AND RESULTS OFOPERATIONS
The following discussion and analysis of the consolidated financial statements
of CNB Financial Corporation (the "Corporation") is presented to provide insight
into management's assessment of financial results. The Corporation's principal
subsidiary, CNB Bank (the "Bank"), provides financial services to individuals
and businesses primarily within the Pennsylvania counties of Cambria, Cameron,
Clearfield, Elk, Indiana, and McKean. It also includes a portion of western
Centre County including Philipsburg Borough, Rush Township and the western
portions of Snow Shoe and Burnside Townships and a portion of Jefferson County,
consisting of the boroughs of Brockway, Falls Creek, Punxsutawney, Reynoldsville
and Sykesville, and the townships of Washington, Winslow and Henderson.
ERIEBANK, a division of CNB Bank, provides financial services to individuals and
businesses in the northwestern Pennsylvania counties of Erie, Crawford, and
Warren.
The Bank is subject to regulation, supervision and examination by the
Pennsylvania State Department of Banking as well as the Federal Deposit
Insurance Corporation. The financial condition and results of operations of the
Corporation and its consolidated subsidiaries are not necessarily indicative of
future performance. CNB Securities Corporation is incorporated in Delaware and
currently maintains investments in debt and equity securities. County
Reinsurance Company is an Arizona Corporation, and provides credit life and
disability insurance for customers of CNB Bank. CNB Insurance Agency,
incorporated in Pennsylvania, provides for the sale of nonproprietary annuities
and other insurance products. Holiday Financial Services Corporation,
incorporated in Pennsylvania, offers small balance unsecured loans and secured
loans, primarily collateralized by automobiles and equipment, to borrowers with
higher risk characteristics. When we use the terms "we", "us" and "our", we mean
CNB Financial Corporation and its subsidiaries. Management's discussion and
analysis should be read in conjunction with the Corporation's consolidated
financial statements and related notes.
GENERAL OVERVIEW
The Bank expanded its ERIEBANK division by opening a full service office in
Meadville, Pennsylvania in the second quarter of 2010, and the Corporation has
obtained regulatory approval for a second Meadville location that is expected to
open in the third quarter of 2012. In addition, a CNB Bank loan production
office was opened in Indiana, Pennsylvania in the third quarter of 2011. A CNB
Bank loan production office in Johnstown, Pennsylvania was closed in the third
quarter of 2011. The Corporation is opening a ninth office for Holiday Financial
Services Corporation in Dubois, Pennsylvania, in the third quarter of 2012. The
Corporation also anticipates the purchase of a consumer discount company in
Ebensburg, Pennsylvania during the third quarter of 2012, resulting in the
acquisition of a loan portfolio of approximately $1 million with a purchase
premium of $200 thousand. The Corporation will operate the acquired location as
its tenth Holiday Financial Service Corporation office.
Management believes that the Corporation's ERIEBANK division, along with the
traditional CNB Bank and Holiday Financial Services Corporation market areas,
should provide the Bank with sustained loan and deposit growth during the
remainder of 2012. Loan growth and deposit growth were $57 million and $101
million, respectively, during the six months ended June 30, 2012.
Management concentrates on return on average equity and earnings per share
metrics, plus other metrics, to measure the performance of the Corporation. The
interest rate environment will continue to play an important role in the future
earnings of the Corporation. Some compression of the net interest margin was
experienced in 2011 and the net interest margin has decreased 8 basis points in
the first six months of 2012 as a result of the current interest rate
environment. During the past several years, measures have been taken such as
instituting rate floors on our commercial lines of credit and home equity lines
as a result of the historic lows on various key interest rates such as the Prime
Rate and 3-month LIBOR. In addition, interest rates were decreased on certain
deposit products during 2011 and the first six months of 2012. Non-interest
costs are expected to increase with the growth of the Corporation; however,
management's growth strategies are expected to result in an increase in earning
assets as well as enhanced non-interest income which is expected to more than
offset increases in non-interest expenses in 2012 and beyond. While past results
are not an indication of future earnings, management believes the Corporation is
well-positioned to sustain core earnings during 2012.
On July 21, 2010, the Dodd-Frank Wall Street and Consumer Protection Act (the
"Dodd-Frank Act") was enacted and this law could impact the performance of the
Corporation in future periods. The Dodd-Frank Act includes numerous provisions
designed to strengthen the financial industry, enhance consumer protection,
expand disclosures and provide for transparency. Some of these provisions
included changes to FDIC insurance coverage, which has now been increased to
$250,000. Additional provisions created a Consumer Financial Protection Bureau,
which is authorized to write rules on all consumer
28
--------------------------------------------------------------------------------
Table of Contents
financial products, and a Financial Services Oversight Council, which is
empowered to determine which entities are systematically significant and require
tougher regulations and is charged with reviewing, and when appropriate,
submitting comments to the Securities and Exchange Commission and Financial
Accounting Standards Board with respect to existing or proposed accounting
principles, standards or procedures. Although the aforementioned provisions are
only a few of the numerous ones included in the Dodd-Frank Act, the full impact
of the entire Dodd-Frank Act will not be known until the full implementation is
completed.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents totaled $24.2 million at June 30, 2012 compared to
$39.7 million at December 31, 2011. Cash and cash equivalents fluctuate based on
the timing and amount of liquidity events that occur in the normal course of
business.
Management believes the liquidity needs of the Corporation are satisfied by the
current balance of cash and cash equivalents, readily available access to
traditional funding sources, and the portion of the investment and loan
portfolios that mature within one year. These sources of funds will enable the
Corporation to meet cash obligations and off-balance sheet commitments as they
come due.
SECURITIES
Securities available for sale and trading securities have combined to increase
$77.7 million or 12.1% since December 31, 2011. The increase is primarily due to
the purchases of residential mortgage and asset backed securities issued by
government sponsored entities and resulted from deposit growth not reinvested in
loans. See the notes to the consolidated financial statements for additional
detail concerning the composition of the Corporation's securities portfolio and
the process for evaluating securities for other-than-temporary impairment.
The Corporation generally buys into the market over time and does not attempt to
"time" its transactions. In doing this, the highs and lows of the market are
averaged into the portfolio and minimize the overall effect of different rate
environments. Management monitors the earnings performance and the effectiveness
of the liquidity of the securities portfolio on a regular basis through meetings
of the Asset/Liability Committee of the Corporation's Board of Directors
("ALCO"). The ALCO also reviews and manages interest rate risk for the
Corporation. Through active balance sheet management and analysis of the
securities portfolio, a sufficient level of liquidity is maintained to satisfy
depositor requirements and various credit needs of our customers.
LOANS
The Corporation experienced an increase in loans, net of unearned discount, of
$56.9 million, or 6.7%, during the first six months of 2012. Lending efforts are
focused in the west, central and northwest Pennsylvania markets and consists
principally of commercial and retail lending, which includes single family
residential mortgages and other consumer loans. The Corporation views commercial
lending as its competitive advantage and continues to focus on this area by
hiring and retaining experienced loan officers and supporting them with quality
credit analysis. The Corporation expects sustained loan demand throughout the
remainder of 2012.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is established by provisions for losses in the
loan portfolio as well as overdrafts in deposit accounts. These provisions are
charged against current income. Loans and overdrafts deemed not collectible are
charged off against the allowance while any subsequent collections are recorded
as recoveries and increase the allowance.
29
--------------------------------------------------------------------------------
Table of Contents
The table below shows activity within the allowance account for the specified
periods (in thousands):
Six months ending Year ending Six months ending
June 30, 2012 December 31, 2011 June 30, 2011
Balance at beginning of
period $ 12,615 $ 10,820 $ 10,820
Charge-offs:
Commercial, industrial, and
agricultural 647 1,796 215
Commercial mortgages 236 175 88
Residential real estate 224 217 77
Consumer 638 907 462
Credit cards 33 39 25
Overdrafts 117 222 115
1,895 3,356 982
Recoveries:
Commercial, industrial, and
agricultural 8 9 4
Commercial mortgages - - -
Residential real estate - 13 -
Consumer 49 88 45
Credit cards 7 10 5
Overdraft deposit accounts 56 94 54
120 214 108
Net charge-offs (1,775 ) (3,142 ) (874 )
Provision for loan losses 2,850 4,937 1,769
Balance at end of period $ 13,690 $ 12,615 $ 11,715
Loans, net of unearned $ 906,767 $ 849,883 $ 821,787
Allowance to net loans 1.51 % 1.48 % 1.43 %
Net charge-offs to average
loans (annualized) 0.41 % 0.38 % 0.22 %
Nonperforming assets $ 18,519 $ 17,513 $ 18,368
Nonperforming % of total
assets 1.08 % 1.09 % 1.23 %
The adequacy of the allowance for loan losses is subject to a formal analysis by
the credit administrator of the Corporation. As part of the formal analysis,
delinquencies and losses are monitored monthly. The loan portfolio is divided
into several categories in order to better analyze the entire pool. First is a
selection of classified loans that is given a specific reserve. The remaining
loans are pooled, by category, into these segments:
Reviewed
• Commercial, industrial, and agricultural
• Commercial mortgages
Homogeneous
• Residential real estate
• Consumer
• Credit cards
• Overdrafts
The reviewed loan pools are further segregated into four categories: special
mention, substandard, doubtful, and unclassified. Historical loss factors are
calculated for each pool excluding overdrafts based on the previous eight
quarters of experience. The homogeneous pools are evaluated by analyzing the
historical loss factors from the most previous quarter end and the two most
recent year ends.
30
--------------------------------------------------------------------------------
Table of Contents
The historical loss factors for both the reviewed and homogeneous pools are
adjusted based on these six qualitative factors:
• levels of and trends in delinquencies, non-accrual loans, and classified
loans;
• trends in volume and terms of loans;
• effects of any changes in lending policies and procedures;
• experience, ability and depth of management;
• national and local economic trends and conditions; and
• concentrations of credit.
The methodology described above was created using the experience of the
Corporation's credit administrator, guidance from the regulatory agencies,
expertise of a third-party loan review provider, and discussions with peers. The
resulting factors are applied to the pool balances in order to estimate the
probable risk of loss within each pool. Prudent business practices dictate that
the level of the allowance, as well as corresponding charges to the provision
for loan losses, should be commensurate with identified areas of risk within the
loan portfolio and the attendant risks inherent therein. The quality of the
credit risk management function and the overall administration of this vital
segment of the Corporation's assets are critical to the ongoing success of the
Corporation.
The previously mentioned analysis considered numerous historical and other
factors to analyze the adequacy of the allowance and current period charges
against the provision for loan losses. Management paid special attention to a
section of the analysis that compared and plotted the actual level of the
allowance against the aggregate amount of loans adversely classified in order to
compute the estimated probable losses associated with those loans. By noting the
"spread" at the present time, as well as prior periods, management determines
the current adequacy of the allowance as well as evaluates trends that may be
developing. The volume and composition of the Corporation's loan portfolio
continue to reflect growth in commercial credits including commercial real
estate loans.
As mentioned in the Loans section of this analysis, management considers
commercial lending to be a competitive advantage and continues to focus on this
area as part of its strategic growth initiatives. However, management must also
consider the fact that the inherent risk is more pronounced in these types of
credits and is also driven by the economic environment within its market areas.
During the six months ended June 30, 2012, the Corporation recorded a provision
for loan losses of $2.9 million, as compared to a provision for loan losses of
$1.8 million for the six months ended June 30, 2011. The increase was a result
of increases in loss reserves, primarily in the commercial loan portfolio. One
relationship comprising two commercial loans which became impaired in 2011
necessitated an additional loss reserve of $360 thousand in the first quarter of
2012 as a result of the revision in the valuation estimate of the loan
collateral. Charge-offs attributable to this loan relationship totaled $600
thousand during the six months ended June 30, 2012, which was the primary factor
in the increase in net loan charge-offs from $874 thousand during the six months
ended June 30, 2011 to $1.8 million during the six months ended June 30, 2012.
In May 2012, CNB management determined that one relationship comprising
commercial loans totaling $2.4 million and two consumer loans totaling $200
thousand became impaired. As of March 31, 2012, the loan relationship was not
deemed to be a criticized or classified loan under applicable regulatory
guidelines or CNB's internal loan policies. CNB charged off the balances of the
consumer loans and recorded a specific allocation of $1.1 million for the
commercial loans based on CNB's evaluation of the borrowers' ability and
willingness to repay the loan. As a result, the provision for loan losses during
the quarter ended June 30, 2012 increased by $1.3 million. It is possible that
further deterioration with respect to the loan relationship may occur in the
future.
Management believes that the allowance for loan losses is reasonable and
adequate to absorb probable incurred losses in its portfolio at June 30, 2012.
31
--------------------------------------------------------------------------------
Table of Contents
FUNDING SOURCES
The Corporation considers deposits, short-term borrowings, and term debt when
evaluating funding sources. Traditional deposits continue to be the main source
of funds in the Corporation, increasing $101 million from $1.35 billion at
December 31, 2011 to $1.46 billion at June 30, 2012. The growth in deposits was
primarily due to increases in savings accounts of $131 million over this period
as a result of the Corporation's marketing of a savings product which carries an
annual percentage yield which is highly competitive in the current interest rate
environment. This increase in savings accounts was offset by an expected
decrease in time deposits of $44 million as customers who previously held
certificates of deposit migrated to the savings product.
Periodically, the Corporation utilizes term borrowings from the Federal Home
Loan Bank ("FHLB") and other lenders to meet funding needs. Management plans to
maintain access to short-term and long-term borrowings as an available funding
source when deemed appropriate.
SHAREHOLDERS' EQUITY AND CAPITAL RATIOS AND METRICS
The Corporation's capital continued to provide a base for profitable growth
through June 30, 2012. Total shareholders' equity was $139.6 million at June 30,
2012 and $131.9 million at December 31, 2011. In the first six months of 2012,
the Corporation earned $8.7 million and declared dividends of $4.1 million, a
dividend payout ratio of 47.2% of net income. The Corporation has also complied
with the standards of capital adequacy mandated by the banking regulators. Bank
regulators have established "risk-based" capital requirements designed to
measure capital adequacy. Risk-based capital ratios reflect the relative risks
of various assets banks hold in their portfolios. A weight category of 0%
(lowest risk assets), 20%, 50%, or 100% (highest risk assets) is assigned to
each asset on the balance sheet.
The Corporation's capital ratios, book value per share and tangible book value
per share as of June 30, 2012 and December 31, 2011 are as follows:
June 30, 2012 December 31, 2011
Total risk-based capital ratio 15.04 % 15.14 %
Tier 1 capital ratio 13.79 % 13.89 %
Leverage ratio 7.90 % 8.22 %
Tangible common equity/tangible assets (1) 7.53 % 7.61 %
Book value per share $ 11.23 $ 10.66
Tangible book value per share (1) 10.36 9.78
(1) Tangible common equity, tangible assets and tangible book value per share are
non-GAAP financial measures calculated using GAAP amounts. Tangible common
equity is calculated by excluding the balance of goodwill from the
calculation of shareholders' equity. Tangible assets is calculated by
excluding the balance of goodwill from the calculation of total assets.
Tangible book value per share is calculated by dividing tangible common equity by the number of shares outstanding. The Corporation believes that
these non-GAAP financial measures provide information to investors that is
useful in understanding its financial condition because they are additional
measures used to assess capital adequacy. Because not all companies use the
same calculation of tangible common equity and tangible assets, this
presentation may not be comparable to other similarly titled measures
calculated by other companies. A reconciliation of these non-GAAP financial
measures is provided below (dollars in thousands, except per share data).
June 30, 2012 December 31, 2011
Shareholders' equity $ 139,647 $ 131,889
Less goodwill 10,821 10,821
Tangible common equity $ 128,826 $ 121,068
Total assets $ 1,721,020 $ 1,602,207
Less goodwill 10,821 10,821
Tangible assets $ 1,710,199 $ 1,591,386
Ending shares outstanding 12,440,423 12,377,318
Tangible book value per share $ 10.36 $ 9.78
Tangible common equity/tangible assets 7.53 % 7.61 %
32
--------------------------------------------------------------------------------
Table of Contents
LIQUIDITY
Liquidity measures an organization's ability to meet cash obligations as they
come due. The consolidated statement of cash flows provides analysis of the
Corporation's cash and cash equivalents. Additionally, management considers that
portion of the loan and investment portfolio that matures within one year to be
part of the Corporation's liquid assets. The Corporation's liquidity is
monitored by both management and the ALCO, which establishes and monitors ranges
of acceptable liquidity. Management believes the Corporation's current liquidity
position is acceptable.
