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EX-32.1 - EXHIBIT 32.2 - COMMERCIAL BANCSHARES INC \OH\v392937_ex32-2.htm

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

 

FORM 10-Q

 

Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the Quarterly Period ended September 30, 2014. Commission File Number 000-27894

 

COMMERCIAL BANCSHARES, INC.

(Exact name of registrant as specified in its charter)

 

 

 

 

OHIO 34-1787239
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)

 

 

118 S. Sandusky Avenue, Upper Sandusky, Ohio 43351

(Address of principal executive offices including zip code)

Registrant’s telephone number, including area code: (419) 294-5781

 

N/A

(Former Name, Former Address and Former Fiscal Year,

if Changed Since Last Report)

 

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, 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 (§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 ¨          No x

 

As of November 13, 2014, the latest practicable date, there were 1,190,418 outstanding of the registrant’s common stock, no par value.

 
 

  

COMMERCIAL BANCSHARES, INC.

 

INDEX

 

 

  Page
   
PART I - FINANCIAL INFORMATION  
     
Item 1. Financial Statements (unaudited)  
     
  Consolidated Balance Sheets 3
     
  Consolidated Statements of Income 4
     
  Consolidated Statements of Comprehensive Income 5
     
  Condensed Consolidated Statements of Changes in Shareholders’ Equity 6
     
  Condensed 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 25
     
Item 3. Quantitative and Qualitative Disclosures about Market Risk 39
     
Item 4. Controls and Procedures 39
     
     
Part II - Other Information  
     
Item 1. Legal Proceedings 40
     
Item 2. Unregistered Sales of Securities and Use of Proceeds 40
     
Item 3. Defaults upon Senior Securities 40
     
Item 4. Mine Safety Disclosures 40
     
Item 5. Other Information 40
     
Item 6. Exhibits 41
     
     
SIGNATURES 42
     
     
EXHIBIT: 13a-14(a) 302 Certification  
  13a-14(a) 906 Certification  

 

 
2
 

 

COMMERCIAL BANCSHARES, INC.

CONSOLIDATED BALANCE SHEETS

 

 

(Dollar amounts in thousands)

 

 

 

   (Unaudited)     
   September 30,   December 31, 
   2014   2013 
ASSETS          
Cash and cash equivalents  $6,129   $4,908 
Federal funds sold   10,014    13,211 
Cash equivalents and federal funds sold   16,143    18,119 
           
Securities available for sale   12,300    13,941 
Other investment securities   2,209    2,259 
Total loans   278,668    269,968 
Allowance for loan losses   (4,364)   (4,343)
Loans, net   274,304    265,625 
Premises and equipment, net   7,322    7,139 
Accrued interest receivable   1,408    1,198 
Bank-owned life insurance   8,849    8,670 
Other assets   2,461    1,047 
Total assets  $324,996   $317,998 
           
LIABILITIES          
Deposits          
Noninterest-bearing demand  $42,746   $48,935 
Interest-bearing demand   118,658    120,262 
Savings and time deposits   75,071    76,008 
Time deposits $100,000 and greater   47,986    36,103 
Total deposits   284,461    281,308 
Federal funds purchased   0    1,757 
FHLB advances   5,221    1,808 
Accrued interest payable   69    56 
Other liabilities   1,664    1,481 
Total liabilities   291,415    286,410 
           
SHAREHOLDERS' EQUITY          
Common stock, no par value; 4,000,000 shares authorized,          
1,190,588 shares issued and 1,190,418 outstanding in 2014          
1,186,638 shares issued and 1,181,068 outstanding in 2013   12,074    11,878 
Retained earnings   22,400    20,586 
Unearned compensation   (191)   (159)
Deferred compensation plan shares; at cost          
53,700 shares in 2014 and 50,777 shares in 2013   (982)   (910)
Treasury stock; 170 shares in 2014 and 5,570 shares in 2013   (4)   (152)
Accumulated other comprehensive income   284    345 
Total shareholders' equity   33,581    31,588 
Total liabilities and shareholders' equity  $324,996   $317,998 

 

See notes to the consolidated financial statements.

 

 
3
 

 

COMMERCIAL BANCSHARES, INC.

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

 

 

(Dollar amounts in thousands, except per share data)

 

 

 

   Three Months Ended   Nine Months Ended 
   September 30,   September 30, 
   2014   2013   2014   2013 
Interest income                    
Interest and fees on loans  $3,577   $3,397   $10,363   $9,924 
Interest on investment securities:                    
Taxable   51    59    158    183 
Tax-exempt   80    98    244    294 
Federal funds sold   7    6    22    32 
Total interest income   3,715    3,560    10,787    10,433 
Interest expense                    
Interest on deposits   203    269    621    894 
Interest on borrowings   12    12    33    33 
Total interest expense   215    281    654    927 
Net interest income   3,500    3,279    10,133    9,506 
Provision for loan losses   26    138    287    289 
                     
Net interest income after                    
provision for loan losses   3,474    3,141    9,846    9,217 
                     
Noninterest income                    
Service fees and overdraft charges   378    377    1,113    1,083 
Gain on sale of bank premises and equipment   0    0    42    0 
Other income   161    159    460    529 
Total noninterest income   539    536    1,615    1,612 
                     
Noninterest expense                    
Salaries and employee benefits   1,535    1,431    4,373    4,292 
Premises and equipment   293    312    921    956 
Miscellaneous loan expense   172    61    281    176 
Professional fees   103    112    307    313 
Data processing   48    56    141    147 
Software maintenance   104    94    306    323 
Advertising and promotional   68    76    182    188 
FDIC deposit insurance   57    68    185    205 
Franchise tax   87    33    290    213 
Loss on repossessed asset sales, net   7    12    24    1 
Other operating expense   310    301    892    839 
Total noninterest expense   2,784    2,556    7,902    7,653 
                     
Income before income taxes   1,229    1,121    3,559    3,176 
Income tax expense   370    329    1,076    926 
                     
Net income  $859   $792   $2,483   $2,250 
                     
Basic earnings per common share  $0.72   $0.67   $2.10   $1.92 
Diluted earnings per common share  $0.71   $0.66   $2.06   $1.90 

 

 

See notes to the consolidated financial statements. 

 

 
4
 

 

COMMERCIAL BANCSHARES, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

 

 

(Dollar amounts in thousands)

 

 

   Three Months Ended 
   September 30, 
   2014   2013 
Net Income  $859   $792 
Unrealized holding gain (loss) on securities:          
Net securities loss during period   (55)   (76)
Tax effect   (19)   (26)
Other comprehensive loss, net of tax   (36)   (50)
Comprehensive income, net of tax  $823    742 

 

 

   Nine Months Ended 
   September 30, 
   2014   2013 
Net Income  $2,483   $2,250 
Unrealized holding gain (loss) on securities:          
Net securities loss during period   (93)   (461)
Tax effect   (32)   (157)
Other comprehensive loss, net of tax   (61)   (304)
Comprehensive income, net of tax  $2,422    1,946 

 

 

 

See notes to the consolidated financial statements.


 
5
 

 

COMMERCIAL BANCSHARES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES

IN SHAREHOLDERS’ EQUITY

(Unaudited)

 

 

(Dollar amounts in thousands, except per share data)

 

 

   Nine Months Ended 
   September 30, 
   2014   2013 
Balance at beginning of period  $31,588   $29,388 
Net income   2,483    2,250 
Other comprehensive loss   (61)   (304)
Stock-based compensation   93    64 
Issuance of treasury stock under stock option plans   33    12 
Deferred compensation plan activity   62    65 
Cash dividends ($0.520 per share in 2014 and $0.445 in 2013)   (617)   (523)
Balance at end of period  $33,581    30,952 

 

 

 

 

See notes to the consolidated financial statements.

 

 
6
 

 

COMMERCIAL BANCSHARES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

 

 

 

   Nine Months Ended 
   September 30, 
   2014   2013 
  ($ in thousands) 
          
Cash flows from operating activities          
Net income  $2,483   $2,250 
Adjustments   311    609 
Net cash from operating activities   2,794    2,859 
          
Cash flows from investing activities          
Securities available for sale:          
Purchases   0    (2,000)
Maturities, calls and repayments   1,531    1,282 
Net change in loans   (10,086)   (12,407)
Proceeds from sale of OREO and other repossessed assets   104    273 
Proceeds from the disposition of premises and equipment   93    2 
Bank premises and equipment expenditures   (699)   (191)
Net cash used in investing activities   (9,057)   (13,041)
          
Cash flows from financing activities          
Net change in deposits   3,153    (366)
Decrease in federal funds purchased   (1,757)   0 
FHLB advances   7,000    9,000 
Repayment of FHLB advances   (3,587)   (3,085)
Cash dividends paid   (617)   (523)
Issuance of treasury stock under stock option plans   33    12 
Deferred compensation plan activity   62    65 
Net cash provided by financing activities   4,287    5,103 
          
Net change in cash equivalents and federal funds sold   (1,976)   (5,079)
          
Cash equivalents and federal funds sold at beginning of period   18,119    22,904 
          
Cash equivalents and federal funds sold at end of period  $16,143   $17,825 
          
          
Supplemental disclosures          
Cash paid for interest  $641   $946 
Cash paid for income taxes   1,200    1,020 
Non-cash transfer of loans to foreclosed/repossessed assets   1,199    160 

 

 

See notes to the consolidated financial statements.

 

 
7
COMMERCIAL BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Principles of Consolidation: The accompanying consolidated financial statements include the accounts of Commercial Bancshares, Inc. (the “Corporation”) and its wholly owned subsidiaries, Commercial Financial and Insurance Agency, LTD (“Commercial Financial”) and The Commercial Savings Bank (the “Bank”). All significant intercompany balances and transactions have been eliminated in consolidation.

 

The condensed consolidated financial statements have been prepared without audit. In the opinion of management, all adjustments (which include normal recurring adjustments) necessary to present fairly the Corporation’s financial position at September 30, 2014, and the results of operations and changes in cash flows for the periods presented have been made.

 

Certain information and footnote disclosures typically included in financial statements prepared in accordance with U.S. generally accepted principles have been omitted. The Annual Report for the year ended December 31, 2013, contains consolidated financial statements and related footnote disclosures, which should be read in conjunction with the accompanying consolidated financial statements. The results of operations for the nine months ended September 30, 2014 are not necessarily indicative of the operating results for the full year or any future interim period.

 

 

NOTE 2 EARNINGS PER SHARE

 

Weighted average shares used in determining basic and diluted earnings per share for the three months ended September 30, 2014 and 2013.

 

   2014   2013 
        
Weighted average shares outstanding during the period   1,187,978    1,177,864 
Dilutive effect of stock options   20,970    14,190 
Weighted average shares considering dilutive effect   1,208,948    1,192,054 
          
Anti-dilutive stock options not considered in computing diluted earnings per share   1,000    1,000 

  

Weighted average shares used in determining basic and diluted earnings per share for the nine months ended September 30, 2014 and 2013.

 

   2014   2013 
        
Weighted average shares outstanding during the period   1,184,703    1,173,259 
Dilutive effect of stock options   18,569    13,145 
Weighted average shares considering dilutive effect   1,203,272    1,186,404 
          
Anti-dilutive stock options not considered in computing diluted earnings per share   12,000    10,950 

 

 
8
COMMERCIAL BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 3 INVESTMENT SECURITIES

 

The amortized cost and estimated fair value of securities available for sale at the dates indicated are presented in the following table.

 

   September 30, 2014 
       Gross   Gross     
   Amortized   Unrealized   Unrealized   Fair 
(Dollar amounts in thousands)  Cost   Gains   Losses   Value 
U.S. Government Agency securities  $2,000   $0   $(39)  $1,961 
State and political subdivisions   7,355    298    (2)   7,651 
Mortgage-backed securities   2,515    173    0    2,688 
Total securities available for sale  $11,870   $471    (41)   12,300 

 

   December 31, 2013 
       Gross   Gross     
   Amortized   Unrealized   Unrealized   Fair 
(Dollar amounts in thousands)  Cost   Gains   Losses   Value 
U.S. Government Agency securities  $2,000   $0   $(60)  $1,940 
State and political subdivisions   8,424    395    0    8,819 
Mortgage-backed securities   2,994    188    0    3,182 
Total securities available for sale  $13,418   $583    (60)   13,941 

 

The estimated fair values of investment securities at September 30, 2014, by contractual maturity are shown below. Securities not due at a single maturity date, primarily mortgage-backed securities, are shown separately.

 

   Amortized   Fair 
(Dollar amounts in thousands)  Cost   Value 
Due less than one year  $1,286   $1,314 
Due after one year through five years   5,852    6,025 
Due after five years through ten years   2,217    2,273 
Due after ten years   0    0 
Mortgage-backed securities   2,515    2,688 
Total securities available for sale  $11,870   $12,300 

 

At September 30, 2014 and December 31, 2013, securities with a carrying value of $9,838,000 and $10,371,000, respectively, were pledged to secure public deposits and other deposits and liabilities as required or permitted by law.

 

Gross unrealized losses on securities and the estimated fair value of the related securities aggregated by security category and length of time the individual securities have been in continuous loss positions at September 30, 2014 and December 31, 2013.

 

(Dollar amounts in thousands)  Less Than Twelve Months   More Than Twelve Months 
   Gross       Gross     
   Unrealized   Fair   Unrealized   Fair 
September 30, 2014  Losses   Value   Losses   Value 
U.S. Government Agency securities  $0   $0   $(39)  $1,961 
State and political subdivisions   (2)   201    0    0 
Mortgage-backed securities   0    0    0    0 
Total available for sale  $(2)  $201   $(39)  $1,961 

 

 

 
9
COMMERCIAL BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

(Dollar amounts in thousands)  Less Than Twelve Months   More Than Twelve Months 
   Gross       Gross     
   Unrealized   Fair   Unrealized   Fair 
December 31, 2013  Losses   Value   Losses   Value 
U.S. Government Agency securities  $(60)  $1,940   $0   $0 
State and political subdivisions   0    0    0    0 
Mortgage-backed securities   0    0    0    0 
Total available for sale  $(60)  $1,940   $0   $0 

 

At September 30, 2014 the Corporation held one security with an estimated fair value of $1,961,000 and an unrealized loss of $39,000 in a continuous unrealized loss position for more than twelve months and one security with an estimated fair value of $201,000 with an unrealized loss of $2,000 in a continuous loss position for less than 12 months. At December 31, 2013, there were no securities in a continuous loss position for more than twelve months and one security with an estimated fair value of $1,940,000 and an unrealized loss of $60,000 in a continuous loss position for less than twelve months.

 

The unrealized losses that exist are primarily due to the changes in market interest rates subsequent to purchase. The Corporation does not consider these investments to be other than temporarily impaired at September 30, 2014 and December 31, 2013 since the decline in market value is primarily attributable to changes in interest rates and not credit quality. In addition, the Corporation does not intend to sell and does not believe that it is more likely than not that the Corporation will be required to sell these investments until there is a full recovery of the unrealized loss, which may be at maturity. As a result, management does not believe that the investment securities in an unrealized loss position at September 30, 2014, represent an other-than-temporary impairment.

 

Other investment securities are carried at cost and consist principally of stock in the Federal Home Loan Bank of Cincinnati.

 

 

NOTE 4 ALLOWANCE FOR LOAN LOSSES

 

The following tables provide information on the activity in the allowance for loan losses by portfolio segment for the periods indicated.

 

   Commercial   Real Estate   Consumer   Total 
   (Dollar amounts in thousands) 
For the Three Months Ended September 30, 2014                
Beginning balance – July 1, 2014  $3,548   $261   $545   $4,354 
Charge-offs   (6)   (31)   (2)   (39)
Recoveries   11    8    4    23 
Net   5    (23)   2    (16)
Provision   (5)   31    0    26 
Ending Balance – September 30, 2014  $3,548   $269   $547   $4,364 

 

 

   Commercial   Real Estate   Consumer   Total 
   (Dollar amounts in thousands) 
For the Three Months Ended September 30, 2013                
Beginning balance – July 1, 2013  $3,279   $285   $603   $4,167 
Charge-offs   0    0    (62)   (62)
Recoveries   10    0    15    25 
Net   10    0    (47)   (37)
Provision   84    0    54    138 
Ending Balance – September 30, 2013  $3,373   $285   $610   $4,268 

 

 

 
10
COMMERCIAL BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

   Commercial   Real Estate   Consumer   Total 
   (Dollar amounts in thousands) 
For the Nine Months Ended September 30, 2014                
Beginning balance – January 1, 2014  $3,517   $235   $591   $4,343 
Charge-offs   (219)   (31)   (75)   (325)
Recoveries   26    8    25    59 
Net   (193)   (23)   (50)   (266)
Provision   224    57    6    287 
Ending Balance – September 30, 2014  $3,548   $269   $547   $4,364 

 

 

   Commercial   Real Estate   Consumer   Total 
   (Dollar amounts in thousands) 
For the Nine Months Ended September 30, 2013                
Beginning balance – January 1, 2013  $3,175   $284   $582   $4,041 
Charge-offs   (4)   (19)   (130)   (153)
Recoveries   40    8    43    91 
Net   36    (11)   (87)   (62)
Provision   162    12    115    289 
Ending Balance – September 30, 2013  $3,373   $285   $610   $4,268 

 

 

The following table presents the allocation of the allowance for loan losses and the recorded investment in loans (in thousands) by portfolio segment at September 30, 2014 and 2013.

 

   Collectively Evaluated   Individually Evaluated   Total 
   Allowance   Recorded   Allowance   Recorded   Allowance   Recorded 
   for loan   investment   for loan   investment   for loan   investment 
   losses   in loans   losses   in loans   losses   in loans 
September 30, 2014                              
Commercial  $3,074   $215,900   $474   $9,068   $3,548   $224,968 
Real estate   269    21,531    0    0    269    21,531 
Consumer   547    32,169    0    0    547    32,169 
Total  $3,890   $269,600   $474   $9,068   $4,364   $278,668 

 

                        
September 30, 2013                              
Commercial  $2,831   $195,623   $542   $10,175   $3,373   $205,798 
Real estate   285    18,110    0    0    285    18,110 
Consumer   610    35,656    0    0    610    35,656 
Total  $3,726   $249,389   $542   $10,175   $4,268   $259,564 

 

 
11
COMMERCIAL BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 5 CREDIT QUALITY INDICATORS

 

As part of its monitoring process, the Corporation categorizes loans when the loan is initially under written into risk categories based on relevant information about the ability of borrowers to service their debt. The assessment considers numerous factors including, but not limited to, current financial information, historical payment experience, credit documentation, public information and current economic trends, among other factors. Loans are graded on a scale of 1 through 9, with a grade of 5 or below classified as “Pass” rated credits. Following is a description of the general characteristics of risk grades 6 through 9:

 

6 – Special Mention These credits have a level of potential weakness such that they warrant management’s closer attention than those on watch.  These credits, opposed to watch credits, require correction or additional financial information for further analysis and verification of repayment capacity.  If left uncorrected, these weaknesses may result in deterioration of the repayment prospects for the asset or in the institution’s credit position at some future date.  Special mention assets are not considered adversely classified assets.  Such credits, do however, warrant consideration of additional reserve.
   
7 – Substandard Substandard loans are inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any.  Loans so classified must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt.  They are characterized by the distinct possibility that the Bank will sustain loss if the deficiencies are not corrected.
   
8 – Doubtful Loans classified doubtful have all the weaknesses inherent in those classified substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently known facts, conditions and values, highly questionable and improbable.
   
9 – Loss Loans are considered uncollectible and of such little value that continuing to carry them as assets on the institution’s financial statements is not feasible.  Accordingly, the Bank does not carry loans classified as loss on the books, instead these loans are charged off.

 

The Corporation’s strategy for credit risk management includes ongoing credit examinations and management reviews of loans exhibiting deterioration of credit quality. A deteriorating credit indicates an elevated likelihood of delinquency. When a loan becomes delinquent, its credit grade is reviewed and changed accordingly. Each downgrade to a classified credit results in a higher percentage of reserve to reflect the increased likelihood of loss for similarly graded credits. Further deterioration could result in a certain credit being deemed impaired, resulting in a collateral valuation for purposes of establishing a specific reserve which reflects the possible extent of such loss for that credit.

 

The following tables present the risk category of loans by class of loans based on the most recent analysis performed at September 30, 2014 and December 31, 2013.

 

Commercial Credit Exposure (dollar amounts in thousands)

Credit risk profile by credit worthiness category

  

                   Commercial   Commercial         
   Commercial   Commercial   Real Estate   Real Estate   Total 
Credit  Operating   Agricultural   1-4 Family   Other   Commercial 
Grade   09/30/14    12/31/13    09/30/14    12/31/13    09/30/14    12/31/13    09/30/14    12/31/13    09/30/14    12/31/13 
Pass  $27,893   $31,967   $44,031   $40,844   $40,369   $41,331   $102,528   $90,104   $214,821   $204,246 
6   2,914    0    0    0    0    0    113    2,801    3,027    2,801 
7   1,035    1,341    159    163    859    1,125    5,067    6,622    7,120    9,251 
8   0    0    0    0    0    0    0    0    0    0 
Total  $31,842   $33,308   $44,190   $41,007   $41,228   $42,456   $107,708   $99,527   $224,968   $216,298 

 

 

 
12
COMMERCIAL BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Real Estate Credit Exposure (dollar amounts in thousands)

Credit risk by credit worthiness category

   Real Estate   Real Estate   Total 
Credit  Construction   Other   Real Estate 
Grade  09/30/14   12/31/13   09/30/14   12/31/13   09/30/14   12/31/13 
Pass  $4,029   $3,246   $17,345   $14,445   $21,374   $17,691 
6   0    0    138    142    138    142 
7   0    130    19    843    19    973 
8   0    0    0    0    0    0 
Total  $4,029   $3,376   $17,502   $15,430   $21,531   $18,806 

 

Consumer Credit Exposure (dollar amounts in thousands)

Credit risk by credit worthiness category

 

   Consumer   Consumer   Consumer   Total 
Credit  Equity   Auto   Other   Consumer 
Grade   09/30/14    12/31/13    09/30/14    12/31/13    09/30/14    12/31/13    09/30/14    12/31/13 
Pass  $17,828   $18,304   $4,850   $5,175   $9,120   $10,848   $31,798    34,327 
6   0    0    0    0    0    0    0    0 
7   209    530    0    3    162    4    371    537 
8   0    0    0    0    0    0    0    0 
Total  $18,037   $18,834   $4,850   $5,178   $9,282   $10,852   $32,169   $34,864 

 

 

NOTE 6 SUMMARY OF IMPAIRED LOANS

 

Loans evaluated for impairment include loans classified as troubled debt restructurings and non-performing multi-family, commercial and construction loans. The following tables set forth certain information regarding the Corporation’s impaired loans, segregated by those for which a specific allowance was required and those for which a specific allowance was not necessary at September 30, 2014 and December 31, 2013.

 

 

(Dollar amounts in thousands)      Unpaid     
Recorded  Recorded   Principal   Related 
September 30, 2014  Investment   Balance   Allowance 
With no related allowance recorded:               
Commercial operating  $0   $0   $0 
Commercial real estate, 1-4 family   0    0    0 
Commercial real estate, other   4,065    4,065    0 
Subtotal  $4,065   $4,065   $0 
                
With an allowance recorded:               
Commercial operating   822    944    103 
Commercial real estate, 1-4 family   1,632    1,632    136 
Commercial real estate, other   2,549    2,549    235 
Subtotal  $5,003   $5,125    474 
Total  $9,068   $9,190   $474 

 

 

 
13
COMMERCIAL BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

       Unpaid     
   Recorded   Principal   Related 
December 31, 2013  Investment   Balance   Allowance 
With no related allowance recorded:               
Commercial operating  $66   $66   $0 
Commercial real estate, 1-4 family   54    54    0 
Commercial real estate, other   6,876    6,876    0 
Subtotal  $6,996   $6,996   $0 
                
With an allowance recorded:               
Commercial operating   967    967    111 
Commercial real estate, 1-4 family   1,679    1,679    232 
Commercial real estate, other   1,282    1,282    181 
Subtotal  $3,928   $3,928   $524 
Total  $10,924   $10,924   $524 

 

Impaired loans with no related allowance recorded at September 30, 2014 was $4,065,000, a decrease of $2,931,000 or 41.9% from $6,996,000 at year-end 2013, while loans with a specified reserve increased 27.4% or $1,075,000. Total impaired loans decreased 17.0% to $9,068,000 at September 30, 2014 from $10,924,000 at December 31, 2013. The decrease in impaired loans is largely due to the transfer of one large commercial credit of approximately $1,101,000 to OREO. The specified reserve related to impaired loans totaled $474,000 at September 30, 2014 compared to $524,000 at December 31, 2013. 

 

The following tables present the average recorded investment in impaired loans and the amount of interest income recognized on a cash basis for impaired loans after impairment by portfolio segment and class for the periods indicated. (All dollar amounts in thousands)

 

 

   No Related   With Related     
   Allowance Recorded   Allowance Recorded   Total 
   Average   Total Interest   Average   Total Interest   Average   Total Interest 
Three Months Ended  Recorded   Income   Recorded   Income   Recorded   Income 
September 30, 2014  Investment   Recognized   Investment   Recognized   Investment   Recognized 
Commercial:                              
Operating  $0   $0   $823   $2   $823   $2 
Real estate, 1-4 family   0    0    1,638    16    1,638    16 
Real estate, other   4,068    69    2,547    23    6,615    92 
Total  $4,068   $69   $5,008   $41   $9,076   $110 
                              
Three Months Ended                              
September 30, 2013                              
Commercial:                              
Operating  $133   $1   $850   $0   $983   $1 
Real estate, 1-4 family   91    0    1,688    47    1,779    47 
Real estate, other   6,236    40    1,191    0    7,427    40 
Total  $6,460   $41   $3,729   $47   $10,189   $88 

 

 

 
14
COMMERCIAL BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

   No Related   With Related     
   Allowance Recorded   Allowance Recorded   Total 
   Average   Total Interest   Average   Total Interest   Average   Total Interest 
Nine Months Ended  Recorded   Income   Recorded   Income   Recorded   Income 
September 30, 2014  Investment   Recognized   Investment   Recognized   Investment   Recognized 
Commercial:                              
Operating  $0   $0   $828   $6   $828   $6 
Real estate, 1-4 family   0    0    1,654    50    1,654    50 
Real estate, other   4,080    192    2,611    72    6,691    264 
Total  $4,080   $192   $5,093   $128   $9,173   $320 
                               
Nine Months Ended                              
September 30, 2013                              
Commercial:                              
Operating  $134   $5   $862   $0   $996   $5 
Real estate, 1-4 family   92    0    1,700    47    1,792    47 
Real estate, other   6,303    86    1,208    0    7,511    86 
Total  $6,529   $91   $3,770   $47   $10,299   $138 

 

 

NOTE 7 TROUBLED DEBT RESTRUCTURINGS

 

A modification of a loan constitutes a troubled debt restructured loan when a borrower is experiencing financial difficulty and the modification constitutes a concession. The Corporation offers various types of concessions when modifying a loan. Concessionary modifications may include, but are not limited to, delays in required payments of principal and interest for a specified period, reduction of the stated interest rate of the loan, reduction of accrued interest, extension of the maturity date or reduction of the face amount or maturity amount of the debt. A concession has been granted when, as a result of the restructuring, the Corporation does not expect to collect all amounts due, including interest at the original stated rate.

 

Similar to other impaired loans, TDRs are measured for impairment based on the present value of expected payments using the loan’s original effective interest rate as the discount rate, or the fair value of the collateral, less selling costs if the loan is collateral dependent. If the recorded investment in the loan exceeds the measure of fair value, impairment is recognized by establishing a valuation allowance as part of the allowance for loan losses or a charge-off to the allowance for loan losses. In periods subsequent to the modification, all TDRs are evaluated individually, including those that have payment defaults, for possible impairment.

 

There have been no financing receivables modified as troubled debt restructurings during the three and nine months ended September 30, 2014. The following table summarizes information relative to loan modifications determined to be troubled debt restructurings during the three and nine months ended September 30, 2013.

  

      Outstanding   Unpaid 
(Dollar amounts in thousands)  Number   Recorded   Principal 
   of TDRs   Investment   Balance 
Three Months Ended September 30, 2013               
Commercial, operating   0   $0   $0 
Commercial real estate, 1-4 family   0    0    0 
Commercial real estate, other   1    2,192    2,192 
Total   1   $2,192   $2,192 

 

 
15
COMMERCIAL BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

      Outstanding   Unpaid 
(Dollar amounts in thousands)  Number   Recorded   Principal 
   of TDRs   Investment   Balance 
Nine Months Ended September 30, 2013               
Commercial, operating   0   $0   $0 
Commercial real estate, 1-4 family   0    0    0 
Commercial real estate, other   1    2,192    2,192 
Total   1   $2,192   $2,192 

 

One TDR, totaling $1,000,000, within the commercial real estate category, was transferred to OREO during the nine months ended September 30, 2014. The Bank accepted a deed-in-lieu of foreclosure and an agreement to sell the property at an amount that will be sufficient to pay the balance due. There are no commitments to lend additional funds to borrowers that are classified as troubled debt restructurings at September 30, 2014.

  

 

NOTE 8 AGE ANALYSIS OF PAST DUE FINANCING RECEIVABLES

 

The following table presents the aging of the recorded investment in loans by past due category and class of loans at September 30, 2014 and December 31, 2013 (dollar amounts in thousands).

 

                          Recorded 
   30-59   60-89   >90           Total   Investment 
   Days   Days   Days   Total       Financing   > 90 Days 
September 30, 2014  Past Due   Past Due   Past Due   Past Due   Current   Receivables   and Accruing 
Commercial                                   
Operating  $0   $0   $706   $706   $31,136   $31,842   $0 
Agricultural   0    0    0    0    44,190    44,190    0 
Real estate, 1-4 family   0    0    24    24    41,204    41,228    0 
Real estate, other   0    0    1,104    1,104    106,604    107,708    0 
Real estate                                   
Construction   0    0    0    0    4,029    4,029    0 
Other   23    0    0    23    17,479    17,502    0 
Consumer                                   
Equity   43    0    62    105    17,932    18,037    0 
Auto   0    0    0    0    4,850    4,850    0 
Other   0    4    8    12    9,270    9,282    0 
Total  $66   $4   $1,904   $1,974   $276,694   $278,668   $0 

 

 

                          Recorded 
   30-59   60-89   >90           Total   Investment 
   Days   Days   Days   Total       Financing   > 90 Days 
December 31, 2013  Past Due   Past Due   Past Due   Past Due   Current   Receivables   and Accruing 
Commercial                                   
Operating  $946   $0   $87   $1,033   $32,275   $33,308   $0 
Agricultural   0    0    0    0    41,007    41,007    0 
Real estate, 1-4 family   31    13    54    98    42,358    42,456    0 
Real estate, other   60    0    1,121    1,181    98,346    99,527    0 
Real estate                                   
Construction   0    0    0    0    3,376    3,376    0 
Other   24    0    130    154    15,276    15,430    0 
Consumer                                   
Equity   14    1    343    358    18,476    18,834    0 
Auto   0    0    0    0    5,178    5,178    0 
Other   60    4    0    64    10,788    10,852    0 
Total  $1,135   $18   $1,735   $2,888   $267,080   $269,968   $0 

 

 

 
16
COMMERCIAL BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 9 FINANCING RECEIVABLES ON NONACCRUAL STATUS

 

The following table summarizes loans (in thousands) on nonaccrual status by class at the dates indicated.

 

   September 30, 2014   December 31, 2013 
Commercial operating  $706   $949 
Commercial real estate, 1-4 family   213    278 
Commercial real estate, other   1,138    1,286 
Real estate, construction   0    0 
Real estate, other   19    137 
Consumer equity   78    358 
Consumer auto   0    3 
Consumer other   177    4 
Total  $2,331    3,015 

  

 

NOTE 10 FAIR VALUES AND MEASUREMENTS OF FINANCIAL INSTRUMENTS

 

The Corporation groups its assets and liabilities measured at fair value into a three-level hierarchy for valuation techniques used to measure assets and liabilities at fair value. This hierarchy is based on whether the valuation inputs are observable or unobservable. These levels are:

 

·Level 1 – Quoted prices in active markets for identical assets or liabilities.

 

·Level 2 – Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities in active markets, and other inputs such as interest rates and yield curves that are observable at commonly quoted intervals.

 

·Level 3 – Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

 

In instances where inputs used to measure fair value fall into different levels in the above fair value hierarchy, fair value measurements in their entirety are categorized based on the lowest level input that is significant to the valuation. The Corporation’s assessment of the significance of particular inputs to these fair value measurements requires significant management judgment or estimation and considers factors specific to each asset or liability.

 

State and political subdivisions

 

The Corporation obtains fair value measurements from a third party vendor that utilizes market valuation models maintained by a team of experienced evaluators and methodologists. Evaluators build internal yield curves, which are adjusted throughout the day based on trades and other pertinent market information. The criteria used to generate these curves and to arrive at the current day’s evaluations are based primarily on factors such as:

 

·Established trading spreads between similar issuers or credits.
·Historical trading spreads over widely accepted market benchmarks.
·New issue scales.
·Market information from third party sources, such as reportable trades, broker-dealers, trustees/paying agents, issuers or from information prepared by an internal credit analysis department or by internally reviewing market sector correlations.

 

Evaluators apply this information to bond sectors, and individual bond evaluations are then extrapolated. Within a given sector, evaluators have the ability to make daily spread adjustments for various attributes that include, but are not limited to, discounts, premiums, credit, alternative minimum tax (AMT), use of proceeds and callability. Analysts evaluate municipal securities backed by insurance, letters of credit, etc. When a municipal bond obtains insurance or other credit enhancements, a public rating is usually applied to the bond that is equal to the higher of (i) the published underlying rating or (ii) the rating of the bond insurer, guarantor, or other credit enhancing entity’s rating. Certain insured bonds with no published underlying ratings may receive an internal credit assessment. Evaluators may use internal credit ratings as an input in the evaluation process. The weight placed on internal credit ratings in the evaluation process may vary from one municipal security to another depending on the availability of other market data.

 

 
17
COMMERCIAL BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Multiple quality control evaluation processes review available market, credit and deal level information to support the evaluation of securities, such as:

 

·Explanations required for all high yield municipal security evaluations adjusted on a per security basis.
·Explanations required for all high grade municipal security evaluation adjustments that break an internal tolerance level.
·Daily review of market information and data changes (including ratings) that may have an impact on evaluations.
·Review of unchanged evaluations and other applicable data.
·Daily review of category adjustments to confirm directional moves are tracking daily market movements.
·Daily reviews by managers of tolerance reports and of evaluator checklists to confirm processes are being followed.
·Monthly management reviews of evaluator work samples (tolerance reports, client challenges and other evaluation-related matters)

  

U.S. Government and federal agencies and mortgage-backed securities

 

For agency/CMOs, depending upon the characteristics of a given tranche, a volatility-driven, multi-dimensional spread table based, single cash flow stream model or an option-adjusted spread (OAS) model is used. If call information is available, the pricing model computes both a yield to call and a yield to maturity to derive an evaluated price for the bond by assuming the most probable scenario. Alternatively, the evaluator may utilize market conventions if different from model-generated assumptions.

 

A team of experienced fixed income evaluators and methodologists closely monitor the structured product markets, interest rate movements, new issue information and other pertinent data. Evaluations of tranches (volatile and non-volatile) are based on the interactive data model’s interpretation of accepted market modeling, trading and pricing conventions. The Interactive data model determines tranche evaluations in four steps:

 

1Cash flows are generated with the deal files to determine principal and interest payments along with an average life.

 

2Spreads/yields are determined for non-volatile fixed and floating-rate issues:

 

·For agency/GSE CMOs, the model takes the average life for each tranche and matches it to the yield of the nearest point on either the swap curve or the “I” Treasury curve. It then uses that benchmark yield as the base yield.

 

·Floating-rate issues are evaluated by a discount margin (DM) calculation. The DM measures the difference between the yield of the issue (at an assumed speed and current index) and the current value of the index over which the security resets.

 

3Spreads are based on tranche characteristics such as average life, tranche type, tranche volatility, underlying collateral and the performance of the collateral and prevailing market conditions. Floating-rate issues take life caps into account.

 

4The appropriate tranche spread or DM is applied to the corresponding benchmark. This value is then used to discount the cash flows to generate an evaluated price.

 

 

 
18
COMMERCIAL BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

The following table presents information about the Corporation’s assets and liabilities measured at fair value on a recurring basis as of September 30, 2014 and December 31, 2013, and the valuation techniques used by the Corporation to determine those fair values.

 

   Quoted Prices in   Significant   Significant     
(Dollar amounts in thousands)  Active Markets   Observable   Unobservable     
   For Identical   Inputs   Inputs     
September 30, 2014  Assets (Level 1)   (Level 2)   (Level 3)   Balance 
Assets                    
U.S. Government Agency securities  $0   $1,961   $0   $1,961 
State and political subdivisions   0    7,651    0    7,651 
Mortgage-backed securities   0    2,688    0    2,688 
Total Assets  $0   $12,300   $0   $12,300 
Liabilities  $0   $0   $0   $0 

 

   Quoted Prices in   Significant   Significant     
(Dollar amounts in thousands)  Active Markets   Observable   Unobservable     
   For Identical   Inputs   Inputs     
December 31, 2013  Assets (Level 1)   (Level 2)   (Level 3)   Balance 
Assets                    
U.S. Government Agency securities  $0   $1,940   $0   $1,940 
State and political subdivisions   0    8,819    0    8,819 
Mortgage-backed securities   0    3,182    0    3,182 
Total Assets  $0   $13,941   $0   $13,941 
Liabilities  $0   $0   $0   $0 

 

Securities characterized as having Level 2 inputs generally consist of obligations of U.S. Government and federal agencies, government-sponsored organizations and obligations of state and political subdivisions. There were no transfers in or out of Levels 1 and 2 for the nine months ended September 30, 2014.

 

The Corporation also has assets that, under certain conditions, are subject to measurement at fair value on a non-recurring basis. These assets consist primarily of impaired loans and other real estate owned (“OREO”). Loans considered impaired under ASC 310-10-35, Receivables, are loans for which, based on current information and events, it is probable that the Corporation will be unable to collect all principal and interest payments due in accordance with the contractual terms of the loan agreement. Impaired loans can be measured based on the present value of expected payments using the loan’s original effective rate as the discount rate, the loan’s observable market price or the fair value of the collateral less selling costs if the loan is collateral dependent.

 

The following table presents financial assets and liabilities measured on a nonrecurring basis:

 

Fair Value Measurements at Reporting Date Using

  Balance at             
(In thousands)  September 30, 2014   Level 1   Level 2   Level 3 
Impaired loans  $9,068   $0   $0   $9,068 
Real estate acquired through foreclosure   1,070    0    0    1,070 
                     
                     
  Balance at             
(In thousands)  December 31, 2013    Level 1    Level 2    Level 3 
Impaired loans  $10,924   $0   $0   $10,924 
Real estate acquired through foreclosure   20    0    0    20 

 

 
19
COMMERCIAL BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

The fair value of impaired loans were primarily measured based on the value of the collateral securing these loans. Impaired loans are classified within Level 3 of the fair value hierarchy. Collateral may be real estate and/or business assets including equipment, inventory and/or accounts receivable. The Corporation determines the value of the collateral based on independent appraisals performed by qualified licensed appraisers. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Appraised values are discounted for costs to sell and may be discounted further based on management’s historical knowledge, changes in market conditions from the date of the most recent appraisal and/or management’s expertise and knowledge of the customer and the customer’s business. Such discounts by management are subjective and are typically significant unobservable inputs for determining fair value. Impaired loans are subject to nonrecurring fair value adjustments to reflect (1) partial write-downs that are based on the observable market price or current appraised value of the collateral, or (2) the full charge-off of the loan carrying value.

 

Included in the impaired balance at September 30, 2014 were troubled debt restructured loans with a balance of $7,794,000 which have specified reserves of $435,000.

 

Other real estate owned, consisting of properties obtained through foreclosure or in satisfaction of loans, are initially recorded at the lower of the loan’s carrying amount or the fair value less costs to sell upon transfer of the loans to OREO. Subsequently, other real estate owned is carried at the lower of carrying value or fair value less costs to sell. Fair values are generally based on third party appraisals of the property and are classified within Level 3 of the fair value hierarchy. The appraisals are sometimes further discounted based on management’s expertise and knowledge of the customer and the customer’s business. Such discounts are typically significant unobservable inputs for determining fair value. In cases where the carrying amount exceeds the fair value, less costs to sell, a loss is recognized in noninterest expense. Additionally, any operating costs incurred after acquisition are also expensed.

 

 

The tables below present the estimated fair values of the Corporation’s financial instruments for the periods indicated.

 

           Quoted Prices   Significant     
           In Active   Other   Significant 
(Dollar amounts in thousands)          Markets for   Observable   Unobservable 
   Carrying   Estimated   Identical Assets   Inputs   Inputs 
September 30, 2014  Amount   Fair Value   (Level 1)   (Level 2)   (Level 3) 
Financial Assets:                         
Cash equivalents and federal funds sold  $16,143   $16,143   $16,143   $0   $0 
Securities available for sale   12,300    12,300    0    12,300    0 
Other investment securities   2,209    2,209    0    0    2,209 
Loans, net of allowance for loan loss   274,304    283,118    0    0    283,118 
Accrued interest receivable   1,408    1,408    0    0    1,408 
                         
Financial Liabilities:                         
Noninterest-bearing deposits  $(42,746)  $(42,746)  $(42,746)  $0   $0 
Interest-bearing deposits   (144,249)   (144,249)   0    (144,249)   0 
Time deposits   (97,466)   (97,474)   0    (97,474)   0 
FHLB advances   (5,221)   (5,067)   0    (5,067)   0 
Accrued interest payable   (69)   (69)   0    0    (69)

 

 

 
20
COMMERCIAL BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

           Quoted Prices   Significant     
           In Active   Other   Significant 
(Dollar amounts in thousands)          Markets for   Observable   Unobservable 
   Carrying   Estimated   Identical Assets   Inputs   Inputs 
December 31, 2013  Amount   Fair Value   (Level 1)   (Level 2)   (Level 3) 
Financial Assets:                         
Cash equivalents and federal funds sold  $18,119   $18,119   $18,119   $0   $0 
Securities available for sale   13,941    13,941    0    13,941    0 
Other investment securities   2,259    2,259    0    0    2,259 
Loans, net of allowance for loan loss   265,625    268,060    0    0    268,060 
Accrued interest receivable   1,198    1,198    0    0    1,198 
                          
Financial Liabilities:                         
Noninterest-bearing deposits  $(48,935)  $(48,935)  $(48,935)  $0   $0 
Interest-bearing deposits   (144,733)   (144,733)   0    (144,733)   0 
Time deposits   (87,640)   (85,771)   0    (85,771)   0 
Federal funds purchased   (1,757)   (1,757)   0    (1,757)     
FHLB advances   (1,808)   (1,477)   0    (1,477)   0 
Accrued interest payable   (56)   (56)   0    0    (56)

 

The following describes the valuation methodologies used by management to measure financial assets and liabilities at fair value. Where appropriate, the description includes information about the valuation models and key inputs to those models.

 

·Cash equivalents and federal funds sold – The carrying value of cash, amounts due from banks and federal funds sold assumed to approximate fair value.

 

·Investment securities – Fair value is based on quoted market prices in active markets for identical assets or similar assets in active markets. If quoted market prices are not available, with the assistance of an independent pricing service, management’s fair value measurements consider observable data which may include market maker bids, quotes and pricing models. Inputs to the pricing models include recent trades, benchmark interest rates, spreads and actual and projected cash flows.

 

·Other investment securities – principally consists of investments in Federal Home Loan Bank stock, which has limited marketability and is carried at cost.

 

·Loans – The loan portfolio includes adjustable and fixed-rate loans, the fair value of which is estimated using discounted cash flow analyses. To calculate discounted cash flows, the loans are aggregated into pools of similar types and expected repayment terms. The expected cash flows were based on historical prepayment experiences and estimated credit losses for non-performing loans and were discounted using current rates at which similar loans would be made to borrowers with similar credit ratings and similar remaining maturities. Fair values for impaired loans are estimated using discounted cash flow analyses or underlying collateral values, where applicable.

 

·Accrued interest receivable – The carrying value of accrued interest receivable approximates fair value due to the short-term duration.

 

·Noninterest-bearing deposits – The fair value of noninterest-bearing demand deposits, which have no stated maturity, were considered equal to their carrying amount, representing the amount payable on demand.

 

·Interest-bearing deposits – The fair value of demand, money market and savings deposits, which have no stated maturity, were considered equal to their carrying amount, representing the amount payable on demand.

 

 
21
COMMERCIAL BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

·Time deposits – The fair value for fixed-rate time deposits is estimated using a discounted cash flow calculation that applies interest rates currently being offered for time deposits with similar terms and similar remaining maturities.

 

·Federal funds purchased – The carrying value of federal funds borrowed is assumed to approximate fair value.

 

·FHLB advances – The fair value of long-term debt was estimated using a discounted cash flow calculation which utilizes the interest rates currently offered for borrowings of similar remaining maturities.

 

·Accrued interest payable – The carrying value of accrued interest payable approximates fair value due to the short-term duration.

 

·Other financial instruments – The fair value of other financial instruments, including loan commitments and unused letters of credit, is based on discounted cash flow analysis and is not material.

  

 

NOTE 11 STOCK-BASED COMPENSATION

 

The Corporation has two share-based compensation plans in existence; the 1997 Stock Option Plan (expired but having outstanding options that may still be exercised) and the 2009 Incentive Stock Option Plan, which is described below.

 

The Corporation’s 2009 Incentive Stock Option Plan is a shareholder approved plan that permits the granting of stock options, restricted stock and certain other stock-based awards to selected key employees on a periodic basis at the discretion of the board. The plan authorizes the issuance of up to 150,000 shares of common stock of which 55,250 shares are available for issuance at September 30, 2014. Option awards are granted with an exercise price equal to the market price of the Corporation’s stock at the date of grant and have an expiration period of ten years.

 

The fair value of each option award is estimated on the date of grant using a Black Scholes option-pricing model that uses the assumptions noted in the table below. Expected volatilities are based on several factors including historical volatility of the Corporation’s common stock, implied volatility determined from traded options and other factors. The Corporation uses historical data to estimate option exercises and employee terminations to estimate the expected life of options. The risk-free interest rate for the expected term of the options is based on the U.S. Treasury yield curve in effect at the time of the grant. The expected dividend yield is based on the Corporation’s expected dividend yield over the life of the options.

 

The fair value of options granted in 2014 and 2013 was determined using the following weighted-average assumptions as of the date of grant.

 

   2014   2013 
Dividend yield   3.15%   3.17%
Risk-free interest rate   2.04%   2.00%
Expected volatility   22.59%   23.00%
Weighted average expected life   8 years    8 years 
Weighted average per share fair value of options  $4.11   $3.63 

 

 

In the third quarter of 2014, 11,000 stock options were granted, subject to a three year vesting period with one third of the options vesting each year on the anniversary date of the grant.

 

Intrinsic value represents the amount by which the fair market value of the Corporation’s stock, $27.00 at September 30, 2014, exceeds the exercise price of the stock options. At September 30, 2014, the aggregate intrinsic value of stock options outstanding and exercisable was $634,000 and $530,000, respectively, compared to an aggregate intrinsic value of $382,000 and $317,000 at December 31, 2013.

 

 
22
COMMERCIAL BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

The following table summarizes stock option activity for the nine months ended September 30, 2014.

 

       Weighted 
   Number   Average 
   Of   Exercise 
Stock Options  Options   Price 
Outstanding options at January 1, 2014   62,550   $16.63 
Granted   11,000    24.47 
Exercised   (2,575)   13.06 
Forfeited   (600)   15.79 
Expired   0    0.00 
Outstanding options at September 30, 2014   70,375   $18.00 
Exercisable at September 30, 2014   47,775   $15.91 

 

The fair value of options granted is amortized as compensation expense, recognized on a straight-line basis over the vesting period of the respective stock option grant. Compensation expense related to employees is included in personnel expense while compensation expense related to directors is included in other operating expense. The Corporation recognized compensation expense of $10,000 and $28,000 for the three and nine months ended September 30, 2014, respectively, related to the vesting of nonrestricted stock options, compared to compensation expense of $8,000 and $25,000 for the same periods in 2013. At September 30, 2014, the Corporation had $77,000 of unrecognized compensation expense related to nonrestricted stock options. This remaining cost is expected to be recognized over a weighted average vesting period of approximately 26.7 months.

 

 

The following is a summary of outstanding and exercisable stock options at September 30, 2014.

 

    Number     Weighted Average     Number  
    Of Shares     Remaining     Of Shares  

Exercise Price

  Outstanding     Contractual Life     Exercisable  
$ 26.75     1,000       1.25   years       1,000  
$ 12.30     13,250       4.87   years       13,250  
$ 13.25     10,700       5.87   years       10,700  
$ 17.40     9,800       6.87   years       9,800  
$ 19.28     14,675       7.78   years       9,709  
$ 21.35     9,950       8.86   years       3,316  
$ 24.47     11,000       9.88   years       0  
Total     70,375       7.20   years       47,775  
                                 

  

 

The following table summarizes information about the Corporation’s nonvested stock option activity for the nine months ended September 30, 2014.

 

   Number   Weighted 
   Of   Average 
Nonvested Options  Options   Price 
Nonvested options at January 1, 2014   23,349   $19.90 
Granted   11,000    24.47 
Vested   (11,649)   19.34 
Forfeited   (100)   19.28 
Nonvested options at September 30, 2014   22,600   $22.41 

 

 

 
23
COMMERCIAL BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

In the third quarter of 2014, the Corporation granted 3,950 shares of restricted stock awards with a total grant date fair value of $97,000. The fair value of restricted stock is equal to the fair market value of the Corporation’s common stock on the date of grant. Restricted stock awards are recorded as unearned compensation, a component of shareholders’ equity, and amortized to compensation expense over the vesting period. The Corporation recognized compensation expense of $23,000 and $65,000 for the three and nine months ended September 30, 2014, respectively, related to restricted stock grants compared to $17,000 and $40,000 for the same periods in 2013. At September 30, 2014, the Corporation had approximately $191,000 of unrecognized compensation expense related to restricted stock awards. This remaining cost is expected to be recognized over a weighted average vesting period of approximately 27.0 months.

 

 

The following table summarizes restricted stock activity for the nine months ended September 30, 2014.

 

       Weighted 
   Nonvested   Average 
   Number of   Grant Date 
Restricted Stock  Shares   Shares 
Nonvested balance at January 1, 2014   12,700   $19.83 
Granted   3,950    24.47 
Vested   (3,750)   17.40 
Forfeited/expired   0    0.00 
Nonvested balance at September 30, 2014   12,900    21.95 

 

 

 
24
COMMERCIAL BANCSHARES, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

INTRODUCTION

 

The following review presents management’s discussion and analysis of the consolidated financial condition of Commercial Bancshares, Inc. and its wholly owned subsidiaries, Commercial Savings Bank and Commercial Financial and Insurance Agency, LTD at September 30, 2014, compared to December 31, 2013, and the consolidated results of operations for the three and nine-month periods ended September 30, 2014 compared to the same periods in 2013. The purpose of this discussion is to provide the reader with a more thorough understanding of the consolidated financial statements and related footnotes.

 

The Corporation is designated as a financial holding company by the Federal Reserve Bank of Cleveland. This status can help the Corporation take advantage of changes in existing law made by the Financial Modernization Act of 1999. As a result of being a financial holding company, the Corporation may be able to engage in an expanded array of activities determined to be financial in nature. This will help the Corporation remain competitive in the future with other financial service providers in the markets in which the Corporation does business. There are more stringent capital requirements associated with being a financial holding company. The Corporation intends to maintain its categorization as a “well capitalized” bank, as defined by regulatory capital requirements.

 

Management believes there have been no changes with respect to its determinations regarding the Corporation’s critical accounting policies as disclosed in the Corporation’s annual report on Form 10-K for the fiscal year ended December 31, 2013.

 

FORWARD-LOOKING STATEMENTS

 

Certain statements contained in this report that are not historical facts are forward-looking statements that are subject to certain risks and uncertainties. Forward-looking statements include statements with respect to the Corporation’s beliefs, plans, objectives, goals, expectations, anticipations, assumptions, estimates, intentions and future performance, and involve known and unknown risks, uncertainties and other factors which may be beyond the Corporation’s control and which may cause the actual results, performances, achievements or financial condition of the Corporation to be materially different from future results, performance, achievements or financial condition expressed or implied by such forward-looking statements.

 

Forward-looking statements are based on various assumptions and may be identified by reference to a future period or periods, or by the use of forward-looking terminology such as “believe”, “estimate”, “anticipate”, “plan”, “intend”, or other similar terms or variations on those terms, or the future or conditional verbs such as “will”, “may”, “should” and “would”. These forward-looking statements may not be realized due to a variety of factors, including, without limitation, (i) the effects of future economic, business and market conditions and changes, (ii) governmental monetary and fiscal policies, (iii) changes in accounting policies, rules and practices, (iv) the risks of changes in interest rates on the levels, composition and costs of deposit, loan demand and the values and liquidity of loan collateral, securities and interest sensitive assets and liabilities, (v) changes in borrower credit risks and payment behaviors, (vi) the effects of competition from a wide variety of local, regional, national and other providers of financial services, (vii) the failure of assumptions and estimates underlying the establishment of reserves for possible loan losses and other estimates and (viii) changes in technology or products that may be more difficult, costly or less effective than anticipated.

  

CRITICAL ACCOUNTING POLICIES

 

The Corporation has established various accounting policies which govern the application of U.S. GAAP in the preparation of its financial statements. Certain accounting policies involve significant judgments and assumptions by management which has a material impact on the reported amount of assets, liabilities, capital, revenues and expenses and related disclosures of contingent assets and liabilities in the consolidated financial statements and accompanying footnotes. The SEC has defined a company’s critical accounting policies as the ones that are most important to the portrayal of the company’s financial condition and results of operations, and which require the company to make its most difficult and subjective judgments, often as a result of the need to make estimates on the matters that are inherently uncertain. Because of the nature of the judgments and assumptions made by management, actual results could differ from estimates and have a material impact on the carrying value of assets, liabilities, capital or the results of operations of the Corporation.

 

 
25
COMMERCIAL BANCSHARES, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Allowance for loan losses: The Corporation assesses the adequacy of its allowance for loan losses prior to the end of each calendar quarter. The level of the allowance is based upon management’s evaluation of the loan portfolio, past loan experience, current asset quality trends, known and inherent risks in the portfolio, adverse situations that may affect a borrower’s ability to repay (including the timing of future payment), the estimated value of any underlying collateral, composition of the loan portfolio, economic conditions, industry and peer bank loan loss rates and other pertinent factors. This evaluation is inherently subjective as it requires material estimates including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change. Loans are charged off, in whole or in part, when management believes that the full collectability of the loan is unlikely. A loan may be partially charged off after a “confirming event” has occurred which serves to validate that full repayment pursuant to the terms of the loan agreement is unlikely.

 

The Corporation deems loans impaired when, based on current information and events, it is probable that the Corporation will be unable to collect all amounts due according to the contractual terms of the loan agreement. Collection of all amounts due according to the contractual term means that both the interest and principal payments of a loan will be collected as scheduled in the loan agreement. An impairment allowance is recognized if the fair value of the loan is less than the recorded investment in the loan. The impairment is recognized through the allowance. Loans that are impaired are recorded at the present value of expected future cash flows discounted at the loan’s effective interest rate, or if the loan is collateral dependent, impairment measurement is based on the fair value of the collateral, less estimated disposal costs. The level of the allowance is believed by management to be adequate to absorb probable losses inherent in the loan portfolio at the balance sheet date. The allowance is increased by provisions charged to expense and decreased by charge-offs, net of recoveries of amounts previously charged off.

 

Fair value estimates: Fair value is defined as the amount at which an asset or liability could be exchanged in a current transaction between willing, unrelated parties, other than in a forced or liquidation sale. Fair value is based on quoted market prices in an active market, or if market prices are not available, is estimated using models employing techniques such as matrix pricing or discounting expected cash flows. The significant assumptions used in the models, which include assumptions for interest rates, discount rates, prepayments and credit losses, are independently verified against observable market data where possible. Where observable market data is not available, the estimate of fair value becomes more subjective and involves a high degree of judgment. In this circumstance, fair value is estimated based on management’s judgment regarding the value that market participants would assign to the asset or liability. This valuation process takes into consideration factors such as illiquidity. Imprecision in estimating these factors can impact the amount recorded on the balance sheet for a particular asset or liability with related impacts to earnings or other comprehensive income. See Note 10 Fair Values and Measurements of Financial Instruments for a further discussion of fair value measurements.

 

OVERVIEW

 

Net income increased 10.4% to $2,483,000 for the nine months ended September 30, 2014 compared to $2,250,000 for the nine months ended September 30, 2013. Basic and diluted earnings per share for September 30, 2014 were $2.10 and $2.06, respectively, compared to $1.92 and $1.90 for the same period in 2013. The increase in net income for the nine months ended September 30, 2014 compared to the same period in 2013 can be largely attributed to an increase in net interest income, partially offset by increases in noninterest expense and income tax expense. Highlights for the nine months ended September 30, 2014:

 

·Net loans totaled $274,304,000 at September 30, 2014, compared to $265,625,000 at year-end 2013, an increase of $8,679,000 or 3.3% with the growth predominantly in the commercial and agricultural loan portfolio.

 

·Deposits totaled $284,461,000 at September 30, 2014, compared to $281,308,000 at year-end 2013, an increase of $3,153,000 or 1.1%, with the growth predominantly in large certificates of deposit balances, partially offset by a decrease in noninterest-bearing demand deposits.

 

 
26
COMMERCIAL BANCSHARES, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

·The Corporation’s net interest margin, on a fully taxable equivalent basis, was 4.64% for the nine months ended September 30, 2014, compared to 4.62% for the nine months ended September 30, 2013.

 

·The Corporation’s return on average equity and return on average assets for the nine months ended September 30, 2014 was 10.11% and 1.04%, respectively, compared to 9.91% and 0.99% for the same period in 2013.

 

·The Corporation’s efficiency ratio, on a fully taxable equivalent basis, was 66.71% for the nine months ended September 30, 2014, compared to 67.88% for the same period in 2013. The efficiency ratio measures the amount of expense incurred to generate a dollar of revenue and is calculated by dividing noninterest expense by the sum of taxable equivalent net interest income before provision and other noninterest income, excluding net gains (losses) on sales of investment securities and net gains (losses) on sales of fixed assets.

 

·The capital position of the Corporation remained strong with all regulatory capital ratios significantly exceeding the “well capitalized” thresholds established by regulators. The Corporation’s leverage and risk-based capital ratios at September 30, 2014 were 10.44% and 13.21%, respectively, compared to leverage and risk-based capital ratios of 10.13% and 12.96% at September 30, 2013.

  

FINANCIAL CONDITION

 

Total assets were $324,996,000 at September 30, 2014, compared to $317,998,000 as of December 31, 2013, an increase of 2.2% or $6,998,000, largely due to an increase in the loan portfolio and partially offset with decreases in cash equivalents and federal funds sold and investment securities. Total liabilities increased 1.8% or $5,005,000 to $291,415,000 as of September 30, 2014, compared to $286,410,000 at December 31, 2013. Shareholders’ equity increased 6.3% to $33,581,000 as of September 30, 2014, compared to $31,588,000 at December 31, 2013, primarily driven by an increase in retained earnings.

 

Cash equivalents and federal funds sold include working cash funds, due from banks, interest-bearing deposits in other financial institutions, items in process of collection and federal funds sold. The Bank is required to maintain average reserve balances with the Federal Reserve Bank based on average daily deposit balances and statutory reserve ratios prescribed by the type of deposit account. The average balance held in reserve for the nine months ended September 30, 2014 was $5,338,000, compared to $5,223,000 for the same period in 2013. At September 30, 2014, cash equivalents and federal funds sold totaled $16,143,000, representing a decrease of $1,976,000 or 10.9% from cash equivalents and federal funds sold of $18,119,000 at December 31, 2013.

 

Total investment securities, consisting of available for sale and other equity securities decreased 10.4% or $1,691,000 to $14,509,000 at September 30, 2014 from $16,200,000 at December 31, 2013. The decline in investment securities was predominantly due to the call of municipal securities totaling $1,057,000 as well as $474,000 in principal pay downs and prepayments of mortgage-backed securities. Securities available for sale are reported at fair value with unrealized holding gains and losses, based on the difference between amortized cost and fair value, reported net of deferred tax, as accumulated other comprehensive income (loss), a separate component of shareholders’ equity. Declines in the fair value of individual available for sale securities below their cost that are other-than temporary, result in write-downs of the individual securities to their fair values. Securities that are held as available for sale are used as part of the Corporation’s asset/liability management strategy. Securities that may be sold in response to interest rate changes, changes in prepayment risk, the need to increase regulatory capital and other similar factors are classified as available for sale.

 

At September 30, 2014, the investment portfolio consisted primarily of obligations of state and political subdivisions, mortgage-backed securities and U.S. Government Agency securities. To reduce the Corporation’s income tax burden, $7,651,000 or 52.73% of the Corporation’s investment portfolio as of September 30, 2014, was invested in tax-exempt obligations of state and political subdivisions, compared to $8,819,000 or 54.44% of available for sale securities as of December 31, 2013.

 

 
27
COMMERCIAL BANCSHARES, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Loans, net of unearned income and deferred costs, totaled $278,668,000 at September 30, 2014, up $8,700,000 or 3.2% from $269,968,000 at December 31, 2013. The increase in loans was primarily due to an increase of $8,670,000 or 4.0% in the commercial and agricultural loan portfolio. Consumer real estate loans increased 14.5% or $2,725,000 while installment and home equity loans decreased $1,898,000 and $797,000, respectively.

 

The Corporation’s loan portfolio represents its largest and highest yielding assets. The fundamental lending business of the Corporation is based on understanding, measuring and controlling the credit risk inherent in the loan portfolio. The Corporation’s loan portfolio is subject to varying degrees of credit risk. Credit risk entails both general risks, which are inherent in the process of lending, and risk specific to individual borrowers. The Corporation’s credit risk is mitigated through portfolio diversification, which limits exposure to any single customer, industry or collateral type. Typically, each consumer and residential lending product has a generally predictable level of credit losses based on historical loss experience. Home mortgage and home equity loans and lines generally have the lowest credit loss experience, while loans secured by personal property, such as auto loans, are generally expected to experience more elevated credit losses. Credit risk in commercial lending can vary significantly, as losses as a percentage of outstanding loans can shift widely during economic cycles and are particularly sensitive to changing economic conditions. Generally, improving economic conditions result in improved operating results on the part of commercial customers, enhancing their ability to meet their particular debt service requirements. Improvements, if any, in operating cash flows can be offset by the impact of rising interest rates that may occur during improved economic times. Declining economic conditions have an adverse effect on the operating results of commercial customers, reducing their ability to meet debt service obligations. The Corporation believes the general economic outlook remains stable without any clear or substantive trends in either employment rates, real estate values or overall consumer or commercial confidence, spending or investment.

 

To control and manage credit risk, management has a credit process in place to ensure credit standards are maintained along with strong oversight and review procedures. The primary purpose of loan underwriting is the evaluation of specific lending risks and involves the analysis of the borrower’s ability to service the debt as well as the assessment of the value of the underlying collateral. Oversight and review procedures include the monitoring of portfolio credit quality, early identification of potential problem credits and the aggressive management of problem credits. Executive management has implemented the following measures to proactively manage credit risk in the loan portfolios:

 

·Reviewed all underwriting guidelines for various loan portfolios and have strengthened underwriting guidelines where needed.

 

·Evaluated outside loan review parameters, engaging the services of a well-established firm to continue with such loan review, addressing not only specific loans but underwriting analysis, documentation, credit evaluation and risk identification.

 

·Increased the frequency of quarterly internal reviews to monthly reviews of past due and delinquent loans to assess probable credit risks early in the delinquency process to minimize losses.

 

·Aggressively seeks ownership and control, when appropriate, of real estate properties, which would otherwise go through time consuming and costly foreclosure proceedings to effectively control the disposition of such collateral.

 

·Aggressively obtaining updated financial information on commercial credits and performing analytical reviews to determine debt source capacities in business performance trends.

 

·Engaged a well-established auditing firm to analyze the Corporation’s loan loss reserve methodology and documentation.

 

As part of the oversight and review process, the Corporation maintains an allowance for loan losses to absorb estimated and probable losses inherent in the loan portfolio at the balance sheet date. The allowance is based on two basic principles of accounting: (1) the requirement that a loss be accrued when it is probable that the loss has occurred at the date of the financial statements and the amount of the loss can be reasonably estimated and (2) the requirement that losses, if any, be accrued when it is probable that the Corporation will not collect all principal and interest payments according to the loan’s contractual terms.

 

 
28
COMMERCIAL BANCSHARES, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

 

The Corporation’s allowance for loan losses has two basic components: a general reserve reflecting historical losses by loan category and loan classification, as adjusted by several factors whose effects are not reflected in historical loss ratios, and specific allowances for individually identified loans. General reserves are based upon historical loss experience by portfolio segment measured and supplemented to address various risk characteristics of the Corporation’s loan portfolio including:

 

·Trends in delinquencies and other non-performing loans
·Changes in the risk profile related to large loans in the portfolio
·Changes in the categories of loans comprising the loan portfolio
·Concentrations of loans to specific industry segments
·Changes in economic conditions on both a local and a national level
·Changes in the Corporation’s credit administration and loan portfolio management processes
·Quality of the Corporation’s credit risk identification process

 

The portion of the reserve representing specific allowances is derived by accumulating the specific allowances established on individually impaired loans that have significant conditions or circumstances that indicate that a loss may be probable. Specific reserves are calculated on individually impaired loans and are established based on the Corporation’s calculation of the probable losses inherent in an individual loan. For loans on which the Corporation has not elected to use the collateral value as a basis to establish the measure of impairment, the Corporation measures impairment based on the present value of expected future cash flows discounted at the loan’s effective interest rate. In determining the cash flows to be included in the discount calculation, the Corporation considers various factors that combined, are used to estimate the probability and severity of potential losses.

 

·The borrower’s overall financial condition
·Resources and payment record
·Support available from financial guarantors

 

At September 30, 2014 the general reserve comprised 89% of the total allowance while the specified allowance accounted for 11% of the total allowance, compared to 88% and 12% at year-end 2013. The severity of estimated losses on impaired loans can differ substantially from actual losses. The general reserve is calculated in two parts based on an internal risk classification of loans within each portfolio segment. General reserves on loans considered to be “classified” under regulatory guidance are calculated separately from loans considered to be “pass” rated under the same guidance. This segregation allows the Corporation to monitor the reserves related to higher risk loans separate from the remainder of the portfolio in order to better manage risk and ensure the sufficiency of reserves.

 

The allowance for loan losses is established and maintained at a level management deems adequate to cover losses inherent in the loan portfolio as of the balance sheet date and is based on management’s evaluation of the risks in the loan portfolio and changes in the nature and volume of loan activity. The amount of the allowance is affected by: (i) loan charge-offs, which decreases the allowance; and (ii) recoveries on loans previously charged off, which increases the allowance; and (iii) the provision of possible loan losses charged to income, which increases the allowance. In determining the provision for possible loan losses, it is necessary for management to monitor fluctuations in the allowance resulting from actual charge-offs and recoveries and to periodically review the size and composition of the loan portfolio in light of current and anticipated economic conditions.

 

The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experience, nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. The evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

 

The allowance for loan losses totaled $4,364,000 at September 30, 2014, an increase of $21,000 or 0.5% compared to $4,343,000 at December 31, 2013. The ratio of annualized net charge-offs to average outstanding loans was 0.13% at September 30, 2014, up slightly from 0.09% at year-end 2013. The Corporation provided $26,000 and $287,000 to the allowance for loan losses for the three and nine months ended September 30, 2014, respectively, compared to $138,000 and $289,000 for the same periods in 2013. Net charge-offs totaled $16,000 and $266,000 for the three and nine month-periods ended September 30, 2014, respectively, compared to net charge-offs of $37,000 and $62,000 for the same periods last year.

 

 
29
COMMERCIAL BANCSHARES, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Based upon its assessment of the loan portfolio, management adjusts the allowance for loan losses to an amount it believes to be appropriate to adequately cover probable losses in the loan portfolio. The Corporation’s allowance for loan losses to total loans was 1.57% at September 30, 2014, down slightly from 1.61% at December 31, 2013. Based upon the evaluation of the loan portfolio, management believes the allowance for loan losses to be adequate to absorb probable losses existing in the loan portfolio at September 30, 2014. While the Corporation’s policies and procedures used to estimate the allowance for loan losses, as well as the resultant provision for loan losses charged to operations, are believed adequate by management and are reviewed from time to time by regulators, they are based on estimates and judgment and are therefore approximate and imprecise. Factors beyond management’s control, such as conditions in the local and national economy, local real estate market or particular industry conditions exist which may negatively and materially affect the Corporation’s asset quality and the adequacy of its allowance for loan losses and thus, the resulting provision for loan losses.

 

In addition, bank regulators, as an integral part of their supervisory functions, periodically review the Corporation’s loan portfolio and related allowance for loan losses. These regulatory agencies may require the Corporation to increase its provision for loan losses or to recognize further loan charge-offs based upon their judgments. An increase in the allowance for loan losses by these regulatory agencies could materially adversely affect the Corporation’s financial condition and results of operations.

 

Before loans are charged off, they typically go through a phase of non-performing status. Various stages exist when dealing with such non-performance. The first stage is simple delinquency, where customers consistently start paying late, 30, 60, 90 days at a time. These accounts may then be put on a list of loans to “watch” as they continue to under-perform according to original terms. Loans are placed on nonaccrual status when management believes the collection of the principal and interest is doubtful. A delinquent loan is generally placed on nonaccrual status when principal and/or interest is past due 90 days or more or if the financial strength of the borrower has declined, collateral value has declined or other facts would make the repayment of the loans suspect, unless the loan is well-secured or in the process of collection. When a loan is placed on nonaccrual, all interest which has been accrued is charged back against current earnings as a reduction in interest income, which adversely affects the yield on loans in the period of reversal. No additional interest is accrued on the loan balance until collection of both principal and interest becomes reasonably certain. Loans placed on nonaccrual status may be returned to accrual status after payments are received for a minimum of six consecutive months in accordance with the loan documents and any doubt as to the loan’s full collectability has been removed or the troubled loan is restructured and evidenced by a credit evaluation of the borrower’s financial condition and the prospects for full payment.

 

The Corporation’s methodology for evaluating whether a loan is impaired begins with risk-rating credits on an individual basis. Loans with a pass rating represent those not classified on the Corporation’s rating scale for problem credits, as minimal credit risk has been identified. Loans classified as special mention have potential weaknesses that deserve management’s close attention. If uncorrected, the potential weaknesses may result in deterioration of the repayment prospects. Loans classified as substandard have a well-defined weakness that jeopardizes the repayment of the debt. Loans classified doubtful have all the weaknesses inherent in loans classified substandard with the added characteristic that collection or liquidation in full, on the basis of current conditions and facts, is highly improbable. Loans rated as doubtful in whole, or in part, are placed in nonaccrual status.

 

Loans are placed on nonaccrual status when management believes the collection of principal and interest is doubtful, or when loans are past due as to principal and interest 90 days or more, except in certain circumstances when interest accruals are continued on loans deemed by management to be fully collateralized and in the process of being collected. At September 30, 2014 and December 31, 2013, there were no 90 day delinquent loans that were on accrual status. In such cases, the loans are individually evaluated in order to determine whether to continue income recognition after 90 days beyond the due dates.

 

Management considers a loan to be impaired when, based on current information and events, it is determined that the Corporation will not be able to collect all amounts due according to the contractual terms of the loan agreement, including scheduled interest payments. When management identifies a loan as impaired, the impairment is measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate or the observable market price of the loan, except when the sole (remaining) source of repayment for the loan is the liquidation of the collateral. In these cases, management uses the current fair value of the collateral, less selling costs when foreclosure is probable, instead of discounted cash flows. If management determines the value of the impaired loan is less than the recorded investment in the loan (net of previous charge-offs and deferred loan fees or costs), impairment is recognized through an allowance estimate or a charge-off to the allowance. When management determines an impaired loan is a confirmed loss, the estimated impairment is directly charged off to the loan rather than creating a specific reserve for inclusion in the allowance for loan losses. However, not all impaired loans are in nonaccrual status because they may be current with regards to the payment terms. Their determination as an impaired loan is based on some inherent weakness in the credit that may, if certain circumstances occur or arise, result in an inability to comply with the loan agreement’s contractual terms. Impaired loans exclude large groups of smaller-homogeneous loans that are collectively evaluated for impairment such as consumer real estate and installment loans.

 

 
30
COMMERCIAL BANCSHARES, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The allowance for loan losses, specifically related to impaired loans at September 30, 2014 and December 31, 2013 was $474,000 and $524,000, respectively, related to loans with principal balances of $5,003,000 and $3,928,000. Impaired loans with no related allowance recorded at September 30, 2014 totaled $4,065,000 compared to $6,996,000 at December 31, 2013. The Corporation’s financial statements are prepared on the accrual basis of accounting, including the recognition of interest income on the loan portfolio, unless a loan is placed on nonaccrual status. Amounts received on nonaccrual loans generally are applied first to principal and then to interest only after all principal has been collected. For the nine months ended September 30, 2014, the Corporation received interest payments of $320,000 related to impaired loans averaging $9,173,000, compared to interest payments of $138,000 related to impaired loans averaging $10,299,000 for the same period in 2013.

 

Management has taken what it believes to be a proactive position on identifying problems with credits and their ultimate collectability using both internal and external portfolio loan reviews, and believes any potential losses which may be incurred on these credits in the future are incorporated into its analysis of the adequacy of the Corporation’s allowance for loan losses.

 

Due to the weakening credit status of a borrower, the Corporation may elect to formally restructure certain loans to facilitate a repayment plan that minimizes the potential losses the Corporation might incur. Restructured loans, or troubled debt restructurings (“TDRs”), are classified as impaired loans and may either be in accruing or nonaccruing status. In most cases the modification is either a concessionary reduction in interest rate, extension of the maturity date or reduction in the principal that would otherwise not be considered. Concessionary modifications are classified as troubled debt restructurings unless the modification results in only an insignificant delay in the payments to be received. Troubled debt restructured loans are separately identified for impairment disclosures and are measured at the present value of estimated future cash flows using the loan’s effective interest rate at inception. If a troubled debt restructured loan is considered to be collateral dependent, the loan is reported net, at the fair value of the collateral. A nonaccrual TDR loan may be returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured. Additionally, there should be a sustained period of repayment performance (generally a period of six months) by the borrower in accordance with the modified contractual terms.

 

Troubled debt restructured loans totaled $7,794,000 at September 30, 2014 and represented seven credit relationships in which economic concessions were granted to borrowers to better align the terms of their loans with their current ability to pay. Troubled debt restructured balances have decreased 15.8% or $1,462,000 from $9,256,000 at December 31, 2013, primarily reflecting the transfer of one loan totaling $1,101,000 to OREO as well as payments received on accounts. As of September 30, 2014, 75% of all restructured loans were performing to the terms of the restructure. The specified reserve required for these TDRs, whether collateral dependent or not, was $435,000, representing 10% of the total loan loss reserve. There are no commitments to lend additional amounts to borrowers with loans classified as troubled debt restructurings as of September 30, 2014.

 

Non-performing loans, comprised of loans on nonaccrual status along with loans that are contractually past due 90 days or more but have not been classified as nonaccrual, totaled $2,331,000, down $684,000 or 22.7% from non-performing loans of $3,015,000 at December 31, 2013. Management evaluated non-performing loans for impairment at September 30, 2014 and based on that impairment analysis, a specified reserve of $474,000 was estimated. Non-performing loans to period end loans was 0.84% at September 30, 2014 compared to 1.12% at December 31, 2013. Non-performing loans represented 0.72% of total assets at September 30, 2014 compared to 0.95% at year-end 2013.

 

Other assets, including premises and equipment, accrued interest receivable, Bank-owned life insurance and other assets, totaled $20,040,000 at September 30, 2014, an increase of $1,986,000 or 11.0% from $18,054,000 at December 31, 2013. The increase in other assets was primarily due to the increase of $1,040,000 in OREO and other repossessed assets as well as increases in net deferred tax assets, accrued interest receivables, premises and equipment and Bank-owned insurance of $271,000, $210,000, $183,000 and $179,000, respectively,

 

OREO is comprised of properties acquired by the Corporation in partial or total satisfaction of problem loans. OREO and other repossessed assets are initially recorded at the lower of cost or fair value on the date of acquisition less estimated costs of disposal (net realizable value). Losses existing at the time of acquisition of such properties are charged against the allowance for loan losses. Subsequent write-downs that may be required are expensed as incurred. Gains and losses realized from the sale of OREO and other repossessed assets, as well as valuation adjustments, are included in noninterest expense as well as expenses of operation. During the nine months ended September 30, 2014, four properties with a carrying value of $86,000 were sold at a loss of $11,000. At September 30, 2014, the Corporation held one property with a carrying value of $1,070,000 in OREO and $18,000 in other repossessed assets compared to one property with a carrying value of $20,000 and $28,000 in other repossessed assets at December 31, 2013.

 

 
31
COMMERCIAL BANCSHARES, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Deposits totaled $284,461,000 at September 30, 2014, increasing $3,153,000 or 1.1% from $281,308,000 at December 31, 2013, largely driven by increases in large certificates of deposits, partially offset by a decline in noninterest-bearing demand deposits. The Bank offers a broad selection of deposit accounts, including noninterest-bearing demand deposits (such as checking accounts), interest-bearing checking accounts and money market accounts, savings accounts and certificates of deposits. Included in the certificates of deposit balances were $28,028,000 of reciprocal certificates of deposits offered under the Certificate Deposit Account Registry Service (“CDARs”), a program in which the Bank participates. Under CDARS, participating banks are able to match customer’s deposits that would otherwise exceed the limits for FDIC insurance with certificates of deposits offered at other participating banks and thereby provide FDIC insurance to these excess deposits. The Corporation also offers a variety of deposit accounts designed for the businesses operating in its market areas. Business banking deposit products include a commercial checking account, a commercial money market account and a checking account specifically designed for small businesses. The Corporation also offers bill paying and cash management services through its online banking system as well as a remote deposit capture product. Interest rates paid are competitively priced for each particular deposit product and structured to meet the Corporation’s funding requirements. Management believes that additional funds can be attracted and deposit growth can be realized through deposit pricing if the Corporation experiences increased loan demand or other liquidity needs.

 

The Corporation utilizes both short-term and long-term borrowings as an alternate funding source to deposits and can be used to fund the Corporation’s liquidity needs. Short-term borrowings, which include federal funds purchased, represent unsecured overnight borrowings from other financial institutions. FHLB advances are loans from Federal Home Loan Bank that can mature daily or have longer maturities for fixed or floating rates of interest. FHLB borrowings are generally used to provide additional funding for loan growth when it is in excess of deposit growth and to manage interest rate risk, but can also be used as an additional source of liquidity for the Corporation. Borrowed funds totaled $5,221,000 at September 30, 2014, an increase of $1,656,000 or 46.5% from $3,565,000 at December 31, 2013, reflecting increased funding needs precipitated by an increase in loan growth that was not immediately available to be funded by deposit balances. The Corporation’s borrowing capacity at FHLB totaled $33,048,000 of which $14,827,000 was available at September 30, 2014. Management believes that the Corporation has adequate liquidity to meet their commitments for the foreseeable future.

 

Total shareholders’ equity increased 6.3% to $33,581,000 as of September 30, 2014 from $31,588,000 at December 31, 2013. The increase in equity was primarily attributable to current earnings of $2,483,000 plus adjustments related to employee compensation costs, stock option accounting, deferred compensation plan activity and treasury stock activity of $188,000. The Corporation declared cash dividends of $0.520 per share for the nine months ended September 30, 2014, decreasing equity by $617,000. Included in shareholders’ equity is accumulated other comprehensive income which includes the net after-tax impact of unrealized gains and losses on investment securities classified as available for sale, which decreased $61,000 during the nine months ended September 30, 2014. Such unrealized gains or losses are generally due to changes in interest rates and represent the difference, net of applicable income tax effect, between the estimated fair value and amortized cost of investment securities classified as available for sale.

 

The Corporation’s tier 1 leverage ratio was 10.4%, tier 1 risk based capital ratio was 12.0% and total risk based capital ratio was 13.2% at September 30, 2014. These ratios exceed the minimum regulatory capital percentages of 5% for tier 1 leverage ratio, 6.0% for tier 1 risk based capital ratio and 10.0% for total risk based capital ratio to be considered “well capitalized.” Based on current regulatory standards, the Corporation is classified as “well capitalized.”

 

During the nine months ended September 30, 2014, the Corporation returned 24.84% of earnings through dividends of $617,000 at $0.520 per share compared to a return on earnings of 23.23% through dividends of $523,000 at $0.445 per share for the same period in 2013. Average shareholders’ equity to average assets was 10.26% for the nine months ended September 30, 2014 compared to 10.02% for the nine months ended September 30, 2013.

 

RESULTS OF OPERATIONS

 

The Corporation recorded net income of $859,000 or $0.71 per diluted share for the three months ended September 30, 2014 compared to net income of $792,000 or $0.66 per diluted share for the three months ended September 30, 2013. Net income for the nine months ended September 30, 2014 was $2,483,000 or $2.06 per diluted share compared to net income of $2,250,000 or $1.90 per diluted share for the same period in 2013. Pre-tax income increased $383,000 or 12.1% year-over-year, primarily resulting from an increase in net interest income of $627,000 partially offset by an increase in operating expenses of $249,000. The increase in operating expenses was largely driven by higher OREO and other loan related expenses as well as an increase in salaries and employee benefits.

 

Net interest income, the largest source of the Corporation’s operating revenue, is the income generated by interest earning assets reduced by the total interest cost of the funds incurred to carry them. Net interest income is impacted by market interest rates and the mix and volume of earning assets and interest-bearing liabilities. For comparative purposes, income from tax-exempt securities has been adjusted to a tax-equivalent basis using the federal statutory tax rate of 34% and a 20% disallowance of interest expense deductibility under the Tax Equity and Fiscal Responsibility Act (“TEFRA”) rules. By making these adjustments, tax-exempt income and their yields are presented on a comparable basis with income and yields from fully taxable earning assets. The net interest margin is calculated by expressing tax equivalent net interest income as a percentage of average interest earning assets and represents the Corporation’s net yield on its earning assets. Net interest margin is an indicator of the Corporation’s effectiveness in generating income from its earning assets. Net interest margin is affected by the structure of the balance sheet as well as by competitive pressures, Federal Reserve regulatory and monetary policies and the economy.

 

On a tax equivalent basis, net interest margin, expressed as a percentage of average earning assets, was 4.70% for the three-month period ended September 30, 2014 compared to 4.73% for the same period in 2013. Net interest spread, which is the average yield on interest earning assets minus the average rate paid on interest-bearing liabilities, was 4.64% and 4.63% for the three months ended September 30, 2014 and 2013, respectively. For the nine months ended September 30, 2014, the Corporation’s net interest margin on a tax equivalent basis was 4.64%, compared to 4.62% for the same period in 2013. The Corporation’s net interest margin remained relatively stable between periods primarily due to an increase in average loan balances as well as lower average rates paid on deposits.

 

 
32
COMMERCIAL BANCSHARES, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Net interest income on a tax equivalent basis for the three months ended September 30, 2014 was $3,542,000, an increase of $212,000 or 6.4% compared to $3,330,000 for the same period in 2013. Net interest margin on a tax equivalent basis for the nine months ended September 30, 2014 was $10,260,000, an increase of $599,000 or 6.2% compared to $9,661,000 for the same period in 2013. The increase in net interest income was largely driven by an increase in average loan balances. Interest income generated by the increase in loan volume between periods more than offset the loss of income due to lower interest rates on the Corporation’s average earning assets. 

 

The table that follows presents the Corporation’s (i) average assets, liabilities and shareholders’ equity, (ii) interest income earned on interest-earning assets and interest expense paid on interest-bearing liabilities, (iii) average yields earned on interest-earning assets and average rates paid on interest-bearing liabilities, (iv) interest rate spread (the difference between the average yield earned on interest-earning assets and the average rate paid on interest-bearing liabilities), and (v) net interest margin (net interest income as a percentage of total average interest-earning assets).

 

TABLE 1 YIELD ANALYSIS

 

For the three-month period ended September 30, 2014 and 2013.

(Dollar amounts in thousands)

  Three Months Ended September 30, 
   2014   2013 
       Interest           Interest     
   Average   Income/   Yield/   Average   Income/   Yield/ 
   Balance   Expense   Rate   Balance   Expense   Rate 
Federal funds sold  $11,332    7    0.25%  $9,801    6    0.24%
Investment securities:                              
Taxable securities (1)   6,970    51    2.90    7,749    59    3.02 
Tax-exempt securities (1)   8,012    121    5.99    9,742    147    5.99 
Loans (2) (3)   272,463    3,578    5.21    252,268    3,399    5.35 
Earning assets   298,777    3,757    4.99%   279,560    3,611    5.12%
Other assets   24,890              22,923           
Total assets  $323,667             $302,483           
                               
Interest-bearing demand deposits  $120,931    24    0.08%  $118,796    24    0.08%
Savings deposits   25,750    2    0.03    23,501    2    0.03 
Time deposits   93,041    177    0.75    80,003    243    1.21 
Borrowed funds   6,143    12    0.78    4,176    12    1.14 
Interest-bearing liabilities   245,865    215    0.35%   226,476    281    0.49%
Noninterest-bearing demand deposits   42,761              43,548           
Other liabilities   1,522              1,537           
Shareholders’ equity   33,519              30,922           
Total liabilities and shareholders’ equity  $323,667             $302,483           
                               
Net interest income       $3,542             $3,330      
Interest rate spread             4.64%             4.63%
Net interest margin (4)             4.70%             4.73%

 

 

(1)Average yields on all securities have been computed based on amortized cost. Income on tax-exempt securities has been computed on a taxable-equivalent basis using a 34% federal tax rate and a 20% disallowance of interest expense deductibility under TEFRA rules. The amount of such adjustment was $42,000 and $51,000 for the three-month period ended September 30, 2014 and 2013.
(2)Average balance is net of deferred loan fees of $593,000 and $486,000 for the three months ended September 30, 2014 and 2013, respectively.
(3)Interest income includes loan fees of $169,000 and $143,000 for the three-month period ended September 30, 2014 and 2013, respectively, as well as $38,000 and $47,000 of deferred dealer reserve expense for the same years.
(4)Net interest margin is the ratio of annualized tax equivalent net interest income to average earning assets.

 

 
33
COMMERCIAL BANCSHARES, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

 

The table that follows presents the Corporation’s (i) average assets, liabilities and shareholders’ equity, (ii) interest income earned on interest-earning assets and interest expense paid on interest-bearing liabilities, (iii) average yields earned on interest-earning assets and average rates paid on interest-bearing liabilities, (iv) interest rate spread (the difference between the average yield earned on interest-earning assets and the average rate paid on interest-bearing liabilities), and (v) net interest margin (net interest income as a percentage of total average interest-earning assets)

 

TABLE 2 YIELD ANALYSIS

 

For the nine-month period ended September 30, 2014 and 2013.

(Dollar amounts in thousands)

 

  Nine Months Ended September 30, 
   2014   2013 
       Interest           Interest     
   Average   Income/   Yield/   Average   Income/   Yield/ 
   Balance   Expense   Rate   Balance   Expense   Rate 
Federal funds sold  $12,239    22    0.24%  $17,511    32    0.24%
Investment securities:                              
Taxable securities (1)   7,125    158    2.96    7,311    183    3.35 
Tax-exempt securities (1)   8,195    368    6.00    9,908    442    5.96 
Loans (2) (3)   268,257    10,366    5.17    244,807    9,931    5.42 
Earning assets   295,816    10,914    4.93%   279,537    10,588    5.06%
Other assets   24,095              23,413           
Total assets  $319,911             $302,950           
Interest-bearing demand deposits  $122,252    72    0.08%  $119,510    74    0.08%
Savings deposits   25,720    6    0.03    23,246    6    0.03 
Time deposits   89,436    543    0.81    80,536    814    1.35 
Borrowed funds   3,611    33    1.22    2,710    33    1.63 
Interest-bearing liabilities   241,019    654    0.36%   226,002    927    0.55%
Noninterest-bearing demand deposits   44,589              45,013           
Other liabilities   1,473              1,566           
Shareholders’ equity   32,830              30,369           
Total liabilities and shareholders’ equity  $319,911             $302,950           
Net interest income       $10,260             $9,661      
Interest rate spread             4.57%             4.51%
Net interest margin (4)             4.64%             4.62%

 

 

 

(1)Average yields on all securities have been computed based on amortized cost. Income on tax-exempt securities has been computed on a taxable-equivalent basis using a 34% federal tax rate and a 20% disallowance of interest expense deductibility under TEFRA rules. The amount of such adjustment was $127,000 and $155,000 for the nine-month period ended September 30, 2014 and 2013.
(2)Average balance is net of deferred loan fees of $564,000 and $457,000 for the nine months ended September 30, 2014 and 2013, respectively.
(3)Interest income includes loan fees of $411,000 and $413,000 for the nine-month period ended September 30, 2014 and 2013, respectively, as well as $150,000 and $169,000 of deferred dealer reserve expense for the same years.
(4)Net interest margin is the ratio of annualized tax equivalent net interest income to average earning assets.

 

 

 
34
COMMERCIAL BANCSHARES, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Interest and fee income, on a fully taxable equivalent basis totaled $3,757,000 for the three-month period ended September 30, 2014, an increase of $146,000 or 4.0% from $3,611,000 for same period in 2013. Average net loans, representing 91.19% and 90.24% of average earning assets at September 30, 2014 and 2013, respectively, increased 8.0% or $20,195,000, while the average tax equivalent yield earned decreased 14 basis points. The decline in interest income on loans was largely due to the downward re-pricing of variable rate loans. Average federal funds sold, representing 3.79% and 3.51% of average earning assets at September 30, 2014 and 2013, respectively, increased 15.6% or $1,531,000, while the average yield earned decreased 1 basis point. Average investment securities, representing 5.01% and 6.26% of average earning assets at September 30, 2014 and 2013, respectively, decreased 14.3% or $2,509,000, while the average tax equivalent yield earned decreased 12 basis points.

 

Interest and fee income, on a fully taxable equivalent basis was $10,914,000 for the nine months ended September 30, 2014, an increase of $326,000 or 3.1%, from $10,588,000 for the same period in 2013. Average net loans, representing 90.68% and 87.58%, of average earning assets at September 30, 2014 and 2013, respectively, increased $23,450,000 or 9.6%, while the average tax equivalent yield earned decreased 25 basis points, resulting from the downward re-pricing of variable rate loans and new loans originating at lower market rates as well as maturities and repayments of loans with higher rates. Average fed funds sold, representing 4.14% and 6.26% of average earning assets at September 30, 2014 and 2013, respectively, decreased 30.1% or $5,272,000, with no change in the average yield earned between periods. Average investment securities, representing 5.18% and 6.16% of average earning assets at September 30, 2014 and 2013, respectively, decreased 11.0% or $1,899,000, while the average tax equivalent yield earned decreased 26 basis points.

 

Interest expense totaled $215,000 for the three months ended September 30, 2014, a decrease of $66,000 or 23.5% compared to $281,000 for the same period in 2013. Average interest-bearing demand deposits, representing 40.48% and 42.49% of average interest-bearing liabilities at September 30, 2014 and 2013, respectively, increased $2,135,000 or 1.8%, with no change in the average rate paid between periods. Average time deposits, representing 31.14% and 28.62% of average interest-bearing liabilities at September 30, 2014 and 2013, respectively, increased $13,038,000 or 16.3%, while the average rate paid decreased 46 basis points. The increase in average time deposits between periods was largely driven by an increase in CDARS certificates of deposits. Average borrowings, representing 2.06% and 1.49% of average interest-bearing liabilities at September 30, 2014 and 2013, respectively, increased $1,967,000 or 47.1%, while the average rate paid decreased 36 basis points.

 

Interest expense totaled $654,000 for the nine months ended September 30, 2014, a decrease of $273,000 or 29.4% compared to $927,000 for the same period in 2013. Average interest-bearing demand deposits, representing 50.72% and 52.88% of average interest-bearing liabilities at September 30, 2014 and 2013, respectively, increased $2,742,000 or 2.3%, with no change in the average rate paid between periods. Average time deposits, representing 37.11% and 35.64% of average interest-bearing liabilities at September 30, 2014 and 2013, respectively, increased $8,900,000 or 11.1%, while the average rate paid decreased 54 basis points. Average borrowings, representing 1.50% and 1.20% of average interest-bearing liabilities at September 30, 2014 and 2013, respectively, increased $901,000 or 33.2%, while the average rate paid decreased 41 basis points. The decrease in interest expense between periods is in part due to a favorable shift in the deposit composition as well as maturing certificates of deposits repricing at lower rates.

 

The Corporation establishes an allowance for loan losses through charges to earnings, which are shown in the statements of operations as the provision for loan losses. Through the provision for loan losses, an allowance is maintained that reflects management’s best estimate of probable incurred losses related to specifically identified loans as well as the inherent risk of loss related to the remaining portfolio. In evaluating the allowance for loan losses, management considers various factors that include loan growth, the amount and composition of the loan portfolio (including non-performing and potential problem loans), diversification, or conversely, concentrations by industry, geography or collateral within the portfolio, historical loan loss experience, current delinquency levels, the estimated value of the underlying collateral, prevailing economic conditions and other relevant factors. Loan charge-offs are recorded to this allowance when loans are deemed uncollectible, in whole or in part. Impacting the provision for loan losses in any accounting period are several factors including the amount of loan growth during the period, broken down by loan type, the level of charge-offs during the period, the changes in the amount of impaired loans, changes in risk ratings assigned to loans, specific loan impairments, credit quality and ultimately, the results of management’s assessment of the inherent risks of the loan portfolio.

 

 
35
COMMERCIAL BANCSHARES, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The provision charged against income for the three and nine months ended September 30, 2014 was $26,000 and $287,000, respectively, compared to $138,000 and $289,000 for the same periods in 2013. Total charge-offs for the nine months ended September 30, 2014 and 2013 was $325,000 and $153,000, respectively, offset with total recoveries of $59,000 and $91,000 for the same periods. At September 30, 2014 the allowance for loan losses totaled $4,364,000 or 1.57% of total loans. Management considers the allowance for loan losses at September 30, 2014 adequate to cover loan losses based on its assessment of various factors affecting the loan portfolio, including the level of problem loans, overall delinquencies, business conditions, estimated collateral values and loss experience. A decline in local and national economic conditions, or other factors, could result in a material increase in the allowance for loan losses which could adversely affect the Corporation’s financial condition and results of operations. Further information relating to factors affecting the allowance for loan losses is discussed under Financial Condition.

 

Noninterest income consists primarily of fees and commissions earned on services that are provided to the Corporation’s banking customers, income generated from the leasing of office space, third-party mortgage referral fee income and to a lesser extent, net gains and losses on sales of OREO and other repossessed assets and other miscellaneous income. Noninterest income for the three and nine months ended September 30, 2014 was $539,000 and $1,615,000, respectively, compared to $536,000 and $1,612,000 for the three and nine months ended September 30, 2013. Following are some of the more significant factors affecting noninterest income in 2014:

 

·A decrease of $13,000 and $23,000 in overdraft charges for the three and nine-month periods, respectively, primarily due to a decline in the volume of insufficient funds (“NSF”) activity.

 

·An increase of $8,000 and $32,000 in service charges and fees on deposit accounts for the three and nine-month periods, respectively, primarily reflecting an increase in minimum balance fees charged on deposit accounts.

 

·An increase of $10,000 in third-party mortgage referral fee income for the three-month period and a decrease of $42,000 for the nine-month period. The YTD decline in third-party mortgage referral fee income is due primarily to a decline in residential mortgage production.

 

·A gain of $41,000 on the sale of a branch office in February 2014.

 

Noninterest expense consists primarily of personnel, occupancy, equipment and other expenses. Noninterest expense for the three and nine months ended September 30, 2014 was $2,784,000 and $7,902,000, respectively, compared to $2,556,000 and $7,653,000 for the three and nine months ended September 30, 2013. Following are some of the more significant factors affecting noninterest expense during 2014:

 

·An increase of $104,000 and $81,000 in salaries and employee benefits for the three and nine-month periods, respectively, largely reflecting an increase in salary and bonus expense, primarily due to annual merit increases as well as an increase in employee compensation expense and partially offset by decreases in hospitalization expense, unemployment compensation expense, group life insurance and other personnel developmental expenses.

 

·A decrease of $19,000 and $35,000 in premises and equipment expense for the three and nine-month periods, respectively, largely due to a decline in depreciation expense as fixed assets became fully depreciated.

 

·An increase of $111,000 and $105,000 in miscellaneous loan expense for the three and nine-month periods, respectively, primarily due to realized holding losses or write-downs on the valuation of OREO properties and other repossessed assets as well as an increase in maintenance costs and property taxes associated with these assets. OREO properties could also be subject to future valuation adjustments as a result of updated appraisal information and further deterioration in real estate values, thus causing fluctuations in other real estate loan expense. Additionally, the Corporation will continue to incur expenses associated with maintenance costs and property taxes associated with these assets until they are sold.

 

 

 
36
COMMERCIAL BANCSHARES, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

For the three and nine months ended September 30, 2014, the Corporation’s pre-tax income was $1,229,000 and $3,559,000, respectively, resulting in a tax provision of $370,000 and $1,076,000, compared to pre-tax income of $1,121,000 and $3,176,000, resulting in a tax provision of $329,000 and $926,000 for the same periods in 2013. The Corporation’s effective tax rate for the three and nine months ended September 30, 2014 was 30.11% and 30.23%, respectively, compared to 29.35% and 29.16% for the same periods in 2013. The increase in the Corporation’s effective tax rate was primarily due to decreases in tax exempt interest income as holdings of municipal securities have declined. 

 

LIQUIDITY

 

Liquidity is the ability to satisfy demands for deposit withdrawals, lending commitments and other corporate needs. The Corporation’s liquidity primarily represented by cash equivalents and federal funds sold, is a result of its operating, investing and financing activities, which are summarized in the Condensed Consolidated Statements of Cash Flows. Primary sources of funds are deposits, prepayments and maturities of outstanding loans and securities. While scheduled payments from the amortization of loans and securities are relatively predictable sources of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions and competition. Funds are primarily used to meet ongoing commitments, satisfy operational expenses, payout maturing certificates of deposit and savings withdrawals and fund loan demand, with excess funds being invested in short-term, interest-earning assets. Additional funds are generated through Federal Home Loan Bank advances, overnight borrowings and other sources.

 

The Corporation’s liquidity ratio at September 30, 2014 was 5.62% compared to 6.39% at year-end 2013. Another measure of liquidity is the relationship of net loans to deposits and borrowed funds with lower ratios indicating greater liquidity. At September 30, 2014, the ratio of net loans to deposits and borrowed funds was 94.69% compared to 93.24% at December 31, 2013. Management believes its sources of liquidity are adequate to meet the needs of the Corporation.

 

As presented in the accompanying unaudited Consolidated Statements of Cash Flows, the sources of liquidity vary between periods. The Corporation’s cash equivalents and federal funds sold totaled $16,143,000 at September 30, 2014, compared to $17,825,000 at September 30, 2013. The primary sources of funds during the nine months of 2014 included $7,000,000 in Federal Home Loan Bank advances, $3,153,000 increase in net deposits, $2,794,000 in net cash provided by operating activities and $1,531,000 in pay downs and maturities of investment securities. The primary uses of funds during the nine months of 2014 included $10,086,000 in net loans, the repayment of $3,587,000 in Federal Home Loan Bank advances, the repayment of $1,757,000 in federal funds purchased, capital expenditures of $699,000 and cash dividends of $617,000.

 

The primary sources of funds during the nine months ended September 30, 2013 included $9,000,000 in Federal Home Loan Bank advances, $2,859,000 in net cash provided by operating activities, $1,282,000 in pay downs and maturities of investment securities and $273,000 in proceeds from the sale of OREO and other repossessed assets. The primary uses of funds during the nine months ended September 30, 2013 included $12,407,000 in net loans, the repayment of $3,085,000 in Federal Home Loan Bank advances, $2,000,000 in security investment purchases and $523,000 in cash dividends. 

 

CAPITAL RESOURCES

 

Banking regulations have established minimum capital requirements for banks including risk-based capital ratios and leverage ratios. Regulations require all banks to have a minimum total risk-based capital ratio of 8.0%, with half of the capital composed of core capital. Minimum leverage ratio requirements range from 3.0% to 5.0% of total assets. Conceptually, risk-based capital requirements assess the riskiness of a financial institution’s balance sheet and off-balance sheet commitments in relation to its capital. Core capital, or Tier 1 capital, includes common equity, perpetual preferred stock and minority interests that are held by others in consolidated subsidiaries minus intangible assets. Supplementary capital, or Tier 2 capital, includes core capital and such items as mandatory convertible securities, subordinated debt and the allowance for loan and lease losses, subject to certain limitations. Qualified Tier 2 capital can equal up to 100% of an institution’s Tier 1 capital with certain limitations in meeting the total risk-based capital requirements.

 

The Bank’s leverage and risk-based capital ratios at September 30, 2014 were 10.1% and 12.9%, respectively, compared to leverage and risk-based capital ratios of 9.8% and 12.6% at year-end 2013. The Bank exceeded minimum regulatory requirements to be considered well capitalized for both periods. Should it become necessary to raise capital to expand the activities of the Corporation, there are sufficient un-issued shares to effect a merger, or solicit new investors.

 

 
37
COMMERCIAL BANCSHARES, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

 

TABLE 3 CONTRACTUAL OBLIGATIONS AND COMMITMENTS

 

The Corporation has certain obligations and commitments to make future payments under contract. The following table presents the Corporation’s contractual obligations and commitments (in thousands) at September 30, 2014:

 

Contractual Obligations 

 

  Payments Due by Period 
       Less Than           After 
  Total   One Year   1-3 Years   3-5 Years   5 Years 
Time deposits and certificates of deposit  $97,466   $49,134   $33,288   $12,640   $2,404 
Borrowed funds    5,221    3,500    0    0    1,721 
Total contractual obligations  $102,687   $52,634   $33,288   $12,640   $4,125 

 

Other Commitments

 

  Amount of Commitment – Expiration by Period 
       Less Than           After 
  Total   One Year   1-3 Years   3-5 Years   5 Years 
Commitments to extend commercial credit  $25,446   $14,864   $3,193   $111   $7,278 
Commitments to extend consumer credit   11,360    1,190    3,190    4,154    2,826 
Standby letters of credit    100    65    35    0    0 
Total other commitments  $36,906   $16,119   $6,418   $4,265    10,104 

 

 

Other obligations and commitments which are not included above include the deferred compensation plan, index plan reserve and split dollar life insurance. The timing of payments for these plans is unknown. See Note 1 of the 2013 Annual Report for additional details.

 

Items listed under “Contractual Obligations” represent standard bank financing activity under normal terms and practices. Such funds normally rollover or are replaced by like items depending on the then-current financing needs. Items shown under “Other Commitments” also represent standard bank activity, but for extending credit to bank customers. Commercial credits generally represent lines of credit or approved loans with drawable funds still available under the contract terms. On an on-going basis, approximately half of these amounts are expected to be drawn. Consumer credits generally represent amounts drawable under revolving home equity lines or credit card programs. Such amounts are usually deemed less likely to be drawn upon in total as consumers tend not to draw down all amounts on such lines. Utilization rates tend to be fairly constant over time. Standby letters of credit represent guarantees to finance specific projects whose primary source of financing comes from other sources. In the unlikely event of the other source’s failure to provide sufficient financing, the bank would be called upon to fill the need. The Corporation is also continually engaged in the process of approving new loans in a bidding competition with other banks. Management and Board committees approve the terms of these potential new loans with conditions and/or counter terms made to the applicant customers. Customers may accept the terms, make a counter proposal, or accept terms from a competitor. These loans are not yet under contract, but offers have been tendered, and would be required to be funded if accepted. Such agreements represent approximately $10,581,000 at September 30, 2014 in varying maturity terms.

 

 

 
38
COMMERCIAL BANCSHARES, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk

 

Market risk refers to the risk of loss arising from adverse changes in interest rates, foreign currency exchange rates, commodity prices, and other relevant market rates and prices. Management seeks to reduce fluctuations in its net interest margin and to optimize net interest income with acceptable levels of risk through periods of changing interest rates. Accordingly, the Corporation’s interest rate sensitivity and liquidity are monitored on an ongoing basis by its Asset and Liability Committee (“ALCO”). ALCO establishes risk measures, limits and policy guidelines for managing the amount of interest rate risk and its effect on net interest income and capital. A variety of measures are used to provide for a comprehensive view of the magnitude of interest rate risk, the distribution of risk, the level of risk over time and the exposure to changes in certain interest rate relationships. ALCO continuously monitors and manages the balance between interest rate sensitive assets and liabilities. The objective is to manage the impact of fluctuating market rates on net interest income within acceptable levels. In order to meet this objective, management may lengthen or shorten the duration of assets or liabilities. Management considers market interest rate risk to be one of the Corporation’s most significant ongoing business risk considerations.

 

The two primary methods to monitor and manage interest rate risk are rate-sensitivity gap analysis and review of the effects of various interest rate shock scenarios. Based upon ALCO’s review, there has been no significant change in the interest rate risk of the Corporation since year-end 2013. (See Quantitative and Qualitative Disclosures about Market Risk in the Annual Report to Shareholders for the year ended December 31, 2013)

  

 

Item 4. Controls and Procedures

 

Under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial Officer, the Corporation conducted an evaluation of its disclosure controls and procedures, pursuant to Securities Exchange Act of 1934. Based on this evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Corporation’s disclosure controls and procedures were effective as of the end of the period covered by this report.

 

There was no change in the Corporation’s internal control over financial reporting that occurred during the Corporation’s fiscal quarter ended September 30, 2014 that has materially affected, or is reasonably likely to materially affect, the Corporation’s internal control over financial reporting.

 

 

 
39
COMMERCIAL BANCSHARES, INC.
FORM 10-Q
Quarter ended September 30, 2014
PART II – OTHER INFORMATION

 

Item 1   Legal Proceedings

 

There are no matters required to be reported under this item.

 

Item 1A   Risk Factors

 

There have been no material changes from risk factors as previously disclosed in Part 1, Item 1.A. of Commercial Bancshares, Inc.’s 10-K filed on March 26, 2013.

 

Item 2   Unregistered Sales of Securities and Use of Proceeds

 

For the three and nine months ended September 30, 2014, the Corporation purchased 100 and 1,363 shares, respectively, totaling $2,450 and $32,850 to fund acquisitions made by participating directors under the Commercial Savings Bank Deferred Compensation Plan, a nonqualified deferred compensation plan. Shares are purchased on the open market and are credited to the respective accounts of the deferred compensation plan participants. In addition to open market purchases, during the three and nine months ended September 30, 2014, a total of 423 and 2,825 shares, respectively, were issued from treasury to the Plan to fund participant acquisitions at a cost of $10,046 and $61,185. None of the acquisitions by plan participants were registered with the Securities and Exchange Commission, but were made in reliance upon the exemption from registration contained in Section 4(a)(2) of the Securities Act of 1933.

 

Except as otherwise indicated above, there were no shares repurchased by the Corporation during the three and nine months ended September 30, 2014, including any shares purchased as part of a repurchase program approved by the Corporation’s Board of Directors in June 2009. The stock repurchase program, which was not publicly announced, allows the Corporation to annually purchase up to 2% of the number of common shares outstanding as of the authorization date. The maximum number of shares which the Corporation may repurchase on a weekly basis under the program is capped at 290 shares. The repurchase program has no formal expiration date, but the Board of Directors is required to review the authorization no less than annually.

 

               Maximum Number 
           Total Number of   (or Approximate 
           Shares   Dollar Value) 
   Total       Purchased as   of Shares that May 
   Number   Average   Part of Publicly   Yet be Purchased 
   of Shares   Price Paid   Announced Plans   Under the Plans 
Period  Purchased   per Share   or Programs   or Programs 
07/01/14 – 07/31/14   100    $24.50    0    23,548 
08/01/14 – 08/31/14   0    $0.00    0    23,548 
09/01/14 – 09/30/14   0    $0.00    0    23,548 
Total   0    $0.00    0    23,548 

 

Item 3   Defaults upon Senior Securities

 

There are no matters required to be reported under this item.

 

Item 4   Mine Safety Disclosures

 

Not applicable.

 

Item 5   Other Information

 

There are no matters required to be reported under this item.

 

 
40
COMMERCIAL BANCSHARES, INC.
FORM 10-Q
Quarter ended September 30, 2014
PART II – OTHER INFORMATION

 

Item 6Exhibits:

  

Exhibit    
Number   Description of Document
     
3.1.a.  

Amended Articles of Incorporation of the Corporation (incorporated by reference to Registrant’s Form 8-K dated April 27, 1995)

     
3.1.b.  

Amendment to the Corporation’s Amended Articles of Incorporation to increase the number of shares authorized for the issuance to 4,000,000 common shares, no par value (incorporated by reference to Appendix I to Registrant’s Definitive Proxy Statement filed March 13, 1997)

     
3.2  

Code of Regulations of the Corporation (incorporated by reference to Registrant’s Form 8-K dated April 27, 1995)

     
4  

Form of Certificate of Common Shares of the Corporation (incorporated by reference to Registrant’s Form 8-K dated April 27, 1995)

     
11   Statement re computation of per share earnings (reference is hereby made to Note 2 of the Consolidated Financial Statements on page 8 hereof)
     
31.1   Certification by CEO Pursuant to Sarbanes Oxley Section 302
     
31.2   Certification by CFO Pursuant to Sarbanes Oxley Section 302
     
32.1   Certification by CEO Pursuant to Sarbanes Oxley Section 906
     
32.2   Certification by CFO Pursuant to Sarbanes Oxley Section 906
     
     
101.INS   XBRL Instance Document
101.SCH   XBRL Taxonomy Extension Schema Document
101.CAL   XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF   XBRL Taxonomy Extension Definition Linkbase Document
101.LAB   XBRL Taxonomy Extension Label Linkbase Document
101.PRE   XBRL Taxonomy Extension Presentation Linkbase Document
     
       

  

  

 

 

 

 

 
41
COMMERCIAL BANCSHARES, INC.
SIGNATURES

 

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 

         
      COMMERCIAL BANCSHARES, INC.  
      (Registrant)  
         
         
         
         
Date: November 13, 2014   /s/ Robert E. Beach  
      (Signature)  
      Robert E. Beach  
      President and Chief Executive Officer  
         
         
         
         
Date: November 13, 2014   /s/ Scott A. Oboy  
      (Signature)  
      Scott A. Oboy  
      Executive Vice President and Chief Financial Officer  
         
         

 

 

 
42