UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2003
--------------
OR
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from <> to <>
Commission file number: 0-20167
NORTH COUNTRY FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
MICHIGAN 38-2062816
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
130 SOUTH CEDAR STREET, MANISTIQUE, MI 49854
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (800) 200-7032
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months, (or for such shorter periods that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
------- -------
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes No X
------- -------
As of April 30, 2003, there were outstanding 7,019,152 shares of the
registrant's common stock, no par value.
NORTH COUNTRY FINANCIAL CORPORATION
INDEX
PART 1. FINANCIAL INFORMATION Page No.
--------
Item 1. Financial Statements
Condensed Consolidated Balance Sheets -
March 31, 2003 (Unaudited) and December 31, 2002................................... 1
Condensed Consolidated Statements of Operations - Three
Months Ended March 31, 2003 (Unaudited) and
March 31, 2002 (Unaudited)....................................................... 2
Condensed Consolidated Statements of Changes in Shareholders'
Equity - Three Months Ended March 31, 2003
(Unaudited) and March 31, 2002 (Unaudited)....................................... 3
Condensed Consolidated Statements of Cash Flows -
Three Months Ended March 31, 2003 (Unaudited) and
March 31, 2002 (Unaudited)....................................................... 4
Notes to Condensed Consolidated Financial
Statements (Unaudited)........................................................... 5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.............................................. 12
Item 3. Quantitative and Qualitative Disclosures About Market Risk......................... 23
Item 4. Controls and Procedures............................................................ 26
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.................................................................. 27
Item 6. Exhibits and Reports on Form 8-K................................................... 27
SIGNATURE ................................................................................... 28
CERTIFICATION .................................................................................. 29
NORTH COUNTRY FINANCIAL CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands)
March 31, December 31,
2003 2002
---- ----
(Unaudited)
ASSETS
Cash and due from banks $ 13,138 $ 17,542
Federal funds sold 35,700 26,250
----------- -----------
Cash and cash equivalents 48,838 43,792
Interest-bearing deposits in other financial institutions 2,016 2,010
Securities available for sale 62,391 67,955
Federal Home Loan Bank stock 4,375 4,375
Total loans 391,568 435,043
Allowance for loan losses (23,332) (24,908)
----------- -----------
Net loans 368,236 410,135
Premises and equipment 15,145 15,592
Other real estate held for sale 5,483 5,409
Other assets 15,284 16,038
----------- -----------
Total assets $ 521,768 $ 565,306
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Non-interest-bearing deposits $ 33,921 $ 40,797
Interest-bearing deposits 361,322 396,697
----------- -----------
Total deposits 395,243 437,494
Borrowings 87,815 87,815
Other liabilities 7,364 7,044
Guaranteed preferred beneficial interests in the Corporation's
subordinated debentures 12,450 12,450
Shareholders' equity:
Preferred stock - No par value:
Authorized 500,000 shares, no shares outstanding Common stock - No
par value:
Authorized - 18,000,000 shares
Issued and outstanding - 7,019,152 16,175 16,175
Retained earnings 1,581 3,086
Accumulated other comprehensive income 1,140 1,242
----------- -----------
Total shareholders' equity 18,896 20,503
----------- -----------
Total liabilities and shareholders' equity $ 521,768 $ 565,306
=========== ===========
See accompanying notes to condensed consolidated financial statements.
1
NORTH COUNTRY FINANCIAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in Thousands, Except per Share Data)
(Unaudited)
Three Months Ended
---------March 31,---------
2003 2002
---- ----
Interest income:
Interest and fees on loans:
Taxable $ 5,641 $ 8,070
Tax-exempt 422 556
Interest on securities:
Taxable 692 959
Tax-exempt 66 68
Other interest income 152 69
----------- -----------
Total interest income 6,973 9,722
----------- -----------
Interest expense:
Deposits 2,545 3,265
Borrowings 1,199 1,262
Subordinated debentures 122 139
----------- -----------
Total interest expense 3,866 4,666
----------- -----------
Net interest income 3,107 5,056
Provision for loan losses 0 50
----------- -----------
Net interest income after provision for loan losses 3,107 5,006
----------- -----------
Other income:
Service fees 430 401
Net security gains (losses) (23) 66
Other loan and lease income 27 263
Net gains on sale of loans 55 184
Other operating income 413 157
----------- -----------
Total other income 902 1,071
----------- -----------
Other expenses:
Salaries, commissions, and related benefits 1,677 2,000
Furniture and equipment expense 366 361
Occupancy expense 399 454
Data processing 407 610
Accounting, legal, and consulting fees 830 304
Loan and deposit expense 574 282
Telephone 333 260
Loss (gain) on sale of premises, equipment, and other real estate (19) 56
Advertising expense 49 122
Other 578 418
----------- -----------
Total other expenses 5,194 4,867
----------- -----------
Income (loss) before provision for income taxes (1,185) 1,210
Provision for income taxes 320 207
----------- -----------
Net income (loss) $ (1,505) $ 1,003
=========== ===========
Earnings (loss) per common share:
Basic $ (0.21) $ 0.14
=========== ===========
Diluted $ (0.21) $ 0.14
=========== ===========
Dividends declared per common share $ 0.00 $ 0.10
=========== ===========
See accompanying notes to condensed consolidated financial statements.
2
NORTH COUNTRY FINANCIAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(Dollars in Thousands)
(Unaudited)
Three Months Ended
---------March 31,---------
2003 2002
---- ----
Balance, beginning of period $ 20,503 $ 47,889
Net income (loss) for period (1,505) 1,003
Net unrealized loss on securities
available for sale (102) (574)
----------- -----------
Total comprehensive income (loss) (1,607) 429
Dividends declared 0 (702)
----------- -----------
Balance, end of period $ 18,896 $ 47,616
=========== ===========
See accompanying notes to condensed consolidated financial statements.
3
NORTH COUNTRY FINANCIAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(Unaudited)
Three Months Ended
---------March 31,---------
2003 2002
---- ----
Increase (decrease) in cash and cash equivalents:
Cash flows from operating activities:
Net income (loss) $ (1,505) $ 1,003
Adjustments to reconcile net income (loss) to
net cash provided by (used in) operating activities:
Depreciation and amortization 578 402
Provision for loan losses 0 50
(Gain) loss on sales of securities 23 (66)
(Gain) loss on sale of premises, equipment, and other real estate (19) 56
Change in other assets 836 (1,166)
Change in other liabilities 320 (358)
----------- -----------
Net cash provided by (used in) operating activities 233 (79)
----------- -----------
Cash flows from investing activities:
Net increase in interest-bearing deposits in other financial institutions (6) (6)
Purchase of securities available for sale 0 (16,061)
Proceeds from sales of securities available for sale 2,978 11,949
Proceeds from maturities, calls, or paydowns of securities available for sale 2,267 2,256
Net decrease in loans 39,768 6,241
Purchase of premises equipment (19) (295)
Proceeds from sale of premises, equipment, and other real estate 2,076 31
----------- -----------
Net cash provided by investing activities 47,064 4,115
----------- -----------
Cash flows from financing activities:
Net decrease in deposits (42,251) (12,312)
Payment of cash dividends 0 (702)
----------- -----------
Net cash used in financing activities (42,251) (13,014)
----------- -----------
Net change in cash and cash equivalents 5,046 (8,978)
Cash and cash equivalents at beginning of period 43,792 36,747
----------- -----------
Cash and cash equivalents at end of period $ 48,838 $ 27,769
=========== ===========
Supplemental cash flow information:
Cash paid (refunded) for:
Interest $ 4,140 $ 4,617
Income taxes (500) 40
Transfers of foreclosures from loans to other real estate 1,810 560
See accompanying notes to condensed consolidated financial statements.
4
NORTH COUNTRY FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The unaudited condensed consolidated financial statements of North Country
Financial Corporation (the "Corporation") have been prepared in accordance
with generally accepted accounting principles for interim financial
information and the instructions to Form 10-Q and Rule 10-01 of Regulation
S-X. Accordingly, they do not include all of the information and footnotes
required by generally accepted accounting principles for complete financial
statements. In the opinion of management, all adjustments (consisting of
normal recurring accruals) considered necessary for a fair presentation
have been included. Operating results for the three-month period ended
March 31, 2003, are not necessarily indicative of the results that may be
expected for the year ending December 31, 2003. The unaudited consolidated
financial statements and footnotes thereto should be read in conjunction
with the audited consolidated financial statements and footnotes thereto
included in the Corporation's Annual Report on Form 10-K for the year ended
December 31, 2002.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the
financial statements, and the reported amounts of revenue and expenses
during the period. Actual results could differ from those estimates.
Allowance for Loan Losses
The allowance for loan losses includes specific allowances related to
commercial loans, which have been judged to be impaired. A loan is impaired
when, based on current information, it is probable that the Corporation
will not collect all amounts due in accordance with the contractual terms
of the loan agreement. These specific allowances are based on discounted
cash flows of expected future payments using the loan's initial effective
interest rate or the fair value of the collateral if the loan is collateral
dependent.
The Corporation continues to maintain a general allowance for loan losses
for loans not considered impaired. The allowance for loan losses is
maintained at a level which management believes is adequate to provide for
possible loan losses. Management periodically evaluates the adequacy of the
allowance using the Corporation's past loan loss experience, known and
inherent risks in the portfolio, composition of the portfolio, current
economic conditions, and other factors. The allowance does not include the
effects of expected losses related to future events or future changes in
economic conditions. This evaluation is inherently subjective since it
requires material estimates that may be susceptible to significant change.
Loans are charged against the allowance for loan losses when management
believes the collectibility of the principal is unlikely. In addition,
various regulatory agencies periodically review the allowance for loan
losses. These agencies may require additions to the allowance for loan
losses based on their judgments of collectibility.
In management's opinion, the allowance for loan losses is adequate to cover
probable losses relating to specifically identified loans, as well as
probable losses inherent in the balance of the loan portfolio as of the
balance sheet date.
Stock Option Plans
The Corporation sponsors three stock option plans. One plan was approved
during 2000 and applies to officers, employees, and nonemployee directors.
A total of 500,000 shares were made available for grant under this plan.
The other two plans, one for officers and employees and the other for
nonemployee directors, were approved in 1997. A total of 600,000 shares
were made available for grant under these plans. Options under all of the
plans are granted at the discretion of a committee of the Corporation's
Board of Directors. Options to purchase shares of the Corporation's stock
are granted at a price equal to the market price of the stock at the date
of grant. The committee determines the vesting of the options when they are
granted as established under the plan.
5
NORTH COUNTRY FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The fair value of each option granted is estimated on the grant date using
the Black-Scholes methodology. The following assumptions were made in
estimating fair value for options granted for the three months ended March
31, 2003:
March 31,
2003
----
Dividend yield 0.00%
Risk-free interest rate 1.25%
Weighted average expected life (years) 7.0
Expected volatility 29.85%
The weighted average fair value of options granted as of their grant date,
using the assumptions shown above, was computed at $.75 per share for
options granted in 2003. There were no options granted in 2002.
The Corporation accounts for stock options using the intrinsic value
method. For all options granted, the intrinsic value was zero; therefore,
no compensation cost has been recognized for the plans. Had compensation
cost been determined on the basis of fair value, net income and earnings
per share would have been reduced for the three months ended March 31, 2003
and the year ended December 31, 2002 (dollars in thousands, except per
share data) as follows:
March 31, December 31,
2003 2002
---- ----
Net loss:
As reported $ (1,505) $ (26,713)
Total stock-based compensation expense
determined under fair value-based method,
net of tax (14) (94)
------------ -------------
Pro forma $ (1,519) $ (26,807)
============ =============
Loss per share - Basic:
As reported $ (0.21) $ (3.81)
============ =============
Pro forma $ (0.22) $ (3.82)
============ =============
Loss per share - Diluted:
As reported $ (0.21) $ (3.81)
============ ==============
Pro forma $ (0.22) $ (3.82)
============ ==============
2. RECENT ACCOUNTING PRONOUNCEMENT
In December 2002, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure," as an amendment to
SFAS No. 123, "Accounting for Stock-Based Compensation." SFAS No. 148
provides alternative methods of transition for a voluntary change to the
fair value-based method of accounting for stock-based employee
compensation. The Corporation has not voluntarily changed to the fair
value-based method of accounting for stock-based employee compensation.
6
NORTH COUNTRY FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
3. EARNINGS (LOSS) PER SHARE
Earnings (loss) per share are based upon the weighted average number of
shares outstanding. The following shows the computation of basic and
diluted earnings (loss) per share for the three months ended March 31, 2003
and 2002 (in thousands, except per share data):
Three Months
Ended March 31,
---------------
2003 2002
---- ----
Basic earnings (loss) per common share:
Net income (loss) $ (1,505) $ 1,003
======== =========
Weighted average common shares outstanding 7,019 7,019
======== =========
Basic earnings (loss) per common share $ (0.21) $ 0.14
======== =========
Diluted earnings (loss) per common share:
Net income (loss) $ (1,505) $ 1,003
======== =========
Weighted average common shares outstanding
for basic earnings (loss) per common share 7,019 7,019
Add: Dilutive effect of assumed exercise
of stock options 0 2
Add: Dilutive effect of directors' deferred stock
compensation 0 1
-------- ---------
Average shares and dilutive potential common shares 7,019 7,022
======== =========
Diluted earnings (loss) per common share $ (0.21) $ 0.14
======== =========
4. INVESTMENT SECURITIES
The amortized cost and estimated fair value of investment securities
available for sale as of March 31, 2003 and December 31, 2002, are as
follows (in thousands):
----------March 31, 2003--------- --------December 31, 2002--------
Amortized Estimated Amortized Estimated
Cost Fair Value Cost Fair Value
Obligations of states and political
subdivisions $ 5,112 $ 5,570 $ 5,172 $ 5,632
Corporate securities 7,594 8,337 10,593 11,264
Mortgage-related securities 47,958 48,484 50,355 51,059
--------------- -------------- -------------- ---------------
Total securities available for sale $ 60,664 $ 62,391 $ 66,120 $ 67,955
=============== ============== ============== ===============
The amortized cost and estimated fair value of investment securities
pledged to treasury deposits and borrowings were $48,951,000 and
$49,836,000, respectively, at March 31, 2003.
7
NORTH COUNTRY FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
5. LOANS
The composition of loans at March 31, 2003 and December 31, 2002 (dollars
in thousands) is as follows:
March 31, December 31,
2003 2002
---- ----
Commercial real estate $ 51,867 $ 61,556
Commercial, financial, and agricultural 264,907 290,371
One- to four-family residential real estate 68,223 74,366
Consumer 4,854 5,706
Construction 1,717 3,044
------------ -----------
Total loans $ 391,568 $ 435,043
============ ===========
An analysis of the allowance for loan losses for the three months ended
March 31, 2003, and 2002 (dollars in thousands) is as follows:
March 31, March 31,
2003 2002
---- ----
Balance at beginning of period $ 24,908 $ 10,444
Provision for loan losses 0 50
Recoveries on loans 137 64
Loans charged off (1,713) (746)
----------- --------------
Balance at end of period $ 23,332 $ 9,812
============ ==============
The aggregate amount of nonperforming residential and consumer loans was
approximately $2,132,000 and $2,212,000 at March 31, 2003 and December 31,
2002, respectively. Nonperforming loans are those which are contractually
past due 90 days or more as to interest or principal payments, on
nonaccrual status, or loans, the terms of which have been renegotiated to
provide a reduction or deferral of interest or principal. The interest
income recorded and that which would have been recorded had residential and
consumer nonaccrual and renegotiated loans been current, or not troubled,
are not material to the consolidated financial statements for the three
months ended March 31, 2003 and 2002. The nonperforming commercial loans
are reflected in the information regarding impaired loans.
Information regarding impaired loans as of March 31, 2003 and
December 31, 2002 (dollars in thousands) is as follows:
March 31, December 31,
2003 2002
---- ----
Total impaired loans $ 47,922 $ 51,602
Impaired loans with a valuation allowance 46,659 51,331
Impaired loans on nonaccrual 37,230 23,992
Valuation allowance related to impaired loans 10,207 6,739
The average investment in impaired loans was approximately $49,763,000 and
$25,073,000 for the three-months ended March 31, 2003 and the year ended
December 31, 2002, respectively.
8
NORTH COUNTRY FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
5. LOANS (CONTINUED)
The Bank, in the ordinary course of business, grants loans to the
Corporation's executive officers and directors, including their families
and firms in which they are principal owners. Activity in such loans is
summarized below (dollars in thousands).
March 31, December 31,
2003 2002
---- ----
Loans outstanding beginning of period $ 10,987 $ 16,625
New loans 137 1,622
Net activity on revolving lines of credit 12 23
Repayment (545) (991)
Decrease related to retired executive officers and directors -0- (6,292)
------------- --------------
Loans outstanding end of period $ 10,591 $ 10,987
============= ==============
Two related-party loans had balances of approximately $6,471,000 and
$3,001,000 at March 31, 2003 and $6,608,000 and $3,025,000 at December 31,
2002. Loans to related-parties of approximately $8,863,000 and $9,182,000
were classified substandard at March 31, 2003 and December 31, 2002,
respectively.
6. BORROWINGS
Borrowings consist of the following at March 31, 2003 and December 31, 2002
(in thousands):
March 31, December 31,
2003 2002
---- ----
Federal Home Loan Bank advances at rates ranging from 4.35% to 7.59% with
maturities from less than one year to ten years $ 86,198 $ 86,198
Farmers Home Administration, fixed rate note payable, maturing August
24, 2024, interest payable at 1% 1,617 1,617
----------- -----------
$ 87,815 $ 87,815
=========== ===========
As of March 31, 2003, the Federal Home Loan Bank borrowings are
collateralized by a specific collateral agreement on the Corporation's
residential mortgage loans of $48,808,000; U.S. government and agency
securities with an estimated fair value of $48,788,000; an interest-bearing
deposit in the amount of $2,000,000; and Federal Home Loan Bank stock of
$4,375,000. Prepayment of the advances is subject to the provisions and
conditions of the credit policy of the Federal Home Loan Bank of
Indianapolis in effect as of March 31, 2003. The Farmers Home
Administration borrowing is collateralized by loans totaling $1,173,000
originated and held by the Corporation's wholly owned subsidiary, First
Rural Relending, and guaranteed by the Corporation.
9
NORTH COUNTRY FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
7. STOCK OPTION PLANS
A summary of stock option transactions for the three months ended March 31,
2003 and the year ended December 31, 2002, is as follows:
Number of Shares
----------------
March 31, December 31,
2003 2002
---- ----
Outstanding shares at beginning of year 772,397 894,797
Granted during the period 50,000 0
Expired during the period (24,400) (122,400)
------------- ---------------
Outstanding shares at end of period 797,997 772,397
============= ==============
Weighted average exercise price per share
at end of period $ 13.54 $ 14.11
============= ==============
Shares available for grant at end of period 85,573 135,573
============= ==============
Options granted in 2003 were granted at a price of $2.95 per share. Under
these plans, options expire ten years after the date of grant.
Following is a summary of the options outstanding and exercisable at March
31, 2003:
Weighted
Average Weighted
Remaining Average
Exercise Contractual Exercise
Price Range Number Life-Years Price
----------- ------ ---------- -----
$2.95 50,000 9.83 $ 2.95
$4.26 5,400 .88 4.26
$7.80 - $12.00 329,800 5.83 9.23
$15.00 - $20.33 412,797 4.87 18.37
-------- ----------- ----------
797,997 5.55 $ 13.54
======== =========== ==========
8. COMMITMENTS, CONTINGENCIES, AND CREDIT RISK
Financial Instruments With Off-Balance-Sheet Risk
The Corporation is a party to financial instruments with off-balance-sheet
risk in the normal course of business to meet the financing needs of its
customers. These financial instruments include commitments to extend credit
and standby letters of credit. Those instruments involve, to varying
degrees, elements of credit risk in excess of the amount recognized in the
consolidated balance sheets.
10
NORTH COUNTRY FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
8. COMMITMENTS, CONTINGENCIES, AND CREDIT RISK (CONTINUED)
The Corporation's exposure to credit loss, in the event of nonperformance
by the other party to the financial instrument for commitments to extend
credit and standby letters of credit, is represented by the contractual
amount of those instruments. The Corporation uses the same credit policies
in making commitments and conditional obligations as it does for
on-balance-sheet instruments. These commitments are as follows (dollars in
thousands):
March 31, December 31
2003 2002
------------ -------------
Commitments to extend credit:
Fixed rate $ 7,287 $ 7,980
Variable rate 65,586 62,632
Standby letters of credit - Variable rate 13,891 13,161
Credit card commitments - Fixed rate 3,896 4,111
------------ -------------
$ 90,660 $ 87,884
============ =============
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 may require payment of a fee. Since many of the commitments are
expected to expire without being drawn upon, the total commitment amounts
do not necessarily represent future cash requirements. The Corporation
evaluates each customer's creditworthiness on a case-by-case basis. The
amount of collateral obtained, if deemed necessary by the Corporation upon
extension of credit, is based on management's credit evaluation of the
party. Collateral held varies but may include accounts receivable;
inventory; property, plant, and equipment; and income-producing commercial
properties.
Standby letters of credit are conditional commitments issued by the
Corporation to guarantee the performance of a customer to a third party.
Those guarantees are primarily issued to support public and private
borrowing arrangements. The credit risk involved in issuing letters of
credit is essentially the same as that involved in extending loan
facilities to customers. The commitments are structured to allow for 100%
collateralization on all standby letters of credit.
Credit card commitments are commitments on credit cards issued by the
Corporation's subsidiary and serviced by other companies. These commitments
are unsecured.
Contingencies
In the normal course of business, the Corporation is involved in various
legal proceedings. In the opinion of management, any liability resulting
from such proceedings would not have a material adverse effect on the
consolidated financial statements.
Concentration of Credit Risk
The Bank grants commercial, residential, agricultural, and consumer loans
throughout Michigan. The Bank's most prominent concentration in the loan
portfolio relates to commercial loans to entities within the hospitality
and tourism industry. This concentration represents $83.9 million, or
26.5%, of the commercial loan portfolio at March 31, 2003. The remainder of
the commercial loan portfolio is diversified in such categories as gaming,
petroleum, forestry, and agriculture. Due to the diversity of the Bank's
locations, the ability of debtors of residential and consumer loans to
honor their obligations is not tied to any particular economic sector.
11
NORTH COUNTRY FINANCIAL CORPORATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS
AND RESULTS OF OPERATIONS
The following discussion and analysis of financial condition and results of
operations provides additional information to assess the condensed consolidated
financial statements of the Corporation and its subsidiaries through the first
quarter of 2003. The discussion should be read in conjunction with those
statements and their accompanying notes.
FORWARD-LOOKING STATEMENTS
This report contains certain forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. The Corporation intends such
forward-looking statements to be covered by the safe harbor provisions for
forward-looking statements contained in the Private Securities Reform Act of
1995 and is including this statement for purposes of these safe harbor
provisions. Forward-looking statements, which are based on certain assumptions
and describe future plans, strategies, or expectations of the Corporation, are
generally identifiable by use of the words "believe," "expect," "intend,"
"anticipate," "estimate," "project," or similar expressions. The Corporation's
ability to predict results or the actual effect of future plans or strategies is
inherently uncertain. Factors that could cause actual results to differ from the
results in forward-looking statements include, but are not limited to:
- General economic conditions, either nationally or in the state(s)
in which the Corporation does business;
- Legislation or regulatory changes which affect the business in
which the Corporation is engaged;
- Changes in the interest rate environment which increase or
decrease interest rate margins;
- Restrictions and requirements imposed on the Corporation and the
Bank by formal action against them by bank regulatory agencies;
- Failure or inability of the Bank to comply with the terms of the
Cease and Desist Order (the "Order") applicable to it;
- Changes in securities markets with respect to the market value of
financial assets and the level of volatility in certain markets
such as foreign exchange;
- Significant increases in competition in the banking and financial
services industry resulting from industry consolidation,
regulatory changes and other factors, as well as action taken by
particular competitors;
- The ability of borrowers to repay loans;
- The effects on liquidity of unusual decreases in deposits;
- Changes in consumer spending, borrowing, and saving habits;
- Technological changes;
- Acquisitions and unanticipated occurrences which delay or reduce
the expected benefits of acquisitions;
- Difficulties in hiring and retaining qualified management and
banking personnel;
- The Corporation's ability to increase market share and control
expenses;
- The effect of compliance with legislation or regulatory changes;
- The effect of changes in accounting policies and practices;
- The costs and effects of unanticipated litigation and of
unexpected or adverse outcomes in such litigation; and
- The factors discussed in Item 1 in this Report and in the
Management's Discussion and Analysis in Item 2, as well as those
discussed elsewhere in this Report.
These risks and uncertainties should be considered in evaluating forward-looking
statements. Further information concerning the Corporation and its business,
including additional factors that could materially affect the Corporation's
financial results, is included in the Corporation's filings with the Securities
and Exchange Commission. All forward-looking statements contained in this report
are based upon information presently available and the Corporation assumes no
obligation to update any forward-looking statements.
12
NORTH COUNTRY FINANCIAL CORPORATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS
AND RESULTS OF OPERATIONS (Continued)
As discussed in the Capital and Regulatory section, the Corporation and the Bank
are subject to minimum regulatory capital requirements. The Bank is also subject
to minimum capital requirements of the Order. As of March 31, 2003, the capital
of the Corporation and the Bank were below those requirements. If the Bank does
not meet the minimum regulatory capital requirements, it could be subject to
material adverse actions taken by bank regulators.
Management's near term strategies are expected to be centered around downsizing
the Bank and returning the Corporation to profitability. This is expected to be
accomplished by a combination of alternatives including: addressing the amount
of nonperforming assets, the associated costs of servicing them, and a potential
sale of these assets; controlling the Bank's growth; and a potential sale of
certain branches. The sale of assets and certain branches may increase the
Corporation's capital ratios. The Corporation's strategies for increasing its
capital and that of the Bank are discussed further in the Capital and Regulatory
section.
Upon completion of these near-term strategies, the Corporation's long-term
strategy is expected to focus on profitable growth of loans and deposits in its
core markets in Michigan.
FINANCIAL OVERVIEW
Year-to-date consolidated net loss was $1.5 million through March 31, 2003,
compared to net income of $1.0 million for the same period in 2002. Basic loss
per share was $0.21 for the three months ended March 31, 2003, compared to
earnings of $0.14 for the same period in 2002. The provision for loan losses
decreased by $50,000 for the three months ended March 31, 2003 as compared to
the same period in 2002. Total assets declined $43.5 million from December 31,
2002 to March 31, 2003. The loan portfolio continued to experience declines
through the first quarter of 2003, decreasing $43.5 million from December 31,
2002 to March 31, 2003. Deposits have decreased $42.3 million since December 31,
2002.
FINANCIAL CONDITION
CASH AND CASH EQUIVALENTS
Cash and cash equivalents increased $5.0 million through the first quarter of
2003. This was due to an increased need to maintain liquidity. See further
discussion of the change in cash in the Liquidity section.
INVESTMENT SECURITIES
Available-for-sale securities decreased $5.6 million, or 8.2%, from December 31,
2002 to March 31, 2003, with the balance on March 31, 2003, totaling $62.4
million. Investment securities are utilized in an effort to manage interest rate
risk and liquidity. As of March 31, 2003, investment securities with an
estimated fair value of $49.8 million were pledged.
LOANS
Through the first quarter of 2003, loan balances decreased by $43.5 million, or
10.0%. As planned, the Bank continues to decrease certain segments of its loan
portfolio through tightened underwriting and credit practices and controls. The
Corporation is attempting to reduce the level of loans to the hotel and tourism
industry. Historically this has been an area of growth in the loan portfolio.
It is expected that the outstanding loan balances will further reduce in the
near term as management continues to tighten credit policies and reduce exposure
in the hotel and tourism industry. Enhancements to the loan approval process and
exception reporting further provide for a more effective management of risk in
the loan portfolio. Management continues to actively manage the loan portfolio
seeking to identify and resolve problem assets at an early stage. Management
believes a properly positioned loan portfolio provides the most attractive
earning asset yield available to the Corporation and, with changes to the loan
approval process and exception reporting, management can effectively manage the
risk in the loan portfolio. As shown in the table below, every segment of the
loan portfolio declined in the first quarter of 2003.
13
NORTH COUNTRY FINANCIAL CORPORATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS
AND RESULTS OF OPERATIONS (Continued)
Following is a summary of the loan portfolio at March 31, 2003 and December 31,
2002 (dollars in thousands):
March 31, % of December 31, % of
2003 Total 2002 Total
---- ----- ---- -----
Commercial real estate $ 51,867 13.3 $ 61,556 14.1
Commercial, financial, and agricultural 264,907 67.7 290,371 66.8
1-4 family residential real estate 68,223 17.4 74,366 17.1
Consumer 4,854 1.2 5,706 1.3
Construction 1,717 0.4 3,044 0.7
------------ ------ ------------ -------
Total loans $ 391,568 100.0 $ 435,043 100.0
============ ====== ============ =======
Following is a table showing the significant industry types in the commercial
loan portfolio as of March 31, 2003 and December 31, 2002 (dollars in
thousands):
----March 31, 2003---- --December 31, 2002--
Outstanding % of Outstanding % of
Balance Capital Balance Capital
------- ------- ------- -------
Hospitality and tourism $ 83,911 444.1 $ 86,802 423.4
Gaming 18,376 97.3 25,938 126.5
Petroleum 11,313 59.9 14,180 69.2
Forestry 4,693 24.8 5,677 27.7
CREDIT QUALITY
The allowance for loan losses is maintained by management at a level considered
to be adequate to cover probable losses related to specifically identified
loans, as well as losses inherent in the balance of the loan portfolio. At March
31, 2003, the allowance for loan losses increased to 6.0% of total loans
outstanding from 5.7% at December 31, 2002.
Management analyzes the allowance for loan losses in detail on a quarterly basis
to ensure that the losses inherent in the portfolio are properly reserved for.
Net charge-offs to gross loans outstanding increased to 0.40% from 0.14% for the
three months ended March 31, 2003 and 2002, respectively. Net charge-offs for
the three-month period ended March 31, 2003, were $1,576,000 compared to
$682,000 for the same period in 2002. The Corporation did not recognize a
provision for loan losses for the three months ended March 31, 2003, a decrease
of $50,000 when compared to the same period in 2002. There were no new
significant problem loans or loan downgrades identified during the first quarter
of 2003.
Following is the allocation of the allowance for loan losses as of March 31,
2003 and December 31, 2002 (in thousands):
March 31, December 31,
2003 2002
---- ----
Commercial loans and leases $ 20,954 $ 22,514
Real estate and mortgages 2,065 2,250
Consumer 103 144
Unallocated 210 -0-
----------- -----------
Totals $ 23,332 $ 24,908
=========== ===========
14
NORTH COUNTRY FINANCIAL CORPORATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS
AND RESULTS OF OPERATIONS (Continued)
The following ratios assist management in the determination of the Corporation's
credit quality:
March 31, December 31,
2003 2002
---- ----
Allowance to total loans 6.0% 5.7%
Net charge-offs to average outstanding loans 1.5% 2.6%
Nonperforming loans to gross loans 10.1% 6.3%
The table presented below shows the balance of nonperforming loans, which
include nonaccrual loans and loans 90 or more days past due and still accruing,
at March 31, 2003 and December 31, 2002 (in thousands):
March 31, December 31,
2003 2002
---- ----
Nonaccrual loans $ 38,376 $ 26,814
Loans 90 days or more past due and still accruing 1,024 401
Total nonperforming loans increased $12.2 million since December 31, 2002, after
the net charge-offs of $1.6 million which have been recognized through March 31,
2003. The increase is primarily due to one loan customer. The weakness in the
overall economy has persisted longer than originally anticipated. As a result,
consumer confidence and spending have continued to drop.
Management continues to address market issues impacting its loan customer base.
Ratings for the commercial loan portfolio are continually reviewed and
management closely monitors the commercial loan portfolio to timely identify
nonperforming loans.
As part of the process of resolving problem credits, the Corporation may acquire
ownership of collateral which secured such credits. The Corporation carries this
collateral in other real estate which is grouped with other assets on the
condensed consolidated balance sheet. The following table represents the
activity in other real estate (in thousands):
Balance at January 1, 2002 $4,211
Other real estate transferred from loans 4,705
Other real estate transferred from premises 1,226
Write-downs of other real estate (2,418)
Other real estate sold (2,315)
------
Balance at December 31, 2002 5,409
Other real estate transferred from loans 1,810
Other real estate sold (1,736)
------
Balance at March 31, 2003 $5,483
======
During the first three months of 2003, the Corporation received real estate in
lieu of loan payments of $1.8 million. Other real estate is initially valued at
the lower of cost or the fair value less selling costs. After the initial
receipt, management periodically reevaluates the recorded balance. Any
additional reductions in the fair value result in a write-down of other real
estate. Write-downs on other real estate may be recorded based on future
reevaluations of current realizable fair values.
15
NORTH COUNTRY FINANCIAL CORPORATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS
AND RESULTS OF OPERATIONS (Continued)
DEPOSITS
The Corporation continued to experience a substantial reduction in deposits in
the first quarter of 2003. Total deposits decreased by $42.3 million, or 9.7%,
in the first quarter of 2003. Due to the reduction in the loan portfolio,
management was able to reduce its reliance on brokered and noncore certificates
of deposits over $100,000. Brokered deposits decreased by $10 million during the
first quarter of 2003 to $45 million at March 31, 2003, while certificates of
deposit over $100,000 decreased by $8.2 million during the first quarter of 2003
to $27.4 million at March 31, 2003. The Corporation's other deposit categories
decreased by $24.1 million in the first quarter of 2003.
Due to the high cost of brokered and Internet deposits, management is
introducing a new deposit product to its local markets during 2003. The plan is
to increase core deposits sufficiently to reduce the dependence on brokered and
Internet deposits.
BORROWINGS
The Corporation has used alternative funding sources to provide long-term,
stable sources of funds. Total borrowings have remained the same from December
31, 2002 to March 31, 2003, at $87.8 million of which $86.2 million of the total
borrowings were from the Federal Home Loan Bank of Indianapolis (FHLB). The FHLB
borrowings carry fixed interest rates and stated maturities ranging through
2011. Fixed rate borrowings totaling $80 million are callable quarterly at the
option of the FHLB and can also be converted to variable rates, at the option of
the FHLB, should rates rise above certain index levels. These borrowings are
secured by a blanket collateral agreement on the Bank's residential mortgage
loans and specific assignment of other assets. Based on the Corporation's
available collateral, management does not anticipate increasing the FHLB
borrowings in the near future.
GUARANTEED PREFERRED BENEFICIAL INTERESTS IN THE CORPORATION'S SUBORDINATED
DEBENTURES
In 1999, the Corporation completed a private offering of capital, or trust
preferred, securities in the amount of $12,450,000. Under regulatory guidelines,
guaranteed preferred beneficial interests in the Corporation's subordinated
debentures are eligible as regulatory capital, as defined, subject to certain
limitations. Due to the present financial condition in the current quarter, the
Board of Directors adopted a resolution to apply for the deferment of interest
payments on the Trust Preferred securities. The trust document allows for a
deferral of interest payments for up to 20 quarters. Management has deferred the
quarterly payments beginning with the November 14, 2002, payment and it is
expected that interest will continue to be deferred until the Board of Directors
believes it is prudent to resume payments.
SHAREHOLDERS' EQUITY
Total shareholders' equity decreased $1.6 million from December 31, 2002 to
March 31, 2003. The decrease is comprised of a net loss of $1.5 million and a
decrease in the net unrealized gain on securities of $102,000. The Board of
Directors does not anticipate declaring any dividends in the near future. The
declaration of dividends is contingent on a variety of factors to include
satisfaction of requirements in the Order.
RESULTS OF OPERATIONS
NET INTEREST INCOME
Net interest income before provision for loan losses for the quarter ended March
31, 2003, decreased by $1.9 million, or 38.6% compared to the same period one
year ago. The decrease in loan volume offset by the decrease in deposit volume
during the past twelve months, combined with increases in nonaccrual loans, and
a continued decline in prevailing market rates, have resulted in the decline in
net interest income. Loan and deposit balances and margins have declined for
the past six quarters. If the decline in deposits continues and if that decline
continues to be funded with a decline in loans as anticipated by management,
then management anticipates margins will continue to decline in both dollars
and as a percent of assets.
16
NORTH COUNTRY FINANCIAL CORPORATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS
AND RESULTS OF OPERATIONS (Continued)
PROVISION FOR LOAN LOSSES
The Corporation records a provision for loan losses at a level it believes is
necessary to maintain the allowance at an adequate level after considering
factors such as loan charge-offs and recoveries, changes in the mix of loans in
the portfolio, loan growth, and other economic factors. The provision for loan
losses decreased by $50,000 for the quarter ended March 31, 2003, compared to
the same period in 2002. Management continues to monitor the loan portfolio for
changes which may impact the required allowance for loan losses. Additional
provisions for loan losses are possible.
OTHER INCOME
Other income decreased by $169,000 for the quarter ended March 31, 2003,
compared to the quarter ended March 31, 2002. In spite of the decline in
deposits, service charge revenue increased $29,000 due to the implementation of
new service charges during the second quarter of 2002. The decreases in loan and
lease income are the result of a $85,000 decline in mortgage subsidiary fee
income and a $150,000 decline in leasing subsidiary fee income. The decline in
mortgage subsidiary activity also caused net gains on the sale of loans to
decline by $133,000.
OTHER EXPENSES
Other expenses increased $327,000 for the quarter ended March 31, 2003, compared
to the same period of 2002. Salaries, commissions, and related benefits
decreased by $323,000 during the first quarter of 2003 compared to the first
quarter of 2002. This decrease was offset by an increase in professional
services expenses of $526,000 during the first quarter of 2003 and an increase
in loan collection expense of $265,000. The Corporation is taking action to
reduce its reliance on external (and more costly) collection resources.
FEDERAL INCOME TAXES
The income tax provision of $320,000 is the result of an addition to the
valuation allowance provided against the deferred tax asset. This provision
increases the valuation allowance to $7.3 million at March 31, 2003, from $7
million at December 31, 2002. The Corporation's current year net losses are
currently anticipated to more likely than not expire prior to their utilization;
therefore, no tax credit is being recorded in anticipation of a future tax
benefit from the use of loss carryovers.
LIQUIDITY
As a result of the Corporation's 2002 annual and first quarter 2003 results,
sources of liquidity, such as lines of credit from correspondent banks,
borrowings from the Federal Home Loan Bank, and the issuance of stock, which
were historically available, are currently not short-term sources of liquidity.
The liquidity issues faced, the Corporation's actions taken to address them, and
the liquidity plan for 2003 are discussed below.
During the first quarter of 2003, the Corporation increased cash and cash
equivalents by $5.0 million. As shown on the Corporation's condensed
consolidated statement of cash flows, despite the net loss of $1.5 million in
the first quarter of 2003, the Corporation was able to generate $233,000 of cash
from operations, due to the noncash expenses such as the depreciation and
amortization of $578,000 and the change in other assets and liabilities. Other
significant factors impacting cash flow were the $39.8 million of cash received
from the decrease in loans and $5.2 million in proceeds from sales and
maturities of securities. These cash inflows were partially offset by the $42.3
million of cash used due to the decrease in deposits.
It is anticipated that during the remainder of 2003, cash generated from
decreases in certain segments of the loan portfolio will be reinvested in
securities and local market loans, and deposits generated locally will replace a
portion of the Internet and brokered deposits.
17
NORTH COUNTRY FINANCIAL CORPORATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS
AND RESULTS OF OPERATIONS (Continued)
As of March 31, 2003, the Corporation has suspended two quarterly payments of
interest on its subordinated debentures that fund quarterly distributions on the
trust preferred securities issued by its trust subsidiary, North Country Capital
Trust. The debenture agreement allows for suspension of payments for up to 20
quarterly payments.
The Corporation's liquidity plan for 2003 includes strategies to increase core
deposits in the Corporation's local markets. New products and advertising
commenced in 2003, with a goal of increasing core deposits to reduce the
dependency on noncore deposits. The Corporation's liquidity plan for 2003 calls
for augmenting local deposit growth efforts with Internet CD funding to the
extent necessary. There is no assurance that Internet CDs will be available in
adequate amounts or at economically feasible pricing.
The 2003 plan is expected to include the possible sale of certain segments of
the loan portfolio to maintain certain loan to asset and loan to deposit ratios
as well as to reduce the concentration of loans in particular industries, such
as hospitality and gaming.
During the fourth quarter of 2002, the unsecured lines of credit the Corporation
had with two correspondent banks were closed by those banks. In the first
quarter of 2003, the Corporation established a secondary borrowing arrangement
collateralized by loans.
CAPITAL AND REGULATORY
During the first quarter of 2003, capital decreased by $1.6 million, as a result
of the net loss of $1.5 million and the decrease in the unrealized gain on
securities available for sale of $102,000. This compares to a decrease in
capital during the same period in the previous year of $273,000, resulting
primarily from net income, changes in the unrealized gain on securities
available for sale, and dividends declared for the first quarter in 2002.
As a bank holding company, the Corporation is required to maintain certain
levels of capital under government regulation. There are several measurements of
regulatory capital and the Corporation is required to meet minimum requirements
under each measurement. The federal banking regulators have also established
capital classifications beyond the minimum requirements in order to risk-rate
deposit insurance premiums and to provide trigger points for prompt corrective
action in the event an institution becomes financially troubled. As of March 31,
2003, the Corporation, and as of December 31, 2002, the Corporation and the
Bank, were undercapitalized. See discussions on the following pages of the
regulatory requirements and the Corporation's plans for increasing its capital
ratios.
Regulatory capital is not the same as shareholders' equity reported in the
accompanying condensed consolidated financial statements. Certain assets cannot
be considered assets for regulatory purposes. The Corporation's acquisition
intangibles and a portion of the deferred tax asset are examples of such assets.
Presented below is a summary of the capital position in comparison to generally
applicable regulatory requirements:
Tier I Tier I Total
Capital to Capital to Capital to
Average Risk-Weighted Risk-Weighted
Assets Assets Assets
----------- -------------- ---------------
Regulatory minimum for capital adequacy purposes 4.0% 4.0% 8.0%
The Corporation:
March 31, 2003 3.8% 5.2% 8.4%
December 31, 2002 3.8% 5.3% 8.3%
The Bank:
March 31, 2003 5.1% 7.0% 8.3%
December 31, 2002 4.8% 6.6% 7.9%
18
NORTH COUNTRY FINANCIAL CORPORATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS
AND RESULTS OF OPERATIONS (Continued)
The capital levels include adjustment for the capital, or trust preferred
securities, issued in May 1999, subject to certain limitations. Federal Reserve
guidelines limit the amount of trust preferred securities which can be included
in Tier I capital to 25% of total Tier I capital. As of March 31, 2003 and
December 31, 2002, $5,128,000 and $5,706,000, respectively, of the $12,450,000
of capital securities were available as Tier I capital of the Corporation.
In September 2002, a regularly-scheduled safety and soundness examination of the
Bank was conducted by its principal regulators, the Michigan Office of Financial
and Insurance Services (OFIS) and the FDIC. During the course of that
examination, the FDIC, the OFIS, and the Federal Reserve Bank of Chicago (FRB)
requested that the Corporation and the Bank take certain actions, including
suspending the payment of dividends and conserving the liquidity of the
Corporation.
In response to the concerns expressed by the regulators, the Board of Directors
of the Corporation and the Bank adopted resolutions providing for prior
regulatory approval of the declaration or payment of any dividend by the
Corporation or the Bank, and suspension of interest payments by the Corporation
in connection with its trust preferred securities.
The agreements relating to the trust preferred securities allow for the
suspension of payments for up to 20 quarters. Therefore, the suspension of the
interest payments does not violate the agreement. However, while interest
payments are suspended, no dividends can be paid on the Corporation's common
stock, and certain other restrictions apply.
Following the completion of the regularly-scheduled safety and soundness
examination of the Bank by the FDIC and the OFIS, and the Bank's receipt of the
related Joint Report of Examination ("Report"), the FDIC and the OFIS, with the
consent of the Bank, on March 26, 2003, entered a formal Cease and Desist Order
(the "Order") under federal and state banking laws. The Order became effective
on April 5, 2003, and will remain in effect until modified or terminated by
action of the FDIC and the OFIS. The Order identifies deficiencies in the Bank's
policies and procedures for safe and sound operation, including its directorate
and management personnel and practices, credit underwriting, credit
administration, and policies regarding asset/liability management, liquidity,
funds management and investments, and its compliance with all applicable laws
and regulations, including Regulations O and U of the Board of Governors of the
Federal Reserve System (the "Board"), the FDIC Rules and Regulations, and the
Michigan Banking Code of 1999. The Order also requires the Bank to maintain
specified capital ratios during the life of the Order.
The Order further requires the Bank and its directors to take the following
specific steps, again within time periods specified in the Order. For the
calendar quarters ending March 31, 2003, and June 30, 2003, the Bank must have a
ratio of Tier 1 capital to total assets ("Tier 1 Capital Ratio") equal to at
least 6.4%. Commencing with the calendar quarter ending September 30, 2003, and
for each calendar quarter thereafter, the Bank must have a Tier 1 Capital Ratio
equal to at least 8.0%. If the Bank's Tier 1 Capital Ratio is below the required
percentage for any such quarter, the Bank must take steps to bring its Tier 1
Capital Ratio to the required level within 60 days. The Order also requires the
Bank to maintain its total risk-based capital ratio at 10.0% or greater for each
calendar quarter ending after the effective date of the Order. If the Bank's
total risk-based capital ratio for any such quarter is less than 10.0%, the Bank
must take steps to bring its total risk-based capital ratio to the required
level within 60 days.
As of March 31, 2003, the Bank's capital ratios do not meet the minimum
requirements of the Order. Following is a summary of the strategies which
management plans to enact in order to restore the Bank's capital to the levels
required by the Order.
The Corporation plans to sell certain branches to reduce the size of the Bank.
In conjunction with the sale of the branches, the Bank plans to sell a select
portion of its loan portfolio. It is anticipated that the cash received from the
sale of the loans will provide the necessary liquidity to fund the branch sales.
The contemplated sales of the branches and loans will require prior regulatory
approval, and may require approval by holders of the trust preferred securities.
19
NORTH COUNTRY FINANCIAL CORPORATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS
AND RESULTS OF OPERATIONS (Continued)
The above sales are anticipated to be inadequate to reduce the overall size of
the Bank, based on current capital levels, to achieve the required regulatory
capital ratios. Therefore, the Corporation is anticipating additional capital
will need to be raised to attain the 8% Tier 1 Capital Ratio.
The Corporation is exploring a possible capital infusion from an outside
investor which might also include an opportunity for existing shareholders to
participate. If no outside investor is found, the Corporation will consider
other alternatives for raising additional capital. Among the options that the
Corporation could consider would be a rights offering for existing shareholders.
It is likely that any new stock issuance could be at a price below the
Corporation's current book value, resulting in a dilution of the existing
shareholders' ownership interests.
Noncompliance with the minimum capital requirements of the Order may impact the
ability of the Corporation and the Bank to remain as ongoing operating entities.
Recruiting firms are being utilized in an effort to attract additional skilled
and experienced banking professionals to augment the senior management team,
which will be able to address the regulatory issues facing the Corporation. By
strengthening the infrastructure of the Corporation, management would be able to
place more emphasis on addressing problem loans, financial matters, and moving
forward with and enacting the daily strategies of the Corporation. In the
future, this would decrease the dependence on outsourced services, which in turn
would decrease expenses associated with these services. The expense reduction
and improvement in the loan portfolio would be significant steps toward
returning the Corporation to profitability, which would further improve the
capital ratios.
The Order imposes specific prohibitions and limitations on the Bank and its
directors regarding certain matters. Without the prior approval of the FDIC and
the OFIS, the Bank may not (i) enter into any material transaction that is not
in the ordinary course of business (including any material acquisition or
disposition of assets), (ii) declare or pay any cash dividend, (iii) extend any
credit, directly or indirectly, to any borrower obligated to the Bank on any
credit which has been charged off or classified loss by bank examiners so long
as such credit remains uncollected, or (iv) authorize any "golden parachute"
payment to any person, within the meaning of the applicable FDIC regulation. In
addition, the Bank is required to notify the FDIC and the OFIS in writing of any
change in the Bank's directors or senior executive officers, and to obtain the
prior approval of the OFIS of the addition of any person as a director or senior
executive officer of the Bank. The Bank is also prohibited from permitting its
Chairman and director, Ronald G. Ford, from negotiating or making any loan,
overdraft, or extension of credit, serving as a member of the Bank's loan
committee, or participating in credit underwriting, other than voting as a
director on matters presented to the Board of Directors.
The Order requires the Bank and its directors to take specific steps, within
time periods specified in the Order, to address the operational deficiencies,
including certain violations of law and regulations, identified by the FDIC and
the OFIS in the Order and the Report. Among other things, the Bank must
establish, and submit to the FDIC and the OFIS for comment, written plans (i) to
reduce the Bank's risk position with respect to certain classified loans
identified in the Report or any subsequent Report of Examination during the life
of the Order, (ii) to reduce identified concentrations of loans to one industry
in excess of 100% of the Bank's Tier 1 capital, (iii) to reduce and collect
delinquent loans, (iv) to eliminate the classified amounts of loans to
directors, executive officers, principal shareholders of the Bank and their
respective related interests, (v) to address the Bank's relationship of volatile
liabilities to temporary investments, rate sensitivity objectives, and
asset/liability management, (vi) setting forth the Bank's strategic plan,
including financial goals and strategies to maintain adequate capital and
liquidity, to reduce problem loans, and to attract and keep qualified
management, (vii) covering the policies and procedures for review and approval
of reimbursement of customer entertainment and business development expenses of
the Bank's directors, officers and employees, (viii) for a realistic budget for
calendar year 2003 and each subsequent year during the life of the Order,
including strategies to improve the Bank's net interest margin, (ix) to reduce
the Bank's portfolio of other real estate owned as a result of foreclosure or
surrender of collateral for loans, and (x) to address procedures for the
directors to monitor, and management to implement, the requirements of the
Order.
20
NORTH COUNTRY FINANCIAL CORPORATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS
AND RESULTS OF OPERATIONS (Continued)
Further actions the Bank must take within periods specified in the Order include
correcting all deficiencies noted in the Report with respect to certain
categories of loans, and all technical exceptions and all violations of law
noted in the Report. The Bank's loan committee, which must include at least
three outside directors who are independent of management and any principal
shareholder, is required to meet at least monthly, and to act with respect to
specified categories of loans and loan applications, including all such
applications involving directors and executive officers of the Bank and their
respective related interests. The Bank's Board of Directors is required to
review and revise the Bank's written loan policy, to submit the revised policy
to the FDIC and OFIS for review and comment, and to conduct an annual review of
the policy. The Bank's Board of Directors is also required to review and revise
the Bank's investment policy, and to submit the revised policy for comment to
the FDIC and the OFIS. The Order mandates the Bank's Board of Directors (i) to
adopt resolutions acknowledging the Bank's designation as a troubled institution
by the FDIC, (ii) to review all agreements for the provision of goods and
services between the Bank and any of its current or former directors, officers,
or employees, and their respective related interests, and to determine whether
such agreements remain in the best interest of the Bank, and (iii) to seek
restitution from Ronald G. Ford of all amounts paid by the Bank pursuant to the
Chairman Agreement entered into as of April 12, 2002, between Mr. Ford and the
Corporation. The Order also requires the Bank to submit to the FDIC and the OFIS
written reports regarding its progress under the Order, signed by each director
of the Bank, every three months following the effective date of the Order.
If the Bank fails or is unable to timely comply with the Order, there could be
material adverse effects on the Bank and the Corporation. Since the entry of the
Order, the Corporation has determined that the Bank was not in compliance with
the minimum capital ratios specified in the Order for the calendar quarter ended
March 31, 2003. There can be no assurance that the Corporation can take steps
in the time limits prescribed by the Order to restore the Bank's capital ratios
to the required levels.
The Corporation and the Bank have been addressing the requirements of the Order
as the Board of Directors and management believe it is in the best interests for
the long-term financial health of the Corporation to address the issues
promptly.
The Order requires development of a comprehensive strategic plan, financial
plan, and profit plan. The development of these plans will provide the Board of
Directors and management with a road map to strengthen the Corporation in many
areas, reduce risk, improve liquidity, and return the Corporation to
profitability. By implementing these strategic plans, improved policies and
resolution of nonperforming assets, the Corporation believes it can more
effectively serve its customers, grow in its markets, return to profitability,
and increase shareholder value.
Addressing the requirements of the Order, carrying out the objectives of the
strategic plan, and returning the Corporation to profitability will require the
strengthening of the executive management team. The Corporation will be seeking
to add management with experience in turnaround situations, loan portfolio,
credit and problem loan administration, and financial management expertise
commensurate with the issues the Corporation must address. The addition of
management may increase expense in the short term. However, the additional
management expertise is expected to help the Corporation resolve many of its
issues more quickly, and improve customer service and financial performance.
The Board of Directors is further required to address the overall
asset/liability management practices of the Bank, interest rate risk management,
and liquidity management. Strengthening the Bank's policies, risk limits, and
procedures in these areas should increase overall liquidity and consistency of
income through interest rate cycles and reduce risk to capital.
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NORTH COUNTRY FINANCIAL CORPORATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS
AND RESULTS OF OPERATIONS (Continued)
SUBSEQUENT EVENTS
Subsequent to the end of the quarter, the Bank has applied for closure of four
of its twenty-six branch locations. If approved by the regulators, these
locations will be closed September 7, 2003. Subsequent to the end of the
quarter, the Bank sold the Newberry administrative office building.
22
NORTH COUNTRY FINANCIAL CORPORATION
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
INTEREST RATE RISK
In general, the Corporation attempts to manage interest rate risk by investing
in a variety of assets which afford it an opportunity to reprice assets and
increase interest income at a rate equal to or greater than the interest expense
associated with repricing liabilities.
Interest rate risk is the exposure of the Corporation to adverse movements in
interest rates. The Corporation derives its income primarily from the excess of
interest collected on its interest-earning assets over the interest paid on its
interest-bearing obligations. The rates of interest the Corporation earns on its
assets and owes on its obligations generally are established contractually for a
period of time. Since market interest rates change over time, the Corporation is
exposed to lower profitability if it cannot adapt to interest rate changes.
Accepting interest rate risk can be an important source of profitability and
shareholder value; however, excess levels of interest rate risk could pose a
significant threat to the Corporation's earnings and capital base. Accordingly,
effective risk management that maintains interest rate risk at prudent levels is
essential to the Corporation's safety and soundness.
Loans are the most significant earning asset. Management offers commercial and
real estate loans priced at interest rates which fluctuate with various indices
such as the prime rate or rates paid on various government issued securities. In
addition the Corporation prices loans so it has an opportunity to reprice the
loan within 12 to 36 months.
The Corporation also has $62.4 million of securities, of which $48.5 million are
mortgage-backed securities providing for scheduled monthly principal and
interest payments as well as unanticipated prepayments of principal. These cash
flows are then reinvested into other earning assets at current market rates.
The Corporation also has federal funds sold to correspondent banks as well as
other interest-bearing deposits with correspondent banks. These funds are
generally repriced on a daily basis.
The Corporation offers deposit products with a variety of terms ranging from
deposits whose interest rates can change on a weekly basis to certificates of
deposit with repricing terms of up to five years.
Beyond general efforts to shorten the loan pricing periods and extend deposit
maturities, management can manage interest rate risk by the maturity periods of
securities purchased, selling securities available for sale, and borrowing funds
with targeted maturity periods, among other strategies. Also, the rate of
interest rate changes can impact the actions taken since the speed of change
affects borrowers and depositors differently.
Exposure to interest rate risk is reviewed on a regular basis. Interest rate
risk is the potential of economic losses due to future interest rate changes.
These economic losses can be reflected as a loss of future net interest income
and/or a loss of current fair market values. The objective is to measure the
effect of interest rate changes on net interest income and to structure the
composition of the balance sheet to minimize interest rate risk and at the same
time maximize income. Management realizes certain risks are inherent and that
the goal is to identify and minimize the risks. Tools used by management include
maturity and repricing analysis and interest rate sensitivity analysis.
The difference between repricing assets and liabilities for a specific period is
referred to as the gap. An excess of repricable assets over liabilities is
referred to as a positive gap. An excess of repricable liabilities over assets
is referred to as a negative gap. The cumulative gap is the summation of the gap
for all periods to the end of the period for which the cumulative gap is being
measured.
Assets and liabilities scheduled to reprice are reported in the following time
frames. Those instruments with a variable interest rate tied to an index and
considered immediately repricable are reported in the 1- to 90-day time frame.
The estimates of principal amortization and prepayments are assigned to the
following time frames.
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NORTH COUNTRY FINANCIAL CORPORATION
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK (Continued)
The following is the Corporation's repricing opportunities at March 31, 2003
(dollars in thousands):
1 - 90 91 - 365 2 - 5 Over 5
Days Days Years Years Total
---- ---- ----- ----- -----
Interest-earning assets:
Loans $ 208,028 $ 62,336 $ 68,221 $ 52,983 $ 391,568
Securities 1,486 4,275 21,550 35,080 62,391
Other 42,091 -0- -0- -0- 42,091
----------- ------------ ------------ ----------- ----------
Total interest-earning assets 251,605 66,611 89,771 88,063 496,050
----------- ----------- ----------- ----------- ----------
Interest-bearing obligations:
Savings deposits 154,381 -0- -0- -0- 154,381
Time deposits 38,246 120,082 47,840 773 206,941
Borrowings 331 391 5,476 81,617 87,815
Subordinated debentures 12,450 -0- -0- -0- 12,450
----------- ------------ ------------ ----------- ----------
Total interest-bearing obligations 205,408 120,473 53,316 82,390 461,587
----------- ----------- ----------- ----------- ---------
Gap $ 46,197 $ (53,862) $ 36,455 $ 5,673 $ 34,463
=========== =========== =========== =========== ==========
Cumulative gap $ 46,197 $ (7,665) $ 28,790 $ 34,463 $ 34,463
=========== =========== =========== =========== ==========
The above analysis indicates that at March 31, 2003, the Corporation had a
cumulative liability sensitivity gap position of $7.7 million within the
one-year time frame. The Corporation's cumulative liability sensitive gap
suggests that if market interest rates increase in the next twelve months, the
Corporation's net interest income could be reduced. Conversely, if market
interest rates continue to decrease over the next twelve months, the above GAP
position suggests the Corporation's net interest income would increase.
At December 31, 2002, the Corporation had a cumulative asset sensitivity gap
position of $20.1 million within the one-year time frame. The Corporation's
cumulative asset sensitive gap suggested that if market interest rates increased
in the next twelve months, the Corporation had the potential to earn more net
interest income. Conversely, if market interest rates continued to decrease over
a twelve-month period, the December 31, 2002, gap position suggested the
Corporation's net interest income would decrease.
The change in the gap position from December 31, 2002 to March 31, 2003, is a
result of the decreases experienced in the loans and deposits with a greater
dollar amount of the loan portfolio reductions in the one-year time frame than
the deposit reductions. A limitation of the traditional gap analysis is that it
does not consider the timing or magnitude of noncontractual repricing or
expected prepayments. In addition, the gap analysis treats savings, NOW, and
money market accounts as repricing within 90 days, while experience suggests
that these categories of deposits are actually comparatively resistant to rate
sensitivity.
The borrowings in the gap analysis include FHLB advances as fixed-rate advances.
A significant portion of these advances give the FHLB the option to convert from
a fixed-rate advance to an adjustable rate advance with quarterly repricing at
three-month LIBOR Flat. The exercise of this conversion feature by the FHLB
would impact the repricing dates currently assumed in the analysis.
The Corporation's primary market risk exposure is interest rate risk and, to a
lesser extent, liquidity risk and foreign exchange risk. The Corporation has no
market risk sensitive instruments held for trading purposes. The Corporation has
limited agricultural-related loan assets and therefore has minimal significant
exposure to changes in commodity prices. Any impact that changes in foreign
exchange rates and commodity prices would have on interest rates are assumed to
be insignificant.
24
NORTH COUNTRY FINANCIAL CORPORATION
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK (Continued)
Evaluating the exposure to changes in interest rates includes assessing both the
adequacy of the process used to control interest rate risk and the quantitative
level of exposure. The Corporation's interest rate risk management process seeks
to ensure that appropriate policies, procedures, management information systems,
and internal controls are in place to maintain interest rate risk at prudent
levels with consistency and continuity. In evaluating the quantitative level of
interest rate risk, the Corporation assesses the existing and potential future
effects of changes in interest rates on its financial condition, including
capital adequacy, earnings, liquidity, and asset quality.
In addition to changes in interest rates, the level of future net interest
income is also dependent on a number of variables, including: the growth,
composition and levels of loans, deposits, and other earning assets and
interest-bearing obligations, and economic and competitive conditions; potential
changes in lending, investing, and deposit strategies; customer preferences; and
other factors.
FOREIGN EXCHANGE RISK
In addition to managing interest rate risk, management also actively manages
risk associated with foreign exchange. The Corporation provides foreign exchange
services, makes loans to, and accepts deposits from, Canadian customers
primarily at its banking offices in Sault Ste. Marie. To protect against foreign
exchange risk, the Corporation monitors the volume of Canadian deposits it takes
in and then invests these Canadian funds in Canadian commercial loans and
securities. As of March 31, 2003, the Corporation had excess Canadian assets of
$4.6 million (or $3.1 million in U.S. dollars). Management believes the exposure
to short-term foreign exchange risk is minimal and at an acceptable level for
the Corporation.
OFF-BALANCE-SHEET RISK
Derivative financial instruments include futures, forwards, interest rate swaps,
option contracts and other financial instruments with similar characteristics.
The Corporation currently does not enter into futures, forwards, swaps or
options. However, the Corporation is party to financial instruments with
off-balance-sheet risk in the normal course of business to meet the financing
needs of its customers. These financial instruments include commitments to
extend credit and standby letters of credit and involve to varying degrees,
elements of credit and interest rate risk in excess of the amount recognized in
the condensed consolidated balance sheets. 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 and may require collateral from the borrower if deemed
necessary by the Corporation. Standby letters of credit are conditional
commitments issued by the Corporation to guarantee the performance of a customer
to a third party up to a stipulated amount and with specified terms and
conditions.
Commitments to extend credit and standby letters of credit are not recorded as
an asset or liability by the Corporation until the instrument is exercised.
IMPACT OF INFLATION AND CHANGING PRICES
The accompanying condensed consolidated financial statements have been prepared
in accordance with generally accepted accounting principles, which require the
measurement of financial position and results of operations in historical
dollars without considering the change in the relative purchasing power of money
over time due to inflation. The impact of inflation is reflected in the
increased cost of the Corporation's operations. Nearly all the assets and
liabilities of the Corporation are financial, unlike industrial or commercial
companies. As a result, the Corporation's performance is directly impacted by
changes in interest rates, which are indirectly influenced by inflationary
expectations. The Corporation's ability to match the interest sensitivity of its
financial assets to the interest sensitivity of its financial liabilities tends
to minimize the effect of changes in interest rates on the Corporation's
performance. Changes in interest rates do not necessarily move to the same
extent as changes in the price of goods and services.
25
NORTH COUNTRY FINANCIAL CORPORATION
ITEM 4. CONTROLS AND PROCEDURES
As of April 8, 2003, an evaluation was performed under the supervision of and
with the participation of the Corporation's management, including the President
and Chief Executive Officer, of the effectiveness of the design and operation of
the Corporation's disclosure controls and procedures. Based on that evaluation,
the Corporation's management, including the President and Chief Executive
Officer, concluded that the Corporation's disclosure controls and procedures
were effective as of April 8, 2003. There have been no significant changes in
the Corporation's internal controls or in other factors that could significantly
affect internal controls subsequent to April 8, 2003.
26
NORTH COUNTRY FINANCIAL CORPORATION
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
As the date hereof, except for the Order referred to below, there were no
material pending legal proceedings, other than routine litigation incidental to
the business of banking to which the Corporation or any of its subsidiaries is a
party or of which any of its properties is the subject. Information pertaining
to the Order is contained in "Management's Discussion and Analysis of Financial
Condition and Results of Operations" under the caption "Capital and Regulatory"
on this Form 10-Q, and is incorporated here by reference.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
Exhibit 3.1 Articles of Incorporation, as amended, incorporated herein by
reference to exhibit 3.1 of the Corporation's Quarterly
Report on Form 10-Q for the quarter ended September 30, 1999.
Exhibit 3.2 Amended and Restated Bylaws, incorporated herein by reference
to exhibit 3.1 of the Corporation's Quarterly Report on Form
10-Q for the quarter ended September 30, 2001.
Exhibit 99.1 Certification of Chief Executive Officer Pursuant to 18
U.S.C. Section 1350.
(b) The following Form 8-K filings occurred subsequent to December 31, 2002:
- Form 8-K dated April 5, 2003, disclosure of the Order to Cease and
Desist entered by the Federal Deposit Insurance Corporation and the
Michigan Office of Financial and Insurance Services, with the consent of
the Bank.
- Form 8-K dated April 21, 2003, disclosure of the employment of Mr.
Robert Taylor as Executive Vice President - Chief Financial Officer.
27
NORTH COUNTRY FINANCIAL CORPORATION
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
NORTH COUNTRY FINANCIAL CORPORATION
-----------------------------------
(Registrant)
5/14/03 By: /s/ Sherry L. Littlejohn
- --------- ------------------------------------------------
Date SHERRY L. LITTLEJOHN,
PRESIDENT AND CHIEF EXECUTIVE OFFICER
(principal executive and financial officer)
28
NORTH COUNTRY FINANCIAL CORPORATION
CERTIFICATION
I, Sherry L. Littlejohn, President and Chief Executive Officer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of North Country
Financial Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations, and cash
flows of the registrant as of and for the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report
is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize, and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
5/14/03 /s/Sherry L. Littlejohn
- --------- -------------------------------------------------
Date SHERRY L. LITTLEJOHN,
PRESIDENT AND CHIEF EXECUTIVE OFFICER
(principal executive and financial officer)
29
10-Q EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION
EX-99.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002