To Our Shareholders:
Well, where are we now, a year "wiser" than mid-summer last year?
When last I wrote you, we were amidst an evolving situation, perhaps
"melt down" would be a better term. The problem began with "subprime
mortgages" originated outside of the protective tent of consumer bank
regulation, funded and sold through securitization by Wall Street
players. But beginning in 2007, the real estate bubble which resulted
from this process had burst. Property values collapsed, especially in a
handful of states, principally Florida, California, and Arizona. By
last summer, an expansive disruption of credit markets both here and
abroad developed because investment in these subprime mortgage
securities was pervasive to a degree that caught the Securities and
Exchange Commission (SEC), Federal Reserve, and regulators world-wide
by surprise.
Though we acknowledged at that time the situation had not involved
the Rochester metropolitan region's geography or its demography to the
degree experienced elsewhere. At mid-year 2008, we had strong
year-over-year performance of $14.19 per share (a 23.5% increase); the
historical extent and breadth of the financial crisis was yet to be
made apparent. On September 15th, Lehman Brothers filed for bankruptcy,
thereafter Merrill-Lynch was acquired by Bank of America rather than
follow Lehman's path down and out, and in downtown Canandaigua, a
fierce wind storm blew over the venerable clock, which stood on our
Main Street for 60 years in front of the "Lower Bank"
(Lincoln-Alliance, Lincoln-Rochester, Lincoln-First, Chase-Lincoln, now
JPMorgan-Chase), in what could only be said to be an omen of future
calamities to come!
And so the calamites did come as the Treasury and Federal Reserve
sought to find the limits of the ensuing "melt down" evinced by the Dow
dipping to 6,500 from 14,000 plus, the iconic investment banks which
had ruled Wall Street for 80 years vanishing in 80 days, and the top
few mega-banks losing 78% to 98% of their stock value capitalization.
There followed the spate of rescue packages like the Troubled Assets
Recovery Plan (TARP) of $700 Billion for some 500 firms (banks and
non-banks alike) and conservatorships for Freddie and Fannie to include
the near conservatorship (79.9%) for AIG.
By the second quarter of 2009, signs that the financial crisis had
been contained and disaster narrowly averted were apparent, and it is
safe to say we are now in what can be termed as "an old fashion
recession" with the familiar downturn of the broad economy, rising past
dues, pressure on some clients businesses, foreclosures, and rising
unemployment.
Though we were approved for a TARP investment of the Treasury of $20
Million which would have created in our hands (leveraged 13 times by
deposits) a quarter of a billion in financial stimulus and wherewithal
to bolster our region's economy, we declined the offer rather than be
subject to oppressive governmental interference in our business
springing from the "outrage" of Congress over CEOs' salaries and
bonuses which was a display in an election year of favoring political
posturing over enacting an effective program to deal with the crisis.
Hundreds of firms rushed in to take the assistance (under the threat of
never having an opportunity for such assistance again) and almost
immediately those who got in clamored to get out when the foolishness
of the terms and restrictions and expense of the engagement finally set
in.
However, as sound as we are today having not engaged in the foolish
activities which overtook the industry over the last decade, we do not
live in a vacuum but in an environment characterized by a slowed
economy. Less obvious is that the inevitable expense of funding the
recovery falls on us by virtue of our member-ship in the FDIC even
though we were not responsible for the problems. The government does
not fund the FDIC; CNB and other community banks fund the restoration
of the FDIC's reserves. Alas, Darwin does not rule in the banking
world, since "to the victors do not go the spoils", but rather the
victors get to shoulder the expense of cleaning up the mess of the
aftermath. That said, we are happier with our lot than the alternative.
We have just completed our routine annual comprehensive exam by the
OCC of the entire bank and passed with flying colors with no loan
portfolio downgrades. Recently we have been cited in the financial
press as being ranked in the top one half of one percent of the banks
in the country based on three-year average of Return On Equity which
places us as the best of class in our region in terms of financial
earnings.
We are pleased to report earnings for the first half of 2009, of
$13.56 per share compared to the unusually strong performance of $14.19
per share for the first half of last year. Net income is $350,000 less
that for the same period in 2008. This reflects the reduction of trust
and investments earning of $820,000, resulting from lower market value
of the assets under management, namely the lower level of the Dow.
Interestingly, mortgage banking income CNB Mortgage Company's earnings
are up a record of $1, 691,000 which is more than double the figure of
the trust and investments shortfall. However, this operational surplus
of $871,000 is nearly fully absorbed by an increased Provision for Loan
Losses which is up by $530,000. This increase is due in part to growth
of the loan portfolio of 13.4% or just over $131 million year over year
and an increase in loans that are "slow pay" which we term
"non-performing" meaning they may be paying but are behind by more than
two months.
Generally, we expense just over 1.00% of each new loan to provide
for the possibility of a loan loss. In times such as these, we add to
our reserves conservatively recognizing the slowness of some of our
loan accounts as customers feel the pressures of the downturn in their
businesses and changes in the earnings of the household. Our net charge
offs remain stable due to our strong underwriting processes, compared
to a sharp rise in charge offs at peer banks.
This year we have two expense events which are "one off" situations,
deemed not part of our recurring expense profile amounting to an
increased expense during the first half of $1,500,000: the first is an
FDIC "special assessment" over which we have no control; and, the
second is an adjustment due to voluntary staff retirements which though
payable over three fiscal years, by accounting rule, must be recognized
all in this second quarter. After tax, these two elements represent
$1.91per share of one-time expense for the first half which more than
offsets the $.63 per share of reported reduced performance. The
earnings increase year over year for the Company, excluding these items
is therefore, actually a positive 9.0% even when including the higher
credit related expense of the increased provision for loan losses and
the offsetting performances of the WSG and CNB Mortgage.
We are pleased to pay a dividend of $5.05 per share up from the
$4.85 in February bringing the total for the year to $9.90 per share or
an increase of 10% over 2008 reflecting our strong fundamentals and
growth of the Company. Again we stand for the proposition that we
intend to grow the Company not to sell it, but to own it and share with
our owners in the current earnings. After dividends and taxes, about
40% of the earnings are retained in the capital account to fuel the
growth for the next year. This capital is leveraged by deposits 13 to 1
to make loans to members of our community. Meanwhile, you as an owner
generally receive about one-third of the earnings after taxes currently
as a dividend to save or spend as you wish, and remain invested with
respect to the other half (an increase in net worth). Our model is
exquisitely simple.
What is on our mind now for the future is the debate in Congress
over the redesign of the financial system. Our associations, to include
the ABA, NYBA, ICBA, and IBANYS, are diligently at work to resist the
onslaught of craziness that appears at this point in the cycle; so do
not get too concerned about the rhetoric and the news reports, yet.
First, Congress should extend the existing regulations which apply
to banks to the 65-70% of the financial activities not covered by those
regulations and which caused most of the problem such as the
securitization of subprime mortgages which were not regulated before
because legislation traditionally focuses narrowly on the charter
(bank, mortgage company, etc.) not the activity (mortgaging, asset
based investments, etc.).
Second, Consumer protection is a populist hot button driven by the
gamey (though legal) practices of credit card companies adjusting the
contract rates and terms in precipitous ways to cover the huge losses
now occurring on the large nonperforming card portfolios which were
based on risky underwriting and are at risk since they are customarily
unsecured. We got out of the consumer credit card issuance business
over five years ago as it was a business in which we could not be
distinctive or provide value to our customers. The mischief here is the
proposal of the Administration to create a super-consumer watch dog
agency separate from the bank's regulator that currently has
responsibility for assuring compliance to consumer laws and which they
do in our case very effectively. Because all financial products would
have to be pre-approved by such an agency, innovation, which we do a
lot of, would be significantly if not completely curtailed so all bank
products would be the same. The right to contract with responsible
customers in a novel way would be too risky or burdensome to engage in.
This attempt to include the two-thirds of the business not covered
before (the shadow banking system) risks the elimination of innovation
and freedom of contract for those of us who were not part of the
problem. Certainly our signature mortgage loan products of a 3- or
10-year call would be eliminated. The flexibility of the call provision
allows us to manage interest rates so we can carry these loans on our
books since we can match our then current cost of funds and thereby
maintain a healthy spread upon which our viability rests. Only though
our viability can we assure our continued availability and strength to
service the financial needs of the community.
No one has dared raise the question of consumer responsibility to
exercise common sense! Of the 4 million subprime mortgages, is it
possible that none of the applicants could have known what they were
doing? This has nothing to do with disclosures that experience shows
few if any read. Thirty years ago it took six to eight pages to close
and file a mortgage. Today that figure is over 100 pages. Our closing
officer goes over the papers with each customer, who then signs based
on that explanation or that of his or her lawyer in the room. The
compliance burden was estimated by the Federal Reserve 15 years ago to
cost the industry $15 Billion a year, adjust for inflation and it is
substantially worse today.
Third, moves by members of Congress and the SEC to place executive
pay of public companies like ours on the shareholder ballots is pure
political tomfoolery. Most firms of our size go through a structured
process using disinterested directors and outside consultants and
industry data to maintain a fair and competitive compensation system.
For well over ten years, our executives have been paid against a
scorecard of specific performance criteria aligned with our strategic
plan. The performance of our Company over those ten years is proof
positive of the effectiveness of our system. Shareholders' voting about
a complex system of pay incentives is as ill advised as formulating
foreign policy by gathering impromptu interviews of pedestrians on a
crowded street.
Likewise, forcing on public companies a rule that as little as 3% of
the outstanding shares of a company may nominate candidates for
director of 25% of the number on the board of directors reduces the
business board to the same level of politics which we have for public
office today. Popularity is not an appropriate criteria for service on
business boards, rather integrity of self and intellect, independent
thinking, willingness to consider all the possibilities not just the
usual commonly accepted alternatives are but just a few elements of
leadership, hard decision making, and deliberate risk taking which are
required for business, and as a decision process is distinctive from
the political decision process. Democratic capitalism, which has made
this county what it is today, is a balancing of the two methodologies
of decision making, each has its objectives. Care should be taken not
to consolidate the two methods and thereby loose the genius which the
paring of them offers. As observed by the Economist Magazine, for over
a century and a half, Democratic Capitalism has raised more people out
of misery than any political combination ever has because of how it
galvanizes the human spirit and ingenuity into a dynamic living
cooperation which meets the needs of the greatest number most directly.
You should also be aware of the problem of internet exposure of the
Company and its stock price. The symbol CNND.OB entered into a search
engine today shows the stock value to be $275, when the results of the
last sealed-bid public auction produced an average price of $314.74 per
share as posted on our web site. The price shown on the internet is the
result of an intra-dealer quotations system and does not include all of
the information for purchases and sales of CNC stock that is available,
it may in fact reflect the offer of a single broker at whatever price
they happen to enter into the quote system, NOT AN ACTUAL SALE. CNC
Stock is not listed on any stock exchange. The sealed bid auction
system for the stock, set up 40 years ago, was designed to offer an
alternative to just the mischief which is happening now. Back then,
unscrupulous brokers would make a market in our stock in their "desk
drawer" and extract a premium by taking advantage of the unwary. If you
wish to buy or sell stock in CNC, I recommend that you go to the
cnbank.com web site for information; the current prices and five years'
of historical data are available. This information is also a part of
our financial statements filed with the SEC and available at www.sec.gov/edgar.shtml.
As we look to the future, our prospects are bright even if the
recovery will take well into 2011 to be visible and widely
acknowledged. In our market, foreclosures remain stable, in contrast to
the 15% increase in the national trends. Year-over-year increases in
loans of 13.4%, deposits of 21.3% and equity (owner's capital) of 9.3%
is real growth that you can bank on. Especially significant in this
performance is 25.4% growth in consumer deposits. We plan to have a
"soft" opening of our Alexander Park Office before the end of the year
and are moving on second sites in Greece and Webster. At long last we
have received our charter for Canandaigua National Trust Company of
Florida (CNTF) in Sarasota where we have renovated a historic bank
building on the old Main Street and are open for business.
Thanks goes to our employees who continue through their dedication
and passion to keep us on track as we meet the elements of our Mission
which is to grow the Community through its households and businesses.
We have much to be thankful for and are happy to be associated in this
wonderful common enterprise; our success will continue with your
support.
Very truly yours,
George W. Hamlin, IV President and CEO