To Our Shareholders:
I am pleased to report that 2012 was a year of continued progress for our company. We posted improved levels of profitability, lower levels of loan losses and credit-related expenses, improved the valuation of our common stock, increased cash dividends, and we successfully exited the U.S. Treasury’s Capital Purchase Program. We achieved these results despite a still struggling Michigan economy, continued high levels of unemployment, and depressed real estate values. I will review the highlights of 2012, our capital and dividend actions, the recent legal restructuring of the company, and our outlook for the future.
2012 Highlights
Net income available to our common shareholders improved by 135% from $3.9 million in 2011 to over $9.2 million in 2012. The most important measure of our financial success is our Return on Average Shareholders' Equity which improved to 7.0% from the 2011 level of 3.75%. While improved, and approximating peer results, this return remains below our historical rate of return on our shareholders investment. Asset quality issues and credit costs improved, but remain the largest hindrance to returning to higher levels of performance. During 2012 we made significant progress in reducing the level of non-performing loans, and in reducing the levels of loan losses, legal fees, and expenses related to collecting, securing, maintaining, and disposing of collateral from customers who could no longer service their loans. Net charge-offs declined from $13.7 million in 2011 to $7.4 million in 2012, and we are working to reduce that level further in 2013. Continuing improvement in the Michigan economy, and in particular a stabilization and increase in real estate values, will help us to achieve increased earnings in 2013.
Our mortgage lending business, despite low real estate valuations, has been robust as customers have refinanced their homes at record low interest rates. In 2012 we had gains from the sale of long term fixed rate loans into the secondary market of over $6.5 million compared to $3.7 million in 2011. All of our mortgage lenders and processing personnel throughout the company have worked tirelessly to help our customers take advantage of these historically low rates - which will literally save our customers tens of thousands of dollars over the lives of their mortgage loans. We take great pride in helping our customers benefit from refinancing, and will continue to assist them with their financing needs in 2013.
Our banks all remain very well capitalized with ample funding and human resources to expand lending. However, our loan portfolios have continued to shrink due to limited good quality lending opportunities within our markets combined with a general reluctance by customers to take on new debt. As a result, total loans declined by 2.0% during 2012, but we remain well-positioned to expand our lending as the Michigan economy improves. Helping to offset the earnings impact of the decline in loans has been our continued focus on building core deposits. Core deposits are generally lower in cost than wholesale funding sources, but more importantly provide us with opportunities to expand our banking relationship with customers who live and work in our local communities. This lower cost funding helped to maintain our net interest margin at 3.99% in 2012, down only slightly from 4.06% in 2011.
Capital and Dividends
Last year I reported that we were developing a plan to redeem at least half of the outstanding preferred shares before 2014, at which the time the dividend rate would increase from 5% to 9%. We were very pleased that in June we had accumulated sufficient capital to be able to redeem $16 million of the $33 million of preferred shares outstanding when the shares were publicly auctioned by the U.S. Treasury. Furthermore, in July we negotiated the repurchase of the warrants we had issued to Treasury in conjunction with the preferred shares. Between the auction proceeds and our warrant payment, the U.S. Treasury received full repayment of the $33
million it had invested in our company. Earnings have improved since that time, capital has continued to build, and both banks maintain capital levels significantly above the minimum amounts required to be considered "well-capitalized" by the regulators. We are now formulating plans to redeem the balance of the $17 million of preferred stock outstanding, all of which is held by private investors. We expect to be able to report to you on those efforts in the near future.
We were also pleased that we were able to share our improved performance with our shareholders through additional cash dividends. We declared five dividends during the year related to 2012 earnings totaling $0.24. This compares with the $0.09 cash dividend paid relating to 2011 earnings. In February of 2013 we returned to our former practice of declaring quarterly cash dividends based upon expected annual earnings, and declared a first quarter cash dividend of $0.06 payable March 28, 2013 to shareholders of record March 12, 2013.
Regulatory Issues & Bank Restructuring
Every shareholder is undoubtedly aware that there have been significant new pieces of legislation enacted over the past few years that are intended to prevent another financial calamity such as we have experienced the past five years. While the target of these new laws is to protect the system from the "too big to fail" financial providers, there will be substantial new regulations to which the community banking industry will now also be subject. These new, and yet to be implemented, regulations will place significant new compliance demands and costs on our company. As a result, it was prudent for us to re-examine the structure of our company so that we will be better prepared to deal with the coming onslaught of new regulations. In October 2012 we announced the consolidation of five small branch offices into other nearby branches, and a legal restructuring of our company, which consolidates the four "Firstbank" charters into one legal entity. These actions are designed to make us more efficient without impacting how we relate to and service our customers and our communities. We continue to believe in our community banking structure and believe it has significant benefits. However, regulatory issues and the related costs are playing a much larger role today and must be addressed. While we favor our community banking structure, we constantly assess its risks and costs, to ensure that we are representing all of our shareholders, customers, communities, and staff members to the best of our abilities.
2013 Outlook
The Michigan economy appears to be steadily improving; unemployment rates are still high but have been declining; the level and severity of problem loans has been declining; and low interest rates on home mortgages continue to drive the highly profitable re-financing activity. However, weak loan demand is resulting in a shrinking net interest margin as assets shift into lower yielding investments; real estate values have failed to show improvement; and regulatory changes will impact both our revenue sources and our cost structure. These factors, combined with the economic uncertainty over the effects of sequestration and the general dysfunction in Washington, are concerning. Overall, we are cautiously optimistic about 2013, but recognize that we will need to remain vigilant on all of these issues to be successful.
In Conclusion
Our company is truly a reflection of all of the team members which comprise our staff. We are fortunate to have so many dedicated and capable individuals who have devoted their time, efforts, and careers to our company, our customers, our communities and our shareholders. I thank each and every one of them for their hard work, dedication, and commitment to Firstbank Corporation and the community banking industry.
Finally, I would like to thank our customers and communities for entrusting us with their business and for allowing us to serve them. We stand strong and ready to serve their future needs. The confidence displayed by our shareholders as we have worked through difficult times has been very reassuring. Your support, encouragement, and investment in Firstbank Corporation are greatly appreciated.
Sincerely,
Thomas R. Sullivan
President & Chief Executive Officer
2012
Annual Report
This 2012 Annual Report contains audited financial statements and a detailed financial review. This is Firstbank Corporation’s 2012 Annual Report to Shareholders.
The report presents information concerning the business and financial results of Firstbank Corporation in a format and level of detail that we believe shareholders will find useful and informative. Shareholders who would like to receive even more detailed information than that contained in this 2012 Annual Report are invited to request our Annual Report on Form 10-K.
Firstbank Corporation’s Form 10-K Annual Report filed with the Securities and Exchange Commission will be provided to any shareholder, without charge, upon written request. Requests should be addressed to Samuel G. Stone, Chief Financial Officer, Firstbank Corporation, 311 Woodworth Avenue, P.O. Box 1029, Alma, Michigan 48801-6029. Firstbank Corporation's Form 10-K Annual Report may also be accessed through our website www.firstbankmi.com
FINANCIAL HIGHLIGHTS
Firstbank Corporation
| (In Thousands of Dollars, Except per Share Data) | | | | | | | | | | | | | |
| For the year: | | 2012 | | | 2011 | | | 2010 | | | 2009 | | | 2008 | |
| Interest income | | $ | 62,866 | | | $ | 67,644 | | | $ | 72,382 | | | $ | 74,686 | | | $ | 82,191 | |
| Net interest income | | | 54,492 | | | | 54,672 | | | | 51,492 | | | | 48,747 | | | | 46,838 | |
| Provision for loan losses | | | 7,690 | | | | 13,337 | | | | 13,344 | | | | 14,671 | | | | 8,256 | |
| Non-interest income | | | 12,670 | | | | 9,675 | | | | 11,829 | | | | 15,409 | | | | 3,990 | |
| Non-interest expense | | | 44,682 | | | | 43,553 | | | | 44,702 | | | | 45,750 | | | | 42,915 | |
| Net income | | | 10,534 | | | | 5,623 | | | | 3,763 | | | | 2,691 | | | | 719 | |
| Net income available to common | | | 9,259 | | | | 3,944 | | | | 2,084 | | | | 1,151 | | | | 719 | |
| | | | | | | | | | | | | | | | | | | | | |
| At year end: | | | | | | | | | | | | | | | | | | | | |
| Total assets | | | 1,498,762 | | | | 1,485,299 | | | | 1,458,343 | | | | 1,482,356 | | | | 1,425,340 | |
| Total earning assets | | | 1,375,946 | | | | 1,351,099 | | | | 1,332,662 | | | | 1,342,530 | | | | 1,292,647 | |
| Loans | | | 966,683 | | | | 984,258 | | | | 1,032,975 | | | | 1,122,185 | | | | 1,159,632 | |
| Deposits | | | 1,241,401 | | | | 1,220,542 | | | | 1,183,783 | | | | 1,149,063 | | | | 1,046,914 | |
| Other borrowings | | | 101,362 | | | | 102,325 | | | | 118,070 | | | | 175,756 | | | | 251,275 | |
| Common shareholders’ equity | | | 130,150 | | | | 122,585 | | | | 115,665 | | | | 114,173 | | | | 114,983 | |
| Total shareholders’ equity | | | 147,058 | | | | 155,377 | | | | 148,428 | | | | 146,880 | | | | 114,983 | |
| | | | | | | | | | | | | | | | | | | | | |
| Average balances: | | | | | | | | | | | | | | | | | | | | |
| Total assets | | | 1,500,015 | | | | 1,489,737 | | | | 1,488,673 | | | | 1,433,555 | | | | 1,396,357 | |
| Total earning assets | | | 1,382,519 | | | | 1,364,139 | | | | 1,351,872 | | | | 1,300,354 | | | | 1,264,425 | |
| Loans | | | 982,124 | | | | 1,004,599 | | | | 1,077,718 | | | | 1,135,868 | | | | 1,145,849 | |
| Deposits | | | 1,230,151 | | | | 1,224,638 | | | | 1,170,195 | | | | 1,064,567 | | | | 1,024,305 | |
| Other borrowings | | | 106,569 | | | | 104,010 | | | | 160,547 | | | | 207,614 | | | | 236,095 | |
| Common shareholders’ equity | | | 125,900 | | | | 117,287 | | | | 114,207 | | | | 114,424 | | | | 118,494 | |
| Total shareholders’ equity | | | 150,535 | | | | 150,065 | | | | 146,948 | | | | 144,583 | | | | 118,494 | |
| | | | | | | | | | | | | | | | | | | | | |
Per common share: | | | | | | | | | | | | | | | | | | | | |
| Basic earnings | | $ | 1.17 | | | $ | 0.50 | | | $ | 0.27 | | | $ | 0.15 | | | $ | 0.10 | |
| Diluted earnings | | $ | 1.16 | | | $ | 0.50 | | | $ | 0.27 | | | $ | 0.15 | | | $ | 0.10 | |
| Cash dividends | | $ | 0.29 | | | $ | 0.04 | | | $ | 0.08 | | | $ | 0.40 | | | $ | 0.90 | |
| Common shareholders’ equity | | $ | 16.24 | | | $ | 15.53 | | | $ | 14.82 | | | $ | 14.77 | | | $ | 15.44 | |
| | | | | | | | | | | | | | | | | | | | | |
| Financial ratios: | | | | | | | | | | | | | | | | | | | | |
| Return on average assets | | | 0.70 | % | | | 0.38 | % | | | 0.25 | % | | | 0.19 | % | | | 0.05 | % |
| Return on average total equity | | | 7.00 | % | | | 3.75 | % | | | 2.56 | % | | | 1.86 | % | | | 0.61 | % |
| Average equity to average assets | | | 10.04 | % | | | 10.07 | % | | | 9.87 | % | | | 10.09 | % | | | 8.38 | % |
Average common equity to average assets | | | 8.39 | % | | | 7.87 | % | | | 7.67 | % | | | 7.98 | % | | | 8.38 | % |
Dividend payout ratio on common stock | | | 21.97 | % | | | 5.58 | % | | | 16.47 | % | | | 113.80 | % | | | 935.73 | % |
The Company’s Form 10-K Annual Report filed with the Securities and Exchange Commission will be provided to any shareholder, without charge, upon written request. Requests should be addressed to: Samuel G. Stone, Chief Financial Officer, Firstbank Corporation, 311 Woodworth Avenue, P.O. Box 1029, Alma, Michigan 48801-6029 The Company’s Form 10-K may also be viewed through our web site at www.firstbankmi.com.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The purpose of this section of the annual report is to provide a narrative discussion about Firstbank Corporation’s financial condition and results of operations. Please refer to the consolidated financial statements and the selected financial data presented in this report in addition to the following discussion and analysis. We also encourage you to read our Annual Report on Form 10-K filed with the U.S. Securities and Exchange Commission.
RESULTS OF OPERATIONS
Highlights
Firstbank Corporation (“We” or “the Company”) had net income of $10.5 million for 2012 compared with $5.6 million in 2011, an increase of $4.9 million, or 87%. After payment of dividends on preferred stock, net income available to common shareholders was $9.3 million for 2012 compared with $3.9 million in 2011, an increase of $5.4 million or 135%. Core banking activities continued to provide a solid basis for earnings as net interest income was relatively constant, down $180,000 from 2011. Lower loan loss provisioning was a key to the improved earnings, declining $5.6 million from a year ago to $7.7 million in 2012.
In June we exited the Treasury’s Capital Purchase Program, buying back $16 million of our outstanding preferred stock, with the remaining $17 million placed with private investors.
In October, we announced our intention to consolidate four of our bank charters into a single organization to achieve a more efficient operation. That consolidation was approved by the regulatory agencies and was completed on February 1, 2013. We further had announced the closing of five smaller branch locations and the consolidation of the loans and deposits into other nearby locations. This consolidation was also completed in February. Earlier in the year we had closed one other location, making a total of six branch closings in 2012.
Gain on the sale of mortgage loans also added substantially to earnings increasing $2.8 million from the prior year as the record low interest rate environment spurred refinance activity. Gains on the sale of mortgage loans were $6.5 million in 2012 compared with $3.7 million in 2011.
We achieved a return on average assets of 0.70%, 0.38%, and 0.25% for 2012, 2011, and 2010, respectively. Total average assets increased $10 million in 2012, $1 million in 2011, and $55 million in 2010. Basic and diluted earnings per share were $1.17 and $1.16 in 2012 compared with, $0.50 for both basic and diluted earnings per share in 2011, and $.27 for both measures in 2010. Return on equity was 7.00% in 2012, 3.75% in 2011, and 2.56% in 2010. While these profitability measures have improved considerably in the current period, they continue to fall short of our expectations. The banking industry nationally, and in Michigan is still experiencing some impacts of the recession, but is showing continuing signs of improvement.
Net Interest Income
Our core business is earning interest on loans and securities while paying interest on deposits and borrowings. In response to an economic recession in the United States, the Federal Reserve maintained overnight interest rates at historically low levels of 0.00% to 0.25% for a fourth consecutive year. While these low short term rates allow us to lower the rates we pay on certain deposit products, it also reduces the rates we are able to earn on variable rate loan products and rates charged on renewing fixed rate loans. The net interest spread, the difference between the interest rates charged on earning assets and the rate paid on interest bearing liabilities, was relatively stable early in the year, before declining in the second half. We ended 2011 with a 3.88% net interest spread in the fourth quarter of 2011 and maintained that level through June 2012, before declining to 3.77% in the fourth quarter of 2012. As a result, our net interest margin decreased, ending the year with a net interest margin of 3.99% compared with 4.06% in 2011, and 3.87% in 2010. During 2012, our average loan to average deposit ratio was 80%, lower than the 82% in 2011 and 92% in 2010. The decreasing ratio is a result of both our efforts in attracting core deposits and declining loan balances. We maintain capital and funding capacity as well as a desire to expand lending; however, demand for quality loans in our local economies remains very soft at this time.
Net interest income decreased in 2012 by $180,000 as our lower net interest margin more than offset a higher level of average earning assets. Average interest earning assets increased $18 million from 2011 levels. The increase in average interest earning assets was largely a result of higher balances in the investment portfolio, which rose by $43 million, more than offsetting a $19 million decrease in average loan balances. A critical task of management is to price assets and liabilities so that the spread between the interest earned on assets and the interest paid on liabilities is maximized while maintaining acceptable levels of risk. While interest rates on earning assets and interest bearing liabilities are subject to market forces, in general and in the short run, we can exert more control over deposit rates than earning asset rates. However, competitive forces and the need to retain and grow deposits as a funding source place limitations on the degree of control over deposit rates. Average interest bearing liabilities decreased $18 million during the year, and the average rate paid on these liabilities fell by 39 basis points resulting in a decrease to interest expense of $4.6 million.
The following table presents a summary of net interest income for 2012, 2011, and 2010.
Summary of Consolidated Net Interest Income
| | | Year Ended December 31, 2012 | | | Year Ended December 31, 2011 | | | Year Ended December 31, 2010 | |
| (In Thousands of Dollars) | | Average | | | | | | Average | | | Average | | | | | | Average | | | Average | | | | | | Average | |
| | | Balance | | | | | | Rate | | | Balance | | | Interest | | | Rate | | | Balance | | | Interest | | | Rate | |
| Average Assets | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest Earning Assets: | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Taxable securities | | $ | 293,554 | | | $ | 4,512 | | | | 1.54 | % | | $ | 264,657 | | | $ | 4,808 | | | | 1.82 | % | | $ | 190,114 | | | $ | 3,647 | | | | 1.92 | % |
Tax exempt securities(1) | | | 54,796 | | | | 1,774 | | | | 3.24 | % | | | 40,273 | | | | 1,719 | | | | 4.27 | % | | | 30,249 | | | | 1,751 | | | | 5.79 | % |
| Total Securities | | | 348,350 | | | | 6,286 | | | | 1.80 | % | | | 304,930 | | | | 6,527 | | | | 2.14 | % | | | 220,363 | | | | 5,398 | | | | 2.45 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Loans(1) (2) | | | 963,027 | | | | 57,086 | | | | 5.93 | % | | | 981,976 | | | | 61,545 | | | | 6.27 | % | | | 1,047,149 | | | | 67,545 | | | | 6.45 | % |
| Federal funds sold | | | 626 | | | | 1 | | | | 0.16 | % | | | 642 | | | | 1 | | | | 0.16 | % | | | 451 | | | | 1 | | | | 0.23 | % |
| Interest bearing deposits | | | 70,516 | | | | 209 | | | | 0.30 | % | | | 76,591 | | | | 253 | | | | 0.33 | % | | | 83,909 | | | | 205 | | | | 0.25 | % |
| Total Earning Assets | | | 1,382,519 | | | | 63,582 | | | | 4.60 | % | | | 1,364,139 | | | | 68,326 | | | | 5.01 | % | | | 1,351,872 | | | | 73,149 | | | | 5.41 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Nonaccrual loans | | | 19,097 | | | | | | | | | | | | 22,623 | | | | | | | | | | | | 30,569 | | | | | | | | | |
| Less allowance for loan loss | | | (21,814 | ) | | | | | | | | | | | (21,650 | ) | | | | | | | | | | | (20,952 | ) | | | | | | | | |
| Cash and due from banks | | | 27,645 | | | | | | | | | | | | 26,867 | | | | | | | | | | | | 26,342 | | | | | | | | | |
| Other non-earning assets | | | 92,568 | | | | | | | | | | | | 97,758 | | | | | | | | | | | | 100,842 | | | | | | | | | |
| Total Assets | | $ | 1,500,015 | | | | | | | | | | | $ | 1,489,737 | | | | | | | | | | | $ | 1,488,673 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Average Liabilities | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest Bearing Liabilities: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Demand | | $ | 344,363 | | | | 801 | | | | 0.23 | % | | $ | 319,053 | | | | 1,306 | | | | 0.41 | % | | $ | 274,570 | | | | 1,736 | | | | 0.64 | % |
| Savings | | | 259,330 | | | | 579 | | | | 0.22 | % | | | 235,422 | | | | 1,032 | | | | 0.44 | % | | | 194,855 | | | | 1,122 | | | | 0.58 | % |
| Time | | | 400,397 | | | | 5,246 | | | | 1.31 | % | | | 470,314 | | | | 8,554 | | | | 1.82 | % | | | 529,947 | | | | 12,877 | | | | 2.43 | % |
| Total Deposits | | | 1,004,090 | | | | 6,626 | | | | 0.66 | % | | | 1,024,789 | | | | 10,892 | | | | 1.06 | % | | | 999,372 | | | | 15,735 | | | | 1.58 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Federal funds purchased and repurchase agreements | | | 47,659 | | | | 87 | | | | 0.18 | % | | | 43,848 | | | | 83 | | | | 0.19 | % | | | 40,341 | | | | 96 | | | | 0.24 | % |
FHLB advances and notes payable | | | 22,831 | | | | 625 | | | | 2.74 | % | | | 24,078 | | | | 802 | | | | 3.33 | % | | | 84,122 | | | | 3,562 | | | | 4.24 | % |
| Subordinated debentures | | | 36,084 | | | | 1,068 | | | | 2.96 | % | | | 36,084 | | | | 1,197 | | | | 3.32 | % | | | 36,084 | | | | 1,497 | | | | 4.15 | % |
| Total Interest Bearing | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Liabilities | | | 1,110,664 | | | | 8,406 | | | | 0.76 | % | | | 1,128,799 | | | | 12,974 | | | | 1.15 | % | | | 1,159,919 | | | | 20,890 | | | | 1.80 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Demand Deposits | | | 226,061 | | | | | | | | | | | | 199,849 | | | | | | | | | | | | 170,823 | | | | | | | | | |
| Total Funds | | | 1,336,725 | | | | | | | | | | | | 1,328,648 | | | | | | | | | | | | 1,330,742 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Other Non-Interest Bearing | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Liabilities | | | 12,755 | | | | | | | | | | | | 11,024 | | | | | | | | | | | | 10,983 | | | | | | | | | |
| Total Liabilities | | | 1,349,480 | | | | | | | | | | | | 1,339,672 | | | | | | | | | | | | 1,341,725 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Average Shareholders’ Equity | | | 150,535 | | | | | | | | | | | | 150,065 | | | | | | | | | | | | 146,948 | | | | | | | | | |
| Total Liabilities and | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Shareholders’ Equity | | $ | 1,500,015 | | | | | | | | | | | $ | 1,489,737 | | | | | | | | | | | $ | 1,488,673 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Net Interest Income(1) | | | | | | $ | 55,176 | | | | | | | | | | | $ | 55,352 | | | | | | | | | | | $ | 52,259 | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Rate Spread(1) | | | | | | | | | | | 3.84 | % | | | | | | | | | | | 3.86 | % | | | | | | | | | | | 3.61 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Net Interest Margin (percent of | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Average earning assets) (1) | | | | | | | | | | | 3.99 | % | | | | | | | | | | | 4.06 | % | | | | | | | | | | | 3.87 | % |
(1) Presented on a fully taxable equivalent basis using a federal income tax rate of 35% for all periods presented.
(2) Interest income includes amortization of loan fees of $2.0 million, $1.8 million, and $1.9 million for 2012, 2011, and 2010, respectively. Uncollected interest on nonaccrual loans is not included.
The table below provides an analysis of the changes in interest income and interest expense due to volume and rate:
| | | 2011/2012 | | | 2010/2011 | |
| | | Change in Interest Due to: (1) | | | Change in Interest Due to: (1) | |
| | | | | | | | | | | | | | | | | | | |
| | | Average Volume | | | Average Rate | | | Net Change | | | Average Volume | | | Average Rate | | | Net Change | |
| | | (In Thousands of Dollars) | |
| | | | | | | | | | | | | | | | | | | |
| Interest Income: | | | | | | | | | | | | | | | | | | |
| Securities | | | | | | | | | | | | | | | | | | |
Taxable Securities(2) | | $ | 393 | | | $ | (770 | ) | | $ | (377 | ) | | $ | 1,465 | | | $ | (223 | ) | | $ | 1,242 | |
| Tax-exempt Securities | | | 530 | | | | (475 | ) | | | 55 | | | | 495 | | | | (527 | ) | | | (32 | ) |
| Total Securities | | | 923 | | | | (1,245 | ) | | | (322 | ) | | | 1,960 | | | | (750 | ) | | | 1,210 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
Loans(2) | | | (1,171 | ) | | | (3,288 | ) | | | (4,459 | ) | | | (4,122 | ) | | | (1,878 | ) | | | (6,000 | ) |
| Interest Bearing Deposits | | | 0 | | | | 37 | | | | 37 | | | | (32 | ) | | | (1 | ) | | | (33 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total Interest Income on Earning Assets | | | (248 | ) | | | (4,496 | ) | | | (4,744 | ) | | | (2,194 | ) | | | (2,629 | ) | | | (4,823 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest Expense: | | | | | | | | | | | | | | | | | | | | | | | | |
| Deposits | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest Paying Demand | | | 97 | | | | (602 | ) | | | (505 | ) | | | 250 | | | | (680 | ) | | | (430 | ) |
| Savings | | | 96 | | | | (549 | ) | | | (453 | ) | | | 208 | | | | (298 | ) | | | (90 | ) |
| Time | | | (1,148 | ) | | | (2,160 | ) | | | (3,308 | ) | | | (1,336 | ) | | | (2,987 | ) | | | (4,323 | ) |
| Total Deposits | | | (955 | ) | | | (3,311 | ) | | | (4,266 | ) | | | (878 | ) | | | (3,965 | ) | | | (4,843 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Federal Funds Purchased and Securities | | | | | | | | | | | | | | | | | | | | | | | | |
| Sold under Agreements to Repurchase | | | 7 | | | | (3 | ) | | | 4 | | | | 8 | | | | (21 | ) | | | (13 | ) |
| FHLB and Other Notes Payable | | | (40 | ) | | | (137 | ) | | | (177 | ) | | | (2,125 | ) | | | (635 | ) | | | (2,760 | ) |
| Subordinated Debentures | | | 0 | | | | (129 | ) | | | (129 | ) | | | 0 | | | | (300 | ) | | | (300 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total Interest Expense on Liabilities | | | (988 | ) | | | (3,580 | ) | | | (4,568 | ) | | | (2,995 | ) | | | (4,921 | ) | | | (7,916 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Net Interest Income | | $ | 740 | | | $ | (916 | ) | | $ | (176 | ) | | $ | 801 | | | $ | 2,292 | | | $ | 3,093 | |
| (1) | Changes in volume/rate have been allocated between the volume and rate variances on the basis of the ratio that the volume and rate variances bear to each other. |
| (2) | Interest is presented on a fully taxable equivalent basis using a federal income tax rate of 35%. |
In 2012, the average rate realized on earning assets was 4.60%, a decrease of 41 basis points from the 2011 results of 5.01%, and 81 basis points lower than the 5.41% realized in 2010. In 2008, in reaction to a weakening economy and a credit crisis in the financial markets, the Federal Reserve aggressively lowered rates by 2.25% between January and April bringing the prime rate down to 5.00%. After a six month pause in the rate reduction strategy, the Federal Reserve then lowered rates by another 1.75% in the fourth quarter with the prime rate settling at 3.25% at year end 2008, where it has remained through the end of 2012. Current language from the Federal Reserve indicates their intention to maintain this level of rates sometime into 2015. In addition, the Federal Reserve has also been purchasing longer term bonds in the open market in an effort to keep longer term rates low.
Average loans outstanding decreased $19 million in 2012 when compared with 2011. As of December 31, 2012, approximately 22% of the loan portfolio was comprised of variable rate instruments, compared with 23% as of the end of 2011. The remaining 78% of the loan portfolio is made up of fixed rate loans that do not re-price until maturity. Of the fixed rate loans approximately $175 million, or 24%, mature within twelve months and are subject to rate adjustments at maturity. At year end 2012, 92% of our variable rate commercial loan portfolio was protected by a floor compared with 89% at the end of 2011.
During 2011 and 2012 maturing securities in the investment portfolio were replaced with securities of comparable quality bearing generally lower yields. As a result, maturing securities ran off from the investment portfolio at higher rates than comparable current offerings, decreasing the overall investment portfolio yield from 2.45% in 2010 to 2.14% in 2011 and 1.80% in 2012.
Average total interest bearing deposits for the year decreased $21 million. The average rate paid on interest bearing liabilities was 0.76% in 2012, compared to 1.15% in 2011, and 1.80% in 2010. Deposit rates decreased during 2011 and 2012 with the soft economy. Average rates paid on time deposits decreased 51 basis points in 2012 compared with 2011 and 112 basis points compared with 2010, as new and renewing deposits re-priced to lower rates. Rates on checking and savings deposits also decreased in 2012, falling 18 basis points and 22 basis points, respectively. These same rates were 23 basis points and 14 basis points lower in 2011 than they had been in 2010.
Brokered CDs are more sensitive to changes in the interest rate than CDs offered in local markets and have been issued with original maturities ranging from three months to two years. The average balance of brokered CDs in 2012 was $18 million, compared with $15 million in 2011 and $11 million in 2010. These CDs carried an average interest rate of 0.69% in 2012 compared with 0.88% in 2011, and 1.05% in 2010.
We fund a portion of our loan portfolio with borrowings from the Federal Home Loan Bank (FHLB). During 2012, the average outstanding balance of FHLB advances decreased $1.2 million although the year-end balance increased $3.0 million when compared with 2011 balances. While FHLB borrowings are one method of funding loans when core deposits are not available, the cost is typically higher than our core deposit costs. As core deposit funding has increased and loan demand decreased, we have been able to reduce our reliance on this source of funding. The 2012 average rate paid for Federal Home Loan Bank advances and notes payable was 2.74%, 59 basis points lower than 2011’s rate of 3.33%. Borrowings from the Federal Home Loan Bank carry significant prepayment penalties that act as a deterrent to early repayment.
In July of 2007, we issued $15.5 million in subordinated debentures to fund a portion of the ICNB acquisition. That issuance was split evenly between debentures that carry a fixed rate of 6.566% for five years, and variable interest rate debentures that carry a rate of 90 day LIBOR plus 1.35%. During 2012 the fixed rate debentures converted to variable rate debenture that carry a rate of 90 day LIBOR plus 1.35%. In January of 2006, we issued $10.3 million in subordinated debentures that carried a fixed rate of 6.049% for five years. During 2011 this issuance converted to a variable interest rate of 90 day LIBOR plus 1.27%. In October of 2004, we issued $10.3 million in subordinated debentures, at a variable interest rate of 90 day LIBOR plus 1.99%. The average rate paid on all subordinated debentures during 2012 was 2.96% compared with 3.32% and 4.15% in 2011 and 2010, respectively. All of the variable rate debentures re-price quarterly.
We utilize short term borrowing, made up of Federal Funds Purchased and Repurchase Agreements as a source of liquidity and to balance our daily cash needs. Average short term borrowed funds increased by $4 million when 2012 is compared with 2011.
The 2012 interest rate spread of 3.84% is two basis points lower than the 2011 spread of 3.86%, and 23 basis points higher than the 2010 spread of 3.61%. Tax equivalent net interest income decreased $176,000 in 2012 as an increase in total average earning assets of $18 million was unable to offset a seven basis point decline in the net interest margin. The net interest margin of 3.99% for 2012 was seven basis points below 2011 but 12 basis points better than in 2010. The decrease in the rate spread in 2012 was the result of rates on average earning assets decreasing 41 basis points while the average cost of interest bearing liabilities decreased 39 basis points. The seven basis point decrease in the net interest margin was a result of a higher percentage of earning assets in the investment portfolio, which earn a lower average interest rate than loans. Average earning assets represented 92% of total average assets in 2012 compared with 91% in 2010 and 2011.
Provision for Loan Losses
In accordance with accounting standards, we allocate a portion of the allowance to loans that we determine to be impaired. We analyze other loans and current market conditions on a pool basis in order to arrive at the appropriate allowance for loan losses. If a loan for which allocations had been established pays off, or the risk of loss is otherwise reduced, we reverse those specific allocations. The methodology described above resulted in a provision for loan losses in 2012 of $7.7 million, compared with $13.3 million in 2011, and $13.3 million in 2010. These provision charges, which exceed historical norms, were incurred as the struggling Michigan economy resulted in new problem loans for which either allocated reserves were established for probable losses, or loans were charged off during the year.
During 2012, we had recoveries of previously charged off loans totaling $1.1 million, and favorable outcomes on certain previously identified problem loans, reducing the amount of provision expense needed, while deterioration of certain loans to problem status and charge offs of $8.4 million increased the amount of provision expense needed. In 2011, we had recoveries of previously charged off loans totaling $1.2 million and favorable outcomes on certain previously identified problem loans, reducing the amount of provision expense needed, while deterioration of certain loans to problem status and charge offs of $14.9 million increased the amount of provision expense needed.
At December 31, 2012, the allowance for loan losses as a percent of total loans was 2.21% compared to 2.14% and 2.06% at December 31, 2011, and December 31, 2010, respectively. Total nonperforming loans (including performing restructured loans) were 3.78% of ending loans at December 31, 2012, compared to 4.27% and 3.60% at the two previous year ends. The decrease in the ratio in 2012 was due to a decrease in nonaccrual loans of $7 million and a decrease in 90 day past due loans of $0.4 million, partially offset by an increase of $2 million in restructured loans. All loans reported as restructured are current or less than 90 days past due and conforming to the agreed upon restructured terms of the loan. The increase in the nonperforming ratio in 2011 was due to a decrease in nonaccrual loans of $3 million, a reduction in 90 day past due loans of $0.2 million, which were more than offset by an increase in restructured loans of $9 million.
Net charged off loans totaled $7.4 million in 2012 compared to $13.7 million in 2011, and $11.0 million in 2010. Net charged off loans as a percent of average loans were 0.75% in 2012, 1.37% in 2011, and 1.02% in 2010. Charge offs of $1.7 million in 2012 had specific reserves established in a prior year, while in 2011 and 2010, $3.9 million and $2.4 million, respectively, of specific allowance allocations had been set aside at the end of the prior year. Provision expense did not need to be increased to cover those previously identified losses.
Non-interest Income
Non-interest income increased by $3.0 million when 2012 is compared with 2011. Affecting the results in 2012 were gains on the sale of mortgages, which were up $2.8 million, and other income which increased $652,000. Partially offsetting these items was a decrease in service charges on deposit accounts of $273,000 and a decline in mortgage servicing income of $320,000. Comparing 2011 to 2010 non-interest income decreased by $2.2 million. Affecting the results in 2011 were gains on the sale of mortgages, which were down $2.2 million, and decreased revenue from our armored car business, which was down $174,000, (sold at the end of the first quarter of 2010). The sale of our armored car business had negligible impact on net income. Other non-interest income increased $198,000 primarily due to improved results in the sale of other real estate owned properties during the year.
Gains on the sale of mortgage loans increased $2.8 million in 2012 compared with 2011. The continued low interest rate environment pushed mortgage rates to record lows during the year, spurring a high level of refinance activity. Mortgage gains decreased $2.2 million when 2011 is compared with 2010. In 2010, rates began the year at a level that did not result in very much refinance or purchase activity, but by mid-year rates had fallen again to a point where refinance activity picked up considerably. In 2011, new regulatory requirements and onerous conditions placed on the sale of loans in the secondary market resulted in lower gains on the sale of loans. By midyear 2011, rates had fallen once again to the point where refinance activity picked up and the second half of the year generated higher gains. Rates remained low throughout 2012 resulting in a consistent level of mortgage refinance activity throughout the entire year.
Mortgage servicing rights, net of amortization, declined from $89,000 in 2011 to a negative $231,000 in 2012 as amortization and write downs of servicing rights due to the high level of refinancing affected this line item. When a mortgage is refinanced or pre-paid, capitalized mortgage servicing rights relating to that mortgage are written off, with the write off amounts included in the amortization cost of servicing rights. The higher level of refinance activity in 2012 compared with 2011 resulted in $605,000 more of servicing rights reversals. Income from servicing loans increased by $285,000 during 2012, partially offsetting the higher servicing rights expense. The lower refinance activity in 2011 compared with 2010 resulted in fewer mortgage loan prepayments, and therefore lower amortization cost of serving rights. Income from servicing loans sold in the secondary market increased by $173,000 over 2010, causing overall mortgage servicing income to be higher by $185,000 in 2011 when compared with 2010. In 2011, mortgage servicing income (servicing income net of amortization of capitalized serving rights) was a positive $89,000 compared with a negative $96,000 in 2010.
Deposit account service charges declined $273,000 from $4.5 million in 2011 to $4.2 million in 2012. Changing customer behavior associated with new regulation regarding overdraft charges put in place mid-year 2011 resulted in lower fees collected. Comparing 2011 to 2010, deposit account fees were down slightly, declining $84,000 from $4.6 million in 2010 to $4.5 million in 2011.
During 2012, we recorded $48,000 in securities gains compared with a loss on securities of $48,000 the prior year. The gains in 2012 and losses in 2011 resulted from routine securities transactions during the year. In 2010 we recorded $7,000 of securities gains. During 2011 we recorded a charge of $150,000 for other than temporary impairment associated with the valuation of one trust preferred security.
Courier and cash delivery services income decreased $174,000 when 2011 is compared with the prior year due to the sale of our armored car company at the end of the first quarter of 2010.
Other income increased $652,000 from $1.5 million in 2011 to $2.1 million in 2012. Other non-interest income was $1.3 million in 2010. Within the category of other income, gains on the sale of other real estate owned improved by $389,000, and other income increased $263,000 primarily due to a $178,000 non-recurring item relating to a director benefit plan. Gains on the sale of other real estate owned were $484,000 in 2012, $95,000 in 2011, and a loss of $354,000 in 2010.
Non-interest Expense
Total non-interest expense was $44.7 million in 2012 compared with $43.6 million in 2011 and $44.7 million in 2010. Within non-interest expense, salaries and benefits increased $1.4 million and other non-interest expense increased $1.7 million, while OREO expense decreased by $1.5 million during 2012. Comparing 2011 to 2010, salaries and benefits increased $374,000 and outside purchased services increased $58,000, while all other categories of expense declined.
Salary and employee benefits expenses increased $1.4 million in 2012 from $21.3 million in 2011 to $22.7 million in 2012. Within this line item, benefits cost increased $131,000, variable compensation expense increased $711,000, and base salaries increased $575,000, or 3.6%. The company’s improved performance resultd in higher payments under the variable compensation plan. In 2011, salaries and benefits increased $374,000 or 1.8% compared with 2010. Within the salary and benefit line, salaries declined $224,000 and benefits increased $598,000. The decline in salaries was in part due to a year over year reduction of $105,000 relating to the sale of our armored car business, with the remaining $119,000 coming from reductions in staffing within our banking business. The increase in benefits cost in 2011 was driven by a $639,000 increase in group insurance. We employed 438 full time equivalent employees at year end of 2012, 435 at both year end of 2011 and 2010.
Occupancy and equipment costs decreased $159,000 in 2012 compared with 2011 primarily due to a $147,000 decrease in depreciation expense. Occupancy and equipment costs also decreased $244,000 in 2011 compared with 2010 primarily due to a $216,000 decrease in depreciation expense.
FDIC expense decreased $340,000 to $1.2 million in 2012, mainly due to the full year impact of a new method of assessing premiums to banks that was instituted mid way through 2011. FDIC expense was $1.6 million in 2011, a decrease of $538,000 from 2010 caused by the new method of assessing premiums to banks that was instituted mid way through the year. FDIC expense was $2.1 million in 2010.
Amortization of intangibles was $483,000 in 2012, compared with $698,000 in 2011, a reduction of $216,000. Amortization expense in 2010 was $796,000. The year over year reduction in the costs are primarily due to the accelerated amortization method used to expense core deposit premiums from recent acquisitions and the completion of amortization on an prior acquisition.
Expenses for outside professional services in 2012 increased $85,000 compared with 2011 after increasing $58,000 from 2010. A substantial portion of the increase in 2011 was due to the reclassification of armored car expense which was previously done in-house.
Advertising and special promotion expense was $1.5 million, up $66,000, or 4.6%, in 2012 following a decrease in 2011 of $259,000. The changes in this expense category are somewhat affected by special promotion expense which is related to mortgage refinance volumes. This expense increased $89,000 during 2012 due to higher mortgage activity.
Other real estate expense and valuation write downs declined $1.5 million to $1.7 million in 2012 from $3.2 million in 2011 and $3.5 million in 2010. The cost of carrying more properties for longer time frames and write downs due to decreasing property values caused the level of these expenses to be elevated in both 2011 and 2010. Within this category of expenses, valuation write downs were $1.1 million in 2012, $2.3 million in 2011, and $2.3 million in 2010.
Other non-interest expense increased to $10.7 million from $8.9 million in 2011 and was $9.0 million in 2010. Affecting the costs on this line in 2012 were one time nonrecurring expenses of $754,000 related to branch closings and $170,000 related to the auction and repurchase of preferred shares. We also recorded a $750,000 reserve for losses associated with mortgage put backs from loans we have sold in the secondary market.
Federal Income Tax
In 2012 we had federal tax expense of $4.3 million on pre-tax earnings of $14.8 million, resulting in an effective tax rate of 29%. In 2011 we had federal tax expense of $1.8 million on pre-tax earnings of $7.5 million, resulting in an effective tax rate of 25% and in 2010 we had federal tax expense of $1.5 million on pre-tax earnings of $5.3 million, resulting in an effective tax rate of 29%. Included in the 2010 federal tax expense was $485,000 relating to a non-cash charge associated with deferred taxes on security losses realized in prior years that we do not expect to be able to claim. Excluding the deferred tax charge, the effective tax rate for 2010 would have been 19%.
Summary of Significant Costs Relating to Asset Quality, Deposit Insurance and Branch Closings
Management believes that understanding certain costs which it believes are elevated in the current business environment may benefit the readers of this report in evaluating potential changes to our future results. The following table illustrates certain costs which management believes are either currently at an elevated level and will return to historically lower levels once the economic environment improves, or are non-recurring and are not expected to continue.
| (In Thousands of Dollars) | | | | | | | | | | | | | | | |
| | | 2012 | | | 2011 | | | 2010 | | | 2009 | | | 2008 | |
| Provision for loan losses | | $ | 7,690 | | | $ | 13,337 | | | $ | 13,344 | | | $ | 14,671 | | | $ | 8,256 | |
| Securities (gains)/losses | | | (48 | ) | | | 48 | | | | (7 | ) | | | (1,321 | ) | | | 5,917 | |
| Loss/(gain) on sale of OREO properties | | | (484 | ) | | | 95 | | | | 354 | | | | 336 | | | | 184 | |
| FDIC expense | | | 1,220 | | | | 1,560 | | | | 2,098 | | | | 2,430 | | | | 562 | |
| Legal fees | | | 745 | | | | 814 | | | | 822 | | | | 734 | | | | 412 | |
| Other real estate operating costs | | | 528 | | | | 894 | | | | 1,206 | | | | 1,116 | | | | 613 | |
| Other real estate valuation write-downs | | | 1,151 | | | | 2,258 | | | | 2,307 | | | | 1,275 | | | | 615 | |
| Branch closing expenses | | | 754 | | | | 0 | | | | 0 | | | | 0 | | | | 0 | |
| Tax benefit on items listed at 34% | | | (3,929 | ) | | | (6,462 | ) | | | (6,842 | ) | | | (6,542 | ) | | | (5,630 | ) |
| Total of items net of tax benefit | | | 7,627 | | | | 12,544 | | | | 13,282 | | | | 12,699 | | | | 10,929 | |
| Deferred tax write off | | | 0 | | | | 0 | | | | 484 | | | | 659 | | | | 0 | |
| Total | | $ | 7,627 | | | $ | 12,544 | | | $ | 13,766 | | | $ | 13,358 | | | $ | 10,929 | |
FINANCIAL CONDITION
Total assets at December 31, 2012 were $1.499 billion, compared with December 31, 2011 total assets of $1.485 billion, an increase of $14 million, or 0.9%. A general lack of loan demand by qualified borrowers has resulted in an overall shrinking loan portfolio, while increases in core deposits have provided an opportunity to run off higher cost wholesale funds. Total portfolio loans decreased 2.0% at December 31, 2012 compared with the balance at the previous year end. Commercial loans decreased $8 million, or 5.2%, while commercial real estate loans decreased $10 million, or 2.1%. First lien residential mortgage loans increased $3 million, or 1.5%, while junior lien residential mortgage loans were $8 million lower at December 31, 2012, decreasing 12.4%, from the previous year end. Consumer loans grew by $3 million or 5.1% during the year. Mortgages serviced for others were $2.3 million, or 0.43% higher.
| (In Thousands of Dollars) | | | |
| | | 2012 | | | 2011 | | | Change | | | % Change | |
| Commercial and industrial | | $ | 150,208 | | | $ | 158,493 | | | $ | (8,285 | ) | | | (5.2 | )% |
| Commercial real estate | | | 472,618 | | | | 482,720 | | | | (10,102 | ) | | | (2.1 | )% |
| First lien residential real estate | | | 214,379 | | | | 211,119 | | | | 3,260 | | | | 1.5 | % |
| Junior lien residential real estate | | | 58,748 | | | | 67,053 | | | | (8,305 | ) | | | (12.4 | )% |
| Consumer | | | 67,809 | | | | 64,524 | | | | 3,285 | | | | 5.1 | % |
| Total | | $ | 963,762 | | | $ | 983,909 | | | $ | (19,847 | ) | | | (2.0 | )% |
| | | | | | | | | | | | | | | | | |
| Mortgages serviced for others | | $ | 608,234 | | | $ | 605,913 | | | $ | 2,321 | | | | 0. 4 | % |
Total securities available for sale increased $11 million, or 3.4%. The increase was mainly due to investment of our excess available funds at better rates than is available in shorter term assets. Securities available for sale were 24% of total assets at year end 2012, compared with 23% at the end of 2011. As loan demand picks up in the future, it is expected that the securities portfolio will decline providing the funding for that growth.
Premises and equipment decreased $731,000 after recognized depreciation of $1.9 million. Investment of $1.2 million in new ATMs, software, equipment and facility updates made up the remainder of the change.
Total deposits increased at the end of 2012 to $1.241 billion, an increase of 1.7%, compared to $1.221 billion at year end 2011. Non-interest bearing demand deposit balances increased from the end of 2011, by $36 million to $251 million at year end 2012, an increase of 16.8%. Interest bearing demand deposits grew by $8 million, or 2.2%, and savings account balances increased $24 million, or 9.8%.
At the end of 2012, we had $18 million of wholesale CDs on the balance sheet, the same level as the end of 2011. Wholesale CDs, which contain both brokered CDs and internet CDs, typically carry a higher interest rate than locally generated CDs of similar duration but are available in large dollar pools which results in lower operational cost than smaller dollar local deposits. Large dollar CDs which are generated internally and placed in our CDARS program to provide FDIC insurance for our customers are included in the wholesale CD total, but typically carry lower rates than other wholesale CDs. At the end of 2012 and 2011, all $18 million of wholesale CDs were part of our CDARS program. Including wholesale CDs, total time deposits decreased $47 million, or 11.0% compared with the end of 2011. Excluding the wholesale CDs, time deposits would have decreased from $405 million in 2011 to $358 million in 2012, a decrease of 11.6%. Time deposits were allowed to run off as we re-priced higher rate CD’s to the current low rate market because of reduced funding needs in the loan portfolio. Much of the declining balances in CDs moved to other deposit categories during the year as customers preferred the liquidity of these products over the marginal increase in rate that could be achieved from locking in their money for a longer term.
Securities sold under agreements to repurchase and federal funds purchased decreased by $4 million due to normal balance fluctuations of our customers. Over the past three to four years, management has focused its branch network on increasing core deposit growth. As a result of the growth in these core deposits and a reduction in the size of our loan portfolio, we have been able to reduce our reliance on Federal Home Loan Bank advance funding to support the loan portfolio. Federal Home Loan Bank advances were just $22 million at year end 2012, an increase of $3 million from December 31, 2011.
Asset Quality
The Michigan economy continued to progress during 2012 resulting in a lower unemployment rate and stronger business climate for our customers. Many banks in our state have shown significant losses associated with bad loans and we were not immune from the impact that the economy had on businesses and consumers, however the improving economy has resulted in improvement in these metrics. After increasing for three years, our net charged off loans declined in 2012, as fewer customers succumbed to the economic problems. Within the last year, the value of development projects and residential properties showed some improvement resulting in fewer charged off loans and nonaccrual loan balances. Our nonaccrual loan balances remained somewhat elevated at year end, but were down 32% from year end 2011. Total of nonaccrual, restructured, and 90 day past due loans decreased 14% from year end 2011 as nonaccrual loans were down $7 million, 90 day past due loans were down $0.4 million and restructured loans increased by $1.8 million. The increase in restructured loans is due to our willingness to work with our customers who are experiencing financial difficulty to manage through the current downturn. While the restructured loan balance often is included in a nonperforming loans total, these loans might be better characterized as underperforming. All loans reported as restructured are in compliance with the renegotiated terms of the loan. Renegotiated terms on a loan may include such things as a reduced interest rate, extending the amortization period for the loan, or in some cases a partial forgiveness of the balance due on the loan. We continue to be vigilant at monitoring these loan relationships and working through these issues with our customers.
Loans are carried at an amount which management believes will be collected. A balance considered not collectible is charged against (reduction of) the allowance for loan losses. In 2012, net charged off loans were $7.4 million, compared with $13.7 million in 2011 and $11.0 million in 2010. Net charged off loans as a percentage of average loans were 0.75% in 2012 compared with 1.37% in 2011 and 1.05% in 2010.
The total of nonaccrual loans, loans 90 days past due and any troubled loans where borrowers are under financial stress and the terms have been renegotiated to below normal market terms was $36.4 million and $42.3 million at December 31, 2012 and 2011, respectively. Total nonaccrual loans were $15.7 million at December 31, 2012, compared to $23.0 million at the end of 2011. The elevated level in nonaccrual loans for both years was largely due to economic stresses being felt in Michigan. Borrowers which had previously been able to meet their loan obligations during better times have become unable to do so in the current environment. Loans past due 90 days or more decreased to $37,000 at year end 2012 compared with $419,000 at the end of 2011, in part because of loans moving to nonaccrual status during the year. Impaired loans are commercial loans for which we believe it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement. The average investment in impaired loans was $35.5 million during 2012 compared to $34.1 million during 2011. At year end, impaired loans were $32.9 million compared with $38.0 million at December 31, 2011. In the current environment, we have deemed it necessary to work with some customers to restructure loans to reduce the probability of loss to the bank. At the end of the year, we had $20.7 million of restructured loans compared with $18.9 million at year end 2011.
The allowance for loan losses was $0.3 million, or 2%, higher at year end 2012 compared with 2011. This increase was a result of provision expense of $7.7 million versus charged off loans of $8.4 million during the year, and recoveries of prior charged off loans of $1.1 million. Through our analysis process, we determined that it was necessary to provide slightly more for future probable losses than we realized in net charge offs this year due to several factors. We record provision for loan loss expense when loans for which losses are likely, are identified. For loans which carry an allocated allowance, no expense is recognized at the time of charge off to the extent that allowance has been previously provided. See the discussion of loan loss provision expense previously presented for additional information. The allowance for loan losses represents 2.21% of outstanding loans at the end of 2012, compared with 2.14% at December 31, 2011.
We maintain the allowance at a level which we believe adequately provides for losses inherent in the loan portfolio. Such losses are estimated by a variety of factors, including specific examination of certain borrowing relationships and consideration of historical losses incurred on certain types of credits. We focus on early identification of problem credits through ongoing reviews by management, loan personnel and an outside loan review specialist. Please refer to Note 6 of the Notes to Consolidated Financial Statements for more information on impaired loans.
LIQUIDITY AND INTEREST RATE SENSITIVITY
Asset liability management aids us in achieving reasonable and predictable earnings and liquidity while maintaining a balance between interest earning assets and interest bearing liabilities. We maintain a complex interest rate risk modeling system which assists management in understanding the impact of changes in rates, both in the past, and forecasted. This information allows management to make adjustment as to its view toward certain products with regard to rate and term in order to minimize our interest rate risk in a changing rate environment.
Cash provided from operations during the year was $23.2 million while investing activities was $0.4 million in cash. Financing activities provided an additional $0.2 million in cash resulting in a total increase in our cash position of $23.8 million. For additional details on these activities see the Consolidated Statement of Cashflows on page 27 of this report.
Liquidity management involves the ability to meet the cash flow requirements of our customers. These customers may be either borrowers needing to meet their credit requirements or depositors wanting to withdraw funds. Management of interest rate sensitivity attempts to manage the level of varying net interest margins and to achieve consistent net interest income through periods of changing interest rates. The net interest margin was 3.99% in 2012 compared to 4.06% in 2011. The yield on the securities portfolio fell 34 basis points, from 2.14% in 2011 to 1.80% in 2012. Loan yields decreased 34 basis points, to 5.94% in 2012, from 6.26% in 2011. Deposit costs decreased 40 basis points from 1.06% in 2011 to 0.66% in 2012. Loan demand was muted through the year as customers were cautious about the economy, resulting in a decrease of $22 million in average loan balances. Average total earning assets increased $18 million as average securities investment increased $43 million and average interest bearing deposits with banks decreased $6 million. The interest bearing deposit balances at banks is primarily due to excess balances held at the Federal Reserve.
Full year average balances in time deposits decreased $70 million compared with the prior year, while average demand and savings balances increased $50 million. The use of Federal Home Loan Bank advances continued to become a less significant source of longer term funding, with average advances decreasing from the prior year by $1.2 million as we utilized increased core deposits to reduce these borrowings.
A decision to decrease deposit rates immediately affects most rates paid, other than time deposits, and has an immediate positive impact on net interest margin. With the exception of variable rate loans, an increase in loan rates does not affect the yield until a new loan is made or an existing loan is renewed. Likewise, an increase in deposit rates raises our cost of funds, and a decrease in loan rates only effects variable rate loans, until such time as a new fixed rate loan is generated, or re-finances. The prime rate is used to price virtually our entire variable rate loan portfolio. Therefore, reductions in the prime rate immediately have a negative effect on earnings, while an increase in prime rate has a positive effect on earnings.
The prime rate, was held constant at 3.25% throughout all of 2011 and 2012 as the Federal Reserve maintained its target fed funds rate at a range of 0 to 0.25% for both years in an effort to get the economy growing again. Prime rate began 2008 at 7.25%, was reduced seven times during the year, and once more in January of 2009 for a cumulative reduction of 4.00%. With the prime rate currently at 3.25%, the Federal Reserve has made no changes to the prime rate through the end of 2012 and has indicated that rates will likely remain at these levels through sometime in 2015.
The principal sources of liquidity for us are maturing securities, federal funds purchased or sold, loan payments by borrowers, investment securities, loans held for sale, deposit or deposit equivalent growth and Federal Home Loan Bank advances. Securities maturing or re-pricing within one year at December 31, 2012 were $103 million, compared to $151 million at December 31, 2011. Total investments available for sale were $354 million at year end 2012, an increase of $11 million from the prior year end.
The table below shows the interest sensitivity gaps for five different intervals as of December 31, 2012. Deposits that do not have a fixed maturity date are shown as immediately re-pricing according to reporting conventions.
| | | Maturity or Re-Pricing Frequency | |
| | | | | | (In Millions of Dollars) | | | | |
| | | 1 Day | | | 2 Days through 3 Months | | | 4 Months through 12 Months | | | 13 Months through 5 Years | | | More than 5 Years | |
| |
| |
| Interest Earning Assets: | | | | | | | | | | | | | | | |
| Loans | | $ | 220.3 | | | $ | 64.9 | | | $ | 165.6 | | | $ | 472.1 | | | $ | 43.8 | |
| Securities | | | 9.3 | | | | 24.3 | | | | 69.6 | | | | 183.1 | | | | 67.4 | |
| Other earning assets | | | 61.0 | | | | 0 | | | | 2.0 | | | | 1.0 | | | | 7.3 | |
| Total | | | 290.6 | | | | 89.2 | | | | 237.2 | | | | 656.2 | | | | 118.5 | |
| | | | | | | | | | | | | | | | | | | | | |
| Interest Bearing Liabilities: | | | | | | | | | | | | | | | | | | | | |
| Deposits | | | 613.9 | | | | 86.0 | | | | 154.6 | | | | 135.8 | | | | 0 | |
| Other interest bearing liabilities | | | 42.8 | | | | 40.6 | | | | 0.1 | | | | 15.8 | | | | 2.1 | |
| Total | | | 656.7 | | | | 126.6 | | | | 154.7 | | | | 151.6 | | | | 2.1 | |
| | | | | | | | | | | | | | | | | | | | | |
| Interest Sensitivity Gap | | $ | (366.1 | ) | | $ | (37.4 | ) | | $ | 82.5 | | | $ | 504.6 | | | $ | 116.4 | |
| | | | | | | | | | | | | | | | | | | | | |
| Cumulative Gap | | $ | (366.1 | ) | | $ | (403.5 | ) | | $ | (321.0 | ) | | $ | 183.6 | | | $ | 300.0 | |
For the one day interval, maturities of interest bearing liabilities exceed those of interest earning assets by $366 million. Included in the one day maturity classification are $614 million in savings and checking accounts which are contractually available to our customers immediately, but in practice, function as core deposits with considerably longer maturities. In the two day through the five year time frame, interest sensitive assets exceed interest sensitive liabilities by $550 million, resulting in a cumulative position of interest sensitive assets exceeding interest sensitive liabilities by $184 million through five years. For the time period greater than five years, the analysis shows an asset sensitive position, such that cumulatively, interest sensitive assets exceed interest sensitive liabilities by $300 million.
Showing a negative cumulative gap through the twelve month period does not necessarily result in a corresponding increase in net interest income during a falling rate environment. In practice, deposit rates do not change as rapidly as would be indicated by the contractual availability of deposit balances to customers. Also, changes in the steepness of the yield curve can cause differing effects on different products. Some of the benefit associated with lower deposit rates is mitigated by rate decreases on variable rate loans, renewals of fixed rate loans to lower rates, and customer prepayments. Conversely, showing a positive cumulative gap through the twelve month period does not necessarily result in a corresponding increase in net interest income during a rising rate environment for similar reasons.
Interest rate sensitivity varies with different types of interest earning assets and interest bearing liabilities. Overnight investments, on which rates change daily, and loans tied to the prime rate differ considerably from long term investment securities and fixed rate loans. Time deposits over $100,000 and money market accounts are more interest sensitive than regular savings accounts. Comparison of the re-pricing intervals of interest earning assets to interest bearing liabilities is a measure of the interest sensitivity gap, not interest rate risk. Balancing interest rate sensitivity is a continual challenge in a changing rate environment. We use a sophisticated computer program to perform analysis of interest rate risk, assist with our asset and liability management, and measure the expected impact of interest rate changes and our sensitivity to those changes.
CONTRACTUAL OBLIGATIONS, COMMITMENTS, CONTINGENT LIABLILITES, AND OFF-BALANCE SHEET ARRANGEMENTS
We have various financial obligations, including contractual obligations and commitments that may require future cash payments.
The following table presents, as of December 31, 2012, significant fixed and determinable contractual obligations to third parties by payment date.
| (In Thousands of Dollars) | | | |
| Contractual Obligation | | One Year or Less | | | 1 – 3 Years | | | 3 - 5 Years | | | More than 5 Years | | | Total | |
| | | | | | | | | | | | | | | | |
| Time Deposits | | $ | 239,810 | | | $ | 100,901 | | | $ | 35,655 | | | $ | 5 | | | $ | 376,371 | |
Federal Funds Borrowed and Repurchase Agreements | | | 42,785 | | | | | | | | | | | | | | | | 42,785 | |
| Long Term Debt | | | 2,500 | | | | 10,777 | | | | 6,181 | | | | 3,035 | | | | 22,493 | |
| Subordinated Debt | | | | | | | | | | | | | | | 36,084 | | | | 36,084 | |
| Operating Leases | | | 332 | | | | 217 | | | | 201 | | | | 0 | | | | 750 | |
Further discussion of the nature of each obligation is included in Notes 7, 10, 11, 12, and 13 to the consolidated financial statements.
Our operating lease obligations represent short and long-term lease and rental payments, primarily for facilities, and to a lesser degree for certain software and data processing equipment.
The following table details the amounts and expected maturities of significant commitments as of December 31, 2012.
| (In Thousands of Dollars) | | | | | | | | | |
| | | One Year or Less | | | | | | | | | | | | Total | |
| Credit: | | | | | | | | | | | | | | | |
| Commercial real estate | | $ | 85,440 | | | $ | 19,741 | | | $ | 10,705 | | | $ | 4,801 | | | $ | 120,687 | |
| Residential real estate | | | 989 | | | | 511 | | | | 0 | | | | 50,141 | | | | 51,641 | |
| Construction loans | | | 3,788 | | | | 416 | | | | 626 | | | | 255 | | | | 5,085 | |
| Revolving home equity and credit card lines | | | 7,506 | | | | 15,671 | | | | 13,042 | | | | 10,442 | | | | 46,661 | |
| Other | | | 1,463 | | | | 14,426 | | | | 3,817 | | | | 1,165 | | | | 20,871 | |
| Commercial standby letters of credit | | | 16,927 | | | | 2 | | | | 417 | | | | 3,080 | | | | 20,426 | |
| Total Commitments | | $ | 116,113 | | | $ | 50,767 | | | $ | 28,607 | | | $ | 69,884 | | | $ | 265,371 | |
Commitments to extend credit, including loan commitments, standby letters of credit and commercial letters of credit, do not necessarily represent future cash requirements in that these commitments often expire without being drawn upon. Further discussion of these commitments is included in Note 18 to the consolidated financial statements.
CRITICAL ACCOUNTING POLICIES
Certain of our accounting policies are important to the portrayal of our financial condition since they require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. Estimates associated with these policies are susceptible to material changes as a result of changes in facts and circumstances. Facts and circumstances which could affect these judgments include, without limitation, changes in interest rates, in local and national economic conditions or the financial condition of borrowers. Our significant accounting policies are discussed in detail in Note 1 of the Notes to the Consolidated Financial Statements.
We view 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. We believe that our critical accounting policies include determining the allowance for loan losses, determining the fair value of securities and other financial instruments, including possible impairment of goodwill and other assets, the valuation of mortgage servicing rights, determination of purchase accounting adjustments, determination of the fair value of other real estate owned, and estimating state and federal tax liabilities.
Allowance for Loan Losses The allowance for loan losses is a valuation allowance for probable incurred credit losses. We use a quantitative and qualitative methodology for analyzing factors which impact the allowance for loan losses consistently across our five banking subsidiaries. The process applies risk factors for historical charge-offs and delinquency experience, portfolio segment weightings and industry and regional factors and trends as they affect the banks’ portfolios. The consideration of exposures to industries potentially most affected by current risks in the economic and political environment, and the review of potential risks in certain credits that either are, or are not, considered part of the non-performing loan category contributed to the establishment of the allowance levels at each bank. Loan losses are charged off against the allowance when management believes the uncollectibility of a loan balance is confirmed.
Loans are reviewed on an ongoing basis for impairment. A loan is impaired when it is probable that we will be unable to collect all amounts due substantially in accordance with the contractual terms of the loan agreement. Impaired loans are measured based on the present value of expected cash flows discounted at the loan’s effective interest rate or, as a practical expedient, the fair value of collateral if the loan is collateral dependent. Loans considered to be impaired are reduced to the present value of expected future cash flow or to the fair value of collateral by allocating a portion of the allowance for loan losses to such loans. If these allocations cause an increase in the calculated allowance for loan losses, such increase is reported as provision for loan loss expense. Increases or decreases in carrying value due to changes in estimates of future payments or the passage of time are reported as reductions or increases in the provision for loan losses.
Smaller balance homogeneous loans such as residential first mortgage loans secured by one to four family residences, residential construction, automobile, home equity and second mortgage loans, are collectively evaluated for impairment. Commercial loans and first mortgage loans secured by other properties are evaluated individually for impairment. When credit analysis of the borrower’s operating results and financial condition indicates the underlying ability of the borrower’s business activity is not sufficient to generate adequate cash flow to service the business’ cash needs, including our loans to the borrower, the loan is evaluated for impairment. Often this is associated with a delay or shortfall in payments of 90 days or less. Commercial loans are rated on a scale of 1 to 10, with grades 1 to 4 being satisfactory grades, 5 and 6 special attention or watch, 7 substandard, 8 impaired, 9 doubtful, and 10 loss. Loans graded 6 through 9 are considered for impairment. Loans are generally moved to nonaccrual status when 90 days or more past due. These loans are often considered impaired. Impaired loans, or portions thereof, are charged off when deemed uncollectible.
Fair Value of Securities and Other Financial Instruments Securities available for sale consist of bonds and notes which might be sold prior to maturity due to changes in interest rate, prepayment risks, yield and availability of alternative investments, liquidity needs or other factors. Securities classified as available for sale are reported at their fair value. Declines in the fair value of securities below their cost that are other than temporary are reflected as realized losses. In estimating other-than-temporary losses, management considers: (1) the length of time and extent that fair value has been less than carrying value; (2) the financial condition and near term prospects of the issuer; and (3) our ability and intent to hold the security for a period of time sufficient to allow for any anticipated recovery in fair value.
Market values for securities available for sale are obtained from outside sources and applied to individual securities within the portfolio. The difference between the amortized cost and the current market value of securities is recorded as a valuation adjustment and reported in other comprehensive income.
Valuation of Mortgage Servicing Rights Mortgage servicing rights are recognized as assets for the allocated value of retained servicing rights on loans sold. Servicing rights are expensed in proportion to, and over the period of, estimated net servicing revenues.
We utilize a discounted cash flow model to determine the value of our servicing rights. The valuation model utilizes mortgage prepayment speeds, the remaining life of the mortgage pool, delinquency rates, our cost to service loans, and other factors to determine the cash flow that we will receive from serving each grouping of loans. These cash flows are then discounted based on current interest rate assumptions to arrive at the fair value of the right to service those loans. Impairment is evaluated based on the fair value of the rights, using groupings of the underlying loans classified by interest rates. Any impairment of a grouping is reported as a valuation allowance.
Acquisition Intangibles Generally accepted accounting principles require us to determine the fair value of all of the assets and liabilities of an acquired entity, and record their fair value on the date of acquisition. We employ a variety of means in determination of the fair value, including the use of discounted cash flow analysis, market comparisons, and projected future revenue streams. For certain items that we believe we have the appropriate expertise to determine the fair value, we may choose to use our own calculation of the value. In other cases, where the value is not easily determined, we consult with outside parties to determine the fair value of the asset or liability. Once valuations have been adjusted, the net difference between the price paid for the acquired company and the value of its balance sheet is recorded as goodwill. Due to the unique market conditions this year and our lower level of earnings, we contracted to have a goodwill impairment analysis completed in the third quarter. The results of that analysis indicated that no impairment existed at that time. See Note 8 to the financial statements for further information on the valuation results.
Other Real Estate Owned is carried at its fair value. Fair value is determined through the use of appraisals and/or broker price opinions, discounted for the expected costs to maintain and sell of the property.
Uncertain Tax Liabilities Uncertain tax liabilities are estimated based on our exposures to interpretation of the applicable tax codes. We estimate our contingent tax liabilities by determining the amount of income that may be at risk of an adverse interpretation by taxing authorities on specific issues, multiplied by our effective tax rate, to determine our gross exposure. Once this exposure is determined, an estimate of the probability of an adverse adjustment being required is determined and applied to the gross liability to determine the contingent tax reserve. While changes to Michigan business taxes are likely, they are not expected to affect tax liabilities relating to prior periods.
Recent Accounting Pronouncements
During 2012, the Company adopted new guidance related to the presentation of comprehensive income in the financial statements. Among other changes, the new guidance eliminated the option to only present comprehensive income in the statement of equity. We have elected to report comprehensive income in a separate statement of comprehensive income that begins with net income. The change in presentation has been applied retrospectively and the 2011 financial statements have been restated to conform to the new presentation method. Other than the change in presentation of comprehensive income and related disclosures, the new guidance did not have a material effect on the financial statements.
In 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2011-02, A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring. This update applies to all creditors, both public and non-public, and was introduced to provide clarification surrounding troubled debt restructurings (“TDR”). The primary characteristics that previously caused a restructuring to qualify as a TDR still exist: (1) the restructuring constitutes a concession to the borrower and (2) the borrower is experiencing financial difficulties. The update provides additional details and examples to provide clarity surrounding these items. The update also prohibits the use of the effective interest rate test when determining whether the restructuring constitutes a concession. The update is effective for annual reporting periods ending on or after December 15, 2012 (therefore, December 31, 2012, for the Company). Lastly, the disclosure requirements set forth by ASU 2010-20 regarding troubled debt restructurings, and later deferred by ASU 2011-01 until December 31, 2012 for the Company, are included in Note 7. Other than the additional disclosures, these updates did not have a significant impact on the financial statements.
In 2011, the FASB issued ASU No. 2011-04, Fair Value Measurement (Topic 820) - Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS. This update to Fair Value Measurement (Topic 820) results in common fair value measurement and disclosure requirements in U.S. GAAP and IFRS. The amendments in this update explain how to measure fair value. They do not require additional fair value measurements and are not intended to establish valuation standards or affect valuation practices outside of financial reporting. However, this update does require expanded disclosure related to the nature and significance of inputs that are used in estimating and measuring the fair value of financial instruments. The amendments in this update are to be applied prospectively and are effective for annual reporting periods beginning after December 15, 2011 (therefore, December 31, 2012, for the Company). This update did not have a significant impact on the financial statements.
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
We face market risk to the extent that both earnings and the fair market values of our financial instruments are affected by changes in interest rates and liquidity of markets. We manage this risk with static GAP analysis and simulation modeling. Our models indicate that we have maintained an overall liability sensitive position, whereby we should benefit as rates decline. These models do not fully incorporate customer preferences and changes in their behavior. As such, we believe we are somewhat less liability sensitive in a downward rate environment than the analysis indicates. In the short run, we expect our net interest margin to be stable to slightly rising as rates on our assets re-price downward at a slower pace than our liabilities. In the longer run as time deposits re-price to lower rates, we believe or net interest margin will be fairly stable, and maintain our overall profitability. As of the date of this annual report we do not know of nor expect there to be any material change in the general nature of our primary market risk exposure in the near term.
Our market risk exposure is mainly comprised of our vulnerability to interest rate risk. We do not accept significant interest rate risk in our mortgage banking operations. To manage our interest rate risk in mortgage banking we generally lock in our sale price to the secondary market at the same time we make a rate commitment to the borrower. Prevailing interest rates and interest rate relationships in the future will be primarily determined by market factors which are outside of our control. All information provided in response to this item consists of forward looking statements. Reference is made to the section captioned “Forward Looking Statements” in this annual report for a discussion of the limitations on our responsibility for such statements.
The following tables provide information about our financial instruments that are sensitive to changes in interest rates as of December 31, 2012 and 2011. They show expected maturity date values for loans and securities which were calculated without adjusting the instruments’ contractual maturity dates for expected prepayments. Maturity date values for interest bearing core deposits were not based on estimates of the period over which the deposits would be outstanding, but rather, the opportunity for re-pricing. We believe that re-pricing dates, as opposed to expected maturity dates, may be more relevant in analyzing the value of such instruments and are reported as such in the following tables. Fair value is computed as the present value of expected cash flows at rates in effect at the date indicated.
| Principal/Notional Amounts Maturing or Re-pricing in: | | | (In Thousands of Dollars) | | | | | | | |
| As of December 31, 2012 | | 2013 | | | 2014 | | | 2015 | | | 2016 | | | 2017 | | | Thereafter | | | Total | | | | |
| Rate Sensitive Assets: | | | | | | | | | | | | | | | | | | | | | | | | |
| Fixed interest rate loans | | $ | 118,044 | | | $ | 86,252 | | | $ | 76,460 | | | $ | 92,776 | | | $ | 135,106 | | | $ | 228,901 | | | $ | 737,539 | | | $ | 735,315 | |
| Average interest rate | | | 6.21 | % | | | 6.46 | % | | | 6.18 | % | | | 5.62 | % | | | 5.16 | % | | | 5.63 | % | | | | | | | | |
| Variable interest rate loans | | | 111,074 | | | | 23,696 | | | | 12,407 | | | | 22,503 | | | | 29,762 | | | | 29,702 | | | | 229,144 | | | | 216,217 | |
| Average interest rate | | | 4.22 | % | | | 4.75 | % | | | 4.81 | % | | | 4.15 | % | | | 4.26 | % | | | 4.43 | % | | | | | | | | |
| Fixed interest rate securities | | | 43,536 | | | | 49,742 | | | | 27,445 | | | | 43,143 | | | | 24,780 | | | | 154,249 | | | | 342,895 | | | | 342,895 | |
| Average interest rate | | | 1.30 | % | | | 1.50 | % | | | 1.82 | % | | | 0.96 | % | | | 1.64 | % | | | 2.33 | % | | | | | | | | |
Variable interest rate Securities | | | | | | | | | | | | | | | | | | | | | | | 10,783 | | | | 10,783 | | | | 10,783 | |
| Average interest rate | | | | | | | | | | | | | | | | | | | | | | | 2.51 | % | | | | | | | | |
| Other interest bearing assets | | | 63,040 | | | | 447 | | | | 497 | | | | | | | | | | | | 7,266 | | | | 71,250 | | | | 71,250 | |
| Average interest rate | | | 0.28 | % | | | 1.29 | % | | | 1.30 | % | | | | | | | | | | | | | | | | | | | | |
| Rate Sensitive Liabilities: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Savings and interest bearing checking | | | 613,921 | | | | | | | | | | | | | | | | | | | | | | | | 613,921 | | | | 613,847 | |
| Average interest rate | | | 0.20 | % | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Time deposits | | | 239,810 | | | | 69,766 | | | | 31,135 | | | | 22,614 | | | | 13,041 | | | | 5 | | | | 376,371 | | | | 378,756 | |
| Average interest rate | | | 0.85 | % | | | 1.24 | % | | | 2.27 | % | | | 1.83 | % | | | 1.01 | % | | | 1.49 | % | | | | | | | | |
Fixed interest rate borrowings | | | 2,500 | | | | 4,000 | | | | 6,777 | | | | 3,094 | | | | 3,087 | | | | 3,035 | | | | 22,493 | | | | 24,122 | |
| Average interest rate | | | 1.81 | % | | | 0.47 | % | | | 1.13 | % | | | 1.42 | % | | | 5.44 | % | | | 6.09 | % | | | | | | | | |
Variable interest rate borrowings | | | | | | | | | | | | | | | | | | | | | | | 36,084 | | | | 36,084 | | | | 36,093 | |
| Average interest rate | | | | | | | | | | | | | | | | | | | | | | | 1.83 | % | | | | | | | | |
| Repurchase agreements | | | 42,785 | | | | | | | | | | | | | | | | | | | | | | | | 42,785 | | | | 42,785 | |
| Average interest rate | | | 0.18 | % | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| As of December 31, 2011 | | 2012 | | | 2013 | | | 2014 | | | 2015 | | | 2016 | | | Thereafter | | | Total | | | | |
| Rate Sensitive Assets: | | | | | | | | | | | | | | | | | | | | | | | | |
| Fixed interest rate loans | | $ | 101,743 | | | $ | 129,355 | | | $ | 111,042 | | | $ | 96,217 | | | $ | 110,175 | | | $ | 207,830 | | | $ | 756,362 | | | $ | 748,060 | |
| Average interest rate | | | 6.77 | % | | | 6.48 | % | | | 6.58 | % | | | 6.45 | % | | | 5.78 | % | | | 6.15 | % | | | | | | | | |
| Variable interest rate loans | | | 114,846 | | | | 26,292 | | | | 24,878 | | | | 13,914 | | | | 21,926 | | | | 26,040 | | | | 227,896 | | | | 217,864 | |
| Average interest rate | | | 4.62 | % | | | 4.29 | % | | | 4.95 | % | | | 5.05 | % | | | 4.42 | % | | | 4.53 | % | | | | | | | | |
| Fixed interest rate securities | | | 26,343 | | | | 36,086 | | | | 58,787 | | | | 60,012 | | | | 13,492 | | | | 133,909 | | | | 328,629 | | | | 328,629 | |
| Average interest rate | | | 1.32 | % | | | 1.51 | % | | | 1.54 | % | | | 1.59 | % | | | 1.72 | % | | | 2.87 | % | | | | | | | | |
Variable interest rate Securities | | | | | | | | | | | | | | | | | | | | | | | 13,555 | | | | 13,555 | | | | 13,555 | |
| Average interest rate | | | | | | | | | | | | | | | | | | | | | | | 2.73 | % | | | | | | | | |
| Other interest bearing assets | | | 37,154 | | | | 1,997 | | | | 450 | | | | 496 | | | | | | | | 7,266 | | | | 47,363 | | | | 47,363 | |
| Average interest rate | | | 0.28 | % | | | 1.29 | % | | | 1.30 | % | | | 1.30 | % | | | | | | | | | | | | | | | | |
| Rate Sensitive Liabilities: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Savings and interest bearing checking | | | 582,545 | | | | | | | | | | | | | | | | | | | | | | | | 582,545 | | | | 582,449 | |
| Average interest rate | | | 0.27 | % | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Time deposits | | | 261,196 | | | | 91,785 | | | | 25,188 | | | | 25,363 | | | | 19,512 | | | | 49 | | | | 423,093 | | | | 426,509 | |
| Average interest rate | | | 1.43 | % | | | 1.64 | % | | | 2.47 | % | | | 2.82 | % | | | 2.25 | % | | | 2.51 | % | | | | | | | | |
Fixed interest rate borrowings | | | 7,776 | | | | 1,500 | | | | | | | | 849 | | | | 3,113 | | | | 13,951 | | | | 27,189 | | | | 29,450 | |
| Average interest rate | | | 2.28 | % | | | 2.74 | % | | | | | | | 4.79 | % | | | 1.45 | % | | | 6.21 | % | | | | | | | | |
Variable interest rate borrowings | | | | | | | | | | | | | | | | | | | | | | | 28,352 | | | | 28,352 | | | | 28,397 | |
| Average interest rate | | | | | | | | | | | | | | | | | | | | | | | 1.96 | % | | | | | | | | |
| Repurchase agreements | | | 46,784 | | | | | | | | | | | | | | | | | | | | | | | | 46,784 | | | | 46,784 | |
| Average interest rate | | | 0.19 | % | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
CAPITAL RESOURCES
We obtain funds for our operating expenses and dividends to shareholders through dividends from our subsidiary banks. In general, the subsidiary banks pay only those amounts required to meet holding company cash requirements, while maintaining appropriate capital at the banks. Capital is maintained at the subsidiary banks to support their current operations and projected future growth.
Bank regulators have established risk based capital guidelines for banks and bank holding companies. Minimum capital levels are established under these guidelines and each asset category is assigned a perceived risk weighting. Off balance sheet items, such as loan commitments and standby letters of credit, also require capital allocations.
As of December 31, 2012, our total capital to risk weighted assets exceeded the minimum requirement for capital adequacy purposes of 8% by $78 million. Tier 1 capital to risk weighted assets exceeded the minimum of 4% by $104 million, and Tier 1 capital to average assets exceeded the minimum of 4% by $84 million. In the current economic environment, regulatory agencies are encouraging banks to maintain capital well above this minimum requirement. At year end 2012, our total capital to risk weighted assets exceeded the well capitalized minimum requirement for capital adequacy purposes of 10% by $58 million. Tier 1 capital to risk weighted assets exceeded the well capitalized minimum of 6% by $85 million, and Tier 1 capital to average assets exceeded the well capitalized minimum of 5% by $69 million.
For a more complete discussion of capital requirements please refer to Note 22 of the Notes to Consolidated Financial Statements. The Federal Deposit Insurance Corporation insures specified customer deposits and assesses premium rates based on defined criteria. Insurance assessment rates may vary from bank to bank based on the factors that measure the perceived risk of a financial institution. One condition for maintaining the lowest risk assessment, and therefore, the lowest insurance rate, is the maintenance of capital at the “well capitalized” level. Each of our affiliate banks has exceeded the regulatory criteria for a “well capitalized” financial institution.
A certain level of capital growth is desirable to maintain an appropriate ratio of equity to total assets. The compound annual growth rate for total average assets for the past five years was 4.2%. The compound annual growth rate for average equity over the same period was 6.5%.
We have established an internal goal of maintaining our dividend payout ratio within a range that will create capital growth to support asset growth in the balance sheet. In 2008 we maintained our dividend payment rate at higher levels and distributed more capital to our shareholders than was generated, resulting in a negative earnings retention percentage. As a result of our earnings in 2008 and the need to preserve capital, the Board of Directors’ reduced the dividend in 2009 to better align with these objectives. Earnings continued under pressure in 2009 and dividends again exceeded earnings, causing a negative retention rate, and resulting in the Board of Directors’ decision to further reduce the dividend in the first quarter and further yet in the second quarter of 2010. In the first quarter of 2012, the Board of Directors determined to pay an additional $0.05 per share cash dividend on common stock in addition to the regular quarterly amount of $0.01 per share, for a total of $0.06 per share, based on the results of earnings for the full year of 2011. As 2012 concluded, the Board of Directors determined to pay an additional $0.20 per share in addition to the regular quarterly amount of $0.01 per share, based on projected 2012 earnings, resulting in a total payout of $0.24 per share relating to 2012. To achieve the goal of acceptable internal capital growth, we intend to continue our efforts to return to higher earnings levels, and will adjust our dividend payout rate as appropriate.
As an additional enhancement to capital growth we offer a dividend reinvestment program. The Firstbank Corporation Dividend Reinvestment Plan was first offered in 1988. At December 31, 1988, 123 owners holding 209,856 shares participated in the Plan. At the end of 2012, 1,226 owners held over 1.3 million shares in the Plan.
To further strengthen our capital position, we elected to participate in the United States Treasury’s Capital Purchase Plan (CPP), whereby we issued $33 million of preferred stock and warrants to purchase up to 578,947 shares of our common stock at a price of $8.55, to the United States Treasury on January 30, 2009. The preferred stock issued in this transaction requires a 5% dividend for five years and then converts to a 9% dividend rate. As our capital position has improved, we exited the CPP and repurchased $16 million of the preferred stock and our outstanding common stock warrants during 2012. The remaining $17 million of the preferred stock was purchased from the Treasury by private investors.
We are not aware of any recommendations by regulatory authorities at December 31, 2012, which are likely to have a material effect on our liquidity, capital resources or operations.
POLICY REGARDING THE CONFIDENTIALITY OF REGULATORY EXAMINATIONS
Firstbank Corporation and its affiliate banks are subject to regular examination by government regulators, as are all other banks and bank holding companies. By law we are prohibited from disclosing the ratings and other information contained in those examination reports. These confidentiality requirements are designed to promote the integrity of the examination process and to avoid the results being used as a rating or endorsement of a particular financial institution.
We sometimes receive inquiries about the contents and results of our regulatory examinations. Disclosing this information could violate the confidentiality requirements under federal law. In addition, even partial disclosure taken out of context could result in misunderstanding and misinterpretation. As a result, it is the policy of Firstbank Corporation and its affiliates not to comment on or disclose information regarding regulatory examination reports and related communications. Firstbank Corporation remains committed to disclosing detailed information through the United States Securities and Exchange Commission reporting process. In addition, the quarterly reports of condition reports for each of our banks are available at www.fdic.gov and information regarding our holding company is available at www.federalreserve.gov.
FORWARD LOOKING STATEMENTS
This annual report including, without limitation, management’s discussion and analysis of financial condition and results of operations, and other sections of our Annual Report to Shareholders, contain forward-looking statements that are based on management’s beliefs, assumptions, current expectations, estimates and projections about the financial services industry, the economy, and about the Company itself. Words such as “anticipate”, “believe”, “determine”, “estimate”, “expect”, “forecast”, “intend”, “is likely”, “plan”, “project”, “opinion”, “should”, variations of such terms, and similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions that are difficult to predict with regard to timing, extent, likelihood, and degree of occurrence. Therefore, actual results and outcomes may materially differ from what may be expressed or forecasted in such forward looking statements. Internal and external factors that may cause such a difference include changes in interest rates and interest rate relationships; demand for products and services; the degree of competition by traditional and non-traditional competitors; changes in banking regulations; changes in tax laws; changes in prices, levies, and assessments; the impact of technological advances; governmental and regulatory policy changes; the outcomes of pending and future litigation and contingencies; trends in customer behavior and customer ability to repay loans; software failure, errors or miscalculations; the ability of the Company to locate and correct all data sensitive computer codes; and the vicissitudes of the national economy. The Company undertakes no obligation to update, amend or clarify forward-looking statements, whether as a result of new information, future events, or otherwise.
COMMON STOCK DATA
Firstbank Corporation Common Stock was held by 1,783 shareholders of record as of December 31, 2012. Total shareholders number approximately 2,800, including those whose shares are held in nominee name through brokerage firms. Our shares are listed on the NASDAQ Global Select Market under the symbol FBMI and are traded by several brokers. The range of high and low sales prices for shares of common stock for each quarterly period during the past two years is as follows:
| Quarter | | High | | | Low | |
| 4th 2012 | | $ | 11.45 | | | $ | 10.00 | |
| 3rd 2012 | | $ | 11.49 | | | $ | 9.19 | |
| 2nd 2012 | | $ | 10.42 | | | $ | 8.32 | |
| 1st 2012 | | $ | 8.68 | | | $ | 4.97 | |
| 4th 2011 | | $ | 5.36 | | | $ | 4.59 | |
| 3rd 2011 | | $ | 6.03 | | | $ | 4.78 | |
| 2nd 2011 | | $ | 6.27 | | | $ | 5.58 | |
| 1st 2011 | | $ | 7.15 | | | $ | 6.14 | |
The prices quoted above were obtained from www.NASDAQ.com. Prices have been adjusted to reflect stock dividends.
The following table summarizes cash dividends paid per share of common stock during 2012 and 2011.
| | | 2012 | | | 2011 | |
| First Quarter | | $ | 0.06 | | | $ | 0.01 | |
| Second Quarter | | | 0.01 | | | | 0.01 | |
| Third Quarter | | | 0.01 | | | | 0.01 | |
| Fourth Quarter | | | 0.21 | | | | 0.01 | |
| Total | | $ | 0.29 | | | $ | 0.04 | |
Our principal sources of funds to pay cash dividends are the earnings of, and dividends paid by, our subsidiary banks. Under current regulations the subsidiary banks are restricted in their ability to transfer funds in the form of cash dividends, loans, and advances to the holding company (See Note 20 of the Notes to Consolidated Financial Statements). As of January 1, 2013, approximately $23.1 million of the subsidiaries’ retained earnings were available for transfer in the form of dividends to the holding company without prior regulatory approval. In addition, the subsidiaries’ 2013 earnings are expected to be available for distributions as dividends to the holding company.
STOCK PERFORMANCE
The following graph compares the cumulative total shareholder return on the common stock of the Corporation to the Standard & Poor’s 500 Stock Index and the NASDAQ Bank Index, assuming a $100 investment at the end of 2007. The Standard & Poor’s 500 Stock Index is a broad equity market index. The NASDAQ Bank Index is composed of banks and savings institutions as well as companies performing functions closely related to banking, such as check cashing agencies, currency exchanges, safe deposit companies and corporations for banking abroad. Cumulative total return is measured by dividing (1) the sum of (A) the cumulative amount of dividends for the measurement period, assuming dividend reinvestment, and (B) the difference between the share price at the end and the beginning of the measurement period; by (2) the share price at the beginning of the measurement period.
The table below shows dollar values for cumulative total shareholder return plotted in the graph above.
| | | 2007 | | | 2008 | | | 2009 | | | 2010 | | | 2011 | | | 2012 | |
| Firstbank Corporation | | $ | 100.00 | | | $ | 63.31 | | | $ | 70.35 | | | $ | 49.63 | | | $ | 43.76 | | | $ | 93.97 | |
| S & P 500 | | $ | 100.00 | | | $ | 63.00 | | | $ | 79.68 | | | $ | 91.68 | | | $ | 93.61 | | | $ | 108.59 | |
| NASDAQ Bank | | $ | 100.00 | | | $ | 78.46 | | | $ | 65.67 | | | $ | 74.97 | | | $ | 67.10 | | | $ | 79.64 | |
MANAGEMENT’S RESPONSIBILITY FOR FINANCIAL REPORTING
The management of Firstbank Corporation has the responsibility for preparing the accompanying consolidated financial statements and for their integrity and objectivity. The statements were prepared in accordance with accounting principles generally accepted in the United States of America. The consolidated financial statements include amounts that are based on management's best estimates and judgments. Management also prepared other information in the annual report and is responsible for its accuracy and consistency with the financial statements.
The Company's 2012 consolidated financial statements have been audited by Plante & Moran, PLLC independent registered public accounting firm. Management has made available to Plante & Moran, PLLC all financial records and related data, as well as the minutes of Boards of Directors' meetings. Management believes that all representations made to Plante & Moran, PLLC during the audit were valid and appropriate.
MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
The management of Firstbank Corporation is responsible for establishing and maintaining adequate internal control over financial reporting. The Company's internal control system is designed to provide reasonable assurance to the Company's management and Board of Directors regarding the reliability of financial reporting and the presentation of published financial statements. The system of internal control provides for division of responsibility and is documented by written policies and procedures that are communicated to employees with significant roles in the financial reporting process and updated as necessary. Management monitors the system of internal control for compliance.
The Company maintains an internal auditing program that independently assesses the effectiveness of the internal controls and recommends possible improvements thereto. However, all internal control systems, no matter how well designed, have inherent limitations.
The Company's management assessed the effectiveness of the Company's internal control over financial reporting as of December 31, 2012. In making this assessment, it used the criteria for effective internal control over financial reporting set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in "Internal Control-Integrated Framework". Based on our assessment management concludes that, as of December 31, 2012, the Company's internal control over financial reporting is effective based on those criteria.
| | | FIRSTBANK CORPORATION | |
| | | | |
| | | | |
| | | | |
| | | \s\ Thomas R. Sullivan | |
| | | Thomas R. Sullivan | |
| | | President & Chief Executive Officer | |
| | | (Principal Executive Officer) | |
| | | | |
| | | | |
| | | | |
| | | \s\ Samuel G. Stone | |
| | | Samuel G. Stone | |
| | | Executive Vice President & Chief Financial Officer | |
| | | (Principal Financial and Accounting Officer) | |
| | | | |
Dated: March 11, 2013
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders
Firstbank Corporation
We have audited the accompanying consolidated balance sheet of Firstbank Corporation as of December 31, 2012 and 2011, and the related consolidated statements of income and comprehensive income, changes in shareholders' equity, and cash flows for each of the three years ended December 31, 2012. Our responsibility is to express an opinion on these financial statements.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. Our audit of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Firstbank Corporation as of December 31, 2012 and 2011, and the results of its operations and its cash flows for each of the years in the three year period ended December 31, 2012 in conformity with accounting principles generally accepted in the United States of America.
| | | \s\ Plante & Moran, PLLC | |
| Grand Rapids, Michigan | | Plante & Moran, PLLC | |
| March 11, 2013 | | | |
FIRSTBANK CORPORATIONCONSOLIDATED BALANCE SHEETS
(In Thousands of Dollars, Except for Share Data)
| | | December 31, | |
| ASSETS | | 2012 | | | 2011 | |
| | | | | | | |
| Cash and due from banks | | $ | 38,544 | | | $ | 40,151 | |
| Short term investments | | | 61,057 | | | | 35,665 | |
| Total cash and cash equivalents | | | 99,601 | | | | 75,816 | |
| FDIC insured bank time certificates of deposit | | | 2,927 | | | | 4,432 | |
| Trading Account Securities | | | 6 | | | | 2 | |
| Securities available for sale | | | 353,678 | | | | 342,184 | |
| Federal Home Loan Bank stock | | | 7,266 | | | | 7,266 | |
| Loans held for sale | | | 2,921 | | | | 349 | |
| Loans | | | 963,762 | | | | 983,909 | |
| Allowance for loan losses | | | (21,340 | ) | | | (21,019 | ) |
| Premises and equipment, net | | | 24,356 | | | | 25,087 | |
| Goodwill | | | 35,513 | | | | 35,513 | |
| Core deposits and other intangibles | | | 965 | | | | 1,448 | |
| Other real estate owned | | | 2,925 | | | | 5,251 | |
| Accrued interest receivable and other assets | | | 26,182 | | | | 25,061 | |
| | | | | | | | | |
| TOTAL ASSETS | | $ | 1,498,762 | | | $ | 1,485,299 | |
| | | | | | | | | |
| LIABILITIES AND SHAREHOLDERS’ EQUITY | | | | | | | | |
| | | | | | | | | |
| LIABILITIES | | | | | | | | |
| Deposits: | | | | | | | | |
| Non-interest bearing demand accounts | | $ | 251,109 | | | $ | 214,904 | |
| Interest bearing accounts: | | | | | | | | |
| Demand | | | 348,598 | | | | 340,942 | |
| Savings | | | 265,323 | | | | 241,603 | |
| Time | | | 376,371 | | | | 423,093 | |
| Total Deposits | | | 1,241,401 | | | | 1,220,542 | |
| | | | | | | | | |
| Securities sold under agreements to repurchase and overnight borrowings | | | 42,785 | | | | 46,784 | |
| Federal Home Loan Bank advances | | | 22,493 | | | | 19,457 | |
| Subordinated debentures | | | 36,084 | | | | 36,084 | |
| Accrued interest payable and other liabilities | | | 8,941 | | | | 7,055 | |
| Total Liabilities | | | 1,351,704 | | | | 1,329,922 | |
| | | | | | | | | |
| SHAREHOLDERS’ EQUITY | | | | | | | | |
Preferred stock; no par value, 300,000 shares authorized; 17,000 and 33,000 shares issued and outstanding in 2012 and 2011 | | | 16,908 | | | | 32,792 | |
Common stock; no par value, 20,000,000 shares authorized; 8,001,903 and 7,892,486 shares issued and outstanding in 2012 and 2011 | | | 115,621 | | | | 115,734 | |
| Retained earnings | | | 10,921 | | | | 3,955 | |
| Accumulated other comprehensive income | | | 3,608 | | | | 2,896 | |
| Total Shareholders’ Equity | | | 147,058 | | | | 155,377 | |
| | | | | | | | | |
| TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY | | $ | 1,498,762 | | | $ | 1,485,299 | |
See notes to consolidated financial statements.
FIRSTBANK CORPORATION
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(In Thousands of Dollars, Except for Per Share Data)
| | | Year Ended December 31, | |
| | | 2012 | | | 2011 | | | 2010 | |
| Interest Income: | | | | | | | | | |
| Loans, including fees | | $ | 56,975 | | | $ | 61,465 | | | $ | 67,390 | |
| Securities: | | | | | | | | | | | | |
| Taxable | | | 4,557 | | | | 4,888 | | | | 3,649 | |
| Exempt from federal income tax | | | 1,169 | | | | 1,118 | | | | 1,138 | |
| Short term investments | | | 165 | | | | 173 | | | | 205 | |
| Total Interest Income | | | 62,866 | | | | 67,644 | | | | 72,382 | |
| | | | | | | | | | | | | |
| Interest Expense: | | | | | | | | | | | | |
| Deposits | | | 6,626 | | | | 10,891 | | | | 15,733 | |
| FHLB advances and notes payable | | | 625 | | | | 801 | | | | 3,564 | |
| Subordinated debentures | | | 1,036 | | | | 1,197 | | | | 1,497 | |
| Other | | | 87 | | | | 83 | | | | 96 | |
| Total Interest Expense | | | 8,374 | | | | 12,972 | | | | 20,890 | |
| Net Interest Income | | | 54,492 | | | | 54,672 | | | | 51,492 | |
| | | | | | | | | | | | | |
| Provision for loan losses | | | 7,690 | | | | 13,337 | | | | 13,344 | |
| Net Interest Income after Provision for Loan Losses | | | 46,802 | | | | 41,335 | | | | 38,148 | |
| | | | | | | | | | | | | |
| Non-Interest Income: | | | | | | | | | | | | |
| Service charges on deposit accounts | | | 4,219 | | | | 4,492 | | | | 4,576 | |
| Gain on sale of mortgage loans | | | 6,523 | | | | 3,683 | | | | 5,907 | |
| Mortgage servicing, net of amortization | | | (231 | ) | | | 89 | | | | (96 | ) |
| Gain/(loss) on trading account securities | | | 4 | | | | (11 | ) | | | 3 | |
| Gain/(loss) on securities transactions | | | 44 | | | | (37 | ) | | | 4 | |
| Courier and cash delivery services | | | 0 | | | | 0 | | | | 174 | |
| Other | | | 2,111 | | | | 1,459 | | | | 1,261 | |
| Total Non-Interest Income | | | 12,670 | | | | 9,675 | | | | 11,829 | |
| | | | | | | | | | | | | |
| Non-Interest Expense: | | | | | | | | | | | | |
| Salaries and employee benefits | | | 22,680 | | | | 21,263 | | | | 20,889 | |
| Occupancy and equipment | | | 5,152 | | | | 5,311 | | | | 5,555 | |
| FDIC insurance premium | | | 1,220 | | | | 1,560 | | | | 2,098 | |
| Amortization of intangibles | | | 483 | | | | 698 | | | | 796 | |
| Outside professional services | | | 1,287 | | | | 1,202 | | | | 1,144 | |
| Advertising and promotions | | | 1,491 | | | | 1,425 | | | | 1,684 | |
| OREO expense and valuation write downs | | | 1,679 | | | | 3,153 | | | | 3,513 | |
| Other | | | 10,690 | | | | 8,941 | | | | 9,023 | |
| Total Non-Interest Expense | | | 44,682 | | | | 43,553 | | | | 44,702 | |
| Income before federal income taxes | | | 14,790 | | | | 7,457 | | | | 5,275 | |
| Federal income taxes | | | 4,256 | | | | 1,834 | | | | 1,512 | |
| NET INCOME | | $ | 10,534 | | | $ | 5,623 | | | $ | 3,763 | |
| | | | | | | | | | | | | |
| Preferred stock dividends and accretion of discount on preferred stock | | $ | 1,275 | | | $ | 1,679 | | | $ | 1,679 | |
| NET INCOME AVAILABLE TO COMMON SHAREHOLDERS | | $ | 9,259 | | | $ | 3,944 | | | $ | 2,084 | |
| | | | | | | | | | | | | |
| Basic earnings per common share | | $ | 1.17 | | | $ | 0.50 | | | $ | 0.27 | |
| | | | | | | | | | | | | |
| Diluted earnings per common share | | $ | 1.16 | | | $ | 0.50 | | | $ | 0.27 | |
| | | | | | | | | | | | | |
| COMPREHENSIVE INCOME | | | | | | | | | | | | |
| Net income | | $ | 10,534 | | | $ | 5,623 | | | $ | 3,763 | |
Change in unrealized gain on securities, net of tax and reclassification effects | | | 712 | | | | 2,750 | | | | (452 | ) |
| TOTAL COMPREHENSIVE INCOME | | $ | 11,246 | | | $ | 8,373 | | | $ | 3,311 | |
See notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2012, 2011, AND 2010
(In Thousands of Dollars, Except for Share and per Share Data)
| | | | | | | | | Retained Earnings/ (Accumulated Deficit) | | | Accumulated Other Comprehensive Income (Loss) | | | Total | |
| Balances at January 1, 2010 | | $ | 114,746 | | | $ | 32,734 | | | $ | (1,198 | ) | | $ | 598 | | | $ | 146,880 | |
| Net income for 2010 | | | | | | | | | | | 3,763 | | | | | | | | 3,763 | |
Cash dividends on common stock - $0.08 per share | | | | | | | | | | | (620 | ) | | | | | | | (620 | ) |
Accrued dividends on preferred stock and accretion of discount on preferred stock | | | | | | | 29 | | | | (1,679 | ) | | | | | | | (1,650 | ) |
| Amortization of stock warrants | | | (29 | ) | | | | | | | 29 | | | | | | | | 0 | |
Issuance of 21,933 shares of common stock through the dividend reinvestment plan | | | 121 | | | | | | | | | | | | | | | | 121 | |
Issuance of 6,555 shares of common stock from supplemental shareholder investments | | | 34 | | | | | | | | | | | | | | | | 34 | |
| Issuance of 44,587 shares of common stock | | | 237 | | | | | | | | | | | | | | | | 237 | |
| Stock option and restricted stock expense | | | 115 | | | | | | | | | | | | | | | | 115 | |
Net change in unrealized gain/(loss) on securities available for sale, net of tax of $(233) | | | | | | | | | | | | (452 | ) | | | (452 | ) |
| BALANCES AT DECEMBER 31, 2010 | | | 115,224 | | | | 32,763 | | | | 295 | | | | 146 | | | | 148,428 | |
| | | | | | | | | | | | | | | | | | | | | |
| Net income for 2011 | | | | | | | | | | | 5,623 | | | | | | | | 5,623 | |
Cash dividends on common stock - $0.04 per share | | | | | | | | | | | (313 | ) | | | | | | | (313 | ) |
Accrued dividends on preferred stock and accretion of discount on preferred stock | | | | | | | 29 | | | | (1,679 | ) | | | | | | | (1,650 | ) |
| Amortization of stock warrants | | | (29 | ) | | | | | | | 29 | | | | | | | | 0 | |
Issuance of 11,610 shares of common stock through the dividend reinvestment plan | | | 62 | | | | | | | | | | | | | | | | 62 | |
Issuance of 34,803 shares of common stock from supplemental shareholder investments | | | 197 | | | | | | | | | | | | | | | | 197 | |
| Issuance of 42,379 shares of common stock | | | 162 | | | | | | | | | | | | | | | | 162 | |
| Stock option and restricted stock expense | | | 118 | | | | | | | | | | | | | | | | 118 | |
Net change in unrealized gain/(loss) on securities available for sale, net of tax of $1,417 | | | | | | | | | | | | 2,750 | | | | 2,750 | |
| BALANCES AT DECEMBER 31, 2011 | | | 115,734 | | | | 32,792 | | | | 3,955 | | | | 2,896 | | | | 155,377 | |
| | | | | | | | | | | | | | | | | | | | | |
| Net income for 2012 | | | | | | | | | | | 10,534 | | | | | | | | 10,534 | |
Cash dividends on common stock - $0.29 per share | | | | | | | | | | | (2,314 | ) | | | | | | | (2,314 | ) |
Accrued dividends on preferred stock and accretion of discount on preferred stock | | | | | | | 22 | | | | (1,269 | ) | | | | | | | (1,247 | ) |
| Redemption of 16,000 shares of preferred stock | | | 850 | | | | (15,906 | ) | | | | | | | | | | | (15,056 | ) |
| Amortization of stock warrants | | | (15 | ) | | | | | | | 15 | | | | | | | | 0 | |
| Repurchase of stock warrants | | | (1,947 | ) | | | | | | | | | | | | | | | (1,947 | ) |
Issuance of 46,512 shares of common stock through the dividend reinvestment plan | | | 440 | | | | | | | | | | | | | | | | 440 | |
Issuance of 21,925 shares of common stock from supplemental shareholder investments | | | 201 | | | | | | | | | | | | | | | | 201 | |
| Issuance of 40,980 shares of common stock | | | 262 | | | | | | | | | | | | | | | | 262 | |
| Stock option and restricted stock expense | | | 96 | | | | | | | | | | | | | | | | 96 | |
Net change in unrealized gain/(loss) on securities available for sale, net of tax of $366 | | | | | | | | | | | | 712 | | | | 712 | |
| BALANCES AT DECEMBER 31, 2012 | | $ | 115,621 | | | $ | 16,908 | | | $ | 10,921 | | | $ | 3,608 | | | $ | 147,058 | |
See notes to consolidated financial statements.
FIRSTBANK CORPORATIONCONSOLIDATED STATEMENTS OF CASHFLOWS
(In Thousands of Dollars)
| | | Year Ended December 31, | |
| | | 2012 | | | 2011 | | | 2010 | |
| | | | | | | | | | |
| OPERATING ACTIVITIES | | | | | | | | | |
| Net income | | $ | 10,534 | | | $ | 5,623 | | | $ | 3,763 | |
Adjustments to reconcile net income to net cash from operating activities: | | | | | | | | | | | | |
| Provision for loan losses | | | 7,690 | | | | 13,337 | | | | 13,344 | |
| Depreciation of premises and equipment | | | 1,915 | | | | 2,062 | | | | 2,278 | |
| Net amortization and accretion of security premiums/discounts | | | 4,096 | | | | 3,783 | | | | 2,161 | |
| (Gain)/Loss on trading account securities | | | (4 | ) | | | 11 | | | | (3 | ) |
| (Gain)/Loss on securities transactions | | | (44 | ) | | | 37 | | | | (4 | ) |
| Amortization of intangibles | | | 483 | | | | 698 | | | | 796 | |
| Stock option and restricted stock grant compensation expense | | | 96 | | | | 118 | | | | 115 | |
| Gain on sale of mortgage loans | | | (6,523 | ) | | | (3,683 | ) | | | (5,907 | ) |
| Proceeds from sales of mortgage loans | | | 200,957 | | | | 115,100 | | | | 186,040 | |
| Loans originated for sale | | | (197,006 | ) | | | (110,411 | ) | | | (180,910 | ) |
| Deferred federal income tax expense/(benefit) | | | (27 | ) | | | (1,299 | ) | | | 499 | |
| Decrease in accrued interest receivable and other assets | | | (860 | ) | | | 4,513 | | | | 6,042 | |
| Increase/(decrease) in accrued interest payable and other liabilities | | | 1,886 | | | | (1,007 | ) | | | (2,595 | ) |
| NET CASH FROM OPERATING ACTIVITIES | | | 23,193 | | | | 28,882 | | | | 25,619 | |
| | | | | | | | | | | | | |
| INVESTING ACTIVITIES | | | | | | | | | | | | |
| Proceeds from sales of securities available for sale | | | 2,780 | | | | 2,190 | | | | 7,420 | |
| Proceeds from maturities of CDs | | | 1,505 | | | | 0 | | | | 0 | |
| Proceeds from maturities and calls of securities available for sale | | | 136,526 | | | | 128,048 | | | | 112,836 | |
| Purchase of securities available for sale | | | (153,775 | ) | | | (210,398 | ) | | | (229,458 | ) |
| Redemption of Federal Home Loan Bank stock | | | 0 | | | | 937 | | | | 881 | |
| Net decrease in portfolio loans | | | 8,632 | | | | 28,015 | | | | 69,346 | |
| Proceeds from sale of other real estate owned | | | 5,873 | | | | 6,850 | | | | 6,645 | |
| Net purchases of premises and equipment | | | (1,184 | ) | | | (1,718 | ) | | | (2,272 | ) |
| NET CASH FROM/(USED IN) INVESTING ACTIVITIES | | | 357 | | | | (46,076 | ) | | | (34,602 | ) |
| | | | | | | | | | | | | |
| FINANCING ACTIVITIES | | | | | | | | | | | | |
| Net increase in deposits | | | 20,859 | | | | 36,759 | | | | 34,720 | |
Net increase/(decrease) in securities sold under agreements to repurchase and overnight borrowings | | | (3,999 | ) | | | 5,456 | | | | 1,919 | |
| Repayment of Federal Home Loan Bank borrowings | | | (7,964 | ) | | | (24,201 | ) | | | (68,605 | ) |
| Proceeds from Federal Home Loan Bank borrowings | | | 11,000 | | | | 3,000 | | | | 9,000 | |
| Repurchase of preferred stock | | | (15,056 | ) | | | 0 | | | | 0 | |
| Repurchase of stock warrants | | | (1,947 | ) | | | 0 | | | | 0 | |
| Cash proceeds from issuance of common stock | | | 903 | | | | 421 | | | | 392 | |
| Cash dividends on preferred stock | | | (1,247 | ) | | | (1,650 | ) | | | (1,650 | ) |
| Cash dividends on common stock | | | (2,314 | ) | | | (313 | ) | | | (620 | ) |
| NET CASH FROM/(USED IN) FINANCING ACTIVITIES | | | 235 | | | | 19,472 | | | | (24,844 | ) |
| | | | | | | | | | | | | |
| INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS | | | 23,785 | | | | 2,278 | | | | (33,827 | ) |
| Cash and cash equivalents at beginning of year | | | 75,816 | | | | 73,538 | | | | 107,365 | |
| | | | | | | | | | | | | |
| CASH AND CASH EQUIVALENTS AT END OF YEAR | | $ | 99,601 | | | $ | 75,816 | | | $ | 73,538 | |
| | | | | | | | | | | | | |
| Supplemental disclosure of cash flow information: | | | | | | | | | | | | |
| Cash paid during the year for: | | | | | | | | | | | | |
| Interest | | $ | 8,677 | | | $ | 13,539 | | | $ | 21,597 | |
| Income taxes | | $ | 4,800 | | | $ | 1,975 | | | $ | 855 | |
| | | | | | | | | | | | | |
| Non cash transfer of loans to other real estate owned | | $ | 4,214 | | | $ | 5,948 | | | $ | 10,167 | |
See notes to consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 – SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations: Firstbank Corporation (the “Company”) is a bank holding company. Each of our subsidiary banks is a full service community bank. The subsidiary banks offer all customary banking services, including the acceptance of checking, savings and time deposits, and the making of commercial, agricultural, real estate, personal, home improvement, automobile and other installment and consumer loans. Our consolidated assets were, $1.5 billion as of December 31, 2012, and primarily represent commercial and retail banking activity. Mortgage loans serviced for others of $608 million, as of December 31, 2012, are not included in the consolidated balance sheet.
Principles of Consolidation: The consolidated financial statements include the accounts of the Company and its subsidiaries, Firstbank – Alma; Firstbank (Mt. Pleasant); Firstbank – West Branch; Keystone Community Bank and Firstbank – West Michigan (the “Banks”); 1st Armored, Incorporated (sold March 31, 2010); 1st Title, Incorporated; 1st Investors Title, LLC; Austin Mortgage Company; and FBMI Risk Management Services, Inc., after elimination of inter-company accounts and transactions. These subsidiaries are wholly owned, except 1st Investors Title, LLC, which we held a 46% share at December 31, 2012. We do not consolidate their results into the results of the Company. Firstbank – St Johns was merged into Firstbank - Alma in 2011. Each of our five banks operates its own Mortgage Company. The operating results of these companies are consolidated into each Bank’s financial statements. During 2004 we formed a special purpose trust, Firstbank Capital Trust I, in 2006 we formed Firstbank Capital Trust II, and in 2007 we formed Firstbank Capital Trust III and Firstbank Capital Trust IV, for the sole purpose of issuing trust preferred securities. These trusts are not consolidated into our financial statements.
Use of Estimates: The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period. Actual results could differ from those estimates.
Investments: Investments are presented at fair value as required by accounting principles. Our investment portfolio is classified as available for sale, as such; adjustments to the fair value are reported as a change in equity. If a security is deemed to be other than temporarily impaired, the adjustment to fair value is recorded through the income statement.
Certain Significant Estimates: The primary estimates incorporated into our financial statements, which are susceptible to change in the near term, include the allowance for loan losses, the determination of the fair value of certain financial instruments, fair value of investments, determination of state and federal tax assets and liabilities, goodwill, purchase accounting and core deposit intangible valuations, valuation of other real estate owned, and the valuation of mortgage servicing rights.
Current Vulnerability Due to Certain Concentrations: Our business is concentrated in the mid-central and southwestern sections of the lower peninsula of Michigan. While the loan portfolio is diversified, the customers’ ability to honor their debts is partially dependent on the local economies. Our service area is primarily dependent on manufacturing (automotive and other), agricultural and recreational industries. Most commercial and agricultural loans are secured by business assets, including commercial and agricultural real estate and federal farm agency guarantees. Generally, consumer loans are secured by various items of personal property and mortgage loans are secured by residential real estate. Our funding sources include time deposits and other deposit products which bear interest. Periods of rising interest rates result in an increase in our cost of funds and an increase in the yields on certain assets. Conversely, periods of falling interest rates result in a decrease in yields on certain assets and costs of certain funds.
Cash and Cash Equivalents: Cash and cash equivalents include cash on hand, amounts due from banks and short term investments with an original maturity of 90 days or less, which include interest bearing deposits with banks and the Federal Reserve, federal funds sold, and overnight money market fund investments. Generally, federal funds and overnight money market funds are purchased for a one day period. We report customer loan transactions, deposit transactions and repurchase agreements and overnight borrowings on a net basis within our cash flow statement.
Trading Account Securities: From time to time, we invest in the common stock of other companies. Trading account securities are adjusted to fair value through the income statement, with increases in value reflected as non-interest income and decreases in value reflected as a decrease to non-interest income.
Securities Available for Sale: Securities available for sale consist of bonds and notes which might be sold prior to maturity due to changes in interest rate, prepayment risks, yield and availability of alternative investments, liquidity needs or other factors. Securities classified as available for sale are reported at their fair value and the related unrealized holding gain or loss (the difference between the fair value and amortized cost of the securities so classified) is reported in other comprehensive income. Other securities such as Federal Home Loan Bank stock are carried at cost. Interest income includes amortization of purchase premium or discount. Premiums and discounts on securities are amortized on the level-yield method. Gains and losses on sales are recorded on the trade date and are determined using the specific identification method.
Declines in the fair value of securities below their cost that are other than temporary are reflected as realized losses. In estimating other-than-temporary losses, management considers: (1) the length of time and extent that fair value has been less than carrying value; (2) the financial condition and near term prospects of the issuer; and (3) the Company’s ability and intent to hold the security for a period of time sufficient to allow for any anticipated recovery in fair value.
Mortgage Banking Activities: Servicing rights are recognized as assets based on the allocated value of retained servicing rights on loans sold. Servicing rights are expensed in proportion to, and over the period of, estimated net servicing revenues. Impairment is evaluated based on the fair value of the rights, using groupings of the underlying loans as to interest rates. Any impairment of a grouping is reported as a valuation allowance.
Servicing fee income is recorded for fees earned for servicing loans. The fees are based on a contractual percentage of the outstanding principal or a fixed amount per loan and are recorded as income when earned. Amortization of mortgage serving rights is netted against loan servicing fee income in the income statement.
Mortgage Derivatives: From time to time, we enter into mortgage banking derivatives such as forward contracts and rate lock commitments in the ordinary course of business. The derivatives are not designated as hedges and are carried at fair value. The net gain or loss on mortgage banking derivatives is included in gain on sale of loans.
Loans Held for Sale: Mortgage loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or market, as determined by outstanding commitments from investors. Net unrealized losses, if any, are recorded as a valuation allowance and charged to earnings.
Mortgage loans held for sale are generally sold with servicing rights retained. Gains and losses on sales of mortgage loans are based on the difference between the selling price and the carrying value of the related loan sold, which is reduced by the cost allocated to the servicing right. We generally lock in the sale price to the purchaser of the loan at the same time we make a rate commitment to the borrower.
Loans: Loans receivable, for which management has the intent and ability to hold for the foreseeable future or payoff are reported at their outstanding unpaid principal balances, net of any deferred fees or costs on originated loans, unamortized premiums or discounts. Loan origination fees and certain origination costs are capitalized and recognized as an adjustment to yield of the related loan. Interest income is reported on the interest method and includes amortization of net deferred loan fees and costs over the loan term without anticipating prepayments. Interest income on mortgage and commercial loans is discontinued at the time the loan becomes 90 days delinquent unless the credit is well secured and in process of collection. Consumer and unsecured consumer line of credit loans are typically charged off no later than 120 days past due. Loans are placed on nonaccrual or charged off at an earlier date if collection of principal or interest is considered doubtful.
All interest accrued, but not received, for loans placed on nonaccrual status, is reversed against interest income. Interest received on such loans is accounted for on the cash-basis or cost-recovery method until qualifying for return to accrual. Loans are returned to accrual status when all of the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
Loans classified as troubled debt restructurings (TDR’s) are accounted for in generally the same manner as all other loans. Troubled debt restructuring of loans is undertaken to improve the likelihood that the loan will be repaid in full under the modified terms in accordance with a reasonable repayment schedule. All modified loans are evaluated to determine whether the loans should be reported as a TDR. A loan is a TDR when we, for economic or legal reasons related to the borrower’s financial difficulties, grant a concession to the borrower by modifying or renewing a loan that we would not otherwise consider. To make this determination, we must determine whether (1) the borrower is experiencing financial difficulties and (2) we have granted the borrower a concession. This determination requires consideration of all of the facts and circumstances surrounding the modification. An overall general decline in the economy or some deterioration in a borrower’s financial condition does not automatically mean the borrower is experiencing financial difficulties.
If the loan is in accrual status at the time of the restructuring, the borrower has the ability to make the payments under the restructured terms, and the restructuring does not forgive principal, the loan remains on an accrual basis under the new terms. If there is a forgiveness of debt or partial charge off, the loan will generally be placed on nonaccrual status with any accrued interest reversed against interest income. If a loan is in nonaccrual status at the time of a restructuring or subsequently becomes nonaccrual, it will remain in nonaccrual status until the borrower has demonstrated the ability to make the payments under the restructured terms by making a minimum of six monthly payments. If the borrower makes the six monthly payments without becoming past due 30 days or more, it may be returned to accrual status. The determination of the need for an allowance for loan loss adjustment is based on the sum of: (1) a factor relating to historical losses multiplied times the balance of the loan, and (2) a net present value adjustment relating to a change in interest rate, if applicable. The amount recorded in the allowance for loan losses for restructured loans during the years ended December 31, 2012 and 2011 was $2.3 million and $591,000, respectively. Restructured loans charged off were $1.7 million in 2012 and $2.4 million in 2011.
Allowance for Loan Losses: The allowance for loan losses is a valuation allowance for probable incurred credit losses. Management uses a quantitative and qualitative methodology for analyzing factors which impact the allowance for loan losses consistently across its banking subsidiaries. The process applies risk factors for historical charge-offs and delinquency experience, portfolio segment weightings and industry and regional factors and trends as they affect the banks’ portfolios. Consideration of exposures to industries potentially most affected by risks in the current economic and political environment, and the review of potential risks in certain credits that are considered part of the non-performing loan category contributed to the establishment of the allowance levels at each bank. Loan losses are charged off against the allowance when management believes the uncollectibility of a loan balance is confirmed.
Loans are reviewed on an ongoing basis for impairment. A loan is impaired when it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impaired loans are measured based on the present value of expected cash flows discounted at the loan’s effective interest rate or, as a practical expedient, the fair value of collateral, if the loan is collateral dependent. Loans considered to be impaired are reduced to the present value of expected future cash flows or to the fair value of collateral by allocating a portion of the allowance for loan losses to such loans. If these allocations cause an increase in the allowance for loan losses such increase is reported as provision for loan loss through the income statement. Increases or decreases in carrying value due to changes in estimates of future payments or the passage of time are reported as reductions or increases in the provision for loan losses.
Smaller balance homogeneous loans such as residential first mortgage loans secured by one to four family residences, residential construction, automobile, home equity and second mortgage loans, are collectively evaluated for impairment. Commercial loans and first mortgage loans secured by other properties are evaluated individually for impairment. When credit analysis of the borrower’s operating results and financial condition indicates the underlying ability of the borrower’s business activity is not sufficient to generate adequate cash flow to service the business’ cash needs, including our loans to the borrower, the loan is evaluated for impairment. Often this is associated with a delay or shortfall in payments of 90 days or less. Commercial and commercial real estate loans are rated on a scale of 1 to 10, with grades 1 to 4 being pass grades, 5 watch, 6 special mention, 7 substandard, 8 impaired, 9 doubtful and 10 loss. Loans graded 6, 7, and 8 are reviewed for possible impairment at least quarterly. Loans are generally moved to nonaccrual status when 90 days or more past due and considered impaired. Impaired loans, or portions thereof, are charged off when deemed uncollectible. For a more complete explanation of our loan grading system, see Note 6.
Premises and Equipment: Premises and equipment are stated on the basis of cost less accumulated depreciation. Depreciation is computed over the estimated useful lives of the assets, primarily by accelerated methods for income tax purposes and by the straight line method for financial reporting purposes. Buildings and related components are assigned useful lives ranging from 5 to 33 years. Furniture, fixtures and equipment are assigned useful lives ranging from 3 to 10 years.
Other Real Estate Owned: Other real estate owned includes properties acquired through either a foreclosure proceeding or acceptance of a deed in lieu of foreclosure and is initially recorded at the fair value less estimated carrying and selling costs when acquired, establishing a new cost basis. These properties are evaluated periodically and, if fair value is deemed to have declined subsequent to foreclosure, a valuation allowance is recorded through noninterest expense. Costs incurred for the property after foreclosure are expensed as incurred. Other real estate owned totaled approximately $2.9 million and $5.3 million at December 31, 2012 and 2011. Gains and losses on the sale of other real estate owned are recorded on the income statement as other income.
The following table summarizes the activity associated with other real estate owned during the years ended December 31:
| (In Thousands of Dollars) | | 2012 | | | 2011 | |
| Balance at beginning of year | | $ | 5,251 | | | $ | 8,316 | |
| Properties transferred into OREO | | | 4,214 | | | | 5,948 | |
| Valuation impairments recorded | | | (1,151 | ) | | | (2,258 | ) |
| Proceeds from sale of properties | | | (5,873 | ) | | | (6,850 | ) |
| Gain on sale of properties | | | 484 | | | | 95 | |
| Balance at end of year | | $ | 2,925 | | | $ | 5,251 | |
Goodwill and Other Intangible Assets: Goodwill results from business acquisitions and represents the excess of the purchase price over the fair value of acquired tangible assets and liabilities and identifiable intangible assets. Goodwill is assessed at least annually for impairment and any such impairment is recognized in the period identified. A more frequent assessment is performed if conditions in the market place or changes in the company’s organizational structure occur. We use a discounted income approach and a market valuation model, which compares the inherent value of our company to valuations of recent transactions in the market place to determine if our goodwill has been impaired. See Note 8 for additional information.
Other intangible assets consist of core deposit intangibles arising from whole bank and branch acquisitions. They are initially measured at fair value and then are amortized on an accelerated method over their estimated useful lives.
Long Term Assets: Premises and equipment, core deposit and other intangible assets, and other long-term assets are reviewed for impairment when events indicate their carrying amount may not be recoverable from future undiscounted cash flows. If impaired, a charge is taken to earnings, and the assets are written down to new estimate of fair value.
Loan Commitments and Related Financial Instruments: Financial instruments include off-balance sheet credit instruments, such as commitments to make loans and commercial letters of credit, issued to meet customer financing needs. The face amount for these items represents the exposure to loss, before considering customer collateral or ability to repay. Such financial instruments are recorded when they are funded.
Income Taxes: We record income tax expense based on the amount of taxes due on our tax return plus the change in deferred taxes, computed based on the future tax consequences of temporary differences between the carrying amounts and tax bases of assets and liabilities using enacted tax rates. A valuation allowance is recorded, if needed, and reduces deferred tax assets to the amount expected to be realized.
Earnings Per Share: Basic earnings per share is calculated by dividing net income available for common shareholders (net income less preferred stock dividends and accretion of the preferred stock discount) by the weighted average number of common shares outstanding. Diluted earnings per share is calculated by dividing net income available for common shareholders by the weighted average common shares outstanding including the dilutive effect of additional common shares that may be issued under outstanding stock options and warrants.
Comprehensive Income: Comprehensive income consists of net income and changes in unrealized gains and losses on securities available for sale, net of tax, which is recognized as a separate component of equity. Accumulated other comprehensive income consists of unrealized gains and losses on securities available for sale, net of tax.
Recent Accounting Pronouncements: During 2012, the Company adopted new guidance related to the presentation of comprehensive income in the financial statements. Among other changes, the new guidance eliminated the option to only present comprehensive income in the statement of equity. We have elected to report comprehensive income in a separate statement of comprehensive income that begins with net income. The change in presentation has been applied retrospectively and the 2011 financial statements have been restated to conform to the new presentation method. Other than the change in presentation of comprehensive income and related disclosures, the new guidance did not have a material effect on the financial statements.
In 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2011-02, A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring. This update applies to all creditors, both public and non-public, and was introduced to provide clarification surrounding troubled debt restructurings (“TDR”). The primary characteristics that previously caused a restructuring to qualify as a TDR still exist: (1) the restructuring constitutes a concession to the borrower and (2) the borrower is experiencing financial difficulties. The update provides additional details and examples to provide clarity surrounding these items. The update also prohibits the use of the effective interest rate test when determining whether the restructuring constitutes a concession. The update is effective for annual reporting periods ending on or after December 15, 2012 (therefore, December 31, 2012, for the Corporation). Lastly, the disclosure requirements set forth by ASU 2010-20 regarding troubled debt restructurings, and later deferred by ASU 2011-01 until December 31, 2012 for the Company, are included in Note 6. Other than the additional disclosures, these updates did not have a significant impact on the financial statements.
In 2011, the FASB issued ASU No. 2011-04, Fair Value Measurement (Topic 820) - Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS. This update to Fair Value Measurement (Topic 820) results in common fair value measurement and disclosure requirements in U.S. GAAP and IFRS. The amendments in this update explain how to measure fair value. They do not require additional fair value measurements and are not intended to establish valuation standards or affect valuation practices outside of financial reporting. However, this update does require expanded disclosure related to the nature and significance of inputs that are used in estimating and measuring the fair value of financial instruments. The amendments in this update are to be applied prospectively and are effective for annual reporting periods beginning after December 15, 2011 (therefore, December 31, 2012, for the Corporation). This update did not have a significant impact on the financial statements.
Effect of Newly Issued Accounting Standards: There are no newly issued and not yet effective accounting standards at this time.
Loss Contingencies: Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. Management does not believe there are such matters that will have a material effect on the financial statements as of December 31, 2012.
Fair Value of Financial Instruments: Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in a separate note. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates.
Reclassification: Certain 2010 and 2011 amounts may have been reclassified to conform to the 2012 presentation.
Operating Segments: While the chief decision-makers monitor the revenue streams of the various products and services, operations are managed and financial performance is evaluated on a company wide basis. Operating segments are aggregated into one as operating results for all segments are similar. Accordingly, all of the financial service operations are considered by management to be aggregated in one reportable operating segment.
NOTE 2 – ACQUISITIONS AND DIVESTITURES
On March 31, 2010, we sold our 1st Armored, Inc. armored car company. No gain or loss was recorded on the transaction. Historical earnings from 1st Armored, Inc. are included in the financial statements presented through the date of its sale within this report. Financial results subsequent to March 31, 2010 are excluded for 1st Armored, Inc. as the sale transaction was completed on that date.
NOTE 3 – RESTRICTIONS ON CASH AND DUE FROM BANKS
Our subsidiary banks are required to maintain average reserve balances in the form of cash and non-interest bearing balances due from the Federal Reserve Bank. The average reserve balances required to be maintained during 2012 and 2011 were $17.8 million and $14.6 million, respectively. These balances earned interest at a rate of 0.25% during both 2012 and 2011.
NOTE 4 – SECURITIES
The fair value of securities available for sale was as follows:
| (In Thousands of Dollars) | | Amortized Cost | | | Gross Unrealized Gains | | | Gross Unrealized Losses | | | Carrying Value | |
| Securities Available for Sale: | | | | | | | | | | | | |
| December 31, 2012: | | | | | | | | | | | | |
| U.S. governmental agency | | $ | 105,629 | | | $ | 1,271 | | | $ | (15 | ) | | $ | 106,885 | |
| States and political subdivisions | | | 116,123 | | | | 1,786 | | | | (95 | ) | | | 117,814 | |
| Mortgage Backed Securities | | | 64,550 | | | | 1,729 | | | | (2 | ) | | | 66,277 | |
| Collateralized Mortgage Obligations | | | 60,278 | | | | 810 | | | | (58 | ) | | | 61,030 | |
| Equity and other Securities | | | 1,610 | | | | 62 | | | | 0 | | | | 1,672 | |
| Total | | $ | 348,190 | | | $ | 5,658 | | | $ | (170 | ) | | $ | 353,678 | |
| | | | | | | | | | | | | | | | | |
| December 31, 2011: | | | | | | | | | | | | | | | | |
| U.S. governmental agency | | $ | 132,534 | | | $ | 1,325 | | | $ | (25 | ) | | $ | 133,834 | |
| States and political subdivisions | | | 76,574 | | | | 1,238 | | | | (23 | ) | | | 77,789 | |
| Mortgage Backed Securities | | | 70,059 | | | | 1,080 | | | | (87 | ) | | | 71,052 | |
| Collateralized Mortgage Obligations | | | 57,006 | | | | 854 | | | | (15 | ) | | | 57,845 | |
| Equity and other Securities | | | 1,606 | | | | 58 | | | | 0 | | | | 1,664 | |
| Total | | $ | 337,779 | | | $ | 4,555 | | | $ | (150 | ) | | $ | 342,184 | |
Securities with unrealized losses at year end 2012 and 2011 not recognized in income are as follows:
| (In Thousands of Dollars) | | Less than 12 Months | | | 12 Months or More | | | Total | |
| Description of Securities | | Fair Value | | | Unrealized Loss | | | Fair Value | | | Unrealized Loss | | | Fair Value | | | Unrealized Loss | |
| December 31, 2012: | | | | | | | | | | | | | | | | | | |
| U.S. governmental agency | | $ | 10,135 | | | $ | (15 | ) | | $ | 0 | | | $ | 0 | | | $ | 10,135 | | | $ | (15 | ) |
| States and political subdivisions | | | 17,141 | | | | (93 | ) | | | 582 | | | | (2 | ) | | | 17,723 | | | | (95 | ) |
| Mortgage Backed Securities | | | 0 | | | | 0 | | | | 513 | | | | (2 | ) | | | 513 | | | | (2 | ) |
| Collateralized Mortgage Obligations | | | 19,995 | | | | (55 | ) | | | 721 | | | | (3 | ) | | | 20,716 | | | | (58 | ) |
| Total Temporarily Impaired | | $ | 47,271 | | | $ | (163 | ) | | $ | 1,816 | | | $ | (7 | ) | | $ | 49,087 | | | $ | (170 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2011: | | | | | | | | | | | | | | | | | | | | | | | | |
| U.S. governmental agency | | $ | 0 | | | $ | 0 | | | $ | 17,974 | | | $ | (25 | ) | | $ | 17,974 | | | $ | (25 | ) |
| States and political subdivisions | | | 3,738 | | | | (2 | ) | | | 2,249 | | | | (21 | ) | | | 5,987 | | | | (23 | ) |
| Mortgage Backed Securities | | | 0 | | | | 0 | | | | 18,091 | | | | (87 | ) | | | 18,091 | | | | (87 | ) |
| Collateralized Mortgage Obligations | | | 0 | | | | 0 | | | | 6,590 | | | | (15 | ) | | | 6,590 | | | | (15 | ) |
| Total Temporarily Impaired | | $ | 3,738 | | | $ | (2 | ) | | $ | 44,904 | | | $ | (148 | ) | | $ | 48,642 | | | $ | (150 | ) |
Unrealized losses on securities shown in the previous tables have not been recognized into income because management has the intent and ability to hold these securities for the foreseeable future. The decline in market value is due to changes in interest rates for debt securities and considered normal market fluctuations for equity securities. Management has also reviewed the issuers’ bond ratings, noting they are of high credit quality.
Trading account securities are marked to market with the change in value reported on the income statement. Gains and losses on available for sale securities are recognized if the security is either deemed to be other than temporarily impaired, or the security is sold. During 2010 we sold one security that was other than temporarily impaired and recognized a $26,000 loss. Due to continuing problems with another security, we recorded an additional charge for other than temporary impairment of $150,000 bringing the carrying value of that security to zero. Both of these securities were trust preferred securities of Michigan banks that had a combined original book value of $500,000. The following table shows gross gains and losses on investment securities for the three year period:
| (In Thousands of Dollars) | | 2012 | | | 2011 | | | 2010 | |
| Trading Account Securities Gains/(Losses) | | $ | 4 | | | $ | (11 | ) | | $ | 3 | |
| | | | | | | | | | | | | |
| Available for Sale Securities | | | | | | | | | | | | |
| Other than temporary impairment losses | | $ | 0 | | | $ | 0 | | | $ | (150 | ) |
| Gross realized gains | | | 44 | | | | 28 | | | | 200 | |
| Gross realized losses | | | 0 | | | | (65 | ) | | | (46 | ) |
| Net realized gains (losses) | | $ | 44 | | | $ | (37 | ) | | $ | 4 | |
The fair value of securities at December 31, 2012, by stated maturity, is shown below. Actual maturities may differ from stated maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.
| (In Thousands of Dollars) | | Fair Value | |
| Due in one year or less | | $ | 93,182 | |
| Due after one year through five years | | | 109,398 | |
| Due after five years through ten years | | | 75,022 | |
| Due after ten years | | | 74,404 | |
| Total | | | 352,006 | |
| | | | | |
| Equity securities | | | 1,672 | |
| Total securities | | $ | 353,678 | |
At December 31, 2012 and 2011, securities with carrying values approximating $45,645,000 and $46,784,000 were pledged to secure public trust deposits, securities sold under agreements to repurchase, and for such other purposes as required or permitted by law.
Federal Home Loan Bank stock is carried at cost, which approximates its fair value.
NOTE 5 – LOAN SERVICING
Loans held for sale at year end are as follows:
| (In Thousands of Dollars) | | | |
| | | 2012 | | | 2011 | |
| Loans held for sale | | $ | 2,921 | | | $ | 349 | |
| Less: Allowance to adjust to lower of cost or market | | | 0 | | | | 0 | |
| Loans held for sale, net | | $ | 2,921 | | | $ | 349 | |
Mortgage loans serviced for others are not reported as assets. The principal balances of these loans at year end are as follows:
| (In Thousands of Dollars) | | | |
| | | 2012 | | | 2011 | |
| Mortgage loan portfolios serviced for: | | | | | | |
| Freddie Mac | | $ | 605,000 | | �� | $ | 601,710 | |
| Fannie Mae | | $ | 1,140 | | | $ | 1,446 | |
| Federal Home Loan Bank | | $ | 2,094 | | | $ | 2,757 | |
Custodial escrow balances maintained in connection with serviced loans were $1,433,000 and $1,438,000 at year end 2012 and 2011.
Activity for capitalized mortgage servicing rights, included in other assets on the Consolidated Balance Sheet, was as follows:
| (In Thousands of Dollars) | | | |
| | | 2012 | | | 2011 | | | 2010 | |
| Servicing rights: | | | | | | | | | |
| Beginning of year | | $ | 4,596 | | | $ | 4,603 | | | $ | 3,705 | |
| Additions | | | 2,512 | | | | 1,505 | | | | 2,428 | |
| Amortized to expense | | | (2,115 | ) | | | (1,512 | ) | | | (1,530 | ) |
| End of year | | $ | 4,993 | | | $ | 4,596 | | | $ | 4,603 | |
Management has determined that no valuation allowance was necessary at December 31, 2012, 2011, or 2010.
The fair value of mortgage servicing rights was $5,494,000 and $6,034,000 at year end 2012 and 2011. Fair value at the end of 2012 was determined using a discount rate of 7.018%, a weighted average constant prepayment rate of 17.01%, depending on the stratification of the specific right, and a weighted average delinquency rate of 1.01%. At the end of 2011, fair value was determined using a discount rate of 7.375%, a weighted average constant prepayment rate of 14.79%, depending on the stratification of the specific right, and a weighted average delinquency rate of 1.09%
The weighted average amortization period is 3.6 years as of December 31, 2012. Estimated amortization expense for each of the next five years is:
| (In Thousands of Dollars) | |
| 2013 | | $ | 1,152 | |
| 2014 | | $ | 949 | |
| 2015 | | $ | 797 | |
| 2016 | | $ | 660 | |
| 2017 | | $ | 530 | |
| Thereafter | | $ | 905 | |
NOTE 6 – LOANS
The following information provides a description of how loan grades are determined for our Commercial and Industrial and Commercial Real Estate segments. In general, for Commercial and Industrial, and Commercial Real Estate segments, the probability of loss increases with each rate change from the Grade 1 Excellent down through the Grade 9 Doubtful Nonaccrual classes. For Consumer and Residential Mortgage segments, the probability of loss increases as loans move down from current to greater than 60 days past due, nonaccrual.
Grade 1 Excellent – Characteristics of loans in this category include: the loan is generally secured by cash or readily marketable securities; the borrower provides annual audited financials with interim financials reviewed quarterly; the loan has no delinquencies over ten days in the past year; the company’s management is considered to have a high degree of integrity; management of the company has over 15 years of experience; lines of credit have not and are not expected to be utilized; financial statements demonstrate consistently strong profits; and the company has little competition and excellent growth prospects.
Grade 2 Quality – Characteristics of loans in this category include: high net worth borrowers with excellent cash flow and a high degree of liquidity; the borrower generally has annual audited financial statements; there has been one or fewer delinquencies over ten days in the past year; the company’s management is considered to have a high degree of integrity; the company’s management has over ten years of experience; lines of credit have had nominal use over the preceding 12 months; financial statements demonstrate consistent profitability; and the company is in an excellent competitive position.
Grade 3 Good – Loans in this category are very strong, but may lack some of the net worth and/or cash flow characteristics of the previous rating. Characteristics of loans in this category include: annual reviewed financial statements and compiled quarterly financial statements; there has only been one or fewer delinquencies over 15 days in the past year; the company’s management has solid integrity; the company’s management is capable and has over five years of experience; lines of credit have regular usage with no balance in the last 60 days; financial statements demonstrate consistent but nominal profits; and the company has good a solid market share.
Grade 4 Acceptable – Characteristics of loans in this category include: annual compiled financial statements with quarterly information available or CPA prepared tax returns; there are only two or fewer delinquencies over 15 days of which only one is over 30 days in the past year; the company’s management has average business experience of over three years; lines of credit have regular use but have no current balance or a significant reduction in balance in the last 30 days; the company has been profitable in two of the preceding three years; and the company is competitive in its market and is maintaining its market share.
Loans graded as one through four are considered as Pass loans and are shown as one class of loans in our credit quality table.
Grade 5 Watch - This rating is used for loans which have shown some sign of weakness, but have not degraded to the point of requiring an impairment review. Characteristics of loans in this rating include: annual management prepared financial statements; delinquencies not exceeding three times over 30 days or one time over 60 days in the past year; weakening financial statements but profitable in two of the last three years; and a declining market share in a competitive market. These loans merit monitoring by management to assure that if circumstances deteriorate further actions are taken to protect the bank’s position.
Grade 6 Special Mention - This rating is used for loans which are included on a watch list and have degraded to a point where additional supervision is required; however, the bank remains confident in the full collection of all principal and interest. These loans are reviewed for impairment on a quarterly basis. Characteristics of loans in this rating may include: repeat delinquency; longer term negative trends in financial results; continuing deterioration of cash flows; concerns regarding the liquidity of guarantors; and other negative business trends.
Grade 7 Substandard - This rating is for loans for which a lender is actively working with the borrower to resolve issues and the full repayment of the loan is questionable. The loan is inadequately protected by current sound worth of the borrower, paying capacity of the guarantor, or pledged collateral. Loans in this grade have well defined weaknesses that jeopardize the full collectability of the loan and a distinct possibility of loss exists. These loans are reviewed for impairment on a quarterly basis. Characteristics of loans in this rating may include: persistent delinquency; poor financial results of the business; negative cash flow; the ability of guarantor(s) to provide support for the loan is questionable.
Grade 8 Impaired Nonaccrual - This rating is for loans which are considered impaired and classified as nonaccrual. Loans in this grade have all the weaknesses of those classified as substandard grade 7 above, with the added characteristic that, based upon currently known facts, the weaknesses make collection of all principal and interest due according to contractual terms unlikely. These loans are reviewed for impairment on a quarterly basis. Loans in this grade may be assigned an allocated reserve in the loan loss allowance analysis if a determination is made that the future cash flows or the value of the collateral do not support the current carrying value of the loan.
Grade 9 Doubtful Nonaccrual- This rating is for loans which are considered impaired and are classified as nonaccrual. Loans in this grade have all the weaknesses of those classified as impaired nonaccrual grade 8 above, with the added characteristic that the weaknesses make full collection through payment or liquidation of the collateral, based on currently known facts, highly questionable or improbable. These loans are reviewed for impairment on a quarterly basis. Loans in this grade may be assigned an allocated reserve in the loan loss allowance analysis if a determination is made that the future cash flows or the value of the collateral do not support the current carrying value of the loan.
Restructured Loans
Impaired Restructured and Accruing - Loans where the borrower is experiencing financial difficulty and the bank has granted a concession to the borrower. A concession may be: a reduction in the contractual interest rate below current market rates for loans of similar quality, a lengthening of the accrual time frame beyond normal market terms, a forgiveness of a portion of the outstanding principal, or acceptance of collateral in lieu of payment for a portion of the loan balance. If the loan is in accrual status at the time of the restructuring, the borrower has the ability to make the payments under the restructured terms, and the restructuring does not forgive principal, the loan remains on an accrual status under the new terms. However, if there is a forgiveness of debt or partial charge off, the loan will generally be graded as impaired nonaccrual (Grade 8) with any accrued interest reversed against interest income. If a loan is in nonaccrual status at the time of a restructuring, it will remain in nonaccrual status (Grade 8) at the time of restructuring. All non-accruing restructured loans remain in nonaccrual status until the borrower has demonstrated the ability to make the payments under the restructured terms by making a minimum of six months of payments. If the borrower makes the six months of payments without becoming past due 30 days or more, the loan may be returned to accrual status. The determination of the need for an allowance for loan loss adjustment is based on a factor relating to historical losses multiplied by the balance of the loan for residential mortgages, or a collateral impairment review for commercial loans, and a net present value adjustment relating to a change in interest rate and other terms, if applicable.
Impaired Restructured and Accruing loans are graded seven or better based on the above definitions. If a restructured loan is graded as eight or nine, it is reported as Impaired Nonaccrual, or Doubtful Nonaccrual, respectively.
For commercial loans graded eight and nine and consumer and residential mortgage loans reported in nonaccrual, interest income is generally not recognized until the loan improves and is returned to accrual status. In some cases, if the loan is well secured and the borrower’s ability to support the loan payments has improved, such as in the case of a restructured nonaccrual loan, interest income may be recognized on a cash basis while the loan is in nonaccrual status.
For Consumer and Residential Mortgage Loan segments, loans are classified by risk based on current delinquency and nonaccrual status. These segments of loans will contain a separate class for restructured loans, if they exist.
The following credit quality indicators provide a system for distribution of our loan portfolio in a manner consistent with the previously described loan grading system and for use in the determination of our loan loss allowance. This presentation differs somewhat by loan category from classification of loans presented elsewhere in our regulatory reports and within this report. These variations primarily relate to how real estate loans are analyzed internally to determine the adequacy of the loan loss allowance, versus how we are required to report real estate loans for regulatory purposes.
Credit Quality Indicators:
| Loans at period end were as follows: | | | |
| (In Thousands of Dollars) | | December 31, 2012 | | | December 31, 2011 | |
| Commercial and Industrial | | | | | | |
| Pass loans | | $ | 133,844 | | | $ | 122,812 | |
| Watch loans | | | 5,375 | | | | 19,542 | |
| Special mention loans | | | 5,433 | | | | 7,878 | |
| Substandard loans | | | 1,879 | | | | 2,928 | |
| Impaired restructured and accruing loans | | | 3,230 | | | | 3,562 | |
| Impaired nonaccrual loans | | | 447 | | | | 1,771 | |
| Total Commercial and Industrial | | | 150,208 | | | | 158,493 | |
| | | | | | | | | |
| Commercial Real Estate | | | | | | | | |
| Pass loans | | $ | 373,527 | | | $ | 373,320 | |
| Watch loans | | | 50,741 | | | | 56,571 | |
| Special mention loans | | | 18,119 | | | | 21,155 | |
| Substandard loans | | | 9,664 | | | | 5,686 | |
| Impaired restructured and accruing loans | | | 12,113 | | | | 10,652 | |
| Impaired nonaccrual loans | | | 8,429 | | | | 15,336 | |
| Doubtful nonaccrual loans | | | 25 | | | | 0 | |
| Total Commercial Real Estate | | | 472,618 | | | | 482,720 | |
| | | | | | | | | |
Residential Mortgages 1st Liens | | | | | | | | |
| Performing loans | | $ | 202,342 | | | $ | 199,117 | |
| Loans > 60 days past due | | | 1,046 | | | | 2,203 | |
| Impaired restructured and accruing loans | | | 4,953 | | | | 4,425 | |
| Nonaccrual loans | | | 6,038 | | | | 5,374 | |
| Total First lien residential mortgage loans | | | 214,379 | | | | 211,119 | |
| | | | | | | | | |
| Residential Mortgages Junior Liens | | | | | | | | |
| Performing loans | | $ | 58,089 | | | $ | 66,169 | |
| Loans > 60 days past due | | | 96 | | | | 328 | |
| Impaired restructured and accruing loans | | | 235 | | | | 278 | |
| Nonaccrual loans | | | 328 | | | | 278 | |
| Total Junior lien residential mortgage loans | | | 58,748 | | | | 67,053 | |
| | | | | | | | | |
| Consumer | | | | | | | | |
| Performing loans | | $ | 67,178 | | | $ | 64,075 | |
| Loans > 60 days past due | | | 39 | | | | 239 | |
| Impaired restructured and accruing loans | | | 191 | | | | 210 | |
| Nonaccrual loans | | | 401 | | | | 0 | |
| Total Consumer | | | 67,809 | | | | 64,524 | |
| | | | | | | | | |
| Total Loans | | $ | 963,762 | | | $ | 983,909 | |
Allowance for Loan Losses
The allowance for loan losses is determined based on management’s estimate of probable losses incurred within the loan portfolio as of the balance sheet date. We determine the amount of the allowance for loan losses based on periodic evaluation of the loan portfolios and other relevant factors. This evaluation is inherently subjective and requires material estimates, which are subject to change. Factors that are considered in the evaluation of individual, and pools of loans, include: historical loss experience; likelihood of default; liquidation value of a loan’s underlying collateral; timing and amounts of expected future cash flows; and our exposure to loss in the event of default. We further estimate the impact of qualitative factors that may cause future losses to differ from historical experience. Such factors include: changes in credit quality, macro economic impacts on our customers, and changes in underwriting standards.
Our historical loss experience is determined based on actual losses incurred over the previous twelve quarters. We utilize a method of averaging these losses whereby we place a heavier emphasis on more recent experience. Our model provides a 50% weighting on the most recent four quarters, 30% weighting on the middle four quarters, and 20% weighting on the oldest four quarters.
The loan portfolio is segmented into five loan types: commercial and industrial loans; commercial real estate loans; consumer loans; residential mortgages – first liens; and residential mortgage – junior liens. These segments are further grouped by credit quality classifications.
The segments comprising commercial and industrial loans and commercial real estate loans are classified based on the loan grading system described above. We group loans rated as one through four together into one class of Pass loans. Commercial and industrial and commercial real estate loans graded as Pass and Watch are assigned a unique pooled loss rate based on historical losses incurred over the prior three years as described above. We adjust the calculated historical loss rate up or down based on current developments, that in management’s judgment are not reflected in the historical losses of the company. The current outstanding balance for each of these classes of loans is then multiplied by the adjusted historical loss rate to determine the amount of allowance for loan losses to reserve on that pool of loans.
Loans graded special mention use a shorter 12 month loss history to determine the loss rate. Losses over the preceding 12 month period are divided by the average balance outstanding of substandard and impaired loans to determine a historical loss rate. That calculated historical loss rate is multiplied by a probability factor to determine a loss rate to be applied to this class of loans. The probability factor is determined from an analysis of the migration of special mention loans to more severe risk classes over the preceding 12 month period.
Loans graded as substandard use the shorter 12 month loss history to determine the loss rate. Losses over the preceding 12 month period are divided by the average balance outstanding of substandard and impaired loans to determine a historical loss rate. The calculated historical loss rate, without adjustment for migration, is then multiplied times the outstanding balance of substandard loans to determine the amount of allowance for loan losses to provide for this class of loans.
Loans graded as impaired nonaccrual, impaired doubtful, and impaired restructured and accruing are individually analyzed for loan losses. An allocated reserve is established within the allowance for loan losses for the difference between the carrying value of the loan and its determined collectable value. To determine the collectable value of the loan, the present value of expected cash flows, the collateral value, or some combination of the two is used. The allocated reserve is established as the difference between the carrying value of the loan and the collectable value.
For consumer and residential loan segments, loans that are current, or less than 60 days past due are assigned a unique historical loss rate as described above for commercial Pass and Watch loans. For loans that are more than 60 days past due including nonaccrual loans, a loss rate is determined based on charge offs within the last 12 months, divided by the sum of the average balance of loans 60 days or more past due and nonaccrual loans. These loss rates are multiplied by the outstanding balances in each unique loan segment at the end of the reporting period to determine the amount of allowance for loan loss.
For restructured loans where the bank has granted a rate concession, an additional amount is added to the loan loss reserve that represents the difference in the present value of the cash flows between the original terms and the new terms of the modified loan, using the original interest rate of the loan as a discount rate. Any change in the present value of the loan due to passage of time is reflected as an adjustment to provision for loan loss expense.
After each of the steps outlined above is completed, the results are aggregated and compared with the existing balance of the allowance for loan losses. If the aggregation is greater than the balance, the allowance for loan losses is increased through a charge to earnings on the provision for loan losses line. If the resulting aggregation is below the current balance of the allowance for loan losses, management will determine, based upon the number, potential impact, and uncertainty of the estimates contained within the process whether the unallocated reserve is excessive. If in management’s judgment the unallocated reserve exceeds a level deemed prudent given the inherent uncertainty of these issues, a reversal of the provision for loan losses may be recorded.
The following table provides a breakdown of our loan portfolio by the primary credit quality indicators we use in the determination of our allowance for loan losses.
Allowance for credit losses and recorded investment in financing receivables:
| (In Thousands of Dollars) | | | | | | | | | | | | | | | | | | | | | |
Twelve months ending December 31, 2012 | | Commercial and Industrial | | | Commercial Real Estate | | | First Lien Residential Mortgages | | | Junior Lien Residential Mortgages | | | Consumer Loans | | | Unallocated | | | Total | |
| Allowance for Credit Losses: | | | | | | | | | | | | | | | | | | | | | |
| Beginning balance | | $ | 2,485 | | | $ | 11,534 | | | $ | 5,393 | | | $ | 505 | | | $ | 931 | | | $ | 171 | | | $ | 21,019 | |
| Provision for loan losses | | | (104 | ) | | | 4,033 | | | | 2,225 | | | | 535 | | | | 309 | | | | 692 | | | | 7,690 | |
| Loans charged off | | | (560 | ) | | | (4,440 | ) | | | (2,220 | ) | | | (485 | ) | | | (727 | ) | | | 0 | | | | (8,432 | ) |
| Recoveries | | | 75 | | | | 438 | | | | 258 | | | | 0 | | | | 292 | | | | 0 | | | | 1,063 | |
| Ending balance | | $ | 1,896 | | | $ | 11,565 | | | $ | 5,656 | | | $ | 555 | | | $ | 805 | | | $ | 863 | | | $ | 21,340 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Ending balance: individually evaluated for impairment | | $ | 515 | | | $ | 2,971 | | | $ | 0 | | | $ | 0 | | | $ | 0 | | | $ | 0 | | | $ | 3,486 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Ending balance: collectively evaluated for impairment | | $ | 1,381 | | | $ | 8,594 | | | $ | 5,656 | | | $ | 555 | | | $ | 805 | | | $ | 863 | | | $ | 17,854 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Financing Receivables: | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Ending balance | | $ | 150,208 | | | $ | 472,618 | | | $ | 214,379 | | | $ | 58,748 | | | $ | 67,809 | | | $ | 0 | | | $ | 963,762 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Ending balance: individually evaluated for impairment | | $ | 3,677 | | | $ | 20,567 | | | $ | 0 | | | $ | 0 | | | $ | 0 | | | $ | 0 | | | $ | 24,244 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Ending balance: collectively evaluated for impairment | | $ | 146,531 | | | $ | 452,051 | | | $ | 214,379 | | | $ | 58,748 | | | $ | 67,809 | | | $ | 0 | | | $ | 939,518 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Twelve months ending December 31, 2011 | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Allowance for Credit Losses: | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Beginning balance | | $ | 3,024 | | | $ | 12,375 | | | $ | 3,960 | | | $ | 774 | | | $ | 1,162 | | | $ | 136 | | | $ | 21,431 | |
| Provision for loan losses | | | 1,836 | | | | 6,611 | | | | 4,468 | | | | 6 | | | | 381 | | | | 35 | | | | 13,337 | |
| Loans charged off | | | (2,546 | ) | | | (7,973 | ) | | | (3,215 | ) | | | (275 | ) | | | (913 | ) | | | 0 | | | | (14,922 | ) |
| Recoveries | | | 171 | | | | 521 | | | | 180 | | | | 0 | | | | 301 | | | | 0 | | | | 1,173 | |
| Ending balance | | $ | 2,485 | | | $ | 11,534 | | | $ | 5,393 | | | $ | 505 | | | $ | 931 | | | $ | 171 | | | $ | 21,019 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Ending balance: individually evaluated for impairment | | $ | 253 | | | $ | 3,622 | | | $ | 0 | | | $ | 0 | | | $ | 0 | | | $ | 0 | | | $ | 3,875 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Ending balance: collectively evaluated for impairment | | $ | 2,232 | | | $ | 7,912 | | | $ | 5,393 | | | $ | 505 | | | $ | 931 | | | $ | 171 | | | $ | 17,144 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Financing Receivables: | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Ending balance | | $ | 158,493 | | | $ | 482,720 | | | $ | 211,397 | | | $ | 66,775 | | | $ | 64,524 | | | $ | 0 | | | $ | 983,909 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Ending balance: individually evaluated for impairment | | $ | 5,331 | | | $ | 25,988 | | | $ | 0 | | | $ | 0 | | | $ | 0 | | | $ | 0 | | | $ | 31,319 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Ending balance: collectively evaluated for impairment | | $ | 153,162 | | | $ | 456,732 | | | $ | 211,397 | | | $ | 66,775 | | | $ | 64,524 | | | $ | 0 | | | $ | 952,590 | |
Twelve months ending December 31, 2010 | | Commercial and Industrial | | | Commercial Real Estate | | | First Lien Residential Mortgages | | | Junior Lien Residential Mortgages | | | Consumer Loans | | | Unallocated | | | Total | |
| Allowance for Credit Losses: | | | | | | | | | | | | | | | | | | | | | |
| Beginning balance | | $ | 3,640 | | | $ | 10,473 | | | $ | 2,502 | | | $ | 967 | | | $ | 1,525 | | | $ | 7 | | | $ | 19,114 | |
| Provision for loan losses | | | 812 | | | | 8,222 | | | | 3,844 | | | | (7 | ) | | | 344 | | | | 129 | | | | 13,344 | |
| Loans charged off | | | (1,707 | ) | | | (6,366 | ) | | | (2,602 | ) | | | (186 | ) | | | (1,102 | ) | | | 0 | | | | (11,963 | ) |
| Recoveries | | | 279 | | | | 46 | | | | 216 | | | | 0 | | | | 395 | | | | 0 | | | | 936 | |
| Ending balance | | $ | 3,024 | | | $ | 12,375 | | | $ | 3,960 | | | $ | 774 | | | $ | 1,162 | | | $ | 136 | | | $ | 21,431 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Ending balance: individually evaluated for impairment | | $ | 812 | | | $ | 4,688 | | | $ | 0 | | | $ | 0 | | | $ | 0 | | | $ | 0 | | | $ | 5,500 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Ending balance: collectively evaluated for impairment | | $ | 2,212 | | | $ | 7,687 | | | $ | 3,960 | | | $ | 774 | | | $ | 1,162 | | | $ | 136 | | | $ | 15,931 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Financing Receivables: | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Ending balance | | $ | 164,332 | | | $ | 509,285 | | | $ | 203,765 | | | $ | 76,293 | | | $ | 77,945 | | | $ | 0 | | | $ | 1,031,620 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Ending balance: individually evaluated for impairment | | $ | 1,972 | | | $ | 24,390 | | | $ | 0 | | | $ | 0 | | | $ | 0 | | | $ | 0 | | | $ | 26,362 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Ending balance: collectively evaluated for impairment | | $ | 162,360 | | | $ | 484,895 | | | $ | 203,765 | | | $ | 76,293 | | | $ | 77,945 | | | $ | 0 | | | $ | 1,005,258 | |
Age Analysis of Past Due Loans:
| (In thousands of dollars) | | | | | | | | | | | | | | | | | | | | | | | | |
| At December 31, 2012 | | 30-59 Days Past Due | | | 60-89 Days Past Due | | | 90 Days or More Past Due | | | Total Past Due | | | Nonaccrual loans | | | Current | | | Total Financing Receivables | | | Recorded Investment > 90 days and accruing | |
| Commercial and Industrial | | $ | 206 | | | $ | 140 | | | $ | 0 | | | $ | 346 | | | $ | 447 | | | $ | 149,415 | | | $ | 150,208 | | | $ | 0 | |
| Commercial Real Estate | | | 604 | | | | 1,881 | | | | 0 | | | | 2,485 | | | | 8,454 | | | | 461,679 | | | | 472,618 | | | | 0 | |
Residential Mortgages 1st Liens | | | 772 | | | | 969 | | | | 37 | | | | 1,778 | | | | 6,038 | | | | 206,563 | | | | 214,379 | | | | 37 | |
| Residential Mortgages Junior Liens | | | 473 | | | | 96 | | | | 0 | | | | 569 | | | | 328 | | | | 57,851 | | | | 58,748 | | | | 0 | |
| Consumer | | | 435 | | | | 39 | | | | 0 | | | | 474 | | | | 401 | | | | 66,934 | | | | 67,809 | | | | 0 | |
| Total | | $ | 2,490 | | | $ | 3,125 | | | $ | 37 | | | $ | 5,652 | | | $ | 15,668 | | | $ | 942,442 | | | $ | 963,762 | | | $ | 37 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| At December 31, 2011 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Commercial and Industrial | | $ | 1,039 | | | $ | 94 | | | $ | 0 | | | $ | 1,133 | | | $ | 1,771 | | | $ | 155,589 | | | $ | 158,493 | | | $ | 0 | |
| Commercial Real Estate | | | 4,313 | | | | 500 | | | | 0 | | | | 4,813 | | | | 15,336 | | | | 462,571 | | | | 482,720 | | | | 0 | |
Residential Mortgages 1st Liens | | | 973 | | | | 1,875 | | | | 328 | | | | 3,176 | | | | 5,374 | | | | 202,569 | | | | 211,119 | | | | 328 | |
| Residential Mortgages Junior Liens | | | 561 | | | | 255 | | | | 73 | | | | 889 | | | | 278 | | | | 65,886 | | | | 67,053 | | | | 73 | |
| Consumer | | | 848 | | | | 221 | | | | 18 | | | | 1,087 | | | | 210 | | | | 63,227 | | | | 64,524 | | | | 18 | |
| Total | | $ | 7,734 | | | $ | 2,945 | | | $ | 419 | | | $ | 11,098 | | | $ | 22,969 | | | $ | 949,842 | | | $ | 983,909 | | | $ | 419 | |
Impaired loans were as follows:
| (In Thousands of Dollars) | | | | | | |
| December 31, 2012 | | Recorded Investment | | | Unpaid Principal Balance | | | Related Allowance | |
| Period end loans with no allocated allowance for loan losses | | | | | | | | | |
| Commercial and Industrial | | $ | 891 | | | $ | 891 | | | $ | 0 | |
| Commercial Real Estate | | | 9,215 | | | | 9,212 | | | | 0 | |
Residential Mortgages 1st Liens | | | 10,993 | | | | 10,993 | | | | 0 | |
| Residential Mortgages Junior Liens | | | 562 | | | | 562 | | | | 0 | |
| Consumer | | | 592 | | | | 592 | | | | 0 | |
| Total | | $ | 22,253 | | | $ | 22,250 | | | $ | 0 | |
| | | | | | | | | | | | | |
| Period end loans with allocated allowance for loan losses | | | | | | | | | | | | |
| Commercial and Industrial | | $ | 2,273 | | | $ | 2,792 | | | $ | 515 | |
| Commercial Real Estate | | | 8,377 | | | | 11,346 | | | | 2,971 | |
Residential Mortgages 1st Liens | | | 0 | | | | 0 | | | | 0 | |
| Residential Mortgages Junior Liens | | | 0 | | | | 0 | | | | 0 | |
| Consumer | | | 0 | | | | 0 | | | | 0 | |
| Total | | $ | 10,650 | | | $ | 14,138 | | | $ | 3,486 | |
| | | | | | | | | | | | | |
| Total | | | | | | | | | | | | |
| Commercial and Industrial | | $ | 3,164 | | | $ | 3,683 | | | $ | 515 | |
| Commercial Real Estate | | | 17,592 | | | | 20,558 | | | | 2,971 | |
Residential Mortgages 1st Liens | | | 10,993 | | | | 10,993 | | | | 0 | |
| Residential Mortgages Junior Liens | | | 562 | | | | 562 | | | | 0 | |
| Consumer | | | 592 | | | | 592 | | | | 0 | |
| Total | | $ | 32,903 | | | $ | 36,388 | | | $ | 3,486 | |
| | | | | | | | | | | | | |
| December 31, 2011 | | | | | | | | | | | | |
| Period end loans with no allocated allowance for loan losses | | | | | | | | | | | | |
| Commercial and Industrial | | $ | 4,358 | | | $ | 5,846 | | | | 0 | |
| Commercial Real Estate | | | 11,940 | | | | 16,987 | | | | 0 | |
Residential Mortgages 1st Liens | | | 10,079 | | | | 11,120 | | | | 0 | |
| Residential Mortgages Junior Liens | | | 278 | | | | 331 | | | | 0 | |
| Consumer | | | 210 | | | | 249 | | | | 0 | |
| Total | | $ | 26,865 | | | $ | 34,533 | | | $ | 0 | |
| | | | | | | | | | | | | |
| Period end loans with allocated allowance for loan losses | | | | | | | | | | | | |
| Commercial and Industrial | | $ | 720 | | | $ | 998 | | | $ | 253 | |
| Commercial Real Estate | | | 10,423 | | | | 15,225 | | | | 3,622 | |
Residential Mortgages 1st Liens | | | 0 | | | | 0 | | | | 0 | |
| Residential Mortgages Junior Liens | | | 0 | | | | 0 | | | | 0 | |
| Consumer | | | 0 | | | | 0 | | | | 0 | |
| Total | | $ | 11,143 | | | $ | 16,223 | | | $ | 3,875 | |
| | | | | | | | | | | | | |
| Total | | | | | | | | | | | | |
| Commercial and Industrial | | $ | 5,078 | | | $ | 6,844 | | | $ | 253 | |
| Commercial Real Estate | | | 22,363 | | | | 32,212 | | | | 3,622 | |
Residential Mortgages 1st Liens | | | 10,079 | | | | 11,120 | | | | 0 | |
| Residential Mortgages Junior Liens | | | 278 | | | | 331 | | | | 0 | |
| Consumer | | | 210 | | | | 249 | | | | 0 | |
| Total | | $ | 38,008 | | | $ | 50,756 | | | $ | 3,875 | |
Note: Recorded investment includes principal outstanding plus deferred fee and accrued interest, net of related allowance for loan losses.
Average recorded investment and income recognized on impaired loans were as follows:
| (In Thousands of Dollars) | | Twelve months ended December 31, 2012 | | | Twelve months ended December 31, 2011 | | | Twelve months ended December 31, 2010 | |
| | | Average Recorded Investment | | | Interest Income Recognized | | | Average Recorded Investment | | | Interest Income Recognized | | | Average Recorded Investment | | | Interest Income Recognized | |
| Period end loans with no allocated allowance for loan losses | | | | | | | | | | | | | | | | | | |
| Commercial and Industrial | | $ | 2,862 | | | $ | 160 | | | $ | 2,073 | | | $ | 116 | | | $ | 1,121 | | | $ | 0 | |
| Commercial Real Estate | | | 10,213 | | | | 846 | | | | 12,444 | | | | 452 | | | | 12,432 | | | | 158 | |
Residential Mortgages 1st Liens | | | 9,998 | | | | 416 | | | | 9,223 | | | | 219 | | | | 7,721 | | | | 253 | |
| Residential Mortgages Junior Liens | | | 502 | | | | 13 | | | | 459 | | | | 2 | | | | 295 | | | | 1 | |
| Consumer | | | 450 | | | | 17 | | | | 192 | | | | 0 | | | | 200 | | | | 5 | |
| Total | | $ | 24,025 | | | $ | 1,452 | | | $ | 24,391 | | | $ | 789 | | | $ | 21,769 | | | $ | 417 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Period end loans with allocated allowance for loan losses | | | | | | | | | | | | | | | | | | | | | | | | |
| Commercial and Industrial | | $ | 880 | | | $ | 24 | | | $ | 722 | | | $ | 0 | | | $ | 438 | | | $ | 0 | |
| Commercial Real Estate | | | 10,561 | | | | 52 | | | | 9,003 | | | | 28 | | | | 8,724 | | | | 125 | |
Residential Mortgages 1st Liens | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | 0 | |
| Residential Mortgages Junior Liens | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | 0 | |
| Consumer | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | 0 | |
| Total | | $ | 11,441 | | | $ | 76 | | | $ | 9,725 | | | $ | 28 | | | $ | 9,162 | | | $ | 125 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total | | | | | | | | | | | | | | | | | | | | | | | | |
| Commercial and Industrial | | $ | 3,742 | | | $ | 184 | | | $ | 2,795 | | | $ | 116 | | | $ | 1,559 | | | $ | 0 | |
| Commercial Real Estate | | | 20,774 | | | | 898 | | | | 21,447 | | | | 480 | | | | 21,156 | | | | 283 | |
Residential Mortgages 1st Liens | | | 9,998 | | | | 416 | | | | 9,223 | | | | 219 | | | | 7,721 | | | | 253 | |
| Residential Mortgages Junior Liens | | | 502 | | | | 13 | | | | 459 | | | | 2 | | | | 295 | | | | 1 | |
| Consumer | | | 450 | | | | 17 | | | | 191 | | | | 0 | | | | 200 | | | | 5 | |
| Total | | $ | 35,466 | | | $ | 1,528 | | | $ | 34,116 | | | $ | 817 | | | $ | 30,931 | | | $ | 542 | |
Loan Modifications as of the period ending:
| (In thousands of dollars) | | Troubled Debt Restructurings | | | Troubled Debt Restructurings that Subsequently Defaulted | |
| | | Number of contracts | | | Pre-modification outstanding recorded investment | | | Post-modification outstanding recorded investment | | | Number of contracts | | | Recorded investment | |
| December 31, 2012 | | | | | | | | | | | | | | | |
| Commercial and Industrial | | | 11 | | | $ | 1,199 | | | $ | 1,188 | | | | 5 | | | $ | 1,143 | |
| Commercial Real Estate | | | 17 | | | | 4,456 | | | | 4,221 | | | | 4 | | | | 401 | |
Residential Mortgages 1st Liens | | | 19 | | | | 1,948 | | | | 1,943 | | | | 2 | | | | 190 | |
| Residential Mortgages Junior Liens | | | 4 | | | | 126 | | | | 126 | | | | 1 | | | | 9 | |
| Consumer | | | 3 | | | | 128 | | | | 127 | | | | 0 | | | | 0 | |
| Total | | | 54 | | | $ | 7,857 | | | $ | 7,605 | | | | 12 | | | $ | 1,743 | |
| | | | | | | | | | | | | | | | | | | | | |
| December 31, 2011 | | | | | | | | | | | | | | | | | | | | |
| Commercial and Industrial | | | 11 | | | $ | 3,615 | | | $ | 3,526 | | | | 2 | | | $ | 468 | |
| Commercial Real Estate | | | 13 | | | | 4,017 | | | | 3,786 | | | | 10 | | | | 1,233 | |
Residential Mortgages 1st Liens | | | 13 | | | | 1,427 | | | | 1,291 | | | | 11 | | | | 828 | |
| Residential Mortgages Junior Liens | | | 1 | | | | 83 | | | | 83 | | | | 0 | | | | 0 | |
| Consumer | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | 0 | |
| Total | | | 85 | | | $ | 9,142 | | | $ | 8,686 | | | | 23 | | | $ | 2,529 | |
| | | | | | | | | | | | | | | | | | | | | |
| December 31, 2010 | | | | | | | | | | | | | | | | | | | | |
| Commercial and Industrial | | | 1 | | | $ | 36 | | | $ | 36 | | | | 0 | | | $ | 0 | |
| Commercial Real Estate | | | 7 | | | | 6,604 | | | | 5,757 | | | | 3 | | | | 860 | |
Residential Mortgages 1st Liens | | | 27 | | | | 3,025 | | | | 2,633 | | | | 8 | | | | 614 | |
| Residential Mortgages Junior Liens | | | 1 | | | | 43 | | | | 0 | | | | 1 | | | | 43 | |
| Consumer | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | 0 | |
| Total | | | 36 | | | $ | 9,708 | | | $ | 8,426 | | | | 12 | | | $ | 1,517 | |
NOTE 7 – PREMISES AND EQUIPMENT
| Year end premises and equipment were as follows: | | | |
| | | | |
| (In Thousands of Dollars) | | 2012 | | | 2011 | |
| Land | | $ | 6,186 | | | $ | 6,186 | |
| Buildings | | | 32,891 | | | | 33,082 | |
| Furniture, fixtures and equipment | | | 17,431 | | | | 17,951 | |
| Total | | | 56,508 | | | | 57,219 | |
| Less: | | | | | | | | |
| Accumulated depreciation | | | (32,152 | ) | | | (32,132 | ) |
| Total | | $ | 24,356 | | | $ | 25,087 | |
Depreciation expense was $1,915,000, $2,062,000, and $2,278,000 for 2012, 2011, and 2010. Facility rent expense was $359,000 in 2012 compared with $377,000 for 2011, and $403,000 for 2010. Equipment rent expense was $249,000 in 2012 compared with $250,000 for 2011, and $252,000 for 2010. Rental commitments for the next five years under non-cancelable operating leases were as follows (before considering renewal options that generally are present):
| (In Thousands of Dollars) | | | | | | | |
| | | Facilities | | | Equipment | | | Total | |
| 2013 | | $ | 325 | | | $ | 7 | | | $ | 332 | |
| 2014 | | | 115 | | | | 3 | | | | 118 | |
| 2015 | | | 97 | | | | 2 | | | | 99 | |
| 2016 | | | 99 | | | | 0 | | | | 99 | |
| 2017 | | | 102 | | | | 0 | | | | 102 | |
| Total | | $ | 738 | | | $ | 12 | | | $ | 750 | |
NOTE 8 – GOODWILL AND INTANGIBLE ASSETS
Goodwill
During the third quarter, Firstbank Corporation retained an independent third party to perform a goodwill impairment analysis. The valuation date was July 31, 2012. The steps that Austin utilized in a Step 1 valuation test included the reporting unit and the appropriate standard and level of value, the calculation of fair value and the comparison of fair value to carrying value. We determined that Firstbank Corporation was the relevant reporting unit to be valued. The standard of value used in the valuation was fair value. The definition of fair value is that it is the value of ownership of the specific business with consideration of synergies, efficiencies and other value enhancing factors. The appropriate level of value used was controlling interest level. This is consistent with allowing for synergies and other factors as described previously and also considers premiums where appropriate. The appraisal methodology utilized by us includes the following valuation approaches:
A. Income Approach: Under this approach, a discounted cash flow value is calculated based on earnings capacity.
B. Asset Approach: This approach is based on the difference between the estimated market value of assets and liabilities.
C. Market Approach: This analysis is based on price-to-earnings multiples, price-to-tangible-book ratios and core deposit premiums for selected bank sale transactions.
We used the individual valuation results to calculate their estimate of the fair value of common equity. This figure was then compared to the carrying value of equity to determine whether the Step 1 test had passed or failed. In its findings, management determined that the fair value of Firstbank’s common equity was $140.0 million, above its carrying value of $127.6 million on the testing date. As required by generally accepted accounting principles, since the Step 1 test passed, it was not necessary to complete a Step 2 test.
Based on the analysis, management concluded that the implied fair value of goodwill exceeded the carrying value; therefore, no goodwill impairment charge was required at this time. Whole bank sale transactions at a premium to tangible book value in the market place play an important role in the determination of fair value of the company. Changes in the pricing of future whole bank sales could negatively affect future valuation and result in goodwill impairment at a future date.
There was no change in the carrying amount of goodwill during the year.
| (In Thousands of Dollars) | | | |
| | | 2012 | | | 2011 | |
| Balance at January 1 | | $ | 35,513 | | | $ | 35,513 | |
| Goodwill from acquisitions/(divestitures) | | | 0 | | | | 0 | |
| Balance at December 31 | | $ | 35,513 | | | $ | 35,513 | |
Acquired Intangible Assets
Acquired intangible assets at year end were as follows:
| (In Thousands of Dollars) | | 2012 | | | 2011 | | | 2010 | |
| Core deposit intangibles resulting from bank and branch acquisitions: | | | | | | | | | |
| Gross Amount | | $ | 7,930 | | | $ | 7,930 | | | $ | 7,930 | |
| Accumulated Amortization | | | (6,965 | ) | | | (6,482 | ) | | | (5,785 | ) |
| Net Carrying Value | | $ | 965 | | | $ | 1,448 | | | $ | 2,145 | |
Aggregate amortization expense was $483,000, $698,000, and $796,000 for 2012, 2011, and 2010, respectively. Our estimated amortization expense for each of the next five years is:
(In Thousands of Dollars)
| Year | | Amount | |
| 2013 | | $ | 370 | |
| 2014 | | | 278 | |
| 2015 | | | 185 | |
| 2016 | | | 99 | |
| 2017 | | | 33 | |
NOTE 9 – FEDERAL INCOME TAXES
Federal income taxes consist of the following:
| (In Thousands of Dollars) | | 2012 | | | 2011 | | | 2010 | |
| Current expense | | $ | 4,283 | | | $ | 3,133 | | | $ | 1,013 | |
| Deferred expense (benefit) | | | (27 | ) | | | (1,299 | ) | | | 14 | |
| Change in deferred tax valuation allowance | | | 0 | | | | 0 | | | | 485 | |
| Total | | $ | 4,256 | | | $ | 1,834 | | | $ | 1,512 | |
A reconciliation of the difference between federal income tax expense and the amount computed by applying the federal statutory tax rate of 34% in 2012, 2011 and 2010 is as follows:
| (In Thousands of Dollars) | | 2012 | | | 2011 | | | 2010 | |
| Tax at statutory rate | | $ | 5,177 | | | $ | 2,610 | | | $ | 1,846 | |
| Effect of tax-exempt interest | | | (479 | ) | | | (443 | ) | | | (489 | ) |
| Deferred tax valuation allowance | | | 0 | | | | 0 | | | | 485 | |
| Other | | | (442 | ) | | | (333 | ) | | | (330 | ) |
| Federal income taxes | | $ | 4,256 | | | $ | 1,834 | | | $ | 1,512 | |
| | | | | | | | | | | | | |
| Effective tax rate | | | 29 | % | | | 25 | % | | | 29 | % |
The components of deferred tax assets and liabilities included in other assets on the Consolidated Balance Sheet consist of the following at December 31st year end:
| (In Thousands of Dollars) | | | |
| | | 2012 | | | 2011 | |
| Deferred tax assets: | | | | | | |
| Allowance for loan losses | | $ | 7,256 | | | $ | 7,147 | |
| Deferred compensation | | | 655 | | | | 718 | |
| Losses on capital investments | | | 1,159 | | | | 1,727 | |
| Other | | | 1,254 | | | | 1,304 | |
| Total deferred tax assets | | | 10,324 | | | | 10,896 | |
| Deferred tax liabilities: | | | | | | | | |
| Fixed assets | | | (1,821 | ) | | | (1,851 | ) |
| Mortgage servicing rights | | | (1,697 | ) | | | (1,563 | ) |
| Purchase accounting adjustments | | | (234 | ) | | | (373 | ) |
| Unrealized gain on securities available for sale | | | (1,859 | ) | | | (1,492 | ) |
| Other | | | (428 | ) | | | (992 | ) |
| Total deferred tax liabilities | | | (6,039 | ) | | | (6,271 | ) |
| Net deferred tax assets | | | 4,285 | | | | 4,625 | |
| Deferred tax valuation allowance | | | (1,143 | ) | | | (1,143 | ) |
| Net deferred tax assets | | $ | 3,142 | | | $ | 3,482 | |
A valuation allowance related to deferred tax assets is required when it is considered more likely than not that all or part of the benefits related to such assets will not be realized. In reviewing the company’s position relative to deferred tax assets associated with certain incurred capital losses, management determined that a valuation adjustment of $1,143,000 was necessary at year end 2012, the same amount as yearend 2011. These valuation adjustments were recorded through the income statement on the Federal income tax line item when they occurred. Based on this determination, a non-cash charge was made to record the valuation adjustment, reducing our deferred tax asset, and increasing income tax expense by $485,000 in 2011. The establishment of a valuation allowance does not relinquish our rights to utilize the deferred asset, but rather recognizes that at the current time management does not believe the deferred asset will be able to be utilized prior to its expiration. The deferred assets for which the valuation allowance was established were related to capital losses for which we do not believe we will have capital gains to offset. These assets are: $70,000 to expire in 2013, and $588,000 to expire in 2015 and $485,000 for which an expiration date has yet to be established, as we have not sold the underlying stock.
Losses on capital investments have a three year carry back and five year carry forward time period for offset. The timeframe begins with the sale of the investment. Certain tax planning strategies have been established, including the possible sale and leaseback of certain of our facilities or other assets that management believes could be executed if necessary to retain the benefits listed above.
Net deferred tax assets at December 31, 2012 and 2011 are included in other assets in the accompanying consolidated balance sheets.
NOTE 10 – DEPOSITS
Time deposits of $100,000 or more were $167 million and $196 million at year end 2012 and 2011. There were $17.6 million and $16.1 million of brokered CDs included in time deposits of $100,000 or more in 2012 and 2011 respectively.
Scheduled maturities of time deposits at December 31, 2012 were as follows:
| (In Thousands of Dollars) | |
| Year | | Amount | |
| 2013 | | $ | 239,810 | |
| 2014 | | | 69,766 | |
| 2015 | | | 31,135 | |
| 2016 | | | 22,614 | |
| 2017 | | | 13,041 | |
| 2018 and thereafter | | | 5 | |
| Total | | $ | 376,371 | |
NOTE 11 – BORROWINGS
Information relating to securities sold under agreements to repurchase is as follows:
| (In Thousands of Dollars) | |
| | | 2012 | | | 2011 | |
| At December 31: | | | | | | |
| Outstanding Balance | | $ | 42,785 | | | $ | 46,784 | |
| Average Interest Rate | | | 0.19 | % | | | 0.19 | % |
| | | | | | | | | |
| Daily Average for the Year: | | | | | | | | |
| Outstanding Balance | | $ | 47,605 | | | $ | 43,847 | |
| Average Interest Rate | | | 0.18 | % | | | 0.19 | % |
| | | | | | | | | |
| Maximum Outstanding at any Month End | | $ | 55,047 | | | $ | 47,603 | |
Securities sold under agreements to repurchase (repurchase agreements) generally have original maturities of less than one year. Repurchase agreements are treated as financings and the obligations to repurchase securities sold are reflected as liabilities. Securities involved with the agreements are recorded as assets of the Company and are primarily held in safekeeping by correspondent banks. Repurchase agreements are offered principally to certain large deposit customers as deposit equivalent investments.
We had no unsecured overnight borrowings, in the form of federal funds purchased at December 31, 2012. There were no overnight borrowings at December 31, 2011.
NOTE 12 – FEDERAL HOME LOAN BANK ADVANCES
Long term borrowings have been secured from the Federal Home Loan Bank. At year end, advances from the Federal Home Loan Bank were as follows:
| (In Thousands of Dollars) | | | |
| | | 2012 | | | 2011 | |
| Borrowings with a fixed rates at year end | | $ | 22,493 | | | $ | 19,457 | |
| | | | | | | | | |
| Borrowings with a variable rate of interest at year end | | $ | 0 | | | $ | 0 | |
Fixed rate advances shown above ranged in the interest rate owed from 0.41% to 7.30% and averaged 2.39% at year end 2012 and maturity dates ranged from January 2013 to March 2026. Higher rate advances were borrowed to match fund specific loans in the past, and are matched in duration and prepayment terms to those loans. At the end of 2011, rates ranged from 1.28% to 7.30% and averaged 3.41%, with maturities ranging from January 2012 to March 2026. Each Federal Home Loan Bank advance is payable at its maturity date without penalty, however, substantial penalties do exist if an advance is paid before its contractual maturity. Such penalties vary from advance to advance and are based on the size, interest rate, and remaining term of each specific advance. Advances of $3.5 million may be converted from fixed to variable rate by the FHLB, but may be repaid, without penalty, if that option is exercised. The advances were collateralized by $177.7 million and $183.7 million of first mortgage loans under a blanket lien arrangement and pledges of specific mortgages at year end 2012 and 2011. As of December 31, 2012, we had $84.4 million of additional borrowing capacity with the Federal Home Loan Bank. Federal Home Loan Bank borrowings have decreased substantially as increased core deposits and low loan demand have combined to reduce the need for this funding in the near term.
Maturities of FHLB advances are as follows:
| (In Thousands of Dollars) | |
| 2013 | | $ | 2,500 | |
| 2014 | | | 4,000 | |
| 2015 | | | 6,777 | |
| 2016 | | | 3,094 | |
| 2017 | | | 3,087 | |
| 2018 and thereafter | | | 3,035 | |
| Total | | $ | 22,493 | |
NOTE 13 – SUBORDINATED DEBENTURES
On October 18, 2004, a trust formed by us issued $10,310,000 of 90 day LIBOR plus 1.99% variable rate trust preferred securities as part of a pooled offering of such securities. We issued subordinated debentures to the trust in exchange for the proceeds of the offering; the debentures represent the sole assets of the trust. We may redeem the subordinated debentures, in whole or in part, any time on or after October 18, 2009 at 100% of the principal amount of the securities. The debentures are required to be paid in full on October 18, 2034.
On January 20, 2006, a trust formed by us issued $10,310,000 of trust preferred securities as part of a pooled offering of such securities. The securities carried an interest rate of 6.049% for five years, and then converted to a variable rate of 90 day LIBOR plus 1.27% in 2011, for the remainder of their term. We issued subordinated debentures to the trust in exchange for the proceeds of the offering; the debentures represent the sole assets of the trust. We may redeem the subordinated debentures, in whole or in part, any time on or after April 7, 2011 at 100% of the principal amount of the securities. The debentures are required to be paid in full on April 7, 2036.
On July 30, 2007, two trusts, formed by us, issued $15,464,000 of trust preferred securities as part of a pooled offering of such securities. One of the trusts issued $7,732,000 of variable rate securities at 90 day LIBOR plus 1.35% (6.71% on the date of issuance). The other trust issued $7,732,000 of fixed rate securities that carried an interest rate of 6.566% for five years, and then converted to a variable rate of 90 day LIBOR plus 1.35% in 2012 for the remainder of their term. Firstbank then issued subordinated debentures to the trust in exchange for the proceeds of the offering; the debentures represent the sole assets of each of the trusts. We may redeem the subordinated debentures, in whole or in part, any time on or after July 30, 2012 at 100% of the principal amount of the securities. The debentures are required to be paid in full on July 30, 2037.
The trusts are not consolidated with the Company’s financial statements, but rather the subordinated debentures are shown as a liability. Our investment in the stock of the trust was $1,084,000 and is included in equity securities available for sale. These investments are restricted from sale and are carried at historical cost, which approximates fair value.
NOTE 14 – SHAREHOLDERS’ EQUITY
We are subject to various regulatory policies and requirements relating to the payment of dividends, including requirements to maintain adequate capital above regulatory minimums. At year end 2012 and 2011 we exceeded all requirements to be classified as well as capitalized.
On January 30, 2009 we issued 33,000 shares of Series A, no par value $1,000 liquidation preference, fixed rate cumulative perpetual preferred stock (Preferred Stock) and warrants to purchase 578,947 shares of our common stock at an exercise price of $8.55 per share (Warrants), to the U.S. Department of Treasury in return for $33 million under the Capital Purchase Program (CPP). Of the proceeds, $32.7 million was allocated to the Preferred Stock and $0.3 million was allocated to the Warrants based on the relative fair value of each. The $0.3 million discount on the Preferred Stock is being accreted using an effective yield method over five years. The Preferred Stock and Warrants qualify as Tier 1 capital.
On June 28, 2012 the U.S. Department of Treasury sold all of the shares of our Preferred Stock in a modified Dutch auction process. During the auction, we successfully bid on and retired 16,000 of the 33,000 outstanding shares of our Preferred Stock at a price of $941.01 per share, or $15.1 million in the aggregate. As a result of the retirement of these shares, 17,000 shares remain outstanding, held by private investors, and carry the same terms under which they were originally issued.
The warrants were immediately exercisable for 578,947 shares of our common stock at an exercise price of $8.55 per common share. The warrants were transferrable and could be exercised at any time on or before January 30, 2019. We negotiated a repurchase of all of the outstanding warrants with the U.S. Treasury at a price of $1,946,670. The repurchase of these warrants occurred in July 2012 and reduced equity by the amount of the purchase price.
The remaining 17,000 shares of Preferred Stock pay cumulative quarterly cash dividends at a rate of 5% per year on the $1,000 liquidation preference through February 15, 2014 and at a rate of 9% per year thereafter. We accrue dividends based on the rates, liquidation preference and time since last quarterly dividend payment. We may redeem the Preferred Stock for the liquidation preference plus accrued and unpaid dividends subject to prior consultation with the Federal Reserve Board.
Under the CPP, the consent of the U.S. Treasury was required for any quarterly common stock dividend of more than $0.225 per share (subject to adjustment for stock splits, stock dividends and certain other transactions) and for any common share repurchases (other than common share repurchases in connection with any benefit plan in the ordinary course of business) in each case until January 30, 2012, unless the Preferred Stock had been fully redeemed or the U.S. Treasury had transferred all the Preferred Stock to third parties prior to that date. This restriction on common stock dividends lapsed in January of 2012. In addition, all accrued and unpaid dividends on the Preferred Stock must be declared and the payment set aside for the benefit of the holders of Preferred Stock before any dividend may be declared on our common stock and before any shares of our common stock may be repurchased, subject to certain limited exceptions. Holders of shares of the Preferred Stock have no right to exchange or convert such shares into any other security of Firstbank Corporation and have no right to require the redemption or repurchase of the Preferred Stock. The Preferred Stock does not have a sinking fund. The Preferred Stock is non-voting, other than class voting rights on certain matters that could adversely affect the Preferred Stock.
NOTE 15 – BENEFIT PLANS
The Firstbank Corporation 401(k) plan, a defined contribution plan, is an IRS qualified 401(k) salary deferral plan, under which Firstbank Corporation stock is one of the investment options. The Board of Directors approved changing the plan to a Safe Harbor 401(k) plan for the 2008 plan year. A Safe Harbor plan relieves administrative testing in exchange for immediate vesting of the employee’s matching contributions. Both employee and employer contributions may be made to the plan. The Company’s 2012, 2011 and 2010 matching 401(k) contributions charged to expense were $539,000, $522,000 and $537,000 respectively. The percent of the Company’s matching contribution to the 401(k), and the determination to offer a Safe Harbor plan, is determined annually by the Board of Directors.
Firstbank – West Michigan had a deferred compensation plan for its directors and executive officers. The plan was frozen before the ICNB acquisition and has a balance at the end of 2012 of $1.9 million compared with $2.1 million at the end of 2011. Expense associated with the plan was $131,000 in 2012, $110,000 in 2011, and $94,000 in 2010. Payments under the deferred plan were $231,000 in 2012, $171,000 in 2011, and $187,000 in 2010.
NOTE 16 – STOCK BASED COMPENSATION
The Company has stock based compensation plans as described below. Total compensation cost that has been charged against income for those plans was $96,000, $118,000, and $115,000 for 2012, 2011 and 2010. The total income tax benefit resulting from these charges was $33,000, $40,000 and $39,000, respectively.
The Firstbank Corporation Stock Compensation Plans of 1993, 1997 and 2006 (“Plans”), as amended, which were shareholder approved, provide for the grant of 395,986, 593,798 and 315,000 shares of stock, respectively, in either restricted form or under option. Options may be either incentive stock options or nonqualified stock options. As of December 31, 2012 only nonqualified stock options and restricted stock shares have been issued under the plans. The Plan of 1993 terminated April 26, 2003. The 1997 Plan terminated April 28, 2007. The 2006 Plan will terminate February 27, 2016. The Board, at its discretion, may terminate any or all of the Plans prior to the Plans’ scheduled termination dates. At year end 2012, there were 61,642 shares available for grant under the 2006 Plan.
Stock Option
Each option granted under the Plans may be exercised in whole or in part during such period as is specified in the option agreement governing that option. Options may only be issued with exercise prices equal to, or greater than, the stock’s market value on the date of issuance. The length of time available for a stock option to be exercised is governed by each option agreement, but has not been more than ten years from the issuance date.
All companies are required to record compensation cost for stock options provided to employees in return for employee service. The cost is measured at the fair value of the options when granted. This cost is expensed over the employee service period, which is normally the vesting period of the options.
The fair value of each option award is estimated on the date of grant using a closed form option valuation (Black-Scholes) model that uses the assumptions noted in the table below. Expected volatilities are based on historical volatilities of our common stock. We use historical data to estimate option exercise and post-vesting termination behavior. The expected term of options granted is based on historical data and represents the period of time that options granted are expected to be outstanding, which takes into account that the options are not transferable. The risk-free interest rate for the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of the grant. The weighted average fair value of options granted was $2.33 in 2010. There were no options granted in 2011 or 2012.
| | | 2010 | |
| | | | |
| Risk-free interest rate | | | 2.11 | % |
| Expected option life (years) | | | 7 | |
| Expected stock price volatility | | | 44.7 | % |
| Dividend yield | | | 0.7 | % |
Activity under the plans:
| | | Twelve months ended December 31, 2012 | | | Twelve months ended December 31, 2011 | |
| Total options outstanding | | Shares | | | Weighted Average Exercise Price | | | Weighted Average Remaining Contractual Life (years) | | | Aggregate Intrinsic Value (000) | | | Shares | | | Weighted Average Exercise Price | | | Weighted Average Remaining Contractual Life (years) | | | Aggregate Intrinsic Value (000) | |
| Beginning of period | | | 396,898 | | | $ | 16.58 | | | | | | | | | | 454,745 | | | $ | 16.55 | | | | | | | |
| Granted | | | 0 | | | | - | | | | | | | | | | 0 | | | | | | | | | | | |
| Exercised | | | 0 | | | | - | | | | | | | | | | 0 | | | | | | | | | | | |
| Forfeited | | | (6,279 | ) | | $ | 19.00 | | | | | | | | | | (25,273 | ) | | $ | 19.45 | | | | | | | |
| Expired | | | (34,589 | ) | | $ | 19.20 | | | | | | | | | | (32,574 | ) | | $ | 13.51 | | | | | | | |
| End of period | | | 356,030 | | | $ | 16.29 | | | | 4.5 | | | $ | 479 | | | | 396,898 | | | $ | 16.58 | | | | 5.1 | | | $ | 0 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Options exercisable, end of period | | | 303,270 | | | $ | 17.95 | | | | 4.0 | | | $ | 269 | | | | 305,468 | | | $ | 19.18 | | | | 4.3 | | | $ | 0 | |
There were no options exercised in either 2012 or 2011. As of December 31, 2012, there was $32,000 of total unrecognized compensation cost related to non-vested stock options granted under the Plans. The cost is expected to be recognized over a weighted-average period of 1.5 years.
Options outstanding at December 31, 2012 were as follows:
| | | | Options outstanding | | | Exercisable | |
Range of exercise prices | | | Shares | | | Weighted Average Exercise Price | | | Weighted Average Contractual Life (years) | | | Shares | | | Weighted Average Exercise Price | |
| $5.19 | - | $8.00 | | | | 97,700 | | | $ | 6.61 | | | | 6.8 | | | | 60,320 | | | $ | 7.03 | |
| $8.01 | – | $16.00 | | | | 90,950 | | | $ | 12.87 | | | | 5.8 | | | | 75,570 | | | $ | 13.74 | |
| $16.01 | - | $23.00 | | | | 89,215 | | | $ | 22.42 | | | | 3.4 | | | | 89,215 | | | $ | 22.42 | |
| $23.01 | - | $26.18 | | | | 78,165 | | | $ | 25.36 | | | | 1.4 | | | | 78,165 | | | $ | 25.36 | |
| Total | | | | 356,030 | | | $ | 16.29 | | | | 4.5 | | | | 303,270 | | | $ | 17.95 | |
Restricted Stock
Restricted shares may be issued under the Plans as described above. Compensation expense is recognized over the vesting period of the shares based on the market value of the shares on the issue date.
A summary of changes in the Company’s non-vested shares for 2012 and 2011 follows:
| | | 2012 | | | 2011 | |
| Non-vested Shares | | Shares | | | Weighted-Average Grant-Date Fair Value | | | Shares | | | Weighted-Average Grant-Date Fair Value | |
| Non-vested at January 1, 2012 | | | 22,627 | | | $ | 5.99 | | | | 13,373 | | | $ | 9.13 | |
| Granted | | | 14,980 | | | $ | 10.30 | | | | 14,120 | | | $ | 5.00 | |
| Vested | | | 3,553 | | | $ | 7.61 | | | | 4,866 | | | $ | 11.77 | |
| Non-vested at December 31, 2012 | | | 34,054 | | | $ | 7.68 | | | | 22,627 | | | $ | 5.99 | |
As of December 31, 2012, there was $210,000 of total unrecognized compensation cost related to non-vested shares granted under the Restricted Stock Plan. The cost is expected to be recognized over a weighted-average period of 2.1 years. The total fair value of shares vested during the years ended December 31, 2012, 2011 and 2010 was $27,000, $57,000, and $23,000. Expense associated with restricted stock and include in the total compensation cost presented earlier in this note were $56,000 in 2012 compared with $37,000 in 2011 and $20,000 in 2010.
NOTE 17 – RELATED PARTY TRANSACTIONS
Loans to principal officers, directors, and their affiliates were as follows:
| (In Thousands of Dollars) | | 2012 | | | 2011 | |
| Beginning balance | | $ | 40,477 | | | $ | 48,510 | |
| New loans | | | 39,074 | | | | 46,283 | |
| Repayments | | | (43,885 | ) | | | (47,972 | ) |
| Deletion of Directors | | | (896 | ) | | | (6,344 | ) |
| Ending balance | | $ | 34,770 | | | $ | 40,477 | |
Deposits from principal officers, directors, and their affiliates at year end 2012 and 2011 were $27.1 million and $28.5 million respectively.
NOTE 18 – FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
Some financial instruments, such as loan commitments, credit lines, letters of credit and overdraft protection are issued to meet customer financing needs. These are agreements to provide credit or to support the credit of others, as long as conditions established in the contract are met and usually have expiration dates. Commitments may expire without being used. Off-balance sheet risk to credit loss exists up to the face amount of these instruments although material losses are not anticipated. The same credit policies are used to make such commitments as are used for loans, including obtaining collateral at exercise of the commitment.
Financial instruments with off-balance sheet risk were as follows at year end:
| (In Thousands of Dollars) | | 2012 | | | 2011 | |
| | | Fixed Rate | | | Variable Rate | | | Fixed Rate | | | Variable Rate | |
Commitments to make loans (at market rates) | | $ | 82,395 | | | $ | 10,137 | | | $ | 44,091 | | | $ | 11,254 | |
Unused lines of credit and letters of credit | | $ | 25,923 | | | $ | 126,490 | | | $ | 22,205 | | | $ | 118,443 | |
| Standby letters of credit | | $ | 5,201 | | | $ | 15,225 | | | $ | 4,776 | | | $ | 15,110 | |
Commitments to make loans are generally made for periods of 60 days or less. Fixed rate loan commitments have interest rates ranging from 3.38% to 7.00% and maturities ranging from 1 year to 10 years.
NOTE 19 – CONTINGENCIES
From time to time certain claims are made against the Company and its banking subsidiaries in the normal course of business. There were no outstanding claims considered by management to be material at December 31, 2012.
NOTE 20 – DIVIDEND LIMITATION OF SUBSIDIARIES
Capital guidelines adopted by Federal and State regulatory agencies and restrictions imposed by law limit the amount of cash dividends the banks can pay to the Company. At December 31, 2012, using the most restrictive of these conditions for each bank, the aggregate cash dividends that the banks can pay the Company without prior approval was $23,118,000. It is not the intent of management to have dividends paid in amounts which would reduce the capital of the banks to levels below those which are considered prudent by management and in accordance with guidelines of regulatory authorities.
NOTE 21 – STOCK REPURCHASE PROGRAM
We currently have no authorized common or preferred stock repurchase program in place. No common stock was repurchased in 2011 or 2012. In June of 2012 we repurchased 16,000 shares of our 33,000 outstanding shares of preferred stock at a price of at a price of $941.01 per share (liquidation preference value $1,000). In July of 2012, we negotiated a repurchase of all 578,947 outstanding common stock warrants, which were issued to the U.S. Treasury at the time of their investment in our preferred shares, for a total price of $1,946,670.
NOTE 22 – CAPITAL ADEQUACY
Banks and bank holding companies are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations involve quantitative measures of assets, liabilities, and certain off-balance sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet capital requirements can initiate regulatory action.
Prompt corrective action regulations provide five classifications: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited; as are asset growth and expansion, and capital restoration plans are required.
At year end 2012 and 2011, the most recent regulatory notifications categorize us as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed that classification.
Actual and required capital amounts at year end and ratios are presented below:
| (In thousands of dollars) | | Actual | | | Minimum Required For Capital Adequacy Purposes | | | To Be Well Capitalized Under Prompt Corrective Action Provisions | |
| | | Amount | | | Ratio | | | Amount | | | Ratio | | | Amount | | | Ratio | |
| 2012 | | | | | | | | | | | | | | | | | | |
| Total Capital to Risk Weighted Assets | | | | | | | | | | | | | | | | | | |
| Consolidated | | $ | 155,135 | | | | 15.99 | % | | $ | 77,618 | | | | 8.00 | % | | $ | 97,023 | | | | 10.00 | % |
| Firstbank – Alma | | | 33,195 | | | | 15.81 | % | | | 16,797 | | | | 8.00 | % | | | 20,997 | | | | 10.00 | % |
| Firstbank – Mt. Pleasant | | | 37,816 | | | | 12.74 | % | | | 23,748 | | | | 8.00 | % | | | 29,685 | | | | 10.00 | % |
| Firstbank – West Branch | | | 23,021 | | | | 14.01 | % | | | 13,144 | | | | 8.00 | % | | | 16,430 | | | | 10.00 | % |
| Keystone Community Bank | | | 28,641 | | | | 15.78 | % | | | 14,521 | | | | 8.00 | % | | | 18,151 | | | | 10.00 | % |
| Firstbank – West Michigan | | | 15,226 | | | | 12.83 | % | | | 9,493 | | | | 8.00 | % | | | 11,866 | | | | 10.00 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Tier 1 (Core) Capital to Risk Weighted Assets | | | | | | | | | | | | | | | | | | | | | | | | |
| Consolidated | | $ | 142,884 | | | | 14.73 | % | | $ | 38,809 | | | | 4.00 | % | | $ | 58,214 | | | | 6.00 | % |
| Firstbank – Alma | | | 30,541 | | | | 14.55 | % | | | 8,399 | | | | 4.00 | % | | | 12,598 | | | | 6.00 | % |
| Firstbank – Mt. Pleasant | | | 34,097 | | | | 11.49 | % | | | 11,874 | | | | 4.00 | % | | | 17,811 | | | | 6.00 | % |
| Firstbank – West Branch | | | 20,945 | | | | 12.75 | % | | | 6,572 | | | | 4.00 | % | | | 9,858 | | | | 6.00 | % |
| Keystone Community Bank | | | 26,333 | | | | 14.51 | % | | | 7,260 | | | | 4.00 | % | | | 10,891 | | | | 6.00 | % |
| Firstbank – West Michigan | | | 13,729 | | | | 11.57 | % | | | 4,746 | | | | 4.00 | % | | | 7,119 | | | | 6.00 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Tier 1 (Core) Capital to Average Assets | | | | | | | | | | | | | | | | | | | | | | | | |
| Consolidated | | $ | 142,884 | | | | 9.71 | % | | $ | 58,854 | | | | 4.00 | % | | $ | 73,568 | | | | 5.00 | % |
| Firstbank – Alma | | | 30,541 | | | | 8.15 | % | | | 14,998 | | | | 4.00 | % | | | 18,748 | | | | 5.00 | % |
| Firstbank – Mt. Pleasant | | | 34,097 | | | | 8.12 | % | | | 16,765 | | | | 4.00 | % | | | 20,994 | | | | 5.00 | % |
| Firstbank – West Branch | | | 20,945 | | | | 8.55 | % | | | 9,803 | | | | 4.00 | % | | | 12,253 | | | | 5.00 | % |
| Keystone Community Bank | | | 26,333 | | | | 11.61 | % | | | 9,072 | | | | 4.00 | % | | | 11,340 | | | | 5.00 | % |
| Firstbank – West Michigan | | | 13,729 | | | | 7.29 | % | | | 7,538 | | | | 4.00 | % | | | 9,422 | | | | 5.00 | % |
| | | Amount | | | Ratio | | | Amount | | | Ratio | | | Amount | | | Ratio | |
| 2011 | | | | | | | | | | | | | | | | | | |
| Total Capital to Risk Weighted Assets | | | | | | | | | | | | | | | | | | |
| Consolidated | | $ | 163,919 | | | | 16.55 | % | | $ | 79,233 | | | | 8.00 | % | | $ | 99,041 | | | | 10.00 | % |
| Firstbank – Alma | | | 32,595 | | | | 15.02 | % | | | 17,358 | | | | 8.00 | % | | | 21,698 | | | | 10.00 | % |
| Firstbank – Mt. Pleasant | | | 37,793 | | | | 13.05 | % | | | 23,165 | | | | 8.00 | % | | | 28,957 | | | | 10.00 | % |
| Firstbank – West Branch | | | 22,843 | | | | 13.39 | % | | | 13,649 | | | | 8.00 | % | | | 17,062 | | | | 10.00 | % |
| Keystone Community Bank | | | 26,838 | | | | 14.03 | % | | | 15,299 | | | | 8.00 | % | | | 19,123 | | | | 10.00 | % |
| Firstbank – West Michigan | | | 20,035 | | | | 16.95 | % | | | 9,454 | | | | 8.00 | % | | | 11,818 | | | | 10.00 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Tier 1 (Core) Capital to Risk Weighted Assets | | | | | | | | | | | | | | | | | | | | | | | | |
| Consolidated | | $ | 151,473 | | | | 15.29 | % | | $ | 39,616 | | | | 4.00 | % | | $ | 59,425 | | | | 6.00 | % |
| Firstbank – Alma | | | 29,855 | | | | 13.76 | % | | | 8,679 | | | | 4.00 | % | | | 13,019 | | | | 6.00 | % |
| Firstbank – Mt. Pleasant | | | 34,168 | | | | 11.80 | % | | | 11,583 | | | | 4.00 | % | | | 17,374 | | | | 6.00 | % |
| Firstbank – West Branch | | | 20,693 | | | | 12.13 | % | | | 6,825 | | | | 4.00 | % | | | 10,237 | | | | 6.00 | % |
| Keystone Community Bank | | | 24,416 | | | | 12.77 | % | | | 7,649 | | | | 4.00 | % | | | 11,474 | | | | 6.00 | % |
| Firstbank – West Michigan | | | 18,533 | | | | 15.68 | % | | | 4,727 | | | | 4.00 | % | | | 7,091 | | | | 6.00 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Tier 1 (Core) Capital to Average Assets | | | | | | | | | | | | | | | | | | | | | | | | |
| Consolidated | | $ | 151,473 | | | | 10.30 | % | | $ | 58,840 | | | | 4.00 | % | | $ | 73,551 | | | | 5.00 | % |
| Firstbank – Alma | | | 29,855 | | | | 8.22 | % | | | 14,536 | | | | 4.00 | % | | | 18,170 | | | | 5.00 | % |
| Firstbank – Mt. Pleasant | | | 34,168 | | | | 8.31 | % | | | 16,443 | | | | 4.00 | % | | | 20,554 | | | | 5.00 | % |
| Firstbank – West Branch | | | 20,693 | | | | 8.39 | % | | | 9,871 | | | | 4.00 | % | | | 12,338 | | | | 5.00 | % |
| Keystone Community Bank | | | 24,416 | | | | 10.09 | % | | | 9,680 | | | | 4.00 | % | | | 12,100 | | | | 5.00 | % |
| Firstbank – West Michigan | | | 18,533 | | | | 9.72 | % | | | 7,625 | | | | 4.00 | % | | | 9,531 | | | | 5.00 | % |
NOTE 23 – FAIR VALUE
Carrying amount and estimated fair values of financial instruments were as follows at year end:
December 31, 2012 (In thousands of dollars) | | Carrying Amount | | | Estimated Fair Value | | | Quoted Prices in Active Markets (Level 1) | | | Significant Other Observable Inputs (Level 2) | | | Significant Unobservable Inputs (Level 3) | |
| Financial Assets: | | | | | | | | | | | | | | | |
| Cash and cash equivalents | | $ | 99,601 | | | $ | 99,601 | | | $ | 99,601 | | | $ | 0 | | | $ | 0 | |
| FDIC insured bank certificates of deposit | | | 2,927 | | | | 2,927 | | | | 2,927 | | | | 0 | | | | 0 | |
| Trading account securities | | | 6 | | | | 6 | | | | 6 | | | | 0 | | | | 0 | |
| Securities available for sale | | | 353,678 | | | | 353,678 | | | | 91 | | | | 331,717 | | | | 21,870 | |
| Federal Home Loan Bank stock | | | 7,266 | | | | 7,266 | | | | 0 | | | | 0 | | | | 7,266 | |
| Loans held for sale | | | 2,921 | | | | 2,921 | | | | 0 | | | | 2,921 | | | | 0 | |
| Loans, net of allowance | | | 942,422 | | | | 930,354 | | | | 0 | | | | 0 | | | | 930,354 | |
| | | | | | | | | | | | | | | | | | | | | |
| Financial Liabilities: | | | | | | | | | | | | | | | | | | | | |
| Deposits | | | (1,241,401 | ) | | | (1,243,712 | ) | | | 0 | | | | 0 | | | | (1,243,712 | ) |
Securities sold under agreements to repurchase and overnight borrowings | | | (42,785 | ) | | | (42,785 | ) | | | 0 | | | | (42,785 | ) | | | 0 | |
| Federal Home Loan Bank advances | | | (22,493 | ) | | | (24,122 | ) | | | 0 | | | | 0 | | | | (24,122 | ) |
| Subordinated debentures | | | (36,084 | ) | | | (36,093 | ) | | | 0 | | | | 0 | | | | (36,093 | ) |
| December 31, 2011 (In thousands of dollars) | | Carrying | | | Fair | |
| | | Amount | | | Value | |
| Financial Assets: | | | | | | |
| Cash and cash equivalents | | $ | 75,816 | | | $ | 75,816 | |
| FDIC insured bank certificates of deposit | | | 4,432 | | | | 4,432 | |
| Trading account securities | | | 2 | | | | 2 | |
| Securities available for sale | | | 342,184 | | | | 342,184 | |
| Federal Home Loan Bank stock | | | 7,266 | | | | 7,266 | |
| Loans held for sale | | | 349 | | | | 349 | |
| Loans, net | | | 962,890 | | | | 944,756 | |
| Accrued interest receivable | | | 4,531 | | | | 4,531 | |
| Financial Liabilities: | | | | | | | | |
| Deposits | | | (1,220,542 | ) | | | (1,215,484 | ) |
Securities sold under agreements to repurchase and overnight borrowings | | | (46,784 | ) | | | (46,784 | ) |
| Federal Home Loan Bank advances | | | (19,457 | ) | | | (21,359 | ) |
| Accrued interest payable | | | (762 | ) | | | (762 | ) |
| Subordinated debentures | | | (36,084 | ) | | | (36,488 | ) |
The methods and assumptions used to estimate fair value are described as follows: The carrying amount is the estimated fair value for cash and cash equivalents, short term borrowings, Federal Home Loan Bank stock, demand deposits, short term debt, and variable rate loans or deposits that re-price frequently and fully. Security fair values are based on market prices or dealer quotes, and if no such information is available, on the rate and term of the security and information about the issuer. For fixed rate loans and variable rate loans, fair value is based on discounted cash flows using current market rates applied to the estimated life and credit risk based on historical losses on similar loan pools. For deposits with infrequent re-pricing or re-pricing limits, fair value is based on discounted cash flows using current market rates applied to the estimated life of the product.
Fair values for impaired loans are estimated using discounted cash flow analysis or underlying collateral values for the specific loans in the portfolio and assumes the bank will resolve them through orderly liquidation. Fair value of loans held for sale is based on market quotes. Fair value of debt is based on current rates for similar financing. The fair value of off-balance sheet items is based on the current fees or cost that would be charged to enter into or terminate such arrangements. The fair value of off-balance sheet items was not material to the consolidated financial statements at December 31, 2012 and 2011.
The following tables present information about our assets measured at fair value on a recurring basis at December 31, 2012 and 2011, and valuation techniques used by us to determine those fair values.
Level 1 assets are those which are actively traded on an open market and pricing is publicly available.
Fair values determined by Level 2 inputs use other inputs that are observable, either directly or indirectly. These Level 2 inputs include quoted prices for similar assets in active markets, and other inputs such as interest rates and yield curves that are observable at commonly quoted intervals.
Level 3 inputs are unobservable inputs, including inputs that are available in situations where there is little, if any, market activity for the related asset or liability. Level 3 securities include local municipal securities where market pricing is not available, trust preferred securities issued by banks, and other miscellaneous investments.
Assets Measured at Fair Value on a Recurring Basis
| (Dollars in Thousands) | | Quoted Prices in Active Markets for Identical Assets (Level 1) | | | Significant Other Observable Inputs (Level 2) | | | Significant Unobservable Inputs (Level 3) | | | Total | |
| December 31, 2012 | | | | | | | | | | | | |
| Securities available for sale | | | | | | | | | | | | |
| U.S. Government Agency Bonds | | $ | 0 | | | $ | 106,885 | | | $ | 0 | | | $ | 106,885 | |
| Mortgage Backed Securities | | | 0 | | | | 66,277 | | | | 0 | | | | 66,277 | |
| U.S. Government Agency CMOs | | | 0 | | | | 61,030 | | | | 0 | | | | 61,030 | |
| States and political subdivisions | | | 0 | | | | 97,525 | | | | 20,289 | | | | 117,814 | |
| Equity and Other Securities | | | 91 | | | | 0 | | | | 1,581 | | | | 1,672 | |
| Total Securities available for sale | | $ | 91 | | | $ | 331,717 | | | $ | 21,870 | | | $ | 353,678 | |
| | | | | | | | | | | | | | | | | |
| Trading equity securities | | $ | 6 | | | $ | 0 | | | $ | 0 | | | $ | 6 | |
| | | | | | | | | | | | | | | | | |
| December 31, 2011 | | | | | | | | | | | | | | | | |
| Securities available for sale | | | | | | | | | | | | | | | | |
| U.S. Government Agency Bonds | | $ | 0 | | | $ | 133,834 | | | $ | 0 | | | $ | 133,834 | |
| Mortgage Backed Securities | | | 0 | | | | 71,052 | | | | 0 | | | | 71,052 | |
| U.S. Government Agency CMOs | | | 0 | | | | 57,845 | | | | 0 | | | | 57,845 | |
| States and political subdivisions | | | 0 | | | | 62,447 | | | | 15,342 | | | | 77,789 | |
| Equity and Other Securities | | | 92 | | | | 0 | | | | 1,572 | | | | 1,664 | |
| Total Securities available for sale | | $ | 92 | | | $ | 325,179 | | | $ | 16,914 | | | $ | 342,184 | |
| | | | | | | | | | | | | | | | | |
| Trading equity securities | | $ | 2 | | | $ | 0 | | | $ | 0 | | | $ | 2 | |
Changes in Level 3 Assets Measured at Fair Value on a Recurring Basis
| (Dollars in Thousands) | | 2012 | | | 2011 | |
| Balance at beginning of year | | $ | 16,914 | | | $ | 10,833 | |
| Total realized and unrealized gains/(losses) included in income | | | 0 | | | | 0 | |
| Total unrealized gains/(losses) included in other comprehensive income | | | 0 | | | | 0 | |
| Purchases of securities | | | 17,262 | | | | 11,325 | |
| Sales of securities | | | 0 | | | | 0 | |
| Calls and maturities | | | (12,663 | ) | | | (5,244 | ) |
| Net transfers in to Level 3 | | | 357 | | | | 0 | |
| Balance at December 31 of each year | | $ | 21,870 | | | $ | 16,914 | |
Both observable and unobservable inputs may be used to determine the fair value of positions classified as Level 3 assets. As a result, the unrealized gains and losses for these assets presented in the tables above may include changes in fair value that were attributable to both observable and unobservable inputs.
Available for sale investments securities categorized as Level 3 assets primarily consist of bonds issued by local municipalities and other like assets. We carry local municipal securities at historical cost, which approximates fair value, unless economic conditions for the municipality changes to a degree requiring a valuation adjustment.
We also have assets that under certain conditions are subject to measurement at fair value on a non-recurring basis. These assets consist of impaired loans and other real estate owned. We have estimated the fair value of impaired loans using Level 3 inputs, specifically valuation of loans based on either a discounted cash flow projection, or a discount to the appraised value of the collateral underlying the loan. We use discounted appraised values or broker’s price opinions to determine the fair value other real estate owned.
Assets Measured at Fair Value on a Nonrecurring Basis
| (Dollars in Thousands) | | Balance at December 31, | | | Quoted Prices in Active Markets for Identical Assets (Level 1) | | | Significant Other Observable Inputs (Level 2) | | | Significant Unobservable Inputs (Level 3) | |
| 2012 | | | | | | | | | | | | |
| Impaired loans | | $ | 36,388 | | | $ | 0 | | | $ | 0 | | | $ | 36,388 | |
| Other real estate owned | | $ | 1,296 | | | $ | 0 | | | $ | 0 | | | $ | 1,296 | |
| Other repossessed assets | | $ | 250 | | | $ | 0 | | | $ | 0 | | | $ | 250 | |
| | | | | | | | | | | | | | | | | |
| 2011 | | | | | | | | | | | | | | | | |
| Impaired loans | | $ | 41,889 | | | $ | 0 | | | $ | 0 | | | $ | 41,889 | |
| Other real estate owned | | $ | 2,223 | | | $ | 0 | | | $ | 0 | | | $ | 2,223 | |
Impaired loans categorized as Level 3 assets consist of non-homogeneous loans that are considered impaired. We estimate the fair value of the loans based on the present value of expected future cash flows using management’s best estimate of key assumptions. These assumptions include future payment ability, timing of payment streams, and estimated realizable values of available collateral (typically based on outside appraisals). Other real estate owned is valued based on either a recent appraisal for the property or a brokers' price opinion of the value of the property, which are discounted for expected costs to dispose of the property. Losses on impaired loans were charged to the allowance for loan losses. Losses in other real estate owned and other repossessed assets were charged to earnings through other non-interest expense on the income statement.
NOTE 24 – BASIC AND DILUTED EARNINGS PER SHARE
| (In Thousands, Except per Share Data) | | Year Ended December 31 | |
| | | 2012 | | | 2011 | | | 2010 | |
| Basic earnings per common share | | | | | | | | | |
| Net income available to common shareholders | | $ | 9,259 | | | $ | 3,944 | | | $ | 2,084 | |
| Weighted average common shares outstanding | | | 7,933 | | | | 7,843 | | | | 7,766 | |
| | | | | | | | | | | | | |
| Basic earnings per common share | | $ | 1.17 | | | $ | 0.50 | | | $ | 0.27 | |
| | | | | | | | | | | | | |
| Diluted Earnings per Share | | | | | | | | | | | | |
| Net income available to common shareholders | | $ | 9,259 | | | $ | 3,944 | | | $ | 2,084 | |
| Weighted average common shares outstanding | | | 7,933 | | | | 7,843 | | | | 7,766 | |
| Add dilutive effects of assumed exercises of options | | | 24 | | | | 2 | | | | 2 | |
| Weighted average common and dilutive potential | | | | | | | | | | | | |
| Common shares outstanding | | | 7,957 | | | | 7,845 | | | | 7,768 | |
| | | | | | | | | | | | | |
| Diluted earnings per common share | | $ | 1.16 | | | $ | 0.50 | | | $ | 0.27 | |
Stock options for 219,223 shares of common stock were not considered in computing diluted earnings per share for 2012, because they were anti-dilutive. Stock options and warrants for 975,845 and 1,033,692 shares of common stock were not considered in computing diluted earnings per share for 2011 and 2010, respectively, because they were anti-dilutive.
NOTE 25 – FIRSTBANK CORPORATION (PARENT COMPANY ONLY)
CONDENSED FINANCIAL INFORMATION
| | | Year Ended December 31, | |
| (In Thousands of Dollars) | | 2012 | | | 2011 | |
| ASSETS | | | | | | |
| Cash and cash equivalents | | $ | 11,167 | | | $ | 16,870 | |
| Investment in and advances to banking subsidiaries | | | 168,883 | | | | 170,981 | |
| Securities | | | 1,090 | | | | 1,086 | |
| Other assets | | | 4,327 | | | | 4,104 | |
| Total Assets | | $ | 185,467 | | | $ | 193,041 | |
| LIABILITIES AND EQUITY | | | | | | | | |
| Accrued expenses and other liabilities | | $ | 2,325 | | | $ | 1,580 | |
| Subordinated Debentures | | | 36,084 | | | | 36,084 | |
| Shareholders’ equity | | | 147,058 | | | | 155,377 | |
| Total Liabilities and Shareholders’ Equity | | $ | 185,467 | | | $ | 193,041 | |
CONDENSED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
| | | Year Ended December 31, | |
| | | 2012 | | | 2011 | | | 2010 | |
| Dividends and returns of capital from banking subsidiaries (net of capital infusions) | | $ | 16,150 | | | $ | 3,680 | | | $ | 4,000 | |
| Other income | | | 5,821 | | | | 5,921 | | | | 5,656 | |
| Other expense | | | (10,043 | ) | | | (8,440 | ) | | | (8,418 | ) |
| Income before income tax and undistributed subsidiary income | | | 11,928 | | | | 1,161 | | | | 1,238 | |
| Income tax benefit | | | 1,416 | | | | 844 | | | | 532 | |
| Equity in undistributed subsidiary income | | | (2,810 | ) | | | 3,618 | | | | 1,993 | |
| Net income | | | 10,534 | | | | 5,623 | | | | 3,763 | |
Change in unrealized gain (loss) on securities, net of tax and classification effects | | | 712 | | | | 2,750 | | | | (452 | ) |
| Comprehensive income | | $ | 11,246 | | | $ | 8,373 | | | $ | 3,311 | |
CONDENSED STATEMENTS OF CASH FLOWS
| | | Year Ended December 31, | |
| | | 2012 | | | 2011 | | | 2010 | |
| Cash flows from operating activities | | | | | | | | | |
| Net income | | $ | 10,534 | | | $ | 5,623 | | | $ | 3,763 | |
| Adjustments: | | | | | | | | | | | | |
| Unrealized (gain)/loss on trading account securities | | | (4 | ) | | | 11 | | | | (3 | ) |
| Equity in undistributed subsidiary income | | | (5,190 | ) | | | (3,618 | ) | | | (1,993 | ) |
| Stock option and restricted stock grant compensation expense | | | 96 | | | | 118 | | | | 115 | |
| Change in other assets | | | (223 | ) | | | 3,797 | | | | 6,734 | |
| Change in other liabilities | | | 745 | | | | 138 | | | | (1,410 | ) |
| Net cash from operating activities | | | 5,958 | | | | 6,069 | | | | 7,206 | |
| | | | | | | | | | | | | |
| Cash flows from investing activities | | | | | | | | | | | | |
| Sale of securities available for sale | | | 0 | | | | 0 | | | | 2,818 | |
| Net decrease in commercial loans | | | 0 | | | | 1,000 | | | | (786 | ) |
| Return from/(payments for) investments in subsidiaries | | | 8,000 | | | | (4,220 | ) | | | (1,950 | ) |
| Net cash from/(used in) investing activities | | | 8,000 | | | | (3,220 | ) | | | 82 | |
| | | | | | | | | | | | | |
| Cash flows from financing activities | | | | | | | | | | | | |
| Redemption of preferred stock | | | (15,056 | ) | | | 0 | | | | 0 | |
| Redemption of common stock warrants | | | (1,947 | ) | | | 0 | | | | 0 | |
| Proceeds from issuance of common stock | | | 903 | | | | 421 | | | | 393 | |
| Dividends on preferred stock | | | (1,247 | ) | | | (1,650 | ) | | | (1,650 | ) |
| Dividends on common stock | | | (2,314 | ) | | | (313 | ) | | | (620 | ) |
| Net cash used for financing activities | | | (19,661 | ) | | | (1,542 | ) | | | (1,877 | ) |
| Net change in cash and cash equivalents | | | (5,703 | ) | | | 1,307 | | | | 5,411 | |
| Beginning cash and cash equivalents | | | 16,870 | | | | 15,563 | | | | 10,152 | |
| Ending cash and cash equivalents | | $ | 11,167 | | | $ | 16,870 | | | $ | 15,563 | |
NOTE 26 – OTHER COMPREHENSIVE INCOME
Other comprehensive income components and related taxes were as follows:
| (In Thousands of Dollars) | | 2012 | | | 2011 | | | 2010 | |
| Change in unrealized holding gains and losses on available for sale securities | | $ | 1,034 | | | $ | 4,204 | | | $ | (689 | ) |
| Reclassification adjustments for gains and losses later recognized in income | | | 44 | | | | (37 | ) | | | 4 | |
| Net unrealized gains and (losses) | | | 1,078 | | | | 4,167 | | | | (685 | ) |
| Tax effect | | | (366 | ) | | | (1,417 | ) | | | 233 | |
| Other comprehensive income (loss) | | $ | 712 | | | $ | 2,750 | | | $ | (452 | ) |
NOTE 27 – QUARTERLY FINANCIAL DATA (UNAUDITED)
| (In Thousands of Dollars, Except per Share Data) | | | | | 2012 | | | | |
| | | 1st Quarter | | | 2nd Quarter | | | 3rd Quarter | | | 4th Quarter | | | Year | |
| Interest income | | $ | 16,126 | | | $ | 16,020 | | | $ | 15,574 | | | $ | 15,146 | | | $ | 62,866 | |
| Net interest income | | | 13,766 | | | | 13,838 | | | | 13,542 | | | | 13,346 | | | | 54,492 | |
| Income before federal income taxes | | | 3,440 | | | | 3,342 | | | | 3,765 | | | | 4,243 | | | | 14,790 | |
| Net income | | | 2,417 | | | | 2,404 | | | | 2,715 | | | | 2,998 | | | | 10,534 | |
| Preferred stock dividends | | | 420 | | | | 420 | | | | 220 | | | | 215 | | | | 1,275 | |
| Net income available to common shareholders | | | 1,997 | | | | 1,984 | | | | 2,495 | | | | 2,783 | | | | 9,259 | |
| Basic earnings per common share | | $ | 0.25 | | | $ | 0.25 | | | $ | 0.32 | | | $ | 0.35 | | | $ | 1.17 | |
| Diluted earnings per common share | | $ | 0.25 | | | $ | 0.25 | | | $ | 0.31 | | | $ | 0.35 | | | $ | 1.16 | |
| | | | | | 2011 | | | | |
| | | 1st Quarter | | | 2nd Quarter | | | 3rd Quarter | | | 4th Quarter | | | Year | |
| Interest income | | $ | 16,989 | | | $ | 17,215 | | | $ | 16,924 | | | $ | 16,516 | | | $ | 67,644 | |
| Net interest income | | | 13,292 | | | | 13,741 | | | | 13,781 | | | | 13,858 | | | | 54,672 | |
| Income before federal income taxes | | | 1,564 | | | | 686 | | | | 2,170 | | | | 3,037 | | | | 7,457 | |
| Net income | | | 1,215 | | | | 628 | | | | 1,630 | | | | 2,150 | | | | 5,623 | |
| Preferred stock dividends | | | 420 | | | | 420 | | | | 420 | | | | 419 | | | | 1,679 | |
| Net income available to common shareholders | | | 795 | | | | 208 | | | | 1,210 | | | | 1,731 | | | | 3,944 | |
| Basic earnings per common share | | $ | 0.10 | | | $ | 0.03 | | | $ | 0.15 | | | $ | 0.22 | | | $ | 0.50 | |
| Diluted earnings per common share | | $ | 0.10 | | | $ | 0.03 | | | $ | 0.15 | | | $ | 0.22 | | | $ | 0.50 | |
NOTE 28 – SUBSEQUENT EVENTS
On February 1, 2013 we completed the consolidation of four of our bank charters into a single organization to achieve a more efficient operation. We also completed the closing of five smaller branch locations and the consolidation of the loans and deposits into other nearby locations on that same date.
FIRSTBANK CORPORATION
| BOARD OF DIRECTORS | | OFFICERS |
| | | |
| William E. Goggin, Chairman | | Thomas R. Sullivan |
| Chairman, Firstbank – Alma | | President & Chief Executive Officer |
| Attorney, Goggin Law Offices | | |
| | | Samuel G. Stone |
| Thomas D. Dickinson, CPA | | Executive Vice President, Chief Financial |
| Certified Public Accountant | | Officer, Secretary & Treasurer |
| Biggs, Hausserman Thompson & Dickinson | | |
| | | William L. Benear |
| David W. Fultz | | Vice President |
| Owner, Fultz Insurance Agency &, | | |
| Kirtland Insurance Agency | | Daniel H. Grenier |
| | | Vice President |
| Jeff A. Gardner | | |
| Certified Property Manager & | | David L. Miller |
| Owner, Gardner Group | | Vice President |
| | | |
| Edward B. Grant, Ph.D., CPA | | Douglas J. Ouellette |
| Chairman, Firstbank (Mt. Pleasant) | | Vice President |
| General Manager, Public Broadcasting, | | |
| Central Michigan University | | Richard D. Rice |
| | | Vice President and Controller |
| Samuel A. Smith | | |
| Owner, Smith Family Funeral Homes | | Thomas O. Schlueter |
| | | Vice President |
| Thomas R. Sullivan | | |
| President & Chief Executive Officer, Firstbank Corporation | | James E. Wheeler, II |
| | | President |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | NON-BANK SUBSIDIARY |
| | | Austin Mortgage Company, LLC |
| | | FBMI Risk Management Services |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| FIRSTBANK CORPORATION | | FIRSTBANK CORPORATION |
| 311 Woodworth Avenue | | OPERATIONS CENTER |
| P. O. Box 1029 | | 308 Woodworth Avenue |
| Alma, Michigan 48801 | | Alma, Michigan 48801 |
| (989) 463-3131 | | |
| www.firstbankmi.com | | |
| BOARD OF DIRECTORS | | OFFICERS |
| | | |
| William E. Goggin, Chairman | | James E. Wheeler, II |
| Chairman, Firstbank Corporation | | President & Chief Executive Officer |
| Attorney, Goggin Law Office | | |
| | | Richard A. Barratt |
| Mark J. Abernathy | | Executive Vice President |
| President, Alma College | | |
| | | Craig A. Bishop |
| Martha A. Bamfield | | Community Bank President-St Johns |
| Dentist, Nester & Bamfield, DDS, PC | | |
| | | Laura A. Crocker |
| Cindy M. Bosley | | Vice President |
| Chief Administrative Officer, Masonic Pathways | | |
| | | Gregory A. Daniels |
| Sara Clark-Pierson | | Vice President |
| Attorney, Certified Public Accountant, Clark Family Enterprises. | | |
| | | Tammy L. Halfmann |
| Todd G. Deitrich | | Vice President |
| President, Olympian Tool, Inc. | | |
| | | Marita A. Harkness |
| Ann M. Flermoen | | Vice President |
| Dentist, Ann M. Flermoen, DDS | | |
| | | Janette Havlik |
| Frank G. Pauli | | Vice President |
| President, Pauli Ford-Mercury, Inc. | | |
| | | Jeffery A. Hicks |
| Samuel A. Smith | | Vice President |
| Owner, Smith Family Funeral Homes | | |
| | | Timothy M. Lowe |
| Thomas R. Sullivan | | Vice President |
| President & Chief Executive Officer | | |
| Firstbank Corporation | | Autumn Redman |
| | | Vice President |
| James E. Wheeler, II | | |
| President & Chief Executive Officer, Firstbank – Alma | | Daniel P. Redman |
| Vice President, Firstbank Corporation | | Vice President |
| | | |
| | | Joan S. Welke |
| | | Vice President |
| | | |
| | | Pamela K. Winters |
| | | Vice President |
| | | |
| | | |
| | | |
| | | SUBSIDIARY |
| | | Firstbank – Alma Mortgage Company |
| | | | | | | |
| OFFICE LOCATIONS | | | | | | |
| | | | | | | |
| Alma | | Ashley | | DeWitt | | Ithaca |
| 7455 N. Alger Road | | 114 S. Sterling St. | | 13215 S. US – 27 B.R. | | 219 E. Center St. |
| (989)463-3134 | | (989) 847-2394 | | (517) 668-8000 | | (989) 875-4107 |
| | | | | | | |
| 230 Woodworth Ave. | | Merrill | | St. Charles | | St. Johns |
| (989)463-3137 | | 125 W. Saginaw St. | | 102 Pine St. | | 201 N. Clinton Ave. |
| | | (989) 643-7253 | | (989) 865-9918 | | (989) 227-8383 |
| 311 Woodworth Ave. | | | | | | |
| (989) 463-3131 | | St. Louis | | Vestbaburg | | 1065 Superior Dr. |
| | | 135 W. Washington Ave. | | 9002 W. Howard City-Edmore Rd | | (989) 227-6995 |
| | | (989) 681-5758 | | (989) 268-5445 | | |
FIRSTBANK (MT. PLEASANT)
| BOARD OF DIRECTORS | | OFFICERS |
| | | |
| Edward B. Grant, Ph.D, CPA, Chairman | | Douglas J. Ouellette |
| General Manager, Public Broadcasting, Central Michigan University | | President & Chief Executive Officer |
| | | |
| Steven K. Anderson | | Peter D. Stalker |
| President & CEO Cadillac Tire Center, Cadillac | | Community Bank President-Cadillac |
| | | |
| Ralph M. Berry | | Daniel J. Timmins |
| Owner, Berry Funeral Homes | | Community Bank President-Clare |
| | | |
| Glen D. Blystone, CPA | | Mark B.Perry |
| Blystone & Bailey, CPA’s PC | | Senior Vice President |
| | | |
| Kenneth C. Bovee | | Robert L. Wheeler |
| President & Chief Executive Officer, Keystone Management Group | | Senior Vice President |
| | | |
| Robert E. List, CPA | | Cheryl L. Gaudard |
| Shareholder, Weinlander Fitzhugh,CPA’s | | Vice President |
| | | |
| Robert J. Long | | Cheryl A. Hall |
| Owner, Summit Petroleum Corporation | | Vice President |
| | | |
| Keith D. Merchant | | Barbara J. Kain |
| President, B&P Manufacturing | | Vice President |
| | | |
| J. Regan O’Neill | | Robert S. Klimczak |
| President and Co-Founder, Network Reporting Corporation | | Vice President |
| President and Co-Founder, NetMed Transcription Services, LLC | | |
| | | Karen L. McKenzie |
| Douglas J. Ouellette | | Vice President |
| President & Chief Executive Officer, Firstbank (Mt. Pleasant) | | |
| Vice President, Firstbank Corporation | | Teresa L. Rupert |
| | | Vice President |
| E. Lynn Pohl | | |
| Partner, Boge, Wybenga & Bradely, PC | | Tracey L. Sallee |
| | | Vice President |
| Kenneth A. Rader | | |
| Owner, Ken Rader Farms | | Dianne M. Stilson |
| | | Vice President |
| Phillip R. Seybert | | |
| President, P.S. Equities, Inc. | | |
| | | |
| Thomas R. Sullivan | | SUBSIDIARY |
| President & Chief Executive Officer, Firstbank Corporation | | Firstbank (Mt. Pleasant) Mortgage Company |
| OFFICE LOCATIONS | | | | | | |
| | | | | | | |
| Mt. Pleasant | | Cadillac | | Howard City | | Remus |
| 102 S. Main St. | | 114 W. Pine St. | | 830 W. Shaw St. | | 201 W Whetland Ave. |
| (989) 773-2600 | | (231) 775-9000 | | (231) 937-4383 | | (989) 967-3602 |
| | | | | | | |
| 4699 Pickard St. | | 8851 E. 34 Road | | Lakeview | | Shepherd |
| (989) 773-2335 | | (231) 779-8954 | | 506 Lincoln Ave. | | 258 W. Wright Ave. |
| | | | | (989) 352-7271 | | (989) 828-6625 |
| 2015 S. Mission St. | | Clare | | | | |
| (989) 773-3959 | | 806 N. McEwan Ave. | | 9531 N. Greenville Rd. | | |
| | | (989) 386-7313 | | (989) 352-8180 | | |
| 1925 E. Remus Rd. | | | | | | |
| (989) 775-8528 | | Canadian Lakes | | | | |
| | | 10049 Buchanan Rd. | | | | |
| | | Stanwood, MI | | | | |
FIRSTBANK – WEST BRANCH
| BOARD OF DIRECTORS | | OFFICERS |
| | | |
| Joseph M. Clark, Chairman | | Daniel H. Grenier |
| Owner, Morse Clark Furniture | | President & Chief Executive Officer |
| | | |
| Bryon A. Bernard | | Kim D. vonKronenberger |
| CEO, Bernard Building Center | | Executive Vice President |
| | | |
| Robert J. Carpenter, CPA | | Danny J. Gallagher |
| Vice President, Robertson & Carpenter CPAs, P.C. | | Senior Vice President |
| | | |
| David W. Fultz | | Frank J. Benjamin |
| Owner, Fultz Insurance Agency & | | Vice President |
| Kirtland Insurance Agency | | |
| | | Lorri A. Burzlaff |
| Daniel H. Grenier | | Vice President |
| President & Chief Executive Officer, Firstbank – West Branch | | |
| Vice President, Firstbank Corporation | | Pamela J. Crainer |
| | | Vice President |
Robert T. Griffin, Jr. | | |
| Owner and President, Griffin Beverage Company, | | Eileen S. Fournier |
| Northern Beverage Co. and West Branch Tank & Trailer | | Vice President |
| | | |
| Christine R. Juarez | | James L. Kloostra |
| Attorney, Juarez and Juarez, PLLC | | Vice President |
| | | |
| Norman J. Miller | | Stevens P. Loomis |
| Owner, Miller Farms and Miller Dairy Equipment and Feed | | Vice President |
| | | |
| Thomas R. Sullivan | | Mark D. Wait |
| President & Chief Executive Officer, Firstbank Corporation | | Vice President |
| | | |
| Mark D. Weber, MD | | Marie A. Wilkins |
| Orthopedic Surgeon | | Vice President |
| | | |
| Kimberly Zygiel | | Lorri A. Burzlaff |
| Accountant, Stephenson, Gracik & Company, PC | | |
| | | Subsidiaries |
| | | Firstbank – West Branch Mortgage Company |
| OFFICE LOCATIONS | | | | | | |
| | | | | | | |
| West Branch | | Fairview | | Hale | | Higgins Lake |
| 502 W. Houghton Ave. | | 1979 Miller Rd. | | 3281 M-65 | | 4522 W. Higgins Lake Dr. |
| (989) 345-7900 | | (989) 848-2243 | | (989) 728-7566 | | (989) 821-9231 |
| | | | | | | |
| 601 W. Houghton Ave. | | Rose City | | St. Helen | | |
| (989) 345-7900 | | 505 S. Bennett St. | | 1990 N. St. Helen Rd. | | |
| | | (989) 685-3909 | | (989) 389-1311 | | |
| 2087 S. M-76 | | | | | | |
| (989) 345-5050 | | | | | | |
| | | | | | | |
| 2375 M-30 | | | | | | |
| (989) 345-6210 | | | | | | |
KEYSTONE COMMUNITY BANK
| BOARD OF DIRECTORS | | OFFICERS |
| | | |
| Kenneth V. Miller, Chairman | | Thomas O. Schlueter |
| Partner, Havirco | | President & Chief Executive Officer |
| Owner, Millennium Restaurant Group | | |
| | | Thomas D. Lundquist |
| John M. Brink | | Senior Vice President |
| Brink, Key & Chludzinski, P.C. | | |
| | | Cynthia J. Carter |
| Michelle L. Eldridge | | Vice President |
| Principal, LVM Capital Management, LTD. | | |
| | | Sara S. Dana |
| Samuel T. Field | | Vice President |
| Attorney, Field & Field, P.C | | |
| | | Kimberly A. Labadie |
| Jeff A. Gardner | | Vice President |
| Certified Property Manager & | | |
| Owner, Gardner Group | | Cynthia L. Mount |
| | | Vice President |
| John E. Hopkins | | |
| Retired, former President & Chief Executive Officer, | | Derek T. Naylor |
| Kalamazoo Community Foundation | | Vice President |
| | | |
| Ronald A. Molitor | | Ryan M. Turtle |
| President, Mol-Son, Inc. | | Vice President |
| | | |
| John M. Novak | | |
| Principal, Miller Canfield Attorneys & Counselors | | |
| | | |
| Thomas O. Schlueter | | |
| President & Chief Executive Officer, Keystone Community Bank | | |
| Vice President, Firstbank Corporation | | |
| | | |
| Thomas R. Sullivan | | |
| President & Chief Executive Officer, Firstbank Corporation | | |
| | | |
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| | | SUBSIDIARY |
| | | Keystone Mortgage Services, LLC |
| | | |
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| OFFICE LOCATIONS | | | | |
| | | | | |
| Kalamazoo | | Portage | | Paw Paw |
| 107 West Michigan Ave. | | 6405 South Westnedge Ave. | | 900 East Michigan Avenue |
| (269) 553-9100 | | (269) 321-9100 | | (269) 655-1000 |
| | | | | |
| 235 North Drake Road | | 3910 West Centre Street | | |
| (269) 544-9100 | | (269) 323-9100 | | |
| | | | | |
| 2925 Oakland Drive | | | | |
| (269) 488-9200 | | | | |
| | | | | |
| 5073 Gull Road | | | | |
| (269)488-4800 | | | | |
FIRSTBANK – WEST MICHIGAN
| BOARD OF DIRECTORS | | OFFICERS |
| | | |
| Janice K. DeYoung, Chairman | | William L. Benear |
| Former Business Owner | | President & Chief Executive Officer |
| | | |
| William L. Benear | | Clare R. Colwell |
| President & Chief Executive Officer, Firstbank – West Michigan | | Executive Vice President |
| Vice President, Firstbank Corporation | | |
| | | Kevin M. Meade |
| Thomas D. Dickinson, CPA | | Senior Vice President |
| Biggs, Hausserman Thompson & Dickinson P.C. | | |
| | | Brian Talbot |
| Jerome I. Gregory | | Senior Vice President |
| Chief Executive Officer, Carr Real Estate, Inc. | | |
| | | Debrann Hausserman |
| David M. Laux | | Vice President |
| President, Industrial Engineering Services, Inc. | | |
| | | William Kavanagh |
| Douglas J. Ouellette | | Vice President |
| President & Chief Executive Officer, Firstbank (Mt. Pleasant) | | |
| Vice President, Firstbank Corporation | | Daniel V. King |
| | | Vice President |
| James E. Reagan, D.D.S. | | |
| Dentist, James E. Reagan, DDS | | Blaine A. Kemme |
| | | Vice President |
| Thomas R. Sullivan | | |
| President & Chief Executive Officer, Firstbank Corporation | | Michele M. Krick |
| | | Vice President |
| | | |
| | | Daniel P. Mitchell |
| | | Vice President |
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| | | Subsidiary |
| | | ICNB Mortgage Company |
| OFFICE LOCATIONS | | | | | | |
| | | | | | | |
| Ionia | | Belding | | Lowell | | Hastings |
| 302 W. Main St. | | 9344 W. Belding Rd. | | 2601 W. Main St. | | 1500 W. M-43 Hwy. |
(616) 527-0220 | | (616) 794-0890 | | (616) 897-6171 | | (269) 948-2905 |
| | | | | | | |
| 202 N. Dexter St. | | | | | | |
| (616) 527-1550 | | | | | | |
| | | | | | | |
| 2600 S. State Rd. | | | | | | |
| (616) 527-9250 | | | | | | |
BUSINESS OF THE COMPANY
Firstbank Corporation is a bank holding company. As of December 31, 2012 our subsidiaries are Firstbank – Alma; Firstbank (Mt. Pleasant); Firstbank – West Branch; Keystone Community Bank; Firstbank – West Michigan; FBMI Risk Management Services, Inc.; and Austin Mortgage Company, LLC. As of December 31, 2012, Firstbank Corporation and its subsidiaries employed 438 people on a full-time equivalent basis.
We are in the business of banking. Each of our subsidiary banks is a full service community bank. The subsidiary banks offer all customary banking services, including the acceptance of checking, savings and time deposits and the making of commercial, agricultural, real estate, personal, home improvement, automobile and other installment and consumer loans. Trust services are offered to customers through Citizens Bank Wealth Management in the Firstbank – Alma main office.
The banks obtain most of their deposits and loans from residents and businesses in Barry, Bay, Clare, Gratiot, Kalamazoo, Ionia, Iosco, Isabella, Mecosta, Midland, Montcalm, Ogemaw, Oscoda, Roscommon, Saginaw, and parts of Clinton, Eaton, Kent, Wexford and Van Buren counties. Firstbank – Alma has its main office and one branch in Alma, Michigan, and branches located in each of the following areas: Ashley, Dewitt, Ithaca, Merrill, Pine River Township (near Alma), St. Charles, St. Johns (2 branches), St. Louis, and Vestaburg, Michigan. Firstbank (Mt. Pleasant) has its main office and one branch located in Mt. Pleasant, Michigan, two branches located in Union Township (near Mt. Pleasant), two branches in Lakeview, two branches in Cadillac, and one branch located in each of the following areas: Canadian Lakes, Clare, Howard City, Remus, and Shepherd, Michigan. Firstbank – West Branch has its main office in West Branch, Michigan, and one branch located in each of the following areas: Fairview, Hale, Higgins Lake, Rose City, St. Helen, and West Branch Township (near West Branch), Michigan. Keystone Community bank has its main office and three branches located in Kalamazoo, Michigan, two additional branches in Portage, Michigan, and one branch in Paw Paw, Michigan. Firstbank – West Michigan has its main office and two additional branches in Ionia, Michigan, and one branch each in Belding, Hastings, and Lowell, Michigan. The banks have no material foreign assets or income. Subsequent to year end, we closed five smaller branch locations in Morley, Winn, Prescott, Sunfield and Woodland. The deposits and loans were consolidated the loans and deposits into other nearby locations on February 1.
Our principal sources of revenues are interest and fees on loans and non-interest revenue resulting from banking and non-bank subsidiary activity. On a consolidated basis, interest and fees on loans accounted for approximately 75% of total revenues in 2012, 79% in 2011, and 80% in 2010. Non-interest revenue accounted for approximately 17% of total revenue in 2012, 13% in 2011, and 14% in 2010. Interest on securities accounted for approximately 8% of total revenue in 2012, 8% in 2011, and 6% in 2010.
Annual Meeting
The annual meeting of shareholders will be held on Monday, April 22, 2013 at 4:30 p.m., Heritage Center, Alma College, Alma, Michigan.
| Independent Auditors | General Counsel |
| Plante & Moran, PLLC | Varnum LLP |
| Grand Rapids, Michigan | Grand Rapids, Michigan |
Stock Information
Firstbank Corporation common stock is traded on the NASDAQ National Market System under the symbol FBMI. For research information and/or investment recommendations, contact:
| Raymond James | - or - | FIG Partners, LLC |
| 800-248-8863 | | 800-677-9654 |
Transfer Agent Information
Registrar and Transfer Company is Firstbank Corporation’s Transfer Agent. You may contact the Investor Relations Department at 800-368-5948.
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