SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED June 30, 2002
Commission file number 0-7818
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INDEPENDENT BANK CORPORATION
- -------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Michigan 38-2032782
- -------------------------------- ---------------------------------------
(State or jurisdiction of (I.R.S. Employer Identification Number)
Incorporation or Organization)
230 West Main Street, P.O. Box 491, Ionia, Michigan 48846
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(Address of principal executive offices)
(616) 527-9450
--------------
(Registrant's telephone number, including area code)
NONE
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Former name, address and fiscal year, if changed since last report.
Indicate by check mark whether the registrant (1) has filed all documents
and reports required to be filed by Sections 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter period
that the registrant was required to file such reports), and (2) has been subject
to such filing requirements for the past 90 days. YES X NO
------- --------
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
Common stock, par value $1 11,622,948
-------------------------- ------------------------------
Class Outstanding at August 12, 2002
INDEPENDENT BANK CORPORATION AND SUBSIDIARIES
INDEX
Page
Number(s)
---------
PART I - Financial Information
Item 1. Consolidated Statements of Financial Condition
June 30, 2002 and December 31, 2001 2
Consolidated Statements of Operations
Three- and Six-month periods ended June 30, 2002 and 2001 3
Consolidated Statements of Cash Flows
Six-month periods ended June 30, 2002 and 2001 4
Consolidated Statements of Shareholders' Equity
Six-month periods ended June 30, 2002 and 2001 5
Notes to Interim Consolidated Financial Statements 6-15
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 16-26
Item 3. Quantitative and Qualitative Disclosures about Market Risk 26
PART II - Other Information
Item 4. Submission of Matters to a Vote of Security Holders 27
Item 6. Exhibits & Reports on Form 8-K 27
Part I
Item 1.
INDEPENDENT BANK CORPORATION AND SUBSIDIARIES
Consolidated Statements of Financial Condition
June 30, December 31,
2002 2001
----------------- -----------------
(unaudited)
-----------------------------------
(in thousands)
Assets
Cash and due from banks $ 57,734 $ 50,525
Securities available for sale 380,558 290,303
Federal Home Loan Bank stock, at cost 21,521 21,266
Loans held for sale 34,184 77,220
Loans
Commercial 513,903 482,046
Real estate mortgage 615,159 661,462
Installment 248,435 241,176
-------------- -------------
Total Loans 1,377,497 1,384,684
Allowance for loan losses (17,494) (16,167)
-------------- -------------
Net Loans 1,360,003 1,368,517
Property and equipment, net 38,239 35,944
Accrued income and other assets 42,398 44,682
-------------- -------------
Total Assets $ 1,934,637 $ 1,888,457
============== =============
Liabilities and Shareholders' Equity
Deposits
Non-interest bearing $ 158,609 $ 160,598
Savings and NOW 634,771 601,949
Time 702,604 624,820
-------------- -------------
Total Deposits 1,495,984 1,387,367
Federal funds purchased 33,650 35,100
Other borrowings 217,202 288,010
Guaranteed preferred beneficial interests in Company's subordinated
debentures 17,250 17,250
Accrued expenses and other liabilities 29,616 28,827
-------------- -------------
Total Liabilities 1,793,702 1,756,554
-------------- -------------
Shareholders' Equity
Preferred stock, no par value - 200,000 shares authorized; none
outstanding
Common stock, $1.00 par value - 30,000,000 shares authorized;
issued and outstanding: 11,723,396 shares at June 30, 2002
and 11,864,876 shares at December 31, 2001 11,723 11,865
Capital surplus 76,525 82,512
Retained earnings 49,529 39,355
Accumulated other comprehensive income (loss) 3,158 (1,829)
-------------- -------------
Total Shareholders' Equity 140,935 131,903
-------------- -------------
Total Liabilities and Shareholders' Equity $ 1,934,637 $ 1,888,457
============== =============
See notes to interim consolidated financial statements
2
INDEPENDENT BANK CORPORATION AND SUBSIDIARIES
Consolidated Statements of Operations
Three Months Ended Six Months Ended
June 30, June 30,
2002 2001 2002 2001
----------- ------------ ------------ -----------
(unaudited) (unaudited)
------------------------- -------------------------
(in thousands, except per share amounts)
Interest Income
Interest and fees on loans $ 26,849 $ 29,423 $ 53,903 $ 59,587
Securities available for sale
Taxable 3,315 2,086 6,026 4,358
Tax-exempt 1,757 1,438 3,400 2,841
Other investments 334 379 647 768
----------- ------------ ------------ -----------
Total Interest Income 32,255 33,326 63,976 67,554
----------- ------------ ------------ -----------
Interest Expense
Deposits 9,042 11,428 17,668 24,359
Other borrowings 2,970 4,788 6,598 8,973
----------- ------------ ------------ -----------
Total Interest Expense 12,012 16,216 24,266 33,332
----------- ------------ ------------ -----------
Net Interest Income 20,243 17,110 39,710 34,222
Provision for loan losses 1,166 1,261 2,093 1,894
----------- ------------ ------------ -----------
Net Interest Income After Provision for Loan Losses 19,077 15,849 37,617 32,328
----------- ------------ ------------ -----------
Non-interest Income
Service charges on deposit accounts 3,241 2,265 5,953 4,083
Net gains on asset sales
Real estate mortgage loans 1,238 2,052 3,044 3,047
Securities 210 123 176 158
Other income 2,896 2,898 5,537 5,056
----------- ------------ ------------ -----------
Total Non-interest Income 7,585 7,338 14,710 12,344
----------- ------------ ------------ -----------
Non-interest Expense
Salaries and employee benefits 9,262 7,874 18,050 15,526
Occupancy, net 1,344 1,183 2,650 2,473
Furniture and fixtures 1,144 1,109 2,250 2,167
Other expenses 4,754 4,802 9,296 8,901
----------- ------------ ------------ -----------
Total Non-interest Expense 16,504 14,968 32,246 29,067
----------- ------------ ------------ -----------
Income Before Federal Income Tax 10,158 8,219 20,081 15,605
Federal income tax expense 2,870 1,970 5,684 4,063
----------- ------------ ------------ -----------
Net Income Before Cumulative Effect of Change
in Accounting Principle 7,288 6,249 14,397 11,542
Cumulative effect of change in accounting
principle, net of tax (35)
----------- ------------ ------------ -----------
Net Income $ 7,288 $ 6,249 $ 14,397 $ 11,507
=========== ============ ============ ===========
Net Income Per Share Before Cumulative
Effect of Change in Accounting Principle
Basic $ .62 $ .52 $ 1.22 $ .95
Diluted .61 .51 1.20 .94
Net Income Per Share
Basic $ .62 $ .52 $ 1.22 $ .95
Diluted .61 .51 1.20 .94
Dividends Per Common Share
Declared $ .18 $ .15 $ .36 $ .30
Paid .18 .15 .36 .29
See notes to interim consolidated financial statements.
3
INDEPENDENT BANK CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Six months ended
June 30,
2002 2001
----------------------------
(unaudited)
----------------------------
(in thousands)
Net Income $ 14,397 $ 11,507
------------- -------------
Adjustments to Reconcile Net Income
to Net Cash from (used in) Operating Activities
Proceeds from sales of loans held for sale 246,365 197,634
Disbursements for loans held for sale (200,285) (213,040)
Provision for loan losses 2,093 1,894
Depreciation and amortization of premiums and accretion of
discounts on securities and loans 3,160 3,219
Net gains on sales of real estate mortgage loans (3,044) (3,047)
Net gains on sales of securities (176) (158)
Decrease in deferred loan fees 895 70
(Increase) decrease in accrued income and other assets 1,684 (1,464)
Decrease in accrued expenses and other liabilities (942) (677)
-------------- ------------
49,750 (15,569)
-------------- ------------
Net Cash from (used in) Operating Activities 64,147 (4,062)
-------------- ------------
Cash Flow used in Investing Activities
Proceeds from the sale of securities available for sale 23,013 5,084
Proceeds from the maturity of securities available for sale 2,673 10,946
Principal payments received on securities available for sale 15,333 11,582
Purchases of securities available for sale (124,179) (27,396)
Portfolio loans purchased (36,480)
Principal payments on portfolio loans purchased 13,634 1,314
Portfolio loans made to customers, net of principal payments (8,108) (7,908)
Capital expenditures (4,546) (1,652)
-------------- ------------
Net Cash used in Investing Activities (82,180) (44,510)
-------------- ------------
Cash Flow from Financing Activities
Net increase (decrease) in total deposits 108,617 (88,068)
Net increase (decrease) in short-term borrowings 40,527 (18,570)
Proceeds from Federal Home Loan Bank advances 214,040 465,500
Payments of Federal Home Loan Bank advances (326,825) (317,897)
Retirement of long-term debt (1,000)
Dividends paid (4,248) (3,579)
Proceeds from issuance of common stock 2,148 1,110
Repurchase of common stock (9,017) (4,957)
-------------- ------------
Net Cash from Financing Activities 25,242 32,539
-------------- ------------
Net Increase (Decrease) in Cash and Cash Equivalents 7,209 (16,033)
Cash and Cash Equivalents at Beginning of Period 50,525 58,149
-------------- ------------
Cash and Cash Equivalents at End of Period $ 57,734 $ 42,116
============== ============
Cash paid during the period for
Interest $ 23,932 $ 36,553
Income taxes 4,100 4,296
Transfer of loans to other real estate 935 1,336
Transfer of securities held to maturity to available for sale 20,098
See notes to interim consolidated financial statements
4
INDEPENDENT BANK CORPORATION AND SUBSIDIARIES
Consolidated Statements of Shareholders' Equity
Six months ended
June 30,
2002 2001
------------ -----------
(unaudited)
-----------------------
(in thousands)
Balance at beginning of period $ 131,903 $ 128,336
Net income 14,397 11,507
Cash dividends declared (4,224) (3,679)
Issuance of common stock 2,889 1,798
Repurchase of common stock (9,017) (4,957)
Net change in accumulated other comprehensive
income (loss), net of related tax effect (note 4) 4,987 (1,583)
------------ ------------
Balance at end of period $ 140,935 $ 131,422
============ ============
See notes to interim consolidated financial statements.
5
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. In the opinion of management of the Registrant, the accompanying unaudited
consolidated financial statements contain all the adjustments (consisting only
of normal recurring accruals) necessary to present fairly the consolidated
financial condition of the Registrant as of June 30, 2002 and December 31, 2001,
and the results of operations for the three- and six-month periods ended June
30, 2002 and 2001. Certain reclassifications have been made in the prior year
financial statements to conform to the current year presentation. Our critical
accounting policies include the adequacy of the allowance for loan losses, the
valuation of derivative financial instruments, the valuation of originated
mortgage servicing rights and the valuation of our deferred tax assets. Refer to
our 2001 Annual Report on Form 10-K for a disclosure of our accounting policies.
2. Our assessment of the allowance for loan losses is based on an evaluation of
the loan portfolio, recent loss experience, current economic conditions and
other pertinent factors. Loans on non-accrual status, past due more than 90
days, or restructured amounted to $12.0 million at June 30, 2002, and $9.0
million at December 31, 2001. (See Management's Discussion and Analysis of
Financial Condition and Results of Operations).
3. The provision for income taxes represents federal income tax expense
calculated using annualized rates on taxable income generated during the
respective periods. The provision for income taxes for the three month period
ended June 30, 2001 also includes a benefit in the amount of $0.4 million
resulting from an adjustment of net deferred tax assets associated with an
increase in our statutory tax rate from 34% to 35%.
4. Comprehensive income for the three-month and the six-month periods ended
June 30 follows:
Three months ended Six months ended
June 30, June 30,
2002 2001 2002 2001
--------- ---------- ---------- ---------
(in thousands)
Net income $ 7,288 $ 6,249 $ 14,397 $ 11,507
Net change in unrealized gain on securities
available for sale, net of related tax effect 4,640 (524) 4,935 1,692
Cumulative effect of change in accounting
principle, net of related tax effect (731)
Net change in unrealized loss on derivative
instruments, net of related tax effect (1,039) (513) 52 (2,544)
--------- ---------- ---------- ---------
Comprehensive income $ 10,889 $ 5,212 $ 19,384 $ 9,924
========= ========== ========== =========
5. Our reportable segments are based upon legal entities. We have four
reportable segments: Independent Bank ("IB"), Independent Bank West Michigan
("IBWM"), Independent Bank South Michigan ("IBSM") and Independent Bank East
Michigan ("IBEM"), collectively the "Banks." We evaluate performance based
principally on net income of the respective reportable segments. We consolidated
two segments, IB and Independent Bank MSB, during the third quarter of 2001.
Prior period financial information has been restated to reflect the
consolidation.
6
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
A summary of selected financial information for our reportable segments for the
three-month and six-month periods ended June 30, follows:
Three months ended June 30,
IB IBWM IBSM IBEM OTHER(1) TOTAL
-------------------------------------------------------------------------------
(in thousands)
2002
Total assets $ 918,241 $ 377,439 $ 300,321 $ 336,814 $ 1,822 $ 1,934,637
Interest income 15,272 6,804 4,875 5,296 8 32,255
Net interest income 9,299 4,850 3,090 3,462 (458) 20,243
Provision for loan losses 536 360 120 150 1,166
Income (loss) before
income tax 4,988 2,833 1,516 1,402 (581) 10,158
Net income (loss) 3,646 1,951 1,095 1,117 (521) 7,288
2001
Total assets $ 931,494 $ 359,526 $ 227,979 $ 324,443 $ (13,721) $ 1,829,721
Interest income 16,469 7,080 4,216 5,552 9 33,326
Net interest income 7,892 4,249 2,299 3,193 (523) 17,110
Provision for loan losses 771 150 90 250 1,261
Income (loss) before
income tax 3,771 2,747 1,272 1,328 (899) 8,219
Net income (loss) 2,721 1,871 943 1,038 (324) 6,249
Six months ended June 30,
IB IBWM IBSM IBEM OTHER(1) TOTAL
-------------------------------------------------------------------------------
(in thousands)
2002
Total assets $ 918,241 $ 377,439 $ 300,321 $ 336,814 $ 1,822 $ 1,934,637
Interest income 30,220 13,410 9,779 10,552 15 63,976
Net interest income 18,248 9,529 6,080 6,768 (915) 39,710
Provision for loan losses 723 470 400 500 2,093
Income (loss) before
income tax 10,050 5,895 2,977 2,525 (1,366) 20,081
Net income (loss) 7,316 4,057 2,161 2,063 (1,200) 14,397
2001
Total assets $ 931,494 $ 359,526 $ 227,979 $ 324,443 $ (13,721) $ 1,829,721
Interest income 33,196 14,458 8,505 11,380 15 67,554
Net interest income 15,732 8,460 4,646 6,486 (1,102) 34,222
Provision for loan losses 1,014 300 180 400 1,894
Income (loss) before
income tax 7,293 5,155 2,389 2,678 (1,910) 15,605
Net income (loss) 5,240 3,435 1,771 2,125 (1,064) 11,507
(1) Includes items relating to the Registrant and certain insignificant
operations.
7
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
6. A reconciliation of basic and diluted earnings per share for the
three-month and the six-month periods ended June 30 follows:
Three months ended Six months ended
June 30, June 30,
2002 2001 2002 2001
---------- ---------- --------- ----------
(in thousands, except per share amounts)
Net income before cumulative effect of change in
accounting principle $ 7,288 $ 6,249 $ 14,397 $ 11,542
========== ========== ========= ==========
Net income $ 7,288 $ 6,249 $ 14,397 $ 11,507
========== ========== ========= ==========
Shares outstanding (Basic) (1) 11,722 12,056 11,760 12,091
Effect of dilutive securities - stock options 222 166 221 155
---------- ---------- --------- ----------
Average shares outstanding (Diluted) 11,944 12,222 11,981 12,246
========== ========== ========= ==========
Net income per share before cumulative effect of
change in accounting principle
Basic $ .62 $ .52 $ 1.22 $ .95
Diluted .61 .51 1.20 .94
Net income per share
Basic $ .62 $ .52 $ 1.22 $ .95
Diluted .61 .51 1.20 .94
(1) Shares outstanding have been adjusted for a 5% stock dividend in 2001.
7. We adopted Statement of Financial Accounting Standards No. 133, "Accounting
for Derivative Instruments and Hedging Activities," ("SFAS #133") on January 1,
2001. SFAS #133, which was subsequently amended by SFAS #138, requires companies
to record derivatives on the balance sheet as assets and liabilities measured at
their fair value. The accounting for increases and decreases in the value of
derivatives depends upon the use of derivatives and whether the derivatives
qualify for hedge accounting.
Our derivative financial instruments according to the type of hedge in which
they are designated under SFAS #133 follows:
June 30, 2002
Average
Notional Maturity Fair
Amount (years) Value
------------ ----------- ----------
(dollars in thousands)
Fair Value Hedge - pay variable interest-rate swap agreements $29,000 6.7 $ (61)
============ ======== =======
Cash Flow Hedge
Pay fixed interest-rate swap agreements $177,000 1.5 $(6,012)
Interest-rate collar agreements 10,000 1.4 (438)
------------ -------- -------
Total $187,000 1.5 $(6,450)
============ ======== =======
No hedge designation
Pay fixed interest-rate swap agreements $26,000 0.3 $ (356)
Pay variable interest-rate swap agreements 15,000 0.2 (3)
Interest-rate cap agreements 22,000 0.1 0
Interest-rate floor agreements 10,000 0.3 0
Rate-lock real estate mortgage loan commitments 20,000 0.1 (28)
Mandatory commitments to sell real estate mortgage loans 43,000 0.1 (207)
------------ -------- -------
Total $136,000 0.2 $ (594)
============ ======== =======
8
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
We have established management objectives and strategies which include
interest-rate risk parameters for maximum fluctuations in net interest income
and market value of portfolio equity. We monitor our interest rate risk position
via simulation modeling reports (See "Asset/liability management"). The goal of
our asset/liability management efforts is to maintain profitable financial
leverage within established risk parameters.
We use variable rate and short-term fixed-rate (less than 12 months) debt
obligations to fund a portion of our balance sheet, which exposes us to
variability in interest rates. To meet our objectives, we may periodically enter
into derivative financial instruments to mitigate exposure to fluctuations in
cash flows resulting from changes in interest rates ("Cash Flow Hedges"). Cash
Flow Hedges currently include certain pay-fixed interest-rate swaps and
interest-rate collars.
Pay-fixed interest-rate swaps convert the variable-rate cash flows on debt
obligations to fixed-rates. Under interest-rate collars, we will receive cash if
interest rates rise above a predetermined level while we will make cash payments
if interest rates fall below a predetermined level. As a result, we effectively
have variable rate debt with an established maximum and minimum rate.
Upon adoption of SFAS #133, we recorded the fair value of Cash Flow Hedges in
accrued expenses and other liabilities. On an ongoing basis, we adjust our
balance sheet to reflect the then current fair value of Cash Flow Hedges. The
related gains or losses are reported in other comprehensive income and are
subsequently reclassified into earnings, as a yield adjustment in the same
period in which the related interest on the hedged items (primarily
variable-rate debt obligations) affect earnings. It is anticipated that
approximately $6.0 million, net of tax, of unrealized losses on Cash Flow Hedges
at June 30, 2002 will be reclassified to earnings over the next twelve months.
To the extent that the Cash Flow Hedges are not effective, the ineffective
portion of the Cash Flow Hedges are immediately recognized as interest expense.
The maximum term of any Cash Flow Hedge at June 30, 2002 is 5.3 years.
We also use long-term, fixed-rate brokered CDs to fund a portion of our balance
sheet. These instruments expose us to variability in fair value due to changes
in interest rates. To meet our objectives, we may enter into derivative
financial instruments to mitigate exposure to fluctuations in fair values of
such fixed-rate debt instruments ("Fair Value Hedges"). Fair Value Hedges
currently include pay-variable interest rate swaps.
Also, upon adoption of SFAS #133, we recorded Fair Value Hedges at fair value in
accrued expenses and other liabilities. The hedged items (primarily fixed-rate
debt obligations) were also recorded at fair value through the statement of
operations, which offsets the adjustment to Fair Value Hedges. On an ongoing
basis, we will adjust our balance sheet to reflect the then current fair value
of both the Fair Value Hedges and the respective hedged items. To the extent
that the change in value of the Fair Value Hedges do not offset the change in
the value of the hedged items, the ineffective portion is immediately recognized
as interest expense.
9
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
Certain derivative financial instruments, discussed in the following paragraphs,
are not designated as hedges. The fair value of these derivative financial
instruments have been recorded on our balance sheet and are adjusted on an
ongoing basis to reflect their then current fair value. The changes in the fair
value of derivative financial instruments not designated as hedges, are
recognized currently as interest expense.
Interest rate caps are used to help manage fluctuations in cash flows resulting
from interest rate risk on certain short-term debt obligations. Under these
agreements, we will receive cash if interest rates rise above a predetermined
level. Pay-fixed interest-rate swaps are also used to manage fluctuations in
cash flows resulting from changes in interest rates on certain short-term debt
obligations.
In the ordinary course of business, we enter into rate-lock real estate mortgage
loan commitments with customers ("Rate Lock Commitments"). These commitments
expose us to interest rate risk. We also enter into mandatory commitments to
sell real estate mortgage loans ("Mandatory Commitments") to hedge price
fluctuations of mortgage loans held for sale and Rate Lock Commitments.
Mandatory Commitments help protect our loan sale profit margin from
fluctuations in interest rates. The changes in the fair value of Rate Lock
Commitments and Mandatory Commitments are recognized currently as part of gains
on the sale of real estate mortgage loans. Interest expense and net gains on the
sale of real estate mortgage loans, as well as net income may be more volatile
as a result of derivative instruments, which are not designated as hedges.
The impact of SFAS #133 on net income and other comprehensive income for the
three-month and six-month periods ended June 30, 2002 and 2001 is as follows:
Income (Expense)
Other
Comprehensive
Net Income Income Total
------------------ ------------------- -------------------
(in thousands)
Change in fair value during the three-
month period ended June 30, 2002
Interest rate swap agreements not
designated as hedges $ 228 $ 228
Rate Lock Commitments 316 316
Mandatory Commitments (655) (655)
Fair value hedges 21 21
Ineffectiveness of cash flow hedges (2) (2)
Cash flow hedges 8 $ (3,230) (3,222)
Reclassification adjustment 1,631 1,631
------------------ ------------------- -------------------
Total (84) (1,599) (1,683)
Federal income tax (29) (560) (589)
------------------ ------------------- -------------------
Net $ (55) $ (1,039) $ (1,094)
================== =================== ===================
10
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
Income (Expense)
Other
Comprehensive
Net Income Income Total
------------------ ------------------- -------------------
(in thousands)
Change in fair value during the six-
month period ended June 30, 2002
Interest rate swap agreements not
designated as hedges $ 489 $ 489
Rate Lock Commitments 1,597 1,597
Mandatory Commitments (2,760) (2,760)
Fair value hedges 22 22
Ineffectiveness of cash flow hedges 22 22
Cash flow hedges 19 $ (3,167) (3,148)
Reclassification adjustment 3,246 3,246
------------------ ------------------- -------------------
Total (611) 79 (532)
Federal income tax (214) 27 (187)
------------------ ------------------- -------------------
Net $ (397) $ 52 $ (345)
================== =================== ===================
Other
Comprehensive
Net Income Income Total
------------------ ------------------- -------------------
(in thousands)
Change in fair value during the three-
month period ended June 30, 2001
Option contracts not designated as
hedges $ (1) $ (1)
Interest rate swap agreements not
designated as hedges (308) (308)
Rate Lock Commitments (278) (278)
Mandatory Commitments 253 253
Ineffectiveness of cash flow hedges (23) (23)
Cash flow hedges 13 $ (777) (764)
Reclassification adjustment (464) (464)
------------------ ------------------- -------------------
Total (344) (1,241) (1,585)
Federal income tax (120) (434) (554)
------------------ ------------------- -------------------
Net $ (224) $ (807) $ (1,031)
================== =================== ===================
11
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
Other
Comprehensive
Net Income Income Total
------------------ ------------------- -------------------
(in thousands)
Change in fair value during the six-
month period ended June 30, 2001
Option contracts not designated as
hedges $ (28) $ (28)
Interest rate swap agreements not
designated as hedges (637) (637)
Rate Lock Commitments (390) (390)
Mandatory Commitments 313 313
Fair value hedges (4) (4)
Ineffectiveness of cash flow hedges (19) (19)
Cash flow hedges 46 $ (3,811) (3,765)
Reclassification adjustment (507) (507)
------------------ ------------------- -------------------
Total (719) (4,318) (5,037)
Federal income tax (251) (1,480) (1,731)
------------------ ------------------- -------------------
Net $ (468) $ (2,838) $ (3,306)
================== =================== ===================
12
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
8. On July 20, 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 141, "Business Combinations,"
("SFAS #141") and Statement of Financial Accounting Standards No. 142, "Goodwill
and Other Intangible Assets," ("SFAS #142"). These two Statements have a
profound effect on how organizations account for business combinations and for
the purchased goodwill and intangible assets that arise from those combinations
or are acquired otherwise. SFAS #141 was effective for all business combinations
initiated after June 30, 2001, and for all purchase method business combinations
completed after June 30, 2001, and requires that such combinations be accounted
for using the purchase method of accounting. SFAS #142 was effective for fiscal
years beginning after December 15, 2001 and requires that the amortization of
goodwill cease and that goodwill instead only be reviewed for impairment. Prior
to 2002, we had been amortizing approximately $0.7 million, net of tax, of
goodwill annually. This amortization ceased upon adoption of SFAS #142 on
January 1, 2002. Based on our review of goodwill recorded on the Statement of
Condition, no impairment existed as of January 1, 2002.
Intangible assets, net of amortization, were comprised of the following at June
30, 2002 and December 31, 2001:
June 30, 2002 December 31, 2001
-------------------------------- --------------------------------
Gross Gross
Carrying Accumulated Carrying Accumulated
Amount Amortization Amount Amortization
--------------- --------------- --------------- ---------------
(dollars in thousands)
Amortized intangible assets -
Core deposit intangibles $ 12,686 $ 6,444 $ 12,666 $ 5,952
=============== =============== =============== ===============
Unamortized intangible assets -
Goodwill $ 7,299 $ 6,859
=============== ===============
Amortization of intangibles, primarily amortization of core deposit intangibles,
has been estimated through 2007 and thereafter in the following table, and does
not take into consideration any potential future acquisitions or branch
purchases.
(dollars in thousands)
Six months ending December 31, 2002 $ 490
Year ending December 31:
2003 982
2004 982
2005 982
2006 982
2007 and thereafter 1,824
----------------------
Total $ 6,242
======================
13
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
Changes in the carrying amount of goodwill by reporting segment for the six
months ended June 30, 2002 were as follows:
IB IBWM IBSM IBEM OTHER(1) TOTAL
------------------------------------------------------------------------------
(dollars in thousands)
Balance, January 1, 2002 $ 6,314 $ 32 $ $ 180 $ 333 $ 6,859
Goodwill acquired during period 440 440
----------- ----------- ----------- ----------- ----------- ------------
Balance, June 30, 2002 $ 6,754 $ 32 $ $ 180 $ 333 $ 7,299
=========== =========== =========== =========== =========== ============
(1) Includes items relating to the Registrant and certain insignificant
operations.
The following is a reconciliation of reported net income to net income adjusted
to reflect the adoption of SFAS No. 142:
Three months ended Six months ended
June 30, June 30,
-------------------------------- --------------------------------
2002 2001 2002 2001
--------------- --------------- --------------- ---------------
(dollars in thousands)
Net income:
Reported net income $ 7,288 $ 6,249 $ 14,397 $ 11,507
Add back - goodwill amortization 168 336
--------------- --------------- --------------- ---------------
Adjusted net income $ 7,288 $ 6,417 $ 14,397 $ 11,843
=============== =============== =============== ===============
Basic earnings per share:
Reported net income $ .62 $ .52 $ 1.22 $ .95
Add back - goodwill amortization .01 .03
--------------- --------------- --------------- ---------------
Adjusted net income $ .62 $ .53 $ 1.22 $ .98
=============== =============== =============== ===============
Diluted earnings per share:
Reported net income $ .61 $ .51 $ 1.20 $ .94
Add back - goodwill amortization .02 .03
--------------- --------------- --------------- ---------------
Adjusted net income $ .61 $ .53 $ 1.20 $ .97
=============== =============== =============== ===============
On October 3, 2001, the FASB issued Statement of Financial Accounting Standards
No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets,"
("SFAS #144") which addresses financial accounting and reporting for the
impairment or disposal of long-lived assets. SFAS #144 was effective for fiscal
years beginning after December 15, 2001. The adoption of SFAS #144 did not have
a material impact on our financial condition or results of operations.
In April 2002, the FASB issued Statement of Financial Accounting Standards No.
145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB
Statement No. 13, and Technical Corrections," ("SFAS #145") which rescinds FASB
Statement No. 4, "Reporting Gains and Losses from Extinguishment of Debt," and
an amendment of that Statement, FASB Statement No. 64, "Extinguishments of Debt
Made to Satisfy Sinking-Fund Requirements." SFAS #145 also rescinds FASB
Statement No. 44, "Accounting for Intangible Assets of Motor Carriers" and
amends FASB Statement No. 13, "Accounting for Leases." SFAS #145 amends other
existing authoritative pronouncements to make various technical corrections,
clarify meanings, or describe their applicability under changed conditions. SFAS
#145 is effective for fiscal years beginning after May 15, 2002, with early
adoption of the provisions related to the rescission of Statement No. 4
encouraged. The adoption of SFAS #145 is not expected to have a material impact
on our results of operations.
In July 2002, the FASB issued Statement of Financial Accounting Standards No.
146, "Accounting for Costs Associated with Exit or Disposal Activities," ("SFAS
#146") which
14
addresses financial accounting and reporting for costs associated with exit or
disposal activities (including restructuring) and nullifies Emerging Issues Task
Force (EITF) Issue No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)." SFAS #146 requires that a liability for a
cost associated with an exit or disposal activity be recognized and measured
initially at fair value only when the liability is incurred. Under Issue 94-3
the liability was recognized at the date of an entity's commitment to an exit
plan. SFAS #146 is effective for exit or disposal activities (including
restructuring) that are initiated after December 31, 2002, with early adoption
encouraged. Adoption of SFAS #146 is not expected to have a material impact on
our results of operations.
9. The results of operations for the three- and six-month periods ended June 30,
2002, are not necessarily indicative of the results to be expected for the full
year.
15
Item 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Management's discussion and analysis of financial condition and results of
operations may contain forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995. Forward-looking statements
include expressions such as "expects," "intends," "believes," and "should" which
are necessarily statements of belief as to the expected outcomes of future
events. Actual results could differ materially from those contained in, or
implied by such forward-looking statements. Independent Bank Corporation
undertakes no obligation to release revisions to these forward-looking
statements or reflect events or circumstances after the date of this report.
The following section presents additional information that may be necessary to
assess our financial condition and results of operations. This section should be
read in conjunction with our consolidated financial statements contained
elsewhere in this report as well as our 2001 Annual Report on Form 10-K.
FINANCIAL CONDITION
SUMMARY Our total assets increased $46.2 million during the first six months of
2002. Loans, excluding loans held for sale ("Portfolio Loans"), totaled $1.377
billion at June 30, 2002, down $7.2 million from December 31, 2001 due to a
decline in real estate mortgage loans. (See "Portfolio loans and asset
quality.") Loans held for sale declined by $43.0 million, as the volume of loan
sales in the first half of 2002 exceeded new originations of such loans. The
declines in these asset categories were offset by a $90.3 million increase in
securities available for sale.
Deposits totaled $1.496 billion at June 30, 2002, compared to $1.387 billion at
December 31, 2001. The $108.6 million increase in total deposits during the
period principally reflects an increase in savings and NOW accounts and an
increase in brokered certificates of deposit ("Brokered CDs"). Other borrowings
totaled $217.2 million at June 30, 2002, a decline of $70.8 million from
December 31, 2001 due to the payoff of short-term and maturing borrowings
primarily as a result of funds generated from the growth in deposits.
SECURITIES We maintain diversified securities portfolios, which include
obligations of the U.S. Treasury and government-sponsored agencies as well as
securities issued by states and political subdivisions, corporate securities,
mortgage-backed securities and other asset-backed securities. We continually
measure and evaluate our asset/liability management needs and attempt to
maintain a portfolio structure that provides sufficient liquidity and cash flow.
(See "Asset/liability management.")
SECURITIES
Unrealized
----------------------------
Amortized Fair
Cost Gains Losses Value
-------------- -------------- ------------- -------------
(in thousands)
Securities available for sale
June 30, 2002 $369,234 $ 12,089 $ 765 $380,558
December 31, 2001 286,571 5,789 2,057 290,303
16
The purchase or sale of securities is dependent upon our assessment of
investment and funding opportunities as well as our asset/liability management
needs. Securities available for sale increased to $380.6 million at June 30,
2002 from $290.3 million at December 31, 2001. This increase was the result of
purchases of securities during the first half of 2002 (in particular during the
first three months of 2002) primarily to offset declines in other interest
earning assets such as Portfolio Loans and loans held for sale. Sales of
securities available for sale were as follows:
SALES OF SECURITIES AVAILABLE FOR SALE
Three months ended Six months ended
June 30, June 30,
2002 2001 2002 2001
-------------- -------------- -------------- -------------
(in thousands)
Proceeds $20,515 $2,921 $23,013 $5,084
============== ============= ============= =============
Gross gains $295 $125 $340 $160
Gross losses (85) (2) (164) (2)
-------------- ------------- ------------- -------------
Net Gains $210 $123 $176 $158
============== ============= ============= =============
PORTFOLIO LOANS AND ASSET QUALITY We believe that our decentralized structure
provides important advantages in serving the credit needs of our principal
lending markets. In addition to the communities served by our branch networks,
principal lending markets include nearby communities and metropolitan areas.
Subject to established underwriting criteria, we also participate in commercial
lending transactions with certain non-affiliated banks and may also purchase
real estate mortgage loans from third-party originators.
Although each of our Banks' management and Boards of Directors retain authority
and responsibility for credit decisions, we have adopted uniform underwriting
standards. Further, our corporate loan committee as well as the centralization
of the commercial loan credit services and loan review functions promotes
compliance with such established underwriting standards. The centralization of
retail loan services also provides for consistent service quality and
facilitates compliance with consumer protection laws and regulations.
We generally retain loans that may be profitably funded within established risk
parameters. (See "Liquidity and capital resources.") As a result, we often
retain adjustable-rate and balloon real estate mortgage loans, while 15- and
30-year, fixed-rate obligations are sold to mitigate exposure to changes in
interest rates. (See "Asset/liability management.") Although total real estate
mortgage loan origination volume in the first half of 2002 was comparable to the
first half of 2001, our balance of real estate mortgage loans declined. This
decline reflects an increase in prepayments in the portfolio (caused primarily
by refinancing activity resulting from lower interest rates) as well as new
origination volume being primarily 15- and 30-year fixed rate obligations, which
are generally sold as explained above. If borrowers continue to prefer
longer-term fixed rate mortgage loans, we believe it may be difficult to grow
our real estate mortgage loan portfolio in the future.
The $31.9 million increase in commercial loans during the first six months of
2002, principally reflects our emphasis on lending opportunities within this
category of loans, particularly in the
17
Lansing and Grand Rapids markets. Loans secured by real estate comprise the
majority of new commercial loans.
Historically we have been able to originate sufficient new Portfolio Loans to
offset scheduled loan amortization and loan prepayments. However, in the first
half of 2002 this was not true due to the decline in real estate mortgage loans
and slower growth in commercial loans and installment (consumer) loans. Weaker
economic conditions and intense competition slowed our growth of commercial
loans and installment loans. Future growth of overall Portfolio Loans is
dependent upon a number of competitive and economic factors. Declines in
Portfolio Loans or competition leading to lower relative pricing on new
Portfolio Loans can adversely impact future operating results.
NON-PERFORMING ASSETS
June 30, December 31,
2002 2001
----------------- -----------------
(dollars in thousands)
Non-accrual loans $8,023 $5,990
Loans 90 days or more past due and
still accruing interest 3,676 2,771
Restructured loans 276 285
----------------- -----------------
Total non-performing loans 11,975 9,046
Other real estate 1,518 1,610
----------------- -----------------
Total non-performing assets $13,493 $10,656
================= =================
As a percent of Portfolio Loans
Non-performing loans 0.87 % 0.65 %
Non-performing assets 0.98 0.77
Allowance for loan losses 1.27 1.17
Allowance for loan losses as a percent of
non-performing loans 146 179
Non-performing loans increased by $2.9 million during the first six months of
2002 and totaled $12.0 million, or 0.87% of total Portfolio Loans at June 30,
2002. The increase in total non-performing loans by loan category is: commercial
$2.2 million, real estate mortgage $0.4 million and installment $0.3 million.
The increase in commercial non-performing loans is primarily due to the addition
of a $2.1 million loan on a hotel property in Bad Axe, Michigan. A specific
reserve of approximately $0.5 million was established on this loan in the first
quarter of 2002. We are vigorously pursuing collection of this credit, but it is
likely that the loan will remain non-performing throughout 2002 as we proceed
with the collection process. The increase in non-performing real estate mortgage
loans and installment loans is believed to primarily reflect economic conditions
in some of our markets that have led to job losses as well as other factors
affecting consumer credit such as increased debt levels.
Impaired loans totaled approximately $8.1 million and $3.1 million at June 30,
2002 and 2001, respectively. At those same dates, certain impaired loans with
balances of approximately $4.8 million and $0.2 million, respectively had
specific allocations of the allowance for loan losses, which totaled
approximately $1.4 million and $0.1 million, respectively. Our average
investment in impaired loans was approximately $6.8 million for the six-month
period ended June 30, 2002. Cash receipts on impaired loans on non-accrual
status are generally applied to the principal balance. Interest recognized on
impaired loans during the first six months of 2002 was approximately $0.1
million.
18
ALLOWANCE FOR LOAN LOSSES
Six months ended
June 30,
2002 2001
------------- ------------
(in thousands)
Balance at beginning of period $16,167 $13,982
Additions (deduction)
Provision charged to operating expense 2,093 1,894
Recoveries credited to allowance 395 302
Loans charged against the allowance (1,161)
(1,029)
------------- ------------
Balance at end of period $17,494 $15,149
============= ============
Net loans charged against the allowance to
average Portfolio Loans (annualized) 0.11% 0.10%
In determining the allowance and the related provision for loan losses, we
consider four principal elements: (i) specific allocations based upon probable
losses identified during our review of the loan portfolio, (ii) allocations
established for other adversely rated loans, (iii) allocations based principally
on historical loan loss experience and (iv) additional allowances based on
subjective factors, including local and general economic business factors and
trends, portfolio concentrations and changes in the size and/or the general
terms of the loan portfolios.
ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
June 30, December 31,
2002 2001
-------------------- --------------------
(in thousands)
Specific allocations $ 1,415 $ 500
Other adversely rated loans 6,828 7,284
Historical loss allocations 3,008 2,837
Additional allocations based on subjective factors 6,243 5,546
-------- --------
$17,494 $16,167
======== ========
DEPOSITS AND BORROWINGS Our competitive position within many of the markets
served by our branch networks limits the ability to materially increase deposits
without adversely impacting the weighted-average cost of core deposits.
Accordingly, we compete principally on the basis of convenience and personal
service, while employing pricing tactics that are intended to enhance the value
of core deposits.
We have implemented funding strategies that incorporate other borrowings and
Brokered CDs to finance a portion of the Portfolio Loans and securities. The use
of such alternate sources of funds supplements our core deposits and is also an
integral part of our asset/liability management efforts.
19
June 30, 2002 December 31, 2001
-------------------------------- ----------------------------------
Average Average
Amount Maturity Rate Amount Maturity Rate
-------------------------------- ----------------------------------
(dollars in thousands)
Brokered CDs(1) $253,430 1.7 years 3.13% $163,315 1.7 years 3.83%
Fixed rate FHLB advances(1) 60,998 8.6 years 5.94 129,084 4.1 years 4.08
Variable rate FHLB advances(1) 48,300 0.4 years 2.22 93,000 0.4 years 1.83
Securities sold under agreements to
Repurchase(1) 93,174 0.1 years 1.91 54,963 0.2 years 1.94
Federal funds purchased 33,650 1 day 2.07 35,100 1 day 1.86
-------------------------------- ----------------------------------
Total $489,552 2.0 years 3.08% $475,462 1.8 years 3.15%
================================ ==================================
(1) Certain of these items have had their average maturity and rate altered
through the use of derivative instruments, including pay-fixed and pay-variable
interest rate swaps.
Derivative financial instruments are employed to manage our exposure to changes
in interest rates. (See "Asset/liability management".) At June 30, 2002, we
employed interest-rate caps, floors and collars with an aggregate notional
amount of $42.0 million. We also employed interest-rate swaps with an aggregate
notional amount of $247.0 million. (See note #7 to interim consolidated
financial statements.)
LIQUIDITY AND CAPITAL RESOURCES Effective management of capital resources is
critical to our mission to create value for our shareholders. The cost of
capital is an important factor in creating shareholder value and, accordingly,
our capital structure includes unsecured debt and Preferred Securities.
We believe that diversified portfolios of quality commercial and consumer loans
will provide superior risk-adjusted returns. Accordingly, we have implemented
balance sheet management strategies that combine efforts to originate Portfolio
Loans with disciplined funding strategies. Acquisitions have also been an
integral component of our capital management strategies.
To supplement our balance sheet and capital management activities, we regularly
repurchase our common stock. We purchased 307,000 shares at an average price of
$29.41 per share in the first six months of 2002 compared to 254,000 shares at
an average price of $19.52 per share during the first six months of 2001. As of
June 30, 2002 we had 490,000 shares remaining to be purchased under share
repurchase plans previously authorized by our Board of Directors.
CAPITALIZATION
June 30, December 31,
2002 2001
------------------- -------------------
(in thousands)
Unsecured debt $ 10,500 $ 10,500
--------- ---------
Preferred Securities 17,250 17,250
--------- ---------
Shareholders' Equity
Preferred stock, no par value
Common Stock, par value $1.00 per share 11,723 11,865
Capital surplus 76,525 82,512
Retained earnings 49,529 39,355
Accumulated other comprehensive income (loss) 3,158 (1,829)
--------- ---------
Total shareholders' equity 140,935 131,903
--------- ---------
Total capitalization $ 168,685 $ 159,653
========= =========
20
Total shareholders' equity at June 30, 2002 increased $9.0 million from December
31, 2001, as the retention of earnings and a positive change in accumulated
other comprehensive income (loss) were partially offset by purchases of our
common stock and cash dividends declared. The change in accumulated other
comprehensive income (loss) was due primarily to an increase in the market value
of securities available for sale over their book value due principally to
declining interest rates which led to higher prices on fixed income securities.
Shareholders' equity totaled $140.9 million, equal to 7.28% of total assets at
June 30, 2002. At December 31, 2001, shareholders' equity totaled $131.9
million, which was equal to 6.98% of total assets.
CAPITAL RATIOS
June 30, 2002 December 31, 2001
--------------------- ----------------------
Equity capital 7.28% 6.98%
Tier 1 leverage (tangible equity capital) 7.57 7.28
Tier 1 risk-based capital 10.08 9.82
Total risk-based capital 11.33 10.98
ASSET/LIABILITY MANAGEMENT Interest-rate risk is created by differences in the
pricing characteristics of our assets and liabilities. Options embedded in
certain financial instruments, including caps on adjustable-rate loans as well
as borrowers' rights to prepay fixed-rate loans also create interest-rate risk.
Our asset/liability management efforts are intended to identify sources of
interest-rate risk and to evaluate opportunities to structure our balance sheet
in a manner that is consistent with our mission to maintain profitable financial
leverage. The marginal cost of funds is a principal consideration in the
implementation of our balance sheet management strategies, but such evaluations
further consider interest-rate and liquidity risk as well as other pertinent
factors.
We employ simulation analyses to monitor our interest-rate risk profiles and
evaluate potential changes in our net interest income and market value of
portfolio equity that result from changes in interest rates.
RESULTS OF OPERATIONS
SUMMARY Net income totaled $7.3 million and $14.4 million during the three- and
six-month periods ended June 30, 2002. The increases from the comparable periods
in 2001 primarily reflect increases in net interest income and non-interest
income, which were partially offset by increases in non-interest expense and
federal income taxes. The amortization of intangible assets declined by $0.2
million and $0.4 million, respectively, during the three- and six-month periods
ended June 30, 2002 from the comparable periods in 2001, as a result of the
adoption of SFAS #142. (See note #8 to interim consolidated financial
statements.)
21
KEY PERFORMANCE RATIOS
Three months ended Six months ended
June 30, June 30,
2002 2001 2002 2001
-------------- -------------- -------------- --------------
Net income to
Average assets 1.55% 1.41% 1.55% 1.31%
Average equity 21.41 19.47 21.38 18.01
Earnings per common share
Basic $0.62 $0.52 $1.22 $0.95
Diluted 0.61 0.51 1.20 0.94
NET INTEREST INCOME Tax equivalent net interest income increased by 18.2% to
$21.3 million and by 16.0% to $41.8 million, respectively, during the three- and
six-month periods in 2002. Increases from the comparable periods of 2001 reflect
an increase in average earning assets and an increase in tax equivalent net
interest income as a percent of average earning assets ("Net Yield") as well as
adjustments related to SFAS #133.
Pursuant to SFAS #133, we recorded adjustments, which increased tax equivalent
net interest income by $0.3 million and $0.6 million, respectively, in the
three- and six-month periods ended June 30, 2002. This compares to adjustments,
which reduced tax equivalent net interest income by approximately $0.3 million
and $0.6 million, respectively, in the three- and six-month periods ended June
30, 2001. These adjustments relate principally to certain derivative financial
instruments that are not designated as hedges. The changes in the fair value of
these derivative financial instruments are recognized currently as adjustments
to interest expense.
Average earning assets totaled $1.779 billion and $1.766 billion during the
three- and six-month periods in 2002, respectively. The increases from the
corresponding periods of 2001 principally reflect increases in securities
available for sale. The average balance of Portfolio Loans declined in both the
three- and six-month periods ended June 30, 2002 compared to the like periods in
2001. (See "Portfolio Loans and asset quality.")
Net Yield increased by 48 basis points to 4.80% during the three-month period in
2002 and by 41 basis points to 4.75% during the six-month period in 2002 as
compared to the like periods in 2001. The increase in Net Yield was primarily
due to a decline in interest expense as a percent of average earning assets
resulting from a lower interest rate environment. The Federal Reserve Bank cut
the target federal funds rate eleven times in 2001, leading to generally lower
rates on our deposits and borrowings. Partially offsetting the decline in
interest expense was a decline in tax equivalent interest income as a percent of
average earning assets ("Yield on Interest Earning Assets"). The decline in
Yield on Interest Earning Assets was also generally due to a lower interest rate
environment that resulted in the prepayment of higher yielding loans and the
origination of new loans and the purchase of securities available for sale at
lower relative interest rates.
22
NET INTEREST INCOME AND SELECTED RATIOS
Three months ended Six months ended
June 30, June 30,
2002 2001 2002 2001
-------------- ------------- ------------- --------------
Average earning assets (in thousands) $1,779,117 $1,670,563 $1,766,408 $1,664,557
Tax equivalent net interest income 21,342 36,065
18,049 41,840
As a percent of average earning assets
Tax equivalent interest income 7.51% 8.21% 7.52% 8.38%
Interest expense 2.71 3.89 2.77 4.04
Tax equivalent net interest income 4.80 4.32 4.75 4.34
Average earning assets as a
percent of average assets 94.49% 93.86% 94.45% 93.97%
Free-funds ratio 11.72% 11.01% 11.60% 10.74%
PROVISION FOR LOAN LOSSES The provision for loan losses was $1.2 million during
the three months ended June 30, 2002, compared to $1.3 million during the
three-month period in 2001. During the six-month periods ended June 30, 2002 and
2001, the provision was $2.1 million and $1.9 million, respectively. The changes
in the provision reflect our assessment of the allowance for loan losses. (See
"Portfolio Loans and asset quality.")
NON-INTEREST INCOME Non-interest income totaled $7.6 million during the three
months ended June 30, 2002, a $0.2 million increase from the comparable period
in 2001. This increase was primarily due to an increase in service charges on
deposits that was partially offset by a decline in net gains on the sale of real
estate mortgage loans. Non-interest income increased to $14.7 million during the
six months ended June 30, 2002, from $12.3 million a year earlier due primarily
to an increase in service charges on deposits.
NON-INTEREST INCOME
Three months ended Six months ended
June 30, June 30,
2002 2001 2002 2001
---------- ---------- ---------- -----------
(in thousands)
Service charges on deposit accounts $3,241 $2,265 $5,953 $4,083
Net gains on asset sales
Real estate mortgage loans 1,238 2,052 3,044 3,047
Securities 210 123 176 158
Manufactured home loan origination fees
and commissions 553 676 997 1,029
Title insurance fees 464 562 1,087 848
Real estate mortgage loan servicing fees 273 165 568 556
Mutual fund and annuity commissions 349 218 578 390
Other 1,257 1,277 2,307 2,233
---------- ---------- ---------- ----------
Total non-interest income $7,585 $7,338 $14,710 $12,344
========== ========== ========== ==========
23
Service charges on deposit accounts increased by 43.1% to $3.2 million and by
45.8% to $6.0 million during the three- and six-month periods ended June 30,
2002, respectively, from the comparable periods in 2001. The increase in service
charges principally relate to growth in checking accounts as a result of deposit
account promotions, which include direct mail solicitations, and increases in
certain fees on both retail and commercial checking accounts that we implemented
in the second quarter of 2001.
Our mortgage lending activities have a substantial impact on total non-interest
income. Net gains on the sale of real estate mortgage loans decreased by $0.8
million during the three months ended June 30, 2002 from the same period in 2001
and were nearly unchanged on a year to date comparative basis. Beginning in the
second quarter of 2001 and continuing into the first quarter of 2002 our volume
of real estate mortgage loans originated and sold increased significantly due to
a surge in mortgage loan refinance activity generally resulting from lower
interest rates. Mortgage loan refinance volume began to subside in the first
quarter of 2002 and continued to ease into the second quarter of 2002. However,
in late June 2002 interest rates for mortgage loans began to decline and
mortgage loan applications related to refinancing once again began to increase.
Also during the second quarter of 2002 gains on the sale of real estate mortgage
loans were reduced by approximately $0.2 million as a result of recording
changes in the fair value of certain derivative instruments pursuant to SFAS
#133. This reduction in gains on the sale of real estate mortgage loans
primarily represents a timing difference that is expected to reverse when the
applicable commitments to sell real estate mortgage loans in the secondary
market are fulfilled.
Three months ended Six months ended
June 30, June 30,
2002 2001 2002 2001
-------------- ------------- ------------- --------------
(in thousands)
Real estate mortgage loans originated $152,759 $192,081 $293,479 $308,052
Real estate mortgage loans sold 91,500 128,073 243,320 194,587
Real estate mortgage loans sold with servicing
rights released 9,158 112,481 21,495 170,400
Net gains on the sale of real estate mortgage loans 1,238 2,052 3,044 3,047
Net gains as a percent of real estate mortgage
loans sold 1.35% 1.60% 1.25% 1.57%
The volume of loans sold is dependent upon our ability to originate real estate
mortgage loans as well as the demand for fixed-rate obligations and other loans
that we cannot profitably fund within established interest-rate risk parameters.
(See "Portfolio loans and asset quality.") Net gains on real estate mortgage
loans are also dependent upon economic and competitive factors as well as our
ability to effectively manage exposure to changes in interest rates and thus can
often be a volatile part of our overall revenues.
Net gains as a percentage of real estate mortgage loans sold declined in 2002
compared to 2001. The decline in these gains as a percentage of real estate
mortgage loans sold is partially attributed to the majority of such sales in
2001 being done on a "service-released" basis. Because of generally higher
prices being paid for mortgage loan servicing in 2001, we began to sell our real
estate mortgage loans on a service-released basis. Beginning in the third
quarter of 2001, the price being paid for mortgage loan servicing declined and
we began to then retain the servicing on the majority of our real estate
mortgage loan sales. Our decision to sell or retain mortgage loan servicing
rights is primarily influenced by an evaluation of the price being paid for
mortgage loan servicing by outside third parties compared to our calculation of
the economic value of
24
retaining such servicing. The sale of mortgage loan servicing rights may result
in declines in mortgage loan servicing income in future periods.
We capitalized approximately $1.9 million and $0.2 million of related servicing
rights during the six-month periods ended June 30, 2002 and 2001, respectively.
The significant difference between the amount of capitalized originated mortgage
loan servicing rights between 2002 and 2001 is due to the majority of loans
being sold on a servicing retained basis in 2002 compared to a servicing
released basis in 2001 as described above. Amortization of capitalized servicing
rights was $0.7 million for each of those periods, respectively. The second
quarter of 2001 included $0.2 million in additional amortization of capitalized
mortgage servicing rights as a result of acceleration in prepayment activity.
The book value of capitalized mortgage servicing rights was $5.5 million at June
30, 2002. The fair value of capitalized servicing rights, which relate to
approximately $841 million of real estate mortgage loans sold and serviced,
approximated $6.4 million at that same date.
Title insurance fees decreased in the second quarter of 2002 compared to the
second quarter of 2001 but increased in the comparative six-month periods. The
changes in title insurance fees primarily reflect the changes in our mortgage
loan origination volume. Mutual fund and annuity commissions have increased in
2002 compared to 2001 due primarily to higher sales volumes.
NON-INTEREST EXPENSE Non-interest expense increased by $1.5 million to $16.5
million and by $3.2 million to $32.2 million during the three- and six-month
periods ended June 30, 2002, respectively, compared to the like periods in 2001.
The increase in non-interest expense is due primarily to an increase in
compensation and benefits expense that is attributable to merit pay increases
that were effective January 1, 2002, staffing level increases associated with
the expansion and growth of the organization and increases in performance-based
compensation and health care insurance costs. We adopted SFAS #142 on January 1,
2002 and as a result, intangible asset amortization declined to $0.2 million in
the second quarter of 2002, from $0.4 million in the second quarter of 2001 and
to $0.5 million for the first six months of 2002 compared to $0.9 million for
the comparative period in 2001.
25
NON-INTEREST EXPENSE
Three months ended Six months ended
June 30, June 30,
2002 2001 2002 2001
--------------- --------------- --------------- ----------------
(in thousands)
Salaries $ 6,312 $ 5,408 $12,130 $10,894
Performance-based compensation
and benefits 1,359 1,051 2,549 1,860
Other benefits 1,591 1,415 3,371 2,772
--------------- --------------- --------------- ---------------
Salaries and benefits 9,262 7,874 18,050 15,526
Occupancy, net 1,344 1,183 2,650 2,473
Furniture and fixtures 1,144 1,109 2,250 2,167
Data processing 714 583 1,427 1,137
Communications 567 577 1,213 1,165
Advertising 565 633 1,177 1,134
Loan and collection 710 608 1,215 1,073
Supplies 338 298 671 667
Amortization of intangible assets 246 425 492 852
Other 1,614 1,678 3,101 2,873
--------------- --------------- --------------- ---------------
Total non-interest expense $16,504 $14,968 $32,246 $29,067
=============== =============== =============== ===============
Item 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
No material changes in the market risk faced by us have occurred since December
31, 2001.
26
Part II
Item 4. Submission of Matters to a Vote of Security-Holders
Our Annual Meeting of Shareholders was held on April 16, 2002. As
described in our proxy statement, dated March 15, 2002, matters
considered at that meeting were:
(1) Election of two nominees to the board of directors
Terry L. Haske and Thomas F. Kohn were elected to serve three-year
terms expiring in 2005.
Directors whose term of office as a director continued after the
meeting were Robert L. Hetzler, Robert J. Leppink, Arch V. Wright,
Jr., Jeffrey A. Bratsburg, Charles A. Palmer, and Charles C. Van Loan.
(2) To consider and vote upon a proposal to approve our Long-Term Incentive
Plan.
The proposal was passed. Tabulations on this proposal are set forth
below.
Broker Non-Votes
Votes FOR Votes AGAINST and Abstentions
--------- ------------- ---------------
9,577,331 855,968 179,705
Item 6. Exhibits & Reports on Form 8-K
(a) The following exhibits (listed by number corresponding to the Exhibit
Table as Item 601 in Regulation S-K) are filed with this report:
11. Computation of Earnings Per Share
99.1 Certificate of the Chief Executive Officer of Independent Bank
Corporation pursuant to Section 906 of the Sarbanes-Oxley Act of
2002 (18 U.S.C. 1350).
99.2 Certificate of the Chief Financial Officer of Independent Bank
Corporation pursuant to Section 906 of the Sarbanes-Oxley Act of
2002 (18 U.S.C. 1350).
(b) Reports on Form 8-K
A report on Form 8-K was filed on July 24, 2002, under item 9. The
report included supplemental data to our press release dated July 24,
2002, regarding our earnings during the quarter ended June 30, 2002.
27
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date August 12, 2002 By /s/ Robert N. Shuster
------------------------ -----------------------------------------
Robert N. Shuster, Principal
Financial Officer
Date August 12, 2002 By /s/ James J. Twarozynski
------------------------ -----------------------------------------
James J. Twarozynski, Principal
Accounting Officer
28
EXHIBIT INDEX
NUMBER DESCRIPTION
- ------ -----------
11 Computation of Earnings Per Share
99.1 Certificate of the Chief Executive Officer of
Independent Bank Corporation pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350).
99.2 Certificate of the Chief Financial Officer of
Independent Bank Corporation pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350).