-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, PPkjPIklGMDUAwgWld38fot6xOqH1Ce7WAB52iEgqBgMdhQbtL8MY8DXFoUfoLM6 KB5YehefeYLO2jyxyLueNA== 0000950152-07-002886.txt : 20070330 0000950152-07-002886.hdr.sgml : 20070330 20070330162002 ACCESSION NUMBER: 0000950152-07-002886 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 20061231 FILED AS OF DATE: 20070330 DATE AS OF CHANGE: 20070330 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CNB FINANCIAL SERVICES INC CENTRAL INDEX KEY: 0001113336 STANDARD INDUSTRIAL CLASSIFICATION: STATE COMMERCIAL BANKS [6022] IRS NUMBER: 550773918 STATE OF INCORPORATION: WV FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-30665 FILM NUMBER: 07733035 BUSINESS ADDRESS: STREET 1: 212 S WASHINGTON STREET CITY: BARKELEY SPRINGS STATE: WV ZIP: 25411-0130 BUSINESS PHONE: 3042581520 MAIL ADDRESS: STREET 1: 212 S WASHINGTON STREET CITY: BARKELEY SPRINGS STATE: WV ZIP: 25411-0130 10-K 1 l24084ae10vk.txt CNB FINANCIAL SERVICES 10-K UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 Form 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2006 Or [ ] 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 0-30665 CNB Financial Services, Inc. (Exact name of registrant as specified in its charter) West Virginia 55-0773918 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.)
101 S. Washington Street, Berkeley Springs, WV 25411 (Address of principal executive offices) (Zip Code)
Registrant's telephone number, (304) 258 - 1520 Securities to be registered under Section 12(b) of the Act: None Securities to be registered under Section 12(g) of the Act: ____ Common Stock, Par Value $1.00 per share (Title of Class) Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes [ ] No [X] Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes [ ] No [X] Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for shorter periods 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K [ ] 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. 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 [ ] No [X] The aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asking price of such common equity, as of the last business day at the registrant's most recently completed second fiscal quarter (June 30, 2006) was approximately $22.5 million. This amount was based on the last closing sale price of a share of common stock of $80.00 as of the same date. Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: 458,048 shares of common stock, par value $1 per share, as of March 26, 2007. DOCUMENTS INCORPORATED BY REFERENCE: None CNB FINANCIAL SERVICES, INC. AND SUBSIDIARY TABLE OF CONTENTS
PAGE ---- PART I Item 1. Business...................................................... 4 Item 1A. Risk Factors.................................................. 7 Item 2. Properties.................................................... 9 Item 3. Legal Proceedings............................................. 10 Item 4. Submission of Matters to a Vote of Security Holders........... 10 PART II Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.......... 11 Item 6. Selected Financial Data....................................... 13 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.................................. 14 Item 7A. Quantitative and Qualitative Disclosures About Market Risk.... 28 Item 8. Financial Statements and Supplementary Data................... 29 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures.................................. 59 Item 9A. Controls and Procedures....................................... 59 Item 9B. Other Information............................................. 59 PART III Item 10. Directors and Executive Officers of the Registrant............ 60 Item 11. Executive Compensation........................................ 62 Item 12. Security Ownership of Certain Beneficial Owners and Management................................................. 66 Item 13. Certain Relationships and Related Transactions................ 67 Item 14. Principal Accountant's Fees and Services...................... 68 PART IV Item 15. Exhibits and Financial Statement Schedules.................... 69 SIGNATURES............................................................... 70
2 FORWARD LOOKING STATEMENTS In our Annual Report and Form 10-K, we include forward-looking statements relating to such matters as anticipated financial performance, business prospects, technological developments, new products and similar matters. You can identify these statements by forward-looking words such as "may," "will," "expect," "anticipate," "believe," "estimate," "plans," "intends," or similar words or expressions. You should read statements that contain these words carefully because they discuss our future expectations or state other "forward-looking" information. We believe that it is important to communicate our future expectations to our shareholders. However, there may be events in the future that we are not able to predict accurately or control, including those factors set forth under "Risk Factors" contained herein. The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements. In order to comply with the terms of the safe harbor, we must inform you that a variety of factors could cause CNB Financial Services, Inc.'s actual results and experiences to differ materially from the anticipated results or other expectations expressed in these forward-looking statements. Our ability to predict the results of the effect of future plans and strategies is inherently uncertain. Some of the risks and uncertainties that may affect the operations, performance, development and results of CNB Financial Services, Inc.'s business include: - - Changes in market interest rates; - - Local and national economic trends and conditions; - - Competition for products and services among community, regional and national financial institutions; - - New services and product offerings by competitors; - - Changes in customer preferences; - - Changes in technology; - - Legislative and regulatory changes; - - Delinquency rates on loans; and - - Changes in accounting principles, policies or guidelines; You should consider these factors in evaluating any forward-looking statements and not place undue reliance on such statements. We are not obligated to publicly update any forward looking statements we may make in this Form 10-K or our Annual Report to reflect the impact of subsequent events. 3 PART I ITEM 1. DESCRIPTION OF BUSINESS ORGANIZATIONAL HISTORY AND SUBSIDIARIES CNB Financial Services, Inc. (the "Company") was organized under the laws of West Virginia in March 2000 at the direction of the Board of Directors of CNB Bank, Inc., formerly Citizens National Bank, (the "Bank") for the purpose of becoming a financial services holding company. The Company and its subsidiary are collectively referred to herein as "CNB". A special meeting of the Bank's shareholders was held on August 4, 2000, and the shareholders approved the Agreement and Plan of Merger between the Bank and the Company, whereby the Bank became a wholly-owned subsidiary of the Company and the shareholders of the Bank became shareholders of the Company. The merger became effective on August 31, 2000. Each Bank shareholder received two shares of the Company stock for each share of the Bank's common stock. On August 31, 2000, the Company consummated its merger with the Bank and subsidiary, in a tax-free exchange of stock. Shareholders of the Bank received two shares of CNB Financial Services, Inc. common stock for each of the 229,024 shares of the Bank's common stock. The merger was accounted for as a pooling of interests. CNB became a 50% member of a limited liability company, Morgan County Title Insurance Agency, LLC in February 2001, for the purpose of selling title insurance. As of January 2003, CNB's percentage of ownership in Morgan County Title Insurance Agency, LLC decreased to 33%. The Bank was organized on June 20, 1934 and has operated as a national banking association continuously until October 16, 2006, at which time the Bank obtained a West Virginia state charter and began operating as a state banking association. The Bank formed CNB Insurance Services, Inc., a wholly owned subsidiary, which was a property and casualty insurance agency selling primarily personal lines of insurance. On June 1, 2006, the Bank sold the assets of CNB Insurance Services, Inc. to Maiden Financial. See Note 16: Discontinued Operations in the Notes to Consolidated Financial Statements for further discussion. EMPLOYEES As of December 31, 2006 and 2005, CNB employed 100 and 107 full-time equivalent employees, respectively. BUSINESS OF CNB FINANCIAL SERVICES, INC. AND CNB BANK, INC. The Company's primary function is to direct, plan and coordinate the business activities of the Bank and its subsidiary. CNB Bank, Inc. is a full-service commercial bank conducting general banking and trust activities through six full-service offices and six automated teller machines located in Morgan and Berkeley Counties, West Virginia and Washington County, Maryland. The Bank exercised an option in December 2003 to purchase a parcel of land in Falling Waters, Berkeley County, West Virginia. Construction on an additional full-service branch began August 2004 and was completed in April 2005. On January 26, 2004, CNB entered into an agreement to purchase certain assets and liabilities associated with the Hancock Branch of Fidelity Bank, a subsidiary bank of Mercantile Bankshares Corporation (formerly Home Federal). The purchase, which took place on June 11, 2004, increased the assets and liabilities of CNB by $14.6 million. CNB assumed responsibility for all the deposit services including checking, savings and certificates of deposit. Additionally, CNB acquired loans, equipment and leasehold improvements and assumed the lease for the real estate located at 333 East Main Street, Hancock, Maryland. CNB Bank, Inc. accepts time, demand and savings deposits including NOW accounts, regular savings accounts, money market accounts, fixed-rate certificates of deposit and club accounts. In addition, the Bank provides safe deposit box rentals, wire transfer services and 24-hour ATM services through a regional network known as STAR. STAR is a participant in the nationwide Cirrus network. The Bank offers a full spectrum of lending services to its customers, including commercial loans and lines of credit, residential real estate loans, consumer installment loans and other personal loans. Commercial loans are generally secured by various collateral, including commercial real estate, accounts receivable and business machinery and equipment. Residential real estate loans consist primarily of mortgages on the borrower's personal residence, and are typically secured by a first lien on the subject property. Consumer and personal loans are generally secured, often by first liens on automobiles, consumer goods or depository accounts. A special effort is made to keep loan products as flexible as possible within the guidelines of prudent banking practices in terms of interest rate risk and credit risk. Bank lending personnel adhere to established lending limits and authorities based on each individual's lending expertise and experience. The Bank's trust department acts as trustee under trusts and wills, as executor of wills and administrator of estates, as guardian for estates of minors and incompetents and serves in various corporate trust capacities. 4 COMPETITION CNB Bank, Inc. faces a high degree of competition for all its services from local banks. Within its market area of Morgan and Berkeley Counties in West Virginia and Washington County in Maryland, numerous competing commercial banks exist. Nonbank competition has also increased in recent years locally by the establishment of finance and mortgage companies and the expansion of insurance operations and credit unions, as well as from mutual funds located throughout the country. West Virginia banks are allowed unlimited branch banking throughout the State. The Interstate Banking and Branch Efficiency Act of 1994 also authorizes interstate branching by acquisition and consolidation nationwide. These and similar provisions impacting both the banking and thrift industries may serve to intensify future competition within the Bank's market. AVAILABLE INFORMATION Our Internet address is www.cnbwv.com. The SEC maintains an Internet website at http://www.sec.gov that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC, and our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act are available, free of charge, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. In addition, any document filed by the company with the SEC can be read and copied at the SEC's public reference facilities at 100 F Street, NE, Washington, DC 20549. The public may obtain information on the operation of the public reference room by calling the SEC at 1-800-SEC-0330. Copies of documents can also be obtained free of charge by any shareholder by writing to Rebecca S. Stotler, VP/CFO, CNB Financial Services, Inc., 101 S. Washington Street, Berkeley Springs, WV 25411. SUPERVISION AND REGULATION The following is a summary of certain statutes and regulations affecting the Company and its subsidiaries and is qualified in its entirety by reference to such statutes and regulations: BANK HOLDING COMPANY REGULATION. The Company is a bank holding company under the Bank Holding Company Act of 1956 ("BHCA"), which restricts the activities of the Company and any acquisition by the Company of voting stock or assets of any bank, savings association or other company. The Company is subject to the reporting requirements of, and examination and regulation by, the Federal Reserve Board. The Company's subsidiary bank is subject to restrictions imposed by the Federal Reserve Act on transactions with affiliates, including any loans or extensions of credit to the Company or its subsidiaries, investments in the stock or other securities thereof and the taking of such stock or securities as collateral for loans to any borrower; the issuance of guarantees, acceptances or letters of credit on behalf of the Company and its subsidiaries; purchases or sales of securities or other assets; and the payment of money or furnishing of services to the Company and other subsidiaries. The Bank is prohibited from acquiring direct or indirect control of more than 5% of any class of voting stock or substantially all of the assets of any bank holding company without the prior approval of the Federal Reserve Board. The Company and its subsidiaries are prohibited from engaging in certain tying arrangements in connection with extensions of credit and/or the provision of other property or services to a customer by the Company or its subsidiaries. On July 30, 2002, the Senate and the House of Representatives of the United State (Congress) enacted the Sarbanes-Oxley Act of 2002, a law that addresses, among other issues, corporate governance, auditing and accounting, executive compensation, and enhanced and timely disclosure of corporate information. The New York Stock Exchange proposed corporate governance rules that were enacted by the Securities and Exchange Commission. The changes are intended to allow stockholders to more easily and efficiently monitor the performance of companies and directors. Effective August 29, 2002, as directed by Section 302(a) of Sarbanes-Oxley, the Bank's chief executive officer and chief financial officer are each required to certify that CNB's Quarterly and Annual Reports do not contain any untrue statement of a material fact. The rules have several requirements, including having these officers certify that: they are responsible for establishing, maintaining, and regularly evaluating the effectiveness of CNB's internal controls; they have made certain disclosures to CNB's auditors and the audit committee of the Board of Directors about CNB's internal controls; and they have included information in CNB's Quarterly and Annual Reports about their evaluation and whether there have been significant changes in CNB's internal controls or in other factors that could significantly affect internal controls subsequent to the evaluation. Effective in 2008, the audit requirements related to internal controls contained in Section 404 of Sarbanes-Oxley will become applicable to CNB. The BHCA also permits the Company to purchase or redeem its own securities. However, Regulation Y provides that prior notice must be given to the Federal Reserve Board if the gross consideration for such purchase or consideration, when aggregated with the net consideration paid by the Company for all such purchases or redemptions during the preceding 12 months, is equal to 10 percent or more of the Company's consolidated net worth. Prior notice is not required if (i) both before and immediately after the redemption, the bank holding company is well-capitalized; (ii) the financial holding company is well-managed and (iii) the bank holding company is not the subject of any unresolved supervisory issues. The Gramm-Leach-Bliley Act (also known as the Financial Services Modernization Act of 1999) permits bank holding companies to become financial holding companies. This allows them to affiliate with securities firms and insurance companies and to engage 5 in other activities that are financial in nature. A bank holding company may become a financial holding company if each of its subsidiary banks is well capitalized, is well managed and has at least a satisfactory rating under the Community Reinvestment Act. No regulatory approval will be required for a financial holding company to acquire a company, other than a bank or savings association, engaged in activities that are financial in nature or incidental to activities that are financial in nature, as determined by the Federal Reserve Board. The Financial Services Modernization Act defines "financial in nature" to include: securities underwriting, dealing and market making; sponsoring mutual funds and investment companies; insurance underwriting and agency; merchant banking activities; and activities that the Federal Reserve Board has determined to be closely related to banking. A bank also may engage, subject to limitations on investment, in activities that are financial in nature, other than insurance underwriting, insurance company portfolio investment, real estate development and real estate investment, through a financial subsidiary of the bank, if the bank is well capitalized, well managed and has at least a satisfactory Community Reinvestment Act rating. BANK SUBSIDIARY REGULATION. The Bank converted from a national bank to a state bank in 2006 and is regulated by the West Virginia Division of Banking and the Federal Deposit Insurance Corporation. The Bank is also subject to supervision, examination and regulation by the Federal Reserve System, and as such is subject to applicable provisions of the Federal Reserve Act and regulations issued there under. The deposits of the Bank are insured by the Federal Deposit Insurance Corporation ("FDIC") to the extent provided by law. Accordingly, the Bank is also subject to regulation by the FDIC. The FDIC may terminate a bank's deposit insurance upon finding that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order or condition enacted or imposed by the bank's regulatory agency. The Bank is a member of the Federal Home Loan Bank of Pittsburgh. The FHLB provided credit to its member in the form of advances. As a member of the FHLB of Pittsburgh, the bank must maintain an investment in the capital stock of that FHLB in an amount equal to the greater of 1% of the aggregate outstanding principal amount of its respective residential mortgage loans, home purchase contracts and similar obligations at the beginning of each year or 5% of its advances from the FHLB. CAPITAL REQUIREMENTS As a bank holding company, the Company is subject to Federal Reserve Board risk-based capital guidelines. The guidelines establish a systematic framework that makes regulatory capital requirements more sensitive to differences in risk profiles among banking organizations, takes off-balance sheet exposures into account and minimizes disincentives to holding liquid, low-risk assets. Under the guidelines, bank holding companies must maintain capital sufficient to meet both a risk-based asset ratio test and leverage ratio test on a consolidated basis. The risk-based ratio is determined by allocating assets and specified off-balance-sheet commitments into four weighted categories, with higher levels of capital being required for categories perceived as representing greater risk. The Bank is subject to substantially similar capital requirements adopted by its applicable regulatory agencies. In addition, the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") established a regulatory framework which ties the level of supervisory intervention by bank regulatory authorities primarily to a depository institution's capital category. Among other things, FDICIA authorized regulatory authorities to take "prompt corrective action" with respect to depository institutions that do not meet minimum capital requirements. FDICIA established five capital tiers: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. The Company is well capitalized as detailed in Note 20: Regulatory Matters in the Notes to Consolidated Financial Statements. FEDERAL AND STATE LAWS The Bank is subject to regulatory oversight under various consumer protection and fair lending laws. These laws govern, among other things, truth-in-lending disclosure, equal credit opportunity, fair credit reporting and community reinvestment. Failure to abide by federal laws and regulations governing community reinvestment could limit the ability of a bank to open a new branch or engage in a merger transaction. Community reinvestment regulations evaluate how well and to what extent a bank lends and invests in its designated service area, with particular emphasis on low-to-moderate income communities and borrowers in such areas. MONETARY POLICY AND ECONOMIC CONDITIONS The business of financial institutions is affected not only by general economic conditions, but also by the policies of various governmental regulatory agencies, including the Federal Reserve Board. The Federal Reserve Board regulates money and credit conditions and interest rates to influence general economic conditions primarily through open market operations in U.S. government securities, changes in the discount rate on bank borrowings and changes in the reserve requirements against depository institutions' deposits. These policies and regulations significantly affect the overall growth and distribution of loans, investments and deposits, and the interest rates charged on loans, as well as the interest rates paid on deposits and accounts. The monetary policies of the Federal Reserve Board have had a significant effect on the operating results of financial institutions in the past and are expected to continue to have significant effects in the future. In view of the changing conditions in the economy and the money markets and the activities of monetary and fiscal authorities, the Company cannot definitely predict future changes in interest rates, credit availability or deposit levels. 6 EFFECT OF ENVIRONMENTAL REGULATION The Bank's primary exposure to environmental risk is through its lending activities. In cases when management believes environmental risk potentially exists, the Bank mitigates its environmental risk exposures by requiring environmental site assessments at the time of loan origination to confirm collateral quality as to commercial real estate parcels posing higher than normal potential for environmental impact, as determined by reference to present and past uses of the subject property and adjacent sites. Environmental assessments are typically required prior to any foreclosure activity involving non-residential real estate collateral. With regard to residential real estate lending, management reviews those loans with inherent environmental risk on an individual basis and makes decisions based on the dollar amount of the loan and the materiality of the specific credit. The Company anticipates no material effect on anticipated capital expenditures, earnings or competitive position as a result of compliance with federal, state or local environmental protection laws or regulations. INTERNATIONAL MONEY LAUNDERING ABATEMENT AND ANTI-TERRORIST FINANCING ACT OF 2001 (U.S. PATRIOT ACT) The International Money Laundering Abatement and Anti-Terrorist Financing Act of 2001 (the "Patriot Act") was adopted in response to the September 11, 2001 terrorist attacks. The Patriot Act provides law enforcement with greater powers to investigate terrorism and prevent future terrorist acts. Among the broad-reaching provisions contained in the Patriot Act are several designed to deter terrorists' ability to launder money in the United States and provide law enforcement with additional powers to investigate how terrorists and terrorist organizations are financed. The Patriot Act creates additional requirements for banks, which were already subject to similar regulations. The Patriot Act authorizes the Secretary of the Treasury to require financial institutions to take certain "special measures" when the Secretary suspects that certain transactions or accounts are related to money laundering. These special measures may be ordered when the Secretary suspects that a jurisdiction outside of the United States, a financial institution operating outside of the United States, a class of transactions involving a jurisdiction outside of the United States or certain types of accounts are of "primary money laundering concern." The special measures include the following: (a) require financial institutions to keep records and report on the transactions or accounts at issue; (b) require financial institutions to obtain and retain information related to the beneficial ownership of any account opened or maintained by foreign persons; (c) require financial institutions to identify each customer who is permitted to use a payable-through or correspondent account and obtain certain information from each customer permitted to use the account; and (d) prohibit or impose conditions on the opening or maintaining of correspondent or payable-through accounts. CRITICAL ACCOUNTING POLICIES CNB's financial position and results of operations are impacted by management's application of accounting policies involving judgments made to arrive at the carrying value of certain assets. Management's greatest challenge in implementing its policies is the need to make estimates about the effect of matters that are inherently less than certain. For a detailed discussion of CNB's significant accounting policies, see Note 1: Summary of Significant Accounting Policies in the Notes to Consolidated Financial Statements. A material estimate that is susceptible to significant change is the determination of the allowance for loan losses. Both the estimates of the amount of the allowance for loan losses and the placement of loans on non-accrual status affect the carrying amount of the loan portfolio and accrued interest receivable. The allowance for loan losses is a subjective judgment that management must make regarding the loan portfolio, and is established and maintained at levels that management believes are adequate to cover losses resulting from the inability of borrowers to make required payments on loans. Where there is a question as to the impairment of a specific loan, management obtains valuations of the property or collateral securing the loan, and current financial information of the borrower, including financial statements, when available. Since the calculation of appropriate loan loss allowances relies on management's estimates and judgments relating to inherently uncertain events, actual results may differ from these estimates. For a more detailed discussion on the allowance for loan losses, see Nonperforming Loans and Allowance For Loan Losses in this Management's Discussion and Analysis and Allowance for Loan Losses in Note 1: Summary of Significant Accounting Policies and Note 4: Loans and Leases Receivable in the Notes to Consolidated Financial Statements. ITEM 1A. RISK FACTORS This report contains, in addition to historical information, forward-looking statements that involve risks and uncertainties. Our actual results could differ materially. Factors that could cause or contribute to such differences include, but are not limited to, those discussed below, as well as those discussed elsewhere in this report. THE BANKING BUSINESS IS VERY COMPETITIVE. The banking business is generally a highly competitive business. Our total assets have grown from approximately $191.6 million at December 31, 2002, to $276.1 million at December 31, 2006. Our business plan calls for continued growth. Our ability to continue to grow depends, in part, upon our ability to successfully attract deposits and identify favorable loan and investment opportunities. In the event that we do not continue to grow, our results of operations could be adversely impacted. 7 Our ability to grow successfully will depend on whether we can continue to fund this growth while maintaining cost controls and asset quality, as well as on factors beyond our control, such as national and regional economic conditions and interest rate trends. If we are not able to control costs and maintain asset quality, such growth could adversely impact our earnings and financial condition. As of June 30, 2006, based on an FDIC analysis done as of June 30 each year, there were eleven other banks in CNB's market area. The total Morgan County commercial bank deposits, which include a total of five banking offices, as of June 30, 2006, were in excess of $218.5 million. The total Berkeley County commercial bank deposits, which include a total of twenty nine banking offices, as of June 30, 2006, were in excess of $989.8 million. The total Hancock, Maryland commercial bank deposits, which include three banking offices, as of June 30, 2006, were in excess of $84.6 million. At this same date CNB had a 73.2% share of the Morgan County commercial bank deposits, a 5.6% share of the Berkeley County commercial bank deposits and a 25.3% share of the Hancock, Maryland commercial bank deposits. CNB represents Morgan County's only locally owned bank, as the other existing commercial banks have their parent-Bank headquarters in Charleston, West Virginia (City National) and Charlotte, North Carolina (BB&T). For most of the services which CNB provides, there is also competition from financial institutions other than commercial banks in attracting deposits and in making loans with local offices and those that do business over the internet. We compete for loans principally through the interest rates and loan fees we charge and the efficiency and quality of services we provide. Increasing levels of competition in our banking and financial services businesses may reduce our market share or cause the prices we charge for our services to fall. Our results may differ in future periods depending upon the nature or level of competition. In addition, some traditional banking services or competing services are offered by insurance companies, investment counseling firms and other business firms and individuals. Many of CNB's competitors have significantly greater financial and marketing resources than we have. The existence of larger financial institutions in Morgan and Berkeley Counties, West Virginia and Washington County, Maryland, some of which are owned by larger regional or national companies, influence the competition in CNB's market area. The principal competitive factors in the market for deposits and loans are interest rates, either paid on deposits or charged on loans. West Virginia law allows statewide branch banking which provides increased opportunities for CNB, but it also increases the potential competition for our service area. In addition, in 1994, Congress passed the Riegle-Neal Interstate Banking and Branching Efficiency Act. Under this Act, absent contrary action by a state's legislature, interstate branch banking was allowed to occur after June 1, 1997. States are permitted to elect to participate to a variety of degrees in interstate banking or states may elect to "opt out." In 1996, the West Virginia Legislature elected to "opt in." Accordingly, out-of-state banks may form de novo banks or may acquire existing branches of West Virginia banks on a reciprocal basis. IN THE FUTURE, CNB'S LENDING LIMIT COULD CREATE A COMPETITIVE DISADVANTAGE. In the future, CNB may not be able to attract larger volume customers because the size of loans that CNB can offer to potential customers is less than the size of the loans that many of CNB's larger competitors can offer. Accordingly, CNB may lose customers seeking large loans to mortgage companies, larger commercial banks and other financial institutions. We anticipate that our lending limit will continue to increase proportionately with CNB's growth in earnings; however, CNB may not be able to successfully attract or maintain larger customers. CNB ENGAGES IN COMMERCIAL AND CONSUMER LENDING ACTIVITIES WHICH ARE RISKIER THAN RESIDENTIAL REAL ESTATE LENDING. CNB makes loans that involve a greater degree of risk than loans involving residential real estate lending. Commercial business loans may involve greater risks than other types of lending because they are often made based on varying forms of collateral, and repayment of these loans often depends on the success of the commercial venture. Consumer loans may involve greater risk because adverse changes in borrowers' incomes and employment after funding of the loans may impact their abilities to repay the loans. CNB's loan portfolio at December 31, 2006, consists of the following:
TYPE OF LOAN PERCENTAGE OF PORTFOLIO - ------------ ----------------------- Residential Real Estate Loans 70% Commercial Loans, principally real estate secured 22% Consumer Loans 8%
CNB HAS LIMITED CONTROL OVER ITS PROFITABILITY BECAUSE CNB CANNOT CONTROL THE VARIOUS FACTORS THAT CAN CAUSE FLUCTUATIONS IN INTEREST RATES. Aside from credit risk, the most significant risk resulting from CNB's normal course of business, extending loans and accepting deposits, is interest rate risk. If market interest rate fluctuations cause CNB's cost of funds to increase faster than the yield of its interest-earning assets, then its net interest income will be reduced. CNB's results of operations depend to a large extent on the level of net interest income, which is the difference between income from interest-earning assets, such as loans and investment securities, and interest expense on interest-bearing liabilities, such as deposits and borrowings. Interest rates are highly sensitive to many factors that are beyond CNB's control, including general economic conditions and the policies of various governmental and regulatory authorities. In establishing interest rates on 8 deposit accounts, CNB considers various factors, including rates offered by competing institutions in their local market. In doing so, CNB does not try to offer the highest rates in their local market which may result in a loss of deposits in other institutions offering marginally higher rates. To effectively monitor the interest rate risk discussed above, CNB uses a computer model to project the change in net interest income under various changes in interest rates. To provide guidance to management, CNB's board of directors, through its Asset/Liability/Investment Committee, has established a policy related thereto which includes interest rate risk parameters within which to operate. As of December 31, 2006, CNB's interest rate risk is within the parameters. CNB'S SUCCESS DEPENDS ON CNB'S MANAGEMENT TEAM. The departure of one or more of CNB's officers or other key personnel could adversely affect CNB's operations and financial position. The Company's management makes most decisions that involve CNB's operations. The key personnel have all been with CNB since 2001. They include Thomas F. Rokisky, Patricia C. Muldoon and Rebecca S, Stotler. AN ECONOMIC SLOWDOWN IN OUR MARKET AREA COULD HURT CNB'S BUSINESS. Because we focus our business in the Eastern Panhandle of West Virginia and the western part of Maryland, an economic slowdown in these areas could hurt our business. An economic slowdown could have the following consequences: - Loan delinquencies may increase; - Problem assets and foreclosures may increase; - Demand for the products and services of CNB may decline; and - Collateral (including real estate) for loans made by CNB may decline in value, in turn reducing customers' borrowing power and making existing loans less secure. CNB IS HIGHLY REGULATED. The operations of CNB are subject to extensive regulation by federal, state and local governmental authorities and are subject to various laws and judicial and administrative decisions imposing requirements and restrictions on them. Policies adopted or required by these governmental authorities can affect CNB's business operations and the availability, growth and distribution of CNB's investments, borrowings and deposits. CNB MAY INCUR INCREASED CHARGE-OFFS AND ADDITIONAL LOAN LOSS PROVISION DUE TO NEGATIVE CREDIT IN THE FUTURE. In the future, CNB could experience negative credit quality trends that could head to a deterioration of asset quality. Such deterioration could require CNB to incur loan charge-offs in the future and incur additional loan loss provision, both of which would have the effect of decreasing earnings. MARKETABILITY OF COMMON STOCK. There is no active market for our outstanding shares, and it is unlikely that an established market for our shares will develop in the near future. We presently do not intend to seek listing of the shares on any securities exchange, or quotation on the Nasdaq interdealer quotation system. It is not known whether significant trading activity will take place for several years, if at all. Accordingly, a shareholder may not be able to sell their shares immediately upon offering them for sale. ITEM 2. PROPERTIES CNB Financial Services, Inc. CNB's headquarters are located at the main office of CNB Bank, Inc. located at 101 South Washington Street, Berkeley Springs, West Virginia. CNB Bank, Inc. The principal executive office and main banking office is located at 101 South Washington Street, Berkeley Springs, West Virginia. In addition, the bank has owned and operated a full service branch bank located at 2450 Valley Road, Berkeley Springs, West Virginia since 1991. In October 1998, the bank opened a full service branch located at 2646 Hedgesville Road, Martinsburg, West Virginia. In March 2002, the bank opened a full service branch located at 14994 Apple Harvest Drive, Martinsburg, West Virginia. In April 2005, the bank opened an additional full service branch located at 1231 T.J. Jackson Drive, Falling Waters, West Virginia. On January 26, 2004, CNB entered into an agreement to purchase certain assets and liabilities associated with the Hancock Branch of Fidelity Bank, a subsidiary bank of Mercantile Bankshares Corporation (formerly Home Federal). The purchase, which took place on June 11, 2004, increased the assets and liabilities of 9 CNB by $14.6 million. CNB assumed responsibility for all the deposit services including checking, savings and certificate of deposits. Additionally, CNB acquired loans, equipment and leasehold improvements and assumed the lease for the real estate located at 333 East Main Street, Hancock, Maryland. Each of the bank's locations provides ATM services, in addition to traditional lobby and drive-in services. In November of 1998, the bank acquired CNB Insurance Services, Inc. which was operated out of the main office in Berkeley Springs until June 1, 2006 at which time the Bank sold the assets of CNB Insurance Services, Inc. to Maiden Financial. The main office and branches are owned free and clear of any indebtedness. The Bank owns all of the facilities described above with the exception of the Hancock, Maryland branch on which the bank owns improvements situated on leased land. Management believes that the facilities are of sound construction, in good operating condition, are appropriately insured and are adequately equipped for carrying on the business of the Company. The net book value of the bank's premises and equipment as of December 31, 2006 is $6.3 million. ITEM 3. LEGAL PROCEEDINGS In the ordinary course of business, the Bank and its subsidiary are involved in various legal proceedings. In the opinion of the management of CNB, there are no proceedings pending to which CNB is a party or to which its property is subject, which, if determined adversely to CNB, would be material in relation to CNB's financial condition. There are no proceedings pending other than ordinary routine litigation incident to the business of CNB. In addition, no material proceedings are pending or are known to be threatened or contemplated against CNB by government authorities. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matter was submitted to a vote of security holders, through the solicitation of proxies or otherwise, during the fourth quarter of 2006. 10 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES The stock of CNB Financial Services, Inc., and prior to the formation of CNB, the Bank, is not listed on an exchange and is not heavily traded. The trades that have occurred are those that, to management's knowledge, have been individually arranged. The prices listed below are based upon information available to management through discussions with shareholders, and to the best of management's knowledge, accurately represent the amount at which its stock was traded during the periods indicated. Prices reflect amounts paid by purchasers of the stock and, therefore, may include commissions or fees. The amounts of such commissions or fees, if any, are not known to management. No attempt was made by management to ascertain the prices for every sale made during these periods. Based on information that management is aware of, the majority of shares sold during 2006 were at a price that ranged from $67 to $80 per share. During 2005, information available to management indicates that stock trades ranged from $67 to $100 per share. Book value per share increased from $41.50 at December 31, 2005 to $44.37 at December 31, 2006. Dividends which have been declared by the Board of Directors semiannually, increased from $1.44 per share in 2005 to $1.54 per share in 2006, a 6.9% increase. The ability of CNB to pay dividends is subject to certain limitations imposed by various banking regulations. See Note 20: Regulatory Matters in the Notes to Consolidated Financial Statements for a more detailed discussion on the limitations. As of March 2, 2007, the number of record holders was 639. The prices listed below represent the high and low market prices for stock trades reported during each quarter.
PER SHARE HIGH LOW DIVIDEND ------- ------ --------- 2006 First quarter $ 80.00 $67.00 Second quarter $ 80.00 $78.00 $0.45 Third quarter $ 73.00 $71.00 Fourth quarter $ 73.00 $73.00 $1.09 2005 First quarter $ 68.00 $68.00 Second quarter $ 67.00 $67.00 $0.42 Third quarter $100.00 $67.00 Fourth quarter $ 90.00 $67.00 $1.02
CNB's stock is not traded on an established exchange and there are no known market makers, therefore there is no established public trading market for CNB's stock. The prices listed above are based upon information available to management through discussions with shareholders, and to the best of management's knowledge, accurately represent the amount at which its stock was traded during the periods indicated. Prices reflect amounts paid by purchasers of the stock and, therefore, may include commissions or fees. The amounts of such commissions or fees, if any, are not known to management. No attempt was made by management to ascertain the prices for every sale made during these periods. During the fourth quarter of the fiscal year, CNB did not purchase any of its own common stock. The following graph compares the yearly percentage change in CNB's cumulative total shareholder return on common stock for the five-year period ending December 31, 2006, with the cumulative total return of the Hemscott Index (SIC Code Index 6022-State Commercial Banks). Shareholders may obtain a copy of the index by calling Hemscott, Inc., at telephone number (804) 775-8118. There is no assurance that CNB's stock performance will continue in the future with the same or similar trends as depicted in the graph. 11 COMPARE CUMULATIVE TOTAL RETURN AMONG CNB FINANCIAL SERVICES, INC., HEMSCOTT INDEX AND SIC CODE INDEX
FISCAL YEAR ENDING --------------------------------------------------------------------------- COMPANY/INDEX/MARKET 12/31/2001 12/31/2002 12/31/2003 12/31/2004 12/30/2005 12/29/2006 - -------------------- ---------- ---------- ---------- ---------- ---------- ---------- CNB Financial 100.00 112.17 147.19 148.08 179.28 199.29 State Commercial Banks 100.00 93.67 122.15 132.84 130.62 148.64 Hemscott Index 100.00 79.43 105.75 118.62 127.02 147.03
ASSUMES $100 INVESTED ON DEC. 31, 2001 ASSUMES DIVIDEND REINVESTED FISCAL YEAR ENDING DEC. 31, 2006 SIC Code Index is SIC 6022 State Commercial Banks Hemscott Index is Hemscott Financial Information Composite Market Value Index The information used to determine CNB's cumulative total shareholder return on its common stock is based upon information furnished to CNB or the bank by one or more parties involved in purchases or sales of CNB's common stock. There is no public market for CNB's common stock, and share prices used to determine CNB's cumulative shareholder return are based upon sporadic trading activity in privately negotiated transactions. We have not attempted to verify or determine the accuracy of the representations made to CNB or the bank. 12 ITEM 6. SELECTED FINANCIAL DATA TABLE 1. FIVE YEAR SELECTED CONSOLIDATED FINANCIAL DATA
2006 2005 2004 2003 2002 -------- -------- -------- -------- -------- In thousands except for per share data AT YEAR-END Total assets $276,069 $258,953 $236,998 $201,056 $191,602 Securities available for sale 50,873 55,194 59,740 39,362 43,430 Loans and lease, net of unearned income 204,319 180,207 154,920 146,273 129,815 Deposits 233,083 219,288 207,729 180,899 173,063 Shareholders' equity 20,322 19,008 18,149 16,569 16,270 SIGNIFICANT RATIOS Return on average assets 0.92% 1.00% 1.07% 0.89% 0.71% Return on average shareholders' equity 12.46 12.91 13.38 10.44 8.38 Average shareholders' equity to average assets 7.35 7.76 8.03 8.48 8.49 Net interest margin 3.77 4.12 4.11 3.83 3.36 SUMMARY OF OPERATIONS Interest income $ 15,989 $ 13,420 $ 11,715 $ 11,569 $ 11,489 Interest expense 6,269 3,850 3,169 4,152 5,342 Net interest income 9,720 9,570 8,546 7,417 6,147 Provision for loan losses 275 352 393 312 261 Net interest income after provision for loan losses 9,445 9,218 8,153 7,105 5,886 Non-interest income 2,222 2,007 1,972 1,728 1,403 Non-interest expense 7,890 7,541 6,789 6,007 5,300 Income before income taxes and discontinued operations 3,653 3,684 3,336 2,826 1,989 Discontinued operations 124 -- -- -- -- Income tax expense 1,308 1,238 992 1,083 681 Net income 2,469 2,446 2,344 1,743 1,308 PER SHARE DATA Net income $ 5.39 $ 5.34 $ 5.12 $ 3.80 $ 2.86 Cash dividends 1.54 1.44 1.38 1.20 1.02 Net book value 44.37 41.50 39.62 36.17 35.52
13 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis presents the significant changes in financial condition and results of operations of CNB, for the years ended December 31, 2006 and 2005. This discussion and analysis should be read in conjunction with the audited, consolidated financial statements and accompanying notes. This discussion includes forward-looking statements based upon management's expectations; actual results may differ. Amounts and percentages used in this discussion have been rounded. All average balances are based on monthly averages. EARNINGS SUMMARY CNB had net income totaling $2.5 million or $5.39 per share, $2.4 million or $5.34 per share and $2.3 million or $5.12 per share for fiscal years 2006, 2005 and 2004, respectively. Annualized return on average assets and average equity were .9% and 12.5%, respectively for 2006 compared to 1.0% and 12.9% for 2005 and 1.1% and 13.4% for 2004. Growth in net income for the year 2007 is projected to increase slightly compared to the growth in net income for 2006 over 2005 due to the strong loan demand the bank experienced in 2005 and 2006 continuing in 2007 offset by a tighter net interest margin caused by the increased cost of funds. Other significant factors affecting the 2007 net income are expenses to be incurred related to the implementation of the Sarbanes-Oxley Act which are expected to be approximately $200,000. Also, 2006 net income included a $145,000 gain on sale of assets of CNB Insurance Services, Inc. NET INTEREST INCOME Net interest income represents the primary component of the Bank's earnings. It is the difference between interest and fee income related to earning assets and interest expense incurred to carry interest-bearing liabilities. Net interest income is impacted by changes in the volume and mix of interest-earning assets and interest-bearing liabilities, as well as by changing interest rates. In order to manage these changes, their impact on net interest income and the risk associated with them, the Bank utilizes an ongoing asset/liability management program. This program includes analysis of the difference between rate sensitive assets and rate sensitive liabilities, earnings sensitivity to rate changes, and source and use of funds. A discussion of net interest income and the factors impacting it is presented below. Net interest income in 2006 increased by $150,000 or 1.6% over 2005. Interest income in 2006 increased by $2.6 million or 19.1% compared to 2005, while interest expense increased by $2.4 million or 62.8% during 2006 as compared to 2005. Interest income increased during 2006 compared to 2005 as a result of an increase in the average balances of loans and investment securities. Average rates earned on these interest earning assets also increased during 2006 compared to 2005. Interest expense increased during 2006 compared to 2005 as a result of an increase in the average balance of money market accounts, time deposit accounts and borrowings and an increase in the average rates paid on all interest bearing liability accounts except savings deposits. However, the increase in interest expense was offset by a decrease in the average balance of savings accounts and NOW accounts. Net interest income in 2005 increased by $1.0 million or 12.0% over 2004. Interest income in 2005 increased by $1.7 million or 14.6% compared to 2004, while interest expense increased by $681,000 or 21.5% during 2005 as compared to 2004. Interest income increased during 2005 compared to 2004 as a result of an increase in the average balances of loans and investment securities offset by a decrease in the average balance of federal funds sold. Average rates earned on all interest earning assets increased during 2005 compared to 2004. Interest expense increased during 2005 compared to 2004 as a result of an increase in the average balance of savings deposits, NOW accounts, money market accounts and borrowings and an increase in the average rates paid on those accounts. Interest expense was also affected by an increase in the average rates paid on time deposits offset by a decrease in the average balance of those accounts. During 2006 and 2005, the Bank used funds generated from deposit account growth, sale of investment securities and FHLB borrowings to fund loan commitments. The net interest margin is impacted by the change in the spread between yields on earning assets and rates paid on interest bearing liabilities. Net interest margin decreased from 2005 to 2006. See Table 1 - Distribution of Assets, Liabilities and Shareholders' Equity; Interest Rates and Interest Differential. 14 TABLE 2. DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY; INTEREST RATES AND INTEREST DIFFERENTIAL
DECEMBER 31, 2006 DECEMBER 31, 2005 DECEMBER 31, 2004 ---------------------------- ---------------------------- ---------------------------- YTD YTD YTD AVERAGE YTD YIELD/ AVERAGE YTD YIELD/ AVERAGE YTD YIELD/ BALANCE INTEREST RATE BALANCE INTEREST RATE BALANCE INTEREST RATE -------- -------- ------ -------- -------- ------ -------- -------- ------ In thousands Interest earning assets: Federal funds sold $ 27 $ 1 4.87% $ 28 $ 1 3.11% $ 2,384 $ 33 1.25% Securities: Taxable 44,674 2,116 4.74 43,245 1,898 4.39 37,526 1,570 4.18 Tax-exempt (1) 11,298 390 5.23 12,092 410 5.14 8,070 273 5.13 Loans (net of unearned interest) (2) (4) (5) 194,712 13,211 6.78 170,158 10,826 6.36 152,984 9,559 6.25 -------- ------- ---- -------- ------- ---- -------- ------- ---- Total interest earning assets (1) $250,711 $15,718 6.27% $225,523 $13,135 5.82% $200,964 $11,435 5.69% ======== ======= ==== ======== ======= ==== ======== ======= ==== Nonearning assets: Cash and due from banks $ 9,170 $ 9,577 $ 9,459 Bank premises and equipment, net 6,464 6,455 5,494 Other assets 5,521 4,635 3,880 Allowance for loan losses (2,136) (1,956) (1,731) -------- -------- -------- Total assets $269,730 $244,234 $218,066 ======== ======== ======== Interest bearing liabilities: Savings deposits $ 30,586 $ 153 0.50% $ 32,340 $ 162 0.50% $ 28,622 $ 147 0.51% Time deposits 99,950 3,791 3.79 87,977 2,391 2.72 92,959 2,493 2.68 NOW accounts 42,720 1,189 2.78 43,790 908 2.07 32,196 436 1.35 Money market accounts 10,905 158 1.45 10,101 91 0.90 9,685 79 0.82 Borrowings 18,751 978 5.22 8,393 298 3.55 873 14 1.60 -------- ------- ---- -------- ------- ---- -------- ------- ---- Total interest bearing liabilities $202,912 $ 6,269 3.09% $182,601 $ 3,850 2.11% $164,335 $ 3,169 1.93% -------- ------- ---- -------- ------- ---- -------- ------- ---- Noninterest bearing liabilities: Demand deposits $ 43,795 $ 40,314 $ 33,931 Other liabilities 3,207 2,368 2,287 Shareholders' equity 19,816 18,951 17,513 -------- -------- -------- Total liabilities and shareholders' equity $269,730 $244,234 $218,066 ======== ======== ======== ------- ------- ------- Net interest income (1) $ 9,449 $ 9,285 $ 8,266 ======= ======= ======= Net interest spread (3) 3.18% 3.71% 3.76% ==== ==== ==== Net interest income to average interest earning assets (1) 3.77% 4.12% 4.11% ==== ==== ====
(1) Yields are expressed on a tax equivalent basis using a 34% tax rate. (2) For the purpose of these computations, nonaccruing loans are included in the amounts of average loans outstanding. (3) Net interest spread is the difference between the weighted average yield on interest-earning assets and the weighted average cost of interest-bearing liabilities. (4) Interest income on loans excludes fees of $271,000 in 2006, $285,000 in 2005 and $280,000 in 2004. (5) Interest income on loans includes fees of $99,722 in 2006, $68,484 in 2005 and $100,527 in 2004 from the Business Manager Program, student loans and lease receivables. 15 Table 3 sets forth a summary of the changes in interest earned and interest expense detailing the amounts attributable to (i) changes in volume (change in average volume times the prior year's average rate), (ii) changes in rate (change in the average rate times the prior year's average volume). The changes in rate/volume (change in the average volume times the change in the average rate), had been allocated to the changes in volume and changes in rate in proportion to the relationship of the absolute dollar amounts of the change in each. During 2006, net interest income increased $836,000 due to changes in volume and decreased $672,000 due to changes in interest rates. Also, net interest income was affected by a $14,000 decrease in loan fees. In 2005, net interest income increased $1.2 million due to changes in volume and decreased $193,000 due to changes in interest rates. Also, net interest income was affected by a $5,000 increase in loan fees. TABLE 3. VOLUME AND RATE ANALYSIS OF CHANGES IN INTEREST INCOME
2006 OVER 2005 2005 OVER 2004 ------------------------ ----------------------- CHANGE DUE TO CHANGE DUE TO --------------- TOTAL -------------- TOTAL (Taxable equivalent basis) VOLUME RATE CHANGE VOLUME RATE CHANGE ------ ------ ------ ------ ----- ------ In thousands Interest earned on: Federal funds sold $ -- $ -- $ -- $ 56 $ (84) $ (28) Taxable securities 62 156 218 248 78 326 Tax-exempt securities (31) 11 (20) 136 1 137 Loans 1,635 750 2,385 1,094 171 1,265 ------ ------ ------ ------ ----- ------ Total interest earned $1,666 $ 917 $2,583 $1,534 $ 166 $1,700 ------ ------ ------ ------ ----- ------ Interest expense on: Savings deposits $ (9) $ -- $ (9) $ 19 $ (3) $ 16 Time deposits 361 1,039 1,400 (136) 38 (98) NOW accounts (22) 303 281 188 281 469 Money market accounts 8 59 67 4 8 12 Other borrowing 492 188 680 247 35 282 ------ ------ ------ ------ ----- ------ Total interest expense $ 830 $1,589 $2,419 $ 322 $ 359 $ 681 ------ ------ ------ ------ ----- ------ Net interest income $ 836 $ (672) $ 164 $1,212 $(193) $1,019 ====== ====== ====== ====== ===== ======
Another method of analyzing the change in net interest income is to examine the changes between interest rate spread and the net interest margin on earning assets. The interest rate spread as shown in Table 4 is the difference between the average rate earned on earning assets and the average rate on interest bearing liabilities. The net interest margin takes into account the benefit derived from assets funded by interest free sources such as non-interest bearing demand deposits and capital. 16 TABLE 4. INTEREST RATE SPREAD AND NET INTEREST MARGIN ON EARNING ASSETS
2006 2005 2004 --------------- --------------- --------------- AVERAGE AVERAGE AVERAGE (Taxable equivalent basis) BALANCE RATE BALANCE RATE BALANCE RATE -------- ---- -------- ---- -------- ---- In thousands Earning assets $250,711 6.27% $225,523 5.82% $200,964 5.69% ======== ======== ======== Interest bearing liabilities $202,912 3.09% $182,601 2.11% $164,335 1.93% ---- ---- ---- Interest rate spread 3.18% 3.71% 3.76% Interest free sources used to fund earning assets(1) 47,799 0.59% 42,922 0.41% 36,629 0.35% -------- ---- -------- ---- -------- ---- Total sources of funds $250,711 $225,523 $200,964 ======== ======== ======== Net interest margin 3.77% 4.12% 4.11% ==== ==== ====
(1) Non-interest bearing liabilities and shareholders' equity less non-interest earning assets. The following discussion analyzes changes in the Bank's spreads and margins in terms of basis points. A basis point is a unit of measure for interest rates equal to .01%. One hundred basis points equals 1%. Interest rate spread decreased 53 basis points in 2006 and the net interest margin decreased 35 basis points. The interest rate spread was negatively impacted by a 98 basis point increase in interest bearing liability costs offset by a 45 basis point increase in earning asset yields. Interest rate spread decreased 5 basis points in 2005 while the net interest margin increased 1 basis point. The interest rate spread was negatively impacted by an 18 basis point increase in interest bearing liability costs offset by a 13 basis point increase in earning asset yields. The prime rate increased 100 basis points during 2006 and 200 basis points during 2005, however longer term rates have fluctuated in a relatively narrow range. For example, the increase in the average ten year Treasury rates fluctuated within a range of 24 basis points in 2005 and 9 basis points in 2006. The variable rate loan portfolio is tied to midterm Treasury rates. As a result, loan yields increased 42 basis points in 2006 and only 11 basis points in 2005. Interest rates on deposit accounts and other liabilities are tied to the shorter term rates such as the prime and federal funds rate. Therefore in 2006, the increase in liability costs of 98 basis points is a direct result of the increase in short term rates. Generally the rates increased on all interest bearing liability accounts except savings accounts which stayed level with 2005. In 2005, the increase in liability costs is primarily the result of the higher cost of funds on NOW, money market accounts and borrowings during the year. PROVISION FOR LOAN LOSSES The amount charged to the provision for loan losses is based on Management's evaluation of the loan portfolio. Management determines the adequacy of the allowance for loan losses based on past loan loss experience, current economic conditions and composition of the loan portfolio. The allowance for loan losses is the best estimate by Management of the probable losses which have been incurred as of the balance sheet date. See Nonperforming Loans and Allowance for Loan Losses for a comprehensive analysis. NONINTEREST INCOME Noninterest income decreased $19,000 or 1.0% during 2006 over 2005. Noninterest income increased $35,000 or 1.8% during 2005 over the prior comparable period. The decrease in 2006 was a direct result of reporting income for CNB Insurance Services, Inc. in discontinued operations for 2006 offset by increases in overdraft protection and overdraft fees, ATM and debit card fees and trust fee income. These increases for 2006 were also offset by a decrease in income from the title insurance company caused by a decrease in the number of policies written during the period. The increase in fees related to overdraft protection and overdraft fees, ATM and debit card fees have a direct correlation to the increased deposit base of the bank. Also, having a positive impact on noninterest income for 2006 was an increase in service charge fees effective October 1, 2006. The increase in noninterest income for 2005 was attributable to fees generated from the overdraft protection program, debit card income, ATM fees and trust fees. These increases in 2005 were offset by a decrease in overdraft fees, travel club fees and miscellaneous customer service fees. The level of trust assets being managed increased from $36.9 million at December 31, 2005 to $39.7 million at December 31, 2006, a 7.6% increase and the fees earned on these assets increased by $24,000 or 14.0%. The average level of trust assets being managed increased by $5.8 million or 17.9%. 17 NONINTEREST EXPENSES Noninterest expenses increased $238,000 or 3.2% during 2006 over the prior comparable period. The expenses related to the discontinued operations of CNB Insurance Services, Inc. were reclassified out of noninterest expenses for 2006. In 2005, CNB Insurance Services, Inc. noninterest expenses totaled $132,000 of which $84,000 was for salaries, $20,000 for benefits and $28,000 was for other operating expenses. These expenses totaled $73,000 in 2006 and are classified in discontinued operations. Salaries increased due to normal merit increases and a full year of salaries for the new Spring Mills branch employees. Additionally in late January 2006, the Bank increased all hourly salaries to become more in line with the area competition. Employee benefits increased due to an increase in pension expense, an increase in health insurance costs and increased salaries. Additionally in 2006, CNB incurred $24,000 of expenses for a severance package offered to and accepted by an employee. Although the bank changed its health insurance program, effective January 1, 2005, to a high deductible plan with reduced per employee premiums, the insurance expense for 2006 showed an increase over the same period last year due to the increased number of employees who were eligible and elected to be in the plan and a normal increase in premiums. Occupancy expense increased due to the cost of needed building repairs at a few of the branch buildings along with the added costs of depreciation and building supplies for an additional branch facility in Spring Mills, West Virginia. Furniture and equipment expense showed a decrease for 2006 as compared to 2005. This decrease was due to a reduction in software amortization expense due to items related to the computer conversion in 2003 being fully amortized in February 2006 offset by the additional depreciation for equipment and software purchased for the new branch facility in Spring Mills and the increased cost and number of maintenance contracts the bank carries on its equipment. The increase in other operating expenses was due to increases in advertising, stationary, supplies and printing, ATM fees, board fees and legal fees. During the first quarter of 2006, the bank increased its newspaper and radio exposure showcasing the Bank's deposit products. This exposure was significantly reduced during the remainder of 2006. Stationary, supplies and printing increased due to the printing expenses related to the bank's charter change from a national bank to a state bank. The ATM expense increase was during the first quarter and was a direct result of the one time conversion costs for a new system. Board fees payable to directors increased in April 2006. Legal fees increased due to expenses related to the bank's charter change. These increases were offset by decreases in postage, data processing, debit card expense, outside service fees, teller shortages and miscellaneous NSF and other check losses. Postage decreased due to the bank's implementation of a new postage system. Data processing expense decreased due to the start up costs of the Spring Mills branch in 2005. Debit card expense decreased due to the bank converting to a new system for processing during the second quarter of 2006. Outside service fees decreased due to expenses being charged in 2005 for compliance with Sarbanes-Oxley Act of 2002. In order to prepare for the anticipated applicability in 2008 of the audit requirements related to internal control contained in Section 404 of Sarbanes-Oxley, outside service fees are expected to increase approximately $200,000 in 2007. Teller shortages decreased due to the bank robbery in 2005. Miscellaneous NSF and other check losses decreased due to the bank experiencing a larger than normal volume of fraudulent checks in 2005. Noninterest expenses increased $752,000 or 11.1% during 2005 over the prior comparable period. The increase was primarily due to an increase in salaries and employee benefits, occupancy expense, furniture and equipment expense and other operating expenses. Salaries and employee benefits increased due to normal merit increases, several new hires, a partial year of salaries and benefits for employees of the Spring Mills branch in northern Berkeley County and a full year of salaries and benefits for employees of the acquired Hancock, Maryland branch. Employee benefits increased due to an increase in pension expense and the increased number of employees. Although the bank changed its health insurance program, effective January 1, 2005, to a high deductible plan with reduced per employee premiums the insurance expense for 2005 showed an increase over the same period in 2004 due to the increased number of employees. Concurrent with the creation of the high deductible insurance plan, the Bank established a vested health contribution plan which enables the Bank to contribute to health reimbursement accounts for each employee on the plan. A $58,989 expense was incurred in 2005 for the health reimbursement accounts. Additional utilities expense and depreciation related to the new branch facility in Spring Mills and a full year of expenses related to the acquired Hancock branch caused occupancy expense and furniture and equipment expense to increase in 2005. Components of other operating expense, which significantly increased during 2005, included telephone expense, debit card expense, outside service fees, audit, tax and accounting fees, miscellaneous NSF check and other losses and the amortization of premium purchased for the Hancock branch facility. These increases were offset by decreases in advertising, stationary, supplies and printing, employee training, overdraft protection expense, legal fees and business manager expense. Telephone expense increased due to the addition of two branch facilities and increased usage. The increase in debit card expense is a result of the increased deposit base of the bank and additional fraud protection expense. Outside service fees and audit, tax and accounting fees increased due to additional costs of compliance with new banking regulations and the provisions of the Sarbanes-Oxley Act of 2002. The increase in miscellaneous NSF check and other losses is due to an increased exposure of the bank to fraudulent financial instruments and schemes. Stationary, supplies and printing decreased due to the purchase of free CNB Bank, Inc. checks for all checking account customers of the acquired Hancock branch in 2004. Employee training decreased as a result of the outsourced staff training on Windows based products and other specialized product training in 2004. Overdraft protection expense decreased due to the expiration of the Bank's contract with Pinnacle Financial Strategies in February 2004. Legal fees decreased as 2004 included expenses pertaining to the Hancock branch acquisition. Business manager expense decreased due to the continued decrease in the volume of receivables the bank purchased throughout 2005 due to a decline in customer need for the program. Advertising expense decreased due to the concentrated advertising campaign in early 2004 which related to the Hancock branch acquisition. 18 The Company performs an annual test of impairment of acquired customer lists. The annual test for impairment resulted in no loss for the years ended December 31, 2006, 2005 or 2004. On June 1, 2006, the customer lists of CNB Insurance Services, Inc. along with all other assets were sold to Maiden Financial. See Note 16: Discontinued Operations in the Notes to Consolidated Financial Statements for further discussion. INCOME TAXES Provision for income tax totaled $1.3 million in 2006, $1.2 million in 2005 and $992,000 in 2004. The effective tax rate was 34.6% in 2006 compared to 33.6% and 29.7% in 2005 and 2004, respectively. The Bank's income tax expense differs from the amount computed at statutory rates primarily due to the tax-exempt earnings from certain investment securities and loans, and non-deductible expenses, such as life insurance premiums. See Note 14: Income Taxes in the Notes to Consolidated Financial Statements for a comprehensive analysis of income tax expense. FINANCIAL CONDITION Table 5 examines CNB Bank, Inc.'s financial condition in terms of its sources and uses of funds. Average funding sources and uses increased $25.2 million or 11.2% in 2006 compared with an increase of $24.6 million or 12.2% in 2005. TABLE 5. SOURCES AND USES OF FUNDS
2006 2005 -------------------------- -------------------------- INCREASE INCREASE 2004 (DECREASE) (DECREASE) -------- AVERAGE --------------- AVERAGE --------------- AVERAGE BALANCE AMOUNT % BALANCE AMOUNT % BALANCE -------- ------- ----- -------- ------- ----- -------- In thousands Funding uses: Federal funds sold $ 27 $ (1) (3.6)% $ 28 $(2,356) (98.8)% $ 2,384 Securities available for sale 55,972 635 1.1 55,337 9,741 21.4 45,596 Loans 194,712 24,554 14.4 170,158 17,174 11.2 152,984 -------- ------- -------- ------- -------- Total uses $250,711 $25,188 11.2% $225,523 $24,559 12.2% $200,964 ======== ======= ==== ======== ======= ===== ======== Funding sources: Interest-bearing demand deposits $ 53,625 $ (266) (0.5)% $ 53,891 $12,010 28.7% $ 41,881 Savings deposits 30,586 (1,754) (5.4) 32,340 3,718 13.0 28,622 Time deposits 99,950 11,973 13.6 87,977 (4,982) (5.4) 92,959 Short-term borrowings 18,751 10,358 123.4 8,393 7,520 861.4 873 Noninterest bearing funds, net(1) 47,799 4,877 11.4 42,922 6,293 17.2 36,629 -------- ------- -------- ------- -------- Total sources $250,711 $25,188 11.2% $225,523 $24,559 12.2% $200,964 ======== ======= ==== ======== ======= ===== ========
(1) Noninterest bearing liabilities and shareholders' equity less noninterest earning assets. Total assets increased $17.1 million or 6.6% to $276.1 million from December 31, 2005 to December 31, 2006 due primarily to a $24.1 million increase in loans offset by a $2.7 million decrease in cash and due from banks and a $4.3 million decrease in investment securities. Total liabilities increased $15.8 million or 6.6% to $255.7 million from December 31, 2005 to December 31, 2006 substantially due to the increase in deposits of $13.8 million, the increase in FHLB borrowings of $700,000, the increase in accrued interest payable of $460,000 and an increase in accrued expenses and other liabilities of $846,000. Shareholders' equity increased $1.3 million to $20.3 million at December 31, 2006 primarily due to net income of $2.5 million, offset by a $449,000 decrease in accumulated other comprehensive income and cash dividends of $705,000. The components of accumulated other comprehensive income at December 31, 2006, were unrealized gains and losses on available for sale securities, net of deferred income taxes and unrecognized pension costs, net of deferred income taxes. The decrease in accumulated other comprehensive income was due to the increase in unrecognized pension costs offset by the lower unrealized market value depreciation of the 19 available for sale investment security portfolio. The unrealized gains and losses are primarily a function of available market interest rates relative to the yield being generated on the available for sale portfolio. No earnings impact results, however, unless the securities are actually sold. The additional minimum pension liability adjustment in 2005 resulted from the accumulated benefit obligation exceeding the fair value of plan assets. In 2006, CNB implemented SFAS No. 158, "Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans" in which the unfunded liability resulting from the projected benefit obligation exceeding the fair value of the plan assets is recorded as a liability and any unrecognized pension costs are recorded net of tax in accumulated other comprehensive income. See Note 11: Pension Plan in the Notes to Consolidated Financial Statements for further details. LOAN PORTFOLIO At December 31, 2006, total loans increased $24.1 million or 13.4% to $204.3 million from $180.2 million at December 31, 2005. The Bank experienced steady loan growth throughout 2006 with the first, second and fourth quarters of 2006 each showing loan growth over $6.0 million. Lending officers continue to be proactive in their marketing efforts of the Bank's loan products. In addition, the Bank offered an employee incentive program to generate loan demand. This program generated over $11.2 million in new loan demand. The Bank's lending area continues to see price appreciation of real property which contributes to the increased mortgage loans outstanding. Interest rates have steadied, mortgage rates have actually decreased and the population in the Bank's lending area continues to increase, all leading to the Bank's increase in loan volume. The loan mix changed slightly from December 31, 2005 with the consumer loan area showing a decrease in outstandings for the time frame. Real estate and commercial real estate loans continue to show strong growth for 2006. The Bank's management believes additional growth in all lending areas is possible into year 2007. Management's intent is to control the loan volume in a manner which would produce a loan to deposit ratio between 80% and 90% and maintain credit quality. The loan to deposit ratio was 87.7% at December 31, 2006 and 82.2% at December 31, 2005. The ratio of net charge-offs to average loans outstanding was .09% in 2006 and .08% in 2005. Table 6 sets forth the amount of loans outstanding (net of unearned income) as of the dates shown: TABLE 6. LOANS AND LEASES OUTSTANDING
DECEMBER 31, ---------------------------------------------------- 2006 2005 2004 2003 2002 -------- -------- -------- -------- -------- In thousands Real estate $143,767 $125,723 $108,159 $ 98,405 $ 83,239 Commercial real estate 36,967 29,492 22,759 21,521 13,935 Consumer 15,934 16,802 16,405 16,853 22,575 Commercial 9,172 9,314 8,881 8,934 9,685 Overdrafts 163 356 82 136 73 -------- -------- -------- -------- -------- $206,003 $181,687 $156,286 $145,849 $129,507 Leases: 124 145 166 186 135 -------- -------- -------- -------- -------- $206,127 $181,832 $156,452 $146,035 $129,642 Net deferred loan fees, premiums and discounts 324 397 275 238 172 Allowance for loan losses (2,132) (2,022) (1,807) (1,608) (1,484) -------- -------- -------- -------- -------- $204,319 $180,207 $154,920 $144,665 $128,330 ======== ======== ======== ======== ========
The commercial loan portfolio consisting of commercial business and commercial real estate loans showed an increase in outstanding loans of $7.3 million from $38.8 million at December 31, 2005 to $46.1 million at December 31, 2006. The commercial loan portfolio is approximately 22% of the total loan portfolio at December 31, 2006 compared to 21% at December 31, 2005. The Bank's activity in the Berkeley County market continues to expand with the three branch locations located in that area. The Bank's loan activity also increased in the Maryland market after acquiring the Hancock, Maryland branch in June 2004. In addition, the Bank's loan growth has benefited from significant real estate development activity in Berkeley County, West Virginia. Management believes additional growth in both commercial business and commercial real estate loans is possible in 2007. Real estate mortgage loans comprised mainly of one to four family residences continued to be the Bank's dominant loan category. Mortgage lending comprises approximately 70% or $143.8 million of the total loan portfolio at December 31, 2006 compared to 69% or $125.7 million at December 31, 2005. The increase in real estate lending is attributable to the Bank's increased presence in Berkeley County, West Virginia, the continued price appreciation of real property in the Bank's market area and the increasing population in the Bank's market area. The consumer loan portfolio showed a decrease of $1.1 million. The primary factor causing the decrease was a decrease in the overall new and used car sales during 2006. Additionally, the Bank experienced a decrease in dealer vehicle loans due to local competition offering a 20 lower rate and/or better loan terms. Another factor impacting the consumer loan portfolio change is a decrease of $193,000 in overdraft deposit accounts. Table 7 summarizes the approximate contractual maturity and sensitivity of certain loan types to changes in interest rates as of December 31, 2006:
DECEMBER 31, 2006 ---------------------------------------------- ONE YEAR ONE THROUGH OVER OR LESS FIVE YEARS FIVE YEARS TOTAL -------- ----------- ---------- -------- In thousands Commercial, financial and agricultural: Floating rate $21,184 $12,497 $ 1,236 $ 34,917 Fixed rate 3,465 4,221 3,536 11,222 ------- ------- ------- -------- Total $24,649 $16,718 $ 4,772 $ 46,139 ======= ======= ======= ======== Real estate - mortgage: Floating rate $ 8,259 $40,503 $ -- $ 48,762 Fixed rate 4,365 3,148 79,275 86,788 ------- ------- ------- -------- Total $12,624 $43,651 $79,275 $135,550 ======= ======= ======= ======== Real estate - construction: Floating rate $ 3,567 $ -- $ -- $ 3,567 Fixed rate 4,650 -- -- 4,650 ------- ------- ------- -------- Total $ 8,217 $ -- $ -- $ 8,217 ======= ======= ======= ======== Consumer: Floating rate $ 86 $ 148 $ -- $ 234 Fixed rate 1,071 11,880 2,912 15,863 ------- ------- ------- -------- Total $ 1,157 $12,028 $ 2,912 $ 16,097 ======= ======= ======= ======== Lease financing: Floating rate $ -- $ -- $ -- $ -- Fixed rate 2 6 116 124 ------- ------- ------- -------- Total $ 2 $ 6 $ 116 $ 124 ======= ======= ======= ========
The Bank has continued to experience a shift from a demand for variable rate loans to a demand for fixed rate mortgage products. Demand for the variable rate loans has continued to fall due to the rising interest rate environment causing these products to not be as attractive as in the past. The Bank's inhouse fixed rate products and secondary market fixed rate products, which are sold to various investors, have seen a greater demand during 2006. As of December 31, 2006, 48.1% of the Bank's mortgage loans were adjustable rate loans and 51.9% were fixed rate loans. Compared to December 31, 2005, 51.2% of the Bank's mortgage loans were adjustable rate loans and 48.8% were fixed rate loans. Currently, the Bank has approximately $2.1 million in fixed rate loans in the portfolio which were originated under terms that would allow them to be sold on the secondary market, although there is no intent to sell these loans. NONPERFORMING LOANS AND ALLOWANCE FOR LOAN LOSSES Nonperforming loans consist of loans in nonaccrual status and loans which are past due 90 days or more and still accruing interest. Bank policy requires those loans which are past due 90 days or more be placed on nonaccrual status unless they are both well secured and in the process of collection. As of December 31, 2006 and 2005, nonaccrual loans approximated .20% and .44% of total loans (net), respectively. The Bank has no loans which are considered to be impaired as of December 31, 2006 and 2005. As of December 31, 2006, management is aware of six borrowers who have exhibited weaknesses. Their loans have aggregate uninsured balances of $1.0 million. No specific allowance for these loans has been established as part of the allowance for loan losses. The loans are collateralized primarily by real estate and management anticipates that any additional potential loss would be minimal. 21 Table 8 sets forth the amounts of nonperforming loans as of the dates indicated: TABLE 8. NONPERFORMING ASSETS
DECEMBER 31 -------------------------------- 2006 2005 2004 2003 2002 ---- ---- ---- ---- ---- In thousands Nonaccrual loans $402 $790 $381 $349 $ 13 Loans past due 90 days or more still accruing interest 5 -- -- 27 553 Other real estate -- -- -- -- 2 ---- ---- ---- ---- ---- Total $407 $790 $381 $376 $568 ==== ==== ==== ==== ====
The allowance for loan losses is the best estimate by management of the probable losses which have been incurred as of the respective balance sheet date. Management makes a determination quarterly by analyzing overall loan quality, changes in the mix and size of the loan portfolio, previous loss experience, general economic conditions, information about specific borrowers and other factors. The Bank's methodology for determining the allowance for loan losses establishes both an allocated and an unallocated component. The allocated portion of the allowance represents the results of analyses of individual loans that are being monitored for potential credit problems and pools of loans within the portfolio. The allocated portion of the allowance for loans is based principally on current loan risk ratings, historical loan loss rates adjusted to reflect current conditions, as well as analyses of other factors that may have affected the collectibility of loans in the portfolio. The Bank analyzes all commercial loans that are being monitored as potential credit problems to determine whether such loans are impaired, with impairment measured by reference to the borrowers' collateral values and cash flows. The unallocated portion of the allowance for loan losses represents the results of analyses that measure probable losses inherent in the portfolio that are not adequately captured in the allocated allowance analyses. These analyses include consideration of unidentified losses inherent in the portfolio resulting from changing underwriting criteria, changes in the types and mix of loans originated, industry concentrations and evaluations, allowance levels relative to selected overall credit criteria and other economic indicators used to estimate probable incurred losses. At December 31, 2006 and 2005, the allowance for loan losses totaled $2.1 million and $2.0 million, respectively. The allowance for loan losses as a percentage of loans was 1.0% and 1.1% as of December 31, 2006 and 2005, respectively. The provision for loan losses exceeded net charge-offs by $110,000 and $215,000 in 2006 and 2005, respectively. 22 Table 9 shows a summary of the Bank's loan loss experience: TABLE 9. ALLOWANCE FOR LOAN LOSSES
2006 2005 2004 2003 2002 -------- -------- -------- -------- -------- In thousands Loans outstanding at end of year $206,127 $181,832 $156,452 $146,035 $129,642 ======== ======== ======== ======== ======== Daily average balance of loans and leases $194,712 $170,158 $152,984 $136,658 $118,530 ======== ======== ======== ======== ======== Balance of allowance for loan losses at beginning of year $ 2,022 $ 1,807 $ 1,608 $ 1,484 $ 1,337 -------- -------- -------- -------- -------- Loans charged off: Commercial, financial and agricultural $ 20 $ -- $ 41 $ 7 $ 1 Real estate - mortgage -- -- -- -- 5 Consumer 298 306 311 262 145 -------- -------- -------- -------- -------- Total loans charged off $ 318 $ 306 $ 352 $ 269 $ 151 -------- -------- -------- -------- -------- Recoveries: Commercial, financial and agricultural $ -- $ 2 $ 5 $ 2 $ 2 Consumer 152 167 153 79 35 -------- -------- -------- -------- -------- Total recoveries $ 152 $ 169 $ 158 $ 81 $ 37 -------- -------- -------- -------- -------- Net charge-offs $ 166 $ 137 $ 194 $ 188 $ 114 -------- -------- -------- -------- -------- Provision charged to expense $ 276 $ 352 $ 393 $ 312 $ 261 -------- -------- -------- -------- -------- Balance, end of year $ 2,132 $ 2,022 $ 1,807 $ 1,608 $ 1,484 ======== ======== ======== ======== ======== SELECTED ASSET QUALITY RATIOS: Net charge-offs to average loans 0.09% 0.08% 0.13% 0.14% 0.10% Allowance for loan losses to loans outstanding at end of year 1.03% 1.11% 1.15% 1.10% 1.14% Non-performing assets (1) to total assets 0.15% 0.31% 0.16% 0.19% 0.30% Non-accrual loans to total loans 0.20% 0.43% 0.24% 0.24% 0.01%
(1) Includes accruing loans past due 90 days or more 23 Table 10 summarizes the allocation of the allowance for loan losses by loan type: TABLE 10. HISTORICAL ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
DECEMBER 31, ------------------------------------------------------------------------------------------------- 2006 2005 2004 2003 2002 ----------------- ----------------- ----------------- ----------------- ----------------- % OF % OF % OF % OF % OF LOANS IN LOANS IN LOANS IN LOANS IN LOANS IN EACH EACH EACH EACH EACH AMOUNT CATEGORY AMOUNT CATEGORY AMOUNT CATEGORY AMOUNT CATEGORY AMOUNT CATEGORY ------ -------- ------ -------- ------ -------- ------ -------- ------ -------- In thousands Commercial, financial and agriculture $1,231 22% $1,056 21% $ 810 20% $ 782 21% $ 330 8% Real estate- construction and mortgages 508 70 528 69 467 69 401 67 391 75 Consumer, leasing and other 225 8 303 10 323 11 274 12 364 17 Unallocated 168 N/A 135 N/A 207 N/A 151 N/A 399 N/A ------ --- ------ --- ------ --- ------ --- ------ --- Total $2,132 100% $2,022 100% $1,807 100% $1,608 100% $1,484 100% ====== === ====== === ====== === ====== === ====== ===
The provision for loan losses is a charge to earnings which is made to maintain the allowance for loan losses at a sufficient level. In 2006, 2005 and 2004, the provision totaled $276,000, $352,000 and $393,000, respectively. Past due and nonaccrual loans have decreased and continue to be minimal and loan quality remains good even though net charge offs as a percentage of average loans increased slightly from .08% in 2005 to .09% in 2006. Therefore, management decreased the provision for loan losses in 2006. Having decreased the provision for loan losses, management believes the allowance for loan losses to be adequate and is not aware of any information relating to the loan portfolio which it expects will materially impact future operating results, liquidity or capital resources. In addition, federal and state regulators may require additional reserves as a result of their examination of the Bank. The allowance for loan losses reflects what management currently believes is an adequate level of allowance, although there can be no assurance that future losses will not exceed the estimated amounts, thereby adversely affecting future results of operations. SECURITIES PORTFOLIO AND FEDERAL FUNDS SOLD The Bank's securities portfolio consists of available for sale securities and restricted investments. Classifying the securities portfolio as available for sale provides management with increased ability to manage the balance sheet structure and address asset/liability management issues when needed. The fair value of the investment portfolio has decreased $4.4 million to $52.6 million at December 31, 2006 from December 31, 2005. The composition of the portfolio continues to reflect the Bank's conservative philosophy which places greater importance on safety and liquidity than on yield. At December 31, 2006, approximately 57.7% of the portfolio is comprised of U.S. Government agencies and corporations, 16.2% in Mortgage Backed securities, 22.8% in State and Municipal securities and 3.3% in restricted investments. The term to maturity is limited to seven years for Treasury and Agency bonds and 10 years for Municipal bonds. Typically, investments in Agency bonds contain a call feature. These bonds generally have a somewhat higher yield. The average term to maturity of the portfolio as of December 31, 2006 was 4.7 years. 24 Table 11 sets forth the carrying amount of investment securities as of the dates shown: TABLE 11. INVESTMENT SECURITIES
DECEMBER 31 --------------------------- 2006 2005 2004 ------- ------- ------- In thousands Available for sale: U.S. Government agencies and corporations $30,347 $34,235 $39,114 State and municipal securities 12,020 12,415 12,264 Mortgage-backed securities 8,506 8,544 8,362 Restricted securities 1,753 1,809 1,300 ------- ------- ------- Total $52,626 $57,003 $61,040 ======= ======= =======
The Bank generally participates in the overnight federal funds sold market. Depending upon specific investing or funding strategies and/or normal fluctuations in loan and deposit balances, the Bank may need, on occasion, to purchase funds on an overnight basis. The average balance in federal funds sold decreased from $28,000 in 2005 to $27,000 in 2006. The continued lower federal funds sold balance is a direct result of the Bank being in a borrowed position to fund the excess of loan growth over deposit growth. See Note 3: Securities in the Notes to Consolidated Financial Statements for a comprehensive analysis of the securities portfolio. DEPOSITS AND OTHER FUNDING SOURCES Total deposits were $233.1 million at December 31, 2006, an increase of $13.8 million or 6.3% over deposits at December 31, 2005. During the first quarter of 2006, the Bank offered an incentive program to all bank employees to generate deposits at all bank locations. This incentive program generated $6.2 million in new deposits for the Bank, of which approximately $4.0 million was in other time deposits and rate sensitive jumbo certificates of deposit. During the fourth quarter of 2006, another incentive program was offered to all bank employees which generated over $4.7 million in new deposits. Another factor contributing to the increase in other time deposits and rate sensitive jumbo certificates of deposit are the competitive rates the Bank was offering on its certificates of deposit during 2006. In our Washington County, Maryland market area, there have been a number of bank mergers and CNB has benefited from these mergers with the increased volume of new deposit accounts. The Bank's Washington County, Maryland branch has grown $6.0 million in deposits since December 31, 2005. Although interest-bearing demand deposits show a decrease of $2.4 million for 2006, core interest-bearing demand deposits actually grew $600,000 offset by a $3.0 million decrease in two public fund deposit relationships which operate in the Bank's market area. Average deposits showed a $13.4 million, or 6.3% growth, to $228.0 million in 2006. Deposits at the Hedgesville branch totaled $19.8 million at December 31, 2006, a decrease of $1.0 million over December 31, 2005. Deposits at the Martinsburg branch totaled $23.8 million at December 31, 2006, a decrease of $2.1 million over December 31, 2005, which is the direct result of a decrease of $2.5 million in the balances of the large public fund deposit account. Deposits at the Spring Mills branch totaled $5.9 million at December 31, 2006, an increase of $3.3 million over December 31, 2005. The Bank has continued to experience a change in the deposit account mix during 2006. Noninterest-bearing deposits grew only slightly by $82,000 or .2%, during 2006. At December 31, 2006, noninterest-bearing deposits represented 18.3% of total deposits, compared to 19.5% for 2005. Average noninterest-bearing deposits increased 8.6% from $40.3 million in 2005 to $43.8 million in 2006. The growth in noninterest-bearing deposits is attributable to steady growth during the first three quarters of 2006 but a substantial decrease in the last quarter of 2006. This decrease was a result of customers transferring excess funds into short term certificates of deposit with attractive rates. Interest-bearing deposits increased by $13.7 million or 7.8% to $190.3 million at December 31, 2006. Interest-bearing checking deposits decreased by $2.4 million in 2006, while, the average interest-bearing checking deposits only decreased $266,000. Included in this category are NOW accounts and Money Market accounts. The Bank's deposit runoff is primarily due to the decrease in the deposits of the two large public fund depositors. The higher average balance growth in deposits is due to the consistent level of growth for the entire year of 2006. While the average savings deposits decreased $1.8 million or 5.4% to $30.6 million in 2006, actual savings accounts decreased $4.8 million at December 31, 2006 to $27.5 million. The difference between the decrease in average savings deposits and actual savings deposits is due to the increase in the runoff of savings accounts in the last quarter of 2006 due to depositors investing in short term certificates of deposit carrying attractive rates. The Bank's largest source of interest-bearing funds is certificates of deposit. These accounts totaled $110.2 million at December 31, 2006, an increase of $20.9 million or 23.3%. This substantial increase is primarily due to customers shifting their deposit dollars from noninterest bearing checking and interest bearing savings accounts to higher interest bearing certificates of deposit. The Bank featured two certificates of deposit throughout 2006 and in the last quarter of 2006 there was an additional focus on short term certificates of deposit with 91 day and 6 month terms. The two featured certificates of deposit throughout 2006 were the 27-month nonrenewable Certificate of Deposit which began in October 2005 and the new 14 month nonrenewable Certificate of Deposit. The Bank's 27-month nonrenewable 25 Certificate of Deposit allows the customer to withdraw all of the CD on the fifteen month anniversary date without penalty. Although no deposits may be made to these CD's, both CD's offered attractive rates and became the certificates of choice for bank customers. Table 12 is a summary of the maturity distribution of certificates of deposit in amounts of $100,000 or more as of December 31, 2006: TABLE 12. MATURITY OF TIME DEPOSITS OF $100,000 OR MORE
AMOUNT PERCENT -------- ------- In thousands Three months or less $ 5,864 5.32% Three through six months 8,456 7.67 Six through twelve months 28,328 25.70 Over twelve months 67,585 61.31 -------- ------ Total $110,233 $ 100% ======== ======
CONTRACTUAL OBLIGATIONS Table 13 shows the Bank's significant contractual obligations as of December 31, 2006: PAYMENTS DUE BY PERIOD
LESS THAN MORE THAN TOTAL 1 YEAR 1-3 YEARS 4-5 YEARS 5 YEARS ---------- -------- --------- --------- ---------- Purchase obligations $ 130,263 $130,263 $ -- $ -- $ -- Other long-term liabilities reflected on the registrant's balance sheet under GAAP Supplemental retirement liability 97,924 -- -- 17,500 80,424 Pension liability 1,494,404 -- -- -- 1,494,404 401k liability 66,006 66,006 -- -- -- Deferred compensation 853,958 5,828 4,780 -- 843,350 Post retirement liability 187,560 22,933 53,311 46,655 64,661 ---------- -------- ------- ------- ---------- Total contractual obligations $2,830,115 $225,030 $58,091 $64,155 $2,482,839 ========== ======== ======= ======= ==========
CAPITAL RESOURCES The Bank remains well capitalized. Total shareholders' equity at December 31, 2006 of $20.3 million represents 7.4% of total assets. This compares to $19.0 million or 7.3%, at December 31, 2005. Included in capital at December 31, 2006 is $655,000 of unrealized losses on available for sale securities and $1.1 million unrecognized pension costs, both net of deferred income taxes. At December 31, 2005, the Bank had unrealized losses on available for sale securities of $756,000 and $516,000 minimum pension liability adjustment, both net of deferred income taxes. Such unrealized gains and losses on the investment portfolio are recorded net of related deferred taxes and are primarily a function of available market interest rates relative to the yield being generated on the available for sale portfolio. No earnings impact will result, however, unless the securities are actually sold. The Federal Reserve's risk-based capital guidelines provide for the relative weighting of both on-balance-sheet and off-balance-sheet items based on their degree of risk. The Bank continues to exceed all regulatory capital requirements, and is unaware of any trends or uncertainties, nor do any plans exist, which may materially impair or alter its capital position. 26 RETURN ON EQUITY AND ASSETS Table 14 shows consolidated operating and capital ratios for the periods indicated: TABLE 14. OPERATING AND CAPITAL RATIOS
YEARS ENDED DECEMBER 31, ------------- 2006 2005 ----- ----- Return on average assets 0.92% 1.00% Return on average equity 12.46 12.91 Dividend payout ratio 28.57 26.97 Average equity to average assets ratio 7.35 7.76
LIQUIDITY AND INTEREST RATE SENSITIVITY The objective of the Bank's liquidity management program is to ensure the continuous availability of funds to meet the withdrawal demands of depositors and the credit needs of borrowers. The basis of the Bank's liquidity comes from the stability of its core deposits. Liquidity is also available through the available for sale securities portfolio and short-term funds such as federal funds sold. At December 31, 2006, these sources totaled $50.9 million, or 18.4% of total assets. In addition, liquidity may be generated through loan repayments, over $7.5 million of available borrowing arrangements with correspondent banks and available collateralized borrowings from the Federal Home Loan Bank. At December 31, 2006, management considered the Bank's ability to satisfy its anticipated liquidity needs over the next twelve months. Management believes that the Bank is well positioned and has ample liquidity to satisfy these needs. The Bank generated $3.6 million of cash from operations in 2006, which compares to $4.1 million in 2005 and $2.2 million in 2004. Additional cash of $13.8 million, $19.9 million and $19.2 million was generated through net financing activities in 2006, 2005 and 2004, respectively. These proceeds along with proceeds from the sales and maturities of investment securities were used to fund loans and purchase securities during each year. Net cash used in investing activities totaled $20.1 million in 2006 compared to $24.0 million in 2005 and $19.1 million in 2004. Details on both the sources and uses of cash are presented in the Consolidated Statements of Cash Flows contained in the financial statements. The objective of the Bank's interest rate sensitivity management program, also known as asset/liability management, is to maximize net interest income while minimizing the risk of adverse effects from changing interest rates. This is done by controlling the mix and maturities of interest-sensitive assets and liabilities. The Bank has established an asset/liability committee for this purpose. Daily management of the Bank's sensitivity of earnings to changes in interest rates within the Bank's policy guidelines are monitored by using a combination of off-balance sheet and on-balance sheet financial instruments. The Bank's Chief Executive Officer, Senior Lending Officer, Chief Financial Officer and the Chief Operations Officer monitor day to day deposit flows, lending requirements and the competitive environment. Rate changes occur within policy guidelines if necessary to minimize adverse effects. Also, the Bank's policy is intended to ensure that the Bank measures a range of rate scenarios and patterns of rate movements that are reasonably possible. One common interest rate risk measure is the gap, or the difference between rate sensitive assets and rate sensitive liabilities. A positive gap occurs when rate-sensitive assets exceed rate-sensitive liabilities. This tends to be beneficial in rising interest rate environments. A negative gap refers to the opposite situation and tends to be beneficial in declining interest rate environments. However, the gap does not consider future changes in the volume of rate sensitive assets or liabilities or the possibility that interest rates of various products may not change by the same amount or at the same time. In addition, certain assumptions must be made in constructing the gap. For example, the Bank considers administered rate deposits, such as savings accounts, to be immediately rate sensitive although their actual rate sensitivity could differ from this assumption. The Bank monitors its gap on a quarterly basis. 27 TABLE 15. INTEREST SENSITIVITY ANALYSIS
DECEMBER 31, 2006 INTEREST SENSITIVITY PERIOD ------------------------------------------------------------------------- 2007 2008 2009 2010 2011 THEREAFTER TOTAL FAIR VALUE ------- -------- -------- -------- -------- ---------- -------- ---------- In thousands Rate sensitive assets Loans, net of unearned interest $80,532 $ 16,879 $ 17,010 $ 13,281 $ 13,764 $ 62,855 $204,319 $203,467 Average interest rate 6.35% 6.79% 6.63% 6.70% 6.75% 7.25% 6.65% Securities 2,499 830 934 3,442 3,547 39,623 50,873 50,873 Average interest rate 5.00% 4.81% 4.73% 4.70% 4.69% 4.70% 4.77% ------- -------- -------- -------- -------- -------- -------- Total interest sensitive assets $83,031 $ 17,708 $ 17,943 $ 16,722 $ 17,310 $102,478 $255,192 ======= ======== ======== ======== ======== ======== ======== Interest sensitive liabilities Non-interest-bearing deposits $ 4,275 $ 4,275 $ 4,275 $ 4,275 $ 4,275 $ 21,376 42,752 $ 42,752 Average interest rate --% --% --% --% --% --% --% Savings and interest-bearing checking 8,010 8,010 8,010 8,010 8,010 40,049 80,098 80,098 Average interest rate 1.85% 1.85% 1.85% 1.85% 1.85% 1.85% 1.85% Time deposits 42,648 37,953 19,278 5,174 5,180 -- 110,233 113,762 Average interest rate 5.00% 5.15% 4.60% 4.50% 4.80% --% 4.80% ------- -------- -------- -------- -------- -------- -------- Total interest sensitive liabilities $54,933 $ 50,238 $ 31,563 $ 17,459 $ 17,465 $ 61,425 $233,083 ======= ======== ======== ======== ======== ======== ======== GAP $28,098 $(32,530) $(13,620) $ (737) $ (155) $ 41,053 Cumulative GAP $28,098 $ (4,432) $(18,052) $(18,789) $(18,943) $ 22,110 GAP to sensitive assets ratio 11.01% (12.75)% (5.34)% (0.29)% (0.06)% 16.09% Cumulative GAP to sensitive assets ratio 11.01% (1.74)% (7.07)% (7.36)% (7.42)% 8.66% GAP to total assets ratio 10.18% (11.78)% (4.93)% (0.27)% (0.06)% 14.87% Cumulative GAP to total assets ratio 10.18% (1.61)% (6.54)% (6.81)% (6.86)% 8.01%
IMPACT OF INFLATION The results of operations and financial position of the Bank have been presented based on historical cost, unadjusted for the effects of inflation, except for the recording of unrealized gains and losses on securities available for sale. Inflation could significantly impact the value of the Bank's interest rate-sensitive assets and liabilities and the cost of noninterest expenses, such as salaries, benefits and other operating expenses. Management of the money supply by the Federal Reserve to control the rate of inflation may have an impact on the earnings of the Bank. Further, changes in interest rates to control inflation may have a corresponding impact on the ability of certain borrowers to repay loans granted by the Bank. As a financial intermediary, the Bank holds a high percentage of interest rate-sensitive assets and liabilities. Consequently, the estimated fair value of a significant portion of the Bank's assets and liabilities change more frequently than those of non-banking entities. The Bank's policies attempt to structure its mix of financial instruments and manage its interest rate sensitivity in order to minimize the potential adverse effects of market forces on its net interest income, earnings and capital. A comparison of the carrying value of the Bank's financial instruments to their estimated fair value as of December 31, 2006 and December 31, 2005 is disclosed in Note 22: Fair Value of Financial Instruments in the Notes to the Consolidated Financial Statements. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Interest Rate Sensitivity" in Item 7 hereof. 28 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The following audited consolidated financial statements are set forth in this Annual Report of Form 10-K on the following pages: CNB Financial Services, Inc. and Subsidiary Independent Registered Public Accounting Firm Report.................... 30 Consolidated Balance Sheets............................................. 31 Consolidated Statements of Income....................................... 32 Consolidated Statements of Stockholders' Equity......................... 33 Consolidated Statements of Cash Flows................................... 34 Notes to Consolidated Financial Statements.............................. 35
29 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Shareholders and Board of Directors CNB Financial Services, Inc. Berkeley Springs, West Virginia We have audited the accompanying consolidated statements of financial condition of CNB Financial Services, Inc. and subsidiary as of December 31, 2006 and 2005, and the related consolidated statements of income, changes in shareholders' equity, and cash flows for each of the three years in the period ended December 31, 2006. These financial statements are the responsibility of CNB Financial Services, Inc.'s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of CNB Financial Services, Inc. and subsidiary as of December 31, 2006 and 2005, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2006 in conformity with accounting principles generally accepted in the United States of America. As described in Notes 1 and 11 to the financial statements, CNB Financial Services, Inc. changed its method of accounting for its pension plan in 2006 as required by the provisions of Statement Financial Accounting Standard No. 158. /s/ SMITH ELLIOTT KEARNS & COMPANY, LLC Hagerstown, Maryland February 22, 2007 30 CNB FINANCIAL SERVICES, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION DECEMBER 31, 2006 AND 2005
2006 2005 ------------ ------------ ASSETS Cash and due from banks $ 7,358,773 $ 10,085,252 Federal funds sold 9,000 38,000 Securities available for sale (at approximate market value) 50,873,335 55,194,216 Federal Home Loan Bank stock, at cost 1,753,000 1,669,900 Federal Reserve Bank stock, at cost -- 138,650 Loans and leases receivable, net 204,318,993 180,207,390 Accrued interest receivable 1,354,041 1,230,777 Premises and equipment, net 6,327,294 6,601,463 Deferred income taxes 1,482,166 1,159,595 Cash surrender value of life insurance 1,394,521 1,279,690 Intangible assets 497,178 620,593 Other assets 700,240 727,896 ------------ ------------ TOTAL ASSETS $276,068,541 $258,953,422 ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY LIABILITIES Deposits: Demand $ 42,751,409 $ 42,669,886 Interest-bearing demand 52,549,478 54,900,737 Savings 27,548,990 32,342,957 Time, $100,000 and over 37,760,199 30,659,767 Other time 72,472,664 58,715,079 ------------ ------------ $233,082,740 $219,288,426 Accrued interest payable 1,071,990 611,512 FHLB borrowings 18,500,000 17,800,000 Accrued expenses and other liabilities 3,091,549 2,245,443 ------------ ------------ TOTAL LIABILITIES $255,746,279 $239,945,381 ------------ ------------ SHAREHOLDERS' EQUITY Common stock, $1 par value; 5,000,000 shares authorized; 458,048 shares outstanding $ 458,048 $ 458,048 Capital surplus 4,163,592 4,163,592 Retained earnings 17,421,402 15,658,134 Accumulated other comprehensive income (loss) (1,720,780) (1,271,733) ------------ ------------ TOTAL SHAREHOLDERS' EQUITY $ 20,322,262 $ 19,008,041 ------------ ------------ TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $276,068,541 $258,953,422 ============ ============
The Notes to Consolidated Financial Statements are an integral part of these statements. 31 CNB FINANCIAL SERVICES, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF INCOME YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004
2006 2005 2004 ----------- ----------- ----------- INTEREST INCOME Interest and fees on loans $13,481,504 $11,110,517 $ 9,839,122 Interest and dividends on securities: U.S. Government agencies and corporations 1,560,210 1,489,230 1,191,842 Mortgage backed securities 441,166 358,302 357,734 State and political subdivisions 403,097 417,242 273,249 Dividend income 81,663 40,212 19,718 Interest on FHLB deposits 20,396 3,988 1,140 Interest on federal funds sold 1,317 797 32,677 ----------- ----------- ----------- $15,989,353 $13,420,288 $11,715,482 ----------- ----------- ----------- INTEREST EXPENSE Interest on interest bearing demand, savings and time deposits $ 5,290,613 $ 3,551,774 $ 3,154,811 Interest on FHLB borrowings 978,243 298,287 14,622 ----------- ----------- ----------- $ 6,268,856 $ 3,850,061 $ 3,169,433 ----------- ----------- ----------- NET INTEREST INCOME $ 9,720,497 $ 9,570,227 $ 8,546,049 PROVISION FOR LOAN LOSSES 275,500 352,000 393,000 ----------- ----------- ----------- NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES $ 9,444,997 $ 9,218,227 $ 8,153,049 ----------- ----------- ----------- NONINTEREST INCOME Service charges on deposit accounts $ 1,273,409 $ 1,227,521 $ 1,177,252 Other service charges and fees 470,101 391,099 294,535 Trust fee income 199,348 174,900 140,114 Insurance income -- 142,523 135,068 Other operating income 61,360 59,224 54,306 Net gain (loss) on sale of securities (37,271) (16,165) 135,546 Income from title company 20,668 27,924 35,207 ----------- ----------- ----------- $ 1,987,615 $ 2,007,026 $ 1,972,028 ----------- ----------- ----------- NONINTEREST EXPENSES Salaries $ 3,065,040 $ 3,061,375 $ 2,708,253 Employee benefits 1,258,295 1,092,788 930,597 Occupancy of premises 509,945 436,247 377,322 Furniture and equipment expense 812,216 891,768 790,932 Other operating expenses 2,114,276 2,059,080 1,982,090 Net (gain) loss on disposal of fixed assets 19,756 -- 273 ----------- ----------- ----------- $ 7,779,528 $ 7,541,258 $ 6,789,467 ----------- ----------- ----------- INCOME BEFORE INCOME TAXES $ 3,653,084 $ 3,683,995 $ 3,335,610 PROVISION FOR INCOME TAXES 1,263,126 1,238,416 991,917 ----------- ----------- ----------- INCOME FROM CONTINUING OPERATIONS $ 2,389,958 $ 2,445,579 $ 2,343,693 ----------- ----------- ----------- NET RESULTS FROM DISCONTINUED OPERATIONS OF CNB INSURANCE SERVICES, INC BEFORE INCOME TAXES $ 124,157 $ -- $ -- PROVISION FOR INCOME TAXES $ 45,453 $ -- $ -- ----------- ----------- ----------- NET RESULTS OF DISCONTINUED OPERATIONS $ 78,704 $ -- $ -- ----------- ----------- ----------- NET INCOME $ 2,468,662 $ 2,445,579 $ 2,343,693 =========== =========== =========== BASIC EARNINGS PER SHARE $ 5.39 $ 5.34 $ 5.12 =========== =========== ===========
The Notes to Consolidated Financial Statements are an integral part of these statements. 32 CNB FINANCIAL SERVICES, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004
ACCUMULATED OTHER TOTAL COMMON CAPITAL RETAINED COMPREHENSIVE SHAREHOLDERS' STOCK SURPLUS EARNINGS INCOME (LOSS) EQUITY -------- ---------- ----------- ------------- ------------- BALANCE, DECEMBER 31, 2003 $458,048 $3,863,592 $12,460,556 $ (213,255) $16,568,941 ----------- Comprehensive income: Net income for 2004 -- -- 2,343,693 -- 2,343,693 Change in unrealized gains (losses) on securities available for sale (net of tax of $65,354) -- -- -- (106,630) (106,630) Change in minimum pension liability adjustment (net of tax of $15,419) -- -- -- (25,159) (25,159) ----------- Total Comprehensive Income 2,211,904 ----------- Cash dividends ($1.38 per share) -- -- (632,105) -- (632,105) -------- ---------- ----------- ----------- ----------- BALANCE, DECEMBER 31, 2004 $458,048 $3,863,592 $14,172,144 $ (345,044) $18,148,740 ----------- Comprehensive income: Net income for 2005 -- -- 2,445,579 -- 2,445,579 Transfer to capital surplus -- 300,000 (300,000) -- -- Change in unrealized gains (losses) on securities available for sale (net of tax of $432,965) -- -- -- (706,418) (706,418) Change in minimum pension liability adjustment (net of tax of $135,005) -- -- -- (220,271) (220,271) ----------- Total Comprehensive Income 1,518,890 ----------- Cash dividends ($1.44 per share) -- -- (659,589) -- (659,589) -------- ---------- ----------- ----------- ----------- BALANCE, DECEMBER 31, 2005 $458,048 $4,163,592 $15,658,134 $(1,271,733) $19,008,041 ----------- Comprehensive income: Net income for 2006 -- -- 2,468,662 -- 2,468,662 Change in unrealized gains (losses) on securities available for sale (net of tax of $61,559) -- -- -- 100,439 100,439 Change in minimum pension liability adjustment (net of tax of $46,688) -- -- -- 76,175 76,175 ----------- Total Comprehensive Income 2,645,276 ----------- Adjustment to initially apply FASB Statement No. 158, (net of tax of $383,469) -- -- -- (625,661) (625,661) Cash dividends ($1.54 per share) -- -- (705,394) -- (705,394) -------- ---------- ----------- ----------- ----------- BALANCE, DECEMBER 31, 2006 $458,048 $4,163,592 $17,421,402 $(1,720,780) $20,322,262 ======== ========== =========== =========== ===========
The Notes to Consolidated Financial Statements are an integral part of these statements. 33 CNB FINANCIAL SERVICES, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004
2006 2005 2004 ------------ ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 2,468,662 $ 2,445,579 $ 2,343,693 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 709,304 833,406 691,928 Provision for loan losses 275,500 352,000 393,000 Deferred income taxes (47,349) (79,401) (79,046) Net (gain) loss on sale and calls of securities 37,271 16,165 (135,546) Loss on disposal and abandonment of fixed assets 19,756 -- 273 Gain on sale of CNB Insurance Services, Inc (143,913) -- -- (Increase) in accrued interest receivable (123,264) (188,204) (169,388) (Increase) decrease in other assets (131,488) 562,856 (713,422) Increase (decrease) in accrued interest payable 460,478 67,961 (130,073) (Increase) in cash surrender value on life insurance in excess of premiums paid (56,009) (51,946) (44,665) Increase in accrued expenses and other liabilities 58,413 31,265 1,465 Amortization of deferred loan (fees) cost 60,439 64,778 25,490 Amortization (accretion) of premium and discount on investments 15,803 63,184 62,601 ------------ ------------ ------------ NET CASH PROVIDED BY OPERATING ACTIVITIES $ 3,603,603 $ 4,117,643 $ 2,246,310 ------------ ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES Net (increase) in loans (24,447,542) (25,704,586) (2,252,891) Proceeds from sales of securities 12,218,693 37,026,097 6,391,436 Proceeds from maturities, repayments and calls of securities 2,675,837 2,711,425 13,152,311 Purchases of securities (10,464,725) (36,410,179) (40,021,143) Purchases of Federal Home Loan Bank stock (6,356,000) (6,909,700) (1,146,200) Purchases of Federal Reserve Bank stock -- (9,000) -- Redemptions of Federal Reserve Bank stock 138,650 -- -- Redemptions of Federal Home Loan Bank stock 6,272,900 6,409,600 842,100 Purchases of premises and equipment and computer software (280,657) (1,072,130) (917,609) Proceeds from sale of CNB Insurance Services Inc 153,332 -- -- Investment in (return of capital from) title company 332 575 (607) Net (increase) decrease in federal funds sold 29,000 53,000 (88,000) Premiums paid on life insurance (58,822) (58,822) (58,822) Cash from acquired branch -- -- 5,020,017 ------------ ------------ ------------ NET CASH (USED IN) INVESTING ACTIVITIES $(20,119,002) $(23,963,720) $(19,079,408) ------------ ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES Net increase (decrease) in demand and savings deposits $ (7,063,703) $ 12,911,331 $ 20,904,756 Net increase (decrease) in time deposits 20,858,017 (1,351,443) (8,649,803) Net increase (decrease) in securities sold under repurchase agreement -- (216,909) 216,909 Net increase in FHLB borrowings 700,000 9,200,000 7,400,000 Cash dividends paid (705,394) (659,589) (632,105) ------------ ------------ ------------ NET CASH PROVIDED BY FINANCING ACTIVITIES $ 13,788,920 $ 19,883,390 $ 19,239,757 ------------ ------------ ------------ NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS $ (2,726,479) $ 37,313 $ 2,406,659 CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 10,085,252 10,047,939 7,641,280 ------------ ------------ ------------ CASH AND CASH EQUIVALENTS AT END OF YEAR $ 7,358,773 $ 10,085,252 $ 10,047,939 ============ ============ ============ SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Cash paid during the year: Interest $ 5,808,377 $ 3,782,100 $ 3,299,506 Income taxes $ 1,386,500 $ 1,362,725 $ 1,169,009 The Company acquired certain assets and liabilities associated with the Hancock Branch of Fidelity Bank. In conjunction with the acquisition, the assets acquired and liabilities assumed were as follows: Fair value of assets acquired $ -- $ -- $ 9,561,420 ------------ ------------ ------------ Fair value of liabilities assumed $ -- $ -- $ 14,581,437 ------------ ------------ ------------ Liabilities assumed in excess of assets acquired (cash received) $ -- $ -- $ 5,020,017 ============ ============ ============
The Notes to Consolidated Financial Statements are an integral part of these statements. 34 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The following is a description of the more significant accounting policies of CNB Financial Services, Inc. and its subsidiary. NATURE OF OPERATIONS: CNB Financial Services, Inc. ("CNB" or the "Company") is a financial services holding company incorporated under the laws of West Virginia in March 2000. It became a bank holding company when it acquired all of the common stock of Citizens National Bank of Berkeley Springs on August 31, 2000. Citizens National Bank operated as a national banking association until October 16, 2006 at which time it became a West Virginia state chartered bank. Concurrent with the charter change, the bank began operating under the legal name of CNB Bank, Inc. CNB Bank, Inc. (the "Bank"), a wholly owned subsidiary of CNB, provides a variety of banking services to individuals and businesses through its two locations in Morgan County, West Virginia, three locations in Berkeley County, West Virginia and one location in Washington County, Maryland. Its primary deposit products are demand deposits and certificates of deposit, and its primary lending products are commercial business, real estate mortgage and installment loans. In February 2001, CNB became a 50% member in a limited liability company, Morgan County Title Insurance Agency, LLC which sells title insurance. In January 2003, the other two members in the limited liability corporation purchased a portion of CNB's membership making each member's share 33%. The Bank formed CNB Insurance Services, Inc., a wholly owned subsidiary, which was a property and casualty insurance agency selling primarily personal lines of insurance. On April 27, 2006, CNB Insurance Services, Inc. entered into an agreement with Maiden Financial, Inc. Under the terms of the agreement, which was completed on June 1, 2006, CNB Insurance Services, Inc. sold to Maiden Financial Inc. certain assets constituting CNB Insurance Services, Inc.'s insurance business for a purchase price of $153,332 resulting in a gain of $143,913. The accounting policies of the Company and its subsidiary conform to accounting principles generally accepted in the United States of America and to general practices within the banking industry. PRINCIPLES OF CONSOLIDATION: The consolidated financial statements of CNB Financial Services, Inc. include the accounts of the Company and its wholly owned subsidiary, CNB Bank, Inc. and CNB Insurance Services, Inc., a wholly owned subsidiary of the Bank. The financial statements of Morgan County Title Insurance Agency, LLC are not included in these consolidated financial statements. All significant intercompany transactions and balances have been eliminated. USE OF ESTIMATES: The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. CNB's most significant estimates are the allowance for loan losses, depreciable lives of fixed assets and actuarial assumptions used in determining pension expense and liability, liability for postretirement benefits and liability for deferred compensation. SECURITIES AND MORTGAGE-BACKED SECURITIES: Investments in equity securities that have readily determinable fair values and for all investments in debt securities are classified and accounted for as follows: a. Debt securities that management has the positive intent and ability to hold to maturity are classified as held-to-maturity securities and reported at amortized cost. b. Debt and equity securities that are bought and held principally for the purpose of selling them in the near term are classified as trading securities and reported at fair value, with unrealized gains and losses included in earnings. c. Debt and equity securities not classified as either held-to-maturity securities or trading securities are classified as available-for-sale securities and reported at fair value, with unrealized gains and losses excluded from earnings and reported in a separate component of shareholders' equity as accumulated other comprehensive income. CNB classifies all investments as available for sale, except for stock in the Federal Reserve Bank and Federal Home Loan Bank, which are restricted investments. 35 Interest and dividends on securities, including amortization of premiums and accretion of discounts, are included in interest income. Declines in the fair value of available-for-sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses. In estimating other-than-temporary impairment losses, management considers (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. Realized gains and losses from the sales of securities are determined using the specific identification method. IMPAIRED LOANS: Impaired loans are defined as those loans for which it is probable that contractual amounts due will not be received. Statement of Financial Accounting Standards (SFAS) No. 114, "Accounting by Creditors for Impairment of a Loan," as amended by SFAS No. 118, requires that the measurement of impaired loans is based on the present value of expected future cash flows discounted at the historical effective interest rate, except that all collateral-dependent loans are measured for impairment based on the fair value of the collateral. Larger groups of small-balance loans such as residential mortgage and installment loans that are considered to be part of homogeneous loan pools are aggregated for the purpose of measuring impairment, and therefore, are not subject to these statements. Management has established a dollar-value threshold for commercial loans. The larger commercial loans are evaluated for impairment. No loans are considered to be impaired at December 31, 2006 and 2005. ALLOWANCE FOR LOAN LOSSES: The allowance for loan losses is maintained at a level which, in management's judgment, is adequate to absorb credit losses inherent in the loan portfolio. The amount of the allowance is based on management's evaluation of the collectibility of the loan portfolio, including the nature of the portfolio, credit concentrations, trends in historical loss experience, specific impaired loans and economic conditions. Allowances for loan losses and impaired loans are generally determined based on collateral values or the present value of estimated cash flows. The allowance is increased by a provision for loan losses, which is charged to expense and reduced by charge-offs, net of recoveries. Changes in the allowance are charged or credited to the provision for loan losses. Because of uncertainties inherent in the estimation process, management's estimate of credit losses inherent in the loan portfolio and the related allowance may change in the near term. LOANS HELD FOR SALE: Mortgage loans held for sale are recorded at the lower of cost or market value. Gains and losses realized from the sale of loans and adjustments to market value are included in non-interest income. Mortgage loans are sometimes sold to the Federal Home Loan Mortgage Corporation (Freddie Mac), West Virginia Housing Development Fund, other secondary market investors and other commercial banks. Beginning in January 2007, all fixed rate mortgage loans will be sold to secondary market investors. INTANGIBLE ASSETS: Intangible assets represent the acquisition of customer lists, contracts and records in the amount of $66,267 by CNB Insurance Services, Inc. and the $780,616 premium from the purchase of core deposit relationships as part of the Hancock branch acquisition. The CNB Insurance Services, Inc. intangible assets were being amortized over four years on a straight line basis and the core deposit intangible relationships from the Hancock branch acquisition are being amortized over seven years on a straight line basis. As of June 1, 2006, the remaining unamortized balance of the intangible asset for CNB Insurance Services, Inc. amounting to $9,419 was included in the sale to Maiden Financial. See Note 16: Discontinued Operations in the Notes to Consolidated Financial Statements for additional discussion. LOAN SERVICING: The cost of mortgage servicing rights is amortized in proportion to, and over the period of, estimated net servicing revenues. Impairment of mortgage servicing rights is assessed based on the fair value of those rights. Fair values are estimated using discounted cash flows based on a current market interest rate. For purposes of measuring impairment, the rights are stratified based on the predominant risk characteristics of the underlying loans: product type, investor type, interest rate, term and geographic location. An analysis of the risk characteristics of CNB's loan servicing portfolio allows for all loans to be defined by one risk category. See Note 5: Loan Servicing in the Notes to Consolidated Financial Statements for additional discussion. INTEREST INCOME ON LOANS: Interest on loans is accrued and credited to income based on the principal amount outstanding. The accrual of interest on loans is discontinued at the time the loan becomes 90 days past due unless in management's judgment collectibility of interest is assured. NONPERFORMING/NONACCRUAL ASSETS: Nonperforming/nonaccrual assets consist of loans on which interest is no longer accrued, loans which have been restructured in order to allow the borrower the ability to maintain control of the collateral, real estate acquired by foreclosure and real estate upon which deeds in lieu of foreclosure have been accepted. Interest previously accrued but not collected on nonaccrual loans is reversed against current income when a loan is placed on a nonaccrual basis. Nonaccrual loans are restored to accrual status when all delinquent principal and interest become less than 90 days past due unless management determines the loan should remain on nonaccrual status. 36 LOANS AND LEASES RECEIVABLE: Loans and leases receivable that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at their outstanding unpaid principal balances reduced by any charge-offs or specific valuation accounts and net of any deferred fees or costs on originated loans, or unamortized premiums or discounts on purchased loans. LOAN ORIGINATION FEES AND COSTS: Loan origination fees, net of certain direct costs of originating loans are being deferred and recognized over the contractual life of the loan as an adjustment of the yield on the related loan. PREMISES AND EQUIPMENT: Premises and equipment are carried at cost less accumulated depreciation. Depreciation is calculated on both straight-line and accelerated methods over the estimated useful lives of 5 to 50 years for buildings and improvements, 10 to 20 years for land improvements, 5 years for bank owned automobiles and 3 to 40 years for equipment. Computer software is being amortized over 3 years. Maintenance and repairs are charged to operating expenses as incurred. INCOME TAXES: Deferred tax assets or liabilities are computed based on the difference between the financial statement and income tax bases of assets and liabilities using the enacted marginal tax rate. Deferred income tax expenses or credits are based on the changes in the asset or liability from period to period. PENSION PLAN: Pension plan costs are funded by annual contributions as required by applicable regulations. CASH AND CASH EQUIVALENTS: For purposes of the Consolidated Statements of Cash Flows, cash and cash equivalents include all highly liquid debt instruments purchased with a maturity of three months or less except for federal funds sold. Those amounts are included in the balance sheet captions "Cash and Due From Banks." Included in "Cash and Due From Banks" are interest bearing deposits with FHLB in the amount of $3,118 and $207,835 at December 31, 2006 and 2005, respectively. EARNINGS AND DIVIDENDS PER SHARE: Basic earnings and dividends per share are computed on the basis of the weighted average number of 458,048 shares of common stock outstanding in 2006, 2005 and 2004. OFF-BALANCE SHEET FINANCIAL INSTRUMENTS: In the ordinary course of business, CNB has entered into off-balance sheet financial instruments consisting of commitments to extend credit, commercial lines of credit and letters of credit. Such financial instruments are recorded in the financial statements when they become due or payable. POSTRETIREMENT AND POSTEMPLOYMENT BENEFITS OTHER THAN PENSIONS: Postretirement insurance benefits are provided to selected officers and employees. During the years that the employee renders the necessary service, the Bank accrues the cost of providing postretirement health and life insurance benefits to the employee. FORECLOSED REAL ESTATE: Real estate properties acquired through, or in lieu of, loan foreclosure are to be sold and are initially recorded at fair value at the date of foreclosure, establishing a new cost basis. After foreclosure, valuations are periodically performed by management and the real estate is carried at the lower of carrying amount or fair value less estimated cost to sell. Revenue and expenses from operations and changes in the valuation allowance are included in loss on foreclosed real estate. The historical average holding period for such properties is twelve to eighteen months. TRUST ASSETS: Assets held by CNB in a fiduciary or agency capacity are not included in the consolidated financial statements since such assets are not assets of CNB. In accordance with banking industry practice, income from fiduciary activities is generally recognized on the cash basis which is not significantly different from amounts that would have been recognized on the accrual basis. ADVERTISING COSTS: The Company expenses advertising costs in the period in which they are incurred. Advertising costs amounted to $173,792, $161,180 and $213,357 for the years ended December 31, 2006, 2005 and 2004, respectively. COMPREHENSIVE INCOME: Comprehensive income is defined as the change in equity from transactions and other events from nonowner sources. It includes all changes in equity except those resulting from investments by shareholders and distributions to shareholders. Comprehensive 37 income includes net income and certain elements of "other comprehensive income" such as foreign currency translations; accounting for futures contracts; employers accounting for pensions; and accounting for certain investments in debt and equity securities. CNB has elected to report its comprehensive income in the Consolidated Statements of Changes in Shareholders' Equity. The elements of "other comprehensive income" that CNB has are the unrealized gains or losses on available for sale securities, additional minimum pension liability adjustment and unrecognized pension costs. The components of the change in "other comprehensive income" were as follows:
2006 2005 2004 --------- ----------- --------- Additional pension liability adjustment arising during the year $(886,267) $ (355,276) $ (40,578) Unrealized holding gains (losses) arising during the year 124,727 (1,155,548) (36,438) Reclassification adjustment for (gains) losses realized in net income 37,271 16,165 (135,546) --------- ----------- --------- Net unrealized holding gains (losses) before taxes $(724,269) $(1,494,659) $(212,562) Tax effect 275,222 567,970 80,773 --------- ----------- --------- Net change $(449,047) $ (926,689) $(131,789) ========= =========== =========
RECENTLY ISSUED ACCOUNTING STANDARDS On March 17, 2006, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 156, "Accounting for Servicing of Financial Assets." The new Standard, which is an amendment to SFAS No. 140, will simplify the accounting for servicing assets and liabilities, such as those common with mortgage securitization activities. Specifically, the new Standard addresses the recognition and measurement of separately recognized servicing assets and liabilities and provides an approach to simplify efforts to obtain hedge-like (offset) accounting. The standard also: 1. Clarifies when an obligation to service financial assets should be separately recognized as a servicing asset or a servicing liability. 2. Requires that a separately recognized servicing asset or servicing liability be initially measured at fair value, if practicable. 3. Permits an entity with a separately recognized servicing asset or servicing liability to choose either of the following methods for subsequent measurement: a. Amortization Method b. Fair Value Method The new Standard is effective for all separately recognized servicing assets and liabilities acquired or issued after the beginning of an entity's fiscal year that begins after September 15, 2006, with early adoption permitted. CNB is in the process of determining whether this new pronouncement will have a material impact on their financial statements. In September 2006, the FASB issued SFAS 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. SFAS 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. CNB is currently evaluating the potential impact, if any, of the adoption of SFAS No. 157 on their consolidated financial position, results of operations and cash flows. On September 29, 2006, the FASB issued SFAS No. 158, "Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans", which amends SFAS No. 87 and SFAS No. 106 to require recognition of the over funded or under funded status of pension and other postretirement benefit plans on the balance sheet. Under SFAS No. 158, gains and losses, prior service costs and credits, and any remaining transition amounts under SFAS No. 87 and SFAS No. 106 that have not yet been recognized through net periodic benefit cost will be recognized in accumulated other comprehensive income, net of tax effects, until they are 38 amortized as a component of net periodic cost. Under SFAS No. 158, the measurement date - the date at which the benefit obligation and plan assets is measured - is required to be the company's fiscal year end. The recognition requirements of SFAS No. 158 are effective for publicly held companies for fiscal years ending after December 15, 2006. CNB has implemented SFAS No. 158 effective December 31, 2006 with the exception of the measurement date requirement. This requirement is effective for fiscal years ending after December 15, 2008. CNB does not anticipate early adoption of the measurement date requirement. In July 2006, the FASB issued Interpretation No. 48 (FIN 48), "Accounting for Uncertainty in Income Taxes." FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise's financial statements in accordance with SFAS No. 109, "Accounting for Income Taxes." FIN 48 prescribes a recognition threshold and measurement attributable for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosures and transitions. FIN 48 is effective for fiscal years beginning after December 15, 2006. CNB will adopt FIN 48 for the year beginning January 1, 2007 and is evaluating the impact on its financial statements. In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin (SAB) 108, "Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements." SAB 108 provides guidance on how prior year misstatements should be taken into consideration when quantifying misstatements in current year financial statements for purposes of determining whether the current year's financial statements are materially misstated. SAB 108 is effective for fiscal years ending on or after November 15, 2006. The adoption of SAB 108 is not expected to have a material impact on CNB's financial statements. In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities." The fair value option established by this SFAS permits all entities to choose to measure eligible items at fair value at specified election dates. A business entity shall report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. This SFAS is effective for fiscal years beginning after November 15, 2007. Early adoption is permitted as of the fiscal year that begins before November 15, 2007 provided the entity also elects to apply the provisions of SFAS No. 157, "Fair Value Measurements." CNB is currently evaluating the potential impact, if any, of the adoption of SFAS No. 159 on their consolidated financial position, results of operations and cash flows. NOTE 2. INVESTMENT IN LIMITED LIABILITY COMPANY In February 2001, CNB paid $5,000 to become a 50% member in a limited liability company, Morgan County Title Insurance Agency, LLC for the purpose of selling title insurance. In January 2003, the other two members in the limited liability company purchased a portion of CNB's membership making each member's share 33%. CNB accounts for their investment in Morgan County Title Insurance Agency, LLC as part of "Other Assets" using the equity method of accounting. The following represents the limited liability company's financial information: MORGAN COUNTY TITLE INSURANCE AGENCY, LLC STATEMENTS OF FINANCIAL CONDITION (UNAUDITED) DECEMBER 31, 2006 AND 2005
2006 2005 ------ ------ ASSETS Cash $3,415 $4,356 ------ ------ TOTAL ASSETS $3,415 $4,356 ====== ====== MEMBERS' EQUITY $3,415 $4,356 ------ ------ TOTAL MEMBERS' EQUITY $3,415 $4,356 ====== ======
39 MORGAN COUNTY TITLE INSURANCE AGENCY, LLC STATEMENTS OF INCOME (UNAUDITED) YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004
2006 2005 2004 -------- -------- -------- INCOME Insurance commissions $101,084 $122,148 $185,154 -------- -------- -------- TOTAL INCOME $101,084 $122,148 $185,154 -------- -------- -------- EXPENSES Management fees $ 32,300 $ 37,500 $ 72,328 Other expenses 6,725 874 8,806 -------- -------- -------- TOTAL EXPENSES $ 39,025 $ 38,374 $ 81,134 -------- -------- -------- NET INCOME $ 62,059 $ 83,774 $104,020 ======== ======== ========
MORGAN COUNTY TITLE INSURANCE AGENCY, LLC STATEMENTS OF CASH FLOWS (UNAUDITED) YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004
2006 2005 2004 -------- -------- --------- CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 62,059 $ 83,774 $ 104,020 -------- -------- --------- NET CASH PROVIDED BY OPERATING ACTIVITIES $ 62,059 $ 83,774 $ 104,020 -------- -------- --------- CASH FLOWS FROM FINANCING ACTIVITIES Profit and capital distributed $(63,000) $(85,500) $(103,800) -------- -------- --------- NET CASH (USED IN) FINANCING ACTIVITIES $(63,000) $(85,500) $(103,800) -------- -------- --------- NET INCREASE IN CASH AND CASH EQUIVALENTS $ (941) $ (1,726) $ 220 CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 4,356 6,082 5,862 -------- -------- --------- CASH AND CASH EQUIVALENTS AT END OF YEAR $ 3,415 $ 4,356 $ 6,082 ======== ======== =========
NOTE 3. SECURITIES The amortized cost and estimated market value of debt securities at December 31, 2006 and 2005 by contractual maturity are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. 40 Securities are summarized as follows:
2006 WEIGHTED ----------------------------------------------------------- AVERAGE GROSS GROSS ESTIMATED TAX AMORTIZED UNREALIZED UNREALIZED FAIR EQUIVALENT COST GAINS LOSSES VALUE YIELD ----------- ---------- ---------- ----------- ---------- Available for sale: U.S. Government agencies and corporations After 1 but within 5 years $24,562,491 $ -- $ 634,791 $23,927,700 4.17% After 5 but within 10 years 6,486,929 2,059 69,338 6,419,650 5.06 ----------- ------- ---------- ----------- $31,049,420 $ 2,059 $ 704,129 $30,347,350 4.35% ----------- ------- ---------- ----------- States and political subdivisions Within one year $ 840,774 $ -- $ 4,922 $ 835,852 2.78% After 1 but within 5 years 1,850,578 3,003 34,366 1,819,215 3.24 After 5 but within 10 years 9,527,281 10 162,575 9,364,716 3.50 ----------- ------- ---------- ----------- $12,218,633 $ 3,013 $ 201,863 $12,019,783 3.41% ----------- ------- ---------- ----------- Mortgage backed securities $ 8,662,318 $ 6,841 $ 162,957 $ 8,506,202 4.99% ----------- ------- ---------- ----------- Total securities available for sale $51,930,371 $11,913 $1,068,949 $50,873,335 4.24% =========== ======= ========== =========== Restricted: Federal Home Loan Bank stock $ 1,753,000 $ -- $ -- $ 1,753,000 5.25% =========== ======= ========== ===========
2005 WEIGHTED -------------------------------------------------------------- AVERAGE GROSS GROSS ESTIMATED TAX AMORTIZED UNREALIZED UNREALIZED FAIR EQUIVALENT COST GAINS LOSSES VALUE YIELD ----------- ----------- ----------- ----------- --------- Available for sale: U.S. Government agencies and corporations After 1 but within 5 years $16,826,758 $ 225 $ 485,392 $16,341,591 4.10% After 5 but within 10 years 18,217,740 -- 324,090 17,893,650 4.77 ----------- ------- ----------- ----------- $35,044,498 $ 225 $ 809,482 $34,235,241 4.45% ----------- ------- ----------- ----------- States and political subdivisions After 1 but within 5 years $ 2,641,897 $ 1,376 $ 52,169 $ 2,591,104 3.04% After 5 but within 10 years 9,980,628 4,224 160,963 9,823,889 3.51 ----------- ------- ----------- ----------- $12,622,525 $ 5,600 $ 213,132 $12,414,993 3.41% ----------- ------- ----------- ----------- Mortgage backed securities $ 8,746,228 $ -- $ 202,246 $ 8,543,982 4.72% ----------- ------- ----------- ----------- Total securities available for sale $56,413,251 $ 5,825 $ 1,224,860 $55,194,216 4.26% =========== ======= =========== =========== Restricted: Federal Reserve Bank stock $ 138,650 $ -- $ -- $ 138,650 6.00% Federal Home Loan Bank stock 1,669,900 -- -- 1,669,900 3.00 ----------- ------- ----------- ----------- Total restricted investments $ 1,808,550 $ -- $ -- $ 1,808,550 3.23% =========== ====== =========== ===========
The carrying value of securities pledged to secure public deposits and for other purposes as required or permitted by law totaled $37,066,060 at December 31, 2006 and $40,610,746 at December 31, 2005. Proceeds from sales of securities available for sale (excluding maturities and calls) for the years ended December 31, 2006, 2005 and 2004 were $12,218,693, $37,026,097 and $6,391,436, respectively. Gross gains and (losses) of $27,291 and $(65,000) in 2006, $145,013 and $(161,178) in 2005, and $135,546 and $(0) in 2004 were realized on the respective sales. The following tables show our investments' gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2006 and 2005, respectively. 41
2006 ----------------------------------------------------------------------------- LESS THAN 12 MONTHS 12 MONTHS OR MORE TOTAL ----------------------- ------------------------ ------------------------ FAIR UNREALIZED FAIR UNREALIZED FAIR UNREALIZED DESCRIPTION OF SECURITIES VALUE LOSSES VALUE LOSSES VALUE LOSSES - ------------------------- ---------- ---------- ----------- ---------- ----------- ---------- U.S. Government agencies and corporations $ -- $ -- $29,352,749 $ 704,129 $29,352,749 $ 704,129 State and political subdivisions 985,973 5,087 10,415,625 196,776 11,401,598 201,863 Mortgage backed securities 1,235,741 1,581 6,402,302 161,376 7,638,043 162,957 ----------- -------- ----------- ---------- ----------- ---------- Total temporarily impaired securities $ 2,221,714 $ 6,668 $46,170,676 $1,062,281 $48,392,390 $1,068,949 =========== ======== =========== ========== =========== ==========
2005 ----------------------------------------------------------------------------- LESS THAN 12 MONTHS 12 MONTHS OR MORE TOTAL ----------------------- ------------------------ ------------------------ FAIR UNREALIZED FAIR UNREALIZED FAIR UNREALIZED DESCRIPTION OF SECURITIES VALUE LOSSES VALUE LOSSES VALUE LOSSES - ------------------------- ---------- ---------- ----------- ---------- ----------- ---------- U.S. Government agencies and corporations $18,797,616 $281,814 $13,938,525 $ 527,668 $32,736,141 $ 809,482 State and political subdivisions 9,722,997 134,731 2,531,396 78,401 12,254,393 213,132 Mortgage backed securities 4,418,522 69,934 4,125,462 132,312 8,543,984 202,246 ----------- -------- ----------- ---------- ----------- ---------- Total temporarily impaired securities $32,939,135 $486,479 $20,595,383 $ 738,381 $53,534,518 $1,224,860 =========== ======== =========== ========== =========== ==========
Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the bank to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. At December 31, 2006, there were 107 available for sale securities that have unrealized losses with aggregate depreciation of 2.2% from the securities amortized cost basis. The unrealized losses relate principally to government obligations. In analyzing the issuer's financial condition, management considers whether the securities are issued by the federal government or its agencies and whether downgrades by bond rating agencies have occurred. Since the securities are primarily government bonds or agency issues and management has the ability to hold the securities until maturity or until such a time that the market value has recovered the unrealized losses, management determined that no declines are deemed to be other-than-temporary. 42 NOTE 4. LOANS AND LEASES RECEIVABLE Major classifications of loans at December 31, 2006 and 2005 were as follows:
2006 2005 ------------ ------------ Loans: Real estate $143,766,546 $125,722,303 Commercial real estate 36,966,855 29,492,744 Consumer 15,933,470 16,801,986 Commercial 9,172,160 9,314,491 Overdrafts 163,469 356,329 ------------ ------------ $206,002,500 $181,687,853 Leases: 123,733 144,869 ------------ ------------ $206,126,233 $181,832,722 Net deferred loan fees, costs, premiums and discounts 324,283 396,798 Allowance for loan losses (2,131,523) (2,022,130) ------------ ------------ $204,318,993 $180,207,390 ============ ============
At December 31, 2006, approximately $93,841,000 or 51.9% of the real estate loans had fixed rates of interest and $86,893,000 or 48.1% had adjustable rates of interest. An analysis of the allowance for loan losses was as follows:
2006 2005 2004 ---------- ---------- ---------- Balance, beginning $2,022,130 $1,807,449 $1,607,763 Provision charged to operations 275,500 352,000 393,000 Recoveries 151,513 168,413 158,850 Loans charged off (317,620) (305,732) (352,164) ---------- ---------- ---------- Balance, ending $2,131,523 $2,022,130 $1,807,449 ========== ========== ==========
Loans are placed on nonaccrual status at the time the loan becomes 90 days past due, unless in management's judgment collectibility is assured. A summary of nonperforming loans is as follows:
DECEMBER 31, ------------------- 2006 2005 -------- -------- Nonaccrual loans $402,014 $789,684 Loans past due 90 days or more still accruing interest 4,942 -- -------- -------- Total $406,956 $789,684 ======== ========
The contractual amount of interest that would have been recorded on nonaccrual loans during 2006 and 2005 was $19,455 and $48,044, respectively. The amount of interest income that was recorded on nonaccrual loans during 2006 and 2005 was $19,549 and $20,832, respectively. The Bank is not committed to lend additional funds to debtors whose loans are nonperforming or on nonaccrual status. The Bank has no loans which are considered to be impaired at December 31, 2006 and 2005. 43 NOTE 5. LOAN SERVICING Mortgage loans serviced for others are not included in the accompanying financial statements. The unpaid principal balances of mortgage loans serviced for others were $3,610,043 and $3,670,323 at December 31, 2006 and 2005, respectively. Custodial balances maintained in connection with the foregoing loan servicing, and included in demand deposits, were $16,080 and $48,288 at December 31, 2006 and 2005, respectively. The Bank did not capitalize any mortgage servicing rights in 2006, 2005 or 2004. Amortization of mortgage servicing rights was $0 in 2006, 2005 and 2004, respectively. There were no mortgage servicing rights at December 31, 2006 and 2005. NOTE 6. PREMISES AND EQUIPMENT Major classifications of premises and equipment at December 31 were as follows:
2006 2005 ---------- ---------- Land and land improvements $2,072,388 $2,072,388 Banking house - Main 1,504,751 1,491,251 Banking house - Valley Road branch 547,936 547,936 Banking house - Hedgesville branch 770,643 766,743 Banking house - Martinsburg branch 697,006 697,006 Banking house - Hancock branch 230,999 230,999 Banking house - Spring Mills branch 885,697 882,844 Bank owned automobiles 41,657 37,228 Furniture, fixtures and equipment 2,889,032 2,848,095 ---------- ---------- $9,640,109 $9,574,490 Less accumulated depreciation 3,312,815 2,973,027 ---------- ---------- $6,327,294 $6,601,463 ========== ==========
Depreciation expense amounted to $505,421, $462,198 and $370,056 in 2006, 2005 and 2004, respectively. The Bank purchased a parcel of land in Falling Waters, Berkeley County, West Virginia on December 15, 2003 for $503,261 to construct a new branch facility. Construction on the new branch facility began in August 2004 and was completed in April 2005. On April 27, 2005, the new branch building opened. Computer software, net of accumulated amortization, included in the statement of financial condition caption "Other Assets" amounted to $101,733 and $167,212 at December 31, 2006 and 2005, respectively. Amortization expense on computer software amounted to $89,887, $253,744 and $255,518 in 2006, 2005 and 2004, respectively. NOTE 7. INTANGIBLE ASSETS Amortized intangible assets representing customer lists, contracts and records acquired by CNB Insurance Services, Inc. had a carrying amount of $66,267 and accumulated amortization of $54,370 at December 31, 2005. On June 1, 2006, CNB Insurance Services, Inc. was sold along with its customer lists which had a remaining unamortized cost of $9,419. See Note 16: Discontinued Operations in the Notes to Consolidated Financial Statements for further discussion on the sale. These intangibles were being amortized on a straight line basis. Amortized intangible asset representing the $780,616 premium from the purchase of core deposit relationships as part of the Hancock branch acquisition has accumulated amortization of $283,438 and $171,921 at December 31, 2006 and 2005, respectively. This core deposit intangible asset from the Hancock branch acquisition is being amortized over seven years on a straight line basis. Amortization expense on intangible assets amounted to $113,995, $117,465 and $66,354 in 2006, 2005 and 2004, respectively. The estimated amortization expense for the next five succeeding years will be: 44 2007 $111,516 2008 $111,516 2009 $111,516 2010 $111,516 2011 $ 51,114
NOTE 9. TIME DEPOSITS At December 31, 2006, the scheduled maturities of time deposits are as follows:
TIME DEPOSITS ALL TIME $100,000 AND OVER DEPOSITS ----------------- ------------ 2007 $14,844,280 42,648,255 2008 14,067,636 37,953,126 2009 6,382,727 19,277,922 2010 1,027,329 5,173,594 2011 1,438,227 5,179,966 ----------- ------------ $37,760,199 $110,232,863 =========== ============
NOTE 9. FEDERAL HOME LOAN BANK BORROWINGS
DECEMBER 31, ------------------------- 2006 2005 ----------- ----------- Federal Home Loan Bank advances $18,500,000 $17,800,000
CNB Bank, Inc. is a member of the Federal Home Loan Bank of Pittsburgh ("FHLB") and, as such, can take advantage of the FHLB program for overnight and term advances at published daily rates. At December 31, 2006, the Bank only has term advances with FHLB. FHLB term advances mature within one year and carry an interest rate of 5.4% at December 31, 2006. Under the terms of a blanket collateral agreement, term advances from the FHLB are collateralized by qualifying mortgages and U.S. Government agencies and mortgage-backed securities. In addition, all of the Bank's stock in the FHLB is pledged as collateral for such debt. Term advances available under this agreement are limited by available and qualifying collateral and the amount of FHLB stock held by the borrower.
2006 2005 ----------- ----------- Maximum balance outstanding $27,500,000 $17,800,000 at any month-end during the year Average balance for the year 18,730,712 8,212,740 Weighted average rate for the year 5.13% 3.55% Weighted average rate at year-end 5.40% 4.20%
NOTE 10. UNUSED LINES OF CREDIT The Bank entered into an open-ended unsecured line of credit with Mercantile Safe Deposit and Trust Company for $3,000,000 for federal fund purchases. Funds issued under this agreement are at the Mercantile Safe Deposit and Trust Company federal funds rate effective at the time of borrowing. The line matures October 4, 2007 and has a compensating balance requirement of $250,000. The Bank had not drawn on these funds at December 31, 2006. The Bank entered into a line of credit with SunTrust Bank for 45 $4,500,000 for federal fund purchases. Funds issued under this agreement are at the SunTrust Bank federal funds rate effective at the time of borrowing. The Bank had not drawn on these funds at December 31, 2006. NOTE 11. PENSION PLAN The Bank is a member of The West Virginia Bankers Association Retirement Plan, a multi-employer, defined benefit pension plan. All employees participate in the plan after completing one year of service and attaining the age of 21. The benefits are based on years of service and the highest average earnings during any five consecutive calendar years. Plan assets are invested primarily in corporate bonds, common stocks and U.S. Government and Agency Securities. The following table sets forth information about the Bank's plan as of October 31:
2006 2005 2004 ----------- ----------- ---------- Change in benefit obligation: Benefit obligation at beginning of year $ 4,186,024 $ 3,423,734 $3,269,219 Adjustment for plan changes -- 106,789 -- Service cost 232,392 162,067 144,323 Interest cost 248,471 229,400 200,152 Actuarial (gain) loss 346,984 428,791 47,693 Benefits paid (154,189) (164,757) (237,653) ----------- ----------- ---------- Benefit obligation at end of year $ 4,859,682 $ 4,186,024 $3,423,734 ----------- ----------- ---------- CHANGE IN PLAN ASSETS: Fair value of plan assets at beginning of year $ 2,760,085 $ 2,427,640 $2,246,999 Actual return on plan assets 346,212 212,052 198,364 Employer contribution 413,170 285,150 249,348 Administrative expenses -- -- (29,418) Benefits paid (154,189) (164,757) (237,653) ----------- ----------- ---------- Fair value of plan assets at end of year $ 3,365,278 $ 2,760,085 $2,427,640 ----------- ----------- ---------- Funded status $(1,494,404) $(1,425,939) $ (996,094) Unrecognized net actuarial (gain) loss 1,578,504 1,464,092 1,054,208 Unrecognized prior service cost 139,910 98,574 -- ----------- ----------- ---------- Prepaid (accrued) benefit cost $ 224,010 $ 136,727 $ 58,114 =========== =========== ========== ADDITIONAL INFORMATION Increase (decrease) in minimum liability included in other comprehensive income (prior to adjustment to implement SFAS No. 158) $ (122,863) $ 355,276 $ 40,578
46
2006 2005 2004 ----------- --------- --------- WEIGHTED AVERAGE ASSUMPTIONS USED TO DETERMINE BENEFIT OBLIGATIONS AS OF OCTOBER 31: Discount rate 5.75% 5.75% 6.5% Expected return on plan assets 8.0% 8.5% 8.5% Rate of compensation increase 3.5% 3.0% 3.5% WEIGHTED AVERAGE ASSUMPTIONS USED TO DETERMINE NET PERIODIC BENEFIT COST FOR YEARS ENDED OCTOBER 31: Discount rate 5.75% 6.5% 6.5% Expected return on plan assets 8.5% 8.5% 8.5% Rate of compensation increase 3.0% 3.5% 3.5% AMOUNTS RECOGNIZED IN THE STATEMENT OF FINANCIAL POSITION CONSIST OF: Accrued benefit cost $(1,494,404) $(793,994) $(418,757) Intangible assets -- 98,574 -- Accumulated other comprehensive income 1,718,414 832,147 476,871 ----------- --------- --------- Net amount recognized $ 224,010 $ 136,727 $ 58,114 =========== ========= =========
The accumulated benefit obligation for the defined benefit pension plan was $3,990,462 and $3,554,079 at October 31, 2006 and October 31, 2005, respectively. COMPONENTS OF NET PERIODIC COST: Service cost $ 232,392 $ 162,067 $ 136,170 Interest cost 248,471 229,400 207,304 Expected return on plan assets (248,419) (230,617) (224,567) Amortization of prior service costs 12,344 8,215 2,753 Recognized net actuarial loss 81,099 37,472 18,736 --------- --------- --------- Net periodic plan cost $ 325,887 $ 206,537 $ 140,396 ========= ========= =========
INCREMENTAL EFFECT OF APPLYING SFAS NO. 158 ON INDIVIDUAL LINE ITEMS IN THE STATEMENT OF FINANCIAL POSITION DECEMBER 31, 2006
BEFORE AFTER APPLICATION OF APPLICATION OF SFAS NO. 158 ADJUSTMENTS SFAS NO. 158 -------------- ----------- -------------- Intangible asset $ 139,910 $(139,910) $ -- Deferred tax asset $ 269,528 $ 383,469 $ 652,997 Total assets $275,824,982 $ 243,559 $276,068,541 Pension liability $ 625,184 $ 869,220 $ 1,494,404 Total liabilities $254,877,059 $ 869,220 $255,746,279 Total OCI - pension $ (439,756) $(625,661) $ (1,065,417) Total stockholders' equity $ 20,947,923 $(625,661) $ 20,322,262
47 PLAN ASSETS
PERCENTAGE OF PLAN ASSETS AT TARGET ALLOWABLE OCTOBER 31, ALLOCATION ALLOCATION ----------- 2006 RANGE 2006 2005 ---------- ---------- ---- ---- Plan assets Equity securities 75% 40 - 80% 74% 73% Debt securities 25% 20 - 40% 20% 22% Real estate 0% 0% 0% 0% Other 0% 3 -10% 6% 5% --- --- Total 100% 100% === ===
INVESTMENT POLICY AND STRATEGY The policy, as established by the Pension Committee, is to invest in assets per the target allocations stated above. The assets will be reallocated periodically to meet the above target allocations. The investment policy will be reviewed periodically, under the advisement of a certified investment advisor, to determine if the policy should be changed. The overall investment return goal is to achieve a return greater than a blended mix of stated indices tailored to the same asset mix of the plan assets by 0.5% after fees over a rolling 5-year moving average basis. Allowable assets include cash equivalents, fixed income securities, equity securities, exchange traded index funds and GICs. Prohibited investments include, but are not limited to, commodities and future contracts, private placements, options, limited partnerships, venture capital investments, real estate and IO, PO, and residual tranche CMOs. Unless a specific derivative security is allowed per the plan document, permission must be sought from the Pension Committee to include such investments. In order to achieve a prudent level of portfolio diversification, the securities of any one company should not exceed more than 10% of the total plan assets, and no more than the 25% of total plan assets should be invested in any one industry (other than securities of U.S. Government or agencies). Additionally, no more than 20% of the plan assets shall be invested in foreign securities (both equity and fixed). 48 DETERMINATION OF EXPECTED LONG-TERM RATE OF RETURN The expected long-term rate of return for the plan's total assets is based on the expected return of each of the above categories, weighted based on the median of the target allocation for each class. CASH FLOWS Expected contributions for fiscal year ending October 31, 2007 Expected employer contributions $ 421,380 Expected employee contributions $ -- Estimated future benefit payments reflecting expected future service for the fiscal year(s) ending 10/31/2007 $ 172,646 10/31/2008 $ 188,972 10/31/2009 $ 199,024 10/31/2010 $ 203,169 10/31/2011 $ 206,634 10/31/2012 - 10/31/2016 $1,167,544
NOTE 12. 401(K) PROFIT SHARING PLAN All employees are eligible to participate in the Bank's 401(k) Profit Sharing Plan after completing one year of service. Employees may defer up to 15% of their salary in 2006, 2005 and 2004. The Bank may, at the discretion of the Board of Directors, match all or part of the employee deferrals. For 2006, 2005 and 2004, the Bank matched 75% of employee deferrals up to 5% of salary. The percentage of match varies based on the Bank's profit level. The assets of the 401(k) Profit Sharing Plan are managed by the Bank's trust department. The Bank's contribution charged to income during 2006, 2005 and 2004 was $64,750, $63,789 and $53,783, respectively. NOTE 13. DEFERRED COMPENSATION PLAN The Bank has a plan pursuant to which a director may elect to waive receipt of all or a portion of his fees for Board of Directors' meetings or committee meetings in exchange for a retirement benefit to be received during a ten-year period after attaining a certain age. The Bank has acquired life insurance on the lives of participating directors to fund its obligation under the plan. The cash surrender value of these life insurance policies has been recorded as an asset. The present value of payments to be paid to directors or their beneficiaries for services rendered to date has been recorded as a liability. The net expense for these benefits was $21,641, $17,948 and $17,702 for 2006, 2005 and 2004, respectively. 49 NOTE 14. INCOME TAXES Income taxes reflected in the statements of income are as follows:
YEARS ENDED DECEMBER 31, ---------------------------------- 2006 2005 2004 ---------- ---------- -------- Federal: Current $1,194,270 $1,154,256 $942,169 Deferred (39,537) (68,049) (67,864) State: Current 161,659 163,560 128,886 Deferred (7,813) (11,351) (11,274) ---------- ---------- -------- Provision for income taxes $1,308,579 $1,238,416 $991,917 ========== ========== ========
Deferred income taxes reflect the impact of "temporary differences" between the amount of assets and liabilities for financial reporting purposes and such amounts as measured by tax laws and regulations. The following is a reconciliation of the statutory federal income tax rate applied to pre-tax accounting income, with the income tax provisions in the statements of income.
YEARS ENDED DECEMBER 31, ------------------------------------ 2006 2005 2004 ---------- ---------- ---------- Income tax expense at the statutory rate (34%) $1,284,262 $1,252,558 $1,134,107 Increases (decreases) resulting from: Nontaxable interest income, net of non-deductible interest expense (120,442) (164,735) (121,892) State income taxes, net of federal income tax benefit 104,293 91,908 83,217 Other 40,465 58,685 (103,515) ---------- ---------- ---------- Provision for income taxes $1,308,578 $1,238,416 $ 991,917 ========== ========== ==========
Federal and state income taxes receivable included in the balance sheet as other assets was $242,662 and $212,091 at December 31, 2006 and 2005, respectively. The components of deferred taxes included in the statement of financial condition as of December 31 are as follows: 50
2006 2005 ---------- ---------- Deferred tax assets: Provision for loan losses $ 702,985 $ 663,605 Deferred compensation plan 307,424 276,713 Postretirement benefits 67,522 64,306 Intangible asset 54,420 54,081 Minimum pension liability adjustment -- 316,216 Unrecognized pension costs 652,997 -- Severence package 2,592 -- Net unrealized loss on securities available for sale 401,674 463,233 ---------- ---------- $2,189,614 $1,838,154 ---------- ---------- Deferred tax liabilities: CSV life insurance $ (278,904) $ (255,938) Defined benefit plan (80,643) (49,222) Depreciation (347,901) (373,399) ---------- ---------- $ (707,448) $ (678,559) ---------- ---------- Net deferred tax asset (liability) $1,482,166 $1,159,595 ========== ==========
Generally accepted accounting principles require a valuation allowance against deferred tax assets if, based on the weight of available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized. The Bank believes that the deferred tax assets will be realized and therefore no valuation allowance was established. NOTE 15. OTHER OPERATING EXPENSES
YEARS ENDED DECEMBER 31, ------------------------------------ 2006 2005 2004 ---------- ---------- ---------- Stationery, supplies and printing $ 245,038 $ 206,124 $ 240,711 Data processing 116,177 132,595 134,100 Director's fees 205,125 178,375 178,650 Postage 124,099 132,363 129,122 Telephone 102,854 104,249 88,985 Professional fees 325,939 297,449 252,160 ATM and debit card fees 215,218 222,539 188,147 Advertising 173,792 161,180 213,357 Amortization of intangible 111,516 371,209 321,872 Other 494,518 252,997 235,259 ---------- ---------- ---------- Total other operating expenses $2,114,276 $2,059,080 $1,982,363 ========== ========== ==========
NOTE 16. DISCONTINUED OPERATIONS On April 27, 2006, CNB Insurance Services, Inc., a wholly-owned subsidiary of CNB Bank, Inc., which is a wholly-owned subsidiary of CNB Financial Services, Inc., entered into an agreement with Maiden Financial Inc. Under the terms of the agreement, CNB Insurance Services, Inc. sold to Maiden Financial Inc. certain assets constituting CNB Insurance Services, Inc.'s insurance business for a purchase price of $153,332 on June 1, 2006 resulting in a gain on sale of $143,913. 51 The following table summarizes the net results of the discontinued operations of CNB Insurance Services, Inc.:
2006 ---------------------------------------------------- FIRST SECOND THIRD FOURTH YEAR ENDED QUARTER QUARTER QUARTER QUARTER DECEMBER 31 ------- -------- ------- ------- ----------- Net income (loss) from operations of CNB Insurance Services, Inc. $2,354 $(22,404) $(58) $ 352 $(19,756) Gain on sale of CNB Insurance Services, Inc. -- 143,913 -- -- 143,913 ------ -------- ---- ------- -------- Net Income before taxes $2,354 $121,509 $(58) $ 352 $124,157 Taxes 902 42,595 -- 1,956 45,453 ------ -------- ---- ------- -------- Net income (loss) $1,452 $ 78,914 $(58) $(1,604) $ 78,704 ====== ======== ==== ======= ========
NOTE 17. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK CNB is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk which are not reflected in the statements of financial condition. The contractual amounts of those instruments reflect the extent of involvement CNB has in particular classes of financial instruments. CNB's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit written is represented by the contractual amount of those instruments. CNB uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. Commitments to extend credit are agreements to lend funds as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses. Commercial line of credit arrangements usually require payment of a fee. CNB evaluates each customer's creditworthiness and related collateral on a case-by-case basis. The amount of collateral obtained if deemed necessary by CNB upon extension of credit is based on management's credit evaluation of the customer. Collateral held varies but may include accounts receivable, inventory, real estate, equipment and income-producing commercial properties. Standby letters of credit written are conditional commitments issued by CNB to guarantee the performance of a customer to a third party. Those guarantees are issued to support public and private borrowing arrangements, bond financing and similar transactions. The credit risk involved in issuing a letter of credit is essentially the same as that involved in extending loan facilities to customers. A summary of off-balance sheet instruments as of December 31 is as follows: 52
2006 2005 ----------- ----------- Commitments to originate: Fixed rate loans $ 1,103,253 $ 2,697,280 Adjustable rate loans 1,619,100 2,396,328 ----------- ----------- $ 2,722,353 $ 5,093,608 Letters of credit 1,022,059 1,990,600 Undisbursed portion of construction loans 11,188,752 3,689,992 Available credit granted on commercial loans 10,479,484 10,213,982 Available credit on personal lines of credit 280,198 296,856 Undisbursed portion of home equity loans 4,270,602 3,743,253 ----------- ----------- $29,963,448 $25,028,291 =========== ===========
NOTE 18. SIGNIFICANT GROUP CONCENTRATIONS OF CREDIT RISK CNB's primary business is mortgage loans, which consists of originating residential, construction, multi-family and commercial real estate loans and consumer and commercial loans. CNB's primary lending area is Morgan and Berkeley Counties, West Virginia and Washington County, Maryland. Loans are occasionally made in surrounding counties in West Virginia, Maryland, Virginia and Pennsylvania. CNB evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained if deemed necessary by CNB upon the extension of credit is based on management's credit evaluation of the customer. Collateral held varies but generally includes vehicles, equipment and real estate. The Company maintains substantial balances of cash on hand, federal funds sold and investments held in safekeeping at corresponding banks. The balances held at the correspondent banks are in excess of the Federal Deposit Insurance Corporation insurance limit. Management considers this to be a normal business risk. NOTE 19. LEGAL CONTINGENCIES Various legal claims arise from time to time in the normal course of business which, in the opinion of management, will have no material effect on the bank's consolidated financial statements. NOTE 20. REGULATORY MATTERS The primary source of funds for the dividends paid by CNB Financial Services, Inc. is dividends received from its banking subsidiary. The payment of dividends by banking subsidiaries is subject to various banking regulations. The most restrictive provision requires regulatory approval if dividends declared in any calendar year exceed the total net profits, as defined, of that year plus the retained net profits, as defined, of the preceding two years. At January 1, 2007, CNB has $5,966,000 available for dividends. The Bank is subject to various regulatory capital requirements administered by the banking regulatory agencies. Pursuant to capital adequacy guidelines, the Bank must meet specific capital guidelines that involve various quantitative measures of the banks' assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios of total and Tier I capital to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). Management believes, as of December 31, 2006, that the Bank meets all capital adequacy requirements to which it is subject. As of December 31, 2006 and 2005, the most recent notification from the banking regulatory agencies categorized the Bank as well-capitalized under the regulatory framework for prompt corrective action. To be categorized as well-capitalized, the Bank must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios. There are no conditions or events since that notification that management believes have changed the institution's category. The Bank's actual capital amounts and ratios are presented in the table. 53
RATIO ---------------------------------------------- ACTUAL TO BE WELL AMOUNT CAPITALIZED UNDER IN FOR CAPITAL PROMPT CORRECTIVE THOUSANDS ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS --------- ------ ----------------- ----------------- As of December 31, 2006: Total Capital (to Risk Weighted Assets) $22,295 13.29% 8.0% 10.0% Tier I Capital (to Risk Weighted Assets) $20,198 12.04% 4.0% 6.0% Tier I Capital (to Average Assets) $20,198 7.34% 4.0% 5.0% As of December 31, 2005: Total Capital (to Risk Weighted Assets) $21,066 13.68% 8.0% 10.0% Tier I Capital (to Risk Weighted Assets) $19,140 12.43% 4.0% 6.0% Tier I Capital (to Average Assets) $19,140 7.49% 4.0% 5.0%
NOTE 21. REGULATORY RESTRICTIONS Included in Cash and Due From Banks are average daily reserve balances the Bank is required to maintain with the Federal Reserve Bank. The amount of these required reserves, calculated based on percentages of certain deposit balances was $4.9 million at December 31, 2006. Certain regulations prohibit the transfer of funds from the Bank to affiliates in the form of loans or advances exceeding 10% of its capital stock and surplus. In addition, all loans or advances to nonbank affiliates must be secured by specific collateral. Based on this limitation, there was approximately $2,204,000 available for loans or advances to affiliates of the Bank as of December 31, 2006, at which time there were no material loans or advances outstanding. NOTE 22. FAIR VALUE OF FINANCIAL INSTRUMENTS The fair value of financial instruments is the amount at which the asset or obligation could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. Fair value estimates are made at a specific point in time based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the entire holdings of a particular financial instrument. Because no market value exists for a significant portion of the financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature, involve uncertainties and matters of judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates. Fair value estimates are based on financial instruments both on and off the balance sheet without attempting to estimate the value of anticipated future business, and the value of assets and liabilities that are not considered financial instruments. Additionally, tax consequences related to the realization of the unrealized gains and losses can have a potential effect on fair value estimates and have not been considered in many of the estimates. The following methods and assumptions were used to estimate the fair value of significant financial instruments: Financial Assets: The carrying amounts of cash, due from Banks and federal funds sold are considered to approximate fair value. The fair value of investment securities, including available for sale, are generally based on quoted market prices. The fair value of loans is 54 estimated using a combination of techniques, including discounting estimated future cash flows and quoted market prices of similar instruments where available. Financial Liabilities: The carrying amounts of deposit liabilities payable on demand are considered to approximate fair value. For fixed maturity (time) deposits, fair value is estimated by discounting estimated future cash flows using currently offered rates for deposits of similar remaining maturities. Off-Balance Sheet Financial Instruments: The fair value of commitments to extend credit and standby letters of credit is estimated using the fees currently charged to enter into similar agreements. The estimated fair value of financial instruments at December 31, is summarized as follows:
2006 2005 --------------------------- --------------------------- CARRYING CARRYING AMOUNT FAIR VALUE AMOUNT FAIR VALUE ------------- ------------ ------------ ------------ Financial Assets: Cash, due from banks and federal funds sold $ 7,367,773 $ 7,367,773 $ 10,123,252 $ 10,123,252 Securities available for sale 50,873,335 50,873,335 55,194,216 55,194,216 Loans 204,318,993 203,467,447 180,207,390 179,658,280 Accrued interest receivable 1,354,041 1,354,041 1,230,777 1,230,777 Financial Liabilities: Demand deposits $122,849,877 $122,849,877 $129,913,580 $129,913,580 Time deposits 110,232,863 113,762,131 89,374,846 91,424,100 Accrued interest payable 1,071,990 1,071,990 611,512 611,512 FHLB borrowings 18,500,000 18,500,000 17,800,000 17,800,000 Securities sold under repurchase agreements -- -- -- -- Off-Balance Sheet Financial Instruments: Letters of credit $ -- $ 6,087 $ -- $ 16,488
NOTE 23. RELATED PARTY TRANSACTIONS In the ordinary course of business, the Bank has granted loans to executive officers, directors, and their affiliates amounting to $2,363,763 and $2,448,437 at December 31, 2006 and 2005, respectively. During 2006, $624,694 of new loans were made, or became reportable, and repayments and other decreases totaled $709,368. Deposits from related parties held by the Bank at December 31, 2006 and 2005 amounted to $5,167,964 and $5,794,438, respectively. 55 NOTE 24. PARENT COMPANY ONLY FINANCIAL INFORMATION The following represents parent company only financial information: STATEMENTS OF FINANCIAL CONDITION (PARENT ONLY) DECEMBER 31, 2006 AND 2005
2006 2005 ----------- ----------- ASSETS Cash $ 248,947 $ 37 Investment in CNB Bank, Inc. 20,040,017 18,992,776 Investment in Morgan County Title Insurance Agency, LLC 1,120 1,452 Deferred income taxes -- -- Other assets 30,961 11,795 ----------- ----------- TOTAL ASSETS $20,321,045 $19,006,060 =========== =========== LIABILITIES AND SHAREHOLDERS' EQUITY LIABILITIES Accrued expenses and other liabilities $ (1,217) $ (1,981) ----------- ----------- TOTAL LIABILITIES $ (1,217) $ (1,981) ----------- ----------- SHAREHOLDERS' EQUITY Common stock, $1 par value; 5,000,000 shares authorized; 458,048 shares outstanding $ 458,048 $ 458,048 Capital surplus 4,163,592 4,163,592 Retained earnings 17,421,402 15,658,134 Accumulated other comprehensive income (loss) (1,720,780) (1,271,733) ----------- ----------- TOTAL SHAREHOLDERS' EQUITY $20,322,262 $19,008,041 ----------- ----------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $20,321,045 $19,006,060 =========== ===========
STATEMENTS OF INCOME (PARENT ONLY) YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004
2006 2005 2004 ---------- ---------- ---------- Dividend income $ 855,394 $ 659,589 $ 662,106 Income from title company 20,668 27,924 35,207 Noninterest expense (66,610) (44,744) (58,038) ---------- ---------- ---------- INCOME BEFORE INCOME TAXES AND EQUITY IN UNDISTRIBUTED EARNINGS OF CNB BANK, INC. $ 809,452 $ 642,769 $ 639,275 Income tax (expense) benefit 12,922 6,844 7,595 ---------- ---------- ---------- INCOME BEFORE EQUITY IN UNDISTRIBUTED EARNINGS OF CNB BANK, INC. $ 822,374 $ 649,613 $ 646,870 Equity in undistributed earnings of CNB Bank, Inc. 1,646,288 1,795,966 1,696,823 ---------- ---------- ---------- NET INCOME $2,468,662 $2,445,579 $2,343,693 ========== ========== ==========
56 STATEMENTS OF CASH FLOWS (PARENT ONLY) YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004
2006 2005 2004 ----------- ----------- ----------- CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 2,468,662 $ 2,445,579 $ 2,343,693 Adjustments to reconcile net income to net cash provided by operating activities: Deferred income taxes -- 602 898 (Increase) decrease in other assets (19,166) (11,201) 1,507 Increase (decrease) in accrued expenses and other liabilities 764 (2,061) 80 Equity in undistributed earnings of CNB Bank, Inc. (1,496,288) (1,795,966) (1,696,823) ----------- ----------- ----------- NET CASH PROVIDED BY OPERATING ACTIVITIES $ 953,972 $ 636,953 $ 649,355 ----------- ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES Investment in title company $ 332 $ 575 $ (607) ----------- ----------- ----------- NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES $ 332 $ 575 $ (607) ----------- ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES Cash dividends paid $ (705,394) $ (659,589) $ (632,106) ----------- ----------- ----------- NET CASH (USED IN) FINANCING ACTIVITIES $ (705,394) $ (659,589) $ (632,106) ----------- ----------- ----------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS $ 248,910 $ (22,061) $ 16,642 CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR $ 37 $ 22,098 $ 5,456 ----------- ----------- ----------- CASH AND CASH EQUIVALENTS AT END OF YEAR $ 248,947 $ 37 $ 22,098 =========== =========== ===========
57 NOTE 25. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
2006 ------------------------------------- FIRST SECOND THIRD FOURTH QUARTER QUARTER QUARTER QUARTER ------- ------- ------- ------- In thousands Interest income $3,685 $ 3,900 $4,153 $4,251 Interest expense 1,282 1,462 1,726 1,799 ------ ------- ------ ------ Net interest income 2,403 2,438 2,427 2,452 Provision for loan losses 112 74 44 46 Noninterest income 499 511 506 472 Noninterest expense 2,020 1,910 1,873 1,976 ------ ------- ------ ------ Income before income taxes 770 965 1,016 902 Provision for income taxes 238 318 386 321 ------ ------- ------ ------ Net results from discontinued operations 1 79 -- (1) Net income $ 533 $ 726 $ 630 $ 580 ====== ======= ====== ====== Basic earnings per share $ 1.16 $ 1.59 $ 1.37 $ 1.27 ====== ======= ====== ======
2005 ------------------------------------- FIRST SECOND THIRD FOURTH QUARTER QUARTER QUARTER QUARTER ------- ------- ------- ------- In thousands Interest income $3,073 $3,282 $3,454 $3,611 Interest expense 808 888 1,004 1,150 ------ ------ ------ ------ Net interest income 2,265 2,394 2,450 2,461 Provision for loan losses 106 102 72 72 Noninterest income 449 513 531 530 Noninterest expense 1,771 1,926 1,892 1,952 Securities gains (losses) (2) 1 3 (18) ------ ------ ------ ------ Income before income taxes 835 880 1,020 949 Provision for income taxes 307 281 315 335 ------ ------ ------ ------ Net income $ 528 $ 599 $ 705 $ 614 ====== ====== ====== ====== Basic earnings per share $ 1.15 $ 1.31 $ 1.54 $ 1.34 ====== ====== ====== ======
58 ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE There were no changes in or disagreements with accountants in accounting and financial disclosure. ITEM 9A. CONTROLS AND PROCEDURES The Company's chief executive officer and chief financial officer have concluded that as of December 31, 2006, which is the end of the period covered by this Annual Report on Form 10-K, the Company's disclosure controls and procedures are adequate and effective for purposes of Rule 13(a)-15(e) and timely, alerting them to material information relating to the Company required to be included in the Company's filings with the Securities and Exchange Commission under the Securities Exchange Act of 1934. There have been no changes in the Company's internal controls over financial reporting in the fiscal quarter ended December 31, 2006, that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting. ITEM 9B. OTHER INFORMATION None. 59 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The following table contains certain information, as of March 2, 2007, with respect to current directors, nominees for directors and certain officers of CNB.
DIRECTOR PRINCIPAL OCCUPATION FOR PAST FIVE YEARS NAME AGE SINCE AND POSITION HELD WITH CNB ---- --- -------- ------------------------------------------- Kenneth W. Apple 50 2003 Certified Public Accountant J. Robert Ayers 77 1974 Retired - President, Citizens National Bank (predecessor to CNB Bank, Inc.) John E. Barker 78 1972 Auto Sales - Service Margaret S. Bartles 52 2002 Realtor Jay E. Dick 54 1983 Retired - Manager-Hunters' Hardware, Inc. Herbert L. Eppinger 74 1979 Retired - Agriculture Robert L. Hawvermale 77 1967 Retired - Professional Engineer J. Philip Kesecker 77 1965 Real Estate Development Jerry McGraw 60 1988 Insurance Martha H. Quarantillo 47 1999 Pharmacist Thomas F. Rokisky 60 1993 President and Chief Executive Officer, CNB and CNB Bank, Inc. Charles S. Trump IV 46 1986 Attorney at Law Arlie R. Yost 59 1988 Licensed Residential Appraiser
All nominees are incumbent directors of CNB Financial Services, Inc. All directors are independent except for Mr. Rokisky, President and CEO of CNB and Charles S. Trump IV, whose firm provides legal services for CNB. CNB's bylaws provide that the board of directors can set the number of directors but also provide that the board of directors must have no less than five nor more than 25 directors. The board of directors has set the number of directors to serve in 2007 at 13, which means that 13 directors will be elected at the 2007 Annual Meeting and will serve a term expiring at the next Annual Meeting or until a successor is selected. 60 The names, ages and position of each executive officer of the company are listed below along with the positions with CNB Bank, Inc. held by each of them during the last five years. Officers are appointed annually by the Board of Directors at the meeting of directors immediately following the annual meeting.
AGE AS OF NAME MARCH 19, 2007 POSITION AND EXPERIENCE DURING THE PAST 5 YEARS - ---- -------------- -------------------------------------------------------------------------- J. Philip Kesecker (1) 77 2000 to present - Chairman of the Board, CNB Financial Services, Inc. 1987 to present - Chairman of the Board, Citizens National Bank Thomas F. Rokisky 60 2000 to present - President/CEO, CNB Financial Services, Inc. 1996 to present - President/CEO, Citizens National Bank 1990 to 1996 - Executive Vice President/COO, Citizens National Bank Rebecca S. Stotler 46 2000 to present - Vice President/CFO, CNB Financial Services, Inc. 1999 to present - Vice President/CFO, Citizens National Bank 1996 to 1999 - Vice President of Finance/Cashier, Citizens National Bank Patricia C. Muldoon 46 2003 to present - Senior Vice President/COO, Citizens National Bank 2001 to 2003 - Vice President/COO, Citizens National Bank 1999 to 2001 - Consultant/Audit Staff, Smith Elliott Kearns & Company, LLC 1997 to 1999 - VP/Mgr of Accounting Operations and Financial Reporting Farmers and Mechanics National Bank
(1) Mr. Kesecker is not an employee of CNB. CNB's board of directors has determined that Kenneth W. Apple, CPA, meets the requirements of an audit committee financial expert as defined by the Securities and Exchange Commission. The board of directors believes that Mr. Apple has the following five attributes that qualify him as an audit committee financial expert. This director, through education and experience, has: - An understanding of financial statements and generally accepted accounting principles; - An ability to assess the general application of generally accepted accounting principles in connection with accounting for estimates, accruals and reserves; - Some experience in preparing, auditing, analyzing and evaluating financial statements that present a level of complexity of accounting issues comparable to the breadth of issues that could reasonably be expected to be presented by CNB's financial statements; - An understanding of internal controls; and - An understanding of audit committee functions. Mr. Apple acquired these attributes through his Bachelor of Science degree from Shepherd College in Shepherdstown, West Virginia, and over 20 years of experience in public accounting, including auditing. Section 16 (a) of the Securities Exchange Act of 1934 requires CNB's directors and executive officers, and persons who own more than 10% of the registered class of CNB's equity securities, to make stock ownership and transaction filings with the Securities and Exchange Commission and to provide copies to CNB. Based solely on a review of the reports furnished to CNB and written statements that no other reports were required, all Section 16(a) filing requirements applicable to its officers and directors were met. CNB is required to report late filings. CODES OF ETHICS Both CNB and the Bank have adopted Codes of Ethics as defined by the rules of the SEC. The Code of Ethics applies to all of CNB's and the Bank's directors, officers, including the Bank's Chief Executive Officer and Chief Financial Officer, and employees. Additionally, CNB and the Bank have adopted a Code of Ethics for Senior Financial Officers. The codes of ethics for all employees and for senior financial officers of CNB and the Bank have been filed as an exhibit to this Annual Report on Form 10-K. If CNB or the Bank makes substantive amendments to the Code of Ethics or the Code of Ethics for Senior Financial Officers or grants any waiver, including any implicit waiver, that applies to any director or executive officer of CNB or the Bank, it will disclose the nature of such amendment or waiver on the website or in a report on Form 8-K in accordance with applicable SEC rules. ITEM 11. EXECUTIVE COMPENSATION The personnel committee of the board of directors has furnished the following report on executive compensation. The personnel committee has not adopted a charter. GENERAL PHILOSOPHY We compensate our senior management through base salary and a benefits package designed to be competitive with comparable employers. We do not believe that it is appropriate to establish compensation levels primarily based on benchmarking. We do believe, however, that information regarding pay practices at other financial institutions is useful in at least two respects. First, we recognize that our compensation practices must be competitive in the marketplace. Second, this marketplace information is one of the many factors that the President and the Personnel Committee consider in assessing the reasonableness of compensation. The President and the Personnel Committee do not attempt to set salaries for executive officers within the industry peer ranges. As only a guideline, the individual executive officer's salaries are compared to the salary survey ranges for the specific job classifications to ensure competitiveness in the market. The President and the Personnel Committee rely more on individual performance and contribution to the bank, reporting structure, internal pay relationship, job responsibilities, growth potential, leadership abilities and the overall bank's performance for the previous year. The committee establishes the compensation for the Chief Executive Officer of CNB and the bank and reviews all personnel related issues including salary administration related to other employees and benefit programs. The CEO establishes compensation levels for executive officers and all other personnel which is reviewed by the personnel committee. Committee objectives include administration of a total compensation package that allows CNB to fill key executive positions with qualified individuals and to utilize effective compensation programs which are directly related to executive officers accomplishing corporate goals and objectives, both operational and financial, aimed at achieving lasting improvement in CNB's long-term financial performance. We rely upon our judgment about each individual executive officer and not on rigid formulas or short-term changes in business performance in determining the amount. The corporate goals and objectives include: - Increase return on shareholders' investment - Increase return on assets - Increase return on equity - Increase market share - Continued strong asset growth - Maintain a high quality loan portfolio with strong underwriting standards - Maintain a high quality investment portfolio The committee and the CEO utilize human resources' staff, and, as appropriate, other qualified consultants to review compensation practices as they compare to industry norms. In 2006, the committee relied only on CNB's human resources' staff for information concerning industry norms. COMPENSATION PROGRAMS The committee utilizes an internal salary administration plan for the basis of its analysis of compensation levels throughout CNB, including the CEO. The plan includes job descriptions for all positions and considers the overall responsibility of each position based on characteristics including job knowledge, problem-solving, accountability, 62 human relations, communications, supervision of others and marketing. Salary ranges for each position are developed based on market information available for similar positions at financial institutions both in the communities where CNB does business and outside its market area. Salary surveys utilized include those provided by the West Virginia Bankers Association and Topnet (a group of West Virginia non-competing independent community banks). These results are used annually by the human resources staff to update the salary administration plan using current market data which reflects marketplace changes, inflation, and, if applicable, corporate performance. The salary surveys performed a comparison study of the current compensation of the CEO and other executive officers at the bank with comparable financial institutions (the "Peer Group"). The Peer Group was used to provide information regarding executive compensation levels against other financial institutions of similar asset size. The Personnel Committee reviews the compensation data compiled in these surveys to ensure that our executive compensation program is competitive. The individual components of CNB's compensation program include: (a) Base Salary. a. Base salary levels are established for the CEO primarily based upon evaluation of the historical performance, degree of responsibility, level of experience and number of years with CNB. With respect to the base salary granted to Mr. Rokisky for the year 2006, the committee took into account the performance during 2005 and information referred to above. Particular emphasis was placed on Mr. Rokisky's individual performance, including his leadership role through a period of continued growth, and CNB's continued strong financial performance. For the year 2007, the committee has established certain goals and objectives for the CEO to attain. The achievement of these goals and objectives may contribute to future salary increases. In comparing Mr. Rokisky's salary to financial institutions in the Peer Group, his salary falls in the average range. Mr. Rokisky has no input into the determination of his salary. b. Base salary levels are established for the Sr. VP/COO and the VP/CFO primarily based upon evaluation of their historical performance, degree of responsibility, industry average percentage increase and the bank's performance for the previous year. Mr. Rokisky determines the salaries for these individuals. As a guideline, Mr. Rokisky compares these individual salaries to the salary survey ranges for these job classifications from the West Virginia Bankers Association and Topnet. (b) Annual Incentives/Bonuses. Bonuses are not granted to senior officers as a regular component of compensation. Contributions to the 401(k) plan on behalf of all employees who defer into the plan are based on bank performance as a percentage of assets. The committee believes that the total compensation awarded to the CEO and other executive officers of CNB is consistent with the committee's objectives. The amounts paid to individual executives are consistent with competition within the market and with banks of similar size as reflected by individual performance of each executive, and are rationally linked with the fulfillment of corporate objectives and corporate financial performance. The following table sets forth for each of the Executive Officers: (a) the dollar value of base salary and bonus earned during the year ended December 31, 2006; (b) the change in pension value and nonqualified deferred compensation earnings during the year, (c) all other compensation for the year; and, finally, (d) the dollar value of total compensation for the year. 63 SUMMARY COMPENSATION TABLE
CHANGE IN PENSION VALUE AND NONQUALIFIED DEFERRED Name and Principal COMPENSATION OTHER ANNUAL TOTAL Position YEAR SALARY BONUS EARNINGS COMPENSATION COMPENSATION ------------------ ---- -------- ----- ------------ ------------ ------------ Thomas F. Rokisky, President/CEO 2006 $140,571 $-- $77,148 $23,906 (1)(2) $241,625 Patricia C. Muldoon, Sr. VP/COO 2006 $ 85,075 $-- $ 7,563 $ 3,158 (1)(2) $ 95,796 Rebecca S. Stotler, VP/CFO 2006 $ 67,695 $-- $ 9,184 $ 2,510 (1)(2) $ 79,389
(1) CNB's group life and health insurance program, which is paid for by CNB, is made available to all full-time employees. Effective January 1, 2005, the bank changed its health insurance program to a high deductible plan and concurrently established health reimbursement accounts for each employee on the plan. The bank funded $750 for each participant in 2005. In accordance with IRS Code Section 79, the cost of group life insurance coverage for an individual in excess of $50,000 is added to the individual's earnings and is included in salary. Also included in this figure are board fees earned and the corporation's contributions to the individual's 401(k) retirement savings program to which the individual has a vested interest. CNB maintains a 401(k) profit sharing plan that generally covers all employees who have completed one year of service. Contributions to the plan are based on bank performance as a percentage of assets and are computed as a percentage of the participant's total deferrals into the plan. The payment of benefits to participants is made at death, disability, termination or retirement. Contributions to the plan for all employees charged to operations during 2006 amounted to $64,750. (2) CNB's contributions to the pension plan, a defined benefit plan, are not and cannot be calculated separately for specific participants. Contributions for the plan year of $413,170, $285,150 and $249,348 were made by CNB in 2006, 2005 and 2004, respectively. CNB does not maintain any form of stock option, stock appreciation rights, or other long-term compensation plans. The following table discloses the actuarial present value of each Senior Executive's accumulated benefit under defined benefit plans, the number of years of credited service under each plan, and the amount of pension benefits paid to each Senior Executive during the year. PENSION BENEFITS TABLE
NUMBER PAYMENTS OF DURING YEARS PRESENT VALUE LAST CREDITED OF ACCUMULATED FISCAL NAME PLAN NAME SERVICE BENEFIT YEAR ---- -------------------- -------- -------------- -------- Thomas F. Rokisky, President/CEO WVBA Retirement Plan 17 $256,498 $-- NSRP (1) -- $ 97,924 $-- Patricia C. Muldoon, Sr. VP/COO WVBA Retirement Plan 5 $ 27,543 $-- Rebecca S. Stotler, VP/CFO WVBA Retirement Plan 23 $ 57,629 $--
64 (1) Effective January 2, 2004, CNB entered into a nonqualified supplemental retirement plan (NSRP) with the President which when fully vested would pay the President or his beneficiary an amount of $30,000 per year for 10 years beginning June 11, 2011, if he retires on or after May 29, 2011. Termination of employment prior to that date other than by reasons of death or disability will result in a reduced benefit. The expense charged to operations related to the plan during 2006 amounted to $32,641. The benefits to be provided by this plan are not being funded by current resources. CNB maintains a non-contributory defined benefit pension plan with employer contributions being based on a pension formula, which targets a certain monthly benefit for each plan participant at retirement. This pension plan is a qualified retirement plan and is available to all full-time employees, including officers, who meet the eligibility requirements. Directors do not participate in this plan. The pension plan is integrated with social security and is applicable to all participants. Pensions for all participants are based on an average of the highest five-years compensation. Annual compensation for the pension plan is defined as the total cash remuneration reportable on the employee's IRS form W-2, plus pre-tax contributions to employee benefit plans. The formula for determining the annual pension benefit is 2.0 percent of the 5-year average compensation multiplied by years of service up to a 25-year maximum effective for the plan year beginning November 1, 2004. The pension benefits are payable to participants on a monthly basis in the form of a joint and 50 percent survivor annuity for all married participants who do not elect otherwise, or in the form of a single life annuity for all other participants or survivors. Joint and 100 percent survivorship, single life annuity or 120 payments guaranteed are other optional forms of distribution. The normal retirement date for employees is the later of the participant's 65th birthday, or the fifth anniversary of the participant joining the plan. An employee must be at least 21 years of age and have one full year of service to become a plan participant. Full vesting in accumulated plan benefits occurs at the end of five years of service; there is no partial vesting. For the 2006 plan year, the employer contribution for all plan participants was $413,170. The following table disclosed the cash and other compensation earned and paid to each of the Company's directors during the fiscal year ended 2006. SUMMARY COMPENSATION TABLE - DIRECTORS
CHANGE IN PENSION VALUE AND NONQUALIFIED FEES EARNED DEFERRED OR PAID IN COMPENSATION ALL OTHER TOTAL NAME YEAR CASH EARNINGS (1) COMPENSATION COMPENSATION ---- ---- ----------- ------------- ------------ ------------ J. Philip Kesecker 2006 $21,050 $ -- $-- $21,050 Kenneth W. Apple 2006 $17,275 $ -- $-- $17,275 J. Robert Ayers 2006 $16,150 $ -- $-- $16,150 John E. Barker 2006 $15,750 $ -- $-- $15,750 Margaret S. Bartles 2006 $15,275 $ 2,854 $-- $18,129 Jay E. Dick 2006 $16,775 $35,170 $-- $51,945 Herbert L. Eppinger 2006 $17,377 $ 661 $-- $18,038 Robert L. Hawvermale 2006 $14,952 $ -- $-- $14,952 Jerald McGraw 2006 $16,800 $21,279 $-- $38,079 Martha H. Quarantillo 2006 $13,950 $ 2,854 $-- $16,804 Thomas F. Rokisky (2) 2006 $10,900 $ -- $-- $10,900 Charles S. Trump IV 2006 $13,875 $19,092 $-- $32,967 Arlie R. Yost 2006 $15,350 $21,279 $-- $36,629
(1) Refer to page 7 Board Compensation for a more detailed discussion of the director's deferred compensation plan. (2) Executive officer of CNB 65 Directors receive $200 for each board meeting of the bank they attend, $175 for each discount committee meeting, $150 for each audit committee meeting and $100 for other committee meetings they attend. There is no compensation for attendance at CNB board meetings. In addition, each director receives a fee of $6,000 per year. The chairman of the board receives an additional $3,500 per year and the vice chairman receives an additional $1,000 per year. Other than the deferred compensation plan described below, there are no other special arrangements with any directors. In 2006, the board of directors of CNB received $205,125, in the aggregate, for all board of directors' meetings attended and all fees paid. CNB maintains a deferred compensation plan for directors pursuant to which a director may elect to defer receipt of a portion of fees for board meetings for at least four years or until he reaches age 65, whichever is later. An amount equal to fees waived in addition to interest at an annual rate of 10% per year will be paid to each participating director or his designated beneficiary during a period of 10 years after the director reaches age 65. The payments after retirement will be paid from the general funds of CNB. CNB purchases and is the beneficiary of insurance on the lives of participants, the proceeds of which are used to help recover the net after-tax cost of the benefits and insurance premiums paid. Funds from the deferred fees of a participating director will be used to reimburse CNB for the costs of the premium for the insurance policies. The cost of the insurance premiums in 2006 was $58,822. At December 31, 2006, these policies had a net accumulated cash value of $1,394,521. PERSONNEL COMMITTEE REPORT The Personnel Committee held two meetings during fiscal year 2006. The Personnel Committee has reviewed and discussed the Compensation Discussion and Analysis required by Item 402(b) of Regulation S-K with management. Based upon such review, the related discussions and such other matters deemed relevant and appropriate by the Personnel Committee, the Personnel Committee has recommended to the Board of Directors that the Compensation Discussion and Analysis be included in the annual report, Form 10-K and the proxy statement. The foregoing report has been furnished by the current members of the personnel committee. Jay E. Dick, Personnel Committee Chairperson Robert L. Hawvermale, Personnel Committee Member Herbert L. Eppinger, Personnel Committee Member Charles S. Trump IV, Personnel Committee Member J. Robert Ayers, Personnel Committee Member J. Philip Kesecker, Ex-Officio member December 5, 2006 This report shall not be deemed to be incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, unless CNB specifically incorporates this report by reference. It will not otherwise be filed under such Acts. PERSONNEL COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION Loans were made to various directors and officers of CNB. These loans were made in the ordinary course of business, made on substantially the same terms, including interest rate and collateral requirements, as those prevailing at the time for comparable transactions with unrelated customers and did not involve more than a normal risk of collectibility or present other unfavorable features. Members of the personnel committee during 2006 were Jay E. Dick, chairman, Messrs. Hawvermale, Eppinger, Trump and Ayers. Mr. Kesecker serves as an ex-officio member of this committee. Mr. Ayers is a retired President of Citizens National Bank predecessor to CNB Bank, Inc. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICAL OWNERS AND MANAGEMENT The following table sets forth information as of February 21, 2007, relating to the beneficial ownership of the common stock by (a) each person or group known by CNB to own beneficially more than 5% of the outstanding common stock; (b) each of CNB's directors; and (c) all directors and executive officers of CNB as a group. Unless otherwise noted below, the persons named in the table have sole investment power with respect to each of the shares reported as beneficially owned by such person. 66
NUMBER OF PERCENT OF NAME AND ADDRESS SHARES CLASS (1) ---------------- --------- ---------- Kenneth W. Apple (2) (15) 1,650 * J. Robert Ayers (3) (15) 1,415 * John E. Barker (4) (15) 18,162 3.97 Margaret S. Bartles (5) (15) 200 * Jay E. Dick (6) (15) 15,691 3.43 Herbert L. Eppinger (7) (15) 2,870 * Robert L. Hawvermale (8) (15) 3,730 * J. Philip Kesecker (9) (15) 13,632 2.98 Jerald McGraw (10) (15) 1,514 * Martha H. Quarantillo (15) 400 * Thomas F. Rokisky (11) (15) 1,544 * Charles S. Trump IV (12) (15) 11,410 2.49 Arlie R. Yost (13) (15) 2,210 * Rebecca S. Stotler (14) (15) 194 * All directors and executive officers as a group (14 persons) (15) 74,622 16.29 D. Louise Stotler and Deborah Dhayer RR 6 Box 12460, Berkeley Springs, WV, 25411 47,488 10.37 Mary Lou Trump RR 7 Box 12840, Berkeley Springs, WV, 25411 53,470 11.67
* Indicates holdings of less than 1%. (1) Includes shares of common stock held by the named individual as of February 21, 2007. (2) Includes 1,000 shares held in an Individual Retirement Account. (3) Includes 1,315 shares held jointly with spouse. (4) Includes 14,300 shares held jointly with spouse and 3,562 shares held jointly with children. (5) Includes 100 shares held jointly with spouse. (6) Includes 15,591 shares held jointly with spouse. (7) Includes 2,770 shares held jointly with spouse. (8) Includes 1,200 shares held by spouse and 100 shares held jointly with spouse. (9) Includes 3,098 shares held by spouse and 1,860 shares held jointly with spouse and 350 held in an educational trust. (10) Includes 110 shares held by spouse and 964 shares held jointly with spouse. (11) Includes 1,425 shares held in an Individual Retirement Account. (12) Includes 200 shares held in an Individual Retirement Account, 842 shares held by spouse and 300 shares held as custodian for children. (13) Includes 1,770 shares held jointly with spouse. (14) Includes 108 shares held jointly with spouse, 74 shares held by spouse and 12 shares held jointly with child. (15) Unless otherwise indicated shares are not pledged as security. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS CNB has had and intends to continue to have banking and financial transactions in the ordinary course of business with directors and executive officers of CNB and their associates. All executive officer and director and their associates loans are approved prior to disbursement by the discount committee and/or the board of directors. These approvals are evidenced by the discount committee and/or Board minutes. The bank's loan policy and Regulation "O" policy governs these transactions. Total loans outstanding from CNB at December 31, 2006, to CNB's officers and directors as a group and members of their immediate families and companies in which they had an ownership interest of 10% or more was $1,987,927, or approximately 8.3% of total equity capital and .8% of total loans. Management believes that all of these transactions were made on substantially the same terms (including interest 67 rates, collateral and repayment terms on loans) as comparable transactions with non-affiliated persons. These loans do not involve more than the normal risk of collectibility or present other unfavorable features. All nominees are incumbent directors of CNB Financial Services, Inc. All directors are independent except for Mr. Rokisky, President and CEO of CNB and Charles S. Trump IV, whose firm provides legal services for CNB. Trump and Trump, in which director Charles S. Trump, IV is a partner, performed legal services for CNB and the bank. Fees paid by CNB and the bank to that law firm were $43,463 during 2006. CNB, Charles S. Trump, IV and George I. McVey are members in a Limited Liability Company, Morgan County Title Insurance Agency, LLC, which was formed in February 2001. Morgan County Title Insurance Agency, LLC, paid Trump and Trump management fees of $32,300. Charles S. Trump, IV and George I. McVey are partners in Trump and Trump. ITEM 14. PRINCIPAL ACCOUNTANT'S FEES AND SERVICES The firm of Smith Elliott Kearns & Company, LLC, Certified Public Accountants, has been selected as CNB's independent registered public firm for the year 2007. Representatives of Smith Elliott Kearns & Company, LLC are expected to be present at the Annual Meeting. The representatives may, if they wish, make a statement and, it is expected, will be available to respond to appropriate questions. Smith Elliott Kearns & Company, LLC, advised CNB that no member of that accounting firm has any direct or indirect material interest in CNB or its subsidiary. The following fees were paid by CNB and the bank to Smith Elliott Kearns & Company, LLC:
2006 2005 ------- ------- Audit Fees $68,400 $59,100 Audit-Related Fees (a) -0- 900 Tax Fees (b) 10,010 8,650 All Other Fees (c) 5,500 8,100
(a) Principally consultation about the application of accounting principles to specific transactions and consultation about internal control matters. (b) Principally tax compliance services (including federal and state returns). (c) Principally consultation related to tax depreciation and agreed upon procedures related to the trust department. The audit committee charter requires that the audit committee pre-approve all audit and non-audit services to be provided to the company by the independent accountants; provided, however, that the audit committee has specifically authorized its chairman to pre-approve the provision of any non-audit service to the company. Further, the foregoing pre-approval policies may be waived, with respect to the provision of any non-audit services consistent with the exceptions for federal securities law. All of the services described above for which Smith Elliott Kearns & Company, LLC billed the company for the fiscal year ended December 31, 2006, were pre-approved by the company's audit committee. For the fiscal year ended December 31, 2006, the company's audit committee did not waive the pre-approval requirement of any non-audit services to be provided to CNB by Smith Elliott Kearns & Company, LLC. The audit committee of the board of directors has determined that the provision of such services is compatible with maintaining Smith Elliott Kearns & Company, LLC's independence. 68 PART IV ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES (a) 1. Financial Statements The consolidated financial statements listed on the index to Item 8 of this Annual Report on Form 10-K are filed as a part of this Annual Report. 2. Financial Statement Schedules All schedules applicable to the Registrant are shown in the respective financial statements or in the notes thereto included in this Annual Report. 3. Exhibits 2.2 Articles of Incorporation of CNB Financial Services, Inc. filed as exhibit 3.1 to the Registration Statement on Form S-4 , Registration No. 333-36186, filed May 3, 2000 with the Securities and Exchange Commission and incorporated by reference herein. 2.3 Bylaws of CNB Financial Services, Inc. filed as exhibit 3.2 to the Registration Statement on Form S-4, Registration No. 333-36186, filed May 3, 2000 with the Securities and Exchange Commission and incorporated by reference herein. 14 Code of Ethics filed as an exhibit hereto. 21 Subsidiaries of CNB Financial Services, Inc. filed as an exhibit hereto. 31.1 Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31.2 Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32.1 Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 32.2 Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (b) See (a) 3 above. (c) See (a) 1 and 2 above. 69 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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. CNB Financial Services, Inc. (Registrant) Date March 30, 2007 /s/ Thomas F. Rokisky ---------------------------------------- Thomas F. Rokisky, President/CEO Date March 30, 2007 /s/ Rebecca S. Stotler ---------------------------------------- Rebecca S. Stotler, Vice President/CFO (Principal Financial and Accounting Officer) 70 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacities indicated on the 23th March 2007.
Signatures Title ---------- -------------------------- /s/ J. Philip Kesecker Chairman and Director - ------------------------------------- J. PHILIP KESECKER /s/ Thomas F. Rokisky President/CEO and Director - ------------------------------------- THOMAS F. ROKISKY /s/ Kenneth W. Apple Director - ------------------------------------- KENNETH W. APPLE /s/ J. Robert Ayers Director - ------------------------------------- J. ROBERT AYERS /s/ John E. Barker Director - ------------------------------------- JOHN E. BARKER /s/ Margaret S. Bartles Director - ------------------------------------- MARGARET S. BARTLES /s/ Jay E. Dick Director - ------------------------------------- JAY E. DICK /s/ Herbert L. Eppinger Director - ------------------------------------- HERBERT L. EPPINGER /s/ Robert L. Hawvermale Director - ------------------------------------- ROBERT L. HAWVERMALE /s/ Jerald McGraw Director - ------------------------------------- JERALD MCGRAW /s/ Martha H. Quarantillo Director - ------------------------------------- MARTHA H. QUARANTILLO /s/ Charles S. Trump IV Director - ------------------------------------- CHARLES S. TRUMP IV /s/ Arlie R. Yost Director - ------------------------------------- ARLIE R. YOST
71 EX-14 2 l24084aexv14.txt EX-14 Exhibit 14 CNB FINANCIAL SERVICES, INC. AND CNB BANK, INC. ETHICAL STANDARDS AND CODE OF ETHICS CNB Financial Services, Inc.'s and CNB Bank, Inc.'s (collectively, "CNB") reputation for integrity is one of its most valuable assets and is determined by the conduct of its directors, officers and employees. Each must manage his/her affairs to avoid situations that might lead to a conflict between his/her self-interest and his/her duty to CNB, its customers and shareholders. These Ethical Standards and Code of Ethics are written in the name of CNB, and the guidelines set forth apply solely to CNB Financial Services, Inc, CNB Bank, Inc. and branches now owned or hereafter acquired. As used herein, the term "employee" applies to all directors, officers (including CNB's Chief Executive Officer, Chief Accounting Officer and Chief Financial Officer ("Senior Financial Officers")) and employees, agents or attorneys of CNB. Its purpose is to promote honest and ethical conduct and compliance with all applicable laws, rules and regulations. The Senior Officers are also covered by a separate Code of Ethics. The following paragraphs provide guidance for the exercise of personal judgment and the avoidance of conflicts of interest or the appearance of such conflicts. From time-to-time, everyone will be confronted with situations not clearly covered by this code. When these situations arise, discussion with the President and/or Executive Vice President is appropriate, but in the end, common sense and good judgment will provide the best guidance. 1. Confidential Information: a. Confidential information with respect to CNB, its customers and suppliers, acquired by an employee through his/her employment is considered to be privileged and must be held in the strictest confidence. It is to be used solely for Bank purposes and not as a basis for personal gain by the employee. In no case shall such information be transmitted to persons outside of CNB, including family of employees, or even to other employees of CNB who do not need to know such information to discharge their duties as employees. The restrictions in this paragraph shall also apply to the reports and statements prepared for use in CNB's business and not generally released. b. Financial information regarding CNB and its customers is not to be released to any person unless it has been published in reports to the shareholders or otherwise made generally available to the public. Any questions regarding disclosure of confidential information should be reviewed prior to disclosure with a department supervisor and/or the Executive Vice President or President in accordance with established existing procedures. 2. Insider Information: Insider information is nonpublic material information. The test or materiality is that the information is sufficiently important that it could be expected to affect the judgment of investors whether to buy, sell, or hold stock and, if generally known, would affect materially the market price of stock. Insider information should not be disclosed without prior consultation with the President. An employee for his/her own gain must not use insider information. Attention is also called to the fact that the use or transmittal of insider information could subject the employee and/or CNB to liability under federal securities laws. 3. Personal Investments and Loans: a. Employees shall disclose to their supervisor whenever they or their immediate families have an ownership or beneficial direct or indirect interest in, or are borrowing from, customers, related companies or suppliers of CNB. b. Employees are welcome and encouraged to invest in CNB stock or other types of investments. However, no employee shall engage in such transactions, or enable others to do so, as a result of material insider information obtained either through employment with CNB or from any other source. c. Employees should not engage in unwarranted speculation. d. Employees will not accept offers, which come to them because of their position or make investments at terms more favorable than those generally available. 72 e. Employees will not deprive CNB of a business opportunity for personal gain. 4. Borrowing From or Lending to Suppliers or Customers: a. Employees are not to borrow from customers, brokers, or suppliers of CNB, other than recognized lending institutions or members of the employee's immediate family. The term "borrow" does not include a purchase from a customer or supplier resulting in an extension of credit in a normal course of business, such as a department store. b. Under no circumstances shall an employee cosign, endorse, assume responsibility for, assume power of attorney for, or lend his/her personal funds to a customer or supplier of CNB, except where such customer or supplier is a member of the employee's immediate family. 5. Gifts and Fees: a. Employees shall not accept any gifts, entertainment or other questionable fees from customers, prospective customers or suppliers. b. Employees shall not accept any fee or other form of remuneration, which violates the law and, in any event, shall not accept any fee or other form of remuneration from CNB customers, prospective customers or suppliers without the prior approval of the Senior Officers. It is important to remember that federal law makes it a crime for a CNB employee to receive anything of value from anyone or give anything of value to anyone in return for any business, service, or confidential information of the Bank and from accepting or giving anything of value from anyone in connection with the business of the Bank, either before or after a transaction is discussed or consummated. (Reference: Bank Bribery - 18 USC 215) c. Employees, as a result of their position with CNB, shall not directly or indirectly accept any bequest or legacy from a CNB customer, except where such customer is a relative. If an employee learns of such a legacy as a result of a customer's probated will, he/she shall report all pertinent facts to CNB Senior Officers, who in turn, shall decide on the appropriateness of the acceptance of such a legacy or bequest. 6. Dealing with Suppliers to CNB: CNB employees will select suppliers in a completely impartial manner on the basis of price, quality, performance and suitability of the product or service. Each employee is expected to avoid doing anything which could imply selection of a supplier on any basis other than the best interests of CNB or which could give any supplier an improper advantage over another. 7. Loans to Relatives: Employees are prohibited from approving extensions of credit to relatives or persons or businesses with which they are in any way affiliated. 8. Purchase of CNB Assets: In order that CNB employees avoid a conflict of interest or the appearance of a conflict of interest, no employee or family member should purchase assets of CNB or of a trust or estate administered by CNB expect at public sale, or for reasonable value if approved by the Senior Officers. 9. Personal Use of CNB Premises and Equipment: a. The use of CNB's bank equipment and premises for personal purposes by employees is restricted, and the supervisor of the department in which the equipment is located must authorize any usage. b. An appropriate fee or price may be charged for the personal use of any CNB equipment. The supervisor in charge of the department will determine this fee or price. 10. Access to Personal and Customer Accounts: 73 Unauthorized and improper access to personal accounts and those of CNB's customers shall not be permitted. 11. Giving Advice to Customers: No employee shall give legal, accounting, or investment advice of any material nature to a customer, or a prospective customer, expect as may be necessary or appropriate in the performance of a fiduciary duty or as may be otherwise required in the ordinary course of his/her duties. Questions of this nature should be referred to independent, outside accountants and lawyers. When referrals to professionals are made, several names should be provided without any indication of favoritism. 12. Fiduciary Appointments: Except with respect to the estate of or a trust created by a member of an employee's family, an employee should not seek or accept appointment as executor, trustee, trust advisor, or guardian except with the written approval of Senior Officers. 13. Outside Activities: a. Employees should not engage in a business activity or any employment in addition to their duties to CNB and its shareholders. Employees shall discuss with Senior Officers all proposed outside employment and directorship of institutions, which are not purely social, civic, religious, fraternal or philanthropic. Outside employment may be considered only in cases of extreme financial hardship. b. Under no circumstances should any employee of CNB accept any position for compensation or without compensation, either within or outside CNB, which will result in or, in the foreseeable future, is likely to result in a conflict of interest with his/her position at CNB. If there is any possibility of present or future conflict of interest, an employee is obligated to inform Senior Officers through his/her manager of the facts and circumstances of the situation and obtain the approval of the Senior Officers before accepting the position. c. Entering into any sort of joint business venture with a customer or supplier of CNB should be avoided under all circumstances. For the employee's own protection, any exception must always be reviewed in advance with a Senior Officer of CNB. 14. Political Activities: a. CNB employees are encouraged to keep themselves well informed about political issues and candidates and take an active interest in governmental affairs. Whenever they do so, they act as individuals and not as representatives of CNB. Any campaigning that is done shall not diminish the employee's commitment to perform his/her job. b. In order to avoid any conflicts of interest, employees should discuss any contemplated political candidacy with the Senior Officers. c. To avoid any interpretation, of CNB sponsorship or endorsement, neither CNB's name nor its address should be used in any material mailed for fund solicitation nor should CNB be identified in any advertisement or literature except in relation to a statement regarding place of employment. d. CNB time, supplies, equipment and resources are not available to support political activities of employees in either a direct or indirect manner. e. CNB shall charge the usual rate then in effect for any banking services furnished within the ordinary course of business. 15. Improper Payments: a. Employees are expected to comply with the laws and regulations of the United States and other countries in which they may be operating. The use of corporate funds for any purpose which contravenes the laws and regulations of the United States and such other countries is strictly prohibited. 74 b. CNB and its employees will not directly or indirectly pay bribes or otherwise attempt to improperly influence any governmental, political, labor, or related persons or group in any city, county, state or country. 16. Convictions: CNB will not employ or retain employees who have been convicted of any act of dishonesty or breach of trust. 17. Personal Conduct: Employees, during or after work hours, should avoid involvement in any situations, incidents, or dealings where such involvement by an employee would be detrimental to the integrity and/or image of CNB. 18. Failure to Comply: Any violation of CNB Ethical Standards and Code of Ethics is a most serious matter and will be grounds for formal disciplinary action, which includes termination of employment. Such action is in addition to any individual criminal liability, which might be imposed by applicable federal, state or local laws. 19. Complying with Laws, Regulations, Policies and Procedures All directors, officers and employees of CNB are expected to understand, respect and comply with all of the laws, regulations, policies and procedures that apply to them in their respective positions with CNB. Employees are responsible for talking with their supervisor to determine which laws, regulations and CNB policies apply to their position and what training is necessary to understand and comply with them. 20. Public Company Reporting: As a public company, it is of critical importance that CNB Financial Services, Inc.'s filings with the Securities and Exchange Commission be accurate and timely. Depending upon their position with CNB Financial Services, Inc., or CNB Bank, Inc., an employee, officer or director may be called upon to provide necessary information to assure that CNB Financial Services, Inc.'s public reports are complete, fair and understandable. CNB expects employees, officers and directors to take this responsibility very seriously and to provide prompt, accurate answers to inquiries related to CNB Financial Service, Inc.'s public disclosure requirements. 21. Financial Statements and Other Records: All of CNB's books, records, accounts and financial statements must be maintained in reasonable detail, must appropriately reflect CNB's transactions and must conform both to applicable legal requirements and to CNB's system of internal controls. Unrecorded or "off the books" funds or assets should not be maintained unless permitted by applicable law or regulation. Records should always be retained or destroyed according to CNB's record retention policies. In accordance with these policies, in the event of litigation or governmental investigation, please consult a Senior Officer. 22. Reporting Illegal or Unethical Behavior: Employees, officers and directors who suspect or know of violations of this Code or illegal or unethical business or workplace conduct by employees, officers or directors have an obligation to contact either their supervisor or superiors or the appropriate contact of CNB's Audit Committee. If the individuals to whom such information is conveyed are not responsive, or if there is reason to believe that reporting to such individuals is inappropriate in particular cases, then the employee, officer or director may contact CNB's external auditors. Such communications will be kept confidential to the extent feasible. If concerns or complaints require confidentiality, then this confidentiality will be protected to the extent feasible, subject to applicable law. 75 23. Accounting Complaints: CNB's policy is to comply with all applicable financial reporting and accounting regulations. If any director, officer or employee of CNB has unresolved concerns or complaints regarding questionable accounting or auditing matters of CNB, then he or she is encouraged to submit those concerns or complaints (anonymously, confidentially or otherwise) to the Chairman of the Audit Committee of CNB Financial Services, Inc. Subject to its legal duties, the Audit Committee and the Board of Directors of CNB Financial Services, Inc., will treat such submissions confidentially. Such submissions may be directed to the attention of the Chairman of the Audit Committee or any director who is a member of the Audit Committee, at the principal executive offices of CNB. 24. Non-Retaliation: CNB prohibits retaliation of any kind against individuals who have made good faith reports or complaints of violations of this Code or other known or suspected illegal or unethical conduct. 25. Amendment, Modification and Waiver: This Code may be amended or modified by the Board of Directors of CNB Financial Services, Inc. Waivers will be disclosed to shareholders as required by the Securities Exchange Act of 1934, and the rules thereunder. 76 EX-21 3 l24084aexv21.txt EX-21 Exhibit 21 CNB Financial Services, Inc. Subsidiaries of CNB Financial Services, Inc. CNB Bank, Inc. Morgan County Title Insurance Agency, LLC (33% owned) Subsidiary of CNB Bank, Inc. CNB Insurance Services, Inc. 77 EX-31.1 4 l24084aexv31w1.txt EX-31.1 Exhibit 31.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 CERTIFICATION I, Thomas F. Rokisky, certify that: 1. I have reviewed this annual report on Form 10-K of CNB Financial Services, Inc.; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial conditions, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report. 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15e and 15d-15e) for the registrant and have: a. designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b. evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this annual report based on such evaluation; and c. disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal year (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial report Date: March 30, 2007 /s/ Thomas F. Rokisky ---------------------------------------- Thomas F. Rokisky Chief Executive Officer 78 EX-31.2 5 l24084aexv31w2.txt EX-31.2 Exhibit 31.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 CERTIFICATION I, Rebecca S. Stotler, certify that: 1. I have reviewed this annual report on Form 10-K of CNB Financial Services, Inc.; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial conditions, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report. 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15e and 15d-15e) for the registrant and have: a. designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b. evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this annual report based on such evaluation; and c. disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal year (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a. all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b. any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial report Date: March 30, 2007 /s/ Rebecca S. Stotler ---------------------------------------- Rebecca S. Stotler Chief Financial Officer 79 EX-32.1 6 l24084aexv32w1.txt EX-32.1 Exhibit 32.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 Pursuant to Section 1350, Chapter 63 of Title 18, United States Code, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, the undersigned, as Chief Executive Officer of CNB Financial Services, Inc. (the "Company"), does hereby certify that: (1) The Company's Annual Report on Form 10-K (the "Report"), fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. /s/ Thomas F. Rokisky ---------------------------------------- Thomas F. Rokisky Chief Executive Officer March 30, 2007 80 EX-32.2 7 l24084aexv32w2.txt EX-32.2 Exhibit 32.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 Pursuant to Section 1350, Chapter 63 of Title 18, United States Code, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, the undersigned, as Chief Executive Officer of CNB Financial Services, Inc. (the "Company"), does hereby certify that: (1) The Company's Annual Report on Form 10-K (the "Report"), fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. /s/ Rebecca S. Stotler ---------------------------------------- Rebecca S. Stotler Chief Financial Officer March 30, 2007 81 -----END PRIVACY-ENHANCED MESSAGE-----