Commercial National Financial Corporation March 2007 10 Q
  
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
 
FORM 10-Q


(Mark One)

ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2007

ྑ
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                to                

Commission file number 0-18676

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


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

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


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


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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “ accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large Accelerated filer [ ]  Accelerated filer [ ] Non-accelerated filer [ x ]

Indicate by check mark whether the registrant is a shell company( as defined in Rule 12b-2 of the Exchange Act).
 
          [ ]yes [x] No
 
Indicate the number of shares outstanding of each of the issuer's classes of common stock.



CLASS
OUTSTANDING AT May 11, 2007
Common Stock, $2 Par Value
3,044,813 Shares

 


PART I - FINANCIAL INFORMATION



ITEM 1. FINANCIAL STATEMENTS


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

ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
  
100
 

ITEM 3. Quantitative and Qualitative Disclosures about Market Risk
  
144
 
ITEM 4. Controls and Procedures
  
155

 
5

PART II - OTHER INFORMATION

 
 
ITEM 1. Legal Proceedings
  
166
ITEM 1A. Risk Factors
  
          16
TEM 2. Unregistered Sales of Equity Securities and Use of Proceeds
  
166
ITEM 3. Defaults Upon Senior Securities
  
166
ITEM 4. Submission of Matters to a Vote of Security Holders
  
166
ITEM 5. Other Information
  
166
ITEM 6. Exhibits
  
177
     
Signatures
  
188
     
     


 



COMMERCIAL NATIONAL FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(dollars in thousands, except per share amounts)
               
 
    
March 31,
    
December 31,
 
     
2007
    
2006
  
 
    
(unaudited)
 		        
 
ASSETS
Cash and due from banks
 
$
9,954
  
$
10,134
  
Interest bearing deposits with banks  
    
248
    
22
  
Total cash and cash equivalents
    
10,202
    
10,156
  
 
 
Federal funds sold
    
5,475
    
-
  
Investment securities available for sale
    
76,623
    
78,996
  
Restricted investments in bank stock
    
1,261
    
1,180
  
 
 
Loans receivable
   
225,043
    
229,528
  
Allowance for loan losses
    
(1,880
)
  
(1,806
)
Net loans
    
223,163
    
227,722
  
 
Premises and equipment, net
    
3,847
    
3,886
  
Investment in life insurance
    
13,566
    
13,452
  
Other assets
    
3,146
    
2,804
  
 
Total assets
  
$
337,283
  
$
338,196
  
 
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits (all domestic):
Non-interest bearing
  
$
67,998
  
$
65,699
  
Interest bearing 
    
230,145
    
228,221
  
Total deposits
    
298,143
    
293,920
  
 
Short-term borrowings
    
-
    
5,000
  
Other liabilities
    
1,791
    
2,047
  
Total liabilities
    
299,934
    
300,968
  
 
Shareholders' equity:
Common stock, par value $2 per share; 10,000,000
shares authorized; 3,600,000 issued;
3,044,813 shares outstanding
   
7,200
    
7,200
  
Retained earnings
    
40,000
    
39,869
  
Accumulated other comprehensive income
    
555
    
566
  
Treasury stock, at cost, 555,187 shares
   
(10,406
)
  
(10,406
)
Total shareholders' equity 
    
37,349
    
37,229
  
 
Total liabilities and
shareholders' equity
  
$
337,283
  
$
338,196
  
 
The accompanying notes are an integral part of these consolidated financial statements.

 



COMMERCIAL NATIONAL FINANCIAL CORPORATION
  
CONSOLIDATED STATEMENTS OF INCOME
  
(Dollars in thousands, except per share data)
  
   
Three Months Ended
  
Three Months Ended
  
   
March 31
  
March 31
  
   
2007
  
2006
  
 
    
(unaudited)
    
(unaudited
)
INTEREST INCOME:
              
Interest and fees on loans
  
$
3,421
  
$
3,003
  
Interest and dividends on investments:
              
Taxable
   
1,094
    
881
  
Exempt from federal income tax
    
60
    
33
  
Other
    
22
    
171
  
Total interest income
    
4,597
    
4,088
  
               
INTEREST EXPENSE
              
Interest on deposits
    
1,588
    
1,199
  
Interest on short-term borrowings
    
64
    
-
  
Total interest expense
    
1,652
    
1,199
  
               
NET INTEREST INCOME
    
2,945
    
2,889
  
PROVISION FOR LOAN LOSSES
    
90
    
30
  
               
NET INTEREST INCOME AFTER
             
PROVISION FOR LOAN LOSSES
    
2,855
    
2,859
  
               
OTHER INCOME
              
Asset management and trust income
    
274
    
209
  
Service charges on deposit accounts
    
151
    
164
  
Other service charges and fees
    
192
    
201
  
Income from investment in life insurance
    
135
    
129
  
Other income
    
46
    
43
  
Total other income
    
798
    
746
  
               
OTHER EXPENSES
              
Salaries and employee benefits
    
1,353
    
1,311
  
Net occupancy expense
    
194
    
196
  
Furniture and equipment expense
    
113
    
166
  
Pennsylvania shares tax
    
140
    
140
  
Legal and professional
   
120
    
301
  
Other expense
    
747
    
758
  
Total other expenses
    
2,667
    
2,872
  
               
INCOME BEFORE INCOME TAXES
    
986
    
733
  
Income tax expense
    
246
    
195
  
               
NET INCOME
  
$
740
  
$
538
  
               
Average shares outstanding
    
3,044,813
    
3,381,238
  
               
EARNINGS PER SHARE, BASIC
  
$
0.24
  
$
0 .16
  
               
Dividend declared per share
  
$
0 .20
  
$
0.20
  


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

 



COMMERCIAL NATIONAL FINANCIAL CORPORATION
  
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
  
(dollars in thousands, except per share data)
  
   
 
                     
Accumulated
        
                     
Other
    
Total
  
   
Common
    
Retained
    
Treasury
    
Comprehensive
    
Shareholders’
  
 
    
Stock
    
Earnings
    
Stock
    
Income
    
Equity
  
(unaudited)
                                
Balance at December 31, 2006
  
$
7,200
  
$
39,869
  
$
(10,406
)
$
566
  
$
37,229
  
                                 
Comprehensive Income
                                
Net income
    
-
    
740
    
-
    
-
    
740
  
                                 
Other comprehensive loss, net of tax:
                                
Unrealized net losses on securities
    
-
    
-
    
-
    
(11
)
  
(11
)
Total Comprehensive Income
                            
729
  
                                 
Cash dividends declared
                                
$.20 per share
    
-
    
(609
)
        
-
    
(609
)
                                 
Balance at March 31, 2007
  
$
7,200
  
$
40,000
  
$
(10,406
)
$
555
  
$
37,349
  
                                 
(unaudited)
                                
Balance at December 31, 2005
  
$
7,200
  
$
39,422
  
$
(3,578
)
$
617
  
$
43,661
  
                                 
Comprehensive Income
                                
Net income
    
-
    
538
    
-
    
-
    
538
  
                                 
Other comprehensive loss, net of tax:
                                
Unrealized net losses on securities
    
-
    
-
    
-
    
(312
)
  
(312
)
Total Comprehensive Income
                            
226
  
                                 
Cash dividends declared
                                
$.20 per share
    
-
    
(683
)
        
-
    
(683
)
Purchase of treasury stock
                              
(362,113 shares )
                
(6,699
)
        
(6,699
)
                                 
Balance at March 31, 2006
  
$
7,200
  
$
39,277
  
$
(10,277
)
$
305
  
$
36,505
  



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

 


 
COMMERCIAL NATIONAL FINANCIAL CORPORATION
  
CONSOLIDATED STATEMENTS OF CASH FLOWS
  
(dollars in thousands)
  
(unaudited)
  
 
 
For Three Months March 31,
 
  
     
2007
    
2006
  
               
OPERATING ACTIVITIES
              
Net income
  
$
740
  
$
538
  
Adjustments to reconcile net income to net cash provided by
              
operating activities:
              
Depreciation and amortization
    
124
   
137
  
Amortization of intangibles
    
24
    
24
  
Provision for loan losses
    
90
   
30
  
Net accretion of loans and securities
    
(12
)
  
(12
)
Income from investment in life insurance
    
(135
)
  
(129
)
Loss on sale of foreclosed real estate
    
7
    
-
  
Decrease in other liabilities
    
(250
)
  
(25
)
Increase in other assets
    
(377
)
  
(243
)
Net cash provided by operating activities
    
211
    
320
  
               
INVESTING ACTIVITIES
              
(Increase) decrease in federal funds sold
    
(5,475
)
  
4,975
  
Purchase of securities
   
-
    
(520
)
Maturities and calls of securities
   
2,389
    
3,300
  
Purchase of restricted investments in bank stock
    
(289
)
  
-
  
Redemption of restricted investments in bank stock
    
208
    
16
  
Net decrease (increase) in loans
    
4,455
    
(6,513
)
Proceeds from sale of foreclosed real estate
   
18
    
-
  
Purchase of premises and equipment
    
(85
)
  
(33
)
Net cash provided by investing activities
    
1,221
    
1,225
  
               
FINANCING ACTIVITIES
              
Net increase in deposits
    
4,223
    
2,836
  
Decrease in other short-term borrowings
    
(5,000
)
  
-
  
Dividends paid
    
(609
)
  
(683
)
Purchase of treasury stock
    
-
    
(6,699
)
Net cash used in financing activities
    
(1,386
)
  
(4,546
)
Increase (decrease) in cash and cash equivalents
    
46
    
(3,001
)
               
Cash and cash equivalents at beginning of year
    
10,156
    
12,881
  
               
Cash and cash equivalents at end of quarter
  
$
10,202
  
$
9,880
  
               
Supplemental disclosures of cash flow information:
              
               
Cash paid during the period for:
              
Interest
  
$
1,800
  
$
1,168
  
               
Income Taxes
  
$
75
  
$
140
  
The accompanying notes are an integral part of these consolidated financial statements.

 

 
                            COMMERCIAL NATIONAL FINANCIAL CORPORATION
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2007

Note 1  Basis of Presentation

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

The accompanying unaudited consolidated interim financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information. However, they do not include all information and footnotes required by generally accepted accounting principles for complete financial statements and should be read in conjunction with the annual financial statements of the Corporation for the year ended December 31, 2006, including the notes thereto. In the opinion of management, the unaudited interim consolidated financial statements include all adjustments (consisting of only normal recurring adjustments) necessary for a fair statement of financial position as of March 31, 2007 and the results of operations for the three-month period ended March 31, 2007 and 2006. The results of operations for the three months ended March 31, 2007 are not necessarily indicative of the results to be expected for the entire year.


Note 2 Allowance for Loan Losses

The provision for loan losses is the amount added to the allowance against which actual loan losses are charged. The amount of the provision is determined by management through an evaluation of the size and quality of the loan portfolio, economic conditions, concentrations of credit, recent loan loss trends, delinquencies and other risks inherent within the loan portfolio.

The corporation recorded a $90,000 provision for the three-month period ended March 31, 2007. By comparison, during the Corporation’s first quarter 2006 the Corporation recorded a $30,000 provision.

Description of changes:
                                                            (dollars in thousands)
  
     
2007
    
2006
  
               
Allowance balance January 1
  
$
1,806
  
$
1,636
  
               
Provision charged to operating expenses
    
90
   
30
  
Recoveries on previously charged off loans
    
4
   
5
  
Loans charged off
    
(20
)
  
(44
)
               
Allowance balance March 31
  
$
1,880
  
$
1,627
  


 


COMMERCIAL NATIONAL FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 3  Comprehensive Income

The components of other comprehensive income (loss) and related tax effects for the three month periods ended March 31, 2007 and 2006 are as follows: (dollars in thousands)

   
For three months
  
   
ended March 31
  
   
2007
  
2006
  
Net unrealized (losses) on
             
securities available for sale
  
$
(16
)
$
(472
)
               
Tax effect
    
(5
)
  
(160
)
Net of tax amount
  
$
(11
)
$
(312
)

Note 4 Legal Proceedings

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

Note 5 Guarantees

The Corporation does not issue any guarantees that would require liability recognition or disclosure, other than its standby letters of credit. Standby letters of credit written are conditional commitments issued by the Bank to secure the performance of a customer to a third party. Of these letters of credit, $600,000 automatically renew within the next twelve months, $51,000 will expire within the next twelve months and $3,357,000 will expire within thirteen to one hundred and forty-nine months. The Bank, generally, holds collateral and/or personal guarantees supporting these commitments. The credit risk involved in issuing letters of credit is essentially the same as those that are involved in extending loan facilities to customers. The current amount of the liability as of March 31, 2007 for guarantees under standby letters of credit issued is not material.

Note 6 Earnings per share

The Corporation has a simple capital structure. Basic earnings per share equals net income divided by the weighted average common shares outstanding during each period presented. The weighted average common shares outstanding for the three months ended March 31, 2007 and 2006 was 3,044,813 and 3,381,238 respectively.

Note 7 New Accounting Standards 

EITF 06-10

In March 2007, the FASB ratified Emerging Issues Task Force Issue No. 06-10 “Accounting for Collateral Assignment Split-Dollar Life Insurance Agreements” (EITF 06-10). EITF 06-10 provides guidance for determining a liability for the postretirement benefit obligation as well as recognition and measurement of the associated asset on the basis of the terms of the collateral assignment agreement. EITF 06-10 is effective for fiscal years beginning after December 15, 2007. The Corporation is currently assessing the impact of EITF 06-10 on its consolidated financial position and results of operations.

SFAS 159

In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities-Including an amendment of FASB Statement No. 115." SFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value. Unrealized gains and losses on items for which the fair value option has been elected will be recognized in earnings at each subsequent reporting date. SFAS No. 159 is effective for our Company January 1, 2008. The Corporation is evaluating the impact that the adoption of SFAS No. 159 will have on our consolidated financial statements. 

 
FAS 157

In September 2006, the FASB issued FASB Statement No. 157, Fair Value Measurements, which defines fair value, establishes a framework for measuring fair value under GAAP, and expands disclosures about fair value measurements. FASB Statement No. 157 applies to other accounting pronouncements that require or permit fair value measurements. The new guidance is effective for financial statements issued for fiscal years beginning after November 15, 2007, and for interim periods within those fiscal years. The Corporations is currently evaluating the potential impact, if any, of the adoption of FASB Statement No. 157 on our consolidated financial position, results of operations and cash flows.

SAB 108
 
On September 13, 2006, the Securities and Exchange Commission “SEC” issued Staff Accounting Bulleting No. 108 (“SAB 108”). SAB 108 provides interpretive guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a potential current year misstatement. Prior to SAB 108, Companies might evaluate the materiality of financial-statement misstatements using either the income statement or balance sheet approach, with the income statement approach focusing on new misstatements added in the current year, and the balance sheet approach focusing on the cumulative amount of misstatement present in a company’s balance sheet. Misstatements that would be material under one approach could be viewed as immaterial under another approach, and not be corrected.
 
SAB 108 now requires that companies view financial statement misstatements as material if they are material according to either the income statement or balance sheet approach. The Company has analyzed SAB 108 and determined that upon adoption it will have no impact on the reported results of operations or financial condition.

 

 



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

SAFE HARBOR STATEMENT

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


CRITICAL ACCOUNTING ESTIMATES

Disclosure of the Corporation’s significant accounting policies is included in Note 1 to the Corporation’s Consolidated Financial Statements contained in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2006 (the 2006 Annual Report). Some of these policies are particularly sensitive, requiring that significant judgments, estimates and assumptions be made by management. Additional information is contained in the Management’s Discussion and Analysis section of the 2006 Annual Report for the most sensitive of these issues, including the provision and allowance for loan losses.

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

OVERVIEW

The Corporation had net income of $740,000 or $0.24 per share, for the first quarter ended March 31, 2007 compared to $538,000 or $0.16 per share for the quarter ended March 31, 2006. The Corporation’s return on average assets for the first quarter of 2007 and 2006 was .88% and .68%, respectively. Return on average equity for the same two periods was 7.95% and 4.97%, respectively.

The Corporation’s largest segment of operating results is dependent upon net interest income. Net interest income is interest earned on interest-earning assets less interest paid on interest-bearing deposits. For the first quarter ended March 31, 2007 and 2006, net interest income was $2.9 million and $2.9 million, respectively.
 

 



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

FINANCIAL CONDITION

The Corporation’s total assets decreased by $913,000, or 0.30%, from December 31, 2006 to March 31, 2007. Federal funds sold increased by $5.5 million and investment securities available for sale decreased by $2.4 million. The decrease in investments was a result of principal pay-downs on mortgage-backed securities. Net loans outstanding decreased by $4.6 million. Declines in construction mortgages of $1.8 million, $1.1 million in lines of credits, $2.8 million in commercial loans and $230,000 in consumer loans were slightly offset by a $1.5 million increase in residential mortgages. The Corporation attributes the loan declines to commercial customers being cautious in the first quarter of 2007. Federal funds sold increased due the decrease in investments and net loans.

The Corporation’s total deposits increased $4.2 million from December 31, 2006 to March 31, 2007. Non-interest bearing deposits increased by $2.3 million and interest-bearing deposits increased by $1.9 million. The increase in non-interest deposits is considered a normal fluctuation in our customer’s checking accounts and the increase in certificates of deposits is due to the corporation matching market rates on shorter duration certificates of deposits. Short term borrowings declined by $5.0 million from December 31, 2006 to March 31, 2007. The increase in deposits eliminated the need for the $5.0 million in short term borrowings.
 
Shareholders' equity was $37.3 million on March 31, 2007 compared to $37.2 million on December 31, 2006. Total shareholders equity increased due to the $740,000 in net income that was offset by $609,000 paid in dividends to shareholders and the decrease in other comprehensive income of $11,000 due to the decrease in the fair value of securities available for sale. Book value per common share increased from $12.23 at December 31, 2006 to $12.27 at March 31, 2007.

RESULTS OF OPERATIONS

First Three Months of 2007 as compared to the First Three Months of 2006

Net income for the first three months of 2007 was $740,000 compared to $538,000 for the same period of 2006, representing a 38% increase. The main reason for the increase was legal and professional fees in 2007 were $181,000 lower compared with 2006. In the first quarter of 2006, the Corporation purchased 362,116 shares of its own common stock. The legal and professional costs associated with this purchase were $150,000.

Interest income for the three months ended March 31, 2007 was $4.6 million, an increase of 12.45% from interest income of $4.1 million for the three months ended March 31, 2006. Loan income increased in 2007 due to higher average loan balances in 2007 and higher yields. The yield on the loan portfolio for the first three months of 2007 increased twenty- six (26) basis points to 6.03% from 5.77% in 2006. In addition, average loan balances increased 8.91% in 2007 compared with the averages for the first quarter 2006. The bank has been able to increase yields due to higher market rates for loans. The yield on the securities portfolio for the first three months of 2007 increased forty-eight (48) basis points to 5.86%. The yield increased mainly due to the corporation’s ability to purchase higher yielding securities between first quarter 2006 and first quarter 2007. The securities purchased were mortgage-backed securities. The yield on total average earning assets for the first three months of 2007 increased thirty-three (33) basis points from 2006 to 5.99%.
 
Total interest expense of $1.65 million for the first three months of 2007 increased by $450,000 or 38% from the first three months of 2006. In the first quarter of 2007, the market cost of interest-bearing deposits increased, in addition, the volume of the Corporation’s interest-bearing deposits increased. The average cost of interest-bearing liabilities for the first three months of 2007 was 2.92%, a sixty-one (61) basis points increase from the same period in 2006.

As a result of the foregoing, net interest income for the first three months of 2007 was substantially the same as the first three months of 2006, $2.9 million.

The Corporation recorded a provision for loan losses of $90,000 for the three months ended March 31, 2007 compared to a $30,000 provision for the three months ended March 31, 2006. The Corporation increased the provision in 2007 due to higher outstanding loan balances.

 



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


Non-interest income for the first three months of 2007 was $798,000, an increase of 7% from 2006. This increase in income of $52,000 is primarily the result of an increase in Asset Management and Trust income of $65,000 offset by a $13,000 reduction in service charge and overdraft fees on deposit accounts.

Non-interest expenses for the first three months of 2007 was $2.7 million, a decrease of $205,000 or 7% from non-interest expenses for the first three months of 2006. Personnel costs increased $42,000 period to period. Legal and Professional expense decreased by $181,000, mainly due to costs associated with the repurchase of stock in 2006. In 2007 Furniture and Equipment expense decreased by $53,000 due to lower equipment maintenance and lower depreciation costs on Furniture and Equipment. Other expenses decreased by $11,000.

Federal income tax for the first three months of 2007 was $246,000 compared to $195,000 for the same period in 2006. The effective tax rates for the first three months of 2007 and 2006 were 24.9% and 26.6%, respectively.

LIQUIDITY

Liquidity measurements evaluate the Corporation’s ability to meet the cash flow requirements of its depositors and borrowers. The most desirable source of liquidity is deposit growth. Additional liquidity is provided by the maturity of investments in loans and securities and the principal and interest received from those earning assets. Another source of liquidity is represented by the Corporation’s ability to sell both loans and securities. The Bank is a member of the Federal Home Loan Bank (FHLB) system. The FHLB provides an additional source for liquidity for long- and short-term funding. Additional sources of funding from financial institutions have been established for short-term funding needs.

The statement of cash flows indicates cash provided by the decrease in loan balances and the maturities and calls of securities were used to increase federal funds sold. The increase in deposits provided funding to eliminate short-term borrowings.
 
As of March 31, 2007, the Corporation had available funding of approximately $187 million at the FHLB, with an additional $26 million of short term funding available through other lines of credit.

OFF BALANCE SHEET ARRANGEMENTS

The Corporation’s financial statements do not reflect off balance sheet arrangements that consist of commitments to purchase securities or commitments to extend credit. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Corporation evaluates each customer's credit worthiness on a case-by-case basis. The amount of collateral, if any, which the Corporation obtains from the customer upon extension of credit, is based on management's credit evaluation of the customer or other obligor. The types of collateral obtained by the Corporation may include accounts receivable, inventory, property, plant and equipment and income-producing commercial properties.

Standby letters of credit, financial standby letters of credit and commercial letters of credit written are conditional commitments issued by the Corporation to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.


 


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


The following table identifies the Corporation’s commitments to extend credit and obligations under letters of credit as of March 31, 2007 (dollars in thousands):

     
TOTAL AMOUNT COMMITTED

 
Financial instruments whose contractual amounts represent credit risk:
    
 
Commitments to extend credit
  
$38,810
 
Standby letters of credit
  
600
 
Financial standby letters of credit
  
3,409
       
       

CREDIT QUALITY RISK

The following table presents a comparison of loan quality as of March 31, 2007 with that as of December 31, 2006. Cash payments received on non-accrual loans are recognized as interest income as long as the remaining balance of the loan is deemed to be fully collectible. When doubt exists as to the collectibility of a loan in non-accrual status, any payments received are applied to principal to the extent the doubt is eliminated. Once a loan is placed on non-accrual status, any unpaid interest is charged against income.
 
   
At or For the
Three month ended
 
At or For the
Year ended
  
   
March 31, 2007
  
December 31, 2006
  
 
(dollars in thousands) 
Non-performing loans:
              
Loans on non-accrual basis
  
$
540
  
$
561
  
Past due loans > 90 days
    
-
    
-
  
Renegotiated loans
    
2,812
    
2,823
  
Total non-performing loans
    
3,352
    
3,384
  
Foreclosed real estate
    
880
    
905
  
               
Total non-performing assets
  
$
4,232
  
$
4,289
  
               
Loans outstanding at end of period
  
$
225,043
  
$
229,528
  
Average loans outstanding (year-to-date)
  
$
226,843
  
$
218,944
  
               
Non-performing loans as a percent of total loans
    
1.49
%
  
1.47
%
Provision for loan losses
  
$
90
  
$
210
  
Net charge-offs
 
$
16
  
$
40
  
Net charge-offs as a percent of average loans
    
.01
%
  
.02
%
Provision for loan losses as a percent of net charge-offs
    
563.00
%
  
525.00
%
Allowance for loan losses
  
$
1,880
  
$
1,806
  
Allowance for loan losses as a percent of average loans outstanding
    
0.83
%
  
0.82
%

As of March 31, 2007, $426,000 of non-accrual loans were paying principal or principal and interest with payments recognized on a cash basis.
 $2.4 million of the renegotiated loan amount relates to a single borrower. The borrower requested a modification of interest and a period of
 interest only payments. At present, the Corporation has no knowledge of other outstanding loans that present a serious doubt in regard to the borrower’s ability to comply with current loan repayment terms.
 
 

 


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

CAPITAL RESOURCES

 
The Federal Reserve Board's risk-based capital guidelines are designed principally as a measure of credit risk. These guidelines require that: (1) at least 50% of a banking organization's total capital be common and certain other "core" equity capital ("Tier I Capital"); (2) assets and off-balance sheet items be weighted according to risk; and (3) the total capital to risk-weighted assets ratio be at least 8.00%; and (4) a minimum 4.00% leverage ratio of Tier I capital to average total assets be maintained for financial institutions that meet certain specified criteria, including asset quality, high liquidity, low interest-rate exposure and the highest regulatory rating. Banking organizations with supervisory, financial, operational, or managerial weaknesses, as well as organizations that are anticipating or experiencing significant growth, are expected to maintain capital ratios well above minimum levels. Moreover, higher capital ratios may be required for any bank holding company if warranted by its particular circumstances or risk profile. In all cases, bank hold holding companies should hold capital commensurate with the level and nature of the risks, including the volume and severity of problem loans, to which they are exposed. As of March 31, 2007, the Corporation, under these guidelines, had Tier I and total equity capital to risk weighted assets ratios of 16.86% and 17.73% respectively. The leverage ratio was 10.87%. The bank’s capital position and related ratios are similar to the Corporation’s amounts listed below.

The table below presents the Corporation's capital position at March 31, 2007
(Dollar amounts in thousands)
 
Percent
 
of Adjusted
 
Amount
Assets
     
Tier I Capital
$ 36,225
16.86%
Tier I Capital Requirement
     8,595
  4.00
     
Total Equity Capital
$ 38,105
17.73%
Total Equity Capital Requirement
   17,190
  8.00
     
     
     
Leverage Capital
$ 36,225
10.87%
Leverage Requirement
   13,329
  4.00
     

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Corporation’s primary market risk is interest rate risk. Interest rate risk arises due to timing differences between interest sensitive assets and liabilities. Interest rate management seeks to maintain a balance between consistent income growth and the risk that is created by variations in the ability to reprice deposit and investment categories. The effort to determine the effect of potential interest rate changes normally involves measuring the "gap" between assets (loans and securities) subject to rate fluctuation and liabilities (interest bearing deposits and long-term borrowings) subject to rate fluctuation as related to earning assets over different time periods and calculating the ratio of interest sensitive assets to interest sensitive liabilities.

Repricing periods for the loans, securities, interest bearing deposits and long-term borrowings are based on contractual maturities, where applicable, as well as the Corporation's historical experience regarding the impact of interest rate fluctuations on the prepayment and withdrawal patterns of certain assets and liabilities. Regular savings, NOW and other similar interest bearing demand deposit accounts are subject to immediate withdrawal without penalty. However, based upon historical performance, management considers a certain portion of the accounts to be stable core deposits and therefore are projected to reprice over a variety of time periods.

The Corporation utilizes a computer simulation analysis that projects the impact of changing interest rates on earnings. Simulation modeling projects a baseline net interest income (assuming no changes in interest rate levels) and estimates changes to that baseline resulting from changes in interest rate levels. The Corporation utilizes the results of this model in evaluating its interest rate risk. This model incorporates a number of additional factors. These factors include: (1) the expected exercise of call features on various assets and liabilities; (2) the expected rates at which various rate sensitive assets and liabilities will reprice; (3) the expected relative movements in different interest rate indexes that are used as the basis for pricing or repricing various assets and liabilities; (4) expected changes in administered rates on interest-bearing transaction, savings, money market and time deposit accounts and the expected impact of competition on the pricing or repricing of such accounts; and (5) other factors. Inclusion of these factors in the model is intended to estimate the Corporation’s changes in net interest income resulting from an immediate and sustained parallel shift in interest rates of up 100 basis points (bps), up 200 bps, down 100 bps and down 200 bps. While the Corporation believes this model provides a useful projection of its interest rate risk, the model includes a number of assumptions and predictions that are subject to continual refinement. These assumptions and predictions include inputs to compute baseline net interest income, growth rates and a variety of other factors that are difficult to accurately predict.

The March 31, 2007 computer simulations analysis projects the following changes in net interest income based on an immediate and sustained parallel shift in interest rates for a twelve month period compared to baseline, with baseline representing no change in interest rates. The model projects net interest income will decrease 5.9% if rates rise 200 bps, and projects a 2.7% decrease of net interest income if rates rise 100 bps. If rates decrease 200 bps, the model projects a 2.7% decrease in net interest income and if rates decrease 100 bps, the model projects net interest income will increase 0.7%.
 
Management regularly monitors the interest sensitivity position and considers this position in its decisions with regard to the Corporation’s interest rates and maturities for interest-earning assets and interest-bearing liabilities.

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures
The Corporation maintains a system of disclosure controls and procedures that is designed to ensure that information required to be disclosed by the Corporation in this Form 10-Q, and in other reports required to be filed under the Securities Exchange Act of 1934 (Exchange Act), is recorded, processed, summarized and reported within the time periods specified in the rules and forms for such filings. Management of the Corporation, under the direction of the Corporation’s Chief Executive Officer and Chief Financial Officer, reviewed and performed an evaluation of the effectiveness of the Corporation’s disclosure controls and procedures (as defined in Rules 13a-15a(e) and 15d-15(e) under the Exchange Act) as of March 31, 2007. Based on that review and evaluation, the Chief Executive Officer and Chief Financial Officer, along with other key management of the Corporation, have determined that the disclosure controls and procedures were and are effective as designed to ensure that material information relating to the Corporation and its consolidated subsidiaries required to be disclosed by the Corporation by the Exchange Act, was recorded, processed, summarized and reported within the applicable time periods.

Changes in Internal Controls

There have been no significant changes in our internal controls or in other factors that could significantly affect our internal controls during the quarter ended March 31, 2007.

 
 

 


PART II - OTHER INFORMATION


ITEM 1. LEGAL PROCEEDINGS

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

ITEM 1A. RISK FACTORS 

There have been no material changes from the risk factors as previously disclosed in the Corporation’s December 31, 2006 Form 10-K, Item 1A.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS


2 (a) None
2 (b) None
2 (c) See table below
ISSUER PURCHASES OF EQUITY SECURITIES
Period
(a) Total Number of Shares Purchased
(b) Average Price Paid per Share
(c) Total Number of Shares Purchased as Part of Publicly Announced Plans
(d) Maximum Number of Shares that May Yet Be Purchased Under the Plans
January 1- January 31
 0
0
0
 166,926
February 1 -February 28
 0
0
0
 166,926
March 1-
March 31
 0
0
0
 166,926
Total
 0
0
0
 166,926

In 2000, the Board of Directors authorized the repurchase of up to 360,000 shares of the Corporation’s common stock from time to time when warranted by market conditions. There have been 193,074 shares purchased under this authorization through March 31, 2007.

In March 2006, the Board of Directors authorized the repurchase of 362,113 shares of the Corporation’s common stock at $18.50 per share. These shares are not included in any previously approved stock repurchase program. Please see the Corporation’s 8-K dated March 27, 2006 for additional information on this transaction.


ITEM 3. DEFAULTS UPON SENIOR SECURITIES

Not applicable.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Not applicable   
 

ITEM 5. OTHER INFORMATION

Not applicable

 



ITEM 6. EXHIBITS

a. Exhibits
 
Exhibit
Number
 
 
Description
Page Number or
Incorporated by
Reference to
     
3.1
Articles of Incorporation
Exhibit C to Form S-4 Registration Statement Filed April 9, 1990
     
3.2
By-Laws of Registrant
Exhibit D to Form S-4 Registration Statement Filed April 9, 1990
     
3.3
Amendment to Articles of Incorporation
Exhibit A to definitive Proxy Statement filed for the special meeting of shareholders held September 18, 1990
     
3.4
Amendment to Articles of Incorporation
Exhibit A to definitive Proxy Statement filed for the meeting of shareholders held on April 15, 1997
     
3.6
Amendment to Articles of Incorporation
Exhibit A to definitive Proxy Statement filed for the meeting of shareholders held September 21, 2004
     
3.8
Amendment to the Bylaws of Registrant
Exhibit 3.8 to Form 10-Q for the quarter
ended September 30, 2004
     
10.1
Employment agreement between Gregg E. Hunter and Commercial Bank of Pennsylvania
Exhibit 10.1 to Form 10-Q for the quarter ended September 30, 2003
     
10.3
Mutual Release and Non-Disparagement Agreement between Commercial Bank of Pennsylvania and Louis T. Steiner
Exhibit 10.3 to Form 10-K for the year ended December 31, 2003
     
31.1
Rule 13a-15(e) and 15d-15(e) Certification of Chief Executive Officer
Filed herewith
     
31.2
Rule 13a-15(e) and 15d-15(e) Certification of Chief Financial Officer
Filed herewith
     
32.1
Section 1350 Certification of the Chief Executive Officer
Filed herewith
     
32.2
Section 1350 Certification of the Chief Financial Officer
Filed herewith



 


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 NATIONAL FINANCIAL CORPORATION
 
(Registrant)
   
   
   
   
   
   
Dated: May 14, 2007
/s/ Gregg E. Hunter
 
Gregg E. Hunter, Vice Chairman
 
President and Chief Executive Officer
   
   
   
   
Dated: May 14, 2007
/s/ Thomas D. Watters
 
Thomas D. Watters, Senior Vice President and
 
Chief Financial Officer