ITEM 1. BUSINESS
DESCRIPTION OF BUSINESS
City National Bancshares Corporation (the "Corporation" or "CNBC") is a New Jersey corporation incorporated on January 10, 1983. At December 31, 2003, CNBC had consolidated total assets of $236.4 million, total deposits of $198.4 million and stockholders' equity of $14.3 million. In addition to its principal subsidiary, City National Bank of New Jersey (the "Bank" or "CNB"), a nationally chartered commercial bank which commenced operations on June 11, 1973, the Corporation formed a subsidiary during 2002, City National Bank Capital Trust I, through which it issued trust preferred securities.
CNB is a national banking association chartered in 1973 under the laws of the United States of America and has one subsidiary, City National Investments, Inc., an investment company which holds, maintains and manages investment assets for CNB. CNB is minority owned and operated and therefore eligible to participate in certain federal government programs. CNB is a member of the Federal Reserve Bank, the Federal Home Loan Bank and the Federal Deposit Insurance Corporation. CNB provides a wide range of retail and commercial banking services through its retail branch network. Deposit services include savings, checking, certificates of deposit, money market and retirement accounts. The Bank also provides many forms of small to medium size business financing, including revolving credit, credit lines, term loans and all forms of consumer financing, including auto, home equity and mortgage loans and maintains banking relationships with several major domestic corporations.
In November, 2001 the United States Department of the Treasury designated both City National Bancshares Corporation and City National Bank as community development enterprises ("CDE's"). This designation means that the Department of Treasury has formally recognized CBNC and CNB for "having a primary purpose of promoting community development" and will facilitate attracting capital by allowing both entities to benefit from the federal government's New Market Tax Program.
The Bank has been, and intends to continue to be, a community-oriented financial institution providing financial services and loans for housing and commercial businesses within its market area. The Bank oversees its nine-branch office network from its headquarters located in downtown Newark, New Jersey. The Bank operates three branches (including the headquarters) in Newark, and one each in Hackensack and Paterson, New Jersey. As a result of the acquisitions of two branches from Carver Federal Savings Bank ("Carver"), the Bank also operates a branch in Brooklyn, New York and one in Roosevelt, Long Island. The Bank opened de novo branches in Hempstead, Long Island in 2002 and Manhattan, New York in 2003.
The Bank gathers deposits primarily from the communities and neighborhoods in close proximity to its branches. Although the Bank lends throughout the New York City metropolitan area, the substantial majority of its real estate loans are secured by properties located in New Jersey. The Bank's customer base, like that of the urban neighborhoods which it serves, is racially and ethnically diverse and is comprised of mostly low to moderate income households. The Bank has sought to set itself apart from its many competitors by tailoring its products and services to meet the needs of its customers, by emphasizing customer service and convenience and by being actively involved in community affairs in the neighborhoods and communities which it serves. The Bank believes that its commitment to customer and community service has permitted it to build strong customer identification and loyalty, which is essential to the Bank's ability to compete effectively. The Bank offers various investment products, including mutual funds.
The Bank does not have a trust department. Sales of annuities and mutual funds are offered to customers under a networking agreement with the Independent Community Bankers of America.
COMPETITION
The market for banking and bank related services is highly competitive. The Bank competes with other providers of financial services such as other bank holding companies, commercial banks, savings and loan associations, credit unions, money market and mutual funds, mortgage companies, and a growing list of other local, regional and national institutions which offer financial services. Mergers between financial institutions within New Jersey and in neighboring states have added competitive pressures. Competition is expected to intensify as a consequence of interstate banking laws now in effect or that may be in effect in the future. CNB competes by offering quality products and convenient services at competitive prices. CNB regularly reviews its products and locations and considers various branch acquisition prospects.
Management believes that as New Jersey's only African-American owned and controlled Bank, it has a unique ability to provide commercial banking services to low and moderate income segments of the minority community.
SUPERVISION AND REGULATION
The banking industry is highly regulated. The following discussion summarizes some of the material provisions of the banking laws and regulations affecting City National Bancshares Corporation and City National Bank of New Jersey.
GOVERNMENTAL POLICIES AND LEGISLATION
The policies of regulatory authorities, including the Federal Reserve Bank and the Federal Deposit Insurance Corporation, have had a significant effect on the operating results of commercial banks in the past and are expected to do so in the future. An important function of the Federal Reserve Bank is to regulate national monetary policy by such means as open market dealings in securities, the establishment of the discount rate on member bank borrowings, and changes in reserve requirements on member bank deposits.
The efforts of national monetary policy have a significant impact on the business of the Bank, which is measured and managed through its interest rate risk policies.
The Federal Open Market Committee lowered the target Federal funds rate from 1.25% to 1.00% in 2003. The three-month U.S. Treasury bill rate started 2003 at 1.19%, declining to .92% at the end of the year. As a result of the continued low interest rate environment, the Bank lowered its prime lending rate once during 2003, from 4.25% to 4.00%, after reducing it from 4.75% to 4.25% in 2003. Rates earned on the Corporation's interest-earning assets and rates paid on interest-bearing liabilities declined in 2003 compared to 2002.
BANK HOLDING COMPANY REGULATIONS
CNBC is a bank holding company within the meaning of the Bank Holding Company Act (the "Act") of 1956, and as such, is supervised by the Board of Governors of the Federal Reserve System (the "FRB").
The Act prohibits CNBC, with certain exceptions, from acquiring ownership or control of more than five percent of the voting shares of any company which is not a bank and from engaging in any business other than that of banking, managing and controlling banks or furnishing services to subsidiary banks. The Act also requires prior approval by the FRB of the acquisition by CNBC of more than five percent of the voting stock of any additional bank. The Act also restricts the types of businesses, activities, and operations in which a bank holding company may engage.
The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the "Interstate Banking and Branching Act") enabled bank holding companies to acquire banks in states other than its home state, regardless of applicable state law. The Interstate Banking and Branching Act also authorized banks to merge across state lines, thereby creating interstate branches. Under such legislation, each state had the opportunity to "opt out" of this provision. Furthermore, a state may "opt-in" with respect to de novo branching, thereby permitting a bank to open new branches in a state in which the bank does not already have a branch. Without de novo branching, an out-of-state commercial bank can enter the state only by acquiring an existing bank or branch. The vast majority of states have allowed interstate banking by merger but not authorized de novo branching.
New Jersey enacted legislation to authorize interstate banking and branching and the entry into New Jersey of foreign country banks. New Jersey did not authorize de novo branching into the state. However, under federal law, federal savings banks which meet certain conditions may branch de novo into a state, regardless of state law.
On November 12, 1999, the President signed the Gramm-Leach-Bliley Financial Modernization Act of 1999 into law. The Modernization Act will allow bank holding companies meeting management, capital and Community Reinvestment Act standards to engage in a substantially broader range of nonbanking activities than currently is permissible, including insurance underwriting and making merchant banking investments in commercial and financial companies. If a bank holding company elects to become a financial holding company, it may file a certification, effective in 30 days, and thereafter may engage in certain financial activities without further approvals. It also allows insurers and other financial services companies to acquire banks, removes various restrictions that currently apply to bank holding company ownership of securities firms and mutual fund advisory companies and establishes the overall regulatory structure applicable to bank holding companies that also engage in insurance and securities operations.
The Modernization Act also modifies other current financial laws, including laws related to financial privacy and community reinvestment.
REGULATION OF BANK SUBSIDIARY
CNB is subject to the supervision of, and to regular examination by the Office of the Comptroller of the Currency of the United States (the "OCC").
Various laws and the regulations thereunder applicable to CNB impose restrictions and requirement in many areas, including capital requirements, the maintenance of reserves, establishment of new offices, the making of loans and investments, consumer protection and other matters. There are various legal limitations on the extent to which a bank subsidiary may finance or otherwise supply funds to its holding company or its non-bank subsidiaries. Under federal law, no bank subsidiary may, subject to certain limited exceptions, make loans or extensions of credit to, or investments in the securities of, its parent or nonbank subsidiaries of its parent (other than direct subsidiaries of such bank) or, subject to broader exceptions, take their securities as collateral for loans to any borrower. Each bank subsidiary is also subject to collateral security requirements for any loans or extension of credit permitted by such exceptions.
CNBC is a legal entity separate and distinct from its subsidiary bank. CNBC's revenues (on a parent company only basis) result from dividends paid to CNBC by its subsidiary. Payment of dividends to CNBC by CNB, without prior regulatory approval, is subject to regulatory limitations. Under the National Bank Act, dividends may be declared only if, after payment thereof, capital would be unimpaired and remaining surplus would equal 100% of capital. Moreover, a national bank may declare, in any one year, dividends only in an amount aggregating not more than the sum of its net profits for such year and its retained net profits for the preceding two years. In addition, the bank regulatory agencies have the authority to prohibit a bank subsidiary from paying dividends or otherwise supplying funds to a bank holding company if the supervising agency determines that such payment would constitute an unsafe or unsound banking practice.
Under the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 ("FIRREA"), a depository institution insured by the FDIC can be held liable for any loss incurred by, or reasonably expected to be incurred by, the FDIC in connection with the default of a commonly controlled FDIC-insured depository institution or any assistance provided by the FDIC to a commonly controlled FDIC-insured depository institution in danger of default, or deferred by the FDIC. Further, under FIRREA, the failure to meet capital guidelines could subject a banking institution to a variety of enforcement remedies available to federal regulatory authorities, including the termination of deposit insurance by the FDIC.
The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") requires each federal banking agency to revise its risk-based capital standards to ensure that those standards take adequate account of interest rate risk, concentration of credit risk and the risks of non-traditional activities. In addition, each federal banking agency has promulgated regulations, specifying the levels at which a financial institution would be considered "well capitalized", "adequately capitalized", "undercapitalized", "significantly undercapitalized", or "critically undercapitalized", and to take certain mandatory and discretionary supervisory actions based on the capital level of the institution.
The OCC's regulations implementing these provisions of FDICIA provide that an institution will be classified as "well capitalized" if it has a total risk-based capital ratio of at least 10%, has a Tier 1 risk-based capital ratio of at least 6%, has a Tier 1 leverage ratio of at least 5%, and meets certain other requirements. An institution will be classified as "adequately capitalized" if it has a total risk-based capital ratio of at least
8%, has a Tier 1 risk-based capital ratio of at least 4%, and has Tier 1 leverage ratio of at least 4%. An institution will be classified as "undercapitalized" if it has a total risk-based capital ratio of less than 6%, has a Tier 1 risk-based capital ratio of less than 3%, or has a Tier 1 leverage ratio of less than 3%. An institution will be classified as "significantly undercapitalized" if it has a total risk-based capital ratio of less than 6%, or a Tier I risk-based capital ratio of less than 3%, or a Tier I leverage ratio of less than 3%. An institution will be classified as "critically undercapitalized" if it has a tangible equity to total assets ratio that is equal to or less than 2%. An insured depository institution may be deemed to be in a lower capitalization category if it receives an unsatisfactory examination.
Insured institutions are generally prohibited from paying dividends or management fees if after making such payments, the institution would be "undercapitalized". An "undercapitalized" institution also is required to develop and submit to the appropriate federal banking agency a capital restoration plan, and each company controlling such institution must guarantee the institution's compliance with such plan.
COMMUNITY REINVESTMENT
Under the Community Reinvestment Act ("CRA"), as implemented by OCC regulations, a national bank has a continuing and affirmative obligation consistent with its safe and sound operation to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institution's discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the CRA. The CRA requires the OCC, in connection with its examination of a national bank, to assess the association's record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications by such association. The CRA also requires all institutions to make public disclosure of their CRA ratings. CNB received an "Outstanding" CRA rating in its most recent examination.
GOVERNMENT POLICIES
The earnings of the Corporation are affected not only by economic conditions, but also by the monetary and fiscal policies of the United States and its agencies, especially the Federal Reserve Board. The actions of the Federal Reserve Board influence the overall levels of bank loans, investments and deposits and also affect the interest rates charged on loans or paid on deposits. The monetary policies of the Federal Reserve Board have had a significant affect on the operating results of commercial banks in the past and are expected to do so in the future. The nature and impact of future changes in monetary and fiscal policies on the earnings of the Corporation cannot be determined.
EMPLOYEES
On December 31, 2003, CNBC and its subsidiaries had 97 full-time equivalent employees. Management considers relations with employees to be satisfactory.
ITEM 2.
ITEM 2. PROPERTIES
The corporate headquarters and main office as well as the operations and data processing center of CNBC and CNB are located in Newark, New Jersey in a building owned by CNB. The Bank has four other branch locations in New Jersey and four in the state of New York. Four of the locations are in leased space while the others are owned by the Bank.
The New Jersey branch offices are located in Newark and Hackensack, all owned, and in Paterson, which is leased. The New York branches are located in Roosevelt and Hempstead, Long Island, both of which are leased and in Harlem and Brooklyn, New York, which is owned. The Harlem branch is leased, while the Brooklyn branch is owned.
In addition to its branch network, the Bank currently maintains five ATM's at remote sites.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
In May of 1998, CNB commenced a lawsuit against an entity that acted as an agent for CNB in the sale of CNB's money orders, and certain affiliates of such entity for fraud and other damages. CNB alleged, among other things, that at various times during its business relationship with the defendants, the defendants stole, misappropriated, hypothecated or embezzled a sum of approximately $805,000 from CNB. CNB has been awarded a $1.7 million judgment, representing the loss, cost of collection and interest. CNB has filed appropriate proofs of loss under various insurance policies, including CNB's fidelity bond. It is unlikely that CNB will receive any of the judgment, and the amount that CNB will ultimately recover, if any, under the insurance policy cannot be determined.
During 2003, the Bank incurred a credit card fraud loss of $295,000. The Bank has filed a claim with its fidelity bond carrier to recover this loss and is contemplating legal action. The amount that CNB will ultimately recover, if any, under the insurance policy or from such legal action cannot be determined.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of 2003 there were no matters submitted to stockholders for a vote.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDERS MATTERS
The Corporation's common stock, when publicly traded, is traded over-the-counter. The common stock is not listed on any exchange and is not quoted on the National Association of Securities Dealers' Automated Quotation System. The last customer trade effected by a market maker was unsolicited and occurred on November 2, 1990. No price quotations are currently published for the common stock, nor is any market maker executing trades. No price quotations were published during 2002.
At February 25, 2004, the Corporation had 1,493 common stockholders of record.
On April 7, 2003, the Corporation paid a cash dividend of $2.50 per share to stockholders of record on April 10, 2003. Whether cash dividends on the common stock will be paid in the future depends upon various factors, including the earnings and financial condition of the Bank and the Corporation at the time. Additionally, federal and state laws and regulations contain restrictions on the ability of the Bank and the Corporation to pay dividends.
FORM 10-K
THE ANNUAL REPORT FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON FORM 10-K IS AVAILABLE WITHOUT CHARGE UPON WRITTEN REQUEST TO CITY NATIONAL BANCSHARES CORPORATION, EDWARD R. WRIGHT, SENIOR VICE PRESIDENT AND CHIEF FINANCIAL OFFICER, 900 BROAD STREET, NEWARK, NEW JERSEY, 07102.
TRANSFER AGENT Registrar and Transfer Company 10 Commerce Drive Cranford, NJ 07016
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
FIVE-YEAR SUMMARY
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The purpose of this analysis is to provide information relevant to understanding and assessing the Corporation's results of operations for each of the past three years and financial condition for each of the past two years.
CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS
This management's discussion and analysis contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are not historical facts and include expressions about management's expectations about new and existing programs and products, relationships, opportunities, and market conditions. Such forward-looking statements involve certain risks and uncertainties. These include, but are not limited to, unanticipated changes in the direction of interest rates, effective income tax rates, loan prepayment assumptions, deposit growth, the direction of the economy in New Jersey and New York, continued levels of loan quality, continued relationships with major customers as well as the effects of general economic conditions and legal and regulatory issues and changes in tax regulations. Actual results may differ materially from such forward-looking statements. The Corporation assumes no obligation for updating any such forward-looking statement at any time.
EXECUTIVE SUMMARY
The primary source of the Corporation's income comes from net interest income, which represents the excess of interest earned on earning assets over the interest paid on interest-bearing liabilities. This income is subject to interest rate risk resulting from changes in interest rates. The most significant component of the Corporation's interest earning assets is the loan portfolio. In addition to the aforementioned interest rate risk, the portfolio is subject to credit risk.
Net income rose to $1,721,000 in 2003 from to $1,720,000 in 2002 due primarily to an increase in net interest income offset by higher operating expenses. Included in both years' earnings were awards received from the U.S. Treasury's Community Development Financial Institution ("CDFI") Fund. The awards were based in part on the Bank's lending efforts in qualifying lower income communities. Award income was $94,000 in 2003 compared to $343,000 in 2002. Additionally, the Bank recorded award income related to deposits made in other CDFI's of $386,000 in 2003 and $384,000 in 2002, respectively. Finally, additional award income of $3,000 was also recorded, representing an award received for opening a branch office in a low-income area. In total, $483,000 of award income was recorded in 2003, while $727,000 was recorded in 2002. Excluding these awards, net income would have totaled $1,409,000 and $1,247,000 in 2003 and 2002, respectively. These awards are dependent on the availability of funds in the CDFI Fund as well as the Bank meeting various qualifying standards. Accordingly, there is no assurance that the Bank will continue to receive these awards in the future.
Total assets increased 9.8% to $236.4 million at the end of 2003 from $215.2 million a year earlier, while average assets rose 7.2% in 2003, due primarily to deposit growth.
CASH AND DUE FROM BANKS
Cash and due from banks rose to $7.4 million at the end of 2003 from $6 million a year earlier. Average cash and due from banks for 2003 totalled $6.6 million, unchanged from a year earlier.
FEDERAL FUNDS SOLD
Federal funds sold declined to $4.5 million at the end of 2003 from $6.2 million at December 31, 2002, while the related average balance decreased 35% to $11.7 million from $18 million in 2002. Both decreases occurred due to the reinvestment into higher earning assets, primarily into the loan portfolio. The Corporation has been steadily reducing its Federal funds sold balances in recent years in an attempt to better utilize funds considered excess liquidity. Management expects to continue this trend.
INTEREST-BEARING DEPOSITS WITH BANKS
Interest-bearing deposits with banks increased to $3.7 million at December 31, 2003 from $3.5 million a year earlier, while the related average balances was $3.6 million for both years. The deposits represent the Bank's participation in the CDFI deposit program. Under this program, the Bank became eligible for an award based on deposits made in other CDFI's. $386,000 and $384,000 were recorded as interest income from interest-bearing deposits with banks in 2003 and 2002, and are considered a yield enhancement on the CDFI deposits.
INVESTMENTS
The investment securities available for sale ("AFS") portfolio declined to $47.3 million at December 31, 2003 from $50.4 million a year earlier, while the related gross unrealized net loss amounted to $48,000 compared to a gain of $526,000 due to the effects of an increase in interest rates.
Mortgage-backed securities ("MBS"), comprised 61.7% of the AFS portfolio at the end of 2003 compared to 47.3% a year earlier, as the Corporation sought to mitigate its interest rate risk by reducing its purchases of bullet investments.
The investment securities held to maturity ("HTM") portfolio totaled to $29.9 million at December 31, 2003, relatively unchanged from $29.6 million a year earlier.
At December 31, 2003, the Bank held callable U.S. Government agency notes with a carrying value of $11.5 million, of which $11.3 million were included in the HTM portfolio. These notes are callable at par at various dates from 2004 until maturity. These callable securities reflect gross unrealized depreciation of $101,000. Favorable spreads provide compensation for the interest rate risk inherent in this investment due to the call feature. Management believes that holding the callable securities will not have a significant impact upon the financial condition of the Corporation.
Reinvestment of proceeds from early redemptions of callable notes in a lower interest rate environment could have a significant impact on the operations of the Corporation. Measurement of this impact, along with other aspects of the Corporation's interest rate risk, is performed quarterly.
The most significant change in the AFS portfolio was an increase in the weighted average life, which at December 31, 2003 was 9.16 years compared to 5.95 years at the end of 2002. The greatest impact on this increase came from the MBS portfolio, in which the average life more than doubled in 2003. Average duration in the portfolio rose correspondingly, from 3.42 to 5.77, also due to the MBS portfolio.
All the mortgage-backed securities held by the Corporation are issued or backed by federal agencies. The mortgage-backed securities portfolio is a source of significant liquidity to the Corporation through the monthly cash flow of principal and interest. Mortgage-backed securities, like all securities, are sensitive to changes in the interest rate environment, increasing and decreasing in value as interest rates fall and rise. As interest rates fall, the increase in prepayments can reduce the yield on the mortgage-backed securities portfolio, and reinvestment of the proceeds will be at lower yields. Conversely, rising interest rates will reduce cash flows from prepayments and extend anticipated duration of these assets. The Corporation monitors the changes in interest rates, cash flows and duration. During 2003, substantial prepayments were received and reinvested at lower yields. This negatively impacted the yield on the investment portfolio. Continued low interest rates during 2004 will likely have similar results.
The MBS portfolio was also affected by the rising long-term interest rate environment during the last quarter of 2003, which decreased prepayment speeds, thus lengthening average lives.
The weighted average life of the HTM portfolio also rose, to 7.65 years at December 31, 2003 compared to 5.57 years at the end of 2002, while average duration also rose to 5.33 from 3.96. The MBS portfolio was the primary contributor to these increases as well.
Information pertaining to the average weighted yields of investments in debt securities at December 31, 2003 is presented below. Maturities of mortgaged-backed securities included with U.S. Government agencies are based on the maturity of the final scheduled payment. Such securities, which comprise most of the balances shown as maturing beyond five years, generally amortize on a monthly basis and are subject to prepayment.
Average yields are computed by dividing the annual interest, net of premium amortization and including discount accretion, by the amortized cost of each type of security outstanding at December 31, 2003. Average yields on tax-exempt obligations of state and political subdivisions have been computed on a fully taxable equivalent basis, using the statutory Federal income tax rate of 34%.
The average yield on the AFS portfolio decreased to 4.36% at December 31, 2003 from 4.47% at December 31, 2002, while the yield on the HTM portfolio rose five basis points to 6.23% at December 31, 2003 from 6.18% at December 31, 2002.
The following table sets forth the carrying value of the Corporation's portfolio for the three years ended December 31:
CONSOLIDATED AVERAGE BALANCE SHEET WITH RELATED INTEREST AND RATES
(1) Includes $386,000 in 2003, $384,000 in 2002 and $97,000 in 2001, representing thirty-three, twenty and six basis point additions to net interest income in 2003, 2002 and 2001 respectively, attributable to income received under the U.S. Treasury Department's Bank Enterprise Award certificate of deposit program.
(2) Includes investment securities available for sale and held to maturity at amortized cost.
(3) Includes nonperforming loans.
(4) Includes loan fees $416,000, $279,000 and $162,000 in 2003, 2002 and 2001 respectively.
(5) Includes noninterest bearing deposits maintained by a state governmental agency of $694,000 in 2003, and $294,000 in 2002 and 2001.
(6) The tax equivalent adjustment was computed assuming a 34% statutory federal income tax rate in 2003, 2002 and 2001.
(7) Includes $94,000 in 2003 attributable to income received under the U.S. Treasury Department's Bank Enterprise Award loan program representing eight basis points.
The table below set forth, on a fully tax-equivalent basis, an analysis of the increase (decrease) in net interest income resulting from the specific components of income and expenses due to changes in volume and rate. Because of the numerous simultaneous balance and rate changes, it is not possible to precisely allocate such changes between balances and rates. Therefore, for purposes of this table, changes which are not due solely to balance and rate changes are allocated to rate.
LOANS
Loans rose 20.7% to $131.8 million December 31, 2003 from $109.2 million a year earlier. Most of the loan increase occurred in the commercial real estate portfolio.
Loans held for sale amounted to $552,000 at December 31, 2003, while there were no loans held for sale at December 31, 2002. Loan originations and sales cash rose in 2003 compared to 2002 due to increased refinancings from the favorable interest rate environment.
Residential mortgage loans, including home equity loans, represent an insignificant part of the Bank's lending business. Such loans that have long-term fixed rates are generally sold into the secondary market, although some loans maybe retained in the portfolio to balance the Bank's loan mix and provide collateral for Federal Home Loan Bank borrowings. Consumer loans, including automobile loans, also comprise a relatively small part of the loan portfolio.
At December 31, 2003, loans to churches totalled $29.3 million, representing 13.6% of total loans outstanding, all of which are secured by real estate, compared to $14.9 million and 22.2% at December 31, 2002. Management does not believe that this loan concentration exposes the Corporation to any unusual degree of risk. Most of the Bank's lending efforts are in northern New Jersey, Manhattan and Nassau County.
The Bank generally secures its loans by obtaining primarily first liens on real estate, both residential and commercial, and does virtually no asset-based financing. Without additional side collateral, the Bank generally requires maximum loan-to-value ratios of 70% for loan transactions secured by commercial real estate. The Bank expects to maintain the aforementioned types of lending.
MATURITIES AND INTEREST SENSITIVITIES OF LOANS
Information pertaining to contractual maturities without regard to normal amortization and the sensitivity to changes in interest rates of loans at December 31, 2003 is presented below.
The following table reflects the composition of the loan portfolio for the five years ended December 31:
SUMMARY OF LOAN LOSS EXPERIENCE
Changes in the allowance for loan losses are summarized below.
The allowance for loan losses is a critical accounting policy and is maintained at a level determined by management to be adequate to provide for inherent losses in the loan portfolio. The allowance is increased by provisions charged to operations and recoveries of loan charge-offs. The allowance is based on management's evaluation of the loan portfolio and several other factors, including past loan loss experience, general business and economic conditions, concentration of credit and the possibility that there may be inherent losses in the portfolio which cannot currently be identified. Although management uses the best information available, the level of the allowance for loan losses remains an estimate which is subject to significant judgment and short-term change.
A standardized method is used to assess the adequacy of the allowance and to identify the risks inherent in the loan portfolio. This process includes the ongoing assessment of individual borrowers' financial condition and payment records and gives consideration to areas of exposure such as conditions within the borrowers' industry, the value of underlying collateral, and the composition of the performing and non-performing loan portfolios. Specific allocations are identified by loan category and allocated according to prior charge-off history as well as future performance projections. All loans are graded and incorporated in the process of assessing the adequacy of the reserve. The allowance is maintained at a level considered sufficient to absorb estimated losses in the loan portfolio, and allowances not allocated to specific loan categories are considered unallocated and evaluated based on management's assessment of the portfolio's risk profile as well as current business and economic conditions in the Bank's market area.
The allowance represented 1.67% of total loans at December 31, 2003 compared to 1.92% a year earlier. The nominal increase in the allowance compared to the increase in the loan portfolio reflects the continued low net charge-off level in the portfolio, as well as an improvement in current business and economic conditions in the Bank's market area.
ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses has been allocated based on management's estimates of the risk elements within the loan categories set forth below at December 31.
Allowance allocations are subject to change based on the levels of classified loans in each segment of the portfolio. The minimum levels of reserves by internal loan classification are .25% for pass loans, 1% for special mention loans, 5% for substandard loans, 50% for doubtful loans, and 100% for loss loans. These minimum reserve levels have been consistently applied for all reported periods. The unallocated allocation is based upon management's evaluation of the underlying inherent risk in the loan portfolio that has not been measured on an individual basis. Such evaluation includes economic and business conditions within the Bank's market area, portfolio concentrations, credit quality and delinquency trends. An additional factor is the demographics in the Bank's market area. Because CNB serves primarily low to moderate income communities, in general, the inherent credit risk profile of the loans it makes has a greater degree of risk than if a more economically diverse demographic area were served.
NONPERFORMING ASSETS
Information pertaining to nonperforming assets at December 31 is summarized below.
Nonperforming assets rose $134,000 to $1,526,000 at December 31, 2003, from $1,392,000 a year earlier. The increase reflects an increase in nonperforming commercial real estate loans. OREO is carried net of a $63,000 reserve at December 31, 2003 and at December 31, 2002.
DEPOSITS
The Bank's deposit levels may change significantly on a daily basis because deposit accounts maintained by municipalities represent a significant part of the Bank's deposits and are more volatile than commercial or retail deposits.
These municipal and U.S. Government accounts represent a substantial part of the Bank's business, tend to have high balance relationships and comprised most of the Bank's accounts with balances of $100,000 or more at December 31, 2003 and 2002.
While the collateral maintenance requirements associated with the Bank's municipal and U.S. Government account relationships might limit the ability to readily dispose of investment securities used as such collateral, management does not foresee any need for such disposal, and in the event of the withdrawal of any of these deposits, these securities are readily marketable. The Bank expects to continue seeking municipal account relationships.
Total deposits rose to $198.4 million at December 31, 2003 from $181.9 million a year earlier, while average deposits increased 5.1%, to $194.4 million in 2003 from $183.3 million in 2002. Higher money market account balances were the primary factor in both increases.
Demand account balances decreased to $34.5 million at December 31, 2003 compared to $37.8 million a year earlier while average demand deposits decreased slightly in 2003 to $32.7 million from $33.8 million in 2002. Lower municipal account balances contributed to these decreases.
Savings deposits rose to $106 million at December 31, 2003 from $90.4 million a year earlier due primarily to higher money market account balances. Average savings accounts rose 16.9% in 2003 for the same reason.
Time deposits rose to $57.9 million at December 31, 2003 from $53.7 million at the end of 2002, while average time deposits were $54.2 million in 2003, 5.7% less than in 2002.
Certain corporations and governmental agencies maintain noninterest-bearing savings accounts with the Bank as compensation for services performed. At December 31, 2003, such balances totalled $694,000.
SHORT-TERM BORROWINGS
There were no short-term borrowings at December 31, 2002 compared to $890,000 at December 31, 2003, while average short-term borrowings of $1 million in 2003 was unchanged from 2002. Most of these balances are comprised of U.S. Treasury, tax and loan note option account balances which are subject to daily redemption and can fluctuate significantly.
LONG-TERM DEBT
Long-term debt rose to $19.3 million at December 31, 2003 from $16.3 million a year earlier, while the related average balance was $17.6 million in 2003 compared to $14.7 million in 2002. The increases were due to higher levels of Federal Home Loan Bank advances, along with the trust preferred securities issued in July, 2002 being outstanding for a full year.
RESULTS OF OPERATIONS - 2003 COMPARED WITH 2002
Net income rose to $1,721,000 in 2003 from to $1,720,000 in 2002 due primarily to an increase in net interest income offset by higher operating expenses. Included in both years' earnings were awards received from the U.S. Treasury's Community Development Financial Institution ("CDFI") Fund. The awards were based in part on the Bank's lending efforts in qualifying lower income communities. Award income was $94,000 in 2003 compared to $343,000 in 2002. Additionally, the Bank recorded award income related to deposits made in other CDFI's of $386,000 in 2003 and $384,000 in 2002, respectively. Finally, additional award income of $3,000 was also recorded, representing an award received for opening a branch office in a low-income area. In total, $483,000 of award income was recorded in 2003, while $727,000 was recorded in 2002. Excluding these awards, net income would have totaled $1,409,000 and $1,247,000 in 2003 and 2002, respectively. These awards are dependent on the availability of funds in the CDFI Fund as well as the Bank meeting various qualifying standards. Accordingly, there is no assumption that the Bank will continue to receive these awards in the future.
On a fully taxable equivalent ("FTE") basis, net interest income rose 6.6% to $9 million in 2003 from $8.5 million in 2002, while the related net interest margin declined two basis points, from 4.27% to 4.25%. Higher levels of interest earning assets was the primary reason for the increased net interest income, while compression from the low interest rate environment contributed to the lower margin.
Interest income on a FTE basis decreased $164,000, or 1.3% in 2003. Lower interest rates on interest earning assets was the reason for this decrease. Because of the decline in rates, the yield on interest earning assets fell 49 basis points, from 6.28% to 5.79%. Interest earning assets averaged $14 million, or 7.1% higher in 2003, with the loan portfolio providing the increase.
Interest income from Federal funds sold decreased by 56.2%, reflecting reinvestment into higher earning assets. The related yield decreased from 1.62% to 1.10%.
Interest income on taxable investment securities declined $369,000 in 2003 due to the lower interest rate environment. The taxable investment portfolio averaged $72 million in 2003 compared to $68.7 million in 2002 with most of the increase occurring in fixed-rate mortgage-backed agency securities. Tax-exempt income was down slightly due to early redemptions and the low rates on replacement securities, precluding reinvestment into similar securities.
Interest income on loans rose $417,000, or 5.7% due to higher loan volumes. The commercial loan portfolio rose slightly, along with the related interest income, while the related yield declined 17 basis points, from 6.14% to 5.97%, due to a reduction in the prime lending rate. The real estate portfolio, comprised mainly of commercial real estate loans, increased $16.5 million, or 20.2% in 2003, while the related yield decreased to 6.77% in 2003 from 7.64% in 2002. Finally, installment loans averaged slightly more in
2003 than in 2002, while the related yield declined 156 basis points.
Interest expense totalled $3.3 million in 2003, a decrease of 18.2% from 2002. This decline resulted primarily from a decrease in deposits. The average rate paid on deposits declined by 66 basis points, from 2.11% to 1.45%.
The largest growth in interest bearing liabilities occurred in savings accounts, which averaged 16.9% higher in 2003 than during the previous year due to higher municipal money market account balances. Interest expense on savings deposits was 33.6% lower in 2003 due to the low interest rate environment. The average rate paid decreased from 1.34% to .76%.
Interest expense on time deposits decreased $403,000 due to the reduction in rates. The average rate paid was 54 basis points lower in 2003, averaging 2.81% compared to 3.35% in 2002. Average volume was down 5.7%.
Average short-term borrowings, along with related Interest expense declined slightly while the average rate paid decreased by 57 basis points, from 1.53% in 2002 to .96, because the rates on these liabilities are tied to the Federal funds rate.
Interest expense on long-term debt rose due to an increase in Federal Home Loan Bank advances while the related interest rate decreased 36 basis points due to lower rates on variable-rate debt.
Service charges on deposit accounts was relatively unchanged from 2003 due to sales promotions and competitive business.
Other operating income decreased $359,000, or 20.5% to $1,396,000 in 2003 from $1,755,000 in 2002. The primary reasons for the decrease was a reduction in CDFI award income from $341,000 to $3,000.
Net gains incurred on securities transactions totalled $12,000 in 2003 compared to $42,000 in losses in 2002. The gains occurred primarily in CNBC's fixed-income securities portfolio.
Other operating expenses, which include expenses other than interest, income taxes and the provision for loan losses, totalled $8.8 million in 2003, a 9.4% increase compared to $8.1 million in 2002. Expenses attributable to the new branches along with a credit card loss of $295,000 were the major contributors to the higher expense levels.
Salary expense rose 8.1% due to normal recurring merit increases, the branch openings and additional staff. Employee benefits expense rose 15.1% due primarily to the higher cost of providing employee health insurance, along with an increase in supplemental employee retirement plan expense.
Occupancy and equipment expense rose 9.9% due primarily to the increased costs from the new branches.
Other expenses increased $231,000, or 8.8% in 2003 due primarily to the aforementioned credit card loss.
Income tax expense as a percentage of pre-tax income was 29.7% in 2003 compared to 34.8% in 2002, due to higher levels of tax-exempt income on Bank-owned life insurance.
LIQUIDITY
The liquidity position of the Corporation is dependent on the successful management of its assets and liabilities so as to meet the needs of both deposit and credit customers. Liquidity needs arise primarily to accommodate possible deposit outflows and to meet borrowers' requests for loans. Such needs can be satisfied by investment and loan maturities and payments, along with the ability to raise short-term funds from external sources.
The Bank depends primarily on deposits as a source of funds and also provides for a portion of its funding needs through short-term borrowings, such as Federal Funds purchased, securities sold under repurchase agreements and borrowings under the U.S. Treasury tax and loan note option program. The Bank also utilizes the Federal Home Loan Bank for longer-term funding purposes.
A significant part of the Bank's deposit growth is from municipal deposits. These relationships arise due to the Bank's urban market, leading to municipal support. The Bank expects to continue emphasizing these relationships.
The major contribution during 2003 from operating activities to the Corporation's liquidity came from net income.
Net cash used in investing activities was primarily used for purchases of investment securities available for sale, which totalled $37.6 million, while sources of cash provided by investing activities were derived primarily from proceeds from maturities, principal payments and early redemptions of investment securities available for sale, amounting to $39.8 million.
The primary source of funds from financing activities resulted from an increase in deposits.
CONTRACTUAL OBLIGATIONS
The Corporation has various financial obligations, including contractual obligations that may require future cash payments. These obligations are included in Notes 4,5,9,10 and 11 of the Notes to Consolidated Financial Statements.
The Corporation also will have future obligations under supplemental executive and directors' retirement plans described in Note 4 of the Notes to Consolidated Financial Statements.
COMMITMENTS, CONTINGENT LIABILITIES, AND OFF-BALANCE SHEET ARRANGEMENTS
The following table shows the amounts and expected maturities of significant commitments as of December 31, 2003. Further information on these commitments is included in Note 20 of the Notes to Consolidated Financial Statements.
Commitments to extend credit do not necessarily represent future cash requirements, as these commitments may expire without being drawn on based upon CNB's historical experience.
EFFECTS OF INFLATION
Inflation, as measured by the CPI, rose 2.3% in 2003 compared to 1.6% in 2002 and 2.8% in 2001.
The asset and liability structure of the Corporation and subsidiary bank differ from that of an industrial company since its assets and liabilities fluctuate over time based upon monetary policies and changes in interest rates. The growth in earning assets, regardless of the effects of inflation, will increase net income if the Corporation is able to maintain a consistent interest spread between earning assets and supporting liabilities. In an inflationary period, the purchasing power of these net monetary assets necessarily decreases. However, changes in interest rates may have a more significant impact on the Corporation's
performance than inflation. While interest rates are affected by inflation, they do not necessarily move in the same direction, or in the same magnitude as the prices of other goods and services.
The impact of inflation on the future operations of the Corporation should not be viewed without consideration of other financial and economic indicators, as well as historical financial statements and the preceding discussion regarding the Corporation's liquidity and asset and liability management.
INTEREST RATE SENSITIVITY
The management of interest rate risk is also important to the profitability of the Corporation. Interest rate risk arises when an earning asset matures or when its interest rate changes in a time period different from that of a supporting interest bearing liability, or when an interest bearing liability matures or when its interest rate changes in a time period different from that of an earning asset that it supports. While the Corporation does not match specific assets and liabilities, total earning assets and interest bearing liabilities are grouped to determine the overall interest rate risk within a number of specific time frames.
It is the responsibility of the Asset/Liability Management Committee ("ALCO") to monitor and oversee the activities of interest rate sensitivity management and the protection of net interest income from fluctuations in interest rates.
Interest sensitivity analysis attempts to measure the responsiveness of net interest income to changes in interest rate levels. The difference between interest sensitive assets and interest sensitive liabilities is referred to as interest sensitive gap. At any given point in time, the Corporation may be in an asset-sensitive position, whereby its interest-sensitive assets exceed its interest-sensitive liabilities or in a liability-sensitive position, whereby its interest-sensitive liabilities exceed its interest-sensitive assets, depending on management's judgment as to projected interest rate trends.
One measure of interest rate risk is the interest-sensitivity analysis, which details the repricing differences for assets and liabilities for given periods. The primary limitation of this analysis is that it is a static (i.e., as of a specific point in time) measurement which does not capture risk that varies nonproportionally with changes in interest rates. Because of this limitation, the Corporation uses a simulation model as its primary method of measuring interest rate risk. This model, because of its dynamic nature, forecasts the effects of different patterns of rate movements on the Corporation's mix of interest sensitive assets and liabilities.
The following table presents the Corporation's sensitivity to changes in interest rates, categorized by repricing period. Various assumptions are used to estimate expected maturities. The actual maturities of these instruments could vary substantially if future prepayments differ from estimated experience.
The Corporation was highly liability-sensitive at the 90-day interval with a $99.6 million negative gap due to the inclusion of all categories of savings accounts as rate-sensitive. Certain categories of savings accounts are less rate-sensitive than others. Because individual interest earnings assets and interest bearing liabilities respond differently to changes in prime, more refined results are obtained when the simulation model is used. These results indicate a reduction in net interest income when rates decrease 100 and 200 basis points of $357,000 and $884,000, respectively and an increase in net interest income when rates rise by 100 and 200 basis points of $117,000 and $175,000, respectively.
CAPITAL
The following table presents the consolidated and bank-only capital components and related ratios as calculated under regulatory accounting practice.
On July 11, 2002, City National Bancshares Corporation issued $3 million of preferred capital securities through City National Bank of New Jersey Capital Trust 1 ("the Trust"), a special-purpose statutory trust created expressly for the issuance of these securities. Distribution of interest on the securities will be payable at an annual rate of 5.52%, representing the 3-month LIBOR plus 3.65%, adjustable quarterly beginning October 7, 2002. The quarterly distributions may, at the option of the Trust, be deferred for up to 20 consecutive quarterly periods. The proceeds have been invested in junior subordinated debentures of CNBC, at terms identical to the preferred capital securities. Cash distributions on the securities are made to the extent interest on the debentures is received by the Trust. In the event of certain changes or amendments to regulatory requirements or federal tax rules, the securities are redeemable. The securities are generally redeemable in whole or in part on or after October 7, 2007, at a price equal to 100% of the principal amount plus accrued interest to the date of redemption. The securities must be redeemed by October 7, 2032.
The subsidiary trust is not included with the consolidated financial statements of the Corporation because of the deconsolidation required by Financial Accounting Standards Board Interpretation No. 46, "Consolidation of Variable Interest Entities".
RESULTS OF OPERATIONS - 2002 COMPARED WITH 2001
Net income rose 31.7% to $1,720,000 in 2002 from to $1,306,000 in 2001 due primarily to an increase in net interest income. Included in both years' earnings were awards received from the U.S. Treasury's Community Development Financial Institution ("CDFI") Fund. The awards were based on the Bank's lending efforts in qualifying lower income communities, related to lending. Award income was $343,000 in 2002, compared to $774,000 in 2001. Additionally, the Bank recorded award income related to deposits made in other CDFI's of $384,000 in 2002 and $97,000 in 2001, respectively. Related earnings per common share on a diluted basis increased to $12.54 from $9.33. Without the aforementioned award income, net income would have totalled $1,246,000 in 2002 and $744,000 in 2001.
Total assets declined to $215.1 million at the end of 2002 from $222.3 million a year earlier due to a planned reduction in short-term municipal certificates of deposits.
On a fully taxable equivalent ("FTE") basis, net interest income rose 8.3% to $8.5 million in 2002 from $7.8 million in 2001, while the related net interest margin rose five basis points, from 4.22% to 4.27%. Higher levels of interest income along with decreased interest expense, contributed to this improvement.
Interest income on a FTE basis decreased $626,000, or 4.8% in 2002. Lower interest on interest earning assets was the primary reason for this decrease. Because of the decline in rates, the yield on interest earning assets fell 79 basis points, from 7.07% to 6.28%. Interest earning assets averaged $13.3 million, or 7.2% higher in 2002, with the loan portfolio providing $12.9 million of that increase.
Interest income from Federal funds sold decreased by 60.9%, reflecting reinvestment into higher earning assets. The related yield decreased from 3.91% to 1.62%.
Interest income from interest-bearing deposits with banks rose from $185,000 in 2001 to $510,000 in 2002 due to the Bank's participation in the CDFI deposit program discussed earlier. The related yield increased from 7.56% to 14.33%.
Interest income on taxable investment securities declined $70,000 in 2002 due to the lower interest rate environment. The taxable investment portfolio averaged $68.7 million in 2002 compared to $59.8 million in 2001 with most of the increase occurring in shorter-term floating-rate agency securities. Tax-exempt income was up 11.1% due mostly to higher volume as the tax-exempt portfolio average increased from $7.7 million in 2001 to $9.1 million in 2002.
Interest income on loans declined $511,000, or 6.5% due to the lower interest rate environment. The commercial loan portfolio decreased, averaging $16 million in 2002 compared to $17.9 million in 2001, while the related yield declined 82 basis points, from 6.96% to 6.14% due to reductions in the prime lending rate during the year. The real estate portfolio, comprised mainly of commercial real estate loans, increased $4.9 million, or 6.4% in 2002, while the related yield decreased to 7.64% in 2002 from 8.45% in 2001. Finally, installment loans averaged 9.1% less in 2002 than in 2001, due primarily to no-rate financing offered by car dealers.
Interest expense totalled $3.9 million in 2002, a decrease of 25.7% from 2001. This decline resulted primarily from a decrease in time deposits. The average rate paid on interest bearing liabilities declined by 89 basis points, from 3.33% to 2.44%.
The largest growth in interest bearing liabilities occurred in savings accounts, which averaged 9.6% higher in 2002 than during the previous year due to the branch acquisition along with higher municipal money market account balances. Interest expense on savings deposits was 21.7% lower in 2002 due to the low interest rate environment. The average rate paid decreased from 1.88% to 1.34%.
Interest expense on time deposits decreased $1 million due to the continued planned reduction in municipal time deposits balances, which are costly funding sources. The average rate paid was 151 basis points lower in 2002, averaging 3.35% compared to 4.86% in 2001. Additionally, early withdrawal penalties reduced the average rate paid by twelve basis points in 2001 while such penalties were nominal in 2002. Average volume was down 5.6%, due to the aforementioned reduction.
Interest expense on short-term borrowings declined primarily to a decrease in the average rate paid by 198 basis points, from 3.51% in 2001 to 1.53%, because the rates on these liabilities are tied to the Federal funds rate.
Interest expense on long-term debt rose 17.9% due to the issuance of $3 million of subordinated debentures in July, 2002. As a result, the average rate paid on long-term debt declined only five basis points in 2002, to 5.56% from 5.61%.
Service charges on deposit accounts rose 22% due to the aforementioned new branches, as well as increases in customer fee schedules.
Other operating income increased $104,000, or 6.3% to $1,755,000 in 2002 from $1,651,000 in 2001. The primary reasons for the increase were an increase in loan syndication fees from $192,000 to $305,000 and an increase in income from an unconsolidated leasing subsidiary from $86,000 in 2001 to $275,000 in 2002. Offsetting these increases was a reduction in CDFI award income from $774,000 to $342,000.
Net losses incurred on securities transactions totalled $42,000 in 2002 compared to an $11,000 gain in 2001. The losses occurred primarily in CNBC's equity securities portfolio and resulted in a change in portfolio managers during 2002.
Other operating expenses, which include expenses other than interest, income taxes and the provision for loan losses, totalled $8.1 million in 2002, a 2.3% increase compared to $7.8 million in 2001. Expenses attributable to the new branches were the major contributor to the higher expense levels. Additionally, data processing charges increased 20.4% due to greater volume and higher servicer fees.
Salary expense rose 13.8% due to normal recurring merit increases, the branch openings and additional staff. Employee benefits rose 21.7% due primarily to the higher cost of providing employee health insurance, along with an increase in supplemental employee retirement plan expense.
Occupancy and equipment expense declined 6.3% due primarily to a reduction in nonrecurring renovation and maintenance costs incurred on a new branch during 2001, along with a decrease in depreciation expense as fixed assets became fully depreciated.
Other expenses declined $258,000, or 9% in 2002 due primarily to lower legal and professional fees along with a decrease in expenses incurred on foreclosed properties.
Income tax expense as a percentage of pre-tax income was 34.8% in 2002 compared to 35.5% in 2001, due to higher levels of tax-exempt income.
CRITICAL ACCOUNTING POLICIES AND USE OF ESTIMATES
The calculation of the allowance for loan losses is a critical accounting policy of the Corporation. Provisions for loan losses will continue to be based upon our assessment of the overall loan portfolio and the underlying collateral, trends in non-performing loans, current economic conditions and other relevant factors including the risk factors inherent in the Bank's low and moderate income market area, in order to maintain the allowance for loan losses at adequate levels to provide for estimated losses.
Management believes that the primary risks inherent in the loan portfolio are possible increases in interest rates, a deterioration in the economy, and a decline in real estate market values in the Bank's market area. Any one or a combination of these events may adversely affect the Bank's loan portfolio, resulting in increased delinquencies, loan losses and future high levels of provisions. Accordingly, the Bank has provided for loan losses at the current level to address the current risks in our loan portfolio. Management considers it important to maintain the ratio of the allowance for loan losses to total loans at an acceptable level given current economic conditions, interest rates and the composition of the portfolio.
Although management believes that the allowance for loan losses has been maintained at adequate levels, additions may be necessary if future economic and other conditions differ substantially from the current operating environment. Although management uses the best information available, the level of the allowance for loan losses remains an estimate that is subject to significant judgment and short-term change.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Information regarding this Item appears under Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" - Interest Rate Sensitivity.
CITY NATIONAL BANCSHARES CORPORATION AND SUBSIDIARY
See accompanying notes to consolidated financial statements.
CITY NATIONAL BANCSHARES CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENT OF INCOME
See accompanying notes to consolidated financial statements.
CITY NATIONAL BANCSHARES CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
See accompanying notes to consolidated financial statements.
CITY NATIONAL BANCSHARES CORPORATION AND SUBSIDIARY
See accompanying notes to consolidated financial statements.
NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accounting and reporting policies of City National Bancshares Corporation (the "Corporation" or "CNBC") and its subsidiary, City National Bank of New Jersey (the "Bank" or "CNB") conform with accounting principles generally accepted in the United States of America and to general practice within the banking industry. In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent liabilities as of the date of the balance sheet and revenues and expenses for the related periods. Actual results could differ significantly from those estimates. The following is a summary of the more significant policies and practices.
PRINCIPLES OF CONSOLIDATION
The financial statements include the accounts of CNBC and its wholly-owned subsidiary. All significant intercompany accounts and transactions have been eliminated in consolidation.
CASH AND CASH EQUIVALENTS
For purposes of the presentation of the Statement of Cash Flows, Cash and cash equivalents includes Cash and due from banks and Federal funds sold.
FEDERAL HOME LOAN BANK OF NEW YORK
The Bank, as a member of Federal Home Loan Bank of New York ("FHLB"), is required to hold shares of capital stock of the FHLB based on a specified formula. The FHLB stock is carried at cost and is included in investment securities available for sale.
INVESTMENT SECURITIES HELD TO MATURITY AND INVESTMENT SECURITIES AVAILABLE FOR SALE
Investment securities are designated as held to maturity or available for sale at the time of acquisition. Securities that the Corporation has the intent and ability at the time of purchase to hold until maturity are designated as held to maturity. Investment securities held to maturity are stated at cost and adjusted for amortization of premiums and accretion of discount to the earlier of maturity or call date using the level yield method.
Securities to be held for indefinite periods of time but not intended to be held until maturity or on a long-term basis are classified as investment securities available for sale. Securities held for indefinite periods of time include securities that the Corporation intends to use as part of its interest rate sensitivity management strategy and that may be sold in response to changes in interest rates, resultant risk and other factors. Investment securities available for sale are reported at fair market value, with unrealized gains and losses, net of deferred tax reported as a component of accumulated other comprehensive income, which is included in stockholders' equity. Gains and losses realized from the sales of securities available for sale are determined using the specific identification method.
The Corporation holds in its investment portfolios mortgage-backed securities. Such securities are subject to changes in the prepayment rates of the underlying mortgages, which may affect both the yield and maturity of the securities.
LOANS HELD FOR SALE
Loans held for sale include residential mortgage loans originated with the intent to sell. Loans held for sale are carried at the lower of aggregate cost or fair value.
LOANS
Loans are stated at the principal amounts outstanding, net of unearned discount and deferred loan fees. Interest income is accrued as earned, based upon the principal amounts outstanding. Loan origination fees and certain direct loan origination costs, as well as unearned discount, are deferred and recognized over the life of the loan revised for loan prepayments, as an adjustment to the loan's yield.
Recognition of interest on the accrual method is generally discontinued when a loan contractually becomes 90 days or more past due or a reasonable doubt exists as to the collectibility of the loan, unless such loans are well-secured and in the process of collection. At the time a loan is placed on a nonaccrual status, previously accrued and uncollected interest is generally reversed against interest income in the current period. Interest on such loans, if appropriate, is recognized as income when payments are received. A loan is returned to an accrual status when it is current as to principal and interest and its future collectibility is expected.
The Corporation has defined the population of impaired loans to be all nonaccrual loans of $100,000 or more considered by management to be inadequately secured and subject to risk of loss. Impaired loans of $100,000 or more are individually assessed to determine that the loan's carrying value does not exceed the fair value of the underlying collateral or the present value of the loan's expected future cash flows. Smaller balance homogeneous loans that are collectively evaluated for impairment such as residential mortgage and installment loans, are specifically excluded from the impaired loan portfolio.
ALLOWANCE FOR LOAN LOSSES
A substantial portion of the Bank's loans are secured by real estate in New Jersey, particularly within the Newark area. Accordingly, as with most financial institutions in the market area, the ultimate collectibility of a substantial portion of the Bank's loan portfolio is susceptible to changes in market conditions.
The allowance for loan losses is maintained at a level determined adequate to provide for losses inherent in the portfolio. The allowance is increased by provisions charged to operations and recoveries of loans previously charged off and reduced by loan charge-offs. The allowance is based on management's evaluation of the loan portfolio considering current economic conditions, the volume and nature of the loan portfolio, historical loan loss experience and individual credit and collateral situations.
Management believes that the allowance for loan losses is adequate. While management uses available information to determine the adequacy of the allowance, future additions may be necessary based on changes in economic conditions or subsequent events unforeseen at the time of evaluation.
In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank's allowance for loan losses. Such agencies may require the Bank to increase the allowance based on their judgment of information available to them at the time of their examination.
BANK PREMISES AND EQUIPMENT
Premises and equipment are stated at cost less accumulated depreciation based upon estimated useful lives of three to 39 years, computed using the straight-line method. Expenditures for maintenance and repairs are charged to operations as incurred, while major replacements and improvements are capitalized. The net asset values of assets retired or disposed of are removed from the asset accounts and any related gains or losses are included in operations.
OTHER REAL ESTATE OWNED
Other real estate owned ("OREO") acquired through foreclosure or deed in lieu of foreclosure is carried at the lower of cost or fair value less estimated cost to sell, net of a valuation allowance. When a property is acquired, the excess of the loan balance over the estimated fair value is charged to the allowance for loan losses. Operating results, including any future writedowns of OREO, rental income and operating expenses, are included in "Other expenses."
An allowance for OREO has been established through charges to "Other expenses" to maintain properties at the lower of cost or fair value less estimated cost to sell.
CORE DEPOSIT PREMIUMS
The premium paid for the acquisition of deposits in connection with the purchases of branch offices is amortized on a straight-line basis over a nine-year period.
INCOME TAXES
Federal income taxes are based on currently reported income and expense after the elimination of income which is exempt from Federal income tax.
Deferred tax assets and liabilities are recognized for future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Such temporary differences include depreciation and the provision for possible loan losses.
NET INCOME PER COMMON SHARE
Basic income per common share is calculated by dividing net income less dividends paid on preferred stock by the weighted average number of common shares outstanding. On a diluted basis, both net income and common shares outstanding are adjusted to assume the conversion of the convertible subordinate debentures.
COMPREHENSIVE INCOME
SFAS No. 130 "Reporting Comprehensive Income," establishes standards for reporting and display of comprehensive income and its components (revenues, expenses, gains, and losses) in a full set of general-purpose financial statements. SFAS 130 requires that all items that are required to be recognized under accounting standards as components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. The required disclosures are included in the Statement of Changes in Stockholders' Equity.
RECENT ACCOUNTING PRONOUNCEMENTS
In November 2002, the Financial Accounting Standards Board ("FASB") issued FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirement of Guarantees, Including Indirect Guarantees of Indebtedness of Others." FIN 45 addresses disclosures to be made by a guarantor in its financial statements about its obligations under guarantees. The interpretation also requires the recognition, at estimated fair value, of a liability by the guarantor at the inception of certain guarantees issued or modified after December 31, 2002. The disclosure requirements of FIN 45 were effective for financial statements of interim or annual periods ending after December 15, 2002. The recognition and measurement provisions are applicable prospectively to guarantees issued or modified after December 31, 2002. The adoption of this interpretation did not have a material impact on the Corporation's consolidated financial statements.
FASB Interpretation No. 46, "Consolidation of Variable Interest Entities ("FIN")" was issued in January 2003 and was reissued as FASB Interpretation No. 46 (revised December 2003) ("FIN 46R"). For public entities, FIN 46 and FIN 46R are applicable to all special-purpose entities ("SPEs") in which the entity holds a variable interest no later than the end of the first reporting period ending after December 15, 2003. FIN 46 and FIN 46R may be applied prospectively with a cumulative-effect adjustment as of the date on which it is first applied or by restating previously issued financial statements for one or more years with a cumulative-effect adjustment as of the beginning of the first year restated. FIN 46 and FIN 46R provide guidance on the identification of entities controlled through means other than voting rights. FIN 46 and FIN 46R specifies how a business enterprise should evaluate its interest in a variable interest entity to determine whether to consolidate that entity. A variable interest entity must be consolidated by its primary beneficiary if the entity does not effectively disperse risks among the parties involved.
The Corporation adopted FIN 46R as of December 31, 2003 and elected to retroactively restate all periods presented. FIN 46R required the Corporation to deconsolidate its investment in the subsidiary trust formed in connection with the issuance of trust preferred securities in July, 2002. In July 2003, the Board of Governors of the Federal Reserve System instructed bank holding companies to continue to include the trust preferred securities in their Tier 1 capital for regulatory capital purposes until notice is given to the contrary. There can be no assurance that the Federal Reserve will continue to allow institutions to include trust preferred securities in Tier 1 capital for regulatory capital purposes. As of December 31, 2003, assuming the Corporation was not allowed to include the $3.0 million in trust preferred securities issued by the subsidiary trust in Tier 1 capital, the Corporation would remain "well capitalized."
The deconsolidation of the subsidiary trusts results in the Corporation reporting on its balance sheet the subordinated debentures that have been issued from City National Bancshares to the subsidiary trust. The adoption of FIN 46 did not have a significant effect on the Corporation's consolidated financial statements.
Statement of Financial Accounting Standards No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities," was issued on April 30, 2003. The Statement amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under Statement 133. This Statement is effective for contracts entered into or modified after June 30, 2003. The adoption of this Statement did not have a significant effect on the Corporation's consolidated financial statements.
RECLASSIFICATIONS
Certain reclassifications have been made to the 2002 and 2001 consolidated financial statements in order to conform with the 2003 presentation.
NOTE 2 CASH AND DUE FROM BANKS
The Bank is required to maintain a reserve balance with the Federal Reserve Bank based primarily on deposit levels. These reserve balances averaged $1,860,000 in 2003 and $2,130,000 in 2002.
NOTE 3 FEDERAL FUNDS SOLD AND SECURITIES PURCHASED UNDER AGREEMENTS TO RESELL
Federal funds sold averaged $11.7 million during 2003 and $18 million in 2002, while the maximum balance outstanding at any month-end during 2003, 2002 and 2001 was $28.4 million, $37 million and $53.8 million, respectively. There were no securities purchased under repurchase agreements in either 2003 or 2002. There were no such transactions outstanding at any month-end during 2003, 2002 or 2001.
NOTE 4 INVESTMENT SECURITIES AVAILABLE FOR SALE
The amortized cost and market values at December 31 of investment securities available for sale were as follows:
The amortized cost and the market values of investments in debt securities available for sale as of December 31, 2003 are distributed by contractual maturity, without regard to normal amortization including mortgage-backed securities, which will have shorter estimated lives as a result of prepayments of the underlying mortgages.
Sales of investment securities available for sale resulted in gross gains of $24,000, $5,000 and $15,000 and gross losses of $21,000, $55,000 and $18,000 in 2003, 2002 and 2001 respectively.
Interest and dividends on investment securities available for sale was as follows:
Investment securities available for sale with a carrying value of $35,372,000 were pledged to secure U.S. government and municipal deposits at December 31, 2003.
Investment securities available for sale which have had continuous unrealized losses are set forth below:
The gross unrealized losses set forth above are attributable primarily to investments purchased during 2003, prior to the fourth quarter, when interest rates increased. Accordingly, these securities were purchased in a lower interest rate environment. The U.S. Treasury securities and obligations of U.S. government agencies that have been in a loss position for at least a year represent primarily floating-rate pools of SBA guaranteed loans, the market value of which has been negatively impacted by the low interest rate environment. The other debt securities represent two floating-rate corporate trust preferred securities similarly effected, as well as by their long maturities, both of which exceed twenty years.
The Corporation has the intent and ability to hold these securities for the time necessary to recover the amortized cost.
NOTE 5 INVESTMENT SECURITIES HELD TO MATURITY
The book and market values as of December 31 of investment securities held to maturity were as follows:
During 2003, $15.6 million of Agency callable securities were redeemed by the issuers prior to maturity, resulting in gross gains of $9,000, while in 2002 $5.5 million of such securities were redeemed, resulting in gross gains of $8,000 and $18.9 million were redeemed in 2001 resulting in gross gains of $4,000.
The book value and the market value of investment securities held to maturity as of December 31, 2003 are distributed by contractual maturity without regard to normal amortization, including mortgage-backed securities, which will have shorter estimated lives as a result of prepayments of the underlying mortgages.
Interest and dividends on investment securities held to maturity was as follows:
Investment securities held to maturity with a carrying value of $16,349,000 were pledged to U.S. government and municipal deposit funds at December 31, 2003.
Investment securities held to maturity which have had continuous unrealized losses are set forth below:
The gross unrealized losses set forth above are attributable primarily to investments purchased during 2003, prior to the fourth quarter, when interest rates increased. Accordingly, these securities were purchased in a lower interest rate environment.
The Corporation has the intent and ability to hold these securities for the time necessary to recover the amortized cost.
NOTE 6 LOANS
Loans, net of unearned discount and net deferred origination fees and costs at December 31 were as follows:
Nonperforming loans include loans which are contractually past due 90 days or more for which interest income is still being accrued and nonaccrual loans.
At December 31, nonperforming loans were as follows:
The effect of nonaccrual loans on income before taxes is presented below.
Nonperforming assets are generally well secured by residential and small commercial real estate. It is the Bank's intent to dispose of all other real estate owned ("OREO") properties at the earliest possible date at or near current market value.
At December 31, 2003, there were no commitments to lend additional funds to borrowers for loans that were on nonaccrual or contractually past due in excess of 90 days and still accruing interest, or to borrowers whose loans have been restructured. A majority of the Bank's loan portfolio is concentrated in first mortgage loans to borrowers in northern New Jersey, particularly within the Newark area. Its borrowers' abilities to repay their obligations are dependent upon various factors including the borrowers' income, net worth, cash flows generated by the underlying collateral, the value of the underlying collateral and priority of the Bank's lien on the related property. Such factors are dependent upon various economic conditions and individual circumstances beyond the Bank's control. Accordingly, the Bank may be subject to risk of credit losses.
There were no impaired loans at December 31, 2003, or at December 31, 2002.
NOTE 7 ALLOWANCE FOR LOAN LOSSES
Transactions in the allowance for loan losses are summarized as follows:
NOTE 8 PREMISES AND EQUIPMENT
A summary of premises and equipment at December 31 follows:
Depreciation and amortization expense charged to operations amounted to $422,000, $401,000, and $434,000 in 2003, 2002, and 2001, respectively.
NOTE 9 DEPOSITS
Deposits at December 31 are presented below.
Time deposits issued in amounts of $100,000 or more have the following maturities at December 31:
Interest expense on certificates of deposits of $100,000 or more was $438,000, $759,000 and $2,468,000 in 2003, 2002 and 2001, respectively.
NOTE 10 SHORT-TERM BORROWINGS
Information regarding short-term borrowings at December 31, is presented below.
The demand note, which has no stated maturity, issued by the Bank to the U.S. Treasury Department is payable with interest at 25 basis points less than the weekly average of the daily effective Federal Funds rate and is collateralized by various investment securities held at the Federal Reserve Bank of New York with a book value of $6,690,000, along with loans guaranteed by the Small Business Administration totalling $899,000. There was no balance outstanding under the note at December 31, 2003.
NOTE 11 LONG-TERM DEBT
Long-term debt at December 31 is summarized as follows:
Interest is payable quarterly on most of the FHLB advances. The advances bear fixed interest rates ranging from 1.95% to 6.15% and are secured by residential mortgages and certain obligations of U.S. Government agencies under a blanket collateral agreement.
Interest is payable semiannually on the capital note due December 28, 2005, on June 29 and December 29, with semiannual principal payments continuing through December, 2005.
The note agreement includes restrictive covenants including the creation of liens on Bank assets, the sale of such assets and certain limitations on investments and dividend payments and requires the maintenance of certain capital levels and earning performance, asset quality and reserve for possible loan loss ratios.
Interest is payable semiannually on the capital note due July 1, 2008 with principal payments commencing in July, 2004 and continuing annually until July, 2008.
Interest is payable quarterly on the capital note due December 28, 2010, with principal payments commencing annually in December, 2006 and continuing until December, 2010.
The 7% note payable on January 1, 2014 is payable in quarterly installments of $31,250 commencing January 1, 2006, with interest only payable quarterly from April 1, 2002 to January 1, 2006. The debt is secured by 5,090 shares of the authorized but unissued shares of CNB common stock.
Interest is payable semiannually through May 6, 2017, at which time the entire principal balance is due. The note is renewable at the option of the Corporation for an additional fifteen years at the prevailing rate of interest.
Scheduled repayments on long-term debt are as follows:
In July 2002, City National Bancshares Corporation sold $3 million of trust preferred securities through a statutory business trust, City National Bank of New Jersey Capital Trust I (the "Trust"). The securities pay interest quarterly on January 7, April 7, July 7 and October 7, based on the current three-month LIBOR rate, plus 3.65%. The rate in effect at December 31, 2003 was 4.77%.
City National Bancshares Corporation owns all of the common securities of this Trust. The Trust has no independent assets or operations, and exists for the sole purpose of issuing trust preferred securities and investing the proceeds thereof in an equivalent amount of junior subordinate debentures issued by City National Bancshares Corporation. The junior subordinate debentures, which are the sole assets of the Trust, are unsecured obligations of City National Bancshares Corporation, and are subordinate and junior in right of payment to all present and future senior and subordinate indebtedness and certain other financial obligations of City National Bancshares Corporation.
The trust preferred securities qualify as Tier I Capital under regulatory guidelines. The principal amount of subordinate debentures held by the trust equals the aggregate liquidation amount of its trust preferred securities and its common securities. The subordinate debentures bear interest at the same rate, and will mature on the same date, as the corresponding trust preferred securities. All of the trust preferred securities may be prepaid at par at the option of the trust, in whole or in part, on or after July 18, 2007. The trust preferred securities effectively mature on April 22, 2032.
Information with respect to the accounting treatment of trust preferred securities is set forth in Note 1.
NOTE 12 OTHER OPERATING INCOME AND EXPENSES
The following table presents the major items of other operating income and expenses:
During 2001, the Bank received $1.9 million from the U.S. Department of the Treasury Community Development Financial Institutions Fund ("CDFI"), of which $209,000 was applicable to the loan commitments made in 2000, and recorded as award income.
Additionally, $473,000 was applicable to loans committed and funded during 2001 and $92,000 was applicable to a new branch location opened in a low-income neighborhood. Finally, $1.1 million applied to a deposit program in which the Bank participated. Under this program, long-term certificates of deposits were purchased from banks located in low-income areas at below-market rates. No award was received in 2002.
In November 2003, the Bank received an award of $513,000 from the CDFI fund, of which $450,000 was attributable to the Bank's lending efforts and $18,000 was attributable to purchasing long-term deposits from banks in low-income areas. An additional $45,000 was received for opening a branch in a low-income community. The loan and deposit awards are being recorded as interest income, representing yield enhancement on the lives of the loans and deposits through 2006.
During 2003, 2002 and 2001, $386,000, $385,000 and $97,000 respectively, was recorded as interest income on deposits with banks as a yield enhancement. An additional $94,000 was recorded as interest income on loans as a yield enhancement during 2003.
NOTE 13 INCOME TAXES
The components of income tax expense are as follows:
Not included in the above table is deferred income tax expense (benefit) of $(222,000), $179,000 and $(46,000) for 2003, 2002 and 2001, respectively, which represents the deferred income tax expense (benefit) on the net unrealized gains (losses) of securities available for sale.
A reconciliation between income tax expense and the total expected federal income tax computed by multiplying pre-tax accounting income by the statutory federal income tax rate is as follows:
The tax effects of temporary differences that give rise to deferred tax assets and liabilities at December 31 are as follows:
The net deferred asset represents the anticipated federal and state tax assets to be realized in future years upon the utilization of the underlying tax attributes comprising this balance. Management believes, based upon estimates of future taxable earnings, that more likely than not there will be sufficient taxable income in future years to realize the deferred tax assets, net of deferred valuation allowance, although there can be no assurance about the level of future earnings.
NOTE 14 BENEFIT PLANS
Savings plan
The Bank maintains an employee savings plan under section 401(k) of the Internal Revenue Code covering all employees with at least six months of service. Participants are allowed to make contributions to the plan by salary reduction, up to 15% of total compensation. The Bank provides matching contributions of 50% of the first 6% of participant salaries subject to a vesting schedule. Contribution expense amounted to $66,000 in 2003, $64,000 in 2002 and $60,000 in 2001.
Bonus plan
The Bank awards profit sharing bonuses to its officers and employees based on the achievement of certain performance objectives. Bonuses charged to operating expense in 2003, 2002 and 2001 amounted to $170,000, $219,000, and $270,000, respectively.
Nonqualified benefit plans
The Bank maintains a supplemental executive retirement plan ("SERP"), which provides a post-employment supplemental retirement benefit to certain key executive officers. SERP expense was $147,000 in 2003, $130,000 in 2002 and $74,000 in 2001. The Bank also has a director retirement plan ("DRIP"). DRIP expense was $52,000 in 2003, $59,000 in 2002 and $11,000 in 2001.
Benefits under both plans are funded through bank-owned life insurance policies. During 2003, the Bank purchased $1 million in bank-owned life insurance to help offset the cost of executive benefits. In addition, expenses for both plans along with the expense related to carrying the policy itself are offset by increases in the cash surrender value of the policy. Such increases are included in "Other income" and totalled $187,000 in 2003, $119,000 in 2002 and $117,000 in 2001, while the related life insurance expense was $40,000 in 2003, $39,000 in 2002 and $38,000 in 2001.
Stock options
No stock options have been issued since 1997. During 1997, the Corporation issued 5,700 stock options at an exercise price equal to the fair market value of the stock on the date of the grant. Under Accounting Principles Board Opinion No. 25, compensation cost for the stock options is not recognized because the exercise price of the stock options equaled the market price of the underlying stock on the date of the grant. The options vested equally over three years. There were no stock options outstanding at December 31, 2003 and 2002.
NOTE 15 PREFERRED STOCK
The Corporation is authorized to issue noncumulative perpetual preferred stock in one or more series, with no par value. Shares of preferred stock have preference over the Corporation's common stock with respect to the payment of dividends. Different series of preferred stock may have different stated or liquidation values as well as different rates. Dividends are paid annually.
Set forth below is a summary of the Corporation's preferred stock issued and outstanding.
NOTE 16 RESTRICTIONS ON SUBSIDIARY BANK DIVIDENDS
Subject to applicable law, the Board of Directors of the Bank and of the Corporation may provide for the payment of dividends when it is determined that dividend payments are appropriate, taking into account factors including net income, capital requirements, financial condition, alternative investment options, tax implications, prevailing economic conditions, industry practices, and other factors deemed to be relevant at the time.
Because CNB is a national banking association, it is subject to regulatory limitation on the amount of dividends it may pay to its parent corporation, CNBC. Prior approval of the Office of the Comptroller of the Currency ("OCC") is required if the total dividends declared by the Bank in any calendar year exceeds net profit, as defined, for that year combined with the retained net profits from the preceding two calendar years.
Under this limitation, $3,583,000 was available for the payment of dividends to the parent corporation at December 31, 2003, subject to the restrictive covenants under long-term debt agreements included in Note 11.
NOTE 17 NET INCOME PER COMMON SHARE
The following table presents the computation of net income per common share.
NOTE 18 RELATED PARTY TRANSACTIONS
Certain directors, including organizations in which they are officers or have significant ownership, were customers of, and had other
transactions with the Bank in the ordinary course of business during 2003 and 2002. Such transactions were on substantially the same terms, including interest rates and collateral with respect to loans, as those prevailing at the time of comparable transactions with others. Further, such transactions did not involve more than the normal risk of collectibility and did not include any unfavorable features.
Total loans to the aforementioned individuals and organizations amounted to $686,000 and $775,000 at December 31, 2003 and 2002, respectively. The highest amount of such indebtedness during 2003 was $975,000 and in 2002 amounted to $782,000. During 2003, new loans totalled $276,000 and paydowns totalled $365,000. All related party loans were performing as of December 31, 2003.
NOTE 19 FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair value of financial instruments is the amount at which an asset or obligation could be exchanged in a current transaction between willing parties, other than in a forced liquidation. Fair value estimates are made at a specific point in time based on the type of financial instrument and relevant market information.
Because no quoted market price exists for a significant portion of the Corporation's financial instruments, the fair values of such financial instruments are derived based on the amount and timing of future cash flows, estimated discount rates, as well as management's best judgment with respect to current economic conditions. Many of these estimates involve uncertainties and matters of significant judgment and cannot be determined with precision.
The fair value information provided is indicative of the estimated fair values of those financial instruments and should not be interpreted as an estimate of the fair market value of the Corporation taken as a whole. The disclosures do not address the value of recognized and unrecognized nonfinancial assets and liabilities or the value of future anticipated business. In addition, tax implications related to the realization of the unrealized gains and losses could have a substantial impact on these fair value estimates and have not been incorporated into any of the estimates.
The following methods and assumptions were used to estimate the fair values of significant financial instruments at December 31, 2003 and 2002.
CASH AND SHORT-TERM INVESTMENTS
These financial instruments have relatively short maturities or no defined maturities but are payable on demand, with little or no credit risk. For these instruments, the carrying amounts represent a reasonable estimate of fair value.
INVESTMENT SECURITIES
Investment securities are reported at there fair values based on quoted market prices.
LOANS
Fair values were estimated for performing loans by discounting the future cash flows using market discount rates that reflect the credit and interest-rate risk inherent in the loans. Fair value for significant nonperforming loans was based on recent external appraisals of collateral securing such loans. If such appraisals were not available, estimated cash flows were discounted employing a rate incorporating the risk associated with such cash flows.
DEPOSIT LIABILITIES
The fair values of demand deposits, savings deposits and money market accounts were the amounts payable on demand at December 31, 2003 and 2002. The fair value of time deposits was based on the discounted value of contractual cash flows. The discount rate was estimated utilizing the rates currently offered for deposits of similar remaining maturities.
SHORT-TERM BORROWINGS
For such short-term borrowings, the carrying amount was considered to be a reasonable estimate of fair value.
LONG-TERM DEBT
The fair value of long-term debt was estimated based on rates currently available to the Corporation for debt with similar terms and remaining maturities.
COMMITMENTS TO EXTEND CREDIT AND LETTERS OF CREDIT
The estimated fair value of financial instruments with off-balance sheet risk is not significant at December 31, 2003 and 2002.
The following table presents the carrying amounts and fair values of financial instruments at December 31:
NOTE 20 COMMITMENTS AND CONTINGENCIES
In the normal course of business, the Corporation or its subsidiary may, from time to time, be party to various legal proceedings relating to the conduct of its business. In the opinion of management, the consolidated financial statements will not be materially affected by the outcome of any pending legal proceedings.
In May of 1998, CNB commenced a lawsuit against an entity that acted as an agent for CNB in the sale of CNB's money orders, and certain affiliates of such entity for fraud and other damages. CNB alleged, among other things, that at various times during its business relationship with the defendants, the defendants stole, misappropriated, hypothecated or embezzled a sum of approximately $805,000 from CNB. CNB has been awarded a $1.7 million judgment, representing the loss, cost of collection and interest. CNB has filed appropriate proofs of loss under the entity's fidelity bond. It is unlikely that CNB will receive any of the judgment, and the amount that CNB will ultimately recover, if any, under the insurance policy cannot be determined.
During 2003, the Bank incurred a credit card fraud loss of $295,000. The Bank has filed a claim with its fidelity bond carrier to recover this loss and is contemplating legal action. The amount that CNB will ultimately recover, if any, under the insurance policy or from such legal action cannot be determined.
NOTE 21 FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
The Bank is 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 lines of credit, commitments to extend standby letters of credit, and could involve, to varying degrees, elements of credit risk in excess of the amounts recognized in the consolidated financial statements.
The Bank'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 is represented by the
contractual amounts of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on balance sheet instruments with credit risk.
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require the payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer's creditworthiness on a case-by-case basis, and the amount of collateral or other security obtained is based on management's credit evaluation of the customer.
Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. These guarantees are primarily issued to support borrowing arrangements and extend for up to one year. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Accordingly, collateral is generally required to support the commitment.
At December 31, 2003 and 2002 the Bank had mortgage commitments of $16,436,000 and $12,750,000, unused corporate lines of credit of $30,559,000 and $34,143,000, and $647,000 and $583,000 of other loan commitments, respectively. There were $40,000 of financial standby letters of credit outstanding at December 31, 2003, while there were none outstanding at December 31, 2002.
The aforementioned commitments and credit lines are made at both fixed and floating rates of interest based on the Bank's prime lending rate.
NOTE 22 PARENT COMPANY INFORMATION
Condensed financial statements of the parent company only are presented below.
CONDENSED BALANCE SHEET
CONDENSED STATEMENT OF INCOME
CONDENSED STATEMENT OF CASH FLOWS
NOTE 23 REGULATORY CAPITAL REQUIREMENTS
FDIC regulations require banks to maintain minimum levels of regulatory capital. Under the regulations in effect at December 31, 2003, the Bank was required to maintain (i) a minimum leverage
ratio of Tier 1 capital to total average assets of 4.0%, and (ii) minimum ratios of Tier I and total capital to risk-adjusted assets of 4.0% and 8.0%, respectively.
Under its prompt corrective action regulations, the FDIC is required to take certain supervisory actions (and may take additional discretionary actions) with respect to an undercapitalized bank. Such actions could have a direct material effect on such bank's financial statements. The regulations establish a framework for the classification of banks into five categories: well-capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. Generally, a bank is considered well-capitalized if it has a leverage capital ratio of at least 5.0%, a Tier 1 risk-based capital ratio of at least 6.0% and a total risk-based capital ratio of at least 10.0%.
The foregoing capital ratios are based in part on specific quantitative measures of assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by the FDIC about capital components, risk adjustments and other factors.
Management believes that, as of December 31, 2003 both City National Bancshares and City National Bank meet all capital adequacy requirements to which it is subject. Further, the most recent FDIC notification categorized City National Bank as a well-capitalized institution under the prompt corrective action regulations. There have been no conditions or events since that notification that management believes have changed City National Bank's capital classification.
The following is a summary of City National Bank's actual capital amounts and ratios as of December 31, 2003 and 2002, compared to the FDIC minimum capital adequacy requirements and the FDIC requirements for classification as a well-capitalized Bank:
NOTE 24 SUMMARY OF QUARTERLY FINANCIAL INFORMATION
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders City National Bancshares Corporation:
We have audited the accompanying consolidated balance sheets of City National Bancshares Corporation and subsidiary (the Corporation) as of December 31, 2003 and 2002, and the related consolidated statements of income, changes in stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 2003. These consolidated financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. 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 City National Bancshares Corporation and subsidiary as of December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2003 in conformity with accounting principles generally accepted in the United States of America.
KPMG LLP
Short Hills, New Jersey March 8, 2004
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
There were no changes in or disagreements with accountants during 2003.
ITEM 9A CONTROLS AND PROCEDURES
Within 90 days prior to the date of this report, management carried out an evaluation of the effectiveness of the design and operation of the Corporation's disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based upon the evaluation, they concluded that the Corporation's disclosure controls and procedures are effective in timely alerting them to material information relating to changes in the Corporation's internal controls or in other factors that could significantly affect internal controls subsequent to the date of the evaluation.
Management does not expect that the disclosure controls and procedures or the internal controls will prevent all errors and all fraud. A control system, no matter how well conceived and operated, provides reasonable, not absolute, assurance that the objectives of the control system are met. The design of a control system reflects resource constraints and the benefits of controls must be considered relative to the costs. Because there are inherent limitations in all control systems, no evaluation of controls can be detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns occur because of simple error or mistake. Controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls is based in part upon certain assumptions about the likelihood of future events. There can be no assurance that any design will succeed in achieving its stated goals under all future conditions; over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with the policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required is incorporated herein by reference to the material responsive to such item in the Corporation's Proxy Statement for the Annual Meeting of Stockholders to be held on May 20, 2004.
ITEM 11. EXECUTIVE COMPENSATION
The information required is incorporated herein by reference to the material responsive to such item in the Corporation's Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required is incorporated herein by reference to the material responsive to such item in the Corporation's Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required is incorporated herein by reference to the material responsive to such item in the Corporation's Proxy Statement.
PART IV
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required is incorporated herein by reference to the material responsive to such item in the Corporation's Proxy Statement.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
The following exhibits are incorporated herein by reference or are annexed to this Annual Report:
(a) The required financial statements and the related independent auditor's report are included in Item 8.