EXHIBIT 13
APPENDIX B
Independent Bank Corporation is an Ionia, Michigan-based bank holding
company with total assets of $2.1 billion. Our four subsidiary banks principally
serve suburban and rural communities located across Michigan's Lower Peninsula
through 97 offices.
We emphasize service and convenience as the principal means of competing in
the delivery of financial services. Accordingly, our community banking
philosophy vests discretion and authority in our management while providing
financial incentives to align the interests of such management with those of our
shareholders.
To support our service and sales efforts, while providing the controls that
are consistent with our decentralized decision-making structure, we have
consolidated many operational and administrative functions and provide these
services to our four subsidiary banks on a centralized basis.
CONTENTS
Management's Discussion and Analysis ............................. A-1
Selected Consolidated Financial Data ............................. A-15
Independent Auditors' Report ..................................... A-16
Consolidated Financial Statements ................................ A-17
Notes to Consolidated Financial Statements ....................... A-21
Quarterly Data ................................................... A-39
Shareholder Information .......................................... A-40
Executive Officers and Directors ................................. A-40
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Any statements in this document that are not historical facts are
forward-looking statements as defined in the Private Securities Litigation
Reform Act of 1995. Words such as "expect," "believe," "intend," "estimate,"
"project," "may" and similar expressions are intended to identify
forward-looking statements. These forward-looking statements are predicated on
management's beliefs and assumptions based on information known to Independent
Bank Corporation's management as of the date of this document and do not purport
to speak as of any other date. Forward-looking statements may include
descriptions of plans and objectives of Independent Bank Corporation's
management for future or past operations, products or services, and forecasts of
the Company's revenue, earnings or other measures of economic performance,
including statements of profitability, business segments and subsidiaries, and
estimates of credit quality trends. Such statements reflect the view of
Independent Bank Corporation's management as of this date with respect to future
events and are not guarantees of future performance; involve assumptions and are
subject to substantial risks and uncertainties, such as the changes in
Independent Bank Corporation's plans, objectives, expectations and intentions.
Should one or more of these risks materialize or should underlying beliefs or
assumptions prove incorrect, the Company's actual results could differ
materially from those discussed. Factors that could cause or contribute to such
differences are changes in interest rates, changes in the accounting treatment
of any particular item, the results of regulatory examinations, changes in
industries where the Company has a concentration of loans, changes in the level
of fee income, changes in general economic conditions and related credit and
market conditions, and the impact of regulatory responses to any of the
foregoing. Forward-looking statements speak only as of the date they are made.
Independent Bank Corporation does not undertake to update forward-looking
statements to reflect facts; circumstances, assumptions or events that occur
after the date the forward-looking statements are made. For any forward-looking
statements made in this document, Independent Bank Corporation claims the
protection of the safe harbor for forward-looking statements contained in the
Private Securities Litigation Reform Act of 1995.
The following section presents additional information to assess the
financial condition and results of operations of Independent Bank Corporation
and its subsidiaries. This section should be read in conjunction with the
consolidated financial statements and the supplemental financial data contained
elsewhere in this appendix.
A-1
RESULTS OF OPERATIONS
SUMMARY. Net income totaled $29.5 million in 2002 compared to $24.4 million
in 2001 and $20.0 million in 2000. The increases in net income are primarily a
result of increases in net interest income, service charges on deposit accounts
and net gains on the sale of real estate mortgage loans, partially offset by
increases in non-interest expense and federal income taxes.
KEY PERFORMANCE RATIOS Year ended December 31,
2002 2001 2000
- ---------------------------------------------------------------------------------------------------------------------
Net income to
Average equity .......................................... 21.34% 18.52% 16.59%
Average assets .......................................... 1.52 1.35 1.15
Net income per share
Basic ................................................... $ 1.61 $ 1.29 $ 1.03
Diluted ................................................. 1.58 1.27 1.02
NET INTEREST INCOME. Tax equivalent net interest income totaled $86.2
million during 2002, compared to $75.8 million and $68.7 million during 2001 and
2000, respectively. The increase in 2002 compared to 2001 reflects 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 Statement of Financial Accounting Standards No. 133, "Accounting for
Derivative Instruments and Hedging Activities," ("SFAS #133").
Pursuant to SFAS #133, we recorded adjustments, which increased tax
equivalent net interest income by $1.0 million in 2002. This compares to
adjustments, which reduced tax equivalent net interest income by approximately
$0.3 million in 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 $1.813 billion
in 2002 compared to $1.705 billion in 2001, principally reflecting an increase
in securities available for sale.
Net Yield increased by 30 basis points to 4.75% in 2002 compared to 4.45% 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 by
50 basis points in 2002, in addition to the 475 basis points 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. A continued decline in the cost of
interest bearing liabilities is dependent, in part, upon external factors that
include the slope of the yield curve, availability of credit, and customer
preferences that may result in changes in the mix or amount of our deposits. The
10.4% increase in tax equivalent net interest income in 2001 compared to 2000
principally reflects a $72.0 million or 4.4% increase in the amount of average
earning assets and a 5.7% increase in Net Yield.
A-2
2002 2001 2000
AVERAGE ------------------------------------------------------------------------------------------
BALANCES AND TAX Average Average Average
EQUIVALENT RATES Balance Interest Rate Balance Interest Rate Balance Interest Rate
- ------------------------------------------------------------------------------------------------------------------------------
(dollars in thousands)
ASSETS
Taxable loans(1) ............ $1,426,286 $108,664 7.62% $1,415,136 $117,002 8.27% $1,341,923 $114,536 8.54%
Tax-exempt loans(1,2) ....... 11,639 974 8.37 13,058 1,127 8.63 10,433 910 8.72
Taxable securities .......... 211,777 12,211 5.77 137,085 9,334 6.81 144,231 9,960 6.91
Tax-exempt securities(2) .... 142,320 11,053 7.77 119,282 9,333 7.82 116,700 9,558 8.19
Other investments ........... 21,342 1,289 6.04 20,348 1,513 7.44 19,612 1,620 8.26
---------- -------- ---------- -------- ---------- --------
Interest earning assets... 1,813,364 134,191 7.40 1,704,909 138,309 8.11 1,632,899 136,584 8.36
-------- -------- --------
Cash and due from banks ..... 40,533 38,602 37,288
Other assets, net ........... 79,848 66,383 72,225
---------- ---------- ----------
Total assets ............. $1,933,745 $1,809,894 $1,742,412
========== ========== ==========
LIABILITIES
Savings and NOW ............. $ 634,357 7,444 1.17 $ 583,817 11,484 1.97 $ 574,556 14,800 2.58
Time deposits ............... 688,297 27,690 4.02 623,657 33,127 5.31 655,591 36,973 5.64
Long-term debt .............. 371 26 7.01 2,247 162 7.21
Other borrowings ............ 287,983 12,874 4.47 304,973 17,823 5.84 243,118 15,930 6.55
---------- -------- ---------- -------- ---------- --------
Interest bearing
liabilities ........... 1,610,637 48,008 2.98 1,512,818 62,460 4.13 1,475,512 67,865 4.60
-------- -------- --------
Demand deposits ............. 156,294 138,200 126,596
Other liabilities ........... 28,762 27,162 19,704
Shareholders' equity ........ 138,052 131,714 120,600
---------- ---------- ----------
Total liabilities and
shareholders' equity ..... $1,933,745 $1,809,894 $1,742,412
========== ========== ==========
Net interest income ...... $ 86,183 $ 75,849 $ 68,719
======== ======== ========
Net interest income
as a percent of
earning assets ......... 4.75% 4.45% 4.21%
==== ==== ====
(1) All domestic.
(2) Interest on tax-exempt loans and securities is presented on a fully tax
equivalent basis assuming a marginal tax rate of 35%.
CHANGE IN TAX EQUIVALENT 2002 compared to 2001 2001 compared to 2000
NET INTEREST INCOME Volume Rate Net Volume Rate Net
- ------------------------------------------------------------------------------------------------------------------------------------
(in thousands)
Increase (decrease) in interest income(1)
Taxable loans(2) .................................. $ 915 $ (9,253) $ (8,338) $ 6,149 $ (3,683) $ 2,466
Tax-exempt loans(2,3) ............................. (120) (33) (153) 227 (10) 217
Taxable securities ................................ 4,478 (1,601) 2,877 (488) (138) (626)
Tax-exempt securities(3) .......................... 1,790 (70) 1,720 209 (434) (225)
Other investments ................................. 71 (295) (224) 59 (166) (107)
-------- -------- -------- -------- -------- --------
Total interest income .......................... 7,134 (11,252) (4,118) 6,156 (4,431) 1,725
-------- -------- -------- -------- -------- --------
Increase (decrease) in interest expense(1)
Savings and NOW ................................... 923 (4,963) (4,040) 235 (3,551) (3,316)
Time deposits ..................................... 3,184 (8,621) (5,437) (1,753) (2,093) (3,846)
Long-term debt .................................... (26) (26) (132) (4) (136)
Other borrowings .................................. (948) (4,001) (4,949) 3,746 (1,853) 1,893
-------- -------- -------- -------- -------- --------
Total interest expense ......................... 3,133 (17,585) (14,452) 2,096 (7,501) (5,405)
-------- -------- -------- -------- -------- --------
Net interest income ......................... $ 4,001 $ 6,333 $ 10,334 $ 4,060 $ 3,070 $ 7,130
======== ======== ======== ======== ======== ========
(1) The change in interest due to changes in both balance and rate has been
allocated to change due to balance and change due to rate in proportion
to the relationship of the absolute dollar amounts of change in each.
(2) All domestic.
(3) Interest on tax-exempt loans and securities is presented on a fully tax
equivalent basis assuming a marginal tax rate of 35%.
A-3
COMPOSITION OF AVERAGE EARNING ASSETS Year ended December 31,
AND INTEREST BEARING LIABILITIES 2002 2001 2000
- ---------------------------------------------------------------------
As a percent of average earning assets
Loans--all domestic ..................... 79.3% 83.8% 82.8%
Other earning assets .................... 20.7 16.2 17.2
----- ----- -----
Average earning assets ................ 100.0% 100.0% 100.0%
===== ===== =====
Savings and NOW ......................... 35.0% 34.2% 35.2%
Time deposits ........................... 24.5 27.5 29.3
Brokered CDs ............................ 13.4 9.1 10.9
Other borrowings and long-term debt ..... 15.9 17.9 15.0
----- ----- -----
Average interest bearing liabilities .. 88.8% 88.7% 90.4%
===== ===== =====
Earning asset ratio ....................... 93.8% 94.2% 93.7%
Free-funds ratio .......................... 11.2 11.3 9.6
PROVISION FOR LOAN LOSSES. The provision for loan losses was $3.6 million
during 2002 compared to $3.7 million and $3.3 million during 2001 and 2000,
respectively. Changes in the provision for loan losses reflect our assessment of
the allowance for loan losses. While we use relevant information to recognize
losses on loans, additional provisions for related losses may be necessary based
on changes in economic conditions; customer circumstances and other credit risk
factors. (See "Portfolio Loans and asset quality.")
NON-INTEREST INCOME. Non-interest income totaled $30.9 million during 2002
compared to $26.9 million and $19.0 million during 2001 and 2000, respectively.
Excluding net gains and losses on assets, non-interest income grew by 13.2% to
$22.8 million during 2002 and by 20.1% to $20.1 million during 2001 from each
comparable prior year. Increases in service charges on deposit accounts, title
insurance fees and other non-interest income account for the majority of the
increase in total non-interest income during 2002 and 2001. The overall
increases in 2002 and 2001 from each comparable prior year were partially offset
by a decline in real estate mortgage loan servicing fees.
Year ended December 31,
NON-INTEREST INCOME 2002 2001 2000
- -----------------------------------------------------------------------------------------------
(in thousands)
Service charges on deposit accounts ...................... $ 13,049 $ 9,936 $ 6,857
Net gains (losses) on assets
Real estate mortgage loans ............................. 8,178 6,306 2,209
Securities ............................................. (24) 522 9
Title insurance fees ..................................... 2,474 1,874 912
Manufactured home loan origination fees and commissions .. 1,949 2,108 2,144
Mutual fund and annuity commissions ...................... 979 798 1,199
Real estate mortgage loan servicing fees, net ............ (870) 833 1,490
Other .................................................... 5,176 4,558 4,141
--------- ------- ---------
Total non-interest income ............................ $ 30,911 $26,935 $ 18,961
========= ======= =========
Service charges on deposit accounts totaled $13.0 million during 2002,
compared to $9.9 million and $6.9 million during 2001 and 2000, respectively.
The increases in such service charges principally relate to growth in checking
accounts as a result of deposit account promotions, including direct mail
solicitations and increases in certain fees on retail and commercial checking
accounts that were implemented in the second quarter of 2001. We opened 22,000
new checking accounts in 2002 compared to 24,000 in 2001 and 22,000 in 2000.
Partially as a result of a leveling off in our growth rate of new checking
accounts, we would expect the growth rate of service charges on deposits to
moderate in future periods. (See "Deposits and borrowings.")
Net gains on the sale of real estate mortgage loans are generally a
function of the volume of loans sold. We realized net gains of $8.2 million on
the sale of such loans during 2002, compared to $6.3 million and $2.2 million
during 2001 and 2000, respectively. 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. In 2002, approximately 69% of the $876.7 million of loans
originated was the result of refinancing activity. We estimate that refinancing
activities accounted for approximately 63% and 58% of the real estate mortgage
loans originated during 2001 and 2000, respectively. Based on forecasts by the
Mortgage Bankers Association and potential changes in market interest rates we
would expect overall mortgage loan refinance activity in 2003 to decline from
our 2002 levels.
A-4
NET GAINS ON THE SALE OF REAL ESTATE Year ended December 31,
MORTGAGE LOANS 2002 2001 2000
- -----------------------------------------------------------------------------------------------------
(dollars in thousands)
Real estate mortgage loans originated ............................ $876,667 $680,702 $345,400
Real estate mortgage loans sold .................................. 600,300 410,998 153,800
Real estate mortgage loans sold with servicing rights released ... 165,133 282,240 36,000
Net gains on the sale of real estate mortgage loans .............. 8,178 6,306 2,209
Net gains as a percent of real estate mortgage loans sold ........ 1.36% 1.53% 1.44%
Net gains as a percentage of real estate mortgage loans sold (our "Loan
Sales Margin") are impacted by several factors including competition and the
manner in which the loan is sold. 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. In
mid-2002 mortgage loan servicing values firmed and we once again began to sell
real estate mortgage loans on a service-released basis. 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 retaining such servicing.
The sale of mortgage loan servicing rights may result in declines in mortgage
loan servicing income in future periods. In addition, gains on the sale of real
estate mortgage loans were reduced by approximately $1.0 million in 2002 as a
result of recording changes in the fair value of certain derivative instruments
pursuant to SFAS #133. This SFAS #133 adjustment in gains on the sale of real
estate mortgage loans in 2002 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. Excluding this SFAS #133
adjustment, the Loan Sales Margin would have been 1.53% in 2002, which is
consistent with 2001.
The purchase or sale of securities is dependent upon our assessment of
investment and funding opportunities as well as asset/liability management
needs. We sold securities with an aggregate market value of $66.4 million during
2002 compared to $18.9 million and $22.3 million during 2001 and 2000,
respectively. (See "Securities."). The net loss on securities in 2002 includes
an impairment charge of $0.8 million on a $1.5 million trust preferred security
that was purchased in 1999, and which was issued by an unaffiliated bank holding
company. This bank holding company is currently experiencing financial
difficulties and has suspended the payment of interest on this security. As a
result of these circumstances and the current indicated market value of this
security, the book value of this asset was written down.
GAINS AND LOSSES ON SECURITIES Year ended December 31,
Proceeds Gains Losses Net
- ------------------------------------------------------------------------------------------
(in thousands)
2002(l).............. $66,390 $809 $833 $ (24)
2001................. 18,925 524 2 522
2000................. 22,319 94 85 9
(1) Losses in 2002 include a $0.8 million impairment charge on a trust-preferred
security (as described above).
Title insurance fees increased to $2.5 million in 2002 compared to $1.9
million in 2001 and $0.9 million in 2000. The increase in title insurance fees
is primarily a function of the increased level of real estate mortgage loans
originated as well as our title insurance agency gaining an increasing share of
our mortgage loan origination business. Mutual fund and annuity commissions
increased in 2002 compared to 2001, but remain below 2000 levels. The decline in
these commissions from the 2000 level is attributable to lower sales volumes,
due in part to a more difficult environment for selling equity-based investments
over the past two years.
Real estate mortgage loan servicing fees, net declined to a negative $0.9
million in 2002, compared to $0.8 million in 2001 and $1.5 million in 2000. The
decline in 2002 compared to 2001, is due to a $0.8 million increase in the
amortization of capitalized mortgage servicing rights and a $1.1 million
impairment charge that we recorded in the third quarter of 2002 on our
capitalized mortgage servicing rights. There was essentially no change in this
impairment reserve at December 31, 2002 from September 30, 2002. Both the
increased level of amortization and the impairment reserve reflect the decline
in interest rates, which has resulted in an increase in the prepayment of real
estate mortgage loans, as well as a dramatic increase in the expected future
level of mortgage loan refinancing/prepayment activity. The decline in 2001
compared to 2000 is due to an increase in the amortization of capitalized
mortgage servicing rights of $0.5 million in 2001 as a result of a rise in the
prepayment of real estate mortgage loans serviced for others as well as an $88
million decline in the average balance of real estate mortgage loans serviced
for others during 2001. For much of 2001, we sold a majority of real estate
mortgage loans on a "service-released basis." As a result, we were retaining
less servicing rights in 2001, as compared to prior periods. At December 31,
2002 we were servicing approximately $794 million in real estate mortgage loans
for others on which servicing rights have been capitalized. This servicing
portfolio had a weighted average coupon rate of 6.78% and a weighted average
service fee of approximately 26 basis points. Remaining capitalized mortgage
servicing rights at December 31, 2002 totaled $4.5 million,
A-5
representing approximately 56 basis points on the related amount of real estate
mortgage loans serviced for others.
Other non-interest income totaled $5.2 million in 2002, compared to $4.6
million and $4.1 million during 2001 and 2000, respectively. The increases in
2002 and 2001 from their respective previous years was partially attributed to
increases in debit card related fees associated with the growth in our checking
account base. Income from bank owned life insurance purchased during 2002 also
contributed to the increase in other non-interest income from 2001.
NON-INTEREST EXPENSE. Non-interest expense totaled $68.3 million during
2002, compared to $61.5 million and $53.4 million during 2001 and 2000,
respectively.
NON-INTEREST EXPENSE Year ended December 31,
2002 2001 2000
- ----------------------------------------------------------------------------
(in thousands)
Compensation ................................. $24,891 $22,226 $20,236
Performance-based compensation and benefits .. 5,247 3,392 2,916
Other benefits ............................... 7,205 5,927 5,162
------- ------- -------
Compensation and benefits .................. 37,343 31,545 28,314
Occupancy, net ............................... 5,424 4,966 4,653
Furniture and fixtures ....................... 4,731 4,371 4,382
Data processing .............................. 3,209 2,558 2,467
Loan and collection .......................... 3,028 2,598 1,463
Advertising .................................. 2,813 2,490 2,129
Communications ............................... 2,484 2,275 2,128
Supplies ..................................... 1,626 1,442 1,155
Amortization of intangible assets ............ 1,014 1,704 1,728
Other ........................................ 6,621 7,570 4,956
------- ------- -------
Total non-interest expense ............... $68,293 $61,519 $53,375
======= ======= =======
The increase in compensation and benefits in 2002 and 2001 compared to each
prior year is primarily attributable to merit pay increases and staffing level
increases associated with the growth and expansion of the organization as well
as increases in certain employee benefit costs such as health care insurance.
Based on current conditions, we expect health care insurance costs to continue
to rise at levels significantly above the general rate of inflation.
We maintain performance-based compensation plans. In addition to
commissions and cash incentive awards, such plans include employee stock
ownership and employee stock option plans. Stock options granted during 2002 and
in prior years did not require the recognition of any expense in our
consolidated statements of operations during those periods. Presently, the
Financial Accounting Standards Board is reviewing the accounting for stock
options and in the future we may be required to recognize the expense of issuing
stock options in our consolidated statements of operations. We believe that
these equity-based plans help align the interests of our officers and employees
with those of our shareholders.
Occupancy, furniture and fixtures, advertising, communications and supplies
expenses all generally increased over the periods presented as a result of the
growth of the organization and expansion of our number of offices. In 2002 we
opened four new full-service banking offices and added loan production offices
related to our purchase of a mortgage brokerage company in March 2002.
The increase in loan and collection expense in 2002 and 2001 over 2000
reflects costs associated with holding or disposal of other real estate and
collection costs associated with increases in the level of non-performing loans.
The increase in data processing costs in 2002 compared to 2001 and 2000
reflects a new five-year contract that we entered into for core data processing
services effective in March 2002, the growth of our organization and additional
third-party vendor costs for several special projects such as disaster recovery
and upgrades to our network.
We adopted Statement of Financial Accounting Standards No. 142, "Goodwill
and Other Intangible Assets," ("SFAS #142") on January 1, 2002 and as a result,
intangible asset amortization declined by approximately $0.7 million in 2002
compared to the prior two years.
Other non-interest expense decreased to $6.6 million in 2002 compared to
$7.6 million in 2001. This decrease is primarily attributable to 2001 including
a $0.9 million loss on de-designating certain cash flow hedges. We terminated
the cash flow hedging relationships relating to $26 million of notional value
fixed pay interest rate swaps in December 2001. As a result, in the fourth
quarter of 2001, pursuant to SFAS #133, we reclassified a $0.9 million charge
from accumulated other comprehensive income to earnings. This charge was
included in other expenses.
Our federal income tax expense has increased generally commensurate with
our increase in pretax earnings. Our actual federal income tax expense is lower
than the amount computed by applying our statutory federal income tax rate to
our pre-tax earnings primarily due to tax exempt interest income.
A-6
FINANCIAL CONDITION
SUMMARY. Our total assets grew to $2.1 billion at December 31, 2002 from
$1.9 billion at December 31, 2001. The growth in total assets primarily reflects
increases in securities available for sale, loans held for sale and the purchase
of $35 million in bank owned life insurance in August 2002. Loans, excluding
loans held for sale ("Portfolio Loans"), totaled $1.381 billion at December 31,
2002, and were relatively unchanged since year end 2001. Total deposits
increased $148.2 million in 2002 primarily as a result of increases in checking
and savings deposits and in brokered certificates of deposit ("Brokered CDs").
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 asset-backed securities. We also invest in
capital securities, which include preferred stocks and trust preferred
securities. We continually evaluate asset/liability management needs and attempt
to maintain a portfolio structure that provides sufficient liquidity and cash
flow. We believe that the unrealized losses on securities available for sale are
temporary in nature and due primarily to changes in interest rates and not a
result of credit related issues, except for a $0.8 million impairment charge
that we recorded on a trust preferred security issued by a bank holding company
as discussed in "Results of Operations" above. In this instance, we believe that
the decline in value is directly due to the issuer's financial difficulties and
is other than temporary in nature. We also believe that we have the ability to
hold securities with unrealized losses to maturity or until such time as the
unrealized losses reverse. (See "Non-interest income" and "Asset/liability
management.")
SECURITIES Amortized Unrealized Fair
Cost Gains Losses Value
- -------------------------------------------------------------------------
(in thousands)
Securities available for sale
December 31, 2002 ......... $358,149 $ 14,890 $ 1,793 $371,246
December 31, 2001 ......... 286,571 5,789 2,057 290,303
Securities available for sale increased by $80.9 million during 2002 to
$371.2 million at December 31, 2002. This increase was due primarily to
purchases of municipal, corporate, mortgage-backed and asset-backed securities
during the year to offset the lack of growth in Portfolio Loans. Generally we
cannot earn the same interest-rate spread on securities as we can on Portfolio
Loans. As a result, offsetting slow Portfolio Loan growth with purchases of
securities will tend to erode some of our profitability measures such as our Net
Yield and our return on assets.
At December 31, 2002 and 2001, we had $42.1 million and $3.2 million of
asset-backed securities included in securities available for sale. All of these
asset-backed securities are rated AAA or AA by a major rating agency.
Approximately 81% of our asset-backed securities at December 31, 2002 are backed
by mobile home loans. The majority of the mobile home loans underlying our
asset-backed securities are being serviced by Conseco Finance Corporation, who
recently declared bankruptcy. Conseco Finance Corporation continues to service
these mobile home loans underlying our asset-backed securities. We do not
foresee, at the present time, any risk of loss or risk of a credit downgrade
below investment quality (by a major rating agency) on our asset-backed
securities.
PORTFOLIO LOANS AND ASSET QUALITY. We believe that our decentralized loan
origination structure provides important advantages in serving the credit needs
of our principal lending markets. In addition to the communities served by our
bank 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.
LOAN PORTFOLIO COMPOSITION December 31,
2002 2001
- ------------------------------------------------------------------------------------
(in thousands)
Real estate(1)
Residential first mortgages ............................ $ 506,652 $ 511,019
Residential home equity and other junior mortgages ..... 126,742 181,905
Construction and land development ...................... 185,583 185,004
Other(2) ............................................... 325,176 292,548
Consumer ................................................. 137,631 134,367
Commercial ............................................... 86,413 65,275
Agricultural ............................................. 13,245 14,566
---------- ----------
Total loans .......................................... $1,381,442 $1,384,684
========== ==========
(1) Includes both residential and non-residential commercial loans secured by
real estate.
(2) Includes loans secured by multi-family residential and non-farm,
non-residential property.
A-7
Although the management and board of directors of each of our banks retain
authority and responsibility for credit decisions, we have adopted uniform
underwriting standards. Further, our loan committee structure as well as the
centralization of commercial loan credit services and the loan review process,
provides requisite controls and promotes compliance with such established
underwriting standards. Such centralized functions also facilitate compliance
with consumer protection laws and regulations.
We generally retain loans that may be profitably funded within established
risk parameters. (See "Asset/liability management.") As a result, we may hold
adjustable-rate and balloon real estate mortgage loans as Portfolio Loans, while
15- and 30-year, fixed-rate obligations are generally sold to mitigate exposure
to changes in interest rates. (See "Non-interest income.")
The increase in other real estate and commercial loans reflects our
emphasis on lending opportunities within these categories, particularly within
the Grand Rapids and Lansing, Michigan markets. The decline in residential home
equity and other junior mortgages is primarily due to a significant increase in
prepayments due to refinance activity associated with lower interest rates.
Construction and land development loans, other commercial real estate loans and
indirect consumer loans are generally thought to expose us to a higher risk of
loss than residential mortgage lending or direct consumer lending. Continued
growth and changes in the mix of Portfolio Loans is dependent upon our
assessment of risks and opportunities in our future lending activities as well
as a variety of competitive and economic factors.
NON-PERFORMING ASSETS December 31,
2002 2001 2000
- ---------------------------------------------------------------------------------------------------
(dollars in thousands)
Non-accrual loans ................................................. $ 5,738 $ 5,990 $ 5,200
Loans 90 days or more past due and still accruing interest ........ 3,961 2,771 1,571
Restructured loans ................................................ 270 285 260
------- ------- -------
Total non-performing loans ...................................... 9,969 9,046 7,031
Other real estate ................................................. 3,908 1,610 2,174
------- ------- -------
Total non-performing assets ................................... $13,877 $10,656 $ 9,205
======= ======= =======
As a percent of Portfolio Loans
Non-performing loans ............................................ .72% .65% .51%
Allowance for loan losses ....................................... 1.21 1.17 1.01
Non-performing assets to total assets ............................. .67 .56 .52
Allowance for loan losses as a percent of non-performing loans .... 168 179 199
Non-performing loans totaled $10.0 million, or 0.72% of total Portfolio
Loans at December 31, 2002, a $1.0 million increase from December 31, 2001. The
increase is attributable to a $0.3 million increase in non-performing commercial
loans and a $0.7 million increase in non-performing mortgage loans. The increase
in non-performing loans is generally a result of weaker economic conditions,
which have adversely impacted businesses and consumers.
The increase in non-performing loans in 2001 compared to 2000 is primarily
the result of one commercial real estate loan totaling $1.3 million at December
31, 2001 [$1.1 million at December 31, 2002]. This loan is secured by a office
building in the Lansing area with an original appraised value of approximately
$1.6 million. However, due to the current vacancy level in the building, a
specific valuation allowance of approximately $0.4 million has been established
on this loan. Although this loan is on non-accrual because of the aforementioned
vacancy level and past delinquencies, it is now current with respect to
payments. This loan matures in June 2003.
We will place a loan that is 90 days or more past due on non-accrual,
unless we believe the loan is both well secured and in the process of
collection. The increase in the level of loans 90 days or more past due and
still accruing interest at December 31, 2002 and 2001 compared to the December
31, 2000 level is primarily due to increases in residential mortgage loans and
commercial loans in this category. We believe the collection of the accrued but
unpaid interest on these loans is probable.
The increase in other real estate in 2002 is due primarily to the addition
of a hotel property that was foreclosed upon during the year. The hotel property
was transferred to other real estate at its estimated fair value (less expected
costs to sell) of $1.5 million. The balance of the increase in other real estate
is due to an increase in the level of residential properties acquired through
foreclosure.
ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES December 31,
2002 2001 2000
- -------------------------------------------------------------------------------------
(in thousands)
Specific allocations .................................. $ 1,313 $ 500 $ 100
Other adversely rated loans ........................... 6,067 7,284 3,166
Historical loss allocations ........................... 2,813 2,837 4,717
Additional allocations based on subjective factors .... 6,512 5,546 5,999
------- ------- -------
Total ............................................. $16,705 $16,167 $13,982
======= ======= =======
A-8
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 the 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, mix and/or the general
terms of the loan portfolios.
The first element reflects our estimate of probable losses based upon our
systematic review of specific loans. These estimates are based upon a number of
objective factors, such as payment history, financial condition of the borrower,
and discounted collateral exposure.
The second element reflects the application of our loan rating system. This
rating system is similar to those employed by state and federal banking
regulators. Loans that are rated below a certain predetermined classification
are assigned a loss allocation factor for each loan classification category that
is based upon a historical analysis of losses incurred. The lower the rating
assigned to a loan or category, the greater the allocation percentage that is
applied.
The third element is determined by assigning allocations based principally
upon the ten-year average of loss experience for each type of loan. Average
losses may be further adjusted based on the current delinquency rate. Loss
analyses are conducted at least annually.
The fourth element is based on factors that cannot be associated with a
specific credit or loan category and reflects our attempt to ensure that the
overall allowance for loan losses appropriately reflects a margin for the
imprecision necessarily inherent in the estimates of expected credit losses. We
consider a number of subjective factors when determining the unallocated
portion, including local and general economic business factors and trends,
portfolio concentrations and changes in the size, mix and the general terms of
the loan portfolios. (See "Provision for loan losses.")
ALLOWANCE FOR LOAN LOSSES Year ended December 31,
2002 2001 2000
- -----------------------------------------------------------------------------
(dollars in thousands)
Balance at beginning of year .............. $ 16,167 $ 13,982 $ 12,985
Provision charged to operating expense .. 3,562 3,737 3,287
Recoveries credited to allowance ........ 733 644 678
Loans charged against allowance ......... (3,757) (2,196) (2,968)
-------- -------- --------
Balance at end of year .................... $ 16,705 $ 16,167 $ 13,982
======== ======== ========
Net loans charged against the allowance
to average Portfolio Loans .............. .23% .11% .17%
Loans charged against the allowance for loan losses, net of recoveries,
were equal to 0.23% of average Portfolio Loans during 2002, compared to 0.11%
and 0.17% during 2001 and 2000, respectively. The increase in net loans charged
against the allowance during 2002 relates to a $0.6 million charge-off related
to the aforementioned hotel property loan that was transferred to other real
estate in the fourth quarter of 2002 and higher levels of charge-offs in both
the consumer and mortgage loan portfolios. We believe that the higher level of
charge-offs in the consumer and mortgage loan portfolios relate primarily to a
weaker economic environment leading to higher unemployment rates, higher overall
levels of consumer debt and increased bankruptcy filings. As a result, we
believed it was appropriate to increase the portion of the allowance for loan
losses allocated due to subjective factors as described above. Our provision for
loan losses in 2002 was lower than 2001, despite a higher level of loans charged
against the allowance for loan losses, net of recoveries, primarily because of a
decline in the level of other adversely rated loans.
DEPOSITS AND BORROWINGS. Our competitive position within many of the
markets served by our branch networks limits our ability to materially increase
deposits without adversely impacting the weighted-average cost of core deposits.
Accordingly, we principally compete on the basis of convenience and personal
service, while employing pricing tactics that are intended to enhance the value
of core deposits.
To attract new core deposits, we have implemented a high-performance
checking program that utilizes a combination of direct mail solicitations,
in-branch merchandising, gifts for customers opening new checking accounts or
referring business to our banks and branch staff sales training. This program
has generated increases in customer relationships as well as deposit service
charges. We believe that the new relationships that result from these marketing
and sales efforts provide valuable opportunities to cross sell related financial
products and services.
A-9
December 31,
ALTERNATE SOURCES OF FUNDS 2002 2001
--------------------------------------------------------------------
Average Average
Amount Maturity Rate Amount Maturity Rate
- -----------------------------------------------------------------------------------------------------------------------
(dollars in thousands)
Brokered CDs(1)............................ $278,012 1.9 years 3.03% $163,315 1.7 years 3.83%
Fixed-rate FHLB advances(1,2).............. 62,861 7.9 years 5.83 129,084 4.1 years 4.08
Variable-rate FHLB advances(1)............. 131,200 .3 years 1.50 93,000 0.4 years 1.83
Securities sold under agreements to
repurchase(1)............................ 98,712 .1 years 1.74 54,963 0.2 years 1.94
Federal funds purchased.................... 23,840 1 day 1.38 35,100 1 day 1.86
-------- --------- ---- -------- --------- ----
Total.................................. $594,625 1.8 years 2.71% $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.
(2) Advances totaling $10 million, at December 31, 2002 and 2001, have
provisions that allow the FHLB to convert fixed-rate advances to
adjustable rates prior to stated maturity.
We have implemented strategies that incorporate federal funds purchased,
other borrowings and Brokered CDs to fund a portion of the increases in
securities available for sale and loans held for sale. The use of such alternate
sources of funds supplements our core deposits and is an integral part of our
asset/liability management efforts.
Other borrowed funds, principally advances from the Federal Home Loan Bank
(the "FHLB") and securities sold under agreements to repurchase ("Repurchase
Agreements"), totaled $310.4 million at December 31, 2002, compared to $288.0
million a year earlier. The $22.4 million increase in other borrowed funds
principally reflects an increase in Repurchase Agreements of $43.7 million,
partially offset by a decline in FHLB advances. The increase in Brokered CDs was
primarily utilized to fund the increase in loans held for sale and securities
available for sale. We were generally able to obtain more favorable pricing on
Brokered CDs than FHLB advances during most of 2002.
We employ derivative financial instruments to manage our exposure to
changes in interest rates. At December 31, 2002, we employed interest-rate caps,
floors and collars with an aggregate notional amount of $10.0 million. We also
employed interest-rate swaps with an aggregate notional amount of $261.0
million. During 2000, we terminated interest-rate caps with a notional amount of
$72.0 million. The realized loss of $0.8 million is amortized as an adjustment
to interest expense over the shorter of the expected remaining term of the
hedged debt or the terminated cap. (See "Asset/liability management.")
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 cumulative trust preferred
securities.
We believe that a diversified portfolio of quality 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 are also an integral component of
our capital management strategies.
CAPITALIZATION December 31,
2002 2001
- ------------------------------------------------------------------------------------------------------
(in thousands)
Unsecured debt ............................................................... $ 12,600 $ 10,500
--------- ---------
Guaranteed preferred beneficial interests in Company's
subordinated debentures..................................................... 17,250 17,250
--------- ---------
Shareholders' equity
Common stock ............................................................... 17,822 17,797
Capital surplus ............................................................ 75,076 76,580
Retained earnings .......................................................... 41,785 39,355
Accumulated other comprehensive income (loss) .............................. 3,364 (1,829)
--------- ---------
Total shareholders' equity ............................................... 138,047 131,903
--------- ---------
Total capitalization ..................................................... $ 167,897 $ 159,653
========= =========
We have supplemented our balance-sheet management activities with purchases
of our common stock. We repurchased 1.1 million shares of our common stock at an
average price of $20.70 in 2002 compared to 0.8 million shares of our common
stock at an average price of $16.37 per share in 2001 and compared to 0.3
million shares at an average price of $10.97 per share in 2000. We anticipate
that repurchases of our common stock will continue in the foreseeable future. We
have approximately 0.8 million shares remaining to be repurchased on plans
expiring through December 31, 2003.
Shareholders' equity totaled $138.0 million at December 31, 2002. The
increase from $131.9 million at December 31, 2001 reflects the retention of
earnings (net of cash dividends paid), the issuance of common stock pursuant to
various equity-based incentive compensation plans and an increase in accumulated
other comprehensive income. Shareholders' equity was equal to 6.71% of total
assets at December 31, 2002, compared to 6.98% a year earlier.
A-10
CAPITAL RATIOS December 31,
2002 2001
- -------------------------------------------------------------------------
Equity capital ................................. 6.71% 6.98%
Average shareholders' equity to average assets . 7.14 7.28
Tier 1 capital to average assets ............... 6.85 7.46
Tier 1 risk-based capital ...................... 9.36 9.82
Total risk-based capital ....................... 10.49 10.98
ASSET/LIABILITY MANAGEMENT. Interest-rate risk is created by differences in
the cash flow 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 identify and evaluate opportunities
to structure the balance sheet in a manner that is consistent with our mission
to maintain profitable financial leverage within established risk parameters. We
evaluate various opportunities and alternate balance-sheet strategies carefully
and consider the likely impact on our risk profile as well as the anticipated
contribution to earnings. 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 have established parameters for interest-rate
risk. We continually monitor our interest-rate risk and report quarterly to our
respective banks' boards of directors.
We employ simulation analyses to monitor each Bank's interest-rate risk
profiles and evaluate potential changes in our Banks' net interest income and
market value of portfolio equity that result from changes in interest rates. The
purpose of these simulations is to identify sources of interest-rate risk
inherent in our balance sheets. The simulations do not anticipate any actions
that we might initiate in response to changes in interest rates and,
accordingly, the simulations do not provide a reliable forecast of anticipated
results. The simulations are predicated on immediate, permanent and parallel
shifts in interest rates and generally assume that current loan and deposit
pricing relationships remain constant. The simulations further incorporate
assumptions relating to changes in customer behavior, including changes in
prepayment rates on certain assets and liabilities.
CHANGES IN MARKET VALUE OF PORTFOLIO EQUITY December 31,2002
AND NET INTEREST INCOME Market Value of Percent Net Interest Percent
Change in Interest Rates Portfolio Equity(1) Change Income(2) Change
- --------------------------------------------------------------------------------------------------------------
(dollars in thousands)
200 basis point rise................ $158,100 - % $85,900 (1.04)%
100 basis point rise................ 161,000 1.83 86,200 (.69)
Base-rate scenario.................. 158,100 86,800
100 basis point decline............. 152,900 (3.29) 86,700 (.12)
200 basis point decline............. 146,400 (7.40) 84,700 (2.42)
(1) Simulation analyses calculate the change in the net present value of our
assets and liabilities, including debt and related financial derivative
instruments, under parallel shifts in interest rates by discounting the
estimated future cash flows using a market-based discount rate. Cash flow
estimates incorporate anticipated changes in prepayment speeds and other
embedded options.
(2) Simulation analyses calculate the change in net interest income under
parallel shifts in interest rates over the next twelve months, based
upon a static balance sheet, which includes debt and related financial
derivative instruments, and do not consider loan fees.
ACQUISITIONS
In March 2002, we acquired substantially all of the assets of Saginaw Bay
Mortgage, a mortgage-broker primarily operating in Bay, Gladwin, Midland and
Saginaw counties in Michigan. As a result of this acquisition, we recorded $0.4
million in goodwill. In October 2002, we acquired a bank branch in Rogers City,
Michigan. At the time of acquisition, this branch had approximately $13.0
million in deposits and we recorded a core deposit premium of approximately $0.7
million (which is being amortized on an accelerated basis over ten years). The
operations of this purchased branch were immediately merged into our already
existing branch in this market.
A-11
CRITICAL ACCOUNTING POLICIES
Our accounting and reporting policies are in accordance with accounting
principles generally accepted within the United States of America and conform to
general practices within the banking industry. Accounting and reporting policies
for the allowance for loan losses, mortgage servicing rights, derivative
financial instruments, income taxes and goodwill are deemed critical since they
involve the use of estimates and require significant management judgments.
Application of assumptions different than those that we have used could result
in material changes in our financial position or results of operations.
Our methodology for determining the allowance and related provision for
loan losses is described above in "Portfolio Loans and asset quality." In
particular, this area of accounting requires a significant amount of judgment
because a multitude of factors can influence the ultimate collection of a loan
or other type of credit. It is extremely difficult to precisely measure the
amount of losses that are probable in our loan portfolio. We use a rigorous
process to attempt to accurately quantify the necessary allowance and related
provision for loan losses, but there can be no assurance that our modeling
process will successfully identify all of the losses that are probable in our
loan portfolio. As a result, we could record future provisions for loan losses
that may be significantly different than the levels that we have recorded in the
past three-year period.
At December 31,2002 we had approximately $4.5 million of mortgage loan
servicing rights capitalized on our balance sheet. There are several critical
assumptions involved in establishing the value of this asset including estimated
future prepayment speeds on the underlying mortgage loans, the interest rate
used to discount the net cash flows from the mortgage loan servicing, the
estimated amount of ancillary income that will be received in the future (such
as late fees) and the estimated cost to service the mortgage loans. We utilize
an outside third party (with expertise in the valuation of mortgage loan
servicing rights) to assist us in our valuation process. We believe the
assumptions that we utilize in our valuation are reasonable based upon accepted
industry practices for valuing mortgage servicing rights and represent neither
the most conservative or aggressive assumptions. Using more aggressive
assumptions (primarily lower estimated rates of prepayments) would have resulted
in a higher valuation of approximately $0.7 million at December 31, 2002. Using
more conservative assumptions (primarily higher estimated rates of prepayments)
would have resulted in a lower valuation of approximately $0.9 million at
December 31.2002.
We use a variety of derivative instruments to manage our interest-rate
risk. These derivative instruments include interest-rate swaps, collars, floors
and caps and mandatory forward commitments to sell mortgage loans. Under SFAS
#133 the accounting for increases or decreases in the value of derivatives
depends upon the use of the derivatives and whether the derivatives qualify for
hedge accounting. In particular, we use pay-fixed interest-rate swaps to convert
the variable-rate cash flows on short-term or variable-rate debt obligations to
fixed rates. At December 31, 2002 we had approximately $236.0 million in fixed
pay interest-rate swaps being accounted for as cash flow hedges, thus permitting
us to report the related unrealized gains or losses in the fair market value of
these derivatives in other comprehensive income and subsequently reclassify such
gains or losses into earnings as yield adjustments in the same period in which
the related interest on the hedged item (primarily short-term or variable-rate
debt obligations) affect earnings. Because of the steep decline in interest
rates over the past two years, the fair market value of our fixed pay
interest-rate swaps being accounted for as cash flow hedges is approximately
negative $7.5 million at December 31, 2002. If we could not continue to account
for these fixed pay interest-rate swaps as cash flow hedges, because for
example, we were unable to continue to renew some or all of the related
short-term or variable-rate debt obligations that are being hedged, we could
have to recognize same or all of the $7.5 million negative fair market value as
an immediate charge against earnings. We expect to continue to be able to
qualify for and account for these fixed pay interest-rate swaps as cash flow
hedges.
Our accounting for income taxes involves the valuation of deferred tax
assets and liabilities primarily associated with differences in the timing of
the recognition of revenues and expenses for financial reporting and tax
purposes. At December 31, 2002 we had recorded a net deferred tax asset of $13.3
million, which included a net operating loss carryforward of $8.2 million. We
have recorded no valuation allowance on our net deferred tax asset because we
believe that the tax benefits associated with this asset will more likely than
not, be realized. However, changes in tax laws, changes in tax rates and our
future level of earnings can adversely impact the ultimate realization of our
net deferred tax asset.
At December 31, 2002 we had recorded $7.3 million of goodwill. Under SFAS
#142, amortization of goodwill ceased, and instead this asset must be
periodically tested for impairment. Our goodwill primarily arose from the past
acquisitions of other banks and a mobile home loan origination company. We test
our goodwill for impairment utilizing the methodology and guidelines established
in SFAS #142. This methodology involves assumptions regarding the valuation of
the business segments that contain the acquired entities. We believe that the
assumptions we utilize are reasonable and even utilizing more conservative
assumptions on valuation would not presently result in any impairment in the
amount of goodwill that we have recorded. However, we may incur impairment
charges related to our goodwill in the future due to changes in business
prospects or other matters that could affect our valuation assumptions.
A-12
RECENT ACCOUNTING PRONOUNCEMENTS
In October, 2001 the Financial Accounting Standards Board ("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 #4 encouraged.
The adoption of SFAS #145 is not expected to have a material impact on our
financial condition or 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 addresses financial accounting and reporting for costs
associated with exit or disposal activities (including restructuring) and
nullifies Emerging Issues Task Force 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 financial condition or results of operations.
In October 2002, the FASB issued Statement of Financial Accounting
Standards No. 147, "Acquisitions of Certain Financial Institutions," ("SFAS
#147") which requires that all acquisitions of financial institutions that meet
the definition of a business, including acquisitions of part of a financial
institution that meet the definition of a business, must be accounted for in
accordance with SFAS No. 141, "Business Combinations" and the related
intangibles accounted for in accordance with SFAS #142. SFAS #147 removes such
acquisitions from the scope of SFAS No. 72, "Accounting for Certain Acquisitions
of Banking or Thrift Institutions," and also amends SFAS #144, to include in its
scope long-term customer-relationship intangible assets of financial
institutions. SFAS #147 is generally effective immediately and did not have a
material impact on our financial condition or results of operations.
In December 2002, the FASB issued Statement of Financial Accounting
Standards No. 148, "Accounting for Stock-Based Compensation - Transition and
Disclosure," ("SFAS #148") which amends SFAS No. 123, "Accounting for
Stock-Based Compensation," ("SFAS #123"). SFAS #148 amends the disclosure
requirements of SFAS #123 for stock-based compensation for annual periods ending
after December 15, 2002 and for interim periods beginning after December 15,
2002. These disclosure requirements apply to all companies, including those that
continue to recognize stock-based compensation under APB Opinion No. 25,
"Accounting for Stock Issued to Employees." Effective for fiscal years ending
after December 15, 2002, SFAS #148 also provides three alternate transition
methods for companies that choose to adopt the fair value measurement provisions
of SFAS #123. Adoption of this Statement did not have a significant impact on
our financial condition or results of operations. See note #13 to the
consolidated financial statements.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others," ("FIN #45") which addresses the
disclosures to be made by a guarantor in its interim and annual financial
statements about its obligations under guarantees. The initial recognition and
measurement provisions of FIN #45 are applicable on a prospective basis to
guarantees issued or modified after December 31, 2002. The disclosure
requirements of FIN #45 are effective for interim and annual periods ending
after December 15, 2002 and are included in note #10 to the consolidated
financial statements. Adoption of this Interpretation is not expected to have a
material impact on our financial condition or results of operations.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities," ("FIN #46") which addresses consolidation by
business enterprises of variable interest entities. This Interpretation applies
immediately to variable interest entities created after January 31, 2003 and to
variable interest entities in which an enterprise obtains an interest after that
date. For enterprises with variable interest entities created before February 1,
2003, this Interpretation applies no later than the beginning of the first
interim or annual reporting period beginning after June 15, 2003. However,
certain disclosure requirements are effective for all financial statements
issued after January 31, 2003. The adoption of this Interpretation is not
expected to have a material impact on our financial condition or results of
operations.
A-13
PAGE INTENTIONALLY LEFT BLANK
A-14
SELECTED CONSOLIDATED FINANCIAL DATA
Year Ended December 31,
2002 2001 2000 1999 1998
- ---------------------------------------------------------------------------------------------------------------------------
(dollars in thousands, except per share amounts)
SUMMARY OF OPERATIONS
Interest income .............................. $ 129,815 $ 134,502 $ 132,841 $ 120,534 $ 120,766
Interest expense ............................. 48,008 62,460 67,865 58,730 64,667
----------- ----------- ----------- ----------- -----------
Net interest income ........................ 81,807 72,042 64,976 61,804 56,099
Provision for loan losses .................... 3,562 3,737 3,287 2,661 3,628
Net gains on the sale of real estate
mortgage loans ............................. 8,178 6,306 2,209 4,247 7,052
Other non-interest income .................... 22,733 20,629 16,752 13,848 12,066
Merger-related securities losses,
charges and litigation settlement .......... 8,000
Other non-interest expenses .................. 68,293 61,519 53,375 57,276 54,584
----------- ----------- ----------- ----------- -----------
Income before federal income tax expense ... 40,863 33,721 27,275 11,962 17,005
Federal income tax expense ................... 11,396 9,288 7,266 3,293 5,056
----------- ----------- ----------- ----------- -----------
Net income before cumulative effect
of change in accounting principle .......... 29,467 24,433 20,009 8,669 11,949
Cumulative effect of change in accounting
principle, net of related tax effect(1) .... (35)
----------- ----------- ----------- ----------- -----------
Net income ............................. $ 29,467 $ 24,398 $ 20,009 $ 8,669 $ 11,949
=========== =========== =========== =========== ===========
PER COMMON SHARE DATA(2)
Net income before cumulative effect of
change in accounting principle
Basic ...................................... $ 1.61 $ 1.29 $ 1.03 $ .44 $ .61
Diluted .................................... $ 1.58 $ 1.27 $ 1.02 $ .43 $ .60
Net income
Basic ...................................... 1.61 1.29 1.03 .44 .61
Diluted .................................... 1.58 1.27 1.02 .43 .60
Cash dividends declared ...................... .48 .41 .35 .26 .19
Book value ................................... 7.75 7.06 6.68 5.83 5.94
SELECTED BALANCES
Assets ....................................... $ 2,057,562 $ 1,888,457 $ 1,783,791 $ 1,725,205 $ 1,660,893
Loans ........................................ 1,381,442 1,384,684 1,379,664 1,290,641 1,152,139
Allowance for loan losses .................... 16,705 16,167 13,982 12,985 11,557
Deposits ..................................... 1,535,603 1,387,367 1,389,900 1,310,602 1,255,544
Shareholders' equity ......................... 138,047 131,903 128,336 113,746 117,042
Long-term debt ............................... 1,000 3,000
SELECTED RATIOS
Tax equivalent net interest income
to average earning assets .................. 4.75% 4.45% 4.21% 4.15% 3.75%
Net income to
Average equity ............................. 21.34 18.52 16.59 7.26 10.72
Average assets ............................. 1.52 1.35 1.15 .52 .72
Average shareholders' equity to
average assets ............................. 7.14 7.28 6.92 7.16 6.76
Tier 1 capital to average assets ............. 6.85 7.46 7.31 6.56 6.12
Non-performing loans to Portfolio Loans ...... .72 .65 .51 .41 .59
(1) Effect of the implementation of SFAS #133. (See note #14 to the
consolidated financial statements.)
(2) Per share data has been adjusted for three-for-two stock splits in 2002
and 1998 and 5% stock dividends in each of the years presented.
A-15
INDEPENDENT AUDITORS' REPORT
Board of Directors and Shareholders
Independent Bank Corporation
Ionia, Michigan
We have audited the accompanying consolidated statements of financial
condition of Independent Bank Corporation and subsidiaries as of December 31,
2002 and 2001, and the related consolidated statements of operations,
shareholders' equity, comprehensive income, and cash flows for each of the years
in the three-year period ended December 31, 2002. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express our opinion on these consolidated 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 Independent
Bank Corporation and subsidiaries as of December 31, 2002 and 2001, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31,2002, in conformity with accounting
principles generally accepted in the United States of America.
As discussed in notes 1 and 14 to the consolidated financial statements,
Independent Bank Corporation changed its method of accounting for derivative
financial instruments and hedging activities in 2001.
/s/ KPMG LLP
KPMG LLP
Detroit, Michigan
February 4, 2003
A-16
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
December 31,
2002 2001
- -----------------------------------------------------------------------------------------------------------------------------------
(in thousands, except share amounts)
ASSETS
Cash and due from banks ........................................................... $ 60,731 $ 50,525
Securities available for sale ..................................................... 371,246 290,303
Federal Home Loan Bank stock, at cost ............................................. 9,704 21,266
Loans held for sale ............................................................... 129,577 77,220
Loans
Commercial ...................................................................... 536,715 482,046
Real estate mortgage ............................................................ 601,799 661,462
Installment ..................................................................... 242,928 241,176
----------- -----------
Total Loans ................................................................... 1,381,442 1,384,684
Allowance for loan losses ....................................................... (16,705) (16,167)
----------- -----------
Net Loans ..................................................................... 1,364,737 1,368,517
Property and equipment, net ................................................... 40,735 35,944
Bank owned life insurance ......................................................... 35,415
Accrued income and other assets ................................................... 45,417 44,682
----------- -----------
Total Assets .................................................................. $ 2,057,562 $ 1,888,457
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits
Non-interest bearing ............................................................ $ 179,871 $ 160,598
Savings and NOW ................................................................. 657,530 601,949
Time ............................................................................ 698,202 624,820
----------- -----------
Total Deposits ................................................................ 1,535,603 1,387,367
Federal funds purchased ........................................................... 23,840 35,100
Other borrowings .................................................................. 310,413 288,010
Guaranteed preferred beneficial interests in Company's subordinated debentures .... 17,250 17,250
Accrued expenses and other liabilities ............................................ 32,409 28,827
----------- -----------
Total Liabilities ............................................................. 1,919,515 1,756,554
----------- -----------
Commitments and contingent liabilities
Shareholders' Equity
Preferred stock, no par value-200,000 shares authorized; none issued or outstanding
Common stock, $1.00 par value-30,000,000 shares authorized; issued and
outstanding: 17,822,090 shares at December 31,2002 and 17,797,314 shares
at December 31, 2001 ............................................................ 17,822 17,797
Capital surplus ................................................................... 75,076 76,580
Retained earnings ................................................................. 41,785 39,355
Accumulated other comprehensive income (loss) ..................................... 3,364 (1,829)
----------- -----------
Total Shareholders' Equity ...................................................... 138,047 131,903
----------- -----------
Total Liabilities and Shareholders' Equity ..................................... $ 2,057,562 $ 1,888,457
=========== ===========
See accompanying notes to consolidated financial statements
A-17
CONSOLIDATED STATEMENTS OF OPERATIONS
Year ended December 31,
2002 2001 2000
- ------------------------------------------------------------------------------------------------------------------------------
(in thousands, except per share amounts)
INTEREST INCOME
Interest and fees on loans .................................................... $ 109,297 $117,735 $115,128
Securities available for sale
Taxable ..................................................................... 12,211 9,334 7,625
Tax-exempt .................................................................. 7,018 5,920 5,587
Securities held to maturity
Taxable ..................................................................... 2,335
Tax exempt ................................................................... 546
Other investments ............................................................. 1,289 1,513 1,620
--------- -------- --------
Total Interest Income ....................................................... 129,815 134,502 132,841
--------- -------- --------
INTEREST EXPENSE
Deposits ...................................................................... 35,134 44,611 51,773
Other borrowings .............................................................. 12,874 17,849 16,092
--------- -------- --------
Total Interest Expense ...................................................... 48,008 62,460 67,865
--------- -------- --------
Net Interest Income ......................................................... 81,807 72,042 64,976
Provision for loan losses ....................................................... 3,562 3,737 3,287
--------- -------- --------
Net Interest Income After Provision for Loan Losses ......................... 78,245 68,305 61,689
--------- -------- --------
NON-INTEREST INCOME
Service charges on deposit accounts ........................................... 13,049 9,936 6,857
Net gains (losses) on assets
Real estate mortgage loans .................................................. 8,178 6,306 2,209
Securities .................................................................. (24) 522 9
Title insurance fees .......................................................... 2,474 1,874 912
Manufactured home loan origination fees and commissions ....................... 1,949 2,108 2,144
Other income .................................................................. 5,285 6,189 6,830
--------- -------- --------
Total Non-interest Income ................................................... 30,911 26,935 18,961
--------- -------- --------
NON-INTEREST EXPENSE
Compensation and employee benefits ............................................ 37,343 31,545 28,314
Occupancy, net ................................................................ 5,424 4,966 4,653
Furniture and fixtures ........................................................ 4,731 4,371 4,382
Other expenses ................................................................ 20,795 20,637 16,026
--------- -------- --------
Total Non-interest Expense .................................................. 68,293 61,519 53,375
--------- -------- --------
Income Before Federal Income Tax ............................................ 40,863 33,721 27,275
Federal income tax expense ...................................................... 11,396 9,288 7,266
--------- -------- --------
Net income before cumulative effect of change in accounting principle ....... 29,467 24,433 20,009
Cumulative effect of change in accounting principle, net of related tax effect .. (35)
--------- -------- --------
Net Income ................................................................ $ 29,467 $ 24,398 $ 20,009
========= ======== ========
Net income per share before cumulative effect of change in accounting principle
Basic ......................................................................... $ 1.61 $ 1.29 $ 1.03
========= ======== ========
Diluted ....................................................................... $ 1.58 $ 1.27 $ 1.02
========= ======== ========
Net income per share
Basic ......................................................................... $ 1.61 $ 1.29 $ 1.03
========= ======== ========
Diluted ....................................................................... $ 1.58 $ 1.27 $ 1.02
========= ======== ========
Cash dividends declared per common share ........................................ $ .48 $ .41 $ .35
========= ======== ========
See accompanying notes to consolidated financial statements
A-18
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31,
2002 2001 2000
- ------------------------------------------------------------------------------------------------------------------------
(in thousands)
Net Income ................................................................ $ 29,467 $ 24,398 $ 20,009
--------- --------- ---------
ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH
FROM OPERATING ACTIVITIES
Proceeds from sales of loans held for sale .............................. 608,478 417,304 155,999
Disbursements for loans held for sale ................................... (652,661) (467,401) (161,657)
Provision for loan losses ............................................... 3,562 3,737 3,287
Deferred federal income tax expense (credit) ............................ 974 (1,086) 937
Deferred loan fees ...................................................... 443 324 (327)
Depreciation, amortization of intangible assets and premiums and
accretion of discounts on securities and loans ........................ 6,511 6,559 6,540
Net gains on sales of real estate mortgage loans ........................ (8,178) (6,306) (2,209)
Net (gains) losses on securities ........................................ 24 (522) (9)
(Increase) decrease in accrued income and other assets .................. (3,438) 843 3,388
Increase in accrued expenses and other liabilities ...................... 225 1,234 4,853
--------- --------- ---------
Total Adjustments ..................................................... (44,060) (45,314) 10,802
--------- --------- ---------
Net Cash Provided by (Used in) Operating Activities ................... (14,593) (20,916) 30,811
--------- --------- ---------
CASH FLOW FROM INVESTING ACTIVITIES
Proceeds from the sale of securities available for sale ................. 66,390 18,925 22,319
Proceeds from the maturity of securities available for sale ............. 4,315 21,987 2,065
Proceeds from the maturity of securities held to maturity ............... 8,631
Principal received on securities available for sale ..................... 49,676 25,644 8,991
Principal received on securities held to maturity ....................... 43,318
Purchases of securities available for sale .............................. (181,228) (120,037) (49,903)
Purchases of securities held to maturity ................................ (500)
Portfolio loans originated, net of principal payments ................... (24,730) 10,342 (94,827)
Portfolio loans purchased ............................................... (36,480)
Principal received on portfolio loans purchased ......................... 24,509 19,242 3,840
Purchase of bank owned life insurance ................................... (35,000)
Capital expenditures .................................................... (9,480) (5,640) (1,645)
--------- --------- ---------
Net Cash Used in Investing Activities ................................ (105,548) (66,017) (57,711)
--------- --------- ---------
CASH FLOW FROM FINANCING ACTIVITIES
Net increase (decrease) in total deposits ............................... 148,236 (2,533) 79,298
Net increase (decrease) in other borrowings and federal funds purchased.. 39,165 61,532 (33,778)
Proceeds from Federal Home Loan Bank advances ........................... 485,090 995,750 274,211
Payments of Federal Home Loan Bank advances ............................. (513,112) (956,754) (281,771)
Retirement of long-term debt ............................................ (1,000) (2,000)
Dividends paid .......................................................... (8,406) (7,236) (6,615)
Repurchase of common stock .............................................. (23,191) (13,168) (3,674)
Proceeds from issuance of common stock .................................. 2,565 2,718 732
--------- --------- ---------
Net Cash Provided by Financing Activities ............................. 130,347 79,309 26,403
--------- --------- ---------
Net Increase (Decrease) in Cash and Cash Equivalents .................. 10,206 (7,624) (497)
Cash and Cash Equivalents at Beginning of Year ............................ 50,525 58,149 58,646
--------- --------- ---------
Cash and Cash Equivalents at End of Year .......................... $ 60,731 $ 50,525 $ 58,149
========= ========= =========
Cash paid during the year for
Interest ................................................................ $ 48,052 $ 64,255 $ 64,250
Income taxes ............................................................ 11,693 9,746 3,000
Transfer of loans to other real estate .................................... 5,399 2,318 3,051
Transfer of securities held to maturity to available for sale ............. 20,098
Real estate loans securitized ............................................. 50,100
See accompanying notes to consolidated financial statements
A-19
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Accumulated
Other Unearned Total
Common Capital Retained Comprehensive ESOP Shareholders'
Stock Surplus Earnings Income(Loss) Shares Equity
- --------------------------------------------------------------------------------------------------------------------------------
(in thousands)
Balances at January 1, 2000 ................... $ 16,853 $ 66,054 $ 33,921 $(2,283) $(799) $113,746
Net income for 2000 ......................... 20,009 20,009
Cash dividends declared, $.35 per share ..... (6,791) (6,791)
5% stock dividend ........................... 835 8,811 (9,659) (13)
Issuance of 161,942 shares of common stock .. 162 623 785
Repurchase and retirement of 334,896 shares
of common stock ........................... (335) (3,339) (3,674)
Net change in unrealized loss on
securities available for sale, net of
$2.2 million of related tax effect ........ 4,210 4,210
Retirement of ESOP shares ................... (100) (699) 64 799 64
-------- -------- -------- ------- ----- --------
Balances at December 31, 2000 ............... 17,415 71,450 37,544 1,927 0 128,336
Net income for 2001 ......................... 24,398 24,398
Cash dividends declared, $.41 per share ..... (7,636) (7,636)
5% stock dividend ........................... 851 14,081 (14,951) (19)
Issuance of 335,748 shares of common stock .. 336 3,412 3,748
Repurchase and retirement of 804,626 shares
of common stock ........................... (805) (12,363) (13,168)
Net change in accumulated other
comprehensive income (loss), net of
$2.0 million of related tax effect ........ (3,756) (3,756)
-------- -------- -------- ------- ----- --------
Balances at December 31, 2001 ............... 17,797 76,580 39,355 (1,829) 0 131,903
Net income for 2002 ......................... 29,467 29,467
Cash dividends declared, $.48 per share ..... (8,756) (8,756)
5% stock dividend ........................... 853 17,407 (18,281) (21)
Issuance of 291,891 shares of common stock .. 292 3,168 3,460
Repurchase and retirement of 1,120,070 shares
of common stock ........................... (1,120) (22,071) (23,191)
Cash in lieu of fractional shares for
three-for-two stock split ................. (8) (8)
Net change in accumulated other
comprehensive income (loss), net of
$2.8 million of related tax effect ........ 5,193 5,193
-------- -------- -------- ------- ----- --------
Balances at December 31, 2002 ........... $ 17,822 $ 75,076 $ 41,785 $ 3,364 $ 0 $138,047
======== ======== ======== ======= ===== ========
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
2002 2001 2000
- ---------------------------------------------------------------------------------------------------------------------------
(in thousands)
Net income ........................................................................... $ 29,467 $ 24,398 $20,009
Other comprehensive income
Net change in unrealized gain (loss) on securities available for sale,
net of related tax effect ........................................................ 6,087 499 4,210
Cumulative effect of change in accounting principle, net of related tax effect ..... (720)
Net change in unrealized loss on derivative instruments, net of related tax
effect ........................................................................... (894) (3,535)
-------- -------- -------
Comprehensive Income ......................................................... $ 34,660 $ 20,642 $24,219
======== ======== =======
See accompanying notes to consolidated financial statements
A-20
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - CRITICAL ACCOUNTING POLICIES
The accounting and reporting policies and practices of Independent Bank
Corporation and subsidiaries conform with accounting principles generally
accepted in the United States of America and prevailing practices within the
banking industry. Our critical accounting policies include accounting for the
allowance for loan losses, the valuation of derivative financial instruments,
the valuation of originated mortgage servicing rights, the valuation of deferred
tax assets and the valuation of goodwill. We are required to make material
estimates and assumptions that are particularly susceptible to changes in the
near term as we prepare the consolidated financial statements and report amounts
for each of these items. Actual results may vary from these estimates.
Our Banks' transact business in the single industry of commercial banking.
Our Banks' activities cover traditional phases of commercial banking, including
checking and savings accounts, commercial lending, direct and indirect consumer
financing, mortgage lending and deposit box services. The principal markets are
the rural and suburban communities across lower Michigan that are served by our
Banks' branches and loan production offices. The economies of these communities
are relatively stable and reasonably diversified. Subject to established
underwriting criteria, our Banks also participate in commercial lending
transactions with certain non-affiliated banks and purchase real estate mortgage
loans from third-party originators. At December 31, 2002, 83% of our Banks' loan
portfolios were secured by real estate.
PRINCIPLES OF CONSOLIDATION - The consolidated financial statements include
the accounts of Independent Bank Corporation and its subsidiaries. The income,
expenses, assets and liabilities of the subsidiaries are included in the
respective accounts of the consolidated financial statements, after elimination
of all material intercompany accounts and transactions.
STATEMENTS OF CASH FLOWS - For purposes of reporting cash flows, cash and
cash equivalents include cash on hand, amounts due from banks, and federal funds
sold. Generally, federal funds are sold for one-day periods. We report net cash
flows for customer loan and deposit transactions.
COMPREHENSIVE INCOME - Statement of Financial Accounting Standards, No.
130, "Reporting Comprehensive Income," established standards for reporting
comprehensive income, which consists of unrealized gains and losses on
securities available for sale and derivative instruments. The net change in
unrealized gain or loss on securities available for sale in 2002 reflects a net
loss reclassified into earnings of $24,000, and reflects net gains reclassified
into earnings of $0.5 million and $9,000, in 2001 and 2000, respectively. The
net change in unrealized loss on derivative instruments in 2001 reflects expense
reclassified into earnings totaling $0.9 million. The reclassification of these
amounts from comprehensive income resulted in a federal income tax benefit of
$8,000 and $0.1 million in 2002 and 2001, respectively, and a federal income tax
expense of $3,000 in 2000.
LOANS HELD FOR SALE - Loans held for sale are carried at the lower of
aggregate amortized cost or market value. Lower of cost or market value
adjustments, as well as realized gains and losses, are recorded in current
earnings. We recognize as separate assets the rights to service mortgage loans
for others. The fair value of originated mortgage servicing rights has been
determined based upon market value indications for similar servicing. These
mortgage servicing rights are amortized in proportion to and over the period of
estimated net loan servicing income. The Banks assess mortgage servicing rights
for impairment based on the fair value of those rights. For purposes of
measuring impairment, the characteristics used by the Banks include interest
rate, term and type.
SECURITIES - We classify our securities as trading, held to maturity or
available for sale. Trading securities are bought and held principally for the
purpose of selling them in the near term and are reported at fair value with
realized and unrealized gains and losses included in earnings. We do not have
any trading securities. Securities held to maturity represent those securities
for which our Banks have the positive intent and ability to hold until maturity
and are reported at cost, adjusted for amortization of premiums and accretion of
discounts computed on the level-yield method. We did not have any securities
held to maturity at December 31, 2002 and 2001. Securities available for sale
represent those securities not classified as trading or held to maturity and are
reported at fair value with unrealized gains and losses, net of applicable
income taxes reported in comprehensive income. We determine whether a decline in
fair value below the amortized cost basis is other than temporary. If the
decline in value is judged to be other than temporary, the cost basis of the
security is written down to fair value as a new cost basis and the amount of the
write-down is recognized as a charge to non-interest income. Gains and losses
realized on the sale of securities available for sale are determined using the
specific identification method and are recognized on a trade-date basis.
Premiums and discounts are recognized in interest income computed on the
level-yield method.
LOAN REVENUE RECOGNITION - Interest on loans is accrued based on the
principal amounts outstanding. The accrual of interest income is discontinued
when a loan becomes 90 days past due and the borrower's capacity to repay the
loan and collateral values appear insufficient. A non-accrual loan may be
restored to accrual status when interest and principal payments are current and
the loan appears otherwise collectible.
Certain loan fees and direct loan origination costs, are deferred and
recognized as an adjustment of yield over the anticipated life of the related
loan. Fees received in connection with loan commitments are deferred until the
loan is advanced and are then recognized over the anticipated life of the loan
as an adjustment of yield. Fees on commitments that expire unused are recognized
at expiration. Fees received for a letter of credit are recognized as revenue
over its life.
ALLOWANCE FOR LOAN LOSSES - Some loans will not be repaid in full.
Therefore, an allowance for loan losses is maintained at a level which
represents our best estimate of losses incurred. In determining the allowance
and the related provision
A-21
for loan losses, we consider four principal elements: (i) specific allocations
based upon probable losses identified during the 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. Increases in the allowance are
recorded by a provision for loan losses charged to expense. Although we
periodically allocate portions of the allowance to specific loans and loan
portfolios, the entire allowance is available for any losses which occur.
Collection efforts may continue and recoveries may occur after a loan is charged
against the allowance.
While we use relevant information to recognize losses on loans, additional
provisions for related losses may be necessary based on changes in economic
conditions, customer circumstances and other credit risk factors.
We measure our investment in an impaired loan based on one of three
methods: the loan's observable market price, the fair value of the collateral or
the present value of expected future cash flows discounted at the loan's
effective interest rate. We do not measure impairment on homogenous residential
mortgage and installment loans.
PROPERTY AND EQUIPMENT - Property and equipment is stated at cost less
accumulated depreciation and amortization. Depreciation and amortization is
computed using both straight-line and accelerated methods over the estimated
useful lives of the related assets.
OTHER REAL ESTATE - Other real estate at the time of foreclosure is
recorded at the lower of cost of acquisition or fair value, less estimated costs
to sell, which becomes the property's new basis. Any write-downs at date of
acquisition are charged to the allowance for loan losses. Expense incurred in
maintaining assets and subsequent write-downs to reflect declines in value are
recorded as other expense.
During 2002 we foreclosed on certain loans secured by real estate and
transferred approximately $5.4 million to other real estate. At the time of
foreclosure amounts were charged-off against the allowance for loan losses to
bring the carrying amount of these properties to their estimated fair market
values, less estimated costs to sell. During 2002, we sold other real estate
with a book balance of approximately $2.9 million.
Other real estate and repossessed assets totaling $3.9 million and $1.6
million at December 31, 2002 and 2001, respectively, are included in accrued
income and other assets.
INTANGIBLE ASSETS - We adopted 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 recognized
approximately $0.7 million, net of tax, of goodwill amortization 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 or December 31, 2002. Prior to the year ended December 31,
2001 goodwill was being amortized on a straight-line basis over the period of
expected benefit, generally 12 to 20 years.
Other intangible assets, including core deposit intangibles, are amortized
using both straight-line and accelerated methods over 10 to 15 years.
INCOME TAXES - We employ the asset and liability method of accounting for
income taxes. This method establishes deferred tax assets and liabilities for
the temporary differences between the financial reporting basis and the tax
basis of our assets and liabilities at tax rates expected to be in effect when
such amounts are realized or settled. Under this method, the effect of a change
in tax rates is recognized in the period that includes the enactment date. The
deferred tax asset is subject to a valuation allowance for that portion of the
asset for which it is more likely than not that it will not be realized.
We file a consolidated federal income tax return. Intercompany tax
liabilities are settled as if each subsidiary filed a separate return.
SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE - Securities sold under
agreements to repurchase are treated as debt and are reflected as a liability in
the consolidated statements of financial condition. The book value of securities
pledged to secure the repurchase agreements remains in the securities portfolio.
DERIVATIVE FINANCIAL INSTRUMENTS - 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.
Upon adoption of SFAS #133, we recorded the fair value of cash-flow hedging
instruments ("Cash Flow Hedges") in accrued expenses and other liabilities. On
an ongoing basis, our Banks adjust their balance sheets to reflect the then
current fair value of the 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 $4.7 million, net of tax, of unrealized
losses on
A-22
Cash Flow Hedges at December 31, 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 December 31, 2002
is 4.8 years.
Also upon adoption of SFAS #133, we recorded fair-value hedging instruments
("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
the Fair Value Hedges. On an ongoing basis, our Banks adjust their respective
balance sheets 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.
Certain derivative financial instruments 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.
When hedge accounting is discontinued because it is determined that a
derivative financial instrument no longer qualifies as a fair-value hedge, we
continue to carry the derivative financial instrument on the balance sheet at
its fair value, and no longer adjust the hedged item for changes in fair value.
The adjustment of the carrying amount of the previously hedged item is accounted
for in the same manner as other components of similar instruments. When hedge
accounting is discontinued because it is probable that a forecasted transaction
will not occur, we continue to carry the derivative financial instrument on the
balance sheet at its fair value, and gains and losses that were included in
accumulated other comprehensive income are recognized immediately in other
non-interest expense. In all other situations in which hedge accounting is
discontinued, we continue to carry the derivative financial instrument at its
fair value on the balance sheet and recognize any changes in its fair value in
interest expense.
For the year ended December 31, 2000, prior to the adoption of SFAS #133,
derivative financial instruments were employed to reduce the cost of certain
liabilities as well as to manage interest-rate risk. Such instruments included
interest-rate swaps, collars, floors and caps. These instruments were accounted
for on an accrual basis. Any net interest differential, including premiums paid,
was recognized as an adjustment to interest expense of the related liability. We
considered our interest-rate swaps to be synthetic alterations of the related
liability as long as (i) a specific liability was designated; (ii) there was a
high correlation with the changes in interest expense generated by the
liability; and (iii) the notional amount was less than or equal to the principal
amount of the designated liability. If these criteria were not met, the swap was
no longer considered a synthetic alteration and changes in fair value were
included in other income in the consolidated financial statements. The criteria
for consideration of a collar, floor or cap as a synthetic alteration were
similar to those for a swap arrangement.
If a synthetic alteration was terminated before maturity, the net proceeds
received or paid were deferred and amortized as an adjustment to interest
expense over the shorter of the remaining contract life or the maturity of the
designated liability. If the designated liability was sold or matured, the
synthetic alteration was marked to market and the gain or loss was included with
the gain or loss on the sale/maturity of the designated liability.
STOCK BASED COMPENSATION - We apply APB Opinion No. 25 in accounting for
our stock based compensation plans and, accordingly, no compensation cost has
been recognized for our stock options. We have elected to provide pro forma
disclosures for our net income and earnings per share as if we had adopted the
fair value accounting method for stock-based compensation. Our stock based
compensation plans are described more fully in Note #13.
COMMON STOCK - At December 31, 2002, 0.5 million shares of common stock
were reserved for issuance under the dividend reinvestment plan and 1.8 million
shares of common stock were reserved for issuance under stock option plans.
RECLASSIFICATION - Certain amounts in the 2001 and 2000 consolidated
financial statements have been reclassified to conform with the 2002
presentation.
NOTE 2 - RESTRICTIONS ON CASH AND DUE FROM BANKS
Our Banks' legal reserve requirements were satisfied by average vault cash
and non-interest earning balances with the Federal Reserve Bank of $15.7 million
and $13.3 million during 2002 and 2001, respectively. Our Banks do not maintain
compensating balances with correspondent banks.
A-23
NOTE 3 - SECURITIES
Securities available for sale consist of the following at December 31:
Amortized Unrealized Fair
Cost Gains Losses Value
- -----------------------------------------------------------------------------------------------------------
(in thousands)
2002
U.S. Treasury ...................................... $ 300 $ 6 $ 306
Mortgage-backed .................................... 81,941 2,983 $ 1 84,923
Other asset-backed ................................. 42,114 855 831 42,138
Obligations of and states political subdivisions.... 155,076 8,090 249 162,917
Trust preferred .................................... 32,013 1,743 545 33,211
Preferred stock .................................... 25,386 911 26,297
Corporate .......................................... 20,682 302 167 20,817
Other .............................................. 637 637
-------- ------- ------- --------
Total ............................................ $358,149 $14,890 $ 1,793 $371,246
======== ======= ======= ========
2001
U.S. Treasury ...................................... $ 10,282 $ 10,282
Mortgage-backed .................................... 73,459 $ 2,353 $ 6 75,806
Other asset-backed ................................. 3,044 156 3,200
Obligations of states and political subdivisions.... 131,120 2,345 1,671 131,794
Trust preferred .................................... 31,150 723 66 31,807
Preferred stock .................................... 19,669 1 34 19,636
Corporate .......................................... 17,151 211 280 17,082
Other .............................................. 696 696
-------- ------- ------- --------
Total ............................................ $286,571 $ 5,789 $ 2,057 $290,303
======== ======= ======= ========
The amortized cost and fair value of securities available for sale at
December 31, 2002, by contractual maturity, follow. The actual maturity will
differ from the contractual maturity because issuers may have the right to call
or prepay obligations with or without call or prepayment penalties.
Amortized Fair
Cost Value
- -----------------------------------------------------------------------------
(in thousands)
Maturing within one year ......................... $ 3,674 $ 3,714
Maturing after one year but within five years .... 37,847 39,404
Maturing after five years but within ten years ... 41,969 44,964
Maturing after ten years ......................... 124,581 129,169
-------- --------
208,071 217,251
Mortgage-backed .................................. 81,941 84,923
Other asset-backed ............................... 42,114 42,138
Preferred stock .................................. 25,386 26,297
Other ............................................ 637 637
-------- --------
Total ........................................ $358,149 $371,246
======== ========
A summary of proceeds from the sale of securities and gains and losses follows:
Realized
Proceeds Gains Losses
- --------------------------------------------------------------------------------
(in thousands)
2002 (1) ................................ $66,390 $809 $833
2001 .................................... 18,925 524 2
2000 .................................... 22,319 94 85
(1) Losses in 2002 include a $0.8 million other than temporary impairment charge
on a trust-preferred security.
Securities with a book value of $136.8 million and $123.4 million at
December 31, 2002 and 2001, respectively, were pledged to secure public deposits
and for other purposes as required by law. There were no investment obligations
of state and political subdivisions that were payable from or secured by the
same source of revenue or taxing authority that exceeded 10% of consolidated
shareholders' equity at December 31, 2002 or 2001.
A-24
NOTE 4 - LOANS
An analysis of the allowance for loan losses for the years ended December 31
follows:
2002 2001 2000
- ----------------------------------------------------------------------------------
(in thousands)
Balance at beginning of year .............. $ 16,167 $ 13,982 $ 12,985
Provision charged to operating expense .. 3,562 3,737 3,287
Recoveries credited to allowance ........ 733 644 678
Loans charged against allowance ......... (3,757) (2,196) (2,968)
-------- -------- --------
Balance at end of year .................... $ 16,705 $ 16,167 $ 13,982
======== ======== ========
Loans are presented net of deferred loan fees of $2.4 million at December
31, 2002, and $2.0 million at December 31, 2001.
Loans on non-accrual status, 90 days or more past due and still accruing
interest, or restructured amounted to $10.0 million, $9.0 million and $7.0
million at December 31, 2002, 2001 and 2000, respectively. If these loans had
continued to accrue interest in accordance with their original terms,
approximately $0.9 million, $0.6 million, and $0.5 million of interest income
would have been realized in 2002, 2001 and 2000, respectively. Interest income
realized on these loans was approximately $0.3 million, $0.2 million and $0.2
million in 2002, 2001 and 2000, respectively.
Impaired loans totaled approximately $5.4 million, $5.1 million and $3.7
million at December 31, 2002, 2001 and 2000, respectively. Our Banks' average
investment in impaired loans was approximately $6.8 million, $4.1 million and
$3.7 million in 2002, 2001 and 2000, respectively. Cash receipts on impaired
loans on non-accrual status are generally applied to the principal balance.
Interest income recognized on impaired loans was approximately $0.2 million,
$0.1 million and $0.2 million in 2002, 2001 and 2000, respectively. Certain
impaired loans with a balance of approximately $3.1 million, $1.4 million and
$0.3 million had specific allocations of the allowance for loan losses totaling
approximately $1.3 million, $0.5 million and $0.1 million at December 31, 2002,
2001 and 2000, respectively.
Our Banks capitalized approximately $3.6 million, $1.4 million and $1.0
million of servicing rights relating to loans that were originated and sold
during the years ended December 31, 2002, 2001 and 2000, respectively.
Amortization of capitalized servicing rights during those years was $2.4
million, $1.6 million and $1.1 million, respectively. The book value of
capitalized mortgage servicing rights (net of a $1.1 million impairment reserve
which was recognized as part of other non-interest income during 2002) was $4.5
million at December 31, 2002 and is included on the consolidated statement of
financial position in accrued income and other assets. The fair value of
capitalized servicing rights at that same date was approximately $4.7 million.
There was no impairment reserve at December 31, 2001. The capitalized servicing
rights relate to approximately $793.7 million of loans sold and serviced at
December 31, 2002.
At December 31, 2002, 2001 and 2000, our Banks serviced loans totaling
$881.7 million, $845.5 million and $995.0 million, respectively, for the benefit
of third parties.
NOTE 5 - PROPERTY AND EQUIPMENT
A summary of property and equipment at December 31 follows:
2002 2001
- --------------------------------------------------------------------------------
(in thousands)
Land ............................................. $ 8,973 $ 7,255
Buildings ........................................ 37,361 33,713
Equipment ........................................ 34,359 30,863
-------- --------
80,693 71,831
Accumulated depreciation and amortization ........ (39,958) (35,887)
-------- --------
Property and equipment, net .............. $ 40,735 $ 35,944
======== ========
NOTE 6 - INTANGIBLE ASSETS
Intangible assets, net of amortization, at December 31 follows:
2002 2001
---------------------------------------------------------
Gross Gross
Carrying Accumulated Carrying Accumulated
Amount Amortization Amount Amortization
---------------------------------------------------------
(in thousands)
Amortized intangible assets - Core deposit intangibles ..... $13,386 $6,966 $12,666 $5,952
======= ====== ======= ======
Unamortized intangible assets - Goodwill ................... $ 7,299 $ 6,859
======= =======
A-25
The $0.4 million increase in the gross carrying amount of goodwill is the
result of the acquisition of substantially all of the assets of Saginaw Bay
Mortgage, a mortgage-broker primarily operating in Bay, Gladwin, Midland and
Saginaw counties in Michigan. The $0.7 million increase in the gross carrying
amount of core deposit intangibles is the result of the acquisition of a bank
branch in Rogers City, Michigan. The $0.7 million is being amortized on an
accelerated basis over ten years.
A summary of estimated intangible amortization, primarily amortization of
core deposit intangibles, at December 31, 2002, follows:
(in thousands)
2003 ........................................................ $1,106
2004 ........................................................ 1,093
2005 ........................................................ 1,081
2006 ........................................................ 1,056
2007 ........................................................ 1,021
2008 and thereafter ......................................... 1,063
------
Total .................................................. $6,420
======
Changes in the carrying amount of goodwill and core deposit intangibles by
reporting segment for the year ended December 31, 2002 follows:
IB IBWM IBSM IBEM Other(1) TOTAL
-------------------------------------------------------------------
(in thousands)
Goodwill
Balance at beginning of year ... $ 6,314 $ 32 $ 180 $ 333 $ 6,859
Acquired during year ......... 440 440
------- ----- ----- ------- ------- -------
Balance at end of year ....... $ 6,754 $ 32 $ 180 $ 333 $ 7,299
======= ===== ===== ======= ======= =======
Core Deposit Intangible, net
Balance at beginning of year ... $ 30 $ 159 $ 878 $ 5,540 $ 105 $ 6,712
Acquired during year ......... 722 722
Amortization ................. (38) (35) (142) (783) (16) (1,014)
------- ----- ----- ------- ------- -------
Balance at end of year ....... $ 714 $ 124 $ 736 $ 4,757 $ 89 $ 6,420
======= ===== ===== ======= ======= =======
(1) Includes items relating to our parent company and certain insignificant
operations.
A reconciliation of reported net income to net income adjusted to reflect
the adoption of SFAS #142 for the years ended December 31 follows:
2002 2001 2000
- -----------------------------------------------------------------------------------
(in thousands, except per share amounts)
Net income:
Reported net income .................. $ 29,467 $ 24,398 $ 20,009
Add back - goodwill amortization ..... 712 731
-------- -------- --------
Adjusted net income ................ $ 29,467 $ 25,110 $ 20,740
======== ======== ========
Basic earnings per share:
Reported net income .................. $ 1.61 $ 1.29 $ 1.03
Add back - goodwill amortization ..... .04 .04
-------- -------- --------
Adjusted net income ................ $ 1.61 $ 1.33 $ 1.07
======== ======== ========
Diluted earnings per share:
Reported net income .................. $ 1.58 $ 1.27 $ 1.02
Add back - goodwill amortization ..... .04 .04
-------- -------- --------
Adjusted net income ................ $ 1.58 $ 1.31 $ 1.06
======== ======== ========
A-26
NOTE 7 - DEPOSITS
A summary of interest expense on deposits for the years ended December 31
follows:
2002 2001 2000
- --------------------------------------------------------------------------------
(in thousands)
Savings and NOW ........................ $ 7,444 $11,484 $14,800
Time deposits under $100,000 ........... 14,219 20,705 21,444
Time deposits of $100,000 or more ...... 13,471 12,422 15,529
------- ------- -------
Total ............................ $35,134 $44,611 $51,773
======= ======= =======
Aggregate time deposits in denominations of $100,000 or more amounted to
$347.5 million, $239.0 million, and $278.0 million at December 31, 2002, 2001
and 2000, respectively.
A summary of the maturity of time deposits at December 31, 2002, follows:
(in thousands)
2003 ...................................................... $414,047
2004 ...................................................... 119,845
2005 ...................................................... 56,680
2006 ...................................................... 35,449
2007 ...................................................... 32,307
2008 and thereafter ....................................... 39,874
--------
Total ................................................ $698,202
========
NOTE 8 - OTHER BORROWINGS
A summary of other borrowings at December 31 follows:
2002 2001
- --------------------------------------------------------------------
(in thousands)
Advances from Federal Home Loan Bank... $194,061 $222,084
Repurchase agreements ................. 98,712 54,963
Notes payable ......................... 12,600 10,500
U.S. Treasury demand notes ............ 4,840 438
Other ................................. 200 25
-------- --------
Total ............................ $310,413 $288,010
======== ========
</Table>
Advances from the Federal Home Loan Bank ("FHLB") are secured by our Banks'
unencumbered qualifying mortgage loans as well as U.S. Treasury and government
agency securities equal to at least 160% of outstanding advances. Advances are
also secured by FHLB stock owned by the Banks. As of December 31, 2002, the
banks had unused borrowing capacity with the FHLB of $188.0 million. Interest
expense on advances amounted to $5.2 million, $11.7 million and $11.3 million
for the years ended December 31, 2002, 2001 and 2000, respectively.
As members of the FHLB, our Banks must own FHLB stock equal to the greater
of 1.0% of the unpaid principal balance of residential mortgage loans or 5.0% of
its outstanding advances. At December 31, 2002, our Banks were in compliance
with the FHLB stock ownership requirements.
Certain fixed-rate advances have provisions that allow the FHLB to convert
the advance to an adjustable rate prior to stated maturity. At December 31,
2002, advances totaling $10 million, with a stated maturity of 2008 are
convertible in 2003 and beyond.
The maturity and weighted average interest rates of FHLB advances at
December 31 follow:
2002 2001
Amount Rate Amount Rate
- -------------------------------------------------------------------------------------------
(dollars in thousands)
Fixed-rate advances
2002 $ 70,270 2.51%
2003 $ 10,515 4.39% 12,515 4.69
2004 4,000 3.17 2,000 3.80
2005 2,100 5.05 2,100 5.05
2007 1,000 4.64 1,000 4.64
2008 and thereafter 45,246 6.46 41,199 6.36
-------- ---- -------- -----
Total fixed-rate advances 62,861 5.83 129,084 4.03
-------- ---- -------- -----
Variable-rate advances
2002 93,000 1.83
2003 131,200 1.50
-------- ---- -------- -----
Total variable-rate advances 131,200 1.50 93,000 1.83
-------- ---- -------- -----
Total advances $194,061 2.90% $222,084 3.11%
======== ==== ======== =====
A-27
Repurchase agreements are secured by U.S. Treasury and mortgage-backed
securities with a book value of approximately $106.0 million and $59.4 million
at December 31, 2002 and 2001, respectively which are being held by our
safekeeping agent.
Repurchase agreements averaged $93.1 million, $13.7 million and $3.3
million during 2002, 2001 and 2000, respectively. The maximum amounts
outstanding at any month end during 2002, 2001 and 2000 were $109.2 million,
$55.0 million and $20.0 million, respectively. Interest expense on repurchase
agreements totaled $1.7 million, $0.3 million and $0.2 million for the years
ended 2002, 2001 and 2000, respectively.
We have established an unsecured credit facility comprised of a $20.0
million revolving credit agreement. At December 31, 2002, the revolving credit
facility had an unpaid principal balance of $12.6 million. The revolving credit
facility accrues interest at federal funds, plus 1.00%. Under the revolving
credit agreement, we are subject to certain restrictive covenants. As of
December 31, 2002, we were in compliance with all covenants.
NOTE 9 - GUARANTEED PREFERRED BENEFICIAL INTERESTS IN COMPANY'S SUBORDINATED
DEBENTURES
Our consolidated trust subsidiary, IBC Capital Finance, has issued and
outstanding, 690,000 shares of cumulative trust preferred securities ("Preferred
Securities") with a liquidation preference of $25 per security. The Preferred
Securities represent an interest in our Company's subordinated debentures,
which have terms that are similar to the Preferred Securities. Distributions on
the securities are payable quarterly at the annual rate of 9.25% of the
liquidation preference and are included in interest expense in the consolidated
financial statements.
The Preferred Securities are subject to mandatory redemption at the
liquidation preference, in whole or in part, upon repayment of the subordinated
debentures at maturity or their earlier redemption. The subordinated debentures
are redeemable prior to the maturity date of December 31, 2026, at our option on
or after December 31, 2001, in whole at any time or in part from time to time.
The subordinated debentures are also redeemable at any time, in whole, but not
in part, upon the occurrence of specific events defined within the trust
indenture. We have the option to defer distributions on the subordinated
debentures from time to time for a period not to exceed 20 consecutive quarters.
Interest expense on our Preferred Securities is recorded in interest
expense on other borrowings.
NOTE 10 - COMMITMENTS AND CONTINGENT LIABILITIES
We and our Banks are routinely engaged in legal proceedings and regulatory
matters that have occurred in the ordinary course of business and do not involve
amounts in the aggregate that are believed to be material to our financial
condition or results of operations.
In the normal course of business, our Banks enter into financial
instruments with off-balance sheet risk to meet the financing needs of customers
or to reduce exposure to fluctuations in interest rates. These financial
instruments may include commitments to extend credit and standby letters of
credit. Financial instruments involve varying degrees of credit and
interest-rate risk in excess of amounts reflected in the consolidated balance
sheets. Exposure to credit risk in the event of non-performance by the
counterparties to the financial instruments for loan commitments to extend
credit and letters of credit is represented by the contractual amounts of those
instruments. We do not, however, anticipate material losses as a result of these
financial instruments.
A summary of financial instruments with off-balance sheet risk at December
31 follows:
2002 2001
- ---------------------------------------------------------------------------------------------------------
(in thousands)
Financial instruments whose risk is represented by contract amounts
Commitments to extend credit ............................................... $141,197 $143,682
Standby letters of credit .................................................. 26,731 26,467
Commitments to extend credit are agreements to lend to a customer as long
as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination clauses
and generally require payment of a fee. Since commitments may expire without
being drawn upon, the commitment amounts do not represent future cash
requirements. Commitments are issued subject to similar underwriting standards,
including collateral requirements, as are generally involved in the extension of
credit facilities.
Standby letters of credit are written conditional commitments issued to
guarantee the performance of a customer to a third party. The credit risk
involved in such transactions is essentially the same as that involved in
extending loan facilities and, accordingly, standby letters of credit are issued
subject to similar underwriting standards, including collateral requirements, as
are generally involved in the extension of credit facilities. The majority of
the letters of credit are to corporations and mature during 2003.
A-28
NOTE 11 - EARNINGS PER SHARE
A reconciliation of basic and diluted earnings per share for the years
ended December 31 follows:
2002 2001 2000
- -----------------------------------------------------------------------------------------------------------------
(in thousands, except per share amounts)
Net income before cumulative effect of change in accounting principle... $29,467 $24,433 $20,009
======= ======= =======
Net income ............................................................. $29,467 $24,398 $20,009
======= ======= =======
Shares outstanding(1) .................................................. 18,301 18,947 19,406
Effect of stock options .............................................. 350 303 162
------- ------- -------
Shares outstanding for calculation of diluted earnings per share(1).. 18,651 19,250 19,568
======= ======= =======
Net income per share before cumulative effect of change in accounting
principle
Basic ................................................................ $ 1.61 $ 1.29 $ 1.03
Diluted .............................................................. $ 1.58 $ 1.27 $ 1.02
Net income per share
Basic ................................................................ $ 1.61 $ 1.29 $ 1.03
Diluted .............................................................. $ 1.58 $ 1.27 $ 1.02
(1) Shares outstanding have been adjusted for a three-for-two stock split in
2002 and 5% stock dividends in each year.
NOTE 12 - FEDERAL INCOME TAX
The composition of federal income tax expense (benefit) for the years ended
December 31 follows:
2002 2001 2000
- --------------------------------------------------------------------------------
(in thousands)
Current ................................ $ 10,422 $ 10,374 $6,329
Deferred ............................... 974 (1,086) 937
-------- -------- ------
Federal income tax expense ........ $ 11,396 $ 9,288 $7,266
======== ======== ======
A reconciliation of federal income tax expense to the amount computed by
applying the statutory federal income tax rate of 35% in 2002, 2001, and 2000 to
income before federal income tax for the years ended December 31 follows:
2002 2001 2000
- -----------------------------------------------------------------------------------------------------------
(in thousands)
Statutory rate applied to income before federal income tax ...... $ 14,302 $ 11,802 $ 9,546
Tax-exempt interest income ...................................... (2,848) (2,387) (2,318)
Amortization of goodwill ....................................... 256 262
Other, net ...................................................... (58) (383) (224)
-------- -------- -------
Federal income tax expense .................................. $ 11,396 $ 9,288 $ 7,266
======== ======== =======
The deferred federal income tax expense of $1.0 million and $0.9 million in
2002 and 2000, respectively and the deferred federal income tax benefit of $1.1
million in 2001, resulted from the tax effect of temporary differences. Federal
income tax expense in 2001 includes a benefit of $0.4 million resulting from an
adjustment of net deferred tax assets associated with an increase in our tax
rate from 34% to 35%.
A-29
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at December 31
follow:
2002 2001
- --------------------------------------------------------------------------------
(in thousands)
Deferred tax assets
Net operating loss carryforward ..................... $ 8,202 $ 9,211
Allowance for loan losses ........................... 5,847 5,658
Unrealized loss on derivative financial instruments.. 3,190 2,709
Loans held for sale ................................. 670 346
Deferred compensation ............................... 431 511
Fixed assets ........................................ 339 14
Purchase discounts .................................. 319 269
Deferred credit life premiums ....................... 287 334
Other ............................................... 347 457
------- -------
Gross deferred tax assets ......................... 19,632 19,509
Deferred tax liabilities
Unrealized gain on securities available for sale .... 4,584 1,306
Mortgage servicing rights ........................... 1,559 1,421
Deferred loan fees .................................. 216 660
------- -------
Gross deferred tax liabilities .................... 6,359 3,387
------- -------
Net deferred tax assets ......................... $13,273 $16,122
======= =======
At December 31, 2002, the Company had a net operating loss ("NOL")
carryforward of approximately $23.4 million which, if not used against taxable
income, will expire as follows:
<Caption>
(in thousands)
2008 .................................................... $11,799
2009 .................................................... 81
2010 .................................................... 6,779
2011 .................................................... 929
2012 .................................................... 411
2018 .................................................... 3,437
-------
Total .............................................. $23,436
=======
The use of the $23.4 million NOL carryforward, which was acquired through
the acquisition of Mutual Savings Bank, f.s.b., is limited to $2.9 million per
year as the result of a change in control as defined in the Internal Revenue
Code.
We believe that the tax benefits associated with the deferred tax assets
will more likely than not be realized, and therefore no valuation allowance is
considered necessary.
NOTE 13 - EMPLOYEE BENEFIT PLANS
We maintain stock option plans for our non-employee directors as well as
certain of our officers and those of our Banks. Options that were granted under
these plans are exercisable not earlier than one year after the date of grant,
at a price equal to the fair market value of the common stock on the date of
grant, and expire not more than ten years after the date of grant.
The per share weighted-average fair value of stock options was obtained
using the Black Scholes options pricing model. A summary of the assumptions used
and values obtained follows:
2002 2001 2000
- --------------------------------------------------------------------------------
Expected dividend yield ................ 2.48% 3.17% 4.46%
Risk-free interest rate ................ 5.11 5.22 6.22
Expected life (in years) ............... 10 10 10
Expected volatility .................... 35.91% 41.62% 27.94%
Per share weighted-average fair value .. $ 10.41 $ 7.45 $ 4.15
A-30
The following table summarizes the impact on our net income had
compensation cost included the fair value of options at the grant date:
2002 2001 2000
- ------------------------------------------------------------------------------------------------------------------
(in thousands, except per share amounts)
Net income - as reported ........................................... $29,467 $24,398 $20,009
Stock based compensation expense determined under fair value based
method, net of related tax effect ................................ (2,318) (1,685) (886)
------- ------- -------
Pro-forma net income ........................................... $27,149 $22,713 $19,123
======= ======= =======
Income per share
Basic
As reported .................................................... $ 1.61 $ 1.29 $ 1.03
Pro-forma ...................................................... 1.48 1.20 .99
Diluted
As reported .................................................... $ 1.58 $ 1.27 $ 1.02
Pro-forma ...................................................... 1.46 1.18 .98
A summary of outstanding stock option grants and transactions follows:
Number Average
of Exercise
Shares Price
- -------------------------------------------------------------------------
Outstanding at January 1, 2000 .............. 1,139,957 $ 8.75
Granted ................................... 327,482 7.60
Exercised ................................. (214,080) 4.28
Forfeited ................................. (46,220) 12.48
--------- ---------
Outstanding at December 31, 2000 ............ 1,207,139 9.03
Granted ................................... 347,725 12.20
Exercised ................................. (434,618) 8.26
Forfeited ................................. (12,802) 11.28
--------- ---------
Outstanding at December 31, 2001 ............ 1,107,444 10.32
Granted ................................... 342,385 18.45
Exercised ................................. (349,983) 9.86
--------- ---------
Outstanding at December 31, 2002 ............ 1,099,846 $ 13.00
========= =========
A summary of stock options outstanding at December 31, 2002 follows:
Options Outstanding Options Exercisable
------------------------------------- -------------------------------------
Weighted-Average Weighted-Average
Number ----------------------- Number --------------------------
of Remaining Exercise of Remaining Exercise
Range of Exercise Prices Shares Life (years) Price Shares Life (years) Price
- -------------------------------------------------------------------------------------------------------------
$3.88 to $8.53 .......... 227,922 7.01 $7.43 227,922 7.01 $7.43
$8.54 to $10.66 ......... 117,922 1.48 9.18 117,922 1.48 9.18
$10.67 to $12.79 ........ 269,709 8.21 12.03 269,709 8.21 12.03
$12.80 to $17.06 ........ 141,908 1.04 13.80 141,908 1.04 13.80
$17.07 to $21.33 ........ 342,385 9.13 18.45
--------- ---- ------ ------- ------ --------
1,099,846 6.60 $13.00 757,461 5.46 $10.53
========= ==== ====== ======= ====== ========
We maintain 401(k) and employee stock ownership plans covering
substantially all of our full-time employees. We match employee contributions to
the 401(k) up to a maximum of 3% of participating employees' eligible wages.
Contributions to the employee stock ownership plan are determined annually and
require approval of our Board of Directors. During 2002, 2001 and 2000, $2.4
million, $1.8 million and $1.9 million respectively, was expensed for these
retirement plans.
Our officers participate in various performance-based compensation plans.
Amounts expensed for all incentive plans totaled $2.6 million, $2.2 million, and
$2.0 million, in 2002, 2001 and 2000, respectively.
We also provide certain health care and life insurance programs to
substantially all full-time employees. Amounts expensed for these programs
totaled $2.8 million, $2.1 million and $1.8 million, in 2002, 2001 and 2000,
respectively. These insurance programs are also available to retired employees
at their expense.
A-31
NOTE 14 - DERIVATIVE FINANCIAL INSTRUMENTS
Our derivative financial instruments according to the type of hedge in
which they are designated under SFAS #133 at December 31 follow:
2002
Average
Notional Maturity Fair
Amount (years) Value
- -------------------------------------------------------------------------------------------------
(dollars in thousands)
Fair Value Hedge - pay variable interest-rate swap agreements ... $ 25,000 7.3 $ 28
======== === ========
Cash Flow Hedge
Pay-fixed interest-rate swap agreements ....................... $236,000 1.5 $ (7,494)
Interest-rate collar agreements ............................... 10,000 0.9 (404)
-------- --- --------
Total .................................................. $246,000 1.5 $ (7,898)
======== === ========
No hedge designation
Rate-lock real estate mortgage loan commitments ............... $ 59,000 .1 $ 504
Mandatory commitments to sell real estate mortgage loans ...... 182,000 .1 (1,492)
-------- --- --------
Total .................................................. $241,000 .1 $ (988)
======== === ========
2001
Average
Notional Maturity Fair
Amount (years) Value
- --------------------------------------------------------------------------------------------------
(dollars in thousands)
Fair Value Hedge - pay variable interest-rate swap agreements ... $ 24,000 6.4 $ (442)
======== === ========
Cash Flow Hedge
Pay-fixed interest-rate swap agreements ....................... $175,000 2.0 $ (6,108)
Interest-rate collar agreements ............................... 10,000 1.9 (458)
-------- --- --------
Total ....................................................... $185,000 2.0 $ (6,566)
======== === ========
No hedge designation
Pay-fixed interest-rate swap agreements ....................... $ 26,000 .8 $ (848)
Interest-rate cap agreements .................................. 47,000 .5
Interest-rate floor agreements ................................ 10,000 .8
Rate-lock real estate mortgage loan commitments ............... 39,000 .1 (1,625)
Mandatory commitments to sell real estate mortgage loans ...... 114,000 .1 2,553
-------- --- --------
Total ....................................................... $236,000 .3 $ 80
======== === ========
Our Banks have established management objectives and strategies that
include interest-rate risk parameters for maximum fluctuations in net interest
income and market value of portfolio equity. We monitor our Banks' interest rate
risk position via simulation modeling reports. The goal of our Banks'
asset/liability management efforts is to maintain profitable financial leverage
within established risk parameters.
Our Banks use variable-rate and short-term fixed-rate (less than 12 months)
debt obligations to fund a portion of their balance sheets, which expose our
Banks to variability in interest rates. To meet their objectives, our Banks may
periodically enter into derivative financial instruments to mitigate exposure to
fluctuations in cash flows resulting from changes in interest rates. 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, our Banks will receive
cash if interest rates rise above a predetermined level while our Banks will
make cash payments if interest rates fall below a predetermined level. As a
result, our Banks effectively have variable-rate debt with an established
maximum and minimum rate.
Our Banks also use long-term, fixed-rate brokered CDs to fund a portion of
their balance sheets. These instruments expose our Banks to variability in fair
value due to changes in interest rates. To meet their objectives, our Banks may
enter into derivative financial instruments to mitigate exposure to fluctuations
in fair values of such fixed-rate debt instruments. Fair Value Hedges currently
include pay-variable interest-rate swaps.
Certain financial derivative instruments have not been 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 fair value of derivative financial
instruments not designated as hedges, are recognized as interest expense.
A-32
In the ordinary course of business, our Banks enter into rate-lock real
estate mortgage loan commitments with customers ("Rate Lock Commitments"). These
commitments expose our Banks to interest rate risk. Our Banks 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 Banks' 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 is as
follows:
Other
Comprehensive
Net Income Income Total
- -----------------------------------------------------------------------------------------------------------------
(in thousands)
Change in fair value during the year ended December 31, 2002
Interest rate swap agreements not designated as hedges ............. $ 848 $ 848
Rate-lock real estate mortgage loan commitments .................... 2,129 2,129
Mandatory commitments to sell real estate mortgage loans ........... (4,045) (4,045)
Fair value hedges .................................................. 22 22
Ineffectiveness of cash flow hedges ................................ 72 72
Cash flow hedges ................................................... 43 $ (8,182) (8,139)
Reclassification adjustment ........................................ 6,807 6,807
---------- --------- -------
Total ............................................................ (931) (1,375) (2,306)
Federal income tax ................................................. (326) (481) (807)
---------- --------- -------
Total, net of federal income tax ............................... $ (605) $ (894) $(1,499)
========== ========= =======
Cumulative effect of change in accounting principle at January 1, 2001
Fair value adjustments of option contracts not designated as
hedges ........................................................... $ (215) $ (215)
Interest rate swap agreements not designated as hedges ............. 310 310
Fair value hedges .................................................. (39) (39)
Cash flow hedges ................................................... (110) $ (1,107) (1,217)
---------- --------- -------
Total ............................................................ (54) (1,107) (1,161)
Federal income tax ................................................. (19) (387) (406)
---------- --------- -------
Total, net of federal income tax ............................... $ (35) $ (720) $ (755)
========== ========= =======
Change in fair value during the year ended December 31, 2001
Option contracts not designated as hedges .......................... $ 26 $ 26
Interest rate swap agreements not designated as hedges ............. (310) (310)
Rate-lock real estate mortgage loan commitments .................... (1,625) (1,625)
Mandatory commitments to sell real estate mortgage loans ........... 2,553 2,553
Fair value hedges .................................................. 16 16
Ineffectiveness of cash flow hedges ................................ (53) (53)
Cash flow hedges ................................................... 26 $ (9,010) (8,984)
Reclassification adjustment ........................................ 3,571 3,571
---------- --------- -------
Total ............................................................ 633 (5,439) (4,806)
Federal income tax ................................................. 222 (1,904) (1,682)
---------- --------- -------
Total, net of federal income tax ............................... $ 411 $ (3,535) $(3,124)
========== ========= =======
NOTE 15 - RELATED PARTY TRANSACTIONS
Certain of our directors and executive officers, including companies in
which they are officers or have significant ownership, were loan and deposit
customers of the Banks during 2002 and 2001.
A summary of loans to directors and executive officers whose borrowing
relationship exceeds $60,000, and to entities in which they own a 10% or more
voting interest for the years ended December 31 follows:
2002 2001
- -------------------------------------------------------------------------
(in thousands)
Balance at beginning of year ................ $ 25,628 $ 17,591
New loans and advances ...................... 18,668 21,411
Repayments .................................. (18,296) (13,374)
--------- ---------
Balance at end of year ...................... $ 26,000 $ 25,628
========= =========
A-33
NOTE 16 - OTHER NON-INTEREST EXPENSES
Other non-interest expenses for the years ended December 31 follow:
2002 2001 2000
- --------------------------------------------------------------------------------
(in thousands)
Data processing ............................. $ 3,209 $ 2,558 $ 2,467
Loan and collection ......................... 3,028 2,598 1,463
Advertising ................................. 2,813 2,490 2,129
Communications .............................. 2,484 2,275 2,128
Supplies .................................... 1,626 1,442 1,155
Amortization of intangible assets ........... 1,014 1,704 1,728
Other ....................................... 6,621 7,570 4,956
------- ------- -------
Total non-interest expense .......... $20,795 $20,637 $16,026
======= ======= =======
NOTE 17 - LEASES
We have non-cancelable operating leases for office facilities that provide
for renewal options.
A summary of future minimum lease payments under non-cancelable operating
leases at December 31, 2002, follows:
<Caption>
(in thousands)
2003 ..................................................... $ 445
2004 ..................................................... 336
2005 ..................................................... 213
2006 ..................................................... 163
2007 ..................................................... 149
2008 and thereafter ...................................... 8
------
Total ............................................... $1,314
======
Rental expense on operating leases totaled $0.4 in 2002 and 2001,
respectively, and $0.3 million in 2000.
NOTE 18 - REGULATORY MATTERS
Capital guidelines adopted by Federal and State regulatory agencies and
restrictions imposed by law limit the amount of cash dividends our Banks can pay
to us. At December 31, 2002, using the most restrictive of these conditions for
each Bank, the aggregate cash dividends that our Banks can pay us without prior
approval was $39.3 million. It is not our intent to have dividends paid in
amounts which would reduce the capital of our Banks to levels below those which
we consider prudent and in accordance with guidelines of regulatory authorities.
We are also subject to various regulatory capital requirements.
Quantitative measures established by regulation to ensure capital adequacy
require minimum amounts and ratios of total and Tier 1 capital to risk-weighted
assets and Tier 1 capital to average assets. Failure to meet minimum capital
requirements can initiate certain mandatory, and possibly discretionary, actions
by regulators that could have a material effect on our consolidated financial
statements. Under capital adequacy guidelines, we must meet specific capital
requirements that involve quantitative measures as well as qualitative judgments
by the regulators. The most recent notification from the FDIC categorized each
of our Banks as well capitalized.
A-34
Our actual capital amounts and ratios at December 31, 2002 follow:
Minimum Ratio Minimum Ratio
Actual for Adequately for Well-Capitalized
Amount Ratio Capitalized Institutions Institutions
- -----------------------------------------------------------------------------------------------------------------------
(dollars in thousands)
Total capital to risk-weighted assets
Consolidated .............................. $155,503 10.49% 8.00% 10.00%
Independent Bank .......................... 72,863 10.95 8.00 10.00
Independent Bank West Michigan ............ 33,741 10.38 8.00 10.00
Independent Bank South Michigan ........... 26,009 10.74 8.00 10.00
Independent Bank East Michigan ............ 25,951 10.67 8.00 10.00
Tier 1 capital to risk-weighted assets
Consolidated .............................. $138,798 9.36% 4.00% 6.00%
Independent Bank .......................... 65,367 9.82 4.00 6.00
Independent Bank West Michigan ............ 29,758 9.16 4.00 6.00
independent Bank South Michigan ........... 23,219 9.59 4.00 6.00
Independent Bank East Michigan ............ 23,515 9.67 4.00 6.00
Tier 1 capital to average assets
Consolidated .............................. $138,798 6.85% 4.00% 5.00%
Independent Bank .......................... 65,367 6.93 4.00 5.00
Independent Bank West Michigan ............ 29,758 7.11 4.00 5.00
Independent Bank South Michigan ........... 23,219 7.38 4.00 5.00
Independent Bank East Michigan ............ 23,515 6.94 4.00 5.00
NOTE 19 - FAIR VALUES OF FINANCIAL INSTRUMENTS
Most of our assets and liabilities are considered financial instruments.
Many of these financial instruments lack an available trading market and it is
our general practice and intent to hold the majority of our financial
instruments to maturity. Significant estimates and assumptions were used to
determine the fair value of financial instruments. These estimates are
subjective in nature, involving uncertainties and matters of judgment, and
therefore, fair values cannot be determined with precision. Changes in
assumptions could significantly affect the estimates.
Estimated fair values have been determined using available data and
methodologies that are considered suitable for each category of financial
instrument. For instruments with adjustable-interest rates which reprice
frequently and without significant credit risk, it is presumed that estimated
fair values approximate the recorded book balances.
Financial instrument assets actively traded in a secondary market, such as
securities, have been valued using quoted market prices while recorded book
balances have been used for cash and due from banks and accrued interest.
The fair value of loans is calculated by discounting estimated future cash
flows using estimated market discount rates that reflect credit and
interest-rate risk inherent in the loans.
Financial instrument liabilities with a stated maturity, such as
certificates of deposit, have been valued based on the discounted value of
contractual cash flows using a discount rate approximating current market rates
for liabilities with a similar maturity.
Derivative financial instruments have principally been valued based on
discounted value of contractual cash flows using a discount rate approximating
current market rates.
Financial instrument liabilities without a stated maturity, such as demand
deposits, savings, NOW and money market accounts, have a fair value equal to the
amount payable on demand.
A-35
The estimated fair values and recorded book balances at December 31 follow:
2002 2001
Estimated Recorded Estimated Recorded
Fair Book Fair Book
Value Balance Value Balance
- --------------------------------------------------------------------------------------------------
(in thousands)
Assets
Cash and due from banks ................... $ 60,700 $ 60,700 $ 50,500 $ 50,500
Securities available for sale ............. 371,200 371,200 290,300 290,300
Net loans and loans held for sale ......... 1,511,900 1,494,300 1,465,000 1,445,700
Accrued interest receivable ............... 9,000 9,000 9,200 9,200
Liabilities
Deposits with no stated maturity .......... $ 837,400 $ 837,400 $ 762,500 $ 762,500
Deposits with stated maturity ............. 706,200 698,200 632,000 624,800
Other borrowings .......................... 361,200 351,500 345,900 340,400
Accrued interest payable .................. 4,600 4,600 4,700 4,700
Derivative financial instruments .......... 8,900 8,900 6,900 6,900
The fair values for commitments to extend credit and standby letters of
credit are estimated to approximate their aggregate book balance.
Fair value estimates are made at a specific point in time, based on
relevant market information and information about the financial instrument.
These estimates do not reflect any premium or discount that could result from
offering for sale the entire holdings of a particular financial instrument.
Fair value estimates are based on existing on- and off-balance sheet
financial instruments without attempting to estimate the value of anticipated
future business, the value of future earnings attributable to off-balance sheet
activities and the value of assets and liabilities that are not considered
financial instruments.
Fair value estimates for deposit accounts do not include the value of the
substantial core deposit intangible asset resulting from the low-cost funding
provided by the deposit liabilities compared to the cost of borrowing funds in
the market.
A-36
NOTE 20 - OPERATING SEGMENTS
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"). The accounting policies of the segments are the same as those
described in Note 1 to the Consolidated Financial Statements. We evaluate
performance based principally on net income of the respective reportable
segments.
A summary of selected financial information for our reportable segments
follows:
IB IBWM IBSM IBEM Other(1) Total
- ------------------------------------------------------------------------------------------------------------------------
(in thousands)
2002
Total assets ......................... $ 965,167 $ 427,465 $ 321,980 $ 341,931 $ 1,019 $2,057,562
Interest income ...................... 61,439 27,644 19,617 21,086 29 129,815
Net interest income .................. 37,698 19,682 12,511 13,754 (1,838) 81,807
Provision for loan losses ............ 1,657 890 390 625 3,562
Income (loss) before income tax ...... 19,970 11,716 6,697 5,615 (3,135) 40,863
Net income (loss) .................... 14,628 8,125 4,849 4,539 (2,674) 29,467
2001
Total assets ......................... $ 878,664 $ 387,607 $ 295,683 $ 321,628 $ 4,875 $1,888,457
Interest income ...................... 64,902 28,883 17,973 22,713 31 134,502
Net interest income .................. 33,099 17,659 10,086 13,281 (2,083) 72,042
Provision for loan losses ............ 1,547 850 510 830 3,737
Income (loss) before income tax ...... 16,581 10,050 5,210 5,561 (3,681) 33,721
Net income (loss) .................... 11,894 6,804 3,829 4,356 (2,485) 24,398
2000
Total assets ......................... $ 898,284 $ 353,556 $ 213,014 $ 313,536 $ 5,401 $1,783,791
Interest income ...................... 64,995 28,862 16,519 22,440 25 132,841
Net interest income .................. 30,484 15,368 8,921 12,684 (2,481) 64,976
Provision for loan losses ............ 1,887 540 380 480 3,287
Income (loss) before income tax ...... 13,811 8,225 4,306 5,036 (4,103) 27,275
Net income (loss) .................... 10,104 5,644 3,252 3,930 (2,921) 20,009
(1) Includes amounts relating to our parent company and certain insignificant
operations.
NOTE 21- INDEPENDENT BANK CORPORATION (PARENT COMPANY ONLY)
FINANCIAL INFORMATION
Presented below are condensed financial statements for our parent company.
CONDENSED STATEMENTS OF FINANCIAL CONDITION
December 31,
2002 2001
- --------------------------------------------------------------------------------
(in thousands)
ASSETS
Cash and due from banks ............................. $ 5,128 $ 10,292
Investment in subsidiaries .......................... 158,676 145,857
Other assets ........................................ 9,606 8,075
-------- --------
Total Assets .................................... $173,410 $164,224
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Notes payable ....................................... $ 12,600 $ 10,500
Subordinated debentures ............................. 17,783 17,783
Other liabilities ................................... 4,980 4,038
Shareholders' equity ................................ 138,047 131,903
-------- --------
Total Liabilities and Shareholders' Equity ...... $173,410 $164,224
======== ========
A-37
CONDENSED STATEMENTS OF OPERATIONS
Year Ended December 31,
2002 2001 2000
- ----------------------------------------------------------------------------------------------------
(in thousands)
OPERATING INCOME
Dividends from subsidiaries ........................................ $26,450 $23,100 $15,400
Management fees from subsidiaries and other income ................. 17,708 14,944 12,905
------- ------- -------
Total Operating Income ........................................... 44,158 38,044 28,305
------- ------- -------
OPERATING EXPENSES
Interest expense ................................................... 1,867 2,114 2,506
Administrative and other expenses .................................. 19,340 16,764 14,281
------- ------- -------
Total Operating Expenses ......................................... 21,207 18,878 16,787
------- ------- -------
Income Before Federal Income Tax and Undistributed Net Income
of Subsidiaries .................................................. 22,951 19,166 11,518
Federal income tax credit ............................................ 825 1,449 1,175
------- ------- -------
Income Before Equity in Undistributed Net Income of Subsidiaries.. 23,776 20,615 12,693
Equity in undistributed net income of subsidiaries ................... 5,691 3,783 7,316
------- ------- -------
Net Income ....................................................... $29,467 $24,398 $20,009
======= ======= =======
CONDENSED STATEMENTS OF CASH FLOWS
Year Ended December 31,
2002 2001 2000
- -----------------------------------------------------------------------------------------------------
(in thousands)
Net Income ...................................................... $ 29,467 $ 24,398 $ 20,009
-------- -------- --------
ADJUSTMENTS TO RECONCILE NET INCOME
TO NET CASH FROM OPERATING ACTIVITIES
Depreciation, amortization of intangible assets and premiums,
and accretion of discounts on securities and loans .......... 1,087 1,005 977
Gain on sale of securities .................................... (146)
(Increase) decrease in other assets ........................... (886) (529) 2,150
Increase in other liabilities ................................. 1,388 819 581
Equity in undistributed net income of subsidiaries ............ (5,691) (3,783) (7,316)
-------- -------- --------
Total Adjustments ........................................... (4,248) (2,488) (3,608)
-------- -------- --------
Net Cash from Operating Activities .......................... 25,219 21,910 16,401
-------- -------- --------
CASH FLOW FROM INVESTING ACTIVITIES
Purchase of securities available for sale ..................... (100)
Proceeds from the sale of securities available for sale ....... 206
Investment in subsidiaries .................................... (1,824)
Capital expenditures .......................................... (1,833) (328) (616)
-------- -------- --------
Net Cash Used in Investing Activities ....................... (3,451) (428) (616)
-------- -------- --------
CASH FLOW FROM FINANCING ACTIVITIES
Proceeds from short-term borrowings ........................... 2,100 1,000
Retirement of long-term debt .................................. (1,000) (2,000)
Dividends paid ................................................ (8,406) (7,236) (6,615)
Repurchase of common stock .................................... (23,191) (13,168) (3,674)
Proceeds from issuance of common stock ........................ 2,565 2,718 732
-------- -------- --------
Net Cash Used in Financing Activities ....................... (26,932) (18,686) (10,557)
-------- -------- --------
Net Increase (Decrease) in Cash and Cash Equivalents ........ (5,164) 2,796 5,228
Cash and Cash Equivalents at Beginning of Year .................. 10,292 7,496 2,268
-------- -------- --------
Cash and Cash Equivalents at End of Year .................. $ 5,128 $ 10,292 $ 7,496
======== ======== ========
A-38
QUARTERLY SUMMARY
Reported Sale Prices of Common Shares
2002 2001 Cash Dividends
--------------------------------------------------- Declared
High Low Close High Low Close 2002 2001
First quarter ...... $19.05 $16.34 $18.26 $12.85 $10.99 $12.20 $.11 $.10
Second quarter ..... 21.59 17.63 20.04 15.78 11.79 14.84 .11 .10
Third quarter ...... 21.59 17.21 21.02 17.84 13.65 15.78 .11 .10
Fourth quarter ..... 22.67 20.03 20.17 18.48 15.43 17.65 .14 .11
We have approximately 2,100 holders of record of our common stock. Our
common stock trades on the Nasdaq National Market System under the symbol
"IBCP." The prices shown above are supplied by Nasdaq and reflect the
inter-dealer prices and may not include retail markups, markdowns or
commissions. There may have been transactions or quotations at higher or lower
prices of which the Company is not aware.
In addition to the provisions of the Michigan Business Corporation Act, our
ability to pay dividends is limited by our ability to obtain funds from our
Banks and by regulatory capital guidelines applicable to us. (See Note 18 to the
Consolidated Financial Statements.)
QUARTERLY FINANCIAL DATA (UNAUDITED)
A summary of selected quarterly results of operations for the years ended
December 31 follows:
Three Months Ended
March June September December
31, 30, 30, 31,
- ---------------------------------------------------------------------------------------------------
(in thousands, except per share amounts)
2002
Interest income .................................... $ 31,721 $ 32,255 $ 32,955 $ 32,884
Net interest income ................................ 19,467 20,243 21,004 21,093
Provision for loan losses .......................... 927 1,166 752 717
Income before income tax expense ................... 9,923 10,158 9,856 10,926
Net income ......................................... 7,109 7,288 7,113 7,957
Income per share
Basic .............................................. $ .38 $ .39 $ .39 $ .45
Diluted ............................................ .38 .39 .38 .44
2001
Interest income ..................................... $ 34,228 $ 33,326 $ 34,048 $ 32,900
Net interest income ................................ 17,112 17,110 18,440 19,380
Provision for loan losses .......................... 633 1,261 1,061 782
Income before income tax expense ................... 7,386 8,219 8,731 9,385
Net income before cumulative effect of change in
accounting principle ............................. 5,293 6,249 6,245 6,646
Net income ......................................... 5,258 6,249 6,245 6,646
Income per share before cumulative effect of change in
accounting principle
Basic .............................................. $ .28 $ .33 $ .33 $ .35
Diluted ............................................ .27 .32 .32 .35
Net income
Basic .............................................. $ .28 $ .33 $ .33 $ .35
Diluted ............................................ .27 .32 .32 .35
A-39
SHAREHOLDER INFORMATION
HOW TO ORDER FORM 10-K
Shareholders may obtain, without charge, a copy of Form 10-K, the 2002
Annual Report to the Securities and Exchange Commission, through our website at
www.ibcp.com or by writing to the Chief Financial Officer, Independent Bank
Corporation, P.O. Box 491, Ionia, Michigan 48846 or by e-mail at info@ibcp.com.
PRESS RELEASES
Our press releases, including earnings and dividend announcements as well
as other financial information, are available on our website at www.ibcp.com.
NOTICE OF ANNUAL MEETING
Our Annual Meeting of Shareholders will be held at 3:00 p.m. on April 17,
2003, in the Ionia Theater located at 205 West Main Street, Ionia, Michigan,
48846.
TRANSFER AGENT AND REGISTRAR
EquiServe Trust Company, N.A., P.O. Box 43011, Providence, RI 02940-3011,
800/426-5523, www.equiserve.com, serves as transfer agent and registrar of our
common stock.
DIVIDEND REINVESTMENT
We maintain an Automatic Dividend Reinvestment and Stock Purchase Plan
which provides an opportunity for shareholders of record to reinvest cash
dividends into our common stock. Optional cash purchases up to $10,000 per
quarter are also permitted. A prospectus is available by writing to our Chief
Financial Officer.
EXECUTIVE OFFICERS AND DIRECTORS
EXECUTIVE OFFICERS
Charles C. Van Loan, President and Chief Executive Officer, Independent Bank
Corporation
Ronald L. Long, President and Chief Executive Officer, Independent Bank East
Michigan
Michael M. Magee, Jr., President and Chief Executive Officer, Independent
Bank
David C. Reglin, President and Chief Executive Officer, Independent Bank West
Michigan
Edward B. Swanson, President and Chief Executive Officer, Independent Bank
South Michigan
Robert N. Shuster, Executive Vice President and Chief Financial Officer,
Independent Bank Corporation
Richard E. Butler, Senior Vice President, Independent Bank Corporation
Peter R. Graves, Senior Vice President, Independent Bank Corporation
James J. Twarozynski, Senior Vice President and Controller, Independent Bank
Corporation
DIRECTORS
Jeffrey A. Bratsburg, Retired, former President and Chief Executive Officer,
Independent Bank West Michigan
Terry L. Haske, President, Ricker & Haske, C.P.A.s, P.C., Marlette
Robert L. Hetzler, President, Monitor Sugar Company, Food Processor, Bay City
Thomas F. Kohn, Chief Executive Officer, Belco Industries, Inc., Manufacturer,
Belding(1)
Robert J. Leppink, President, Leppink's Inc., Retail Grocer, Belding(1)
James E. McCarty, President, McCarty Communications, Graphic Design and
Commercial Printer, Saranac
Charles A. Palmer, Professor of Law, Thomas M. Cooley Law School, Lansing
Charles C. Van Loan, President and Chief Executive Officer, Independent Bank
Corporation, Ionia
Arch V. Wright, Jr., President, Charlevoix Development Company, Real Estate
Development, Charlevoix
(1) Retired at December 31, 2002.
A-40