EXHIBIT 13
CAPITAL DIRECTIONS, INC.
2001
ANNUAL REPORT
THE MISSION OF MASON STATE BANK
IS TO OPERATE AS A FINANCIAL SERVICES ORGANIZATION
IN A SAFE, SECURE, AND ETHICAL MANNER
AND TO PRODUCE SUPERIOR RETURNS FOR OUR SHAREHOLDERS.
THIS WILL BE ACCOMPLISHED BY BEING CUSTOMER FOCUSED
AND PROVIDING QUALITY SERVICES AND PRODUCTS
DELIVERED THROUGH A STAFF OF HIGHLY TRAINED
AND MOTIVATED PROFESSIONALS.
TABLE OF CONTENTS
2001 ANNUAL REPORT
<Table>
A message from the President and CEO .......................2
Shareholder returns 1991-2001 ..............................3
Stock and shareholder information ..........................4
Market for common stock and related
security holder matters ...............................4
Management, officers and directors .......................4-5
Financial highlights .......................................5
Selected financial data ....................................6
Management's discussion and analysis
of financial condition and results
of operations ......................................7-11
Report of independent auditors ............................12
Capital Directions, Inc. consolidated balance sheets ......13
Capital Directions, Inc. consolidated statements
of income ............................................14
Capital Directions, Inc. consolidated statements
of cash flows ........................................15
Capital Directions, Inc. consolidated statements
of changes in shareholders' equity ...................16
Notes to consolidated financial statements
(December 31, 2001, 2000 and 1999) ................17-24
</Table>
2001 o ANNUAL REPORT o CDI 1
TO THE SHAREHOLDERS:
[PHOTO]
TIMOTHY P. GAYLORD
PRESIDENT & CEO
It is my pleasure to report record results for Capital Directions, Inc. in 2001.
This was the corporation's 12th consecutive year of increased earnings. In light
of the weak economy, one with record bankruptcies, the World Trade Center
attacks, and eleven Federal Reserve interest rate cuts, Capital Direction's
performance was especially gratifying. Net income for the year of $1,738,000
represents the highest earnings in corporate history and a 5.3% increase over
2000. Basic earnings per share grew to $2.91 compared with $2.76 in 2000. Return
on shareholder equity of 12.94% and return on assets of 1.53% reflects an
outstanding operating performance.
OUTSTANDING CREDIT QUALITY
As a community bank, our knowledge of customers and markets allows us to meet
customer needs. This knowledge also enables us to identify and address potential
problems quickly. Our continued adherence to a strong credit culture has enabled
the bank to achieve a prudent balance between credit risk and financial reward.
The soundness of our strategy is reflected in the strong performance of the loan
portfolio during the most recent economic downturn. Our net charge-offs to
average loans ratio of .01% and non-performing assets to loans ratio of .36% are
considerably lower than those of our peers.
EXCELLENT EXPENSE CONTROL
Controlling expenses continues to be instrumental in the success of the bank. An
emphasis on effective use of technology has been a contributing factor.
Installation of a new mainframe and operating system in 2001 allowed the bank to
reduce processing times and automate multiple accounting functions. Capital
Directions' efficiency ratio ranks among the top 10% of peer banks. At 50.29%,
it is the corporation's lowest ever. With margins continuing to narrow, the
corporation's low operating costs allow the bank a competitive advantage.
INTEREST RATE ENVIRONMENT
Throughout the year, falling loan rates stimulated mortgage activity. Our
personalized service allows us to take an application anytime, anywhere. The
bank continues to work to develop strong relations with builders and realtors to
assure a steady flow of business, even in a changing rate environment. Our
quality of service goal is to close new purchase mortgages within 30 days of a
completed application. The quality of service provided by our mortgage
department continues to be rated as excellent by our customers, realtors and
builders.
STRONG CAPITAL BASE
Capital Directions continues to strive to improve shareholder value. During
2001, dividends paid increased 13%. Over the last seven years, dividends have
increased 278%. An investment in Capital Directions, utilizing the dividend
reinvestment program, would have returned an annual compounded rate of 19.67%
over the last 10 years. Mason State Bank is a well-capitalized organization. Our
capital ratio ranks in the top 12% of peer banks. Mason State Bank is one of the
strongest banks in the region.
FUTURE
The banking industry continues to consolidate and offer new challenges. We look
at these challenges as opportunities. With the dedication of the Board of
Directors, Management and staff we will consistently improve our performance.
Thank you for your support. We look forward to seeing you at the Annual Meeting
of Shareholders on April 25, 2002.
Sincerely,
/s/ TIMOTHY GAYLORD
Timothy Gaylord
President & CEO
2 CDI o ANNUAL REPORT o 2001
STOCK PERFORMANCE
Capital Directions, Inc. shareholders taking advantage of the dividend
reinvestment program experienced an overall annual compounded rate of return of
15.61% since December of 1996(1).
THE 5-YEAR ANNUALIZED RETURN
ON CAPITAL DIRECTIONS, INC.
STOCK WAS 15.61%(1)
THE 10-YEAR ANNUALIZED RETURN
ON CAPITAL DIRECTIONS, INC.
STOCK WAS 19.67%(1)
[BAR CHART]
<Table>
<Caption>
DECEMBER 31, 1996 DECEMBER 31, 2001
$10,000 $21,329
</Table>
(1) Computation assumes quarterly reinvestment of dividends. Capital Directions,
Inc. stock is not listed on any exchange. Its shares are traded through local
brokers. Management has not verified the accuracy of their bid reporting, nor
will the price be reflective if the stock was listed on an active exchange.
Return is determined by an investment accumulation schedule using the beginning
value per share and the ending value per share including additional shares or
fractional shares earned through quarterly dividend reinvestment.
SHAREHOLDER RETURNS 1991-2001
NET INCOME
(In thousands)
<Table>
<Caption>
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
- -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- --------
$ 678 $ 835 $ 869 $ 930 $ 1,050 $ 1,136 $ 1,235 $ 1,334 $ 1,449 $ 1,650 $ 1,738
</Table>
RETURN
ON EQUITY
(ROE)
<Table>
<Caption>
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
- ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ------
11.54% 13.10% 12.62% 12.48% 12.71% 12.67% 12.47% 12.53% 13.06% 13.28% 12.94%
</Table>
RETURN
ON ASSETS
(ROA)
<Table>
<Caption>
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
- -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- --------
.85% 1.10% 1.14% 1.24% 1.40% 1.49% 1.56% 1.47% 1.44% 1.54% 1.53%
</Table>
BOOK VALUE
PER SHARE
(Retroactively
adjusted for
stock splits)
<Table>
<Caption>
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
- ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ------
$10.23 $11.14 $12.17 $12.86 $14.45 $15.80 $17.17 $18.48 $19.82 $21.46 $23.09
</Table>
SHAREHOLDERS'
EQUITY TO
TOTAL ASSETS
<Table>
<Caption>
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
- ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ------
7.69% 8.47% 9.52% 10.05% 11.04% 11.91% 12.78% 10.97% 11.19% 11.16% 11.74%
</Table>
2001 o ANNUAL REPORT o CDI 3
STOCK AND SHAREHOLDER INFORMATION
STOCK TRANSFER AGENT AND REGISTRAR
American Stock Transfer and Trust Company 59 Maiden Lane New York, New York
10038
AUTOMATIC DIVIDEND REINVESTMENT AND STOCK PURCHASE PLAN
Participating Capital Directions, Inc. shareholders take the opportunity to
reinvest the cash dividends paid on their shares to purchase additional shares
of Capital Directions, Inc. common stock. Participants may also purchase
additional shares through cash payment without paying fees or commissions.
DIRECT DEPOSIT
The Corporation continues to provide convenient services to meet your needs. For
quick transfer and availability, your cash dividends may be deposited directly
into your Mason State Bank checking, savings or money market account. To learn
more about the Automatic Dividend Reinvestment and Stock Purchase Plan, or to
initiate direct deposit of your cash dividends, please contact Kimberly A.
Dockter, CPS, Executive Secretary, at (517) 676-0500.
ANNUAL MEETING OF SHAREHOLDERS
The annual meeting for the year ended December 31, 2001 will be held at Mason
State Bank's Main Office, 322 South Jefferson Street, Mason, Michigan on
Thursday, April 25, 2002 at 6:30 p.m.
HOW TO ORDER FORM 10-K
The Corporation's 2001 Annual Report on Form 10-K, as filed with the Securities
and Exchange Commission can be found on the Internet. It is also available,
without charge, to shareholders upon request. Send requests to Lois A. Toth,
Treasurer, Capital Directions, Inc., P. O. Box 130, Mason, Michigan 48854-0130
or call (517) 676-0500.
MARKET FOR COMMON STOCK AND RELATED SECURITY HOLDER MATTERS
Capital Directions, Inc. stock is not listed on any exchange. Its shares are
traded through the local brokers of Stifel, Nicolaus & Co., Inc., Monroe
Securities, Morgan Stanley Dean Witter and Raymond James & Assoc., Inc.
Management has not verified the accuracy of their bid reporting, nor will the
price be reflective if the stock was listed on an active exchange. At December
31, 2001, there were approximately 426 holders of the Company's common stock.
Dividends are declared on a quarterly basis with a total of $849,000 declared in
2001 and $760,000 in 2000.
<Table>
<Caption>
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
-------- -------- -------- --------
2001
High ................. $ 40.00 $ 39.75 $ 40.25 $ 41.00
Low .................. 36.25 36.37 37.00 37.55
Dividend
per share
declared ........... 0.34 0.35 0.36 0.37
2000
High ................. $ 42.00 $ 40.75 $ 40.50 $ 40.50
Low .................. 39.25 39.50 35.00 36.25
Dividend
per share
declared ........... 0.30 0.31 0.32 0.34
</Table>
CAPITAL DIRECTIONS, INC. BOARD OF DIRECTORS AND OFFICERS
BOARD OF DIRECTORS
George A. Sullivan
Chairman, Capital Directions, Inc.
Private Practice Attorney
Gerald W. Ambrose
Vice Chairman, Capital
Directions, Inc.
County Controller, Ingham County
Timothy P. Gaylord
President & Chief Executive
Officer, Capital Directions, Inc.
Douglas W. Dancer
Secretary, Capital Directions, Inc.,
Partner, Nu-Horizons, Inc. and
Realtor, Vision Real Estate
Marvin B. Oesterle
Partner, Golden Acres Farms and
Oesterle Brothers Seed Corn
Paula Johnson
Co-owner, Vision Real Estate and
Developer, PAL, LLC (ie: Vision
Village Condominiums)
James W. Leasure
Owner, Paul's Marathon, Inc. and
Showtime, Inc.
OFFICERS
George A. Sullivan
Chairman
Gerald W. Ambrose
Vice Chairman
Timothy P. Gaylord
President & Chief Executive Officer
Douglas W. Dancer
Secretary
Lois A. Toth
Treasurer
4 CDI o ANNUAL REPORT o 2001
FINANCIAL HIGHLIGHTS
<Table>
<Caption>
CHANGE CHANGE
2001 2000 AMOUNT PERCENT
------------ ------------ ------------ ------------
INCOME STATEMENT
Net interest income ......................... $ 4,334,000 $ 4,160,000 $ 174,000 4.18%
Net income .................................. 1,738,000 1,650,000 88,000 5.33
Basic earnings per share .................... 2.91 2.76 0.15 5.43
Cash dividend declared per share ............ 1.42 1.27 0.15 11.81
RATIOS
Return on average shareholders' equity ...... 12.94% 13.28%
Return on average assets .................... 1.53 1.54
Standard efficiency (1) ..................... 50.29 50.85
Average shareholders' equity as a
percentage of average assets .............. 11.83 11.59
BALANCE SHEET
Total assets ................................ $117,277,000 $115,023,000 $ 2,254,000 1.96%
Total earning assets ........................ 111,330,000 109,249,000 2,081,000 1.90
Total loans, net ............................ 91,784,000 84,596,000 7,188,000 8.50
Total deposits .............................. 70,933,000 72,423,000 (1,490,000) (2.06)
</Table>
- ----------
(1) Calculated as noninterest expense divided by the sum of net interest income,
on a fully taxable equivalent basis, plus noninterest income.
MASON STATE BANK MANAGEMENT
Timothy P. Gaylord
President & Chief Executive Officer
Thomas L. Peterson
Senior Vice President, Retail
Banking & Operations
Kathleen R. Baker
Vice President, Mortgage Loans
Thomas W. Schroeder
Vice President, Commercial Loans
Elizabeth J. Luttrell-Wilson
Assistant Vice President, Human
Resources & Security
Lea L. Ammerman
Director of Branch Administration
and Marketing
Thelma Hines
Customer Service Officer
Lois A. Toth
Vice President & Controller
MASON STATE BANK 2001
[PHOTO]
George Sullivan will end 27 years of service as a Director of Capital
Directions, Inc. and Mason State Bank with his 2001 term. Sullivan became a
director on September 1, 1975 and will retire on April 25, 2002.
Sullivan held various positions on the Board including Chairman of the Audit
Committee, Secretary, Vice Chairman and most recently, Chairman of the Board.
Sullivan was instrumental in guiding the Bank to establish a holding company.
This allowed the Bank to expand its product offerings to include investment and
insurance services.
Sullivan's leadership helped the Bank become recognized as a top performer among
the nation's publicly traded banks. Under his tenure, Mason State Bank's
earnings increased from $236,000 in 1975 to $1,738,000 in 2001. Also during this
time, assets grew from $28,318,000 to $117,277,000.
As a dedicated director and community leader, Sullivan's contributions will be
missed by all.
[PHOTO]
During 2001, Mason State Bank promoted Lea Ammerman to Director of Branch
Administration and Marketing. Ammerman has been an employee of Mason State Bank
since 1988. Most recently she served as Branch Manager in Leslie.
[PHOTO]
Also in 2001, Mason State Bank promoted Debbie Satchell to Loan Processing
Manager. Satchell has been an employee of Mason State Bank since 1989. Most
recently she was a Personal Banker at the Main Office.
2001 o ANNUAL REPORT o CDI 5
SELECTED FINANCIAL DATA
(In thousands, except per share data)
<Table>
<Caption>
2001 2000 1999 1998 1997
---------- ---------- ---------- ---------- ----------
SUMMARY OF OPERATIONS
Interest and dividend income ..................... $ 8,049 $ 7,958 $ 7,525 $ 6,880 $ 6,092
Interest expense ................................. 3,715 3,798 3,440 3,125 2,594
---------- ---------- ---------- ---------- ----------
Net interest income .............................. 4,334 4,160 4,085 3,755 3,498
Provision for loan losses ........................ -- 6 48 (23) --
Noninterest income ............................... 819 794 592 565 568
Noninterest expense .............................. 2,640 2,569 2,471 2,461 2,340
---------- ---------- ---------- ---------- ----------
Income before income tax expense ................. 2,513 2,379 2,158 1,882 1,726
Income tax expense ............................... 775 729 659 548 491
---------- ---------- ---------- ---------- ----------
Net income ....................................... $ 1,738 $ 1,650 $ 1,499 $ 1,334 $ 1,235
========== ========== ========== ========== ==========
PER SHARE(1)
Average shares outstanding ....................... 598,017 597,704 596,200 595,064 594,926
Basic earnings(2) ................................ $ 2.91 $ 2.76 $ 2.51 $ 2.24 $ 2.08
Diluted earnings(2) .............................. 2.88 2.74 2.49 2.22 2.07
Dividends declared ............................... 1.42 1.27 1.14 0.96 0.70
Book value ....................................... 23.09 21.46 19.82 18.48 17.17
RATIOS BASED ON NET INCOME
Net income to average shareholders' equity ....... 12.94% 13.28% 13.06% 12.53% 12.47%
Net income to average assets ..................... 1.53 1.54 1.44 1.47 1.56
BALANCE SHEET
Assets ........................................... $ 117,277 $ 115,023 $ 105,713 $ 100,229 $ 79,957
Net loans ........................................ 91,784 84,596 88,057 80,904 60,299
Short-term investments ........................... 4,331 5,963 54 626 188
Securities ....................................... 14,167 17,637 10,726 12,383 14,118
Deposits ......................................... 70,933 72,423 72,030 72,389 64,421
Long-term Federal Home Loan Bank
borrowings .................................... 31,125 28,339 18,861 15,593 3,670
Shareholders' equity ............................. 13,763 12,834 11,828 10,997 10,216
</Table>
(1) A 2-for-1 stock split was declared on the common stock November 3, 1997 and
paid December 1, 1997. Earnings, dividends, book value, price per share figures
and share amounts have been restated to give retroactive effect to this split.
(2) Restated to reflect adoption of SFAS No. 128 on December 31, 1997.
6 CDI o ANNUAL REPORT o 2001
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis provides additional information concerning
the consolidated financial condition and results of operations for Capital
Directions, Inc. (the "Corporation") and its wholly owned subsidiaries. It
should be read in conjunction with the consolidated financial statements and
supplemental data contained elsewhere in this report.
Capital Directions, Inc., a one-bank holding company, commenced operations on
July 22, 1988. This was facilitated by the acquisition of 100% of the
outstanding shares of Mason State Bank in an exchange of common stock.
The Corporation is not aware of any market or institutional trends, events, or
circumstances that will have or are reasonably likely to have a material effect
on liquidity, capital resources, or operations except as discussed herein. Also,
the Corporation is not aware of any current recommendations by regulatory
authorities that will have such affect if implemented.
PERFORMANCE SUMMARY
In 2001, Capital Directions, Inc. and its subsidiaries reported record net
earnings of $1,738,000. This is an increase of 5.33% over the previous year.
Basic earnings per share were $2.91 in 2001 compared to $2.76 in 2000. In 2001,
return on average assets decreased slightly to 1.53% from 1.54% in 2000. This
decrease is attributable to the growth percentage in net average assets of the
Corporation exceeding the percentage growth in net income during 2001. Return on
shareholders' equity was 12.94%, down from 13.28% in 2000. As of December 31,
2001 the leveraged capital ratio, which excludes the net unrealized gain or loss
on securities available for sale was 11.6%, up from 11.4% the prior year and
well in excess of the 4.0% minimum required by regulatory authorities.
The following table provides a summary of the factors impacting net income in
2001 compared to the same components in 2000:
(In thousands)
<Table>
2000 NET INCOME ........................ $ 1,650
Increase (decrease) in net income
Interest income ...................... 91
Interest expense ..................... 83
Provision for loan losses ............ 6
Noninterest income ................... 25
Noninterest expense .................. (71)
Income taxes ......................... (46)
-------
2001 NET INCOME ........................ $ 1,738
-------
</Table>
In 2000, net income for the Corporation was $1,650,000, which was an increase of
10.07% over net earnings of $1,499,000 for 1999. Basic earnings per share
increased to $2.76 in 2000 compared to $2.51 in 1999. The 2000 return on average
assets increased to 1.54% from 1.44% in 1999. Return on average shareholders'
equity was 13.28%, up from 13.06% in 1999. The leveraged capital ratio for the
year ending December 31, 2000 was 11.4%, up from 11.1% the prior year.
The operations of our Holding Corporation did not materially affect the
consolidated financial results for 2001, 2000 or 1999.
NET INTEREST INCOME
The largest segment of the Corporation's operating income is net interest
income. Net interest income is determined by adding interest and certain fees
from earning assets, then subtracting the interest paid on deposits and other
funding sources. This may be impacted by changes in volume and mix of earning
assets, funding sources, deposits, interest rates, loan demand and other market
factors.
Net interest income for 2001, on a fully taxable equivalent basis, was
$4,431,000, an increase of $173,000 over 2000. For 2000, net interest income, on
a fully taxable equivalent basis, increased $55,000 over 1999. Average balances
and rates on major categories of interest earning assets and interest-bearing
liabilities appear in Table 1. The affect on net interest income from changes in
average balances ("volume") and yields and rates ("rate") are quantified in
Table 2. As shown, net interest income improved in 2001 generally due to the
impact of rate decreases on interest-bearing liabilities exceeding the impact of
rate decreases on interest earning assets, and in 2000 generally due to the
impact of rate increases on interest earning assets exceeding the impact of rate
increases on interest-bearing liabilities.
Yields on assets and funding rates were lower in 2001 compared to 2000,
reflecting a declining rate environment. Average tax equivalent yields on
earning assets decreased to 7.55% in 2001 from 7.91% in 2000. Interest-bearing
liability rates decreased to 4.20% in 2001 from 4.54% in 2000. Despite an
increase in net interest income related primarily to increased volume, the tax
equivalent net interest margin decreased by 7 basis points. This was primarily
related to the change in the structure of earning assets and the Bank's
liability sensitive GAP position. As loan demand declined throughout the early
part of the year, these funds were used to increase the securities portfolio,
which tend to be at lower yields as compared to loans. In addition, because of
the Bank's liability sensitive position, as discussed more fully below, and
considering the falling interest rate environment during 2001, the Bank's
interest-bearing liabilities repriced at lower rates at a faster pace than the
Bank's interest-bearing assets.
2001 o ANNUAL REPORT o CDI 7
TABLE 1
<Table>
<Caption>
2001 2000 1999
INTEREST AVERAGE INTEREST AVERAGE INTEREST AVERAGE
AVERAGE INCOME/ YIELD/ AVERAGE INCOME/ YIELD/ AVERAGE INCOME/ YIELD/
BALANCE EXPENSE* RATE* BALANCE EXPENSE* RATE* BALANCE EXPENSE* RATE*
-------- -------- ------- -------- -------- ------- -------- -------- -------
(Dollars in thousands)
Loans ................... $ 86,794 $ 6,852 7.89% $ 87,651 $ 7,063 8.06% $ 86,397 $ 6,798 7.87%
Other
earning
assets ................ 21,035 1,294 6.15 14,220 993 6.98 12,245 845 6.90
-------- -------- -------- -------- -------- --------
Total
earning
assets ................ 107,829 8,146 7.55 101,871 8,056 7.91 98,642 7,643 7.75
Other
assets ................ 5,733 5,309 5,702
-------- -------- --------
Total ................... $113,562 $107,180 $104,344
======== ======== ========
Interest
bearing
liabilities ........... $ 88,487 $ 3,715 4.20% $ 83,689 $ 3,798 4.54% $ 81,409 $ 3,440 4.23%
-------- -------- --------
Noninterest
bearing
liabilities
and
equity ................ 25,075 23,491 22,935
-------- -------- --------
Total ................... $113,562 $107,180 $104,344
======== ======== ========
Net interest
income ................ $ 4,431 $ 4,258 $ 4,203
======== ======== ========
Net interest
margin on
earning
assets ................ 4.11% 4.18% 4.26%
</Table>
- ----------
* Fully taxable equivalent basis.
TABLE 2
<Table>
<Caption>
(Dollars in thousands) 2001 COMPARED TO 2000 2000 COMPARED TO 1999
CHANGE DUE TO: VOLUME RATE TOTAL VOLUME RATE TOTAL
------ ------ ------- ------ ------ -------
Earning assets*:
Loans ................................ $ (79) $ (142) $ (221) $ 122 $ 157 $ 279
Loans (nontaxable) ................... 11 (1) 10 (23) 9 (14)
Taxable investment securities ........ 285 (13) 272 88 9 97
Investment securities (nontaxable) ... (3) (8) (11) (60) 12 (48)
Federal funds sold and other ......... 113 (73) 40 87 12 99
------ ------ ------- ------ ------ -------
Total interest income .................. $ 327 $ (237) $ 90 $ 214 $ 199 $ 413
Interest-bearing liabilities:
Interest-bearing demand deposits ..... $ (8) $ (19) $ (27) $ (11) $ (22) $ (33)
Savings deposits ..................... (2) (158) (160) (11) 42 31
Time deposits under $100,000 ......... (51) (57) (108) 21 16 37
Time deposits $100,000 or more ....... (37) (142) (179) 28 91 119
Federal funds purchased .............. (13) -- (13) (13) 6 (7)
Other borrowings ..................... 448 (44) 404 191 20 211
------ ------ ------- ------ ------ -------
Total interest expense ................. $ 337 $ (420) $ (83) $ 205 $ 153 $ 358
Net interest income* ................... $ (10) $ 183 $ 173 $ 9 $ 46 $ 55
</Table>
- ----------
* Fully taxable equivalent basis.
8 CDI o ANNUAL REPORT o 2001
PROVISION AND ALLOWANCE FOR LOAN LOSSES
Provision for losses on loans is charged to operations based on management's
evaluation of potential losses in the portfolio. Provision is based upon regular
review of the level and trend of non-performing assets; charge-offs and
recoveries; the mix of loans in the portfolio; and anticipated economic
conditions. Based on contraction due to diminished demand in the Bank's loan
portfolio in 2001 and 2000, the provision for loan losses was eliminated in 2001
and reduced in 2000 to $6,000 as compared to $48,000 in 1999.
Net charge-offs for 2001 totaled $5,000, while 2000 totaled $8,000. Excellent
loan portfolio performance reflects attention to underwriting standards as well
as consistent monitoring of the portfolio. Mason State Bank management rates the
overall quality of the loan portfolio as good and concludes the $1,048,000
allowance or 1.13% allowance to total loans appropriate to cover inherent losses
in the portfolio at year-end 2001.
Non-performing loans are defined as all loans which are accounted for as
non-accrual; loans 90 days or more past due and still accruing interest; or
loans which have been renegotiated due to the borrowers' inability to comply
with the original terms. As of December 31, 2001, non-performing loans totaled
$303,000 or .33% of total loans. This represents an increase of $166,000 in
non-performing loans from 2000 levels. Non-performing loans totaled .16% of
total loans in 2000. This was a decrease of $201,000 from the 1999 levels.
<Table>
<Caption>
DECEMBER 31, 2001 2000
-------- --------
Non-accrual .................. $ 20,000 $ --
90 days or more past due ..... 255,000 137,000
Renegotiated ................. 28,000 --
-------- --------
Total ........................ $303,000 $137,000
</Table>
A loan is considered impaired when full collection of principal and interest is
not expected under the original terms of the loan. There were no impaired loans
in the portfolio at December 31, 2001, 2000 or 1999.
NONINTEREST INCOME
Noninterest income increased by $25,000 from the previous year. The largest
increases were attributable to servicing rights recognized on sold loans.
Service charges for all deposit products were adjusted to reflect market rates
within the area and continue to be adjusted periodically as changes occur.
Investment commissions decreased due to less favorable economic and stock market
conditions throughout 2001. The change in noninterest income from 2000 to 1999
was an increase of $202,000. This increase was attributable to increased deposit
service charges as well as an increase in investment commission fees. In
addition, increases were realized from fees earned by outsourcing official check
processing, merchant processing and gains in the cash value of life insurance
policies.
NONINTEREST EXPENSE
Noninterest expense increased $71,000 during 2001. This increase is primarily
attributable to increased building expenses and depreciation, director services,
salary and wages, audit services and expenses related to other real estate.
Noninterest expense increased by $98,000 from 1999 to 2000. This increase was a
result of increased salary and benefits costs and expenses for outsourced
services. Salary and benefits costs in 2000 include some positions that were
vacant for a portion of 1999.
INCOME TAX EXPENSE
The 2001 provision for income tax was $775,000, up from $729,000 in 2000. The
2000 provision was up $70,000 from the $659,000 provision in 1999. This figure
reflects a higher taxable income in 2001 and 2000.
LIQUIDITY AND INTEREST RATE SENSITIVITY MANAGEMENT
The primary objective of asset/liability management is to assure adequate
liquidity and net interest income by maintaining appropriate maturities and
balances between interest sensitive earning assets and interest-bearing
liabilities. Liquidity management insures sufficient funds are maintained to
meet the cash withdrawal requirements of depositors and the credit demands of
borrowers.
Sources of liquidity include: federal funds sold, investment security maturities
and pay downs. The Bank maintained an average balance of $4,815,000 in federal
funds sold in 2001. The Bank is a member of the Federal Home Loan Bank system
for several reasons: access to an alternative funding source, lower costs for
credit services and an alternative tool to manage interest rate risk. Throughout
1997, 1998, 1999, 2000 and 2001 the Bank used this source of funding (see Note 8
to the consolidated financial statements) to directly offset loans of like terms
and conditions.
Other sources of liquidity include: internally generated cash flow from
operations, repayments and maturities of loans, other borrowings and growth in
core deposits.
At December 31, 2001, the securities available for sale were valued at
$12,200,000. It is not anticipated that management will use these funds due to
the optional sources that may be available in 2002.
Interest rate sensitivity management seeks to maximize net interest margins
through periods of changing interest risks. The Bank develops strategies to
assure that desired levels of interest sensitive assets and interest-bearing
liabilities mature or reprice within selected time frames. Strategies include
the use of variable loan products as well as managing deposit accounts and
maturities in the investment portfolio. The chart shown on the following page,
using recommended regulatory standards, reflects "the rate sensitive position"
or the difference between loans and investments, and liabilities that mature or
reprice within the next year and beyond. The financial industry has generally
referred to this difference as the "GAP" and its handling as "GAP Management."
At year-end 2001, the percentage of rate sensitive assets to rate sensitive
liabilities within the one-year time horizon was 49%.
2001 o ANNUAL REPORT o CDI 9
<Table>
<Caption>
GAP 0-30 31-90 SECOND THIRD FOURTH ANNUAL 1-3 3-5 OVER 5
MEASUREMENT DAYS DAYS QUARTER QUARTER QUARTER TOTAL YEARS YEARS YEARS
-------- -------- -------- -------- -------- -------- -------- -------- --------
(Dollars in
thousands)
ASSETS
Loans ................... $ 4,624 $ 7,417 $ 2,675 $ 3,089 $ 3,569 $ 21,374 $ 5,082 $ 10,730 $ 55,646
Allowance for loan
losses .................. -- -- -- -- -- -- -- -- --
Investments(1) .......... 2,572 20 1,606 -- 2,157 6,355 6,762 506 544
Short-term
investments ............. 4,331 -- -- -- -- 4,331 -- -- --
Other non earning
assets .................. -- -- -- -- -- -- -- -- --
-------- -------- -------- -------- -------- -------- -------- -------- --------
Total ................... $ 11,527 $ 7,437 $ 4,281 $ 3,089 $ 5,726 $ 32,060 $ 11,844 $ 11,236 $ 56,190
======== ======== ======== ======== ======== ======== ======== ======== ========
LIABILITIES
Noninterest-
bearing deposits ........ $ -- $ -- $ -- $ -- $ -- $ -- $ -- $ -- $ --
Interest-bearing
deposits ................ 41,017 3,130 5,188 3,165 2,895 55,395 4,151 917 --
Long-term FHLB
borrowings(2) ........... 1,016 5,000 -- 2,000 1,707 9,723 11,280 9,258 864
Other liabilities ....... -- -- -- -- -- -- -- -- --
Capital ................. -- -- -- -- -- -- -- -- --
-------- -------- -------- -------- -------- -------- -------- -------- --------
Total ................... $ 42,033 $ 8,130 $ 5,188 $ 5,165 $ 4,602 $ 65,118 $ 15,431 $ 10,175 $ 864
======== ======== ======== ======== ======== ======== ======== ======== ========
GAP ..................... $(30,506) $ (693) $ (907) $ (2,076) $ 1,124 $(33,058) $ (3,587) $ 1,061 $ 55,326
Cumulative GAP .......... $(30,506) $(31,199) $(32,106) $(34,182) $(33,058) $(33,058) $(36,645) $(35,584) $ 19,742
GAP ratio ............... 27% 91% 83% 60% 124% 49% 77% 110% 6,503%
</Table>
<Table>
<Caption>
GAP
MEASUREMENT TOTAL
--------
(Dollars in
thousands)
ASSETS
Loans ................... $ 92,832
Allowance for loan
losses .................. (1,048)
Investments(1) .......... 14,167
Short-term
investments ............. 4,331
Other non earning
assets .................. 6,995
--------
Total ................... $117,277
========
LIABILITIES
Noninterest-
bearing deposits ........ $ 10,470
Interest-bearing
deposits ................ 60,463
Long-term FHLB
borrowings(2) ........... 31,125
Other liabilities ....... 1,456
Capital ................. 13,763
--------
Total ................... $117,277
========
GAP .....................
Cumulative GAP ..........
GAP ratio ...............
</Table>
(1) Maturities reflect probable prepayments and calls.
(2) FLHB borrowings include putable advances, which may be converted to
adjustable rates or prepaid without penalty beginning one, two or three years
after the purchase date. The above schedule reflects maturities at prepayment
date on the putable advances.
10 CDI o ANNUAL REPORT o 2001
The chart shows the Bank's GAP position as of December 31, 2001. The Bank has a
liability sensitive position within one year of approximately $33,058,000, which
indicates higher net interest income may be earned if rates decrease during the
period and lower net interest income may be earned if rates increase during the
period. Due to the limitations of GAP analysis, modeling is also used to enhance
measurement and control.
CAPITAL RESOURCES
The adequacy of the Corporation's capital is reviewed regularly to ensure that
sufficient capital is available to meet current and future funding needs and
comply with regulatory requirements.
Shareholders' equity, excluding the net unrealized gain on securities available
for sale, increased $783,000 or 6.16% to $13,489,000 at year-end 2001, which
represented 11.50% of total assets. At December 31, 2000, the similar ratio of
shareholders' equity to total assets was 11.05% of total assets. Dividends
declared per common share increased by 11.81% to $1.42 compared to $1.27 in
2000. The Corporation has a strong capital position that will meet our needs in
2002.
Regulators established "risk-based" capital guidelines that became effective
December 31, 1990. Under the guidelines, minimum capital levels, which may
include all or a portion of the allowance for loan losses, are based on the
perceived risk in asset categories and certain off-balance-sheet items, such as
loan commitments and standby letters of credit. On December 31, 2001, the Bank
has a "risk-based" total capital to asset ratio of 19.6%. The ratio exceeds the
requirements established by regulatory agencies as shown below.
<Table>
<Caption>
(Dollars in thousands) MINIMUM REQUIRED
TO BE WELL
MINIMUM REQUIRED CAPITALIZED UNDER
FOR CAPITAL PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION REGULATIONS
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
-------- -------- -------- -------- -------- --------
DECEMBER 31, 2001
Total capital (to risk weighted assets) ..... $ 14,358 19.6% $ 5,877 8.0% $ 7,346 10.0%
Tier 1 capital (to risk weighted assets) .... 13,438 18.3 2,938 4.0 4,407 6.0
Tier 1 capital (to average assets) .......... 13,438 11.6 4,627 4.0 5,783 5.0
</Table>
Federal and State banking laws and regulations place certain restrictions on the
amount of dividends and loans that a bank can pay its parent Corporation. Of the
$14,358,000 in risk-based capital, $6,735,000 is available for dividends to the
parent Corporation in 2002 (before considering 2002 net income and any changes
in risk-based assets). The remaining $7,623,000 is restricted based on the
minimum risk-based capital requirements and State bank regulations now in
effect.
IMPACT OF INFLATION AND CHANGING PRICES
The majority of assets and liabilities of the Corporation are monetary in nature
and therefore the Corporation differs greatly from most commercial and
industrial companies that have significant investments in fixed assets and
inventories. However, inflation does have an important impact on the growth of
assets in the banking industry and the resulting need to increase equity capital
at higher than normal rates in order to maintain an appropriate equity to assets
ratio. Inflation significantly affects other expenses, which tend to rise during
periods of general inflation.
Management believes the most significant impact on financial results is the
Corporation's ability to react to changes in interest rates. Management seeks to
maintain an essentially balanced position between interest sensitive assets and
liabilities and actively manage the amount of securities available for sale in
order to protect against the effects of wide interest rate fluctuations on net
income and shareholders' equity.
2001 o ANNUAL REPORT o CDI 11
REPORT OF
INDEPENDENT AUDITORS
[CROWE CHIZEK LOGO]
Board of Directors and Shareholders
Capital Directions, Inc.
Mason, Michigan
We have audited the accompanying consolidated balance sheets of Capital
Directions, Inc. as of December 31, 2001 and 2000 and the related consolidated
statements of income, changes in shareholders' equity and cash flows for the
years ended December 31, 2001, 2000 and 1999. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Capital Directions,
Inc. as of December 31, 2001 and 2000, and the results of its operations and its
cash flows for the years ended December 31, 2001, 2000 and 1999 in conformity
with accounting principles generally accepted in the United States of America.
As disclosed in Note 1, on April 1, 1999 the Company changed its method of
accounting for derivative instruments and hedging activities to comply with new
accounting guidance.
/s/ CROWE, CHIZEK AND COMPANY LLP
Crowe, Chizek and Company LLP
Grand Rapids, Michigan
January 30, 2002
12 CDI o ANNUAL REPORT o 2001
CAPITAL DIRECTIONS, INC. CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2001 AND 2000
<Table>
<Caption>
(In thousands, except share and per share data) DECEMBER 31, 2001 2000
---------- ----------
ASSETS
Cash and noninterest-bearing deposits .................................................... $ 2,642 $ 2,603
Interest-bearing deposits ................................................................ 38 58
Federal funds sold ....................................................................... 4,293 5,905
---------- ----------
Total cash and cash equivalents .................................................. 6,973 8,566
Securities available for sale ............................................................ 12,200 15,670
Federal Home Loan Bank (FHLB) stock ...................................................... 1,967 1,967
Total loans .............................................................................. 92,832 85,649
Less allowance for loan losses ........................................................... (1,048) (1,053)
---------- ----------
Net loans ........................................................................ 91,784 84,596
Premises and equipment, net .............................................................. 1,107 947
Accrued interest receivable .............................................................. 550 663
Other assets ............................................................................. 2,696 2,614
---------- ----------
TOTAL ASSETS ..................................................................... $ 117,277 $ 115,023
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Deposits: Noninterest-bearing .......................................................... $ 10,470 $ 9,885
Interest-bearing ............................................................. 60,463 62,538
---------- ----------
Total deposits ........................................................... 70,933 72,423
Accrued interest payable ................................................................. 203 274
Other liabilities ........................................................................ 1,253 1,153
Long-term FHLB borrowings ................................................................ 31,125 28,339
---------- ----------
Total liabilities ................................................................ 103,514 102,189
Shareholders' equity
Common stock: $5 par value, 1,300,000 shares authorized; 595,956 and
598,056 shares outstanding in 2001 and 2000 .............................. 2,980 2,990
Additional paid-in capital ............................................................. 2,597 2,590
Retained earnings ...................................................................... 7,912 7,126
Accumulated other comprehensive income, net of tax of $141 in 2001 and $66 in 2000 ..... 274 128
---------- ----------
Total shareholders' equity ....................................................... 13,763 12,834
---------- ----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY ....................................... $ 117,277 $ 115,023
========== ==========
</Table>
See accompanying notes to consolidated financial statements.
2001 o ANNUAL REPORT o CDI 13
CAPITAL DIRECTIONS, INC. CONSOLIDATED STATEMENTS OF INCOME
DECEMBER 31, 2001, 2000 AND 1999
<Table>
<Caption>
(In thousands, except per share data) FOR THE YEARS ENDED DECEMBER 31, 2001 2000 1999
------ ------ ------
INTEREST AND DIVIDEND INCOME
Loans, including fees ................................................ $6,837 $7,051 $6,782
Federal funds sold ................................................... 180 140 40
Securities: Taxable -- available for sale ............................ 726 506 403
Taxable -- held to maturity .............................. -- -- 25
Tax exempt -- available for sale ......................... 159 166 142
Tax exempt -- held to maturity ........................... -- -- 56
Dividends on FHLB stock .............................................. 146 94 75
Other interest income ................................................ 1 1 2
------ ------ ------
TOTAL INTEREST AND DIVIDEND INCOME ............................. 8,049 7,958 7,525
INTEREST EXPENSE
Deposits ............................................................. 2,032 2,506 2,352
Federal funds purchased .............................................. 1 13 20
Long-term FHLB borrowings ............................................ 1,682 1,279 1,068
------ ------ ------
TOTAL INTEREST EXPENSE ......................................... 3,715 3,798 3,440
------ ------ ------
NET INTEREST INCOME .................................................... 4,334 4,160 4,085
Provision for loan losses .............................................. -- 6 48
------ ------ ------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES .................... 4,334 4,154 4,037
NONINTEREST INCOME
Service charges on deposits .......................................... 320 335 283
Investment commission fees ........................................... 54 93 50
Net gain on sales of loans ........................................... 74 -- --
Other income ......................................................... 371 366 259
------ ------ ------
TOTAL NONINTEREST INCOME ....................................... 819 794 592
NONINTEREST EXPENSE
Salaries and wages ................................................... 1,111 1,102 1,023
Pension and other employee benefits .................................. 362 365 344
Net occupancy expense of premises .................................... 180 161 162
Equipment rentals, depreciation, and maintenance ..................... 146 147 143
Other operating expense .............................................. 841 794 799
------ ------ ------
TOTAL NONINTEREST EXPENSE ...................................... 2,640 2,569 2,471
------ ------ ------
INCOME BEFORE INCOME TAX EXPENSE ....................................... 2,513 2,379 2,158
Income tax expense ..................................................... 775 729 659
------ ------ ------
NET INCOME ............................................................. $1,738 $1,650 $1,499
====== ====== ======
Basic earnings per common share ........................................ $ 2.91 $ 2.76 $ 2.51
====== ====== ======
Diluted earnings per common share ...................................... $ 2.88 $ 2.74 $ 2.49
====== ====== ======
</Table>
See accompanying notes to consolidated financial statements.
14 CDI o ANNUAL REPORT o 2001
CAPITAL DIRECTIONS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS
DECEMBER 31, 2001, 2000 AND 1999
<Table>
<Caption>
(In thousands) FOR THE YEARS ENDED DECEMBER 31, 2001 2000 1999
-------- -------- --------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income ........................................................................ $ 1,738 $ 1,650 $ 1,499
Adjustments to reconcile net income to net cash from operating activities
Depreciation .................................................................... 129 115 118
Provision for loan losses ....................................................... -- 6 48
Net amortization (accretion) on securities ...................................... 5 (1) 25
Loans originated for sale ....................................................... (3,815) -- --
Proceeds from sales of loans originated for sale ................................ 3,889 -- --
Net gain on sales of loans ...................................................... (74) -- --
Changes in assets and liabilities: Accrued interest receivable .................. 113 (148) (6)
Accrued interest payable ..................... (71) 45 (3)
Other assets ................................. (157) (34) (163)
Other liabilities ............................ 83 64 28
-------- -------- --------
NET CASH FROM OPERATING ACTIVITIES ....... 1,840 1,697 1,546
CASH FLOWS FROM INVESTING ACTIVITIES
Securities available for sale: Purchases .......................................... (1,028) (8,202) (2,439)
Maturities, calls, and principal payments .......... 4,714 2,428 3,980
Securities held to maturity: Maturities, calls, and principal payments .......... -- -- 265
Purchase of FHLB stock ............................................................ -- (992) (188)
Net change in loans ............................................................... (7,188) 3,322 (7,201)
Premises and equipment expenditures ............................................... (289) (294) (102)
-------- -------- --------
NET CASH FROM INVESTING ACTIVITIES ....... (3,791) (3,738) (5,685)
CASH FLOWS FROM FINANCING ACTIVITIES
Net change in deposits ............................................................ (1,490) 393 (359)
Net change in federal funds purchased ............................................. -- (1,700) 1,700
Proceeds from long-term FHLB borrowings ........................................... 7,000 12,700 4,000
Repayment of long-term FHLB borrowings ............................................ (4,214) (3,222) (732)
Proceeds from shares issued upon exercise of stock options ........................ 12 21 22
Repurchase of common stock ........................................................ (118) -- --
Dividends paid .................................................................... (832) (736) (662)
-------- -------- --------
NET CASH FROM FINANCING ACTIVITIES ....... 358 7,456 3,969
-------- -------- --------
Net change in cash and cash equivalents ............................................. (1,593) 5,415 (170)
Cash and cash equivalents at beginning of year ...................................... 8,566 3,151 3,321
-------- -------- --------
CASH AND CASH EQUIVALENTS AT END OF YEAR ........... $ 6,973 $ 8,566 $ 3,151
======== ======== ========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the year for: Interest ........................................... $ 3,786 $ 3,753 $ 3,443
Income taxes -- federal ............................ 802 730 660
SUPPLEMENTAL DISCLOSURES OF NON-CASH TRANSACTIONS
Transfer from securities held to maturity to securities available for sale ........ $ -- $ -- $ 6,011
Transfer from loans to other real estate owned .................................... -- 133 --
</Table>
See accompanying notes to consolidated financial statements.
2001 o ANNUAL REPORT o CDI 15
CAPITAL DIRECTIONS, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
<Table>
<Caption>
(In thousands, except share and per share data) ACCUMULATED
OTHER TOTAL
FOR THE YEARS ENDED ADDITIONAL COMPREHEN- SHARE-
DECEMBER 31, 2001, COMMON PAID-IN RETAINED SIVE INCOME, HOLDERS'
2000 AND 1999 STOCK CAPITAL EARNINGS NET OF TAX EQUITY
-------- ---------- -------- ------------ --------
BALANCES, JANUARY 1, 1999 .................................. $ 2,976 $ 2,561 $ 5,418 $ 42 $ 10,997
Net income for the year .................................... -- -- 1,499 -- 1,499
Other comprehensive income (loss), net:
Net change in net unrealized gain (loss) on
securities available for sale, net of tax of ($70) ....... -- -- -- (134) (134)
Net unrealized gain on securities transferred
from held to maturity to available for sale,
net tax of $65 ........................................... -- -- -- 125 125
--------
Total other comprehensive income (loss), net ............... (9)
--------
Comprehensive income ....................................... 1,490
Issuance of 1,499 shares of common stock upon
exercise of stock options ................................ 7 15 -- -- 22
Cash dividends ($1.14 per share) ........................... -- -- (681) -- (681)
-------- ---------- -------- ----------- --------
BALANCES, DECEMBER 31, 1999 ................................ $ 2,983 $ 2,576 $ 6,236 $ 33 $ 11,828
Net income for the year .................................... -- -- 1,650 -- 1,650
Other comprehensive income (loss), net:
Net change in net unrealized gain (loss) on
securities available for sale, net of tax of $49 ......... -- -- -- 95 95
--------
Comprehensive income ....................................... 1,745
Issuance of 1,434 shares of common stock upon
exercise of stock options ................................ 7 14 -- -- 21
Cash dividends ($1.27 per share) ........................... -- -- (760) -- (760)
-------- ---------- -------- ----------- --------
BALANCES, DECEMBER 31, 2000 ................................ $ 2,990 $ 2,590 $ 7,126 $ 128 $ 12,834
Net income for the year .................................... -- -- 1,738 -- 1,738
Other comprehensive income (loss), net:
Net change in net unrealized gain (loss) on
securities available for sale, net of tax of $75 ......... -- -- -- 146 146
--------
Comprehensive income ....................................... 1,884
Issuance of 900 shares of common stock upon
exercise of stock options ................................ 5 7 -- -- 12
Repurchase of 3,000 shares of common stock ................. (15) -- (103) -- (118)
Cash dividends ($1.42 per share) ........................... -- -- (849) -- (849)
-------- ---------- -------- ----------- --------
BALANCES, DECEMBER 31, 2001 ................................ $ 2,980 $ 2,597 $ 7,912 $ 274 $ 13,763
======== ========== ======== =========== ========
</Table>
See accompanying notes to consolidated financial statements.
16 CDI o ANNUAL REPORT o 2001
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DECEMBER 31, 2001, 2000 AND 1999)
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF REPORTING: Capital Directions, Inc. (the "Company") is a holding
company whose wholly-owned subsidiaries include Mason State Bank (the "Bank")
and Monex Financial Services, Inc. ("Monex"). Lakeside Insurance Agency is a
wholly-owned subsidiary of the Bank. Monex Financial Services, Inc. was
liquidated and dissolved during 1999. The accounting policies of the Company and
its subsidiaries conform with accounting principles generally accepted in the
United States of America and prevailing practices within the banking and
securities industry. The accrual basis of accounting is followed for all major
items in the preparation of the consolidated financial statements. All material
intercompany balances and transactions are eliminated in consolidation.
NATURE OF OPERATIONS AND LINES OF BUSINESS: The Company and its subsidiaries
provide a broad range of banking and financial services. Substantially all
revenues and services are derived from banking products and services. The Bank
operates predominantly in Central Michigan as a commercial bank. The Bank's
primary services include accepting retail deposits and making residential,
consumer and commercial loans. While the Company's 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. Accordingly, all
of the Company's banking operations are considered by management to be
aggregated in one reportable operating segment.
CONCENTRATION OF CREDIT RISK: The Company grants loans to and accepts deposits
from customers located primarily in its delineated community. The Company also
invests in securities issued by local governmental units.
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 based on available
information. These estimates and assumptions affect the amounts reported in the
financial statements and the disclosures provided. Actual results could differ
from those estimates. The allowance for loan losses and fair values of
securities and other financial instruments are particularly susceptible to
change in the near term.
SECURITIES: Securities are classified as held to maturity and carried at
amortized cost when management has the positive intent and ability to hold them
to maturity. Securities are classified as available for sale when they might be
sold prior to maturity due to changes in interest rates, 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 net unrealized holding gain or loss is reported, net of related income tax
effects, as a separate component of other comprehensive income or loss and
shareholders' equity, until realized. Other securities such as Federal Home Loan
Bank stock are carried at cost. Securities are written down to fair value when a
decline in fair value is not temporary.
Gains and losses resulting from the sale of securities are computed by the
specific identification method. Premium amortization is deducted from, and
discount accretion is added to, interest income from securities using the
level-yield method.
Under Statement of Financial Accounting Standards (SFAS) No. 133, Accounting for
Derivative Investments and Hedging Activities, all derivative instruments are
recorded at their fair values. If derivative instruments are designated as
hedges of fair values, both the change in the fair value of the hedge and the
hedged item are included in current earnings. Fair value adjustments related to
cash flow hedges are recorded in other comprehensive income or loss and
reclassified to earnings when the hedged transactions are reflected in earnings.
Ineffective portions of hedges are reflected in income currently. As of April 1,
1999, the Company adopted SFAS No. 133 and, in accordance with its provisions,
chose to reclassify certain securities from held-to-maturity to
available-for-sale. The amortized cost of the securities transferred to
available-for-sale was $6,011,000. The Company does not have derivative
instruments in its portfolio to account for under provisions of this statement.
LOANS HELD FOR SALE: Loans held for sale are reported at the lower of cost or
market value in the aggregate.
LOANS: Loans are reported at the principal balance outstanding, net of deferred
loan fees and costs, the allowance for loan losses and charge-offs. Interest
income is reported on the interest method and includes amortization of net
deferred loan fees and costs over the loan term.
When full loan repayment is in doubt, interest income is not reported. Payments
received on such loans are reported as principal reductions.
ALLOWANCE FOR LOAN LOSSES: Because some loans may not be repaid in full, an
allowance for loan losses is recorded. Increases to the allowance are recorded
by a provision for loan losses charged to expense. Estimating the risk of the
loss and amount of loss on any loan is necessarily subjective. Accordingly, the
allowance is maintained by management at a level considered adequate to cover
losses that are currently anticipated based on its regular review of
nonperforming assets, as well as loans 90 days or more past due but not
considered nonperforming, charge-offs and recoveries, growth and portfolio mix
of loans, general economic conditions, and other factors and estimates which are
subject to change over time. While management may periodically allocate portions
of the allowance for specific problem loan situations, the whole allowance is
available for any loan charge-offs that occur. A loan is charged-off against the
allowance by management as a loss when deemed uncollectible, although collection
efforts may continue and future recoveries may occur.
Loan impairment is reported when full payment under the loan terms is not
expected. Impairment is evaluated in total for smaller-balance loans of similar
nature such as residential mortgages, consumer loans, credit card loans, and on
an individual loan basis for other loans. If a loan is impaired, a portion of
the allowance is allocated so that the loan is reported, net, at the present
value of estimated future cash flows using the loan's existing rate or at the
fair
2001 o ANNUAL REPORT o CDI 17
value of the collateral if repayment is expected solely from collateral. Loans
totaling $75,000 or more are evaluated for impairment when payments are delayed,
typically 90 days or more, or when it is probable that all principal and
interest will not be collected according to the original terms of the loan.
PREMISES AND EQUIPMENT: Asset cost is reported net of accumulated depreciation.
Depreciation expense is calculated on both accelerated and straight-line methods
over asset useful lives. These assets are reviewed for impairment when events
indicate the carrying amount may not be recoverable.
OTHER REAL ESTATE: Real estate acquired in settlement of loans is reported at
the lower of fair value less cost to sell or cost. Expenses, gains and losses on
disposition and changes in the valuation allowance are reported in other
operating expense. There was one property with a carrying value of approximately
$117,000 held as other real estate at December 31, 2001. There was one property
with a carrying value of approximately $133,000 held as other real estate at
December 31, 2000.
STOCK OPTIONS: No expense for stock options is recorded, as the grant price
approximates the market price of the stock at the date of grant. Proforma
disclosures in a separate note show the effect on net income and earnings per
common share had the options' fair value been recorded using an option pricing
model.
INCOME TAXES: Income tax expense is the sum of the current year income tax due
or refundable and the change in deferred tax assets and liabilities. Deferred
tax assets and liabilities are computed based on the expected future tax
consequences of temporary differences between the carrying amounts and tax bases
of assets and liabilities, using enacted tax rates. A valuation allowance, if
needed, reduces deferred tax assets to the amount expected to be realized.
FAIR VALUES 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.
CASH FLOW REPORTING: Cash and cash equivalents are defined to include cash on
hand, noninterest-bearing deposits in other institutions, short-term
interest-bearing deposits in other institutions and federal funds sold. Customer
loan and deposit transactions, cash management funds,long-term interest-bearing
deposits made with other financial institutions and short-term borrowings with
an original maturity of 90 days or less are reported on a net cash flow basis.
EARNINGS AND DIVIDENDS PER COMMON SHARE: Basic earnings per common share is
based on net income divided by the weighted average number of common shares
outstanding during the period. Diluted earnings per common share shows the
dilutive effect of any additional potential common shares. Earnings and
dividends per common share are restated for stock splits and stock dividends.
COMPREHENSIVE INCOME: Comprehensive income consists of net income and other
comprehensive income or loss. Other comprehensive income or loss includes net
unrealized gains and losses on securities available for sale, net of tax, which
are also recognized as a separate component of shareholders' equity.
NEW ACCOUNTING PRONOUNCEMENTS: A new accounting standard requires all business
combinations to be recorded using the purchase method of accounting for any
transaction initiated after June 30, 2001. Under the purchase method, all
identifiable tangible and intangible assets and liabilities of the acquired
company must be recorded at fair value at date of acquisition, and the excess of
cost over fair value of net assets acquired is recorded as goodwill.
Identifiable intangible assets must be separated from goodwill. Identifiable
intangible assets with finite useful lives will be amortized under the new
standard, whereas goodwill, both amounts previously recorded and future amounts
purchased, will cease being amortized starting in 2002. Annual impairment
testing will be required for goodwill with impairment being recorded if the
carrying amount of goodwill exceeds its implied fair value. Adoption of this
standard on January 1, 2002 will not have any effect on the Company's
consolidated financial statements, as the Company has no intangible assets.
NOTE 2 - RESTRICTIONS ON CASH AND NONINTEREST-BEARING DEPOSITS
To satisfy legal reserve and clearing requirements, noninterest-bearing balances
are required to be maintained as deposits with the Federal Reserve or as cash on
hand. The total required reserve and clearing balances were $401,000 and
$400,000 at year-end 2001 and 2000, respectively. These balances do not earn
interest.
NOTE 3 - SECURITIES
Year-end securities were as follows:
<Table>
<Caption>
(In thousands) GROSS GROSS
FAIR UNREALIZED UNREALIZED
VALUE GAINS LOSSES
---------- ---------- ----------
AVAILABLE FOR SALE
DECEMBER 31, 2001:
Obligations of U.S. Government
treasuries and agencies ........... $ 5,903 $ 202 $ --
Obligations of states and
political subdivisions ............ 3,182 99 --
Corporate securities .............. 3,115 114 --
---------- ---------- ----------
TOTALS ......................... $ 12,200 $ 415 $ --
========== ========== ==========
DECEMBER 31, 2000:
Obligations of U.S. Government
treasuries and agencies ........... $ 7,019 $ 77 $ (2)
Obligations of states and
political subdivisions ............ 3,608 87 (1)
Corporate securities .............. 5,043 34 (1)
---------- ---------- ----------
TOTALS ......................... $ 15,670 $ 198 $ (4)
========== ========== ==========
</Table>
The fair values of securities available for sale at year-end 2001 by contractual
maturity are shown in the following chart. Expected maturities may differ from
contractual maturities because borrowers may have the right to call or prepay
obligations with or without call or prepayment penalties. Securities not due at
a single maturity date are shown separately.
18 CDI o ANNUAL REPORT o 2001
<Table>
<Caption>
(In thousands) FAIR
VALUE
-------
AVAILABLE FOR SALE
Due in one year or less .......................... $ 3,274
Due from one to five years ....................... 6,710
Due from five to ten years ....................... 1,123
Due after ten years .............................. 339
-------
$11,446
U.S. Government mortgage-backed securities
Fixed rate ..................................... 435
Variable rate .................................. 319
-------
TOTAL ........................................ $12,200
=======
</Table>
There were no sales of securities in 2001, 2000 and 1999.
Securities with a carrying value of approximately $3,145,000 and $2,747,000 at
year-end 2001 and 2000 were pledged to secure public deposits, and for other
purposes as required or permitted by law. Additional securities are pledged as
collateral to secure FHLB borrowings as disclosed in a separate note.
In conjunction with the adoption of SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities, in 1999, the Company transferred from
held-to-maturity to available-for-sale securities with amortized cost of
$6,011,000 and net unrealized gains of $190,000. Shareholders' equity increased
by $125,000, net of income tax of $65,000, as a result of the transfer.
NOTE 4 - LOANS
Year-end loans were as follows:
<Table>
<Caption>
(In thousands) 2001 2000
-------- --------
Commercial and agricultural ..... $ 5,188 $ 6,038
Real estate mortgage ............ 85,378 75,923
Installment ..................... 2,266 3,688
-------- --------
TOTAL ........................... $ 92,832 $ 85,649
======== ========
</Table>
Certain directors, executive officers and principal shareholders of the Company,
including associates of such persons, were loan customers of the Company. A
summary of activity related to these loans follows:
<Table>
<Caption>
(In thousands) 2001 2000
-------- --------
Balance, January 1, .......... $ 2,200 $ 1,051
New loans .................... 546 451
Repayments ................... (698) (549)
Other changes, net ........... -- 1,247
-------- --------
BALANCE, DECEMBER 31, ........ $ 2,048 $ 2,200
======== ========
</Table>
Other changes include adjustments for loans applicable to one reporting period
that are excludable from the other reporting period. Other changes for 2000
primarily relate to the loans of a new director added during 2000.
NOTE 5 - ALLOWANCE FOR LOAN LOSSES
Activity in the allowance for loan losses was as follows:
<Table>
<Caption>
(In thousands) 2001 2000 1999
-------- -------- --------
Balance, beginning of period ...... $ 1,053 $ 1,055 $ 1,011
Loans charged-off ................. (36) (27) (37)
Recoveries ........................ 31 19 33
Provision for loan losses ......... -- 6 48
-------- -------- --------
BALANCE, END OF PERIOD ............ $ 1,048 $ 1,053 $ 1,055
======== ======== ========
</Table>
During 2001, 2000 and 1999, the Company had no loans which were considered
impaired. Nonperforming loans were not considered significant at December 31,
2001 and 2000.
NOTE 6 - PREMISES AND EQUIPMENT, NET
Year-end premises and equipment were as follows:
<Table>
<Caption>
(In thousands) 2001 2000
-------- --------
Land .............................. $ 86 $ 86
Buildings and improvements ........ 1,471 1,149
Construction in progress .......... -- 175
Furniture and equipment ........... 2,623 2,481
-------- --------
Total cost ..................... 4,180 3,891
Less accumulated depreciation ..... (3,073) (2,944)
-------- --------
PREMISES AND EQUIPMENT, NET ....... $ 1,107 $ 947
======== ========
</Table>
NOTE 7 - INTEREST-BEARING DEPOSITS
Year-end interest-bearing deposits were as follows:
<Table>
<Caption>
2001 2000
-------- --------
Interest-bearing demand .......................... $ 10,177 $ 9,801
Savings .......................................... 20,003 19,237
Time: In denominations less than $100,000 ........ 18,505 20,604
In denominations of $100,000 or more ....... 11,778 12,896
-------- --------
TOTAL INTEREST-BEARING DEPOSITS .................. $ 60,463 $ 62,538
======== ========
</Table>
At year-end 2001, stated maturities of time deposits were as follows:
<Table>
<Caption>
(In thousands)
2002 ......................... $ 24,086
2003 ......................... 2,616
2004 ......................... 1,973
2005 ......................... 896
2006 ......................... 692
Thereafter ................... 20
--------
TOTAL ........................ $ 30,283
========
</Table>
Related party deposits totaled approximately $1,049,000 and $1,280,000 at
year-end 2001 and 2000.
2001 o ANNUAL REPORT o CDI 19
NOTE 8 - LONG-TERM FHLB BORROWINGS
At year-end, advances from the Federal Home Loan Bank were as follows:
<Table>
<Caption>
(In thousands) 2001 2000
------- -------
Maturities February 2001 through January 2003,
primarily fixed rate at rates from 5.67% to 6.72%,
averaging 6.17% at year-end 2001 and
6.33% at year-end 2000 ................................ $ 832 $ 1,525
Maturities January 2003 through November 2008,
primarily fixed rate at rates from 5.27% to 6.02%,
averaging 5.75% at year-end 2001 and year-end 2000 .... 10,093 10,114
Maturities February 2004 through April 2005,
primarily fixed rate at rates from 5.19% to 5.82%,
averaging 5.77% at year-end 2001 and 5.62% at
year-end 2000 ......................................... 3,000 4,000
Maturities February 2001 through December 2010,
primarily putable advances at rates from 4.98% to
7.61%, averaging 5.57% at year-end 2001 and
5.80% at year-end 2000 ................................ 10,200 12,700
Maturities February 2006 through November
2006, primarily fixed rate at rates from 5.03% to
5.70%, averaging 5.42% at year-end 2001 ............... 7,000 --
------- -------
TOTAL ................................................. $31,125 $28,339
======= =======
</Table>
For the putable advances, the FHLB has the option to convert the advance to an
adjustable rate beginning one, two or three years after the purchase date,
depending on the advance, and quarterly thereafter.
Each advance has a prepayment penalty which is determined based upon the lost
cash flow to the FHLB. In addition to FHLB stock, the advances were
collateralized by approximately $63,741,000 and $60,713,000 of securities and
first mortgage loans under a blanket lien arrangement at year-end 2001 and 2000.
At year-end 2001, scheduled principal reductions on these advances were:
<Table>
<Caption>
(In thousands)
2002 .................... $ 723
2003 .................... 9,254
2004 .................... 1,026
2005 .................... 2,228
2006 .................... 7,030
Thereafter .............. 10,864
--------
TOTAL ................... $ 31,125
========
</Table>
NOTE 9 - BENEFIT PLANS
A retirement and savings plan has been established for all full-time employees.
Annual matching contributions are made based on a percentage of participants'
compensation plus a discretionary amount determined by the Board of Directors.
The expense for the plan was approximately $44,000 in 2001, $42,000 in 2000 and
$40,000 in 1999.
An incentive compensation plan is also maintained for certain employees and is
based upon key performance factors. The expense for the plan was approximately
$71,000 in 2001, $67,000 in 2000 and $59,000 in 1999.
A stock option plan was approved in 1994 to provide officers and other key
employees an opportunity to acquire a proprietary interest in the Company with
an incentive to their continued employment and efforts to promote the Company's
success. Under the plan, up to 40,000 unauthorized and newly issued shares of
common stock may be issued upon exercise of stock options granted under the
plan. The plan provides for stock options to be granted at prices that
approximate the fair value of the stock at the respective dates of grant.
Accordingly, no compensation cost for stock options was recognized in 2001, 2000
and 1999. The vesting of stock options does not start until two years from the
date of grant. After two years, the options will vest evenly over a three year
period. The plan terminates on May 20, 2003. All shares and per share amounts
have been restated for stock splits.
A summary of activity in the plan is as follows:
<Table>
<Caption>
WEIGHTED WEIGHTED
AVERAGE AVERAGE
AVAILABLE OPTIONS EXERCISE GRANT DATE
FOR GRANT OUTSTANDING PRICE FAIR VALUE
--------- ----------- --------- ----------
Balance
January 1, 1999 ....... 24,933 14,800 $ 21.64
Granted ................. (5,133) 5,133 35.88 3.17
Exercised ............... -- (1,499) 15.10
Forfeited ............... 662 (662) 33.94
--------- -----------
Balance
December 31, 1999 ..... 20,462 17,772 25.85
Granted ................. (5,000) 5,000 40.90 5.56
Exercised ............... -- (1,434) 14.34
Forfeited ............... 1,131 (1,131) 29.44
--------- -----------
Balance
December 31, 2000 ..... 16,593 20,207 30.19
Granted ................. (4,000) 4,000 40.00 2.75
Exercised ............... -- (900) 12.75
Forfeited ............... 1,300 (1,300) 39.65
--------- -----------
BALANCE
DECEMBER 31, 2001 ..... 13,893 22,007 $ 32.12
========= =========== =========
</Table>
For the options outstanding at December 31, 2001, the range of exercise prices
was $12.75 to $41.50 per share, with a weighted average remaining contractual
life of 7.10 years. At December 31, 2001, 2000 and 1999, 10,051, 7,401 and 5,532
options were exercisable at a weighted average exercise price of $24.39, $20.28
and $16.42 per share, respectively.
20 CDI o ANNUAL REPORT o 2001
Had compensation cost for stock options been measured using SFAS No. 123, net
income and earnings per share would have been the pro forma amounts indicated in
the following chart. The pro forma effect may increase in the future if more
options are granted.
<Table>
<Caption>
(In thousands, except per share data) 2001 2000 1999
---------- ---------- ----------
Net income as reported ...................... $ 1,738 $ 1,650 $ 1,499
Pro forma net income ........................ 1,727 1,637 1,490
Basic earnings per share
as reported ............................... 2.91 2.76 2.51
Pro forma basic earnings
per share ................................. 2.89 2.74 2.50
Diluted earnings per share
as reported ............................... 2.88 2.74 2.49
Pro forma diluted earnings
per share ................................. 2.86 2.71 2.48
</Table>
The pro forma effects are computed using option pricing models, using the
following weighted average assumptions as of the grant date.
<Table>
<Caption>
(In thousands) 2001 2000 1999
-------- -------- --------
Risk-free interest rate ........... 4.95% 6.57% 5.07%
Expected option life .............. 5 years 5 years 5 years
Expected stock price volatility ... 3.90% 4.64% 6.28%
Expected dividend yield ........... 3.44% 3.16% 3.37%
</Table>
A deferred compensation plan has been adopted to provide retirement benefits to
the directors, at their option, in lieu of annual directors' fees. The present
value of future benefits are accrued annually over the period of active service
of each participant. The expense for the plan was $96,000 in 2001, $93,000 in
2000 and $85,000 in 1999. Insurance on the lives of the participants has also
been purchased with the Bank as owner and beneficiary of the policies.
NOTE 10 - OTHER OPERATING EXPENSE
Other operating expense consists of:
<Table>
<Caption>
(In thousands) 2001 2000 1999
------ ------ ------
Supplies ..................... $ 63 $ 59 $ 53
State taxes .................. 70 70 75
Deferred compensation ........ 96 93 85
Other expense ................ 612 572 586
------ ------ ------
TOTAL ........................ $ 841 $ 794 $ 799
====== ====== ======
</Table>
NOTE 11 - INCOME TAX
Income tax expense consists of:
<Table>
<Caption>
(In thousands) 2001 2000 1999
------ ------ ------
Taxes currently payable ...... $ 746 $ 742 $ 667
Deferred expense (benefit) ... 29 (13) (8)
------ ------ ------
TOTAL ........................ $ 775 $ 729 $ 659
====== ====== ======
</Table>
Year-end deferred tax assets and liabilities consist of:
<Table>
<Caption>
(In thousands) 2001 2000 1999
------ ------ ------
Deferred tax assets
Allowance for loan losses ............. $ 240 $ 240 $ 237
Deferred compensation ................. 333 326 309
Deferred loan fees .................... -- -- 1
Other ................................. 3 1 4
------ ------ ------
576 567 551
Deferred tax liabilities
Fixed assets .......................... (54) (48) (50)
Net unrealized gain on
securities available for sale....... (141) (66) (17)
Other ................................. (46) (14) (9)
------ ------ ------
(241) (128) (76)
------ ------ ------
TOTAL .................................... $ 335 $ 439 $ 475
====== ====== ======
</Table>
An allowance against deferred tax assets has not been recorded for 2001, 2000 or
1999.
The difference between the financial statement income tax expense and the
amounts computed by applying the federal income tax rate to pretax income is
reconciled as follows:
<Table>
<Caption>
(In thousands) 2001 2000 1999
------ ------ ------
Statutory rate ......................... 34% 34% 34%
Income tax computed at
statutory rate ...................... $ 854 $ 809 734
Tax effect of: Nontaxable income ....... (56) (56) (68)
Other ................... (23) (24) (7)
------ ------ ------
TOTAL .................................. $ 775 $ 729 $ 659
====== ====== ======
</Table>
2001 o ANNUAL REPORT o CDI 21
NOTE 12 - EARNINGS PER COMMON SHARE
A reconciliation of the numerators and denominators of the basic earnings per
common share and diluted earnings per common share computations for the years
ended is presented below:
<Table>
<Caption>
(In thousands, except per share data) 2001 2000 1999
-------- -------- --------
Basic earnings per common share:
Net income available to common
shareholders .............................. $ 1,738 $ 1,650 $ 1,499
======== ======== ========
Weighted average common
shares outstanding ........................ 598 598 596
======== ======== ========
BASIC EARNINGS PER
COMMON SHARE .............................. $ 2.91 $ 2.76 $ 2.51
======== ======== ========
Diluted earnings per common share:
Net income available to common
shareholders .............................. $ 1,738 $ 1,650 $ 1,499
======== ======== ========
Weighted average common
shares outstanding for basic
earnings per common share ................. 598 598 596
Add: dilutive effect of assumed
exercise of stock options ................. 5 5 6
======== ======== ========
Weighted average common
shares outstanding for diluted
earnings per common share ................. 603 603 602
======== ======== ========
DILUTED EARNINGS PER
COMMON SHARE .............................. $ 2.88 $ 2.74 $ 2.49
======== ======== ========
</Table>
Stock options for 8,000, 4,000 and 600 shares of common stock were not
considered in computing diluted earnings per common share in 2001, 2000 and 1999
because they were not dilutive.
NOTE 13 - OTHER COMPREHENSIVE INCOME (LOSS)
Other comprehensive income (loss) components and related taxes were as follows:
<Table>
<Caption>
(In thousands) 2001 2000 1999
------ ------ ------
Net change in net unrealized
gain (loss) on securities
available for sale:
Unrealized net gain (loss) on
securities available for sale ........ $ 221 $ 144 $ (204)
Reclassification adjustments for
net unrealized gains on securities
transferred from held-to-maturity
to available-for-sale upon
adoption of SFAS No. 133 ............. -- -- 190
------ ------ ------
NET CHANGE IN NET UNREALIZED
GAIN (LOSS) ON SECURITIES
AVAILABLE FOR SALE ................. 221 144 (14)
Tax expense (benefit) .................. 75 49 (5)
------ ------ ------
TOTAL OTHER COMPREHENSIVE
INCOME (LOSS), NET ..................... $ 146 $ 95 $ (9)
====== ====== ======
</Table>
NOTE 14 - COMMITMENTS AND CONTINGENCIES
Periodically, in the normal course of business, there are various outstanding
commitments and contingent liabilities, such as commitments to extend credit and
guarantees, which are not reflected in the accompanying consolidated financial
statements. The exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for unused lines of credit, commitments
to make loans and standby letters of credit is represented by the contractual
amount of those instruments. The same credit policy to make commitments is
followed for those loans recorded in the consolidated financial statements.
The contract amounts of these financial instruments are as follows at year-end:
<Table>
<Caption>
(In thousands) 2001 2000
------ ------
Unused lines of credit ....... $6,505 $6,188
Commitments to make loans .... 1,542 169
Standby letters of credit .... 10 65
</Table>
Commitments are generally made at variable rates, primarily tied to Bank One's
prime rate, with maximum commitment periods generally around 365 days. Since
many of the commitments to make loans expire without being used, the amount does
not necessarily represent future cash commitments. Collateral obtained upon the
exercise of the commitments is determined using management's credit evaluation
of the borrower and may include real estate, vehicles, business assets, deposits
and other items. In management's opinion, these commitments represent normal
banking transactions and no material losses are expected to result.
NOTE 15 - REGULATORY MATTERS
The Bank is subject to regulatory capital requirements administered by federal
banking agencies. Capital adequacy guidelines and 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 about components, risk weightings, and other factors, and the
regulators can lower classifications in certain cases. Failure to meet various
capital requirements can initiate regulatory action that could have a direct
material effect on the consolidated financial statements.
The prompt corrective action regulations provide five classifications, including
well capitalized, adequately capitalized, undercapitalized, significantly
undercapitalized, and critically undercapitalized, although these terms are not
used to represent overall financial condition. If only adequately capitalized,
regulatory approval is required to accept brokered deposits. If
undercapitalized, capital distributions are limited, as is asset growth and
expansion, and plans for capital restoration are required. The minimum
requirements are:
<Table>
<Caption>
CAPITAL TO TIER 1
RISK-WEIGHTED ASSETS CAPITAL TO
AVERAGE
TOTAL TIER 1 ASSETS
---------- ---------- ----------
Well capitalized .................. 10% 6% 5%
Adequately capitalized ............ 8 4 4
Undercapitalized .................. 6 3 3
</Table>
22 CDI o ANNUAL REPORT o 2001
At year-end, the Bank's actual capital levels and minimum required levels were:
<Table>
<Caption>
(Dollars in thousands) MINIMUM REQUIRED TO
MINIMUM REQUIRED BE WELL CAPITALIZED
FOR CAPITAL UNDER PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION REGULATIONS
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
-------- -------- -------- -------- -------- --------
2001
Total capital (to risk weighted assets) ..... $ 14,358 19.6% $ 5,877 8.0% $ 7,346 10.0%
Tier 1 capital (to risk weighted assets) .... 13,438 18.3 2,938 4.0 4,407 6.0
Tier 1 capital (to average assets) .......... 13,438 11.6 4,627 4.0 5,783 5.0
2000
Total capital (to risk weighted assets) ..... $ 13,559 18.4% $ 5,888 8.0% $ 7,359 10.0%
Tier 1 capital (to risk weighted assets) .... 12,639 17.2 2,944 4.0 4,416 6.0
Tier 1 capital (to average assets) .......... 12,639 11.4 4,424 4.0 5,530 5.0
</Table>
The Bank was considered well capitalized at year-end 2001 and 2000.
Federal and State banking laws and regulations place certain restrictions on the
amount of dividends and loans a bank can pay to its parent company. Under the
most restrictive of these regulations, as of year-end 2001, the Bank could pay
approximately $6,735,000 in dividends to the parent company without prior
regulatory approval.
NOTE 16 - FAIR VALUES OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate fair values for
financial instruments. The carrying amount is considered to estimate fair values
for cash and cash equivalents, demand and savings deposits, short-term
borrowings, accrued interest, FHLB stock and variable rate loans or deposits
that reprice frequently and fully. Securities fair values are based on quoted
market prices or, if no quotes are available, on the rate and term of the
security and on information about the issuer. For fixed rate loans or time
deposits and for variable rate loans or time deposits with infrequent repricing
or repricing limits, the fair value is estimated by discounted cash flow
analysis using current market rates for the estimated life and credit risk. Fair
values for impaired loans are estimated using discounted cash flow analysis or
underlying collateral values, where applicable. Fair value of loans held for
sale is based on market estimates. The allowance for loan losses is considered
to be a reasonable estimate of discount for credit quality concerns. The fair
value of debt is based on currently available rates for similar financing. The
fair value of off-balance-sheet items is based on the fees or costs that would
currently be charged to enter into or terminate such arrangements and are not
material to this presentation.
The estimated year-end fair values of financial instruments were as follows:
<Table>
<Caption>
(In thousands) 2001 2000
CARRYING ESTIMATED CARRYING ESTIMATED
VALUE FAIR VALUE VALUE FAIR VALUE
---------- ---------- ---------- ----------
FINANCIAL ASSETS
Cash and cash
equivalents ........... $ 6,973 $ 6,973 $ 8,566 $ 8,566
Securities available
for sale .............. 12,200 12,200 15,670 15,670
FHLB stock .............. 1,967 1,967 1,967 1,967
Loans, net of
allowance for
loan losses ........... 91,784 92,155 84,596 83,398
Accrued interest
receivable ............ 550 550 663 663
FINANCIAL
LIABILITIES
Deposits ................ (70,933) (71,607) (72,423) (72,608)
Long-term FHLB
borrowings ............ (31,125) (31,298) (28,339) (27,681)
Accrued interest
payable ............... (203) (203) (274) (274)
</Table>
While these estimates of fair value are based on management's judgment of the
most appropriate factors, there is no assurance that were the Company to have
disposed of such items at year-end 2001 or 2000, the estimated fair values would
necessarily have been achieved at that date, since the market values may differ
depending on various circumstances. Also, the use of different market
assumptions and/or estimation methodologies may have a material effect on the
estimated fair value amounts. The estimated fair values at year-end 2001 and
2000 should not necessarily be considered to apply at subsequent dates.
In addition, other assets and other liabilities of the Company that are not
defined as financial instruments are not included in the above disclosures, such
as premises and equipment. Also, non-financial
2001 o ANNUAL REPORT o CDI 23
instruments typically not recognized in financial statements nevertheless may
have value but are not included in the above disclosures. These include, among
other items, the estimated earnings power of core deposit accounts, the trained
workforce, customer goodwill and similar items.
NOTE 17 - CAPITAL DIRECTIONS, INC. (PARENT COMPANY ONLY) CONDENSED FINANCIAL
INFORMATION
<Table>
<Caption>
CONDENSED BALANCE SHEETS
- ------------------------
(In thousands) DECEMBER 31, 2001 2000
-------- --------
ASSETS
Cash, due from banks, and other
cash equivalents ............................ $ 25 $ 58
Investment in Mason State Bank .............. 13,719 12,767
Other assets ................................ 239 212
-------- --------
TOTAL ASSETS .............................. $ 13,983 $ 13,037
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Dividends payable ........................... $ 220 $ 203
Shareholders' equity ........................ 13,763 12,834
-------- --------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY ...................... $ 13,983 $ 13,037
======== ========
</Table>
<Table>
<Caption>
CONDENSED STATEMENTS OF INCOME (YEARS ENDED DECEMBER 31,)
- ---------------------------------------------------------
(In thousands) 2001 2000 1999
-------- -------- --------
OPERATING INCOME
Dividends from Mason State Bank ............. $ 848 $ 760 $ 680
Dividends from Monex Financial
Services, Inc ............................... -- -- 2
-------- -------- --------
848 760 682
OPERATING EXPENSES
Wages and benefits .......................... 19 6 5
Other expenses and income tax
benefit ..................................... 14 14 17
-------- -------- --------
33 20 22
-------- -------- --------
INCOME BEFORE EQUITY IN
UNDISTRIBUTED NET INCOME OF
SUBSIDIARIES ................................ 815 740 660
Equity in undistributed net income
of Mason State Bank ......................... 923 910 843
Equity in excess distributed net
income of Monex Financial
Services, Inc ............................... -- -- (4)
-------- -------- --------
923 910 839
-------- -------- --------
NET INCOME .................................. $ 1,738 $ 1,650 $ 1,499
======== ======== ========
</Table>
Other comprehensive income and comprehensive income for the Parent Company are
equal to the amounts reported for the Consolidated Company for 2001, 2000 and
1999 as disclosed in the Consolidated Statements of Changes in Shareholders'
Equity.
<Table>
<Caption>
CONDENSED STATEMENTS OF CASH FLOWS (YEARS ENDED DECEMBER 31,)
- -------------------------------------------------------------
(In thousands) 2001 2000 1999
-------- -------- --------
CASH FLOWS FROM OPERATING
ACTIVITIES
Net income .................................. $ 1,738 $ 1,650 $ 1,499
Adjustments to reconcile net income
to net cash from operating activities
Equity in undistributed net
income of subsidiaries .................... (923) (910) (839)
Change in other assets .................... (27) (20) (19)
-------- -------- --------
Net cash from operating activities .......... 788 720 641
CASH FLOWS FROM INVESTING
ACTIVITIES
Return of capital from Mason State
Bank ........................................ 117 -- --
-------- -------- --------
Net cash from investing activities .......... 117 -- --
CASH FLOWS FROM FINANCING
ACTIVITIES
Proceeds from shares issued
upon exercise of stock options .............. 12 21 22
Repurchase of common stock .................. (118) -- --
Dividends paid .............................. (832) (736) (662)
-------- -------- --------
Net cash from financing activities .......... (938) (715) (640)
-------- -------- --------
Net change in cash and cash
equivalents ................................. (33) 5 1
Cash and cash equivalents at
beginning of year ........................... 58 53 52
-------- -------- --------
CASH AND CASH EQUIVALENTS AT
END OF YEAR ................................. $ 25 $ 58 $ 53
======== ======== ========
</Table>
24 CDI o ANNUAL REPORT o 2001