Form 10-K
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

F O R M 1 0 – K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended December 31, 2010   Commission File Number 0-13396

CNB FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)

 

Pennsylvania      

25-1450605

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

1 South Second Street

P.O. Box 42

Clearfield, Pennsylvania 16830

(Address of principal executive office)

Registrant’s telephone number, including area code (814) 765-9621

Securities registered pursuant to Section 12 (b) of the Act:

 

Title of each class

 

Name of each exchange on which registered

Common Stock, no par value per share   The NASDAQ Stock Market LLC
  (NASDAQ Global Select Market)

Securities registered pursuant to Section 12 (g) of the Act:

None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

¨  Yes  x  No

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

¨  Yes  x  No

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). ¨  Yes  ¨  No

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

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

 

Large accelerated filer  ¨   Accelerated filer  x   Non-accelerated filer  ¨   Smaller reporting company  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).

¨  Yes  x  No

Aggregate market value of the common stock held by nonaffiliates of the registrant as of June 30, 2010:

$125,552,567

The number of shares outstanding of the registrant’s common stock as of March 4, 2011:

12,267,082 shares

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the proxy statement for the annual shareholders’ meeting on April 19, 2011 are incorporated by reference into Part III.


Table of Contents

TABLE OF CONTENTS

 

PART I.   

ITEM 1.

  

Business

     1   

ITEM 1A.

  

Risk Factors

     16   

ITEM 1B.

  

Unresolved Staff Comments

     28   

ITEM 2.

  

Properties

     28   

ITEM 3.

  

Legal Proceedings

     28   

ITEM 4.

  

[Removed and Reserved]

     28   

PART II.

  

ITEM 5.

  

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

     29   

ITEM 6.

  

Selected Financial Data

     31   

ITEM 7.

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     32   

ITEM 7A.

  

Quantitative and Qualitative Disclosures about Market Risk

     47   

ITEM 8.

  

Financial Statements and Supplementary Data

     49   

ITEM 9.

  

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

     100   

ITEM 9A.

  

Controls and Procedures

     100   

ITEM 9B.

  

Other Information

     102   

PART III.

  

ITEM 10.

  

Directors, Executive Officers and Corporate Governance

     103   

ITEM 11.

  

Executive Compensation

     103   

ITEM 12.

  

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

     103   

ITEM 13.

  

Certain Relationships and Related Transactions, and Director Independence

     103   

ITEM 14.

  

Principal Accountant Fees and Services

     103   

PART IV.

  

ITEM 15.

  

Exhibits and Financial Statement Schedules

     104   

SIGNATURES

     106   


Table of Contents

PART I.

ITEM 1.  BUSINESS

CNB Financial Corporation (the “Corporation”) is a financial holding company registered under the Bank Holding Company Act of 1956, as amended. It was incorporated under the laws of the Commonwealth of Pennsylvania in 1983 for the purpose of engaging in the business of a financial holding company. On April 26, 1984, the Corporation acquired all of the outstanding capital stock of County National Bank, a national banking chartered institution. In December 2006, County National Bank changed its name to CNB Bank, referred to as the Bank, and became a state bank chartered in Pennsylvania and subject to regulation by the Pennsylvania Department of Banking and the Federal Deposit Insurance Corporation.

In addition to the Bank, the Corporation has four other subsidiaries. One of its subsidiaries, CNB Securities Corporation, is incorporated in Delaware and currently maintains investments in debt and equity securities. County Reinsurance Company, also a subsidiary, is an Arizona corporation, and provides credit life and disability insurance for customers of CNB Bank. CNB Insurance Agency, incorporated in Pennsylvania, provides for the sale of nonproprietary annuities and other insurance products. Holiday Financial Services Corporation, incorporated in Pennsylvania, offers small balance unsecured loans and secured loans, primarily collateralized by automobiles and equipment, to borrowers with higher risk characteristics.

CNB Bank

The Bank was incorporated in 1934 and is chartered in the Commonwealth of Pennsylvania. The Bank has 27 full service branch offices and one loan production office located in various communities in its market area. The Bank’s primary market area consists of the Pennsylvania counties of Cambria, Cameron, Clearfield, Elk, McKean and Warren. It also includes a portion of western Centre County including Philipsburg Borough, Rush Township and the western portions of Snow Shoe and Burnside Townships and a portion of Jefferson County, consisting of the boroughs of Brockway, Falls Creek, Punxsutawney, Reynoldsville and Sykesville, and the townships of Washington, Winslow and Henderson.

ERIEBANK, a division of CNB Bank, began operations in 2005 and provides financial services to individuals and businesses located within its market areas, which include the northwestern Pennsylvania county of Erie and the city of Meadville located in Crawford County. ERIEBANK currently has four full service branch offices in the city of Erie, Pennsylvania, and one full service branch office in the city of Meadville, Pennsylvania.

The Bank is a full service bank engaging in a full range of banking activities and services for individual, business, governmental and institutional customers. These activities and services principally include checking, savings, and time deposit accounts; real estate, commercial, industrial, residential and consumer loans; and a variety of other specialized financial services. The Bank’s Wealth & Asset Management Services division offers a full range of client services.

Holiday Financial Services Corporation

In 2005, the Corporation entered the consumer discount loan and finance business, which is conducted through a wholly owned subsidiary, Holiday Financial Services Corporation. Holiday currently has eight offices within the Corporation’s footprint. Management believes that it has made the necessary investments in experienced personnel and technology which has helped facilitate the growth of Holiday into a successful and profitable subsidiary.


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Competition

The financial services industry in the Corporation’s service area continues to be extremely competitive, both among commercial banks and with other financial service providers such as consumer finance companies, thrifts, investment firms, mutual funds and credit unions. The increased competition has resulted from changes in the legal and regulatory guidelines as well as from economic conditions. Mortgage banking firms, leasing companies, financial affiliates of industrial companies, brokerage firms, retirement fund management firms, and even government agencies provide additional competition for loans and other financial services. Some of the financial service providers operating in the Corporation’s market area operate on a large-scale regional or national basis and possess resources greater than those of the Corporation. The Corporation is generally competitive with all competing financial institutions in its service area with respect to interest rates paid on time and savings deposits, service charges on deposit accounts and interest rates charged on loans.

Supervision and Regulation

The Corporation is a financial holding company and the Bank is a Pennsylvania state-chartered bank that is not a member of the Federal Reserve System. Accordingly, the Corporation is subject to the oversight of the Federal Reserve Board and the Pennsylvania Department of Banking, and the Bank is subject to the oversight of applicable federal and state banking agencies, including the Pennsylvania Department of Banking and Federal Deposit Insurance Corporation (“FDIC”). The Corporation and Bank are also subject to various requirements and restrictions under federal and state law, such as requirements to maintain reserves against deposits, restrictions on the types, amounts and terms and conditions of loans that may be granted, and limitation on the types of investments that may be made and the types of services that may be offered. Various consumer protection laws and regulations also affect the operation of the Bank. In addition to the impact of regulation, commercial banks are affected significantly by the actions of the Federal Reserve Board, including actions taken with respect to interest rates, as the Federal Reserve Board attempts to control the money supply and credit availability in the U.S. in order to influence the economy.

The following summary sets forth certain of the material elements of the regulatory framework applicable to bank holding companies and their subsidiaries and provides certain specific information about us and our subsidiaries. It does not describe all of the provisions of the statutes, regulations and policies that are identified. To the extent that the following information describes statutory and regulatory provisions, it is qualified in its entirety by express reference to each of the particular statutory and regulatory provisions. A change in applicable statutes, regulations or regulatory policy may have a material effect on our business.

Bank Holding Company Regulation

As a bank holding company, the Corporation is subject to regulation and examination by the Pennsylvania Department of Banking and the Federal Reserve Board. We are required to file with the Federal Reserve Board an annual report and such additional information as the Federal Reserve Board may require pursuant to the Bank Holding Company Act of 1956, as amended (the “BHC Act”), and applicable regulations. For instance, the BHC Act requires each bank holding company to obtain the approval of the Federal Reserve Board before it may acquire substantially all the assets of any bank, or before it may acquire ownership or control of any voting shares of any bank if, after such acquisition, it would own or control, directly or indirectly, more than five percent of the voting shares of such bank.

 

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Such a transaction may also require approval of the Pennsylvania Department of Banking. Pennsylvania law permits Pennsylvania bank holding companies to control an unlimited number of banks.

Pursuant to provisions of the BHC Act and regulations promulgated by the Federal Reserve Board thereunder, the Corporation may only engage in, or own companies that engage in, activities deemed by the Federal Reserve Board to be permissible for bank holding companies or financial holding companies. Activities permissible for bank holding companies are those that are so closely related to the business of banking or managing or controlling banks as to be a proper incident thereto. Permissible activities for financial holding companies include those “so closely related to banking” as well as certain additional activities deemed “financial in nature.” The Corporation must obtain permission from the Federal Reserve Board prior to engaging in most new business activities.

A bank holding company and its subsidiaries are subject to certain restrictions imposed by the BHC Act on any extensions of credit to the Bank, investments in the stock or securities thereof, and on the taking of such stock or securities as collateral for loans to any borrower. A bank holding company and its subsidiaries are also prohibited from engaging in certain tying arrangements in connection with any extension of credit, lease or sale of property or furnishing of services.

Under Federal Reserve Board regulations, a bank holding company is required to serve as a source of financial and managerial strength to its subsidiary banks and may not conduct its operations in an unsafe or unsound manner. In addition, it is the Federal Reserve Board’s policy that in serving as a source of strength to its subsidiary banks, a bank holding company should stand ready to use available resources to provide adequate capital funds to its subsidiary banks during periods of financial stress or adversity and should maintain the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks. A bank holding company’s failure to meet its obligations to serve as a source of strength to its subsidiary banks will generally be considered by the Federal Reserve Board to be an unsafe and unsound banking practice or a violation of the Federal Reserve Board regulations or both. This doctrine is commonly known as the “source of strength” doctrine.

The federal banking regulators have adopted risk-based capital guidelines for bank holding companies. Currently, the required minimum ratio of total capital to risk-weighted assets (including off-balance sheet activities, such as standby letters of credit) is 8%. At least half of the total capital is required to be Tier 1 capital, consisting principally of common shareholders’ equity, non-cumulative perpetual preferred stock, a limited amount of cumulative perpetual preferred stock and minority interests in the equity accounts of consolidated subsidiaries, less goodwill. The remainder (Tier 2 capital) may consist of a limited amount of subordinated debt and intermediate-term preferred stock, certain hybrid capital instruments and other debt securities, perpetual preferred stock and a limited amount of the general loan loss allowance.

In addition to the risk-based capital guidelines, the federal banking regulators have established minimum leverage ratio (Tier 1 capital to total assets) guidelines for bank holding companies. These guidelines provide for a minimum leverage ratio of 3% for those bank holding companies which have the highest regulatory examination ratings and are not contemplating or experiencing significant growth or expansion. All other bank holding companies are required to maintain a leverage ratio of at least 4%.

 

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Regulation of CNB Bank

CNB Bank is a Pennsylvania-chartered bank and is subject to regulation, supervision and regular examination by the Pennsylvania Department of Banking and the FDIC. Federal and state banking laws and regulations govern, among other things, the scope of a bank’s business, the investments a bank may make, the reserves against deposits a bank must maintain, the loans a bank makes and collateral it takes, the maximum interest rates a bank may pay on deposits, the activities of a bank with respect to mergers and consolidations, the establishment of branches, management practices, and numerous other aspects of banking operations.

Recent Legislation

On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). This new law includes numerous provisions designed to strengthen the financial industry, enhance consumer protection, expand disclosures and provide for transparency, and will significantly change the current bank regulatory structure and affect the lending, deposit, investment, trading and operating activities of financial institutions and their holding companies. The Dodd-Frank Act also includes provisions that will create a Consumer Financial Protection Bureau, which is authorized to write rules on all consumer financial products, and a Financial Services Oversight Council, which is empowered to determine which entities are systematically significant and require tougher regulations and is charged with reviewing, and when appropriate, submitting comments to the Securities and Exchange Commission and Financial Accounting Standards Board with respect to existing or proposed accounting principles, standards or procedures.

The Dodd-Frank Act requires various federal agencies to adopt a broad range of new rules and regulations, and to prepare various studies and reports for Congress. The federal agencies are given significant discretion in drafting such rules and regulations. With that discretion, market litigation, and continued legislative efforts, many of the details and much of the impact of the Dodd-Frank Act may not be known for months or years.

It is difficult to predict at this time with specificity the full range of the impact the Dodd-Frank Act and any future implementing rules and regulations will have on the Corporation. The legislation and any implementing rules that are ultimately issued could have adverse implications on the financial industry, the competitive environment, and the Corporation’s ability to conduct business. The Corporation will have to apply resources to ensure that it is in compliance with all applicable provisions of the Dodd-Frank Act and any implementing rules, which may increase its costs of operations and adversely impact its earnings.

Dividend Restrictions

The Corporation is a legal entity separate and distinct from the Bank. Declaration and payment of cash dividends depends upon cash dividend payments to the Corporation by the Bank, which is our primary source of revenue and cash flow. Accordingly, the right of the Corporation, and consequently the right of our creditors and shareholders, to participate in any distribution of the assets or earnings of any subsidiary is necessarily subject to the prior claims of creditors of the subsidiary, except to the extent that claims of the Corporation in its capacity as a creditor may be recognized.

 

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As a Pennsylvania state-chartered bank, the Bank is subject to regulatory restrictions on the payment and amounts of dividends under the Pennsylvania Banking Code. Further, the ability of banking subsidiaries to pay dividends is also subject to their profitability, financial condition, capital expenditures and other cash flow requirements.

The payment of dividends by the Bank and the Corporation may also be affected by other factors, such as the requirement to maintain adequate capital above regulatory guidelines. The federal banking agencies have indicated that paying dividends that deplete a depository institution’s capital base to an inadequate level would be an unsafe and unsound banking practice. A depository institution may not pay any dividend if payment would cause it to become undercapitalized or if it already is undercapitalized. Moreover, the federal agencies have issued policy statements that provide that bank holding companies and insured banks should generally only pay dividends out of current operating earnings. Federal banking regulators have the authority to prohibit banks and bank holding companies from paying a dividend if the regulators deem such payment to be an unsafe or unsound practice.

Capital Adequacy and Operations

Under applicable “prompt corrective action” (“PCA”) provisions, depository institutions are placed into one of five capital categories, ranging from “well capitalized” to “critically undercapitalized.” An institution that is not well capitalized is generally prohibited from accepting brokered deposits and offering interest rates on deposits higher than the prevailing rate in its market; in addition, “pass through” insurance coverage may not be available for certain employee benefit accounts. An undercapitalized depository institution must submit an acceptable capital restoration plan to the appropriate federal bank regulatory agency. One requisite element of such a plan is that the institution’s parent holding company must guarantee compliance by the institution with the plan, subject to certain limitations. In the event of the parent holding company’s bankruptcy, the guarantee, and any other commitments that the parent holding company has made to federal bank regulators to maintain the capital of its depository institution subsidiaries, would be assumed by the bankruptcy trustee and entitled to priority in payment.

At December 31, 2010, the Bank qualified as “well capitalized” under applicable regulatory capital standards.

Community Reinvestment Act

Under the Community Reinvestment Act of 1977 (“CRA”), the FDIC is required to assess the record of all financial institutions regulated by it to determine if these institutions are meeting the credit needs of the community (including low and moderate income neighborhoods) which they serve. CRA performance evaluations are based on a four-tiered rating system: Outstanding, Satisfactory, Needs to Improve and Substantial Noncompliance. CRA performance evaluations are considered in evaluating applications for such things as mergers, acquisitions and applications to open branches. The Bank received a CRA rating of “Satisfactory” at its most current CRA exam.

Restrictions on Transactions with Affiliates and Insiders

The Bank and Corporation also are subject to the restrictions of Sections 23A and 23B of the Federal Reserve Act, and their implementing Regulation W, issued by the Federal Reserve Board. Section 23A requires that loans or extensions of credit to an affiliate, purchases of securities issued by an affiliate,

 

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purchases of assets from an affiliate (except as may be exempted by order or regulation), the acceptance of securities issued by an affiliate as collateral and the issuance of a guarantee, acceptance of letters of credit on behalf of an affiliate (collectively, “Covered Transactions”) be on terms and conditions consistent with safe and sound banking practices. Section 23A also imposes quantitative restrictions on the amount of and collateralization requirements on such transactions. Section 23B requires that all Covered Transactions and certain other transactions, including the sale of securities or other assets to an affiliate and the payment of money or the furnishing of services to an affiliate, be on terms comparable to those prevailing for similar transactions with non-affiliates.

The Bank and Corporation are also subject to Sections 22(g) and 22(h) of the Federal Reserve Act, and their implementing Regulation O issued by the Federal Reserve Board. These provisions impose limitations on loans and extensions of credit from the bank to its executive officers, directors and principal shareholders and their related interests. The limitations restrict the terms and aggregate amount of such transactions. Regulation O also imposes certain recordkeeping and reporting requirements.

Deposit Insurance and Premiums

The deposits of the Bank are insured up to applicable limits per insured depositor by the FDIC. The Dodd-Frank Act has permanently increased the standard maximum deposit insurance amount (“SMDIA”) to $250,000 per depositor per insured depository institution, retroactive to January 1, 2008, and qualifying non-interest bearing transaction accounts have unlimited deposit insurance through December 31, 2012.

The Dodd-Frank Act also broadens the base for FDIC insurance assessments. Assessments will now be based on the average consolidated total assets less tangible equity capital of a financial institution.

Other Federal Laws and Regulations

State usury and other credit laws limit the amount of interest and various other charges collected or contracted by a bank on loans. The Bank is also subject to lending limits on loans to one borrower and regulatory guidance on concentrations of credit. The Bank’s loans and other products and services are also subject to numerous federal and state laws, including, but not limited to, the following:

 

   

Truth-In-Lending Act, which governs disclosures of credit terms to consumer borrowers;

 

   

Truth-in-Savings Act, which governs disclosures of the terms of deposit accounts to consumers;

 

   

Home Mortgage Disclosure Act, requiring financial institutions to provide information to regulators to enable determinations as to whether financial institutions are fulfilling their obligations to meet the home lending needs of the communities they serve and not discriminating in their lending practices;

 

   

Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, gender or other prohibited factors in extending credit;

 

   

Real Estate Settlement Procedures Act, which imposes requirements relating to real estate settlements, including requiring lenders to disclose certain information regarding the nature and cost of real estate settlement services;

 

   

Fair Credit Reporting Act, covering numerous areas relating to certain types of consumer information and identity theft;

 

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Privacy provisions of the Gramm-Leach-Bliley Act and related regulations, which require that financial institutions provide privacy policies to consumers, to allow customers to “opt out” of certain sharing of their nonpublic personal information, and to safeguard sensitive and confidential customer information.

 

   

Electronic Fund Transfer Act, which is a consumer protection law regarding electronic fund transfers;

 

   

The Bank Secrecy Act and USA Patriot Act, which require financial institutions to take certain actions to help prevent, detect and prosecute international money laundering and the financing of terrorism; and

 

   

Numerous other federal and state laws and regulations, including those related to consumer protection and bank operations.

Sarbanes-Oxley Act of 2002

On July 30, 2002, President Bush signed into law the Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act represents a comprehensive revision of laws affecting corporate governance, accounting obligations and corporate reporting. The Sarbanes-Oxley Act is applicable to all companies with equity securities registered or that file reports under the Securities Exchange Act of 1934, including publicly held financial holding companies such as the Corporation. In particular, the Sarbanes-Oxley Act establishes: (i) requirements for audit committees, including independence, expertise, and responsibilities; (ii) additional responsibilities regarding financial statements for the Chief Executive Officer and Chief Financial Officer of the reporting company; (iii) standards for auditors and regulation of audits; (iv) increased disclosure and reporting obligations for the reporting company and its directors and executive officers; and (v) new and increased civil and criminal penalties for violations of the securities laws. Many of the provisions were effective immediately while other provisions became effective over a period of time and are subject to rulemaking by the SEC.

Governmental Policies

Our earnings are significantly affected by the monetary and fiscal policies of governmental authorities, including the Federal Reserve Board. Among the instruments of monetary policy used by the Federal Reserve Board to implement these objectives are open-market operations in U.S. Government securities and federal funds, changes in the discount rate on member bank borrowings and changes in reserve requirements against member bank deposits. These instruments of monetary policy are used in varying combinations to influence the overall level of bank loans, investments and deposits, and the interest rates charged on loans and paid for deposits. The Federal Reserve Board frequently uses these instruments of monetary policy, especially its open-market operations and the discount rate, to influence the level of interest rates and to affect the strength of the economy, the level of inflation or the price of the dollar in foreign exchange markets. The monetary policies of the Federal Reserve Board have had a significant effect on the operating results of banking institutions in the past and are expected to continue to do so in the future. It is not possible to predict the nature of future changes in monetary and fiscal policies, or the effect which they may have on our business and earnings.

Other Legislative Initiatives

Proposals may be introduced in the United States Congress, in the Pennsylvania Legislature, and/or by various bank regulatory authorities that could alter the powers of, and restrictions on, different types of

 

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banking organizations and which could restructure part or all of the existing regulatory framework for banks, bank and financial holding companies and other providers of financial services. Moreover, other bills may be introduced in Congress which would further regulate, deregulate or restructure the financial services industry, including proposals to substantially reform the regulatory framework. It is not possible to predict whether these or any other proposals will be enacted into law or, even if enacted, the effect which they may have on our business and earnings.

Employees

As of December 31, 2010, the Corporation had a total of 304 employees of which 261 were full time and 43 were part time.

Executive Officers

The Corporation’s executive officers, their ages, and their principal occupations are as follows:

 

Name

    

Age

  

Principal Occupation

Joseph B. Bower, Jr.      47   

President and Chief Executive Officer, CNB Bank and CNB Financial Corporation, since January 1, 2010; previously, Secretary, CNB Financial Corporation, since 2003; Executive Vice President and Chief Operating Officer, CNB Bank, since 2003; and previously Chief Financial Officer, CNB Bank, since 1997.

Mark D. Breakey      52   

Executive Vice President and Credit Risk Manager, CNB Bank, since 2004; and previously Senior Loan Officer, CNB Bank, since 1995.

Richard L. Greslick, Jr.      34   

Senior Vice President/Administration and Secretary, CNB Financial Corporation, since July 28, 2010; previously, Vice President/Operations since 2007; and previously Controller, CNB Bank and CNB Financial Corporation, since 2003.

Charles R. Guarino      48   

Treasurer, Principal Financial Officer and Principal Accounting Officer, CNB Financial Corporation, since April 2006; Chief Financial Officer, CNB Bank, since 2004; and previously a Certified Public Accountant in public practice.

Richard L. Sloppy      60   

Executive Vice President and Senior Loan Officer, CNB Bank, since 2004; and previously Vice President Commercial Banking, CNB Bank, since 1998.

Vincent C. Turiano      60   

Senior Vice President/Operations, CNB Bank, since November 25, 2009; previously Financial Consultant for RBC Wealth Management (formerly Ferris, Baker Watts, Inc.) since 2006; and previously Executive Vice President of Omega Bank and Omega Financial Corporation.

 

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Officers are elected annually at the reorganization meeting of the Board of Directors. There are no arrangements or understandings between any officer and any other persons pursuant to which he was selected as an officer.

Available Information

The Corporation makes available free of charge on its website (www.bankcnb.com) its Annual Report on Form 10-K, its quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as practicable after it electronically files such material with, or furnishes it to, the Securities and Exchange Commission. Information on the Corporation’s website is not incorporated by reference into this report.

Shareholders may obtain a copy of the Corporation’s Annual Report on Form 10-K free of charge by writing to: CNB Financial Corporation, 1 South Second Street, PO Box 42, Clearfield, PA 16830, Attn: Shareholder Relations.

Statistical Disclosure

The following tables set forth statistical information relating to the Corporation and its wholly owned subsidiaries. The tables should be read in conjunction with the consolidated financial statements of the Corporation.

 

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Average Balances and Net Interest Margin

(Dollars in thousands)

 

     December 31, 2010            December 31, 2009     December 31, 2008  
     Average
Balance
    Annual
Rate
    Interest
Inc./
Exp.
           Average
Balance
    Annual
Rate
    Interest
Inc./
Exp.
    Average
Balance
    Annual
Rate
    Interest
Inc./
Exp.
 

Assets

                   

Interest-bearing deposits with banks

  $ 8,680        1.44   $ 125        $ 9,088        2.37   $ 215      $ 7,875        5.45   $ 429   

Federal funds sold and securities purchased under agreements to resell

    -          -          2        0.00     0        13,341        2.56     342   

Securities:

                   

Taxable (1)

    383,373        3.02     11,603          223,814        3.29     7,687        157,185        4.53     7,419   

Tax-Exempt (1, 2)

    69,033        5.28     3,572          55,642        5.60     3,057        31,809        6.54     2,053   

Equity Securities (1, 2)

    1,607        2.30     37          1,502        2.89     44        5,732        6.24     296   
                                                       

Total Securities

    454,013        3.35     15,212          280,958        3.86     10,788        194,726        4.88     9,768   
                                                       

Loans

                   

Commercial (2)

    258,550        5.62     14,542          242,719        5.82     14,129        241,648        6.48     15,663   

Mortgage (2)

    431,599        6.14     26,514          396,017        6.41     25,387        357,583        6.98     24,961   

Consumer

    51,565        12.81     6,605          47,702        14.57     6,952        47,605        15.09     7,182   
                                                       

Total Loans (3)

    741,714        6.43     47,661          686,438        6.77     46,468        646,836        7.39     47,806   
                                                       

Total earning assets

    1,204,407        5.23   $   62,998          976,486        5.89   $   57,471        862,778        6.72   $   58,345   
                                                       

Non Interest Earning Assets

                   

Cash & Due From Banks

    33,885              33,237            29,815       

Premises & Equipment

    23,969              23,004            22,425       

Other Assets

    53,867              49,640            41,805       

Allowance for Loan Losses

    (10,443           (9,320         (7,508    
                                     

Total Non Interest Earning Assets

    101,278              96,561            86,537       
                                     

Total Assets

  $   1,305,685            $   1,073,047          $   949,315       
                                     

Liabilities and Shareholders’ Equity

                   

Interest-Bearing Deposits

                   

Demand – interest-bearing

  $   258,826        0.75   $   1,954        $   241,505        0.79   $   1,904      $   207,293        1.42   $ 2,947   

Savings

    346,346        1.29     4,464          201,827        1.70     3,434        98,463        1.96     1,928   

Time

    349,401        2.04     7,140          320,477        2.42     7,753        349,544        2.88     10,081   
                                                       

Total interest-bearing deposits

    954,573        1.42     13,558          763,809        1.71     13,091        655,300        2.28     14,956   

Short-term borrowings

    5,282        0.15     8          1,961        0.20     4        961        1.25     12   

Long-term borrowings

    87,336        5.39     4,708          104,107        4.34     4,523        101,613        4.52     4,597   

Subordinated Debentures

    20,620        3.79     782          20,620        4.12     850        20,620        4.94     1,018   
                                                       

Total interest-bearing liabilities

    1,067,811        1.78   $   19,056          890,497        2.07   $   18,468        778,494        2.64   $   20,583   
                                     

Demand – non-interest-bearing

    127,287              104,773            97,578       

Other liabilities

    13,203              11,568            6,774       
                                     

Total Liabilities

    1,208,301              1,006,838            882,846       

Shareholders’ Equity

    97,384              66,209            66,469       
                                     

Total Liabilities and Shareholders’ Equity

  $ 1,305,685            $ 1,073,047          $ 949,315       
                                     

Interest Income/Earning Assets

      5.23   $ 62,998            5.89   $ 57,471          6.72   $ 58,345   

Interest Expense/Interest Bearing Liabilities

      1.78     19,056            2.07     18,468          2.64     20,583   
                               

Net Interest Spread

      3.45   $ 43,942            3.82   $ 39,003          4.08   $ 37,762   
                               

Interest Income/Earning Assets

      5.23   $ 62,998            5.89   $ 57,471          6.72   $ 58,345   

Interest Expense/Earning Assets

      1.58     19,056            1.89     18,468          2.39     20,583   
                               

Net Interest Margin

      3.65   $ 43,942            4.00   $ 39,003          4.33   $ 37,762   
                               

 

(1)

Includes unamortized discounts and premiums. Average balance is computed using the carrying value of securities. The average yield has been computed using the historical amortized cost average balance for available for sale securities.

(2)

Average yields and interest income are stated on a fully taxable equivalent basis using the Corporation’s marginal federal income tax rate of 35%.

(3)

Average outstanding includes the average balance outstanding of all non-accrual loans. Loans consist of the average of total loans less average unearned income. The amount of loan fees included in the interest income on loans is not material.

 

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Net Interest Income
Rate-Volume Variance
(Dollars in thousands)
   For Twelve Months Ended
December 31, 2010 over
(under) 2009
Due to Change In (1)
     For Twelve Months Ended
December 31, 2009 over
(under) 2008
Due to Change In (1)
 
      Volume      Rate      Net      Volume      Rate      Net  

Assets

                 

Interest-Bearing Deposits with Banks

   $ (10)       $ (80)       $ (90)       $ 66       $ (280)       $ (214)   

Federal Funds Sold and securities purchased under agreements to resell

     -         -         -         (342)         -         (342)   

Securities:

                 

Taxable

     4,951         (1,035)         3,916         4,700         (4,432)         268   

Tax-Exempt (2)

     736         (221)         515         1,649         (645)         1,004   

Equity Securities (2)

     2         (9)         (7)         (211)         (41)         (252)   
        

Total Securities

     5,689         (1,265)         4,424         6,138         (5,118)         1,020   

Loans

                 

Commercial (2)

     922         (509)         413         69         (1,603)         (1,534)   

Mortgage (2)

     2,281         (1,154)         1,127         2,683         (2,257)         426   

Consumer

     563         (910)         (347)         15         (245)         (230)   
        

Total Loans (3)

     3,766         (2,573)         1,193         2,767         (4,105)         (1,338)   
        

Total Earning Assets

   $   9,445       $   (3,918)       $   5,527       $   8,629       $   (9,503)       $ (874)   
        

Liabilities and Shareholders’ Equity

                 

Interest-Bearing Deposits

                 

Demand – Interest-Bearing

   $ 137       $ (87)       $ 50       $ 486       $ (1,529)       $ (1,043)   

Savings

     2,459         (1,429)         1,030         2,024         (518)         1,506   

Time

     700         (1,313)         (613)         (838)         (1,490)         (2,328)   
        

Total Interest-Bearing Deposits

     3,295         (2,828)         467         1,672         (3,537)         (1,865)   

Short-Term Borrowings

     7         (3)         4         12         (20)         (8)   

Long-Term Borrowings

     (729)         914         185         113         (187)         (74)   

Subordinated debentures

     -         (68)         (68)         0         (168)         (168)   
        

Total Interest-Bearing Liabilities

   $ 2,573       $ (1,985)       $ 588       $ 1,797       $ (3,912)       $ (2,115)   
        
                 
        

Change in Net Interest Income

   $ 6,872       $ (1,933)       $ 4,939       $ 6,832       $ (5,591)       $   1,241   
        

 

1.

The change in interest due to both volume and rate have been allocated entirely to rate changes.

2.

Changes in interest income on tax-exempt securities and loans are presented on a fully taxable-equivalent basis, using the Corporation’s marginal federal income tax rate of 35%.

3.

Included in loan interest income is $1,835, $1,774 and $1,806 of fees for the years ending 2010, 2009 and 2008, respectively.

 

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Securities                                                                        
(Dollars In Thousands)   December 31, 2010     December 31, 2009     December 31, 2008  
   

Amortized

Cost

    Unrealized    

Market

Value

   

Amortized

Cost

    Unrealized    

Market

Value

   

Amortized

Cost

    Unrealized    

Market

Value

 
      Gains     Losses         Gains     Losses         Gains     Losses    

Securities Available for Sale

                       

U.S. Treasury

    $8,139        $66        $        -        $8,205        $10,288        $5        $    (24)        $10,269        $10,059        $257        $        -        $10,316   

U.S. Government Sponsored Entities

    104,328        2,016        (403)        105,941        107,615        94        (748)        106,961        40,779        486        (1)        41,264   

State and Political Subdivisions

    117,928        1,011        (2,528)        116,411        55,710        991        (140)        56,561        54,467        667        (719)        54,415   

Residential mortgage and asset backed

    221,304        2,364        (1,249)        222,419        144,878        1,188        (666)        145,400        104,664        580        (1,357)        103,887   

Corporate notes and bonds

    14,347            -        (3,596)        10,751        18,713            -        (5,082)        13,631        28,694        31        (6,032)        22,693   

Pooled trust preferred

    2,190        12        (910)        1,292        4,594            -        (2,685)        1,909        7,080        37        (4,038)        3,079   

Pooled SBA

    33,788        266        (92)        33,962        8,894        102        (7)        8,989            -            -            -            -   

Other securities

    1,670        26            -        1,696        1,670        28        (3)        1,695        1,670            -        (35)        1,635   
       
    $503,694        $5,761        $(8,778)        $500,677        $352,362        $2,408        $(9,355)        $345,415        $247,413        $2,058        $(12,182)        $237,289   
       

Maturity Distribution of Investment Securities

(Dollars In Thousands)

December 31, 2010

 

    Within
One Year
     After One But
Within Five Years
    After Five But
Within Ten
Years
    After Ten Years      Collaterialized Mortgage
Obligations and Other
Asset Backed  Securities
 
    $ Amt.      Yield     $ Amt.     Yield     $ Amt.      Yield     $ Amt.      Yield      $ Amt.      Yield  

Securities Available for Sale

                        

U.S. Treasury

    $4,091         0.91%        $4,114        1.29%                   

U.S. Government Sponsored Entities

    23,490         2.13%        28,513        2.36%        $46,145         3.67%        $7,793         4.09%         

State and Political Subdivisions

    2,603         4.62%        16,415        4.52%        57,462         5.04%        39,931         5.71%         

Corporate notes and bonds

         992        2.27%             9,759         3.03%         

Pooled trust preferred

                  1,292         2.06%         

Pooled SBA

         4,996        4.15%        22,978         3.32%        5,988         3.55%         

Residential mortgage and asset backed

                        $222,419         2.96%   
       

TOTAL

    $30,184         2.18%        $55,030        3.08%        $126,585         4.43%        $64,763         4.84%         $222,419         2.96%   
       

The weighted average yields are based on market value and effective yields weighted for the scheduled maturity with tax-exempt securities adjusted to a taxable-equivalent basis using a tax rate of 35%. The portfolio contains no holdings of a single issuer that exceeds 10% of shareholders’ equity other than the US Treasury and governmental sponsored entities.

 

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LOAN PORTFOLIO

(Dollars in thousands)

A. TYPE OF LOAN

 

    2010           2009           2008           2007           2006  

Commercial, industrial and agricultural

  $ 257,491        $ 239,966        $ 227,141        $ 217,651        $ 214,339   

Commercial mortgages

    212,878          193,632          210,080          176,470          160,159   

Residential real estate

    266,604          226,931          179,420          160,585          143,453   

Consumer

    53,202          54,854          57,241          46,112          27,855   

Credit cards

    2,870          2,248          1,411          1,535          1,675   

Overdrafts

    3,964          391          859          1,188          465   
                                               

Gross loans

    797,009          718,022          676,152          603,541          547,946   

Less: unearned income

    2,447          2,880          4,596          3,853          926   
                                               

Total loans net of unearned

  $ 794,562        $ 715,142        $ 671,556        $ 599,688        $ 547,020   
                                               

B. LOAN MATURITIES AND INTEREST SENSITIVITY

 

    December 31, 2010  
    One Year
or Less
          One Through
Five Years
          Over
Five Years
          Total Gross
Loans
 

Commercial, industrial and agricultural

             

Loans With Fixed Interest Rate

  $ 112,952        $ 61,861        $ 23,061        $ 197,874   

Loans With Floating Interest Rate

    13,467          21,640          24,510          59,617   
                                     
  $ 126,419        $ 83,501        $ 47,571        $ 257,491   
                                     

C. RISK ELEMENTS

 

    2010           2009           2008           2007           2006  

Loans on non-accrual basis

  $ 11,926        $ 12,757        $ 3,046        $ 1,979        $ 1,619   

Accruing loans which are contractually past due 90 days or more as to interest or principal payment

    889          584          533          395          128   

Troubled debt restructurings

    1,714          -          -          -          -   
                                               
  $ 14,529        $ 13,341        $ 3,579        $ 2,374        $ 1,747   
                                               

Interest income recorded on the non-accrual loans for the year ended December 31, 2010 was $383. Additional interest income which would have been recorded on these loans had they been on accrual status was $492.

Loans are placed in non-accrual status when the interest or principal is 90 days past due, unless the loan is in collection, well secured and it is believed that there will be no loss of interest or principal.

At December 31, 2010, there were $12,503 in special mention loans, $45,699 in substandard loans, and $125 in doubtful loans which are considered problem loans. These loans are not included in the table above. In the opinion of management, these loans are adequately secured and losses are believed to be minimal.

 

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Table of Contents

SUMMARY OF LOAN LOSS EXPERIENCE

(Dollars in Thousands)

 

Analysis of the Allowance for Loan Losses

                      
Years Ended December 31,    2010            2009            2008            2007            2006  

Balance at beginning of Period

   $ 9,795         $ 8,719         $ 6,773         $ 6,086         $ 5,603   

Charge-Offs:

                      

Commercial, industrial and agricultural

     543           860           33           39           -   

Commercial mortgages

     2,061           381           178           28           144   

Residential real estate

     211           378           330           180           203   

Consumer

     1,223           1,622           1,123           322           348   

Credit cards

     94           101           46           95           124   

Overdrafts

     239           269           334           346           272   
                                                    
     4,371           3,611           2,044           1,010           1,091   

Recoveries:

                      

Commercial, industrial and agricultural

     11           2           2           -           3   

Commercial mortgages

     3           -           -           -           3   

Residential real estate

     2           1           6           12           4   

Consumer

     100           62           72           67           78   

Credit cards

     10           13           12           24           22   

Overdrafts

     112           144           111           82           93   
                                                    
     238           222           203           185           203   

Net charge-offs

     (4,133        (3,389        (1,841        (825        (888

Provision for loan losses

     5,158           4,465           3,787           1,512           1,371   
                                                    

Balance at end of period

   $ 10,820         $ 9,795         $ 8,719         $ 6,773         $ 6,086   
                                                    

Percentage of net charge-offs during the period

to average loans outstanding

     0.56        0.49        0.28        0.14        0.17

The provision for loan losses reflects the amount deemed appropriate by management to establish an adequate reserve to meet the present and foreseeable risk characteristics of the present loan portfolio. Management’s judgment is based on the evaluation of individual loans, the overall risk characteristics of various portfolio segments, past experience with losses, the impact of economic condition on borrowers, and other relevant factors.

ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES

(Dollars In Thousands)

 

    2010     2009     2008     2007     2006  
    Amount     % of Loans
in each
Category
    Amount     % of Loans
in each
Category
    Amount     % of Loans
in each
Category
    Amount     % of Loans
in each
Category
    Amount     % of Loans
in each
Category
 

Commercial, industrial, and agricultural

  $ 3,517        32.31   $ 2,790        33.42   $ 2,660        33.59   $ 2,253        36.06   $ 2,553        39.12

Commercial mortgages

    3,511        26.71     3,291        26.97     2,836        31.07     1,915        29.24     2,066        29.23

Residential real estate

    1,916        33.45     1,583        31.61     1,273        26.54     1,012        26.61     646        26.18

Consumer

    1,561        6.68     1,751        7.64     1,589        8.47     1,196        7.64     551        5.08

Credit Cards

    96        0.35     85        0.31     82        0.20     91        0.25     66        0.31

Overdrafts

    219        0.50     295        0.05     279        0.13     306        0.20     199        0.08

Unallocated

    -        0.00     -        0.00     -        0.00     -        0.00     5        0.00
                                                                               

Total

  $ 10,820        100.00   $ 9,795        100.00   $ 8,719        100.00   $ 6,773        100.00   $ 6,086        100.00
                                                                               

In determining the allocation of the allowance for loan losses, the Corporation considers economic trends, historical patterns and specific credit reviews.

 

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Table of Contents

With regard to the credit reviews, a “watchlist” is evaluated on a monthly basis to determine potential commercial losses. Consumer loans and mortgage loans are allocated using historical loss experience. The total of these reserves is deemed “allocated” while the remaining balance is “unallocated”.

Analysis of the Allowance for Loan Losses

The unallocated component of the allowance for loan losses has been eliminated beginning in 2007 as management has refined its methodology for monitoring and measuring credit risk. In 2010, 2009, 2008, and 2007, additional individual loans were subject to specific review, resulting in an increase in specific allowance allocations. In addition, consideration of current economic risk factors were applied to individual pools of homogeneous loans. In prior years, economic risk factors were applied to the portfolio of loans as a whole and were reflected as unallocated.

DEPOSITS

(Dollars In Thousands)

 

     Year Ended December 31,  
     2010     2009     2008  
     Average
Amount
     Annual
Rate
    Average
Amount
     Annual
Rate
    Average
Amount
     Annual
Rate
 

Demand – Non Interest Bearing

   $ 127,287         $ 104,773         $ 97,578      

Demand – Interest Bearing

     258,826         0.75     241,505         0.79     207,293         1.42

Savings Deposits

     346,346         1.29     201,827         1.70     98,463         1.96

Time Deposits

     349,401         2.04     320,477         2.42     349,544         2.88
                                 

TOTAL

   $   1,081,860         $   868,582         $   752,878      
                                 

 

The maturity of certificates of deposits and other time deposits

in denomination of $100,000 or more as of December 31, 2010

(Dollars In Thousands)

  

Maturing in:

  

Three months or less

   $ 39,363   

Greater than three months and through twelve months

     36,365   

Greater than one year and through three years

     79,942   

Greater than three years

     9,956   
        
   $ 165,626   
        

RETURN ON EQUITY AND ASSETS

 

       Year Ended December 31,    
     2010     2009     2008  

Return on average assets

     0.87     0.79     0.55

Return on average equity

     11.62     12.86     7.88

Dividend payout ratio

     61.27     67.27     105.53

Average equity to average assets ratio

     7.46     6.17     7.00

 

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Table of Contents

ITEM 1A.  RISK FACTORS

The Corporation’s financial condition and results of operations are subject to various risks inherent in the its business. The material risks and uncertainties that management believes affect the Corporation are described below. If any of these risks actually occur, the Corporation’s business, financial condition, liquidity, results of operations and prospects could be materially and adversely affected. You should consider all of the following risks together with all of the other information in this Annual Report on Form 10-K.

Difficult market conditions have adversely affected the banking and financial services industry and the Corporation’s business, and a continuation of these conditions could adversely affect its financial condition and results of operations.

Dramatic declines in the national housing market since 2008, with falling home prices and increasing foreclosures, unemployment and under-employment, have negatively impacted the credit performance of mortgage loans and resulted in significant write-downs of asset values by financial institutions, including government-sponsored entities as well as major commercial and investment banks. These write-downs, initially of mortgage-backed securities but spreading to credit default swaps and other derivative and cash securities, in turn, have caused many financial institutions to seek additional capital, to merge with larger and stronger institutions and, in some cases, to fail. Reflecting concern about the stability of the financial markets generally and the strength of counterparties, many lenders and institutional investors have reduced or ceased providing funding to borrowers, including to other financial institutions. This market turmoil and tightening of credit have led to an increased level of commercial and consumer delinquencies, lack of consumer confidence, increased market volatility and widespread reduction of business activity generally. The resulting economic pressure on consumers and lack of confidence in the financial markets could adversely affect the Corporation’s business, financial condition and results of operations. In particular, the Corporation may face the following risks in connection with these events:

 

   

The Corporation expects to face increased regulation of the banking and financial services industry. Compliance with such regulation may increase its costs and limit its ability to pursue business opportunities.

   

Market developments may affect customer confidence levels and may cause increases in loan delinquencies and default rates, which management expects would adversely impact the Bank’s charge-offs and provision for loan losses.

   

Market developments may adversely affect the Bank’s securities portfolio by causing other-than-temporary-impairments, prompting write-downs and securities losses.

   

The Corporation’s and the Bank’s ability to borrow from other financial institutions or to access the debt or equity capital markets on favorable terms or at all could be adversely affected by further disruptions in the capital markets or other events, including actions by rating agencies and deteriorating investor expectations.

   

Competition in banking and financial services industry could intensify as a result of the increasing consolidation of financial services companies in connection with current market conditions.

   

The Bank may be required to pay significantly higher premiums to the FDIC because market developments have significantly depleted the insurance fund of the FDIC and reduced the ratio of reserves to insured deposits.

 

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The Bank’s allowance for loan losses may not be adequate to cover loan losses which could have a material adverse effect on the Corporation’s business, financial condition and results of operations.

A significant source of risk for the Corporation arises from the possibility that losses will be sustained because borrowers, guarantors and related parties may fail to perform in accordance with the terms of their loan agreements. Most loans originated by the Bank are secured, but some loans are unsecured based upon management’s evaluation of the creditworthiness of the borrowers. With respect to secured loans, the collateral securing the repayment of these loans principally includes a wide variety of real estate, and to a lesser extent personal property, either of which may be insufficient to cover the obligations owed under such loans.

Collateral values and the financial performance of borrowers may be adversely affected by changes in prevailing economic, environmental and other conditions, including declines in the value of real estate, changes in interest rates and debt service levels, changes in oil and gas prices, changes in monetary and fiscal policies of the federal government, widespread disease, terrorist activity, environmental contamination and other external events, which are beyond the control of the Bank. In addition, collateral appraisals that are out of date or that do not meet industry recognized standards might create the impression that a loan is adequately collateralized when in fact it is not. Although the Bank may acquire any real estate or other assets that secure defaulted loans through foreclosures or other similar remedies, the amounts owed under the defaulted loans may exceed the value of the assets acquired.

The allowance for loan losses is subject to a formal analysis by the credit administrator of CNB using a methodology whereby loan pools are segregated into special mention, substandard, doubtful and unclassified categories and the pools are evaluated based on historical loss factors. The Bank monitors delinquencies and losses on a monthly basis. The Bank has adopted underwriting and credit monitoring policies and procedures, including the review of borrower financial statements and collateral appraisals, which management believes are appropriate to mitigate the risk of loss by assessing the likelihood of borrower non-performance and the value of available collateral. The Bank also manages credit risk by diversifying its loan portfolio. An ongoing independent review, subsequent to management’s review, of individual credits is performed by an independent loan review function, which reports to the Loan Committee of the Corporation’s Board of Directors. However, such policies and procedures have limitations, including judgment errors in management’s risk analysis, and may not prevent unexpected losses that could have a material adverse effect on the Corporation’s business, financial condition and results of operations.

Interest rate volatility could significantly reduce the Corporation’s profitability.

The Corporation’s earnings largely depend on the relationship between the yield on its earning assets, primarily loans and investment securities, and the cost of funds, primarily deposits and borrowings. This relationship, commonly known as the net interest margin, is susceptible to significant fluctuation and is affected by economic and competitive factors that influence the yields and rates, and the volume and mix of the Bank’s interest earning assets and interest bearing liabilities.

Interest rate risk can be defined as the sensitivity of net interest income and of the market value of financial instruments to the direction and frequency of changes in interest rates. Interest rate risk arises from the imbalance in the re-pricing, maturity and/or cash flow characteristics of assets and liabilities. The Corporation is subject to interest rate risk to the degree that its interest bearing liabilities re-price or mature more slowly or more rapidly or on a different basis than its interest earning assets. Changes

 

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in interest rates will affect the levels of income and expense recorded on a large portion of the Bank’s assets and liabilities, and fluctuations in interest rates will impact the market value of all interest sensitive assets. Significant fluctuations in interest rates could have a material adverse impact on the Corporation’s business, financial condition, results of operations, or liquidity.

The Bank’s interest rate risk measurement and management techniques incorporate the re-pricing and cash flow attributes of its balance sheet and off-balance sheet instruments as they relate to current and potential changes in interest rates. The level of interest rate risk, measured in terms of the potential future effect on earnings, is determined through the use of static gap analysis and earnings simulation modeling under multiple interest rate scenarios. Management’s objectives are to measure, monitor and develop strategies in response to the interest rate risk profile inherent in the Bank’s balance sheet in order to preserve the sensitivity of net interest income to actual or potential changes in interest rates. At December 31, 2010, the interest rate sensitivity position was asset sensitive in the short-term. For further information on risk relating to interest rates, refer to Part I, Item 7a, “Quantitative and Qualitative Disclosures about Market Risk,” herein.

The Corporation cannot assure you that recent actions by governmental agencies and regulators, as well as recently enacted legislation, will stabilize the U.S. financial system, and new legislation may significantly affect the Corporation’s financial condition.

Beginning in 2008 and continuing into 2009 and 2010, the Board of Governors of the Federal Reserve System, the United States Congress, the United States Department of the Treasury, the FDIC and others have taken numerous steps to stabilize and stimulate the financial services industry. These measures include: (1) homeowner relief that encourages loan restructuring and modification; (2) the establishment of significant liquidity and credit facilities for financial institutions and investment banks; (3) the lowering of the federal funds rate; and (4) coordinated efforts to address liquidity and other weaknesses in the banking sector.

The Corporation cannot predict the actual impact, if any, that new legislation or other governmental initiatives will have on the economy or the financial markets, or whether any impact will be positive or negative. The failure of legislation or other initiatives to stabilize the financial markets could weaken public confidence in financial institutions and have a substantial and material adverse effect on the Corporation’s business, financial condition, results of operations, access to credit, or the trading price of our common stock. Additionally, compliance with such initiatives may increase the Corporation’s costs and limit its ability to pursue business opportunities, and participation in specific programs may subject it to additional restrictions. Further, it may be required to pay significantly higher FDIC premiums in the future if market developments which have significantly depleted the FDIC insurance fund and reduced the ratio of reserves to insured deposits continue.

The Bank’s loans are principally concentrated in certain areas of Pennsylvania, and adverse economic conditions in those markets could adversely affect the Corporation’s business, financial condition and results of operations.

The Corporation’s success is dependent to a significant extent upon general economic conditions in the United States and, in particular, the local economies in northwest and central Pennsylvania, the primary markets served by the Bank. The Bank is particularly exposed to real estate and economic factors in the northwest and central areas of Pennsylvania, as most of its loan portfolio is concentrated among borrowers in these markets. Furthermore, because a substantial portion of the Bank’s loan portfolio is secured by real estate in these areas, the value of the associated collateral is also subject to regional real estate market conditions.

 

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Since 2008, the financial and capital marketplaces have been affected by significant disruption and volatility. This turbulence has been attributable to a variety of factors, including the fallout associated with the subprime mortgage market. One aspect of this fallout has been significant deterioration in the activity of the secondary residential mortgage market. These disruptions have been exacerbated by the continued decline of the real estate housing market along with significant mortgage loan related losses incurred by many lending institutions. The turmoil in the mortgage market has impacted the global markets as well as the domestic markets and has led to a significant credit and liquidity crisis. In addition, the significant decline in economic growth, both nationally and globally, led to a national economy in deep recession. The Bank is not immune to negative consequences arising from overall economic weakness and, in particular, a sharp downturn in the real estate market. While the Bank’s loan portfolio has not shown significant signs of credit quality deterioration to the extent of national markets, we cannot assure you that these conditions will continue. An economic recession in the markets served by the Bank, and the nation as a whole, could negatively impact household and corporate incomes. This impact could lead to decreased loan demand and increase the number of borrowers who fail to pay the Bank interest or principal on their loans, and accordingly, could have a material adverse effect on the Corporation’s business, financial condition, results of operations, or liquidity.

The Corporation’s investment securities portfolio is subject to credit risk, market risk, and liquidity risk, and declines in value in its investment securities portfolio may require it to record other- than- temporary impairment charges that could have a material adverse effect on its results of operations and financial condition.

The Corporation’s investment securities portfolio has risks beyond its control that can significantly influence the portfolio’s fair value. These factors include, but are not limited to, rating agency downgrades of the securities, defaults of the issuers of the securities, lack of market pricing of the securities, and continued instability in the credit markets. Recent lack of market activity with respect to certain of the securities has, in certain circumstances, required the Corporation to base its fair market valuation on unobservable inputs. The Corporation has engaged valuation experts to price these certain securities using proprietary models, which incorporate assumptions that market participants would use in pricing the securities, including bid/ask spreads and liquidity and credit premiums. Any change in current accounting principles or interpretations of these principles could impact the Corporation’s assessment of fair value and thus its determination of other-than-temporary impairment of the securities in its investment securities portfolio.

The Bank may be required to record other-than-temporary impairment charges on its investment securities if they suffer declines in value that are considered other-than-temporary. Numerous factors, including collateral deterioration underlying certain private label mortgage-backed securities, lack of liquidity for re-sales of certain investment securities, absence of reliable pricing information for certain investment securities, adverse changes in business climate, adverse actions by regulators, or unanticipated changes in the competitive environment could have a negative effect the Bank’s securities portfolio in future periods. An other-than-temporary impairment charge could have a material adverse effect on the Corporation’s results of operations and financial condition.

 

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The Corporation’s business and that of the Bank is highly regulated and impacted by monetary policy, limiting the manner in which the Corporation and the Bank may conduct business and obtain financing, and modifications to the existing regulatory framework under which the Corporation operates could have a material adverse effect on its business, financial condition, results of operations or liquidity.

As a financial holding company and state-chartered financial institution, respectively, the Corporation and the Bank are subject to extensive regulation and supervision under federal and state laws and regulations. The restrictions imposed by such laws and regulations limit the manner in which the Corporation and the Bank conduct business, undertake new investments and activities, and obtain financing. These laws and regulations are designed primarily for the protection of the deposit insurance funds and consumers and not to benefit shareholders. These laws and regulations may sometimes impose significant limitations on the Corporation’s operations. These regulations, along with the existing tax, accounting, securities, insurance, and monetary laws, regulations, rules, standards, policies and interpretations control the methods by which financial institutions conduct business, implement strategic initiatives and tax compliance, and govern financial reporting and disclosures. These laws, regulations, rules, standards, policies and interpretations are constantly evolving and may change significantly over time.

The nature, extent, and timing of the adoption of significant new laws and regulations, including laws currently proposed in the U.S. Congress, or changes in or repeal of existing laws and regulations, or specific actions of our regulators, could have a material adverse effect on our business, financial condition, results of operations or liquidity. Furthermore, federal monetary policy, particularly as implemented through the Federal Reserve System, significantly affects credit risk and interest rate risk conditions for the Bank and the Corporation, and any unfavorable change in these conditions could have a material adverse effect on the Corporation’s business, financial condition, results of operations or liquidity.

Compliance with the Recently Enacted Dodd-Frank Act Will Increase Our Regulatory Compliance Burdens, and May Increase Our Operating Costs and/or Adversely Impact Our Earnings and/or Capital Ratios.

On July 21, 2010, President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) into law. The Dodd-Frank Act represents a significant overhaul of many aspects of the regulation of the financial-services industry. Among other things, the Dodd-Frank Act creates a new federal Consumer Financial Protection Bureau (“CFPB”), tightens capital standards, imposes clearing and margining requirements on many derivatives activities, and generally increases oversight and regulation of financial institutions and financial activities.

In addition to the self-implementing provisions of the statute, the Dodd-Frank Act calls for over 200 administrative rulemakings by various federal agencies to implement various parts of the legislation. While some rules have been finalized and/or issued in proposed form, many have yet to be proposed. It is impossible to predict when all such additional rules will be issued or finalized, and what the content of such rules will be. We will have to apply resources to ensure that we are in compliance with all applicable provisions of the Dodd-Frank Act and any implementing rules, which may increase our costs of operations and adversely impact our earnings.

The Dodd-Frank Act and any implementing rules that are ultimately issued could have adverse implications on the financial industry, the competitive environment, and/or our ability to conduct business.

 

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The Corporation relies on its management and other key personnel, and the loss of any of them may adversely affect its operations.

The Corporation is and will continue to be dependent upon the services of its executive management team. In addition, it will continue to depend on its ability to retain and recruit key client relationship managers. The unexpected loss of services of any key management personnel, or the inability to recruit and retain qualified personnel in the future, could have an adverse effect on its business and financial condition.

Strong competition within the Corporation’s markets may have a material adverse impact on its profitability.

The Corporation competes with an ever-increasing array of financial service providers. As noted above, as a financial holding company and state-chartered financial institution, respectively, the Corporation and the Bank are subject to extensive regulation and supervision, including, in many cases, regulations that limit the type and scope of activities. The non-bank financial service providers that compete with the Corporation and the Bank may not be subject to such extensive regulation, supervision, and tax burden. Competition from nationwide banks, as well as local institutions, is strong in the Corporation’s markets.

The financial services industry is undergoing rapid technological change. In addition to improving customer services, effective use of technology increases efficiency and enables financial institutions to reduce costs. Furthermore, technological advances are likely to intensify competition by enabling more companies to provide financial resources. Accordingly, the Corporation’s future success will depend in part on its ability to address customer needs by using technology. The Corporation cannot assure you that it will be able to develop new technology driven products and services, or be successful in marketing these products to its customers. Many of its competitors have far greater resources to invest in technology.

Regional, national and international competitors have far greater assets and capitalization than the Corporation has and they have greater access to capital markets and can offer a broader array of financial services than it can. We cannot assure you that we will continue to be able to compete effectively with other financial institutions in the future. Furthermore, developments increasing the nature or level of competition could have a material adverse effect on the Corporation’s business, financial condition, results of operations, or liquidity. For further information on competition, refer to Part I, Item 1, “Competition” herein.

Non-compliance with applicable laws and/or regulations, including the Bank Secrecy Act and USA Patriot Act, may adversely affect the Corporation’s operations and its financial results and could result in significant fines or sanctions.

Federal and state regulators have the ability to impose substantial sanctions, restrictions and requirements on the Corporation’s banking and nonbanking subsidiaries if they determine, upon examination or otherwise, that it has violated laws or regulations with which it or its subsidiaries must comply, or that weaknesses or failures exist with respect to general standards of safety and soundness. Such enforcement may be formal or informal and can include, among other things, civil money penalties and orders to take certain actions or to refrain from certain actions. The imposition of regulatory sanctions, including any monetary penalties, may have a material impact on the

 

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Corporation’s financial condition and results of operations, damage its reputation, and/or cause it to lose its financial holding company status. In addition, compliance with any such action could distract management’s attention from the Corporation’s operations, cause the Corporation to incur significant expenses, restrict it from engaging in potentially profitable activities, and limit its ability to raise capital.

The USA Patriot and Bank Secrecy Acts require financial institutions to develop programs to prevent the institutions from being used for money laundering and terrorist activities. If certain activities are detected, financial institutions are obligated to file suspicious activity reports with the U.S. Treasury Department’s Financial Crimes Enforcement Network. These rules also require financial institutions to establish procedures for identifying and verifying the identity of customers seeking to open new financial accounts or conduct transactions, and require the filing of certain reports, such as those for cash transactions above a certain threshold. Financial institutions must also refrain from transacting business with certain countries or persons designated by the Office of Foreign Assets Control.

Non-compliance with laws and regulations such as these could result in significant fines or sanctions. These particular laws and regulations have significant implications for all financial institutions, establish new crimes and penalties, and require the federal banking agencies, in reviewing merger and acquisition transactions, to consider the effectiveness of the parties to such transactions in combating money laundering and terrorist activities. Even inadvertent non-compliance and technical failure to follow the regulations may result in significant fines or other penalties, which could have a material adverse impact on the Corporation’s business, financial condition, results of operations or liquidity.

The Corporation is exposed to a variety of operational risks that could result in significant financial losses.

The Corporation is exposed to many types of operational risk, including reputation risk, legal and compliance risk, the risk of fraud or theft by employees or outsiders, unauthorized transactions by employees or operational errors, including clerical or record-keeping errors or those resulting from faulty or disabled computer or telecommunications systems.

Negative public opinion can result from actual or alleged conduct in any number of activities, including lending practices, corporate governance and acquisitions, and from actions taken by government regulators and community organizations in response to those activities. Negative public opinion can adversely affect the Corporation’s ability to attract and keep customers and can expose the Corporation to litigation and regulatory action.

Given the volume of transactions, certain errors may be repeated or compounded before they are discovered and successfully rectified. The Corporation’s necessary dependence upon automated systems to record and process transaction volumes may further increase the risk that technical system flaws or employee tampering or manipulation of those systems will result in losses that are difficult to detect. The Corporation may also be subject to disruptions of its operating systems arising from events that are wholly or partially beyond its control (for example, computer viruses, computer hacking or electrical or telecommunication outages), which may give rise to disruption of service to customers and to financial loss or liability. The Corporation is further exposed to the risk that its external vendors may be unable to fulfill their contractual obligations (or will be subject to the same risk of fraud or operational errors by their respective employees as the Corporation is) and to the risk that the Corporation’s (or our vendors’) business continuity and data security systems prove to be inadequate.

The Corporation regularly assesses the level of operational risk throughout the organization and has established systems of internal controls that provide for timely and accurate information. Testing of the

 

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operating effectiveness of these control systems is performed regularly. While not providing absolute assurance, these systems of internal controls have been designed to manage operational risks at appropriate, cost-effective levels. Procedures exist that are designed to ensure policies relating to conduct, ethics, and business practices are followed. From time to time losses from operational risk may occur, including the effects of operational errors. Such losses are recorded as non-interest expense.

While the Corporation continually monitors and improves its system of internal controls, data processing systems, and corporate-wide risk management processes and procedures, it cannot assure you that future losses arising from operational risk will not occur and have a material impact on its business, financial condition, results of operations, or liquidity.

The Corporation may not be able to meet its cash flow needs on a timely basis at a reasonable cost, and the Corporation’s cost of funds for banking operations may significantly increase as a result of general economic conditions, interest rates and competitive pressures.

Liquidity is the ability to meet cash flow obligations as they come due and cash flow needs on a timely basis and at a reasonable cost. The liquidity of the Bank is used to make loans and to repay deposit and borrowing liabilities as they become due, or are demanded by customers and creditors. Many factors affect the Bank’s ability to meet liquidity needs, including variations in the markets served by its network of offices, its mix of assets and liabilities, reputation and standing in the marketplace, and general economic conditions.

The Bank’s primary source of funding is retail deposits, gathered throughout its network of banking offices. Periodically, the Corporation utilizes term borrowings from the Federal Home Loan Bank of Pittsburgh, or FHLB, of which the Bank is a member, and other lenders to meet funding obligations. The Bank’s securities and loan portfolios provide a source of contingent liquidity that could be accessed in a reasonable time period through sales.

Significant changes in general economic conditions, market interest rates, competitive pressures or otherwise, could cause the Bank’s deposits to decrease relative to overall banking operations, and it would have to rely more heavily on brokered funds and borrowings in the future, which are typically more expensive than deposits.

Management and the Board of Directors of CNB, through its Asset/Liability Committee, or the ALCO, monitor liquidity and the ALCO establishes and monitors acceptable liquidity ranges. The Bank actively manages its liquidity position through target ratios. Continual monitoring of these ratios, both historical and through forecasts under multiple rate scenarios, allows the Bank to employ strategies necessary to maintain adequate liquidity.

Changes in economic conditions, including consumer savings habits and availability of or access to capital, could potentially have a significant impact on the Bank’s liquidity position, which in turn could materially impact the Corporation’s financial condition, results of operations and cash flows.

Recent levels of market volatility remain elevated, which may have a material adverse effect on the Corporation’s ability to access capital and on the Corporation’s business, financial condition and results of operations.

The capital and credit markets have been experiencing volatility and disruption since early 2008. In the fourth quarter of 2008, the volatility and disruption reached unprecedented levels. In some cases, the

 

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markets have produced downward pressure on stock prices and credit availability for certain issuers without regard to those issuers’ underlying financial strength. If the current recovery stalls and current levels of market disruption and volatility continue or worsen, the Corporation cannot assure you that the Corporation will not experience an adverse effect, which may be material, on its ability to access capital and on its business, financial condition and results of operations.

A substantial decline in the value of the Bank’s FHLB common stock may adversely affect the Corporation’s results of operations, liquidity and financial condition.

As a requirement of membership in the FHLB of Pittsburgh, the Bank must own a minimum required amount of FHLB stock, calculated periodically based primarily on its level of borrowings from the FHLB. Borrowings from the FHLB represent the Bank’s primary source of short-term and long-term wholesale funding.

In an extreme situation, it is possible that the capitalization of a FHLB, including FHLB of Pittsburgh, could be substantially diminished or reduced to zero. Consequently, given that there is no market for the Bank’s FHLB common stock, the Corporation’s management believes that there is a risk that the Corporation’s investment could be deemed impaired at some time in the future. If this occurs, it may adversely affect the Corporation’s results of operations and financial condition.

In addition, if the capitalization of FHLB of Pittsburgh is substantially diminished, the Bank’s liquidity may be adversely impaired if it is not able to obtain alternative sources of funding.

There are 12 banks of the FHLB, including Pittsburgh. To conserve capital, some FHLB banks are suspending dividends, cutting dividend payments, and not buying back excess FHLB stock that member banks hold. The 12 FHLB banks are jointly liable for the consolidated obligations of the FHLB system. To the extent that one FHLB bank cannot meet its obligations to pay its share of the system’s debt, other FHLB banks can be called upon to make the payment. The Corporation cannot assure you, however, that the FHLB system will be able to meet these obligations.

The Bank could be held responsible for environmental liabilities relating to properties acquired through foreclosure, resulting in significant financial loss.

In the event the Bank forecloses on a defaulted commercial or residential mortgage loan to recover its investment, it may be subject to environmental liabilities in connection with the underlying real property, which could significantly exceed the value of the real property. Although the Bank exercises due diligence to discover potential environmental liabilities prior to acquiring any property through foreclosure, hazardous substances or wastes, contaminants, pollutants, or their sources may be discovered on properties during its ownership or after a sale to a third party. The Corporation cannot assure you that the Bank would not incur full recourse liability for the entire cost of any removal and cleanup on an acquired property, that the cost of removal and cleanup would not exceed the value of the property, or that the Bank could recover any of the costs from any third party. Losses arising from environmental liabilities could have a material adverse impact on the Corporation’s business, financial condition, results of operations, or liquidity.

Federal and state governments could pass legislation responsive to current credit conditions which could cause the Corporation to experience higher credit losses.

The Corporation could experience higher credit losses because of federal or state legislation or regulatory action that reduces the amount the Bank’s borrowers are otherwise contractually required to

 

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pay under existing loan contracts. Also, the Corporation could experience higher credit losses because of federal or state legislation or regulatory action that limits the Bank’s ability to foreclose on property or other collateral or makes foreclosure less economically feasible. The Corporation cannot assure you that future legislation will not significantly and adversely impact its ability to collect on its current loans or foreclose on collateral.

The preparation of the Corporation’s financial statements requires the use of estimates that could significantly vary from actual results, which could have a material adverse effect on the Corporation’s business, financial condition, results of operations or liquidity.

The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the U.S. requires management to make significant estimates that affect the financial statements. For example, one of these significant estimates is the allowance for loan losses. Due to the inherent nature of estimates, the Corporation cannot provide absolute assurance that it will not significantly increase the allowance for loan losses and/or sustain credit losses that are significantly higher than the provided allowance, which could have a material adverse effect on the Corporation’s business, financial condition, results of operations or liquidity.

The Corporation’s financial results may be subject to the impact of changes in accounting standards or interpretation in new or existing standards.

From time to time the Financial Accounting Standards Board, or FASB, and the SEC change accounting regulations and reporting standards that govern the preparation of the Corporation’s financial statements. In addition, the FASB, SEC, bank regulators and the outside independent auditors may revise their previous interpretations regarding existing accounting regulations and the application of these accounting standards. These revisions in their interpretations are out of the Corporation’s control and may have a material impact on its financial statements.

The Corporation’s information technology systems may be vulnerable to attack or other technological failures, exposing it to significant loss.

The Corporation depends upon data processing software, communication and information exchange on a variety of computing platforms and networks including the Internet. Despite instituted safeguards, the Corporation cannot be certain that all of its systems are entirely free from vulnerability to electronic attack or other technological difficulties or failures. The Corporation also relies on the services of a variety of third party vendors to meet its data processing and communication needs. If information security is breached or other technology difficulties or failures occur, information may be misappropriated, services and operations may be interrupted and the Corporation could be exposed to claims from customers, suffer loss of business and suffer loss of reputation in its marketplace. Any of these results could have a material adverse effect on the Corporation’s business, financial condition, results of operations or liquidity.

Customer information may be obtained and used fraudulently, which may negatively impact the Corporation’s reputation and customer base, cause increased regulatory scrutiny and expose the Corporation to litigation.

Risk of theft of customer information resulting from security breaches by third parties exposes the Corporation to reputation risk and potential monetary loss. CNB has exposure to fraudulent use of its customers’ personal information resulting from its general business operations and through customer use of financial instruments such as debit cards. While CNB has policies and procedures designed to

 

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prevent or limit the effect of this risk, the Corporation cannot assure you that any such security breaches will not occur or, if they do occur, that they will be adequately addressed. The occurrence of any security breaches could damage CNB’s reputation, result in a loss of customer business, subject CNB to additional regulatory scrutiny, or expose CNB to civil litigation and possible financial liability, any of which could have a material adverse effect on CNB’s financial condition and results of operations.

The soundness of other financial institutions with which the Corporation does business could adversely affect the Corporation’s business, financial condition or results of operations.

The financial services industry and the securities markets have been materially adversely affected by significant declines in values of almost all asset classes and by a lack of liquidity in the capital and credit markets. Financial institutions specifically have been subject to increased volatility and an overall loss in investor confidence.

Financial institutions are interrelated as a result of trading, clearing, counterparty, investment or other relationships. The Corporation routinely executes transactions with counterparties in the financial services industry such as commercial banks, brokers and dealers, investment banks and other institutional clients for a range of transactions including loan participations, derivatives and hedging transactions. In addition, the Corporation invests in securities or loans originated or issued by financial institutions or supported by the loans they originate. Many of these transactions expose the Corporation to credit or investment risk in the event of default by the Corporation’s counterparty. In addition, the Corporation’s credit risk may be exacerbated if the collateral it holds cannot be realized or is liquidated at prices not sufficient to recover the full amount of the loan or other exposure to the Corporation. The Corporation could incur losses to its securities portfolio as a result of these issues. These types of losses may have a material adverse effect on the Corporation’s business, financial condition or results of operation.

Some provisions contained in the Corporation’s articles of incorporation and its bylaws and under Pennsylvania law could deter a takeover attempt or delay changes in control or management of the Corporation.

Certain anti-takeover provisions of the Pennsylvania Business Corporation Law of 1988, as amended, apply to Pennsylvania registered corporations (e.g., publicly traded companies) including, but not limited to, those relating to (1) control share acquisitions, (2) disgorgement of profits by certain controlling persons, (3) business combination transactions with interested shareholders, and (4) the rights of shareholders to demand fair value for their stock following a control transaction. Pennsylvania law permits corporations to opt-out of these anti-takeover provisions, but the Corporation has not done so. Such provisions could have the effect of deterring takeovers or delaying changes in control or management of the Corporation. Additionally, such provisions could limit the price that some investors might be willing to pay in the future for shares of the Corporation’s common stock.

For example, the Corporation’s amended and restated articles of incorporation require the affirmative vote of 66% of the outstanding shares entitled to vote to effect a business combination. In addition, the Corporation’s amended and restated articles of incorporation, subject to the limitations prescribed in such articles and subject to limitations prescribed by Pennsylvania law, authorize the Corporation’s board of directors, from time to time by resolution and without further shareholder action, to provide for the issuance of shares of preferred stock, in one or more series, and to fix the designation, powers, preferences and other rights of the shares and to fix the qualifications, limitations and restrictions

 

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thereof. As a result of its broad discretion with respect to the creation and issuance of preferred stock without shareholder approval, the board of directors could adversely affect the voting power and other rights of the holders of common stock and, by issuing shares of preferred stock with certain voting, conversion and/or redemption rights, could discourage any attempt to obtain control of CNB.

The Corporation’s bylaws, as amended and restated, provide for the division of the Corporation’s board of directors into three classes of directors, with each serving staggered terms. In addition, any amendment to the Corporation’s bylaws must be approved by the affirmative vote of a majority of the votes cast by all shareholders entitled to vote thereon and, if any shareholders are entitled to vote thereon as a class, upon receiving the affirmative vote of a majority of the votes cast by the shareholders entitled to vote as a class.

Any of the foregoing provisions may have the effect of deterring takeovers or delaying changes in control or management of the Corporation.

The price of the Corporation’s common stock may fluctuate significantly, and this may make it difficult for you to resell shares of common stock owned by you at times or at prices you find attractive.

The price of the Corporation’s common stock on the NASDAQ constantly changes. The Corporation expects that the market price of its common stock will continue to fluctuate, and the Corporation cannot give you any assurances regarding any trends in the market prices for its common stock.

The Corporation’s stock price may fluctuate as a result of a variety of factors, many of which are beyond its control. These factors include the Corporation’s:

 

   

past and future dividend practice;

   

financial condition, performance, creditworthiness and prospects;

   

quarterly variations in the Corporation’s operating results or the quality of the Corporation’s assets;

   

operating results that vary from the expectations of management, securities analysts and investors;

   

changes in expectations as to the Corporation’s future financial performance;

   

announcements of innovations, new products, strategic developments, significant contracts, acquisitions and other material events by the Corporation or its competitors;

   

the operating and securities price performance of other companies that investors believe are comparable to the Corporation;

   

future sales of the Corporation’s equity or equity-related securities;

   

the credit, mortgage and housing markets, the markets for securities relating to mortgages or housing, and developments with respect to financial institutions generally; and

   

changes in global financial markets and global economies and general market conditions, such as interest or foreign exchange rates, stock, commodity or real estate valuations or volatility and other geopolitical, regulatory or judicial events.

The Corporation’s ability to pay dividends is limited by law and regulations.

The future declaration of dividends by the Corporation’s Board of Directors will depend on a number of factors, including capital requirements, regulatory limitations, the Corporation’s operating results and financial condition and general economic conditions. The Corporation’s ability to pay dividends depends primarily on the receipt of dividends from the Bank. Dividend payments from the Bank are

 

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subject to legal and regulatory limitations, generally based on retained earnings, imposed by bank regulatory agencies. The ability of the Bank to pay dividends is also subject to financial condition, regulatory capital requirements, capital expenditures and other cash flow requirements. The Corporation cannot assure you that the Bank will be able to pay dividends to CNB in the future. The Corporation may decide to limit the payment of dividends even when the Corporation have the legal ability to pay them in order to retain earnings for use in the Corporation’s business.

ITEM 1B.  UNRESOLVED STAFF COMMENTS

None

ITEM 2.  PROPERTIES

The headquarters of the Corporation and the Bank are located at 1 South Second Street, Clearfield, Pennsylvania, in a building owned by the Corporation. The Bank operates 27 full-service offices and one loan production office. Of these 28 offices, 21 are owned and seven are leased from independent owners. Holiday Financial Services Corporation has eight full-service offices of which six are leased from independent owners and two are leased from the Bank. There are no encumbrances on the offices owned and the rental expense on the leased property is immaterial in relation to operating expenses. The initial lease terms range from one to twenty years.

ITEM 3.  LEGAL PROCEEDINGS

There are no material pending legal proceedings to which the Corporation or any of its subsidiaries is a party, or of which any of their property is the subject, except ordinary routine proceedings which are incidental to the business.

ITEM 4.  [REMOVED AND RESERVED]

 

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PART II.

ITEM 5.  MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Quarterly Share Data; Holders

Our common stock is traded on the Global Select Market of The NASDAQ Stock Market LLC under the symbol CCNE. The following tables set forth, for the periods indicated, the quarterly high and low sales price of the Corporation’s common stock as reported by the NASDAQ Global Select Market and actual cash dividends paid per share. As of December 31, 2010, the approximate number of shareholders of record of the Corporation’s common stock was 3,520.

Price Range of Common Stock

 

     2010      2009  
     High      Low      High      Low  

First quarter

   $ 18.99       $ 14.70       $ 11.48       $ 8.32   

Second quarter

     16.50         10.53         15.82         9.51   

Third quarter

     13.93         10.75         18.00         13.76   

Fourth quarter

     15.83         13.00         18.74         14.51   

Cash Dividends Paid

 

     2010      2009  

First quarter

   $ 0.165       $ 0.165   

Second quarter

     0.165         0.165   

Third quarter

     0.165         0.165   

Fourth quarter

     0.165         0.165   

See Note 17 to the consolidated financial statements in Item 8 and “Supervision and Regulation –Dividend Restrictions” in Part I, Item 1 for a discussion of dividend restrictions.

Issuer Purchases of Equity Securities

There were no shares purchased as part of publicly announced plans or programs from October 1, 2010 to December 31, 2010. The maximum number of shares that may yet be purchased under publicly announced plans or programs is 168,386.

 

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Performance Graph

Set forth below is a chart comparing the Corporation’s cumulative return to stockholders against the cumulative return of the NASDAQ Composite Index and a Peer Group Index of banking organizations for the five-year period commencing December 31, 2005 and ended December 31, 2010.

LOGO

 

     Period Ending  
Index    12/31/05      12/31/06      12/31/07      12/31/08      12/31/09      12/31/10  

 

 

CNB Financial Corporation

     100.00         104.65         104.60         90.59         136.32         132.06   

NASDAQ Composite

     100.00         110.39         122.15         73.32         106.57         125.91   

SNL Bank NASDAQ

     100.00         112.27         88.14         64.01         51.93         61.27   

 

Source : SNL Financial LC, Charlottesville, VA

  

© 2011

  
www.snl.com   

 

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ITEM 6.   SELECTED FINANCIAL DATA

 

   

Year ended December 31,

 
(Dollars in thousands, except per share data)   2010     2009     2008     2007     2006  

 

 

INTEREST AND DIVIDEND INCOME:

         

Loans including fees

  $ 46,955      $ 45,839      $ 47,355      $ 44,559      $ 40,198   

Deposits with banks

    125        215        429        492        437   

Federal funds sold

    -        -        342        334        293   

Securities:

         

Taxable

    11,603        7,687        7,419        6,669        5,876   

Tax-exempt

    2,435        2,095        1,414        1,457        1,706   

Dividends

    29        34        224        422        362   
                                       

Total interest and dividend income

    61,147        55,870        57,183        53,933        48,872   
                                       

INTEREST EXPENSE:

         

Deposits

    13,558        13,091        14,956        18,087        17,106   

Borrowed funds

    4,716        4,527        4,609        3,510        2,881   

Subordinated debentures

    782        850        1,018        1,325        866   
                                       

Total interest expense

    19,056        18,468        20,583        22,922        20,853   
                                       

NET INTEREST INCOME

    42,091        37,402        36,600        31,011        28,019   

PROVISION FOR LOAN LOSSES

    5,158        4,465        3,787        1,512        1,371   
                                       

Net interest income after provision for loan losses

    36,933        32,937        32,813        29,499        26,648   

NON-INTEREST INCOME

    9,520        7,720        2,490        8,189        8,435   

NON-INTEREST EXPENSES

    31,668        29,791        28,801        25,273        22,111   
                                       

INCOME BEFORE INCOME TAXES

    14,785        10,866        6,502        12,415        12,972   

INCOME TAX EXPENSE

    3,469        2,354        1,267        3,281        3,350   
                                       

NET INCOME

  $ 11,316      $ 8,512      $ 5,235      $ 9,134      $ 9,622   
                                       

PER SHARE DATA:

         

Basic

  $ 1.06      $ 0.98      $ 0.61      $ 1.05      $ 1.08   

Fully diluted

    1.06        0.98        0.61        1.05        1.07   

Dividends declared

    0.66        0.66        0.645        0.62        0.57   

Book value per share at year end

    8.96        7.92        7.27        8.10        8.15   

AT END OF PERIOD:

         

Total assets

  $  1,413,511      $  1,161,591      $  1,016,518      $  858,700      $  780,850   

Securities

    503,028        347,748        238,181        162,792        156,696   

Loans, net of unearned discount

    794,562        715,142        671,556        599,688        547,020   

Allowance for loan losses

    10,820        9,795        8,719        6,773        6,086   

Deposits

    1,162,868        956,858        814,596        659,157        631,322   

FHLB and other borrowings

    105,259        100,003        107,478        98,000        57,885   

Subordinated debentures

    20,620        20,620        20,620        20,620        10,310   

Shareholders’ equity

    109,645        69,409        62,467        69,283        72,279   

KEY RATIOS:

         

Return on average assets

    0.87%        0.79%        0.55%        1.12%        1.26%   

Return on average equity

    11.62%        12.86%        7.88%        12.82%        13.51%   

Loan to deposit ratio

    68.33%        74.74%        82.44%        90.98%        86.65%   

Dividend payout ratio

    61.27%        67.27%        105.53%        59.05%        53.05%   

Average equity to average assets ratio

    7.46%        6.17%        7.00%        8.65%        9.31%   

 

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ITEM 7.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of the consolidated financial statements of CNB Financial Corporation (the “Corporation”) is presented to provide insight into management’s assessment of financial results. The Corporation’s subsidiary, CNB Bank (the “Bank”), provides financial services to individuals and businesses primarily within the west central Pennsylvania counties of Cambria, Cameron, Clearfield, Elk, McKean and Warren. ERIEBANK, a division of CNB Bank, provides financial services to individuals and business in the northwestern Pennsylvania counties of Erie and Crawford. The Bank is subject to regulation, supervision and examination by the Pennsylvania State Department of Banking as well as the Federal Deposit Insurance Corporation. The financial condition and results of operations of the Corporation and its consolidated subsidiaries are not necessarily indicative of future performance. One of the Corporation’s subsidiaries, CNB Securities Corporation, is incorporated in Delaware and currently maintains investments in debt and equity securities. County Reinsurance Company, also a subsidiary, is an Arizona Corporation, and provides credit life and disability insurance for customers of CNB Bank. CNB Insurance Agency, incorporated in Pennsylvania, provides for the sale of nonproprietary annuities and other insurance products. Holiday Financial Services Corporation (“Holiday”), incorporated in Pennsylvania, offers small balance unsecured loans and secured loans, primarily collateralized by automobiles and equipment, to borrowers with higher risk characteristics. Management’s discussion and analysis should be read in conjunction with the audited consolidated financial statements and related notes.

Risk identification and management are essential elements for the successful management of the Corporation. In the normal course of business, the Corporation is subject to various types of risk, including interest rate, credit, and liquidity risk. These risks are controlled through policies and procedures established by the Corporation.

Interest rate risk is the sensitivity of net interest income and the market value of financial instruments to the direction and frequency of changes in interest rates. Interest rate risk results from various repricing frequencies and the maturity structure of the financial instruments owned by the Corporation. The Corporation uses its asset/liability management policy and systems to control, monitor and manage interest rate risk.

Credit risk represents the possibility that a customer may not perform in accordance with contractual terms. Credit risk results from loans to customers and the purchase of securities. The Corporation manages credit risk by following an established credit policy and using a disciplined evaluation of the adequacy of the allowance for loan losses. Also, the investment policy limits the amount of credit risk that may be taken in the securities portfolio.

Liquidity risk represents the inability to generate or otherwise obtain funds at reasonable rates to satisfy commitments to borrowers and obligations to depositors. The Corporation has established guidelines within its asset-liability management policy to manage liquidity risk. These guidelines include contingent funding alternatives.

Forward-Looking Statements

The information below includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as

 

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amended, with respect to the financial condition, liquidity, results of operations, future performance and our business. These forward-looking statements are intended to be covered by the safe harbor for “forward-looking statements” provided by the Private Securities Litigation Reform Act of 1995. Forward-looking statements are those that are not historical facts. Forward-looking statements include statements with respect to beliefs, plans, objectives, goals, expectations, anticipations, estimates and intentions that are subject to significant risks and uncertainties and are subject to change based on various factors (some of which are beyond our control). Forward-looking statements often include the words “believes,” “expects,” “anticipates,” “estimates,” “forecasts,” “intends,” “plans,” “targets,” “potentially,” “probably,” “projects,” “outlook” or similar expressions or future conditional verbs such as “may,” “will,” “should,” “would” and “could.” Such known and unknown risks, uncertainties and other factors that could cause the actual results to differ materially from the statements, include, but are not limited to, (i) changes in general business, industry or economic conditions or competition; (ii) changes in any applicable law, rule, regulation, policy, guideline or practice governing or affecting financial holding companies and their subsidiaries or with respect to tax or accounting principals or otherwise; (iii) adverse changes or conditions in capital and financial markets; (iv) changes in interest rates; (v) higher than expected costs or other difficulties related to integration of combined or merged businesses; (vi) the inability to realize expected cost savings or achieve other anticipated benefits in connection with business combinations and other acquisitions; (vii) changes in the quality or composition of our loan and investment portfolios; (viii) adequacy of loan loss reserves; (ix) increased competition; (x) loss of certain key officers; (xi) continued relationships with major customers; (xii) deposit attrition; (xiii) rapidly changing technology; (xiv) unanticipated regulatory or judicial proceedings and liabilities and other costs; (xv) changes in the cost of funds, demand for loan products or demand for financial services; and (xvi) other economic, competitive, governmental or technological factors affecting our operations, markets, products, services and prices. Such developments could have an adverse impact on our financial position and our results of operations.

The forward-looking statements are based upon management’s beliefs and assumptions. Any forward-looking statement made herein speaks only as of the date on which it is made. Factors or events that could cause the our actual results to differ may emerge from time to time, and it is not possible for us to predict all of them. We undertake no obligation to publicly update any forward-looking statement, whether as a result of new information, future developments or otherwise, except as may be required by law.

General Overview

The Corporation expanded its ERIEBANK division by opening a full service office in Meadville, Pennsylvania in the second quarter of 2010. In addition, a CNB Bank branch was opened in Kylertown, Pennsylvania in the third quarter of 2010. Management believes that our ERIEBANK division, along with our traditional CNB Bank market areas, should provide the Bank with moderate loan growth during 2011. Deposit growth was significant in both 2010 and 2009 as a result of the Corporation’s continued offering of competitive rates and growth of its ERIEBANK division, but is expected to moderate in 2011.

On June 18, 2010, the Corporation completed an equity offering, resulting in the issuance of 3,365,853 shares of common stock at $10.25 per share. In total, the Corporation raised proceeds of $32.1 million, net of issuance costs. The Corporation used proceeds from the offering of approximately $9.1 million to repay debt. In addition, $20.0 million was invested in CNB Bank, and the remainder was invested in CNB Securities Corporation.

 

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The interest rate environment will continue to play an important role in the future earnings of the Corporation. We experienced some compression of our net interest margin in 2010 and some additional compression is expected in 2011 as a result of the current interest rate environment. The Corporation’s net interest margin of 3.65% for the year ended December 31, 2010 was also adversely affected by a prepayment penalty of $707 thousand that was incurred due to an early payoff of a $10 million FHLB borrowing that had a maturity date of March 2012 and an interest rate of 5.63%. Excluding this prepayment penalty, the Corporation’s net interest margin for the year ended December 31, 2010 would have been 3.71%

During the past several years, we have taken measures such as instituting rate floors on our commercial lines of credit and home equity lines as a result of the historic lows on various key interest rates such as the Prime Rate and 3-month LIBOR. In addition, we decreased interest rates on certain deposit products during 2010, including the savings account rate in our ERIEBANK market from 2.0% at the beginning of 2010 to 1.34% by the end of the second quarter of 2010. Based on management’s evaluation of interest rates for similar deposit products in the ERIEBANK market, the current savings account rate continues to place the Corporation at a competitive advantage. Finally, the Corporation repaid a $20 million FHLB borrowing during 2010 that had a fixed interest rate of 4.52% and an original maturity date of January 24, 2012. The Corporation re-borrowed $20 million from FHLB at a fixed interest rate of 2.09% with a maturity date of September 17, 2015. In connection with the refinance, the Corporation incurred a prepayment penalty of $1.1 million, which will be amortized into earnings during the 5 year term of the new borrowing, resulting in an effective interest rate for the new borrowing of 3.14%.

While non-interest costs are expected to increase with the growth of the Corporation, management’s growth strategies are expected to result in an increase in earning assets as well as enhanced non-interest income which we believe will more than offset increases in non-interest expenses in 2011 and beyond. In addition, throughout 2009 and 2010, management conducted a cost management study covering all areas of non-interest expense. Cost savings as a result of this study were recognized in 2009 and 2010 with benefits continuing into subsequent years.

Management concentrates on return on average equity and earnings per share evaluations, plus other methods to measure and direct the performance of the Corporation. While past results are not an indication of future earnings, we feel the Corporation is well positioned to sustain core earnings during 2011.

As noted above, on July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street and Consumer Protection Act (the “Dodd-Frank Act”) that could impact the performance of the Corporation in future periods. The Dodd-Frank Act includes numerous provisions designed to strengthen the financial industry, enhance consumer protection, expand disclosures and provide for transparency. Some of these provisions include changes to FDIC insurance coverage, which includes a permanent increase in the coverage to $250,000 and extending the Temporary Account Guarantee Program to December 31, 2010. Additional provisions create a Consumer Financial Protection Bureau, which is authorized to write rules on all consumer financial products, and a Financial Services Oversight Council, which is empowered to determine which entities are systematically significant and require tougher regulations and is charged with reviewing, and when appropriate, submitting comments to the Securities and Exchange Commission and Financial Accounting Standards Board with respect to existing or proposed accounting principles, standards or procedures. Although the aforementioned provisions are only a few of the numerous ones included in the Dodd-Frank Act, the full impact of the entire Dodd-Frank Act will not be known until the full implementation is completed, which may take more than 12 months from the date that the law was enacted.

 

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Financial Condition

The following table presents ending balances, growth, and the percentage change of certain measures of our financial condition for specified years (dollars in millions):

 

     2010
Balance
     $ Change
vs. prior
year
     % Change
vs. prior
year
     2009
Balance
     $ Change
vs. prior
year
     % Change
vs. prior
year
     2008
Balance
 

Total assets

   $ 1,413.5       $ 251.9         21.7       $ 1,161.6       $ 145.1         14.3       $ 1,016.5   

Total loans, net

     783.7         78.4         11.1         705.3         42.5         6.4         662.8   

Total securities

     503.0         155.3         44.7         347.7         109.6         46.0         238.2   

Total deposits

     1,162.9         206.0         21.5         956.9         142.3         17.5         814.6   

Total shareholders’ equity

     109.6         40.2         57.9         69.4         6.9         11.1         62.5   

The above table is referenced for the discussion in this section of Form 10-K.

Overview of Balance Sheet

The increase in assets of 21.7% during 2010 was primarily the result of continued deposit growth and the Corporation’s equity offering, with corresponding investments in the loan and securities portfolios. The loan growth occurred in both the commercial and residential mortgage areas due to our focus on private banking and the historically low interest rates throughout 2010 which resulted in significant refinancing activity as well as new mortgage loans and home equity borrowings. Although the Corporation’s loan growth was notable at 11.1% for the year ended December 31, 2010, its deposit growth was even more significant as total deposits grew by $206.0 million, or 21.5%, during 2010. As such, the Corporation purchased additional available-for-sale securities. The specific effects to each area are described in the following sections.

Cash and Cash Equivalents

Cash and cash equivalents totaled $37.4 million at December 31, 2010 compared to $22.4 million at December 31, 2009. Cash and cash equivalents will fluctuate based on the timing and amount of liquidity events that occur in the normal course of business. The year end balance is considered reasonable to support our expected funding needs in the short term.

We believe the liquidity needs of the Corporation are satisfied by the current balance of cash and cash equivalents, readily available access to traditional funding sources, Federal Home Loan Bank financing, and the portion of the securities and loan portfolios that matures within one year. These sources of funds will enable the Corporation to meet cash obligations and off-balance sheet commitments as they come due.

Securities

Securities available for sale and trading securities have combined to increase $155.3 million, or 44.7%, at December 31, 2010 when compared to December 31, 2009. The increase is primarily due to purchases of securities issued by state and local political subdivisions, structured collateralized mortgage obligations, and pooled Small Business Association securities, and resulted from excess deposit growth not reinvested in loans. In addition, as more fully described below, the Corporation had a higher than normal volume of sales and purchases of securities available for sale during 2010.

 

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The Corporation’s structured pooled trust preferred securities currently do not trade in an active, open market with readily observable prices and are therefore classified within Level 3 of the valuation hierarchy. The fair value of these securities has been calculated using a discounted cash flow model and market liquidity premium. With the current market conditions, the assumptions used to determine the fair value of Level 3 securities has greater subjectivity due to the lack of observable market transactions. The fair values of these securities have declined due to the fact that the subsequent offerings of similar securities pay a higher market rate of return. The higher rate of return reflects the increased credit and liquidity risks in the market.

When the structured pooled trust preferred securities were purchased, they were considered to be investment grade based on ratings assigned by Moody’s. As a result of liquidity disruptions within the credit markets and the generally stressed conditions within the financial services industry, Moody’s has downgraded the rating of these securities since they were purchased by the Corporation. As of December 31, 2010, the Corporation held two structured pooled trust preferred securities rated Ca by Moody’s having an amortized cost of $918,000 and fair value of $270,000, one structured pooled trust preferred security rated C by Moody’s having an amortized cost of $280,000 and fair value of $19,000, and one structured pooled trust preferred security rated Baa2 by Moody’s having an amortized cost of $992,000 and fair value of $1,004,000. Based on our evaluation of certain structured pooled trust preferred securities, the present value of the projected cash flows was not sufficient for full repayment of the amortized cost for three of the securities resulting in total impairment charges of $2,241,000 realized during the year ended December 31, 2010. For the other pooled trust preferred security, the present value of the projected cash flows was sufficient for full repayment of amortized cost, and, therefore, it is believed the decline in fair value is temporary due to current market conditions. However, without recovery, other-than-temporary impairments may occur in future periods.

During 2010, management sold certain debt securities in an attempt to re-position a portion of its portfolio into lower risk-weighted assets. Proceeds from the sales were reinvested in other available for sale securities. Individually and in the aggregate, none of these sales resulted in the realization of a significant loss.

The Corporation generally buys into the market over time and does not attempt to “time” its transactions. In doing this, the highs and lows of the market are averaged into the portfolio and minimize the overall effect of different rate environments. We monitor the earnings performance and the effectiveness of the liquidity of the securities portfolio on a regular basis through meetings of the Asset/Liability Committee of the Corporation’s Board of Directors (“ALCO”). The ALCO also reviews and manages interest rate risk for the Corporation. Through active balance sheet management and analysis of the securities portfolio, we maintain a sufficient level of liquidity to satisfy depositor requirements and various credit needs of our customers.

Loans

The Corporation’s lending is focused in the west central and northwest Pennsylvania markets and consists principally of commercial and retail lending, which includes single family residential mortgages and other consumer loans.

As detailed in the table below, at December 31, 2010, the Corporation had $794.6 million in loans outstanding, net of unearned discount, an increase of $79.4 million (or 11.1%) since December 31, 2009. The increase was primarily the result of two factors. The first factor was increasing demand for commercial, industrial, and agricultural loans, as well as commercial mortgage products. The

 

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Corporation views commercial lending as its competitive advantage and continues to focus on this area by hiring and retaining experienced loan officers and supporting them with quality credit analysis. The second factor was increasing demand for residential mortgage loan products due to historically low interest rates throughout 2010, resulting in both significant refinancing activity as well as new mortgage loans and home equity borrowings.

 

(dollars in thousands)    2010     2009  

Commercial, industrial, and agricultural

   $ 257,491      $ 239,966   

Commercial mortgages

     212,878        193,632   

Residential real estate

     266,604        226,931   

Consumer

     53,202        54,854   

Credit cards

     2,870        2,248   

Overdrafts

     3,964        391   

Less: unearned discount

     (2,447     (2,880
                

Total loans, net of unearned discount

   $ 794,562      $ 715,142   
                

With continued economic improvement in our market areas, the Corporation expects loan demand in 2011 consistent with 2010.

Loan Concentration

The Corporation monitors loan concentrations by individual industries in order to track potential risk exposures resulting from industry related downturns. At December 31, 2010, no concentration existed within our commercial or real estate loan portfolio that exceeded 10% of the total loans.

Loan Quality

The Corporation has established written lending policies and procedures that require underwriting standards, loan documentation, and credit analysis standards to be met prior to funding a loan. Subsequent to the funding of a loan, ongoing review of credits is required. Credit reviews are performed annually on a minimum of 60% of the commercial loan portfolio by an outsourced loan review partner. In addition, classified assets, past due loans and nonaccrual loans are reviewed by the loan review partner semiannually and monthly by our credit administration staff.

The following table presents information concerning loan delinquency and other non-performing assets at December 31, 2010, 2009, and 2008 (dollars in thousands):

 

     2010      2009      2008  

Non-accrual loans

   $ 11,926       $ 12,757       $ 3,046   

Accrual loans greater than 89 days past due

     889         548         533   
                          

Total nonperforming loans

     12,815         13,305         3,579   

Other real estate owned

     396         252         671   
                          

Total nonperforming assets

   $ 13,211       $ 13,557       $ 4,250   
                          

Total loans, net of unearned income

   $ 794,562       $ 715,142       $ 671,556   

Nonperforming loans as a percentage of loans, net

     1.61%         1.86%         0.53%   

Total assets

   $ 1,413,511       $ 1,161,591       $ 1,016,518   

Nonperforming assets as a percentage of total assets

     0.93%         1.17%         0.42%   

 

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Management continues to closely monitor nonperforming loans. Although the ratio of nonperforming loans to total net loans increased from 0.53% in 2008 to 1.86% in 2009 and 1.61% in 2010, management does not believe the increase to be a result of deterioration in our underwriting or credit analysis processes, but more a result of overall economic conditions regionally as well as nationally. The Corporation’s nonperforming loans to total loans ratio continues to be favorable compared to peer institutions. See the “Allowance for Loan Losses” section for further discussion of credit review procedures and increases in nonperforming loans.

Allowance for Loan Losses

The allowance for loan losses is established by provisions for losses in the loan portfolio as well as overdrafts in deposit accounts. These provisions are charged against current income. Loans and overdrafts deemed not collectible are charged off against the allowance while any subsequent collections are recorded as recoveries and increase the allowance.

The following table presents activity within the allowance for loan losses during the years ended December 31, 2010, 2009, and 2008 (dollars in thousands):

 

     2010     2009     2008  

Balance at beginning of period

   $ 9,795      $ 8,719      $ 6,773   

Charge-offs:

      

Commercial, industrial, and agricultural

     543        860        33   

Commercial mortgages

     2,061        381        178   

Residential real estate

     211        378        330   

Consumer

     1,223        1,622        1,123   

Credit cards

     94        101        46   

Overdrafts

     239        269        334   
                        
     4,371        3,611        2,044   
                        

Recoveries:

      

Commercial, industrial, and agricultural

     11        2        2   

Commercial mortgages

     3        -        -   

Residential real estate

     2        1        6   

Consumer

     100        62        72   

Credit cards

     10        13        12   

Overdrafts

     112        144        111   
                        
     238        222        203   
                        

Net charge-offs

     (4,133     (3,389     (1,841
                        

Provision for loan losses

     5,158        4,465        3,787   
                        

Balance at end of period

   $ 10,820      $ 9,795      $ 8,719   
                        

Loans, net of unearned

   $ 794,562      $ 715,142      $ 671,556   

Allowance to net loans

     1.36%        1.37%        1.30%   

 

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The adequacy of the allowance for loan losses is subject to a formal analysis by the credit administrator of the Corporation. As part of the formal analysis, delinquencies and losses are monitored monthly. The loan portfolio is divided into several categories in order to better analyze the entire pool. First is a selection of classified loans that is given a specific reserve. The remaining loans are pooled, by category, into these segments:

Reviewed

   

Commercial, industrial, and agricultural

   

Commercial mortgages

Homogeneous

   

Residential real estate

   

Consumer

   

Credit cards

   

Overdrafts

The reviewed loan pools are further segregated into three categories: special mention, substandard, and doubtful. Historical loss factors are calculated for each pool excluding overdrafts based on the previous eight quarters of experience. The homogeneous pools are evaluated by analyzing the historical loss factors from the most previous quarter end and the two most recent year ends.

The historical loss factors for both the reviewed and homogeneous pools are adjusted based on these six qualitative factors:

 

   

levels of and trends in delinquencies, non-accrual loans, and classified loans;

   

trends in volume and terms of loans;

   

effects of any changes in lending policies and procedures;

   

experience, ability and depth of management;

   

national and local economic trends and conditions; and

   

concentrations of credit

The methodology described above was created using the experience of our credit administrator, guidance from the regulatory agencies, expertise of our third party loan review provider, and discussions with our peers. The resulting factors are applied to the pool balances in order to estimate the probable risk of loss within each pool. As a result of the application of these procedures, the allocation of the allowance for loan losses was as follows at December 31, 2010, 2009 and 2008 (in thousands):

 

     2010      2009      2008  

Commercial, industrial, and agricultural

   $ 3,517       $ 2,790       $ 2,660   

Commercial mortgages

     3,511         3,291         2,836   

Residential real estate

     1,916         1,583         1,273   

Consumer

     1,561         1,751         1,589   

Credit cards

     96         85         82   

Overdrafts

     219         295         279   
                          

Total

   $ 10,820       $ 9,795       $ 8,719   
                          

 

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During 2010, the Corporation increased its provision for loan losses and allowance as compared to 2009 and 2008. The increase was a result of increases in net charge-offs in the commercial mortgage portfolio, as well as growth in loans outstanding.

Although the Corporation experienced a minimal change in its nonperforming loans from December 31, 2009 to December 31, 2010, the composition of nonperforming loans changed significantly during 2010. One commercial loan, a shared national credit in which the Corporation participates, with a carrying value of $4.3 million at December 31, 2009 was placed on nonaccrual status during the third quarter of 2009. As a result of nine consecutive months of current payments and approval by the regulatory oversight body of the lead institution in the shared national credit, this loan was reinstated to accrual status during the third quarter of 2010 with no loss incurred by the Corporation. In addition, a commercial loan with a carrying value of $2.0 million at December 31, 2009 was repaid during the second quarter of 2010 and no loss was incurred by the Corporation. The specific allocation for these two loans totaled $713 thousand at December 31, 2009.

As of September 30, 2010, the Corporation expected a performing commercial mortgage loan to be restructured and recorded a related provision for loan losses of $260 thousand. However, during the fourth quarter of 2010, the loan became impaired before the restructuring was finalized and a balance of $1.8 million was charged off. The carrying value of this loan at December 31, 2010 is $6.1 million, and the specific allocation for this loan at December 31, 2010 is $258 thousand.

Prudent business practices dictate that the level of the allowance, as well as corresponding charges to the provision for loan losses, should be commensurate with identified areas of risk within the loan portfolio and the attendant risks inherent therein. The quality of the credit risk management function and the overall administration of this vital segment of the Corporation’s assets are critical to the ongoing success of the Corporation.

The previously mentioned analysis considered numerous historical and other factors to analyze the adequacy of the allowance and charges against the provision for loan losses. Management paid special attention to a section of the analysis that compared and plotted the actual level of the allowance against the aggregate amount of loans adversely classified in order to compute the estimated probable losses associated with those loans. By noting the “spread” at that time, as well as prior periods, management can determine the current adequacy of the allowance as well as evaluate trends that may be developing. The volume and composition of the Corporation’s loan portfolio continue to reflect growth in commercial credits including commercial real estate loans.

As mentioned in the “Loans” section of this analysis, management considers commercial lending a competitive advantage and continues to focus on this area as part of its strategic growth initiatives. However, management must also consider the fact that the inherent risk is more pronounced in these types of credits and is also driven by the economic environment of its market areas.

Management believes that both its 2010 provision and allowance for loan losses were reasonable and adequate to absorb probable incurred losses in its portfolio at December 31, 2010.

Premises and Equipment

Premises and equipment increased $780 thousand, or 3.3%, since December 31, 2009. This increase is the result of growth initiatives with the ERIEBANK division. As mentioned in the General Overview section, the Corporation completed the construction of a full service branch in Meadville, Pennsylvania in the second quarter of 2010.

 

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Bank Owned Life Insurance

The Corporation has periodically purchased Bank Owned Life Insurance (“BOLI”). The policies cover executive officers and a select group of other employees with the Bank being named as beneficiary. Earnings from the BOLI assist the Corporation in offsetting its benefit costs. During the first quarter of 2010, additional BOLI of $2.5 million was purchased. The Corporation expects to purchase additional BOLI of $5 million in 2011.

Funding Sources

Although the Corporation considers short-term borrowings and long-term debt when evaluating funding sources, traditional deposits continue to be the main source for funding. As noted in the following table, traditional deposits increased 21.5% during 2010, and that year’s growth was significant in all deposit categories.

 

   

Percentage change
2010 vs. 2009

   

Percentage change
2009 vs. 2008

   

2010

   

2009

   

2008

 

Demand, Non interest bearing

    21.1     18.7   $ 140,836      $ 116,310      $ 97,999   

Demand, Interest bearing

    16.5     3.7     284,538        244,218        235,611   

Savings deposits

    34.8     98.8     368,055        273,096        137,344   

Time deposits

    14.3     (5.9 %)      369,439        323,234        343,642   
                           

Total

    21.5     17.5   $ 1,162,868      $ 956,858      $ 814,596   
                           

The Corporation continued to expand its business and consumer relationships in the ERIEBANK market during 2010, including the territory that is served by its new Meadville, Pennsylvania branch. In addition, a large regional bank that had a significant presence in northwestern Pennsylvania merged with another financial institution in 2009, resulting in opportunities to market the Corporation’s deposit products to potential new customers. Savings deposits held by ERIEBANK grew from $179.6 million at December 31, 2009 to $257.2 million at December 31, 2010.

Periodically, the Corporation utilizes term borrowings from the Federal Home Loan Bank (FHLB) and other lenders to meet funding obligations or match fund certain loan assets. The terms of these borrowings are detailed at Note 10 to the consolidated financial statements.

Shareholders’ Equity

The Corporation’s capital continues to provide a base for profitable growth. As mentioned in the General Overview section, the Corporation raised net proceeds of $32.1 million from its equity offering in 2010, which contributed to the increase in shareholders’ equity of $40.2 million or 60.0% during 2010. The Corporation earned $11.3 million and declared dividends of $6.9 million, resulting in a dividend payout ratio of 61.3% of net income.

 

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The Corporation has complied with the standards of capital adequacy mandated by the banking industry. Bank regulators have established “risk-based” capital requirements designed to measure capital adequacy. Risk-based capital ratios reflect the relative risks of various assets banks hold in their portfolios. A weight category of 0% (lowest risk assets), 20%, 50%, or 100% (highest risk assets), is assigned to each asset on the balance sheet. The Corporation’s capital ratios and book value per common share at December 31, 2010 and 2009 are as follows:

 

     2010     2009  

Total risk-based capital ratio

     15.38     11.95

Tier 1 capital ratio

     14.13     10.70

Leverage ratio

     8.81     7.87

Tangible common equity/tangible assets (1)

     7.05     5.08

Book value per share

   $ 8.96      $ 7.92   

Tangible book value per share (1)

   $ 8.08      $ 6.68   

 

(1)

Tangible common equity, tangible assets and tangible book value per share are non-GAAP financial measures calculated using GAAP amounts. Tangible common equity is calculated by excluding the balance of goodwill and other intangible assets from the calculation of stockholders’ equity. Tangible assets is calculated by excluding the balance of goodwill and other intangible assets from the calculation of total assets. Tangible book value per share is calculated by dividing tangible common equity by the number of shares outstanding. The Corporation believes that these non-GAAP financial measures provide information to investors that is useful in understanding its financial condition. Because not all companies use the same calculation of tangible common equity and tangible assets, this presentation may not be comparable to other similarly titled measures calculated by other companies. A reconciliation of these non-GAAP financial measures is provided below (dollars in thousands, except per share data).

 

     December 31,
2010
     December 31,
2009
 

Shareholders’ equity

   $ 109,645       $ 69,409   

Less goodwill

     10,821         10,821   

Less other intangible assets

     -         85   
                 

Tangible common equity

   $ 98,824       $ 58,503   
                 

Total assets

   $ 1,413,511       $ 1,161,591   

Less goodwill

     10,821         10,821   

Less other intangible assets

     -         85   
                 

Tangible assets

   $ 1,402,690       $ 1,150,685   
                 

Ending shares outstanding

     12,237,261         8,761,273   

Tangible book value per share

   $ 8.08       $ 6.68   

Tangible common equity/tangible assets

     7.05%         5.08%   

Liquidity

Liquidity measures an organization’s ability to meet cash obligations as they come due. The consolidated statements of cash flows included in the accompanying financial statements provide

 

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analysis of the Corporation’s cash and cash equivalents and the sources and uses of cash. Additionally, the portion of the loan portfolio that matures within one year and maturities within one year in the investment portfolio is considered part of the Corporation’s liquid assets. Liquidity is monitored by both management and the Board’s ALCO, which establishes and monitors ranges of acceptable liquidity. Also, the Bank is a member of FHLB which provides the Bank with a total borrowing line of approximately $440 million with approximately $371 million available at December 31, 2010. Management believes that the Corporation’s current liquidity position is acceptable.

Year Ended December 31, 2010 vs. Year Ended December 31, 2009

Overview of the Income Statement

The Corporation had net income of $11.3 million for 2010 compared to $8.5 million for 2009. The increase in net income is attributable to an increase in net interest income of $4.7 million, or 12.5%, as well as an increase in non-interest income of $1.7 million, or 21.4%. The earnings per diluted share increased from $0.98 in 2009 to $1.06 in 2010. The return on assets and the return on equity for 2010 are 0.87% and 11.62% as compared to 0.79% and 12.86% for 2009.

Interest Income and Expense

Net interest margin on a fully tax equivalent basis was 3.65% for the year ended December 31, 2010, compared to 4.00% for the year ended December 31, 2009. Total interest and dividend income increased by $5.3 million, or 9.4%, as compared to 2009. Although the Corporation’s earning assets continue to grow, these increases have been offset by decreases in the yield on earning assets as a result of the current interest rate environment. The Corporation’s average earning assets increased by $227.9 million for the year ended December 31, 2010 while the yield during that time decreased by 66 basis points from 5.89% to 5.23%. Total interest expense increased $588 thousand, or 3.2%, for the year ended December 31, 2010 as compared to the comparable period in 2009. As a result of the Corporation’s focus on deposit mix and active management of deposit rates, the cost of interest bearing deposits decreased by 29 basis points which offset the increase in average interest bearing deposits of $190.8 million.

The Corporation’s interest expense on borrowings was negatively impacted by a $707 thousand prepayment penalty that was recorded in the fourth quarter of 2010 when management elected to prepay a long-term borrowing having a fixed interest rate of 5.63%. The effect of this prepayment penalty was to reduce the net interest margin by 6 basis points for the year ended December 31, 2010.

Provision for Loan Losses

The Corporation recorded a provision for loan losses of $5.2 million in 2010 compared to $4.5 million in 2009. As discussed in more detail in the Allowance for Loan Losses section of this analysis, the Corporation experienced an increased level of charge-offs over the prior year even though net charge-offs as a percentage of average loans remain at a modest level in comparison to our peer group. However, because of the increase in net charge-offs and the overall growth of the loan portfolio, as well as management’s detailed evaluation of problem loans, criticized assets, and the overall effects of the economy in our markets, an increase in the provision was deemed necessary. Management believes the charges to the provision in 2010 are appropriate and the allowance for loan losses is adequate to absorb probable incurred losses in our portfolio as of December 31, 2010.

 

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Non-Interest Income

Net realized securities gains during the year ended December 31, 2010 were $1.7 million, compared to net realized securities gains of $395 thousand for the year ended December 31, 2009. During the year ended December 31, 2010 and 2009, an other-than-temporary impairment charge of $2.2 million and $2.4 million, respectively, was recorded in earnings on structured pooled trust preferred securities. CNB’s remaining exposure in structured pooled trust preferred securities is $2.2 million at December 31, 2010.

Excluding the effects of securities transactions, non-interest income was $10.1 million for the year ended December 31, 2010, compared to $9.7 million for the year ended December 31, 2009. Wealth and asset management fees increased $378 thousand, or 26.1%, during the year ended December 31, 2010 as a result of growth in this business segment’s customer base as well as growth in the market value of the portfolios of existing customers.

Non-Interest Expense

Total non-interest expense increased $1.8 million, or 5.9%, during the year ended December 31, 2010 compared to the year ended December 31, 2009. Salaries and benefits expenses increased $1.0 million, or 7.0%, during the year ended December 31, 2010 compared to the year ended December 31, 2009, primarily as a result of an increase in full-time equivalent employees from 280 at December 31, 2009 to 290 at December 31, 2010.

Insurance premiums due to the FDIC decreased by $128 thousand, or 7.3%, for the year ended December 31, 2010 compared to the year ended December 31, 2009 due to the special assessment in the amount of $475 thousand that was incurred during the quarter ended June 30, 2009. Excluding this special assessment, FDIC insurance premiums increased $347 thousand during the year ended December 31, 2010 as compared to the year ended December 31, 2009, as a result of increases in the deposits on which the premium assessment is based as well as higher assessment rates in 2010.

Net occupancy expenses increased $255 thousand, or 6.3%, and data processing expenses increased $309 thousand, or 12.4%, during the year ended December 31, 2010 as a result of the Corporation’s continued growth.

Year Ended December 31, 2009 vs. Year Ended December 31, 2008

Overview of the Income Statement

The Corporation had net income of $8.5 million for 2009 compared to $5.2 million for 2008. The increase in net income is primarily attributable to lower other-than-temporary impairment losses and losses on securities for which the fair value option was elected, which was offset by increases in the Corporation’s provision for loan losses and FDIC insurance expense. The earnings per diluted share increased from $0.61 in 2008 to $0.98 in 2009. The return on assets and the return on equity for 2009 are 0.79% and 12.86% as compared to 0.55% and 7.88% for 2008.

Interest Income and Expense

Net interest income totaled $37.4 million in 2009, an increase of $802 thousand, or 2.2%, over 2008. Total interest and dividend income decreased by $1.3 million, or 2.3%, as compared to 2008. Although the Corporation’s earning assets continue to grow, these increases have been offset by decreases in the yield on earning assets as a result of the current interest rate environment. The Corporation’s average

 

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earning assets increased by $113.7 million for the year ended December 31, 2009 while the yield during that time decreased by 83 basis points from 6.72% to 5.89%. Total interest expense, however, decreased $2.1 million, or 10.3%, for the year ended December 31, 2009 as compared to the comparable period in 2008. While the Corporation’s deposits grew in 2009, interest expense was positively impacted by decreases in rates paid on deposit accounts, primarily as a result of historically low short-term interest rates throughout 2009. As a result, the cost of interest bearing liabilities decreased by 57 basis points which more than offset the increase in average interest bearing liabilities of $112.0 million.

Provision for Loan Losses

The Corporation recorded a provision for loan losses of $4.5 million in 2009 compared to $3.8 million in 2008. As discussed in more detail in the Allowance for Loan Losses section of this analysis, the Corporation experienced an increased level of charge-offs in 2009 compared to 2008 even though net charge-offs as a percentage of average loans remain at a modest level in comparison to our peer group. However, because of the increase in net charge-offs and the increasing level of nonperforming loans, as well as management’s detailed evaluation of problem loans, criticized assets, and the overall effects of the economy in our markets, an increase in the provision in 2009 was deemed necessary. Management believes the charges to the provision in 2009 were appropriate.

Non-Interest Income

Non-interest income improved significantly during the year ended December 31, 2009. A substantial portion of the change is a result of unrealized gains on securities for which the fair value option election was made, compared to total losses of $3.4 million in 2008 and lower other-than-temporary impairment losses incurred during 2009 as compared to 2008.

Excluding the effects of securities transactions, the Corporation’s other income increased $296 thousand (or 3.1%) during 2009. The most significant increase of $611 thousand occurred in mortgage banking income, which is a result of the volume of refinancing transactions processed by the Corporation’s mortgage banking department in 2009 compared to 2008. The proceeds of mortgage loans sold to Freddie Mac increased from $12.5 million in 2008 to $50.5 million in 2009. This increase in mortgage banking income was offset by a decrease in trust and wealth management fees of $434 thousand.

Non-Interest Expense

Non-interest expense increased by $1.5 million, or 5.4%, to $30.0 million in 2009 compared to $28.5 million in 2008, primarily because the Corporation’s insurance premiums payable to the FDIC increased by $1.3 million. This increase occurred because of increases in the deposits on which the premium assessment is based, higher assessment rates, and the 2009 special assessment described in the paragraph below.

As an institution insured by the FDIC, the Corporation is required to pay deposit insurance premiums to the FDIC. Because the FDIC’s deposit insurance fund fell below prescribed levels in 2008, the FDIC announced increased premiums for all insured depository institutions, including the Corporation, in order to begin recapitalizing the fund. In addition, in the second quarter of 2009, the FDIC imposed a 5 basis point emergency assessment on insured depository institutions based on total assets less Tier 1 capital at June 30, 2009 which was paid on September 30, 2009. The Corporation’s expense attributable to this special assessment was $475 thousand.

 

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This increase in FDIC insurance expense was offset by a decrease in state and local income taxes of $205 thousand as a result of a one-time credit that the Corporation was able to apply on its Pennsylvania shares tax return in the amount of $246 thousand. The Commonwealth of Pennsylvania awarded the Corporation an Enterprise Zone Tax Credit in connection with the Corporation’s investment in a real estate limited partnership in the community of St. Marys, Pennsylvania.

Income Tax Expense

Income taxes were $3.5 million in 2010, compared to $2.4 million in 2009 and $1.3 million in 2008. The effective tax rates were 23.5%, 21.7%, and 19.5% for 2010, 2009 and 2008, respectively. The effective tax rate for the periods differed from the federal statutory rate of 35.0% principally as a result of tax-exempt income from securities and loans as well as earnings from bank owned life insurance. The increase in the effective tax rate from 2008 and 2009 to 2010 is attributable to a lower percentage of tax-exempt income in 2010 compared to pre-tax income.

Contractual Obligations and Commitments

The Corporation has various financial obligations, including contractual obligations and commitments that may require future cash payments. The following table presents, as of December 31, 2010, significant fixed and determinable contractual obligations to third parties by payment date. Further discussion of the nature of each obligation is included in the referenced note to the consolidated financial statements.

 

     Payments Due In  
(dollars in thousands)    Note
Reference
     One
Year or
Less
     One to
Three Years
     Three to
Five Years
     Over Five
Years
     Total  

Deposits without a stated maturity

      $ 793,429         -         -         -       $ 793,429   

Certificates of deposit

     9         178,679         156,395         27,899         6,466         369,439   

Treasury, tax and loan borrowings

     10         1,248         -         -         -         1,248   

FHLB and other borrowings

     10         31,489         255         20,278         53,237         105,259   

Operating leases

     6         352         494         355         1,420         2,621   

Sale-leaseback

     6         112         224         224         1,229         1,789   

Subordinated debentures

     10         -         -         -         20,620         20,620   

The Corporation’s operating lease obligations represent short and long-term lease and rental payment for facilities. The Corporation’s sale-leaseback obligation represents a long-term real estate lease associated with one of the Corporation’s branch office locations.

The Corporation also has obligations under its postretirement plan for health care and supplemental executive retirement plan as described in Note 13 to the consolidated financial statements. The postretirement benefit payments represent actuarially determined future benefit payments to eligible plan participants. The supplemental executive retirement plan allocates expenses over the participant’s service period. The Corporation reserves the right to terminate these plans at any time.

Off-Balance Sheet Arrangements

See Note 18 to the consolidated financial statements for information about our off-balance sheet arrangements.

 

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Applications of Critical Accounting Policies

The Corporation’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the U.S. and follow general practices within the industries in which the Corporation operates. Application of these principles requires management to make estimates or judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements could reflect different estimates or judgments. Certain policies inherently have a greater reliance on the use of estimates, and as such have a greater possibility of producing results that could be materially different than originally reported. Estimates or judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried on the financial statements at fair value warrants an impairment write-down or valuation reserve to be established, or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. The fair values and the information used to record valuation adjustments for certain assets and liabilities are based either on quoted market prices or are provided by other third party sources, when available. When third-party information is not available, valuation adjustments are estimated in good faith by management primarily through the use of internal cash flow modeling techniques.

The most significant accounting policies used by the Corporation are presented in Note 1 to the consolidated financial statements. These policies, along with the disclosures presented in the other financial statement notes and in this financial review, provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined. Management views critical accounting policies to be those which are highly dependent on subjective or complex judgments, estimates and assumptions, and where changes in those estimates and assumptions could have a significant impact on the financial statements. Management currently views the determination of the allowance for loan losses and fair value of securities to be critical accounting policies.

ITEM 7A  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market risk is the risk of loss arising from adverse changes in the fair value of financial instruments due to changes in interest rates, exchange rates, and equity prices. As a financial holding company, the Corporation is primarily sensitive to the interest rate risk component. Changes in interest rates will affect the levels of income and expense recorded on a large portion of the Bank’s assets and liabilities. Additionally, such fluctuations in interest rates will impact the market value of all interest sensitive assets. The ALCO is responsible for reviewing the interest rate sensitivity position and establishing policies to control exposure to interest rate fluctuations. The primary goal established by these policies is to increase total income within acceptable risk limits.

The Corporation monitors interest rate risk through the use of two models: earnings simulation and static gap. Each model standing alone has limitations; however, taken together they represent in management’s opinion a reasonable view of the Corporation’s interest rate risk position.

STATIC GAP: Gap analysis is intended to provide an approximation of projected repricing of assets and liabilities at a point in time on the basis of stated maturities, prepayments, and scheduled interest rate adjustments within selected time intervals. A gap is defined as the difference between the principal

 

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amount of assets and liabilities which reprice within those time intervals. The cumulative one year gap at December 31, 2010 was 3.23% of total earning assets compared to policy guidelines of plus or minus 15.0%. The ratio was (0.60%) at December 31, 2009.

Fixed rate securities, loans and CDs are included in the gap repricing based on time remaining until maturity. Mortgage prepayments are included in the time frame in which they are expected to be received.

Certain shortcomings are inherent in the method of analysis presented in Static Gap. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may not react correspondingly to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate with changes in market interest rates, while interest rates on other types of assets may lag behind changes in market rates. Additionally, certain assets, such as adjustable-rate loans, have features, like annual and lifetime rate caps, which restrict changes in interest rates both on a short-term basis and over the life of the asset. Further, in the event of a change in interest rates, prepayment and early withdrawal levels would likely deviate from those assumed in the table. Finally, the ability of certain borrowers to make scheduled payments on their adjustable-rate loans may decrease in the event of an interest rate increase.

EARNINGS SIMULATION: This model forecasts the projected change in net income resulting from an increase or decrease in the federal funds rate. The model assumes a one time shock of plus or minus 200 basis points or 2%.

The model makes various assumptions about cash flows and reinvestments of these cash flows in the different rate environments. Generally, repayments, maturities and calls are assumed to be reinvested in like instruments and no significant change in the balance sheet mix is assumed. Actual results could differ significantly from these estimates which would produce significant differences in the calculated projected change in income. The limits stated above do not necessarily represent measures that would be taken by management in order to stabilize income results. The instruments on the balance sheet react at different speeds to various changes in interest rates as discussed under Static Gap. In addition, there are strategies available to management that may help mitigate a decline in income caused by a rapid change in interest rates.

The following table below summarizes the information from the interest rate risk measures reflecting rate sensitive assets to rate sensitive liabilities at December 31, 2010 and 2009:

 

     2010     2009  

Static 1-Yr. Cumulative Gap

     3.23     (0.60 %) 

Earnings Simulation:

    

-200 bps vs. Stable Rate

     N/A        N/A   

+200 bps vs. Stable Rate

     0.10     (6.57 %) 

The interest rate sensitivity position at December 31, 2010 was asset sensitive in the short term; whereas the Corporation was slightly liability sensitive at December 31, 2009. As the federal funds rate was at 0.25% on December 31, 2010 and 2009, the -200 bps scenario has been excluded. Management measures the potential impact of significant changes in interest rates on both earnings and equity. By the use of computer generated models, the potential impact of these changes has been determined to be acceptable with modest effects on net income and equity given an interest rate shock of an increase or decrease in rates of 2.0%. We continue to monitor the interest rate sensitivity through the ALCO and use the data to make strategic decisions.

 

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

CONSOLIDATED BALANCE SHEETS

Dollars in thousands

 

   
   

December 31,

 
     2010     2009  

ASSETS

  

Cash and due from banks

  $ 24,584      $ 19,959   

Interest bearing deposits with other banks

    12,848        2,399   
               

Total cash and cash equivalents

    37,432        22,358   

Interest bearing time deposits with other banks

    2,817        6,388   

Securities available for sale

    500,677        345,415   

Trading securities

    2,351        2,333   

Loans held for sale

    4,451        1,218   

Loans

    797,009        718,022   

Less: unearned discount

    (2,447     (2,880

Less: allowance for loan losses

    (10,820     (9,795
               

Net loans

    783,742        705,347   

FHLB and other equity interests

    6,415        6,907   

Premises and equipment, net

    24,135        23,355   

Bank owned life insurance

    19,742        16,440   

Mortgage servicing rights

    908        876   

Goodwill

    10,821        10,821   

Other intangible assets

    -        85   

Accrued interest receivable and other assets

    20,020        20,048   
               

TOTAL ASSETS

  $ 1,413,511      $ 1,161,591   
               

LIABILITIES AND SHAREHOLDERS’ EQUITY

  

Non-interest bearing deposits

  $ 140,836      $ 116,310   

Interest bearing deposits

    1,022,032        840,548   
               

Total deposits

    1,162,868        956,858   

Treasury, tax and loan borrowings

    1,248        1,380   

FHLB and other borrowings

    105,259        100,003   

Subordinated debentures

    20,620        20,620   

Accrued interest payable and other liabilities

    13,871        13,321   
               

Total liabilities

    1,303,866        1,092,182   
               

Common stock, $0 par value; authorized 50,000,000 shares; issued 12,599,603 shares at December 31, 2010 and 9,233,750 shares at December 31, 2009

    -        -   

Additional paid in capital

    44,676        12,631   

Retained earnings

    73,059        68,676   

Treasury stock, at cost (362,342 shares for 2010 and 472,477 for 2009)

    (5,417     (7,023

Accumulated other comprehensive loss

    (2,673     (4,875
               

Total shareholders’ equity

    109,645        69,409   
               

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY

  $ 1,413,511      $ 1,161,591   
               

 

 

See Notes to Consolidated Financial Statements

 

49


Table of Contents

CONSOLIDATED STATEMENTS OF INCOME

Dollars in thousands, except per share data

 

 

    

Year ended December 31,

 
      2010     2009     2008  

INTEREST AND DIVIDEND INCOME:

      

Loans including fees

   $ 46,955      $ 45,839      $ 47,355   

Deposits with banks

     125        215        429   

Federal funds sold

     -        -        342   

Securities:

      

Taxable

     11,603        7,687        7,419   

Tax-exempt

     2,435        2,095        1,414   

Dividends

     29        34        224   
                        

Total interest and dividend income

     61,147        55,870        57,183   
                        

INTEREST EXPENSE:

      

Deposits

     13,558        13,091        14,956   

Borrowed funds

     4,716        4,527        4,609   

Subordinated debentures

     782        850        1,018   
                        

Total interest expense

     19,056        18,468        20,583   
                        

NET INTEREST INCOME

     42,091        37,402        36,600   

PROVISION FOR LOAN LOSSES

     5,158        4,465        3,787   
                        

NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES

     36,933        32,937        32,813   
                        

NON-INTEREST INCOME:

      

Wealth and asset management fees

     1,829        1,451        1,885   

Service charges on deposit accounts

     4,226        4,309        4,335   

Other service charges and fees

     1,396        1,322        1,405   

Net realized losses from sales of securities for which fair value was elected

     (68     -        (602

Net unrealized gains (losses) on securities for which fair value was elected

     230        293        (2,793

Mortgage banking

     814        1,058        447   

Bank owned life insurance

     802        720        621   

Other

     1,002        845        716   
                        
     10,231        9,998        6,014   
                        

Total other-than-temporary impairment losses on available-for-sale securities

     (2,241     (2,443     (3,963

Less portion of loss recognized in other comprehensive loss

     -        -        -   
                        

Net impairment losses recognized in earnings

     (2,241     (2,443     (3,963

Net realized gains on available-for-sale securities