thousands)

   
 
Recorded Investment
   
Unpaid Principal Balance
   
 
Related Allowance
   
Average Recorded Investment
   
Interest Income Recognized
 
                               
With no related allowance recorded:
                             
Commercial
 
 
   
 
   
 
   
 
   
 
 
  Commercial,
                             
       Industrial & Other
  $ 29     $ 29     $ 0     $ 36     $ 3  
  Commercial real estate
    278       278       0       296       19  
Residential mortgages
    29       29       0       34       3  
Loans to Individuals
    0       0       0       0       0  
        Subtotal
    336       336       0       366       25  
With an allowance recorded:
                                       
Commercial
                                       
  Commercial,
                                       
       Industrial & Other
    0       0       0       0       0  
  Commercial real estate
    0       0       0       0       0  
Residential mortgages
    0       0       0       0       0  
Loans to Individuals
    0       0       0       0       0  
        Subtotal
    0       0       0       0       0  
 Total
  $ 336     $ 336     $ 0     $ 366     $ 25  



 
12

 


The following table provides detail related to the allowance for loan losses:
     
Three-months ended
March 31, 2012
(Dollars in Thousands)
 
   
   
Commercial, Industrial & Other
   
Commercial Real Estate
   
Residential Mortgages
   
Loans to Individuals
   
 
          Unallocated
   
                   Total
 
   
Allowance for credit losses:
 
   
Beginning Balance
  $ 155     $ 1,360     $ 94     $ 25     $ 39     $ 1,673  
      Charge-offs
    0       0       0       0       0       0  
       Recoveries
    0       0       0       6       0       6  
       Provision
    25       (31 )     (9 )     (1 )     16       0  
Ending Balance
  $ 180     $ 1,329     $ 85     $ 30     $ 55     $ 1,679  
                                                 
     
                                                 



Three-months ended
March 31, 2011
(Dollars in Thousands)
 
   
   
Commercial, Industrial & Other
   
Commercial Real Estate
   
Residential Mortgages
   
Loans to Individuals
   
 
         Unallocated
   
     Total
 
   
Allowance for credit losses:
 
   
Beginning Balance
  $ 107     $ 1,378     $ 110     $ 31     $ 60     $ 1,686  
      Charge-offs
    0       0       0       0       0       0  
       Recoveries
    0       0       0       0       0       0  
       Provision
    79       (217 )     (5 )     (2 )     145       0  
Ending Balance
  $ 186     $ 1,161     $ 105     $ 29     $ 205     $ 1,686  



 
13

 


 



The following table provides detail related to the allowance for loan losses and recorded investment in financing receivables as of March 31, 2012:
(Dollars in Thousands)
 
 


 
 
Commercial,
Industrial & Other
 
Commercial Real Estate
 
Residential Mortgages
 
  Loans to Individuals
 
   Unallocated
 
                 Total

Allowance for  credit losses:
Ending balance: individually evaluated for impairment
  $           0
  $           0
  $          0
  $          0
  $          0
  $           0
Ending balance: collectively evaluated for impairment
  $       180
  $    1,329
  $        85
  $        30
  $         55
  $    1,679
Ending balance: loans acquired with deteriorated credit quality
  $          0
  $           0
  $          0
  $          0
  $          0
  $           0
             
Loans receivable:
Ending Balance
  $  35,130
   $64,640
  $ 52,961
  $ 19,999
  $          0
  $ 172,730
Ending balance: individually evaluated for impairment
  $         28
   $     268
 $        27
  $          0
  $          0
  $        323
Ending balance: collectively evaluated for impairment
  $  35,102
   $64,372
  $ 52,934
  $ 19,999
  $          0
  $ 172,407
Ending balance: loans acquired with deteriorated credit quality
  $          0
   $         0
 $          0
  $          0
  $          0
  $          0

 
 
 
 
14

 

 
The following table provides detail related to the allowance for loan losses and recorded investment in financing receivables as of December 31, 2011:
(Dollars in Thousands)


 
Commercial,
Industrial & Other
 
Commercial Real Estate
 
Residential Mortgages
 
  Loans to Individuals
 
         Unallocated
 
                   Total

Allowance for  credit losses:
Ending balance: individually evaluated for impairment
  $           0
  $           0
  $          0
  $          0
  $          0
  $           0
Ending balance: collectively evaluated for impairment
  $       155
  $    1,360
  $        94
  $        25
  $         39
  $    1,673
Ending balance: loans acquired with deteriorated credit quality
  $          0
  $           0
  $          0
  $          0
  $          0
  $           0
             
Loans receivable:
Ending Balance
  $  35,751
  $  64,202
   $ 58,992
  $ 20,441
  $          0
  $179,386
Ending balance: individually evaluated for impairment
  $        29
  $       278
  $       29
  $          0
  $          0
  $       336
Ending balance: collectively evaluated for impairment
  $ 35,722
  $  63,924
   $58,963
  $ 20,441
  $          0
  $179,050
Ending balance: loans acquired with deteriorated credit quality
  $         0
  $          0
   $         0
  $          0
  $          0
  $          0


 
 
 

 
The Corporation has adopted ASU No. 2011-02, A Creditor’s Determination of Whether A Restructuring Is a Troubled Debt Restructuring, which clarifies when a loan modification or restructuring is considered a troubled debt restructuring (TDR). The Corporation has determined that as of and for the periods ending March 31, 2012 and December 31, 2011, there were no loans considered as a troubled debt restructures.
 

 


 
15

 





Note 3 - Securities
 
The amortized cost and fair values of securities available for sale are as follows:
 
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
 
(In Thousands)

March 31, 2012:
             
               
Obligations of states and political
subdivisions
$  79,145
 
$  4,136
 
$        0
 
$   83,281
Mortgage-backed securities - GSE
40,525
 
4,465
 
0
 
44,990

 
$119,670
 
$  8,601
 
$        0
 
$128,271
December 31, 2011:
             
               
Obligations of states and political
subdivisions
$135,525
 
$  5,685
 
$   (257)
 
$140,953
Mortgage-backed securities - GSE
44,194
 
4,751
 
0
 
48,945

 
$179,719
 
$10,436
 
$   (257)
 
$189,898



The amortized cost and fair value of securities at March 31, 2012 by contractual maturity are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

   
Amortized
Cost
 
Fair
Value
   
(In Thousands)

 
Due within one year
$            0
 
$            0
 
Due after one year through five years
0
 
 0
 
Due after five years through ten years
579
 
586
 
Due after ten years
78,566
 
82,695
 
Mortgage Backed Securities
 40,525
 
44,990

   
$119,670
 
$128,271

 
As of March 31, 2012, none of the Corporation’s investment securities were in an unrealized loss position.   The following tables show the Corporation’s gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position:
   
 
December 31, 2011
 
Less than 12 Months
 
12 Months or More
 
Total
 
Fair
Value
 
Unrealized Losses
 
Fair
Value
 
Unrealized Losses
 
Fair
Value
 
Unrealized Losses
 
(In Thousands)

Obligations of states and political subdivisions
$12,783
 
$     (257)
 
$         0
 
$         0
 
$12,783
 
$     (257)


 
16

 
 
The Corporation reviews its position quarterly to determine if there is Other-Than-Temporary Impairment (OTTI) on any of its securities.   All of the Corporation’s securities are debt securities and we assess whether OTTI is present when the fair value of a security is less than its amortized cost basis.  The Corporation monitors the credit ratings of all securities for downgrades as well as any other indication of OTTI condition.  As of March 31, 2012, no securities were in an unrealized loss position.
  
The Corporation sold taxable municipals with a fair market value of $52.0 million and tax-free municipals with a fair market value of $8.1 million.  These municipal bonds sales resulted in a $3.2 million (pre-tax) gain. This action was based on several factors.  The main factor was a strategic decision to decrease the Corporation’s market risk by reducing the average maturity of the bond portfolio.  In addition, the Corporation determined the potential future credit risk associated with municipal bonds should be reduced. These municipal bond sales provide the Corporation with additional liquidity and flexibility going forward.

Note 4   Comprehensive Income

The components of other comprehensive income and related tax effects for the three month periods ended March 31, 2012 and 2011 are as follows (dollars in thousands):

   
           For three months
 
   
            ended March 31
 
   
2012
   
2011
 
Net unrealized gains on
           
   securities available for sale
  $ 1,607     $ 432  
Less reclassification adjustment
               
   for gains realized in income
    (3,186 )     0  
Tax effect
    537       (146 )
Net of tax amount
  $ (1,042 )   $ 286  

Note 5   Legal Proceedings

Other than proceedings which occur in the normal course of business, there are no legal proceedings to which either the Corporation or any of its subsidiaries is a party, which, in the opinion of management, will have any material effect on the financial position or results of operations of the Corporation and its subsidiaries.

Note 6   Guarantees

The Corporation does not issue any guarantees that would require liability recognition or disclosure, other than its standby letters of credit.  Standby letters of credit written are conditional commitments issued by the Bank to secure the performance of a customer to a third party. Of these letters of credit, $329,000 automatically renews within the next twelve months. The Bank, generally, holds collateral and/or personal guarantees supporting these commitments. The credit risk involved in issuing letters of credit is essentially the same as those that are involved in extending loan facilities to customers. The current amount of the liability as of March 31, 2012 for guarantees under standby letters of credit issued is not material.

Note 7   Earnings per share

The Corporation has a simple capital structure. Basic earnings per share equals net income divided by the weighted average common shares outstanding during each period presented. The weighted average common shares outstanding for the three months ended March 31, 2012 and 2011 was 2,860,953.

Note 8   New Accounting Standards

In May 2011, the FASB issued ASU No. 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs.  The ASU is the result of joint efforts by the FASB and International Accounting Standards Board (“IASB”) to develop a single, converged fair value framework on how (not when) to measure fair value and on what disclosures to provide about fair value measurements. While the ASU is largely consistent with existing fair value measurement principles in U.S. GAAP, it expands existing disclosure requirements for fair value measurements and makes other amendments to ASC 820, Fair Value Measurement. Many of these amendments were made to eliminate unnecessary wording differences between U.S. GAAP and IFRSs. However, some could change how the fair value measurement guidance in ASC 820 is applied. The ASU is effective for interim and annual periods beginning after December 15, 2011. The adoption of this ASU did not have a material impact on the Corporation’s financial condition and results of operation.
 
 
 
17

 
 
 
In September 2011, the FASB issued ASU No. 2011-05, Presentation of Comprehensive Income, which revises the manner in which entities present comprehensive income in their financial statements. The new guidance eliminates the option to present components of other comprehensive income as part of the Statements of Changes to Stockholders’ Equity and requires entities to report components of comprehensive income in either (1) a continuous statement of comprehensive income or (2) two separate but consecutive statements. Under the two-statement approach, the first statement would include components of net income, which is consistent with the income statement format used today, and the second statement would include components of other comprehensive income (“OCI”). The ASU does not change the items that must be reported in OCI. This ASU is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. Guidance must be applied retrospectively for all periods presented in the financial statements. The adoption of this ASU did not have a material impact on the Corporation’s financial condition and results of operation.
 
In September 2011, the FASB issued ASU No. 2011-08, Testing Goodwill for Impairment, which amends the guidance on testing goodwill impairment. Under the revised guidance, entities testing goodwill for impairment have the option of performing a qualitative assessment before calculating the fair value of the reporting unit (i.e. step 1 of the goodwill impairment test). If entities determine, on the basis of qualitative factors, that the fair value of the reporting unit is more likely than not less than the carrying amount, the two-step impairment test would be required. The ASU does not change how goodwill is calculated or assigned to reporting units, nor does it revise the requirement to test goodwill annually for impairment. In addition, the ASU does not amend the requirement to test goodwill for impairment between annual tests if events or circumstances warrant; however, it does revise the examples of events and circumstances that an entity should consider. This ASU is effective for annual and interim goodwill impairment tests performed for fiscal years, and interim periods within those years, beginning after December 15, 2011. The adoption of this ASU will not have a material impact on the Corporation’s financial condition and results of operation.
 
In December 2011, the FASB issued ASU 2011-12, Deferral of the Effective Date to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update 2011-05. In response to concerns regarding the operational ramifications of the presentation requirements for reclassification of items out of accumulated other comprehensive income for current and previous years, the FASB has deferred the implementation date of this provision in ASU 2011-05, Presentation of Comprehensive Income, to allow time for further consideration. The requirement in ASU 2011-05 for the presentation of a combined statement of comprehensive income or separate, but consecutive, statements of net income and other comprehensive income is still effective for fiscal years and interim periods beginning after December 15, 2011 for public companies. The adoption of this ASU did not have a material impact on the Corporation’s financial condition and results of operation.
 
Note 9   Restricted Investment in Bank Stock
     
Federal law requires the Bank, a member institution of the Federal Home Loan Bank system, to hold stock of its district Federal Home Loan Bank (FHLB) according to a predetermined formula.  This restricted stock is carried at cost, and as of March 31, 2012, consists of the common stock of FHLB of Pittsburgh.
 
The Corporation evaluates impairment in FHLB stock when certain conditions warrant further consideration. After evaluating such factors as the capital adequacy of the FHLB, its overall operating performance and the FHLB's liquidity and funding position, the Corporation concluded that the par value was ultimately recoverable and no impairment charge was recognized at March 31, 2012.  Our evaluation of the factors described above in future periods could result in the recognition of impairment charges on FHLB stock.
 
Note 10   Fair Value Measurements and Fair Value of Financial Instruments

FASB ASC-820 establishes a fair value hierarchy that prioritizes the inputs to valuation methods 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 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy under FASB ASC-820 are as follows:

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 asset or liability.

Level 3:  Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (ie., supported with little or no market activity).
 
 
 
 
18

 

For assets measured at fair value on a recurring basis, the fair value measurement by level within the fair value hierarchy are as follows:
 
 
(Level 1)
Quoted Prices In active Markets For Identical Assets
 
(Level 2)
 
Significant Other Observable Inputs
 
(Level 3)
 
Significant Unobservable Inputs
 
           
 
 
March 31, 2012:
   
(In Thousands)
     
Obligations of states and political
subdivisions
$            0
 
$  83,281
 
$            0
 
Mortgage-backed securities
              0
 
   44,990
 
             0
 

 
$            0
 
$128,271
 
$            0
 
 
 
December 31, 2011:
           
Obligations of states and political
subdivisions
$            0
 
$140,953
 
$            0
 
Mortgage-backed securities
              0
 
    48,945
 
             0
 

 
$            0
 
$189,898
 
$            0
 

We may be required to measure certain other financial assets at fair value on a nonrecurring basis.  These adjustments to fair value usually result from the application of lower-of-cost-or-market accounting or write-downs of individual assets.  The Level 3 disclosures shown below represent the carrying value of loans for which adjustments are primarily based on the appraised value of collateral or the present value of expected future cash flows, which often results in significant management assumptions and input with respect to the determination of fair value.  There were no realized or unrealized gains or losses relating to Level 3 financial assets and liabilities measured on a nonrecurring basis for the quarter ended March 31, 2012 and December 31, 2011.

For assets measured at fair value on a nonrecurring basis, the fair value measurement by level within the fair value hierarchy used are as follows:

 
(Level 1)
Quoted Prices In active Markets For Identical Assets
 
(Level 2)
 
Significant Other Observable Inputs
 
(Level 3)
 
Significant Unobservable Inputs
 
           


March 31, 2012:
   
(In Thousands)
     
             
Impaired Loans
$            0
 
$           0
 
$             0
 
             
Other Real Estate Owned
$            0
 
$           0
 
$             0
 

December 31, 2011:
           
             
Impaired Loans
$            0
 
$           0
 
$             0
 
             
Other Real Estate Owned
$            0
 
$           0
 
$             8
 
             
 
There were no impaired loans at March 31, 2012 and December 31, 2011, which were measured using the fair value of the collateral less estimated costs to sell for collateral-dependent loans.
Other real estate owned at December 31, 2011, which is measured using the fair value of the collateral less estimated costs to sell, had a carrying amount of $8,000.
 

 
 
19

 
 
ASC 825-10-65, Transition Related to FSP FAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments,” require disclosure of the fair value of financial assets and financial liabilities, including those financial assets and financial liabilities that are not measured and reported at fair value on a recurring basis or non-recurring basis. The methodologies for estimating the fair value of financial assets and financial liabilities that are measured at fair value on a recurring or non-recurring basis are as discussed above. The methodologies for other financial assets and financial liabilities are discussed below.
 
The carrying amounts and fair values of the Corporation’s financial instruments as of March 31, 2012 are presented in the following table:

(Dollars in Thousands)

   
 
 
 
 
 
Carrying Amount
   
 
 
 
 
Fair
Value Estimate
   
(Level 1)
 Quoted Prices In Active Markets For Identical Assets
   
(Level 2)
 
Significant Other Observable Inputs
   
(Level 3)
 
Significant Unobservable Inputs
 
                               
Financial Assets:
                             
  Cash and equivalents
  $ 47,325     $ 47,325     $ 47,325     $ 0     $ 0  
  Securities available for  sale
    128,271       128,271       0       128,271       0  
  Restricted investment in bank stock
    3,357       3,357       3,357       0       0  
  Net loans receivable
    171,051       175,843       0       0       175,843  
  Accrued interest receivable
    1,615       1,615       1,615       0       0  
Financial liabilities:
                                       
  Deposits
  $ 313,558     $ 308,968     $ 224,210     $ 84,758     $ 0  
  Short-term borrowings
    0       0       0       0       0  
  Long-term borrowings
    0       0       0       0       0  
  Accrued interest payable
    221       221       221       0       0  
                                         
Off-balance sheet financial instruments
    0       0       0       0       0  


 
The carrying amounts and fair values of the Corporation’s financial instruments as of December 31, 2011 are presented in the following table:

   
December 31, 2011
 
   
Carrying Amount
   
Fair
Value
 
(In Thousands)
 
Financial assets:
           
Cash and equivalents
  $ 6,460     $ 6,460  
Securities available for sale
    189,898       189,898  
Restricted investments in bank stock
    3,534       3,534  
Net loans receivable
    177,713       183,458  
               Accrued interest receivable
    2,545       2,545  
Financial liabilities:
               
Deposits
  $ 303,816     $ 299,593  
Short-term borrowings
    29,450       29,450  
Long-term borrowings
    10,000       10,000  
              Accrued interest payable
    281       281  
Off-balance sheet financial instruments
    0       0  

 
 
 
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Cash and Short-Term Investments

The carrying amounts for cash and short-term investments approximate the estimated fair values of such assets.

Securities Available for Sale

The Corporation utilizes a third party in determining the fair values for securities held as available for sale.  For the Corporation’s agency mortgage backed securities, the third party utilizes market data, pricing models that vary based on asset class and include available trade, bid and other market information. Methodology includes broker quotes, proprietary models, descriptive terms and conditions.  The third party uses their own proprietary valuation matrices in determining fair values for municipal bonds.  These matrices utilize comprehensive municipal bond interest rate tables daily to determine market price, movement and yield relationships.
 
Restricted Investments in Bank Stock

The carrying amounts of restricted investments in bank stock approximate the estimated fair value of such assets.

Loans Receivable

Fair values of variable rate loans subject to frequent repricing and which entail no significant credit risk are based on the carrying values.  The estimated fair values of other loans are estimated by discounting the future cash flows using interest rates currently offered for loans with similar terms to borrowers of similar credit quality.

Accrued Interest Receivable

The carrying amounts for accrued interest receivable approximate the estimated fair value of such assets.

Deposits

For deposits which are payable on demand at the reporting date, representing all deposits other than time deposits, management estimated that the carrying value of such deposits is a reasonable estimate of fair value.  Fair values of time deposits are estimated by discounting the future cash flows using interest rates currently being offered and a schedule of aggregate expected maturities.

Short-Term Borrowings

The carrying amounts for short-term borrowings approximate the estimated fair value of such liabilities.


Long-Term Borrowings

Fair values of long-term borrowings are estimated by discounting the future cash flows using interest rates currently available for borrowings with similar terms and maturity.

Accrued Interest Payable

The carrying amounts for accrued interest receivable approximate the estimated fair value of such liabilities.

Off-Balance Sheet Instruments

The fair value of commitments to extend credit and for outstanding letters of credit is estimated using the fees currently charged to enter into similar agreements, taking into account market interest rates, the remaining terms and present credit worthiness of the counterparties.

Note 11   Subsequent Events
 
Commercial National Financial Corporation has evaluated subsequent events through the date these consolidated financial statements were filed with the Securities and Exchange Commission.  We have incorporated into these consolidated financial statements the effect of all material known events determined by ASC Topic 855, “Subsequent Events,” to be recognizable events.




 
21

 


ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
 
AND RESULTS OF OPERATIONS

SAFE HARBOR STATEMENT

Forward-looking statements (statements which are not historical facts) in this Quarterly Report on Form 10-Q are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. For this purpose, any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the generality of the foregoing, words such as “may,” “will,” “to,” “expect,” “believe,” “anticipate,” “intend,” “could,” “would,” “estimate,” or “continue” or the negative or other variations thereof or comparable terminology are intended to identify forward-looking statements. These statements are based on information currently available to the Corporation, and the Corporation assumes no obligation to update these statements as circumstances change. Investors are cautioned that all forward-looking statements involve risk and uncertainties, including changes in general economic and financial market conditions, unforeseen credit problems, and the Corporation’s ability to execute its business plans. The actual results of future events could differ materially from those stated in any forward-looking statements herein.

CRITICAL ACCOUNTING ESTIMATES

Disclosure of the Corporation’s significant accounting policies is included in Note 1 to the Corporation’s Consolidated Financial Statements contained in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2011 (the 2011 Annual Report). Some of these policies are particularly sensitive, requiring that significant judgments, estimates and assumptions be made by management. Additional information is contained in the Management’s Discussion and Analysis section of the 2011 Annual Report for the most sensitive of these issues, including the provision and allowance for loan losses.

Significant estimates are made by management in determining the allowance for loan losses. Management considers a variety of factors in establishing these estimates, including current economic conditions, diversification of the loan portfolio, delinquency statistics, results of internal loan reviews, financial and managerial strengths of borrowers, adequacy of collateral (if collateral dependent) and other relevant factors. Estimates related to the value of collateral also have a significant impact on whether or not the Corporation continues to accrue income on delinquent loans and on the amounts at which foreclosed real estate is recorded in the Consolidated Statements of Financial Condition. Management discussed the development and selection of critical accounting estimates and related Management and Discussion and Analysis disclosure with the Corporation’s Audit Committee. There were no material changes made to the critical accounting estimates during the periods presented within.

OVERVIEW

The Corporation had net income of $3.8 million or $1.33 per share, for the first quarter ended March 31, 2012 compared to $1.4 million or $0.48 per share for the quarter ended March 31, 2011. The Corporation’s return on average assets for the first quarter of 2012 and 2011 was 3.83% and 1.52%, respectively.  Return on average equity for the same two periods was 27.97% and 11.74%, respectively.

In March 2012, the Corporation sold $49.8 million in book value taxable municipal bonds and $7.4 million in book value tax-free municipal bonds. These municipal bond sales resulted in a $3.2 million pre-tax gain which equated to a $2.1 million earnings benefit (or $0.74 per average share outstanding). This action was based on several factors. The main factor was a strategic decision to decrease the Corporation’s future market exposure by reducing the average maturity of the bond portfolio. In addition, the Corporation determined the potential future credit exposure associated with municipal bonds should be reduced. These municipal bond sales provide the Corporation with enhanced liquidity and flexibility going forward. The Corporation used the proceeds to eliminate all FHLB borrowings with the balance being available for future investment opportunities.

The Corporation’s largest segment of operating results is dependent upon net interest income. Net interest income is interest earned on interest-earning assets less interest paid on interest-bearing deposits. For the first quarter ended March 31, 2012 and 2011, net interest income was $4.2 million and $3.8 million, respectively. The Corporation anticipates the ongoing net interest income will be lower based on the March 2012 reduction in investments.

The Corporation’s gain on the sale of municipal bonds in 2012 had a significant positive effect on the Corporation’s March 31, 2012 earnings; the gain on the sale increased the Corporation’s tax rate for the quarter. The March 31, 2012 quarter ending tax rate was 26.87% compared with 15.58% for the first three months of 2011. The Corporation estimates the full year tax rate for 2012 will be in the range of 23-26%.